Franklin Electric - Q1 2016
May 2, 2016
Transcript
Operator (participant)
Good day, ladies and gentlemen, and welcome to the Franklin Electric Company's Q1 2016 earnings conference call. At this time, all participant lines are in a listen-only mode to reduce background noise, but later we will be conducting a question-and-answer session, and instructions will follow at that time. If anyone should require operator assistance during the program today, you may dial star then zero on your keypad in order to speak with an operator. As a reminder, today's conference call is being recorded. I would now like to introduce your first speaker for today, Jeff Reppert, Treasurer. You have the floor, sir.
Jeff Reppert (Treasurer)
Thank you, Andrew, and welcome everyone to Franklin Electric's Q1 2016 earnings conference call. With me today are Gregg Sengstack, our CEO, Robert J. Stone, Senior Vice President and President of our International Water Systems unit, and John J. Haines, our CFO. On today's call, Gregg will review our Q1 business results, and then John will review our Q1 financial results. When John is through, we will 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.
The 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. During this call, we will also discuss certain non-GAAP financial measures, which the company believes helps investors understand underlying trends in the company's business more easily. A full reconciliation from non-GAAP to GAAP financial measures is included in today's earnings release, which you can find on Franklin Electric's website. With that, I will now turn the call over to our CEO, Gregg Sengstack.
Gregg Sengstack (CEO)
Thank you, Jeff. Our company delivered solid results in the Q1, led by the improved profitability of our US Water business and record performance in our Fueling Systems business. Excluding the impact of foreign exchange, we achieved 3% organic growth in the Q1 of 2016, growing both our Water and Fueling Systems segments. Adjusted operating income increased 33% as we realized the continuing benefits of improved cost, sales mix, and pricing. The performance of our Water Systems business continues to improve. After non-GAAP adjustments, Water Systems operating income increased 25% on a reported 6% sales decline. Water Systems operating margins increased 200 basis points sequentially and increased 360 basis points compared to the Q1 of 2015.
Our Fueling Systems business had our record Q1, with operating income increasing 8% on a 7% increase in sales. Our adjusted earnings per share declined 9% as compared to the Q1 of 2015. You may recall we had transactions in the Q1 of 2015 that generated significant below-the-line benefit on the tax line, all related to purchase accounting. John will give more details on that in a minute. Turning to end markets, our U.S. groundwater business showed signs of recovery during the quarter. The year-over-year revenue decline in agricultural pumping system sales was about 5%, compared to the 20%+ decline experienced in the last half of last year. Our overall revenue from groundwater system sales was up year-over-year. Our surface pumping business was weak in two regions.
Our Canadian business was impacted by the dramatic swing in the value of the Canadian dollar over the quarter, and our retail sump pump business was soft due to the mild winter in the Upper Midwest. Overall, our water business in the U.S. and Canada was flat compared to last year. Outside the U.S. and Canada, business was uneven but overall positive. Excluding the impact of foreign translation, we again saw organic growth. Weakness in Southern Africa and Latin America due to the weak mining sector and Brazilian economy, respectively, was more than offset by strong results in our businesses in Asia, Europe, and Turkey. Around the globe, we continue to grow our business with the introduction of new products and product line extensions.
In our Fueling Systems business, excluding the 1% headwind from foreign currency translation, our business grew 8% organically, both in the U.S. and internationally. Domestically, the continued decline in vapor recovery system sales due to decommissioning was more than offset by double-digit growth in pumping systems, site containment systems, and fuel management systems. Outside the U.S., business was solid around the world, with strong results in India offsetting continued weakness in tank sales for North Sea oil production. Here again, double-digit growth in pumping and fuel management systems offset weak vapor recovery system sales. We expect vapor recovery equipment sales to improve in the back half of the year. Looking forward, as we outlined last quarter, we continue to be challenged with an exchange rate headwind. However, global currencies have strengthened over the last quarter relative to the US dollar.
Considering this factor in our Q1 results, we are raising our full-year 2016 earnings guidance to a range of $1.60-$1.70 per share. I will now turn the call over to John J. Haines, our CFO.
John Haines (CFO)
Thank you, Greg. Our fully diluted earnings per share reported were $0.28 for the Q1 of 2016 versus $0.41 for the Q1 of 2015. As we note in the table in the earnings release, the company adjusts the as-reported GAAP operating income and earnings per share for items we consider not operational in nature. Non-GAAP expenses for the Q1 of 2016 were $1.1 million and included $800,000 in restructuring costs and $300,000 of expenses related to retired executive pension costs. The Q1 of 2016 non-GAAP adjustments had a net EPS impact that reduced earnings by $0.01.
