Franklin Electric - Q2 2017
July 25, 2017
Transcript
Operator (participant)
Good day, ladies and gentlemen, and welcome to the Franklin Electric second quarter 2017 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If anyone should require operator assistance during the conference, please press star and then zero on your telephone keypad. As a reminder, today's conference is being recorded. I would now like to turn the call over to Mr. John Haines, Chief Financial Officer. Sir, you may begin.
John J Haines (CFO)
Thank you, Chelsea, and welcome everyone to Franklin Electric's second quarter 2017 earnings conference call. With me today are Gregg Sengstack, our Chairman and Chief Executive Officer, and Robert Stone, Senior Vice President and President of our International Water Systems unit. On today's call, Greg will review our second quarter business results, and then I will review our second 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 will now turn the call over to our Chairman and Chief Executive Officer, Gregg Sengstack.
Gregg C Sengstack (Chairman and CEO)
Thank you, John. We're pleased with the overall performance of our company in the second quarter, in which we achieved solid organic growth in both our water and fueling system segments. In the U.S. and Canada Water Systems business, we had organic growth in all three product lines: groundwater, surface, and dewatering. While a little delayed due to record rains in the West, groundwater pumping equipment sales strengthened throughout the quarter as weather generally turned hotter and drier across many regions. Surface pumping equipment sales continued to show steady single-digit sales growth, and dewatering equipment sales and backlog continued to accelerate, with strengthening demand in domestic gas field service as well as international markets. Outside the U.S. and Canada, the story was mixed. Sales in Asia Pacific were down 10% as the drought in Southeast Asia had ended.
In Brazil, the political turmoil, economic malaise finally caught up to our business, and we saw a similar sales decline. The rest of Latin America was basically flat. While business in Europe, the Middle East, and Africa was generally up, our revenues remained below plan due to the lack of orders coming from the Gulf States. Our fueling systems business had another strong quarter on the top line. However, margins were down due to mix, both product and geography. The U.S. and Canada markets continued to do well. As I mentioned last quarter, we continued to gain share with major marketers and see increased customer traffic on our Site Builder and FFS Pro University platforms. Outside the U.S. and Canada, fueling sales have improved across Europe, Africa, and Asia.
Our business in China is strong, as a national initiative to replace existing underground piping systems with more environmentally safe double-wall piping systems is accelerating. Our main U.S. distribution segment had a good initial quarter. While we estimate pro forma sales were down a couple of points due to weak weather-related demand in the West, margins were better than planned as cost synergies were realized ahead of schedule. The multi-quarter back-office integration of the acquired entities is on schedule. Looking forward, we are raising our annual guidance by $0.10 based on the following. First, the $0.06 gain on our previously held equity investments was not entirely in our original guidance. Second, about 10% of our sales is in euros, and overall, half of our manufacturing business revenue is outside the U.S. Therefore, the dollar's decline generally should lift our reported results.
Most importantly, however, we see strengthening demand across many markets, while at the same time remain cautious about the timing of recoveries in the Southeast Asia, the Gulf, and the Brazilian end markets. I will now turn the call back over to John.
John J Haines (CFO)
Thanks, Greg. Our fully diluted earnings per share were $0.64 for the second quarter of 2017 versus $0.50 for the second quarter of 2016, an increase of 28%. Second quarter 2017 sales were $305.3 million, an increase of 21% compared to 2016 second quarter sales of $252.1 million. Water system sales were $203.4 million in the second quarter of 2017, an increase of $8.8 million, or about 5%, versus the second quarter of 2016 sales of $194.6 million. Water system sales decreased by about $1.8 million, or about 1%, in the quarter due to foreign currency translation.
Water Systems organic sales were up about 6% compared to the second quarter of 2016. Water Systems sales in the United States and Canada were up about 10% compared to the prior year's second quarter. Sales of the dewatering equipment increased by 25% in the second quarter when compared to the prior year, resulting from the continued diversification of customers, new channel development, and international sales of the Pioneer-branded equipment. Sales of other surface pumping equipment increased by 8% in part due to wet weather conditions in the upper Midwest and Canada. Sales of groundwater pumping equipment increased about 5%. Water Systems sales in markets outside the United States and Canada overall declined by about 1% due primarily to the impact of foreign currency translation.
