Franklin Electric - Q1 2017
April 27, 2017
Transcript
Operator (participant)
Good day, ladies and gentlemen. I would like to introduce your host for today's conference, Mr. John Haines, Chief Financial Officer. You may begin.
John Haines (CFO)
Thank you, Amanda. Welcome, everyone, to Franklin Electric's first quarter 2017 earnings conference call. With me today are Gregg Sengstack, our Chairman and Chief Executive Officer. On today's call, Gregg will review our first quarter business results, and then I will review our first 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'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 this call are based on information currently available, and 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 Chairman and Chief Executive Officer, Gregg Sengstack.
Gregg Sengstack (Chairman and CEO)
Thank you, John. Outside of the U.S. groundwater business, we had a good start to the year with organic sales growth of approximately 5% led by our Fueling Systems business and our Latin America water business. Our fueling business continues to grow globally. Organically sales increased 7% in the U.S. and Canada and 11% internationally. Our strategy of focusing on safety and lowest total cost of ownership continues to gain traction. Through the development of our SiteBuilder website and FFS PRO University, we are winning business in North America with major marketers as well as distributor discretionary business. With the stabilization of oil prices outside of North America, we are seeing pockets of increased demand for our products and systems as well. For example, during the quarter, we had a definite uptick in demand for the China market, which we see carrying on through the balance of the year.
We are also seeing strength in our water business in developing regions. Latin America growth accelerated to over 10%. Southern Africa, while still soft, had better results than last year, and even with a particularly tough comp, Asia-Pacific eked out an increase. We had another record quarter in local currency in Turkey. However, Europe and the balance of the Middle East remain relatively flat. Focusing on the U.S., our dewatering equipment business was up about 12% as we are seeing increased backlog in quoting activity. Revenue of our other surface pumping equipment declined by 3%. In our U.S. groundwater business, we saw about a $7 million decrease in sales as compared to the first quarter of 2016. Excluding sales to the Headwater distribution entities, sales of groundwater pumping systems were down about $1 million.
Weather in the West and Canada wasn't great, and we had a very strong finish to last year in the channel with a year-end price increase. And if 2016 was a better year than 2015, many distributors stretched for volume rebates, so we expect channel inventory to be healthy. As John will explain in a minute, the Headwater distributors that we are acquiring this quarter had different matters to consider. But in short, they had nothing to gain by increasing their purchases from Franklin Electric in the quarter, and we had no incentive to promote more sales to them. So our U.S. water sales were down, and as margins on groundwater pumping systems are higher than our corporate average due to vertical integration, our operating income for the quarter suffered.
One other data point: on a pro forma basis, the first quarter revenue of the four entities that we are acquiring to form the Headwater Companies overcame a 10% decline in sales in the West Coast and were up 4% on a consolidated basis in the quarter. So as we look forward to the balance of 2017, despite the slow start in the U.S. and Canada groundwater markets, we remain positive about our ability to achieve organic top-line growth in the 5%-7% range for our pre-acquisition segments. This growth allows us to reaffirm our 2017 adjusted earnings per share guidance range of $1.77-$1.87. I will now turn the call back over to John.
John Haines (CFO)
Thank you, Gregg. Our fully diluted earnings per share were $0.33 for the first quarter of 2017 versus $0.28 for the first quarter of 2016, an increase of 18%. First quarter 2017 sales were $220.3 million, an increase of 1% compared to 2016 first quarter sales of $218.4 million. The company's organic sales growth was 1%, and the impact of foreign currency translation was not significant. The company is not reporting non-GAAP adjustments in the first quarter of 2017 as we are now reporting the first quarter 2016 operating income in the same format. The $0.3 million of restructuring expense reported in the first quarter is related to the ongoing restructuring effort in Brazil. Water Systems sales were $167.2 million in the first quarter of 2017, a decrease of $1.6 million or about 1% versus the first quarter of 2016 sales of $168.8 million.