Non-GAAP expenses for the Q1 of 2015 were $800,000 and included $500,000 in restructuring costs, primarily for the European manufacturing realignment, and $300,000 of other non-GAAP expenses related to retired executive pension costs. The company redeemed the minority shareholding of Pioneer during the Q1 of 2015. This transaction created multiple accretive benefits for the company, a portion of which were called out as non-GAAP and a portion that were not. In last year's Q1, a tax benefit resulting from the Pioneer purchase of about $4.8 million was treated as a non-GAAP adjustment. I will discuss additional income statement impacts of last year's Pioneer transaction in a few moments. In total, the Q1 of 2015 non-GAAP adjustments had the effect of lowering the EPS by $0.09.
So after consideration of the non-GAAP items, Q1 2016 adjusted earnings per share is $0.29 versus the Q1 of 2015 adjusted earnings per share of $0.32, a decline of about 9%. It is worth noting that the company estimates the Q1 2016 adjusted earnings per share was negatively impacted by $0.03 due to the translation impacts alone of foreign exchange. As Greg noted, global currencies have strengthened over the last quarter relative to the US dollar. However, we still had year-over-year deterioration versus the US dollar in many key currencies which we do business in when compared to the Q1 of 2015. This deterioration causes the earnings of these units to be translated back to fewer US dollars.
Water Systems sales were $168.8 million in the Q1 of 2016, a decrease of $10.4 million or about 6% versus the Q1 of 2015 sales of $179.2 million. Foreign currency translation reduced Water Systems sales by $13.3 million, or about 7% in the quarter. Excluding foreign currency translation, Water Systems sales grew about 1% compared to the Q1 of 2015. Water Systems operating income after non-GAAP adjustments was $24.6 million in the Q1 of 2016, up $4.9 million, or 25%, versus the Q1 of 2015.
The Q1 operating income margin after non-GAAP adjustments was 14.6%, up 360 basis points from 11% in the Q1 of 2015. Fueling system sales were $49.6 million in the Q1 of 2016, an increase of $3.1 million, or about 7%, versus the Q1 of 2015 sales of $46.5 million. Fueling system sales decreased by $0.5 million, or about 1% in the quarter, due to foreign currency translation. Fueling system sales were up about 8% after excluding foreign currency translation. Fueling systems operating income after non-GAAP adjustments was $10.6 million in the Q1 of 2016, compared to $9.8 million after non-GAAP adjustments in the Q1 of 2015, an increase of about 8%.
The Q1 operating income margin after non-GAAP adjustments was 21.4%, an increase of 30 basis points from 21.1% of net sales in the Q1 of 2015. As Greg said, Fueling System sales and adjusted operating income in the Q1 of 2016 were a record for any Q1 in the history of the segment. The company's consolidated gross profit was $74.2 million for the Q1 of 2016, an increase of $2.7 million, or about 4%, from the Q1 of 2015 gross profit of $71.5 million. The gross profit as a percent of net sales was 34% in the Q1 of 2016 and increased about 230 basis points versus 31.7% during the Q1 of 2015.
The gross profit margin increase was primarily due to favorable pricing, lower direct material costs, and lower fixed costs. Selling, general, and administrative expenses were $52.3 million in the Q1 of 2016, compared to $55.2 million in the Q1 of the prior year, a decrease of $2.9 million or about 5%. The company's SG&A expenses decreased by $2.5 million in the quarter due to lower costs from foreign exchange. The effective tax rate for the Q1 of 2016 was about 27%, and before the impact of discrete events was about 26%.... The effective tax rate for the Q1 of 2015 was negative 20%, and before the impact of discrete events was about 27%.
The lower effective tax rate last year is due entirely to the impact of purchasing the remaining outstanding shares of Pioneer that resulted in the reversal of deferred tax liability created in or prior to 2012, when the company acquired the controlling interest in the Pioneer subsidiary. The tax rate as a percentage of pretax earnings for the full year of 2016 is projected to be about 26%, flat to the Q1 of 2016 tax rate before discrete adjustments. As we had mentioned in the Q1 of 2015, the company purchased the remaining outstanding shares of the Pioneer subsidiary that resulted in significant income statement impact, some of which were characterized as non-GAAP and some of which were not.