International Water Systems sales were led by improved sales in Europe, the Middle East, and Africa, but were offset by lower sales volumes in the Latin American and Asia Pacific markets in the quarter compared to last year. Water Systems operating income was $32.8 million in the second quarter of 2017, up $1.3 million or 4% versus the second quarter of 2016, and operating income margin was 16.1% compared to the 16.2% in the second quarter of 2016. Fueling Systems sales were $61.4 million in the second quarter of 2017, an increase of $3.9 million or about 7% versus the second quarter of 2016 sales of $57.5 million.
Fueling systems sales decreased by $0.7 million, or about 1% in the quarter due to foreign currency translation. Fueling systems organic sales increased about 8% compared to the second quarter of 2016. Fueling systems operating income was $14.9 million in the second quarter of 2017, down $0.6 million or about 4% compared to $15.5 million in the second quarter of 2016, and the second quarter operating income margin was 24.3%, a decrease of 270 basis points from the 27% of net sales in the second quarter of 2016. The decline in operating income was primarily due to adverse product and geography sales mix shifts. As Gregg pointed out, we were happy with the first quarter, the first reported quarter for the new distribution entity and segment.
Sales were $59.1 million in the second quarter of 2017. On a pro forma basis, we estimate this is about a 2% decline from the second quarter of 2016, primarily driven by adverse weather conditions in the western portion of the United States. Distribution operating income was $3.7 million in the second quarter of 2017, and the second quarter operating income margin was 6.3%. As we had described in our first quarter 2017 earnings conference call, we are now reporting inter-segment sales and the related elimination of sales and operating income from the transfer of products between our reporting segments. These eliminations primarily relate to sales from the water system segment to the distribution segment.
For the second quarter 2017, the total sales elimination for inter-segment transfers is $18.6 million, and the total operating income elimination is $3.3 million. The inter-segment elimination of operating income effectively defers the operating income on sales from water systems to distribution in our consolidated financial results until such time as the transferred product is sold from the distribution segment to its end third-party customer. This deferral of operating income or the elimination will be greatest during the first six to 12 months following the acquisition, as pre-acquisition inventory held in distribution entities is sold and post-acquisition inventory increases to an optimal level to support our customers.
The company's consolidated gross profit was $102.8 million for the second quarter of 2017, an increase of $12.1 million, or about 13% from the second quarter of 2016 gross profit of $90.7 million. The gross profit as a percent of net sales was 33.7% in the second quarter of 2017 and decreased about 230 basis points versus 36% during the second quarter of 2016. The gross profit increase was primarily due to higher sales. The decline in gross profit margin percentage is primarily due to the lower gross profit margin of the new distribution segment, which will have lower overall profit margins than our legacy water and fueling systems segments.
Excluding the new distribution segment, gross profit margin was 34.5% and declined primarily due to higher raw material and other direct variable expenses, including freight. Selling, general, and administrative expenses were $68.3 million in the second quarter of 2017, compared to $58 million in the second quarter of the prior year, an increase of $10.3 million or about 18%. The increase in SG&A expenses from acquired businesses were $13 million. Excluding the acquired entities, the company's SG&A expenses in the second quarter of 2017 decreased by $2.7 million, or about 5%. Overall, the lower SG&A spending outside the acquired entities is due to lower advertising and promotion, engineering and engineering project costs, and certain variable employee benefit costs.
The company's second quarter 2017 earnings included gains on the previously held equity investments in the three distribution entities. as indicated in the announcement made on April 10, regarding the acquisition of the controlling interest of these entities. This gain, included in other income in the company's income statement, was about $4.8 million, or about $0.06 of earnings per share. The company ended the second quarter of 2017 with a cash balance of about $55 million versus about $104 million at the end of 2016, down primarily due to acquisitions and increased working capital needs. Inventory levels at the end of the second quarter of 2017 were $297 million versus year-end 2016 of $203 million. About $60 million of the inventory increase is due to the distribution segment acquisitions.