Water Systems organic sales were also down about 1% compared to the first quarter of 2016. As Gregg already mentioned, sales of groundwater pumping equipment in the United States and Canada declined in total about $7 million. However, about $6 million was due to reduced sales to the Headwater distribution entities that the company announced the acquisition of on April 10th. There was no incentive for these entities to buy up inventory from Franklin in the quarter, especially considering their large fourth quarter purchases and weak end market conditions in the Western United States. Likewise, due to the deferral of profit recognition on sales between the Water Systems segment and Headwater until the product is sold to the Headwater customer, there was also no rationale for the Water Systems segment to incentivize or promote higher sales to these customers in the first quarter.
The profit recognition deferral is elongated by the amount of Franklin inventory the Headwater Companies had on hand at the time the acquisitions were completed. We estimate that the lower sales of groundwater pumping equipment to the Headwater Companies explains about a $0.04 difference in EPS from the first quarter of 2016 to the first quarter of this year. Water Systems operating income was $21.4 million in the first quarter of 2017, down $2.8 million or 12% versus the first quarter of 2016. Operating income margin was 12.8%, a decline of 150 basis points from 14.3% in the first quarter of 2016. Water Systems first quarter 2017 operating income and operating income margins before restructuring expenses were $21.7 million and 13%, respectively.
The decline in Water Systems operating income and operating income margin is primarily attributed to lower sales volume and higher marketing and selling expenses, which increased about $2.7 million from the first quarter of the prior year. Fueling Systems sales were $53.1 million in the first quarter of 2017, an increase of $3.5 million or about 7% versus the first quarter 2016 sales of $49.6 million. Fueling Systems sales decreased by $0.8 million or about 2% in the quarter due to foreign currency translation. Fueling Systems sales increased about 9% after excluding foreign currency translation. Fueling Systems operating income was $11 million in the first quarter of 2017, up about $0.8 million or about 8% compared to $10.2 million in the first quarter of 2016.
The first quarter operating income margin was 20.7%, an increase of 10 basis points from the 20.6% of net sales in the first quarter of 2016. The company's consolidated gross profit was $75.8 million for the first quarter of 2017, an increase of $1.6 million or about 2% from the first quarter of 2016 gross profit of $74.2 million. The gross profit as a percentage of net sales was 34.4% in the first quarter of 2017 and increased about 40 basis points versus 34% during the first quarter of 2016. The gross profit margin increase was primarily due to favorable pricing and lower direct material costs, partially offset by higher fixed costs. Selling, general and administrative expenses were $57 million in the first quarter of 2017 compared to $52.3 million in the first quarter of the prior year, an increase of $4.7 million or about 9%.
Sales related support costs, including marketing and selling-related expenses, increased by about $3.3 million, and transaction and other costs associated with the recently acquired distribution companies were about $0.8 million. Additionally, foreign currency translation increased SG&A about $0.6 million in the quarter. The company realized discrete income tax benefits related to foreign net operating losses and currency exchange losses in the first quarter of 2017, which lowered the consolidated effective tax rate to about 1%. The effective tax rate in the first quarter of 2016 was about 27%. The company ended the first quarter of 2017 with a cash balance of about $71 million versus about $104 million at the end of 2016, down due primarily to increased inventory. Inventory levels at the end of the first quarter of 2017 were $236 million versus year-end 2016 of $203 million.
The inventory increase is primarily due to seasonal demand and due to lower than anticipated sales of groundwater pumping equipment in the United States and Canada markets. The company had no borrowings on its revolving debt facilities at the end of either Q1 2017 or year-end 2016. The company did not purchase any shares of its common stock in the open market during the first quarter of 2017, as at the end of the first quarter of 2017, 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)
Thank you, ladies and gentlemen. At this time, if you do have a question, please press the star and the number one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. And again, that star and the number one to ask a question. Our first question comes from the line of Edward Marshall of Stifel. Your line is open.
Edward Marshall (Analyst)
Hey, guys. How are you? Good morning.
John Haines (CFO)
Morning, buddy.
Edward Marshall (Analyst)
Hey, Edward. I wanted to ask, in the original guidance, did you plan on the discrete tax item at that point? Is there anything else that you can see in the financials that would lead you to think that that would continue throughout the year?
John Haines (CFO)
Yeah, Ed, a portion of it certainly was planned, but a portion was not planned. So the discrete benefit that we got in the first quarter was a little bit better than we had originally believed it would be. But when we reaffirm the guidance today, the $1.82 midpoint, we're considering several different pluses and minuses. So yeah, we're going to get a bit of a plus on the tax side, we think, but there's a few other minuses that get us back to that $1.82. So the answer is part of it was assumed, but a portion of it was not as well.