In short, reported EPS included about $0.10 of benefit, primarily from the reversal of deferred tax liability, which were characterized as non-GAAP and are included in the table to reconcile reported earnings per share and adjusted earnings per share on page 2 of our earnings release. Additionally, about $0.10 of other benefits, including $2.7 million of other income and $3.5 million of incremental tax benefits, were not characterized as non-GAAP and are included in the $0.32 of adjusted earnings per share for the Q1 2015. In the case of last year's Pioneer transaction, the company followed a methodology, a methodology to match the GAAP or non-GAAP characterization of each matter to the same characterization of that matter when the original transactions were recorded.
The company ended the Q1 of 2016 with a cash balance of $74.6 million, which was $7 million lower than at the end of 2015. The cash balance decreased primarily due to higher capital expenditures in the Q1 and reduced borrowing on the company's revolving line of credit. The company generated about $14 million more free cash flow in the Q1 of 2016 than it did in the Q1 of 2015. The company had borrowings of $11.5 million on its revolving debt facilities at the end of the Q1 of 2016. The company had no borrowings on its revolving debt facility at the end of 2015.
The company purchased 144,600 shares of common stock for approximately $3.8 million in the open market during the Q1 of 2016. As of the end of Q1 2016, the total remaining authorized shares that may be repurchased is about 2.2 million. This concludes our prepared remarks, and we'd now like to turn the call over for questions.
Operator (participant)
Ladies and gentlemen, if you have a question for the speakers at this time, you may dial star, then the number one key on your keypad. That's star, then one. If your question has been answered, or if you wish to remove yourself from the queue, you may press the pound key. Once again, ladies and gentlemen, star, then one will place you into the queue. Our first question comes from the line of David Rose from Wedbush. Your line is open.
David Rose (SVP)
Good morning. Thank you for taking my call.
John Haines (CFO)
Good morning, David.
David Rose (SVP)
Just a couple, you know, you noted that the groundwater pumping business had improved and, you know, ag had been down 5 versus down 20. So is your sense -- so this is question one: Is your sense that you're at the bottom of ag? Is it was there something that suggests that there might be more volatility in international markets? And then maybe just kind of give us a sense of how ag looks domestically versus internationally. And then the last question is on the margin front, is you clearly had some tailwinds, as you noted, in material costs. How should we think about those headwinds as some of those costs have increased? Will that roll out in Q3, some of it in Q2?
How should we think about the headwinds in the back half of the year?
Gregg Sengstack (CEO)
Okay, David, I'll take the first half of that, and I'll have John speak to the margin questions you had there. Yes, in the North American or U.S. market, we saw groundwater the decline to be, you know, much less than the back half of last year. I'd say that in my travels through the center of the country over the last month or so, that the sense is that it, people are still a little reluctant to take inventory. Clearly, demand will be driven by the use of pumps in the second and Q3 as, you know, for the ag space, which is, you know, somewhat weather dependent. So we'll have to see how that unfolds over that time.
But I'd say that the comp was in our decline last year was in the Q2, so the comp was pretty fair this quarter. I'd say that there was a nice improvement, and we would expect, and we are expecting, continued improvement throughout the year. But also to the international markets, yeah, again, stability. Our ag business globally was, you know, up just, you know, a little bit. So, you know, we have a sense that, you know, kind of globally, there's stability in that business. There's some puts and takes. We're doing well in Brazil, in our groundwater business. We're doing well in the Middle East, Europe, but South Africa has certainly been impacted. We talked about mining, but it's also been impacted there.
They've had a really tough situation with their maize crop, and with general farming direction now importing
... products that are standard as opposed to exporting, which they were doing a couple of years ago. So I think from the standpoint of the ag business, again, domestically improving, internationally stable. John, you want to talk about the, on the margin side?
John Haines (CFO)
Yeah, David, you're right. The key drivers of the margin expansion in the Q1 were some of the tailwinds that we've discussed, not least of which is lower raw material input costs. We expect to continue to see margin expansion for the balance of the year, although in the latter half of the year, the comps will become a little bit more difficult. And as you mentioned, there is some indications that some of the favorable raw material trends may start to reverse themselves a bit in the back half of the year. Last year, which, as you know, was not a fantastic margin year for us, we ended on a consolidated basis at 10.3% in total.