The company realized discrete income tax benefits related to the one-time gain on the acquisition of the controlling interest in distribution entities and the expiration of uncertain tax positions in foreign jurisdictions in the second quarter of 2017, which lowered the consolidated effective tax rate to about 19%. The effective tax rate in the second quarter of 2016 was about 25%. The company believes 25% is a reasonable estimate of the effective income tax rate for the remainder of 2017. The company had $113 million in borrowings on its revolving debt facilities at the end of Q2 2017, and no borrowings at year-end 2016. These borrowings were primarily to fund the distribution acquisitions made in the quarter and for seasonal working capital needs.
The company did not purchase any shares of its common stock in the open market during the second quarter of 2017. As of the end of the second quarter of 2017, the total remaining authorized shares that may be repurchased is about 2.2 million. Yesterday, the Franklin Electric Board of Directors declared a quarterly cash dividend of $0.1075 per share, payable August seventeenth, to shareholders of record on August third, 2017. This concludes our prepared remarks, and we would now like to turn the call over for questions.
Operator (participant)
Ladies and gentlemen, if you have a question at this time, please press the star and then the 1 key on your telephone keypad. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Once again, that is star 1 for questions. And our first question comes from the line of Mike Halloran with Robert Baird. Your line is now open.
Michael Halloran (Analyst)
Can you hear me, guys?
Gregg C Sengstack (Chairman and CEO)
We can. Yeah, hi, Nish.
Michael Halloran (Analyst)
Hey, yeah, this is actually Mike. We must have had our lines crossed up.
Gregg C Sengstack (Chairman and CEO)
Sorry, Mike.
Michael Halloran (Analyst)
No, no, no, it would have been on our end, not your end. So a couple questions. First, maybe just some initial thoughts on the distribution side, how that integration is going so far. A few, you know, the comments were that it's ahead of expectation. Maybe just a little bit more on what you've done so far and kind of what the next steps are.
Gregg C Sengstack (Chairman and CEO)
Sure, Mike. Initially, obviously, we've got costs out that we're not going to be, you know, private ownership costs out of the business. We're on four separate, actually, three separate platforms right now from an ERP point of view, so we wanted to get some level of reporting across the platforms into the corporate office in Denver. We're working on standardizing, you know, the operations platform, standardizing logistics, getting all the employee benefit plans in line. Just, you know, the typical things you'll do when you're integrating acquisitions. In this case, though, we're integrating them into each other as opposed to into Franklin. So, those processes are all underway. So we look at, you know, being on a, you know, standard platform, an ERP system, say, within 12 months.
We look at having all the benefit plans lined up by the end of the year. We look at getting, you know, greater visibility to the inventory levels because this is all about managing inventory and working capital. Your operations team is doing that as we speak. So those are the kinds of activities, and the cost out was really on the side of kind of, you know, the owner costs of, if you'd see them typically in a private business, rationalizing those on a relatively quick basis so that we could get to a running, operating expense on a go-forward basis.
Michael Halloran (Analyst)
No, that makes sense. The, the margins were certainly an encouraging start there. Any, any thoughts on, on the channel now that you've had it in the fold for a few months? What, what are your channel partners, the, the customer base saying at this point? Any, any worries on the competitive side yet?
Gregg C Sengstack (Chairman and CEO)
Well, you know, I think you, you see the, the range of responses that we talked about in, in our earlier call. I mean, you, you see, you know, a range of response from, "Okay, we, we see there's a new owner, and, and the same face is calling on me, so nothing's changed from that point of view," to more of a wait-and-see attitude. We'd say that generally, if you look at the first half of the year, buying patterns of all Franklin Electric's manufacturing customers are pretty much similar to prior years. We've had, you know, a couple situations where we've had suppliers to Headwater choose not to continue to supply. That's opened up other opportunities for us with other suppliers, which we're pursuing and have pursued.
You know, it's kind of, I think, the normal start of activity and not much different than what we described in our last call.