Edward Marshall (Analyst)
Following on that, what do you think the tax rate for the year is going to be?
John Haines (CFO)
I think our best view right now, before the impact of discrete items, is still in that 26-27 range. After the impact of discrete items, it's going to be more in the 20-22 range.
Edward Marshall (Analyst)
Okay. A couple of weeks back, when you had the acquisition call, you confirmed your outlook and said that it was going to be neutral to earnings. Now, I mean, looking at kind of the first quarter and some of the other items that are flowing through, is there a language change there, or do you still expect it to be kind of neutral for 2017?
John Haines (CFO)
Yeah, it's all part of that same math, Ed. We're trying to estimate several moving pieces here as it relates to the distribution acquisitions, the amount of income they'll generate on their own kind of from May 1st on when we own them. The added cost, we had some cost in the first quarter. We're trying to think through the amount of reduced sales that we would have in the first quarter to them, which obviously impacted our first quarter results. Then the most important thing is this deferral of the recognition of profit that will take place when these are wholly owned subsidiaries.
So we won't, as we've explained a couple of times, we won't be able to recognize profit on sales from the Water Systems segment to the distribution segment until the distribution segment completes the sale of that Franklin product all the way through to their end customer, their contractor installer. So all those variables are in play. And what we're trying to do is say, "Okay, based on all that, based on our first quarter results that had pluses and minuses in it, we still think the 1.82 midpoint is where we'll be for 2017.
Edward Marshall (Analyst)
Got it. Sounds like you have a tough job to help us out, so we appreciate it. I guess let's talk about the core business and then add in the acquisitions on it. You had a relatively higher SG&A in the first quarter. On the core business itself, is that kind of the run rate for the year, or was there something specific that drove that higher? And that's absent acquisitions because I know that number's going to change.
John Haines (CFO)
Yeah, Ed, I guess the thing I would point to is just, yeah, the SG&A was up $3.3 million in the quarter related specifically to sales and marketing-related activity globally and across both segments. So that was true for water. It was true for fueling. Fueling was up. But when you think about it, we had 4% water organic growth outside of the U.S. and Canada, and we had 9% organic growth in fueling in the first quarter. And we're also reaffirming the belief that our core entities, the core Franklin before the acquisitions, is going to achieve between 5%-7% organic growth for the full year. So we're hanging on to that guidance as well. So in retrospect, some higher sales and marketing expense, from our perspective, is to be expected.
Now, the good news about SG&A is that we can kind of turn that down and turn that off if we proceed through 2017 here and see that some of these growth rates are not materializing the way that we want them to. So the entire $3.3 million was related to sales and marketing stuff. I wouldn't really say there was a lot of one-time stuff, but about $600,000 of it was related to FX. So that was a driver in our total SG&A as well. Does that answer it for you, Ed?
Edward Marshall (Analyst)
No, it does. I appreciate the comments. Thanks, guys.
John Haines (CFO)
Ed, thanks for recognizing John and his team's efforts. There are a lot of moving parts, and they've done a fine job trying to keep this all in front of everybody.
Edward Marshall (Analyst)
I agree. Thanks.
Operator (participant)
Thank you. Our next question is from the line of Ryan Cassil of Seaport Global. Your line is open.
Ryan Cassil (Senior Analyst)
Hey, good morning.
John Haines (CFO)
Good morning. Hi, Ryan.
Ryan Cassil (Senior Analyst)
I was wondering if you could just parse out, I guess, some of the higher selling costs between the segments. Just looking at fueling, really nice volume growth, as you pointed out. The incremental margins, just sort of low double digits, is sort of lower than we expected. Was that mix-related, or did you have was more of that selling cost in fueling, perhaps? If any color, that'd be great.
John Haines (CFO)
Yeah, I think there was a portion of it that was mix-related. Ryan, as I said, the marketing and selling was up in fueling as well. The other thing, I guess, I would point to in fueling is they didn't have quite as high a price realization in the quarter as what we would expect. It was sub-200 basis points. So the other thing that we're trying to balance this year with our price increases is this balance of raw material inflation coming at us offset by price. And I think that gross profit margin is probably the best place to look at how that's working. And we did incrementally improve our gross profit margin. So I think that might be the only other factor along with mix in fueling.