We're optimistic that we can be somewhere in the 180-200 basis point improvement over that for the full year, 2016. So, it will be more first and Q2 expansion and quite less in the back half of the year.
Gregg Sengstack (CEO)
Okay, great. Thank you.
Operator (participant)
Thank you. Our next question comes from the line of Edward Marshall from Sidoti & Company. Your line is open.
Edward Marshall (Senior Equity Research Analyst)
Hey, guys. Good morning.
John Haines (CFO)
Morning.
Gregg Sengstack (CEO)
Hi, Ed.
Edward Marshall (Senior Equity Research Analyst)
In the gross margin comments, you talked about pricing. I don't know if you actually clarified it yet. Can you talk about where you might have been getting some pricing, and what geographic area, and then what the product line?
John Haines (CFO)
Yeah, the pricing, Ed, we had a really strong quarter in the Q1 on pricing. In total, on a consolidated basis, we achieved right around 360 basis points in total price. A good portion of that total price is being realized in our international markets, and especially in those international markets that have experienced the most significant foreign exchange deterioration of the local currency to the US dollar. So we saw meaningful price improvements in places like Brazil, South Africa, and then the balance of the world kind of getting the rest. Fueling had a nice price quarter as well. So we saw a really broad-based improvement in price.
But I would say that where we saw it the strongest was in these international markets that were, you know, that are fighting this FX, continuing to fight this FX headline.
Edward Marshall (Senior Equity Research Analyst)
Got it. So if I look at the three, I think there's three points, direct more material costs, lower fixed costs, and pricing. Pricing would be the largest of those three buckets for the gross profit margin, it sounds like.
John Haines (CFO)
I would say pricing and the lower raw material input costs are similar.
Edward Marshall (Senior Equity Research Analyst)
Got it. And what were your assumptions heading into the year for the dollar, and then what are your assumptions now? It looks like you were for about a $40 million headwind from FX and currency. It doesn't -- it sounds like that's improved.
John Haines (CFO)
Yeah, the view that has caused us to be more optimistic about our earnings for the full year, Ed, is really around two currencies where we didn't see the weakness in the Q1 and haven't seen it so far in the Q2. One is the Brazilian real, and one is the euro. So our assumptions for both were meaningfully weaker than where they currently are. Now, that doesn't mean that can't change. We all know how volatile these things can be. But the good news is that we went through the entire Q1 with the real in the 3.50-3.60 range.
We went through the entire Q1 with the euro in that low teens, you know, call it 1.10-1.13 range, and they are maintaining there so far in the Q2. So that's all good for us. Those are both significantly stronger than we had assumed. So as we look out for the balance of the year, it's kind of the view that, you know, how many months can we get away with the euro at, you know, 1.13? How many months can we get with the real at something like 3.50 or 3.60? And every month that goes by and we're translating more income back, and that's favorable to what our original assumptions were.
Edward Marshall (Senior Equity Research Analyst)
Got it. It looks like you took out debt. You also bought back some stock, and I think the two are unrelated, but maybe you can kind of talk about how you'll use the balance sheet for kind of the remainder of the year, and the expectations there. It does look like CapEx stepped up a bit, too, and I was curious what you might be using. What, where the dollars, both Q4 and Q1, and where those $ might be being spent as well. I guess there's a couple parts there.
John Haines (CFO)
Yeah. The view ahead toward the capital deployment really hasn't changed. You know, our priority will be accretive acquisitions. We continue to have a fairly robust pipeline of acquisitions that we're looking at, but as we talked in previous quarters, you know, price expectations are high right now. We think some of that expectation is driven by the fact that the dollar is so strong to many international currencies, especially as we look at international transactions. Our FX view has not changed significantly. We have a little timing of maybe more of it in the Q1 of this year than what we usually see, but somewhere in the $35 million-$40 million range for FX.
Gregg Sengstack (CEO)
CapEx.
John Haines (CFO)
I'm sorry. Excuse me.
Gregg Sengstack (CEO)
CapEx.
John Haines (CFO)
CapEx. Excuse me, for the entire year of 2016 is still the assumption. And that's about where our depreciation and amortization levels are. So we're trying to manage that in that same neighborhood, if you will. In terms of the share repurchases, you know, as we've discussed, what we're first trying to do is offset the dilution of the equity awards that we make to our leadership team. That's somewhere in the neighborhood of 300,000 shares a year. We'll try to do that. We're not hard and fast on that, though, Ed, and what we're really trying to do on the share repurchases is kind of protect that forward multiple price.