Michael Halloran (Analyst)
Okay, and that makes sense. And then, strong water trends in North America in the quarter. Any sense for inventory through the channel? Probably in a pretty fair spot at this point?
Gregg C Sengstack (Chairman and CEO)
.Yeah, I'd say that, you know, this hot, dry weather, as you've followed Franklin for a number of years, I mean, when it dries out, demand goes up pretty quickly, and we're responding. But I suspect that channel inventories are reasonable to maybe a little low. And as you know, as people are addressing, they're now in the middle of the season. We came off a really wet start to the year. People had strong inventories last year, at the end of last year, at least of Franklin product. So they're coming in, and everyone feels pretty good. And then, you know, when the heat comes on, so does demand.
Now, not so much in the California market because they have so much surface water that they're using, which is basically kind of for free. So, you know, the California market's going to continue to rely on surface water until those surface water rates are depleted. Then we'll start seeing more shift to groundwater. You know, again, we expect kind of in the back half.
Michael Halloran (Analyst)
Last one for me, then on the dewatering side. Good to see that turning the corner. What are the thoughts on sustainability on that side?
Gregg C Sengstack (Chairman and CEO)
Yeah, we're really pleased with the level of backlog and, touch wood, it's been doing really nice. We're seeing it again across both the gas field service. And I think after, you know, a couple of years of, you know, not buying much capital equipment, there's a need for new pumps, there's a need for repair parts, which is good for us. So that's going well. We're seeing, and we've increased our reach within the North American market and other channels, and then internationally, the business has picked up. So, we're encouraged. But, one quarter is not a trend make, but the backlog has been lengthening out, and, we're very optimistic with that business.
Michael Halloran (Analyst)
Great. Appreciate the time, guys.
Gregg C Sengstack (Chairman and CEO)
Yes, sir. Thanks, Mark.
Operator (participant)
Thank you. And our next question comes from the line of Edward Marshall with Sidoti & Company. Your line is now open.
Edward Marshall (Analyst)
Hey, guys. Just wanted to follow up with that distribution margin for a second. First, I wanted to see if that was a clean number. Was there any step up in inventory adjustments from the consolidation? But secondly, as you've discussed outperforming expectations, I'm curious, is this sustainable or are you overearning the quarter?
Gregg C Sengstack (Chairman and CEO)
Yeah, we think it's sustainable, Ed. This is John Haines. There's really no, you know, accounting adjustments, per se, in that $3.7 million of OI that the distribution segment's reporting. I guess what I would make sure we all understand, though, is that, you know, this is a U.S. primarily groundwater business, and as Gregg just said, you know, it is sensitive to weather swings, and it is seasonal, excuse me. So the second quarter of every year probably is going to be the best quarter, profitability-wise, for that segment. Although the third quarter could certainly be good as well. So, there's really nothing unusual, I would say, about the reported result.
You know, I would just remind us all, it is the second quarter, and it will be sensitive to weather fluctuations.
Edward Marshall (Analyst)
Okay. So are you saying, just, just to kind of read between the lines here, are you saying it's a low single-digit margin in a normalized, kind of, unseasonal, unseasonally strong business, quarter?
Gregg C Sengstack (Chairman and CEO)
Yeah. Well, we said initially and continue to believe that the distribution segment should be a 4%-6% operating income margin business. I think you know that's what we're trying to achieve for the long term. That 4%-6% operating income margin business will then translate into a return on invested capital that we think is adequate. You'll see quarterly fluctuations in that operating income margin like you do in our water systems segment. But that's what the long-term objective and goals are for distribution.
Edward Marshall (Analyst)
Got it. John, I apologize. I missed what you said on the tax rate in your prepared remarks. Could I ask you to repeat that?
Gregg C Sengstack (Chairman and CEO)
Yeah, the tax, the tax rate in the quarter was nineteen percent. I, you know, we have been kind of talking about something in the 26%-27% range. The discrete items that lowered that in the quarter were gain, this gain that we're talking about on the, on, acquiring the controlling interest in the distribution segment entities. That drove some tax benefit. We also had some uncertain tax positions in foreign jurisdictions that we were able to free up in the quarter. That drove some of the benefit as well. So effectively, we kind of went from mid-twenties, call it, Ed, both in our guidance and the prior year to kinda, high teens, 19%.