You'll recall, I hope, from prior conversations that when fueling was kicking around in mid-20 kind of operating income margin, we always said that, "Hey, that's pretty high." There's a lot of factors that are going really well for them, and that, I don't know, 22-24 might be a more reasonable point for fueling.
Ryan Cassil (Senior Analyst)
Right. That's kind of where I was going. You guys have always it seemed like this segment was sort of out-earning. Does it feel like we're sort of normalizing maybe, or is it maybe a change in the competitive landscape that we see it going to mid- to low-20s% margin rate over the longer term? And I guess, how quickly do you think that plays out?
John Haines (CFO)
Ryan, there's enough different factors that will move it around quarter to quarter. We don't see a fundamental underlying change in the competitive landscape. Over the last year and a half, I guess it's been now there's been some consolidation of the spending space, but that has not impacted our business. It's a function of where in the world it's sold, what product line sold. There are just different margin characteristics for the different product lines in the different regions. And so that's why when we're out talking with people, we say, as John pointed out, low 20s is kind of what to expect. If it's better than that, it's been a good quarter. And here again, this idea of turning on and turning off fixed costs, we need to continue to invest our fueling business to continue to get the top-line growth as in the high single digits.
We're going to do that where it's appropriate, and then we'll get leverage on that as we go.
Ryan Cassil (Senior Analyst)
Understood. Appreciate it. And then just lastly, on the water side, you guys reiterated your confidence in the organic outlook, 5%-7%. Have you seen things kind of snap back, or could you give any commentary just with respect to ground Water Systems early here in Q2?
John Haines (CFO)
Yeah, this is always kind of the critical time or tough time to call that because it's still late April. The second quarter is when things start moving along. But we don't want to overplay weather, but weather is a component of when this business starts in the U.S. Outside the U.S., the groundwater business has been, as we pointed out, pretty solid. It's been not particularly strong in Europe, but outside the U.S. and other parts of the world, it continues to be very strong. But specific to your question, the U.S., we're seeing good order flow rates. We're seeing kind of normal seasonality. But to start calling the second quarter, that would be premature.
Ryan Cassil (Senior Analyst)
Okay. Appreciate it. Thanks for the call.
Operator (participant)
Thank you. Our next question is from the line of Ryan Connors of Boenning. Your line is open.
Ryan Connors (Research Analyst)
Great. Thank you. My question has to do with just trying to get a better understanding of this destocking by your to-be-acquired entities and exactly how the tactical dynamics of that work. So I mean, they're going to destock. How does that impact their ability to meet demand in the very near term? And are there competitive dynamics that arise there? And how quickly do you sort of scale up your own inventory to meet that demand? If you can kind of just walk us through how that dynamic works.
John Haines (CFO)
Sure, Ryan. Again, in Q1, people or companies like Franklin here are promoting and move product onto the shelves of distribution in anticipation of seasonality in North America. That was kind of the normal Q1 cadence. That's what didn't occur once it was clear to these owners that we were going to proceed with purchasing them. You'll notice that Franklin's inventories are up. Availability, we've talked to you about, is a strategic imperative for Franklin, only next to quality. We've got deep inventory. We can deliver on a relatively short basis. We see an opportunity logistically with these entities to work on that supply chain aspect, to increase service levels, maintain or increase service levels with less overall inventory. John can take you through, again, the math of how inventory at closing has this intercompany profit aspect to it in more detail.
But from a standpoint of the business, there was no incentive for these guys to buy. We knew we could deliver as necessary to supply the markets as Franklin Electric manufacturing. We're confident we can do that. For our piece of it, they're obviously going to continue to buy from other suppliers as well. And then on the math, if you have some specific questions, again, for John, he can sort you through on that piece.
Ryan Connors (Research Analyst)
Great. Great. No, that's very helpful. Thanks. And then just one other quick one. I did notice and you may have mentioned this, but I might have missed it, but there was a line in the press release about a 12% increase in dewatering, which looked actually pretty positive. I wonder if you can kind of just talk to us about some of the drivers behind that and how that changed the outlook for that business.