So as we've discussed, if we see that market price go below what we think is an acceptable forward multiple, then we'll become more aggressive in share repurchases. If it's at or above, then we'll basically be just looking opportunistically to get that 300,000 shares. So that's kind of the view. We do have a second installment on our approved term debt. Relative to our debt, we'll cover some of that with incremental revolver borrowing. But, you know, we feel, you know, we feel like we can end the year pretty solidly at a gross debt to EBITDA ratio below 1.5. And that's kind of the way we're thinking about it. Long-winded answer to a simple question.
Gregg Sengstack (CEO)
Right. I mean, you wouldn't share the multiple or the price that you kind of enter the market, would you?
John Haines (CFO)
Yeah, we probably won't do that.
Edward Marshall (Senior Equity Research Analyst)
Can't hurt, can't hurt to try. All right, guys. Thanks very much. Appreciate it.
John Haines (CFO)
Thank you.
Operator (participant)
Thank you. Our next question comes from the line of Kevin Bennett from Sterne Agee. Your line is open.
Kevin Bennett (Analyst)
Thank you. Good morning, guys.
John Haines (CFO)
Hi, Kevin.
Gregg Sengstack (CEO)
Good morning, Kevin.
Kevin Bennett (Analyst)
I wanted to go back to the margins, I guess, and sticking to water specifically, and Greg or John, I guess, I was wondering if you could kind of break down the 360 basis points of year-over-year improvement by those buckets, whether it's mix or price cost or the cost cuts you've done or leverage. Then I guess kind of, should we expect that kind of improvement going forward, you know, as we progress throughout this year?
John Haines (CFO)
Yeah, Kevin, the, you know, we haven't broken down the, in great detail. As I said, I think to David's question, when we look at the 360, you know, I would characterize, you know, equal proportions of it being between the raw material input and, the price, impact. As I said, we had a pretty decent price quarter. Other factors that contributed were lower fixed costs. That was a smaller, factor. Some mixed favorability in certain markets. We saw a little bit toward groundwater in some markets, that helped as well. Better translation of European Union, units. So there were other factors, but the key ones were priced in the, raw material input.
In terms of the balance of the year, as I said, I would not expect... I, you know, I think, the comps for the Q2 is a, you know, a fairly, reasonable comp. As we get back into the back half of the year, we'll see more difficult comps. I would say, you know, that you'll see less margin expansion in the back half of the year. But overall, still looking, you know, for something in the 110-200 basis points or so.
Kevin Bennett (Analyst)
Got it. Okay, that's helpful. Thank you, John. And then, Greg, I was wondering if we could talk about Pioneer for a minute, and just kind of have you seen it? It seems like that business certainly has stabilized. Was wondering what kind of you've seen there.
Gregg Sengstack (CEO)
It has stabilized. We were still a little bit down, and domestically in the quarter, not really enough to call out. We saw international growth in Pioneer. So yeah, I would characterize the business as stable. You know, I still think there's a lot of commentary out there about how this kind of secondary impact of the weak oil price, although it's now rebounded in the forties, having kind of cascading and further drag on the economy and businesses.
And so there may be some of that, but as we pointed out, you know, the exposure we have now is really so minimal that this is the base business, which is, you know, broadly covering, you know, oil and gas, dewatering, municipal, mining activity, which is also soft, but we would expect mining is kind of at its nadir point as well. So, Pioneer is stable, and we had a good quarter overall in revenue and profitability.
Kevin Bennett (Analyst)
Okay, great. And then last question for me on, on fueling. You mentioned or called out the strength in India, and I know that's been a lumpy business in the past. So I was wondering if this was just one of those good quarters that you saw, or if you're seeing something that's, I guess, more sustainable in, in your Indian business?
Gregg Sengstack (CEO)
India is lumpy because it's on tenders. We think that we're gonna have a, you know, pretty steady flow of business from India this year. So, and we should expect some of this to continue. But this is, you know, we start off the year with a nice business in India compared to last year. But the business is lumpy because it's a tender nature of the business, and you win some, you lose some. But overall, we think that the international business for fueling, you know, is stable. We're expecting China to start, you know, strengthening as we get towards the back half of the year.