You know, we think that mid-20s number is the best number to use right now for the balance of 2017.
Edward Marshall (Analyst)
Got it. And, the cash flow quarter, generally, you know, 2Q is a really good free cash flow quarter. This is kind of not stacking up to the prior few. I'm curious, is this recognition of cash with the inventory adjustments for water to distribution? Is that the right way to think about maybe what happened on the Q on the cash for the quarter?
Gregg C Sengstack (Chairman and CEO)
No, I don't, I don't think those, those adjustments that you're referring to, Ed, really had a big impact on the cash flow at all. You know, when you look at our, our cash flow statement, what you see is kind of a change in receivables and inventories. The pieces are a little bit different, but they're basically about the same as they were last year. Our accounts payable, accrued expenses are much lower this year than they were last year. Some of that's just timing of inventory receipts, timing of, of other compensation payments that we made throughout the year. The other part of this is some of our tax liabilities. You know, to get some of these discrete tax benefits that we take, you know, we have tax liabilities, but then those liabilities go away once we take that benefit.
So, that's part of what you see below, or not below the line, but in the other section of that cash flow section. As Gregg pointed out, I think our biggest opportunity is inventory management, not only in distribution, but in our water systems and fueling systems segments as well. We continue to push on a better working capital and inventory management.
Edward Marshall (Analyst)
Got it. Thanks very much.
Operator (participant)
Thank you. Our next question comes from the line of Ryan Connors with Boenning and Scattergood. Your line is now open.
Ryan Connors (Analyst)
Great, thank you. I had a question on the distribution side, and I recognize this is an issue you can't talk too much about. But, you know, in terms of the pipeline and your strategy there on the forward integration, just still trying to get an idea of whether, you know, Headwaters was more of a one-off and a situation that opportunistically made sense, or whether this is something that you're really going to push to, you know, we should expect that business to grow through further acquisition going forward. Can you just give us an update on your thinking there, Greg?
Gregg C Sengstack (Chairman and CEO)
Yeah, sure, Ryan. Thanks for the question. You look at it again, when we first talked about Headwater. These first three significant distributors all had transition challenges from one generation to the next. And, you know, 5 of the 6 leaders I pointed out were all over the age of 65 and looking for an exit strategy. So it was important for us to have stability there. And so you could look at that as being a starting point. That said, we've had, you know, several people contact us. We are, you know, evaluating this model as we go.
You know, the first job for the team made it very clear with Dean and his team is we need to get these businesses integrated and hit the ROIC numbers that we modeled. Based on that performance, we'd be encouraged to do more. And so we're going to see how this unfolds. We think it's a very interesting additive strategy to our manufacturing plan in a market we know very well, where there are a number of privately held companies, where there's not necessarily a logical successor or whether there's the capital in the family to create a transaction. So we see this as being a new platform. We see it as being a platform that needs to prove itself out.
We're confident it'll do that, and as it does that, we will look at other opportunities.
Ryan Connors (Analyst)
Okay, well, that's helpful. And then my other one was, I may have missed it, but I didn't hear you say too much about ag, in general, in terms of the quarter and the outlook and the order board there. Can you just give us an update on that particular market?
Gregg C Sengstack (Chairman and CEO)
Yeah, Ryan. You know, we, you know, the big story in the United States, as we talked about U.S. and Canada, was on the water systems side than surface. You know, groundwater was up 5% within that. We didn't really see a lot of increase in ag. Ag was pretty flat to slightly down. Most of the benefit we saw in groundwater in the U.S. and Canada was related to residential systems. So, we, you know, now some of this may be, you know, the way inventory is built in the channel and then runs down, but the second quarter was not a particularly strong ag quarter for Franklin.
Ryan Connors (Analyst)
Got it. Okay. Thanks for your time.