John Haines (CFO)
Yeah. I mean, when you talk about dewatering, we're talking about the Pioneer product line. You may recall that that business back in 2014 was $100 million top line. With the falloff in oil prices, that business dropped in about half and a little more than half in 2015. It's recovered a little bit. As we've now repositioned that business and are growing with customers not only in the oil and gas channel but other channels as well, we're just seeing a nice little tick up in demand there. We're very pleased to see that. The team's been working hard. We've gotten more feet on the street, not only in the U.S. but around the globe. The business is beginning to grow nicely.
Ryan Connors (Research Analyst)
Great. Well, thanks for your time this morning.
Operator (participant)
Thank you. Our next question is from the line of Matt Somerville of Alembic Global. Your line is open.
Matthew Somerville (Analyst)
Thanks. Good morning. John, I'm trying to get to the Headwater acquisitions. And I guess, what is your top-line assumption in terms of your sell-in to the Headwater companies during the period you own them in 2017? So let's call it 7 months, 7.5 months, whatever the right figure is. So you have a sell-in assumption, and I would assume you have a sell-through assumption as well. If you could help us, from a modeling standpoint, how you're thinking about those figures, that would be helpful.
John Haines (CFO)
Yeah, Matt. As we said, the volume that we sold to the Headwater Companies in 2016 was about $50 million. Given the first quarter results here, I think what we'll sell into them in 2017 is probably going to be more in the mid-40s. I think there's going to be some growth, but I think the first quarter is what it is, and there's certainly a decline there. In terms of their sell-through of Franklin product only, I'm not sure that I have a real current estimate of that. What we're trying to do is understand more the timing of that, Matt, really than anything because the timing's what's going to influence the ultimate recognition of our profit.
So the factor in the first quarter that is most meaningful is that our sales to them were down by $6 million, which is obviously very meaningful to groundwater and to the U.S. results. That was a little bit more than we had expected. We expected them to be down. We attribute that a little bit more to kind of the underlying market conditions on the West Coast, which is where Hydro and, to a large extent, 2M operate. They were not very favorable during the first quarter.
Matthew Somerville (Analyst)
And then I guess maybe, Gregg, as you're out speaking with other distributors which you do not own and will be directly competing with them given the footprint you're acquiring, what kind of feedback are you getting from your other distribution folks that you deal with?
Gregg Sengstack (Chairman and CEO)
We're getting the range of feedback one would expect in this situation. We have again, for Franklin's piece of this, we have selective distribution. And so but forward ownership changed. Nothing else fundamentally has changed there. But I'd say that you get the range of reaction of cautious to wait and see to we get what you guys are doing. And it's somewhat comforting for some of these guys to know that there's potentially somebody out there that has now created an entity that they may be able to sell their business to at some point in the future. So we've got the range you'd expect.
Matthew Somerville (Analyst)
I guess thinking longer term, recognizing you've just now kind of gone this route from a vertical integration standpoint into distribution. But again, thinking longer term, what is the next logical, acquisitive step for Franklin in North America distribution? Is it a geographic play? Is it a product set play? Talk about that a little bit. And then also, Gregg, is this model that you're moving forward with in North America, does it fit anywhere else, geographically speaking, outside of the U.S.?
Gregg Sengstack (Chairman and CEO)
Okay, Matt. Several questions buried in there. Let me see if I can pick them off one at a time. If you look at the footprint that we have, there are logical geographies where we could expand if it was appropriate to do so, keeping in mind, as you pointed out, we've been in this business for two weeks. And so we've got a lot to do just to integrate these four businesses onto one platform and to move forward. But you can look at it. There's a logical look at saying that there are geographic opportunities to expand. Your other point is very well taken, which is that if you look at each of these entities, they all had niche businesses that were adjacent to their core groundwater. Hydro is strong in commercial in California. You've got 2M is strong in turf irrigation.