You know, they went through a lot of corruption issues in the two Chinese owned oil companies, which disrupted the top leadership and disrupted you know, capital purchases. But generally around you know, fueling around the globe is good, and India was the highlight.
Kevin Bennett (Analyst)
... Okay, so, so this kind of high single digit organic revenue growth, it sounds like you think that's sustainable, especially, I guess, as we have some easier comps later this year?
Gregg Sengstack (CEO)
Yeah, we've you know, fueling has been a pretty consistent high single digit business. And again, you look at demographics, you know, with the continued growth in population and standards of living, even with kind of the depressed global economy today, you know, in developing regions, is just gonna lend itself to having more infrastructure to support more vehicles on the road. So, we've been seeing this kind of consistent mid to high single digit growth rate in fueling. We had a little bit, it was a little bit softer Q4 last year, if I recall. But generally speaking, fueling has been kind of a steady climb, both domestically and internationally.
Speaker 9
Got it. Thank you, guys.
Operator (participant)
Thank you. Our next question comes from the line of Matt Somerville from Alembic Global Advisors. Your line is open.
Matt Summerville (Analyst)
Hey, guys. Good morning.
Gregg Sengstack (CEO)
Hi, Matt.
Matt Summerville (Analyst)
A couple things. First, with this whole distributor reset you kind of went through over the last year or so, have you been able to see net margin accretion from migrating away from kind of this one big large guy to a lot of smaller, guys, if you will? And do you feel like the inventory may be bloating that resulted either at the OE or distributor level as part of this whole reset, is that fully behind you at this point?
Gregg Sengstack (CEO)
Matt, in response to the first part of your question, you know, I'd say that anytime you have, you know, a disruption to the, an industry, you're gonna see aggressive pricing. People are looking to, you know, move share around and so on. you know, that's, and that's along with the fact that the market's been soft because of the decline in ag generally, I think it's made for some tough pricing and margins. You know, I think we're, we're beginning to move through all that, as we enter into this year, because it's been over the last 12-24 months that we had that experience. but still, you know, pricing is pretty aggressive on the street. Relative to the inventory, I, I'd say, again, we don't have great visibility into distribution. It's mostly anecdotal.
Certainly, with the tremendous, you know, wet record Q2 rain throughout the center of the country that loaded inventories, you had that with a combination, again, kind of a slowdown of ag. We somewhat called out, and we thought inventories were a little heavy Q3, maybe a little less heavy Q4. I think just kind of a general reluctance, again, to be buying up, you know, until people see end demand. With that said, distributors that we do talk to that handle Franklin product, we're seeing increased throughput, and that's encouraging.
So, I guess the broad answer or the short answer to your question is that pricing is still a little bit tough, and we expect inventories are more in line now, as they were 12, 24 months ago.
Matt Summerville (Analyst)
Just to get back to the question on ag, sticking domestically, we're four months into the year. What is your assessment as to the net favorability, at least I would think there's net favorability, in weather versus where we stood at this point last year? And then could you speak more specifically about what you're seeing in California, Texas, maybe the Corn Belt in particular?
Gregg Sengstack (CEO)
Sure. You know, the really wet weather came, you know, in May and June last year. So we're not quite into that, and we're really just starting, you know, planting season, as I understand it, in the United States. So it's still a little bit early to tell, but again, you know, our premise is that, you know, we have a large replacement portion of our business. We estimate 80% plus of our business is replacement. And so when people start turning on pumps, that's when we'll start seeing, you know, incremental revenue. You know, with California, you know, the Valley of California is a large line shaft turbine market, and we're not in the line shaft turbine space.
Certainly, California is an important market to us, but I would think that, you know, the, to the degree that it was wet early in the quarter, that would be impacting more of the line shaft turbine players than Franklin Electric, specifically. Texas, I was there last month, it looked to be a little bit drier, but of course, the rain around the Houston area is well documented, as it was in Louisiana. West Texas has been getting some rain, but I don't want to get into—I don't follow it on a daily basis. But I'd say that generally, conditions this year look a little more favorable than the conditions were last year. The Corn Belt, Upper Midwest, we had a mild winter.
And again, I haven't tracked rainfall specifically in that area.
Matt Summerville (Analyst)
Great. Thank you very much.
Operator (participant)
Thank you. Our next question comes from the line of Brian Casteel from Seaport Global. Your line is open.
Speaker 9
Hey, guys. Good morning.