Operator (participant)
Thank you. Our next question comes from the line of Ryan Cassil with Seaport Global. Your line is now open.
Ryan Casill (Analyst)
Hey, good morning.
Gregg C Sengstack (Chairman and CEO)
Good morning. Hi, Ryan.
Ryan Casill (Analyst)
Just, sorry if I missed this, but in the water system side, I think, you know, we were targeting 5%-7% growth for the full year, you know, even with the slower start in Q1. You know, just looking at first half results now and the tougher comps in the second half, is that still what we're targeting, or was there a change within the guidance on some of those underlying assumptions?
Gregg C Sengstack (Chairman and CEO)
Ryan, we still think we're going to be able to hit the lower end of that, or we're optimistic we're going to hit the lower end of that. We did have a slow start. It's principally offshore. Robert Stone's here. He can give you a little travelogue around the world of how the first half unfolded and how we're looking at the second half in our international markets, because that'll be the driver of that, the achievement of that original guidance. Robert?
Robert P Stone (SVP and President, International Water Systems)
Sure. The very mixed bag around the globe. Southeast Asia, for us, was off. Gregg, I think, mentioned in his comments about the weather change there. Going forward, that looks to be a continued headwind for us. Europe is mixed, get some help at times from currency. Brazil is and South America generally are struggling economically. So we think we're going to have some continued challenge there as well. Some bright spots, though, we were actually up in a couple of areas, including Africa and parts of the Middle East and Near East were a little bit better than last year. Southeast Asia, if I go back to that, was also a very tough comp against prior year.
Probably, I mean, our forecast would say that the back half of the year we're going to be. We'll be not as bad off in Southeast Asia in the back half of the year as we were in the first half.
Ryan Casill (Analyst)
Okay. Okay, thanks for the color there. And then on Headwater, the profitability was great to see in Q2. I had thought, you know, we were targeting sort of 4%-6% margins, 2018 and beyond, and, and, you know, 2017 was going to be about break even. Have you changed the thinking there, where we could be or should be above that for the remainder of the year? Are you thinking there could be some offset that still keeps us, you know, flat? Any thought there?
Gregg C Sengstack (Chairman and CEO)
Yeah. Again, we're in the summer season in the US, so the second and third quarters, you're going to get the leverage on operating expenses. You know, we're going to that'll back off in the fourth quarter and first quarters. Again, we're going to be in break even for the quarter, or excuse me, for the year. That includes the fact that we're deferring some profit inventory and some higher interest expense. I think this time we're a little more confident it's going to be, you know, above that number. But, you know, 4-6 has been the number we've talked about, and with a return on invested capital pre-tax of in the mid-teens. That's those are the goals. John, you want to add anything to that?
Yeah, I don't think you'll see 6.3% on our margins in the back half of the year. Yeah. So, you know, to Gregg's point, I don't think our view of this has really changed. Maybe doing some of the integration a little bit quicker, but you know, you would always expect the second quarter, as I said earlier, to be good. I don't know that, you know, for 2017 profitability, our thoughts have really changed that much, margin-wise.
Ryan Casill (Analyst)
Okay. Okay, thanks. Appreciate it. And then last one, just looking at the fueling system side and understanding there's a little bit different, you know, some differences in the offering. But, you know, one of your competitors had commented that, you know, there was going to be a delay with the EMV cycle, particularly in the developed markets. And yet you guys don't seem to be, you know, that seems to be where you're stronger. And they were, you know, maybe stronger internationally, where you guys were weaker. Could you just comment on sort of some of the competitive dynamics there you're seeing, and whether or not you expect an impact from some of those EMV dynamics?
Gregg C Sengstack (Chairman and CEO)
Yeah, to be clear, we actually were stronger internationally in the quarter than domestically, although both were up. But EMV does have some impact. For us, it's probably a slight positive, with the delay, that's allowing people to do other upgrades in their gas stations on types of products that we sell. You know, so again, our U.S. business was up, you know, about 5%, U.S. and Canada, and then internationally, stronger than that to get the 8% organic in the quarter. We're really seeing