DPS has got some strength in the wastewater or graywater space. So these are all kind of logical adjacencies for us to look at cross-selling and then for us to also potentially look at as a manufacturer of increasing our footprint in those situations. So it really does give us, as we said back 12 years ago, before it integrated the pumps, giving us more headroom for growth. This also gives us more headroom for growth. Your question about outside the U.S. is really interesting because it's a little bit market-to-market. The pro-groundwater channel is rather unique to the U.S. market. But as we look around the world and as we've expanded through our acquisitions and developing platforms, I could take you to the example of Brazil, which has worked obviously very well for us. But the Schneider acquisition was principally a surface pumping business.
They had sold submersibles in the past. They had sold Franklin Electric Motors with Goulds Pumps. So they had access to the channel. But they had 5,000 customers. So in effect, we were going into Brazil. We were buying a really strong brand with a really strong reach. But their average customer buys just a few thousand dollars or tens of thousands of dollars a year, not hundreds of thousands of dollars. It's a much more fragmented customer base. But going into Brazil and having that distribution reach allowed us, again, to accelerate the penetration of the market on the groundwater side, which put pressure on a couple of competitors and kept the dialogue going with Bombas Leão. And then we bought Bombas Leão, which is kind of right in the Franklin Groundwater Fairway.
So when you look at Turkey, there are a couple of ways people go to market for us. We have about 300 distributors. Other competitors in Turkey have less. They have a few distributors that are more like master distributors. So we've been steadily kind of pushing down our position in each of these markets to be closer and closer to the end customer. But the U.S. is really kind of the most unique platform in the submersible space in the world.
Matthew Somerville (Analyst)
Got it. And then you mentioned pricing, I think, pertaining to the fueling business. What was your realization in the Water Systems segment in Q1? And what would your full-year expectation be for fueling overall?
John Haines (CFO)
Yeah. In water, it was about 280 basis points, Matt, in the first quarter. Our expectation is slightly below that for the full year.
Matthew Somerville (Analyst)
Got it. And then just to follow up and get back to the organic guidance of 5-7 for the full company, I assume that water is squarely kind of down the fairway between those two goalposts, if you will. You're starting out the year down 1. You face, I'm going to call it, normal comps in Q2 and Q3 and a big comp in Q4. I guess, give me comfort that the math sort of works there to get to the midpoint of that fairway given what I sort of articulated with how you came into Q1 and then how your comp looks in Q4.
John Haines (CFO)
Yeah. Again, I think, Matt, when you look at outside the U.S. and Canada, it was a reasonable organic growth story on the water side, about 4%. And I think when you consider this Headwater, call it inventory adjustment or reduction in buy that happened in the first quarter, we think that that was more of a one-time kind of impact in the first quarter that's not likely to repeat in the subsequent quarters. So I would say those are the primary factors that give us confidence. I think fueling at 9% is off to a good start. And most of the indicators on the fueling side are positive. So we have a lot of confidence that that would be above that range, which is what our assumption was all along.
Matthew Somerville (Analyst)
Thanks, guys.
Operator (participant)
Thank you. And as a reminder, if you have a question, please press the star on the number one key on your touch-tone telephone. Our next question is on the line of Spencer Joyce of Hilliard Lyons. Your line is open.
Spencer Joyce (Analyst)
Hey. Good morning, guys. Thanks for taking the call.
John Haines (CFO)
Good morning, Spencer.
Spencer Joyce (Analyst)
Yeah. To piggyback a little bit off both Ryan and Matt's questions earlier, I want to talk a little bit about the Headwater acquisitions here. So the delays and the destocking, I thought you all did a good job explaining that to us. But I guess my question is, we should see a little bit of that phenomenon play out in the second quarter as well. Is that right, or were those inventory levels substantially alleviated kind of before these deals closed?
John Haines (CFO)
Well, if I'm understanding, Spencer, your question, the phenomena of profit recognition by the consolidated entity will start the deferral of that profit recognition will start in the second quarter. It is impacted by how much inventory these units have on hand to start with, right? So as we said when we announced on April 10th that and we said again this morning, if they're selling inventory or selling Franklin product that they have in inventory that we've already recognized profit on because we've already sold it to them, right, then Franklin Consolidated is not going to recognize any profit on sales to these entities until all that inventory is sold. They buy new inventory and sell that. So that's what's giving rise to this period of deferral.