Gregg Sengstack (CEO)
Morning, Brian.
Speaker 9
I think, most of my question's been answered here, but perhaps on Fueling systems, it sounded like vapor recovery systems were down globally, but you expect those to improve in the second half. Is that just on easier comps, or do you actually see demand improving there?
Gregg Sengstack (CEO)
There's two parts to that. Domestically, we called out that vapor recovery is declining because outside the state of California, Stage IIsystems are being decommissioned, ORVR automobiles are considered to be in widespread use. So that'll be a decline to, you know, a new level, which we expect to see probably within this year, which will reflect our business, which is principally in California. Outside the United States, we saw a slowdown in China in the back half of last year. So it will be a little bit of easier comp in the back half. But we're also expecting to see some additional traction in other parts of the world. India's began to look at vapor recovery again, after a number of years where they really have been in hiatus.
As we know, they have a real air quality problem in India, so they're looking at vapor recovery. So we just think that, as we get to the back half, yes, it will be somewhat easier comps, but also we just think the underlying organic demand for vapor recovery is gonna continue, in many parts of the world.
Speaker 9
Okay, great. And then, lastly, if I heard you correctly, it sounds like, you know, regional distributors are feeling a little bit better about inventories. Is this an opportunity for you guys to reduce your own inventory, you know, as we move throughout the year?
Gregg Sengstack (CEO)
Well, we certainly look at, you know, inventory as part of our working capital, and we wanna keep it in check. But keep in mind that our second key factor for success at Franklin is availability. And having that product on the shelf when the customer needs it is critical to our business because we frankly make a lot more margin having the product than we would on return on invested capital by having less inventory. So we're very conscious about having inventory on the shelf when our customer needs it, particularly as you're moving into, you know, the summer in the northern hemisphere. We do have a seasonal business. The second and Q3s are the stronger quarters, and so we wanna have it there.
Naturally, as we cut back to the back half of the year, you know, there may be some opportunity there, but, we're very cautious about, inventory levels at this time of the year.
Speaker 9
Gotcha. All right, thanks, guys.
Operator (participant)
Thank you. Our next question comes from the line of Richard Verity from Oppenheimer. Your line is open.
Speaker 8
Good morning, and thank you for taking my call. Most of my questions have pretty much been covered, but I, I just have one question left that would be helpful. You know, when I think about the Franklin story, one of the compelling chapters is the product pipeline. And so I was wondering if you could provide us with a sense of what it might look like in 2016, if it's geared more to the water system segment or the fueling side, and then what it might be focused on in 2017?
Gregg Sengstack (CEO)
Sure. We have been building a robust pipeline of new products over the last several years. Matter of fact, last year we had a record number of new products launched in water, specifically. In our fueling business, we look at as a systems-type business. We continue to innovate and improve on the system in our fueling side. We spend similar amounts of R&D relative to sales in both businesses. So we're gonna continue to come out with product line extensions and new products. We're focused particularly on drives on the water side, and drives and controls, because it gives us a systems solution.
So the customer can come to one company, and they can get a system solution where they're gonna get a more efficient system, and in case of larger systems, a lower total cost of ownership because it's higher efficiency, and because Franklin has this deep knowledge in these applications, as you point out in this, in Franklin's story, we have a deep understanding of these applications, and we're able then to optimize the equipment to help the contractor get exactly what they're looking for. You know, our fueling business has been a systems business now for almost a decade. And we have, again, the most complete underground system offering, both domestically and internationally.
And to the point that a major customer like Shell, with 28,000 gas stations that they oversee around the globe, again, signed up a 5-year deal with Franklin Fueling Systems. And we've continued to support Shell throughout the world, not only the supply of the product, but also the design optimization of systems for both reducing risk of injury to people on the forecourt, overall safety, and then also, of course, lowest total cost of ownership. So we're gonna continue to focus on system sales both in water and fuel, and you're gonna see an emphasis on drives and controls over the next 12-18 months.
Speaker 8
Okay, great. Thank you very much. That's good color.
Operator (participant)
Thank you. That's all the questions that we have for today. So I'd like to turn the call back over to Gregg Sengstack for closing remarks.
Gregg Sengstack (CEO)
We thank you for listening to our Q1 conference call and look forward to speaking with you all again in July.
Operator (participant)
Ladies and gentlemen, thank you again for your participation in today's conference call. This now concludes the program, and you may all disconnect your telephone lines.