So certainly, from Franklin's perspective, and that was the point we were trying to make this morning, from our perspective, it's better that they have lower inventory because they'll sell that faster and then buy more, and then we'll get back to the profit recognition more quickly, right? And as we also said, they really didn't have a financial or closing or proceeds advantage of building more inventory in the first quarter either. So that was part of the thinking there. So that's basically what we're facing up against. But if your question is, "Is this going to start to impact us in the second quarter?" the answer is absolutely yes. It is.
Spencer Joyce (Analyst)
Okay. Yeah. That's very helpful. Sticking with Headwater here for a second, so we have the three acquisitions here right off the bat, which I'm assuming still leaves us with a segment that's even much smaller than fueling and presumably at lower operating margins. And I'm just wondering what the plan is kind of over the next 6-12 months or perhaps 6-18 months as far as getting that up to kind of critical mass, whether it be perhaps an escalation of organic capex or is there still a pretty robust pipeline of another 4, 5, 6 other tuck-in type deals that you could do here?
Gregg Sengstack (Chairman and CEO)
Well, the run rate of this business, we figure it's going to be around $275 million on an annual basis. That's going to be actually a little bit larger than fueling, although, to your point, the operating margins in distribution are lower. And that's what we discussed on their call a couple of weeks ago. We got plenty to do with these businesses. The scale, the opportunities we have is getting everybody on a single platform and really working on both the input value streams so that we're getting a really good flow of inventory from all suppliers into the entities and also increasing service levels so that we continue to win customers on the sales side. So this is the largest entity that we believe by branch count, by employment, we think by revenue run rate - we don't have visibility, everybody - in the space.
So we think we got the scale. We just got plenty of work to do to get these entities all integrated and all on one platform and increasing service levels throughout the supply chain. So that's really the focus for the next period of time.
Spencer Joyce (Analyst)
Okay. Yeah. That's helpful as well. I guess a couple of kind of housekeeping questions. And I apologize. I've had to kind of jump on and off here a little bit. John, did you mention or give us any kind of guidance to tax items for the balance of the year? Are the NOL items from Q1 contained to Q1, and we should be modeling fairly normal over the balance of the year?
John Haines (CFO)
Yeah. We talk about our tax rate, Spencer, in two pieces before the discrete items. So that's the 26%-27% range. And then we have, from time to time, these discrete benefits. Sometimes they're not benefits. Sometimes they go the other way. But we have these discrete items that lower our effective rate. So what we're saying, I don't know if it was Ryan or somebody asked the question earlier. The 26%-27% is before the discrete items. We think with the discrete items, it's 20%-22%. And that assumes not only the first quarter of discrete items that we already recognize but then some estimate of what the balance of the year might be. So that's how we're currently thinking about it. Some of these things are really hard to predict, as you might guess.
You don't really know if you're going to get them until you actually get them. So that's what makes kind of putting some of these into the forecast and talking confidently about them difficult.
Spencer Joyce (Analyst)
Yeah. Okay. So we're looking at 20-22 for the full year, including the discrete items?
John Haines (CFO)
Including. Yes.
Spencer Joyce (Analyst)
Is some of the discrete items that we might see related to the new share-based compensation accounting guidance? I know we've seen that pop up for a lot of companies kind of across sectors. Are you all dealing with that at all, or is that?
John Haines (CFO)
Yeah. That's certainly playing into it, Spencer. I would not say those were the critical drivers in the first quarter. In the first quarter, we realized a foreign currency translation loss on the repayment of an intercompany loan that gave us a permanent tax benefit. The other thing that happened in the first quarter is we completed an international tax jurisdiction restructuring that released a valuation allowance on a deferred tax asset that gave us a big benefit in the first quarter. So the answer to your question is yes. The share-based comp is impacting the tax rate. But the bigger impacts in the first quarter were these two items that I just mentioned.
Spencer Joyce (Analyst)
All right. That's all I had. Thanks, guys.
John Haines (CFO)
Thank you.
Operator (participant)
Thank you. At this time, I'm showing no further questions. I'd like to turn the call back over to Mr. Gregg Sengstack for closing remarks.
Gregg Sengstack (Chairman and CEO)
Thank you, Amanda. We appreciate everybody joining us on this first quarter conference call. Look forward to speaking to you all after the second quarter. Have a good day.
Operator (participant)
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everybody have a great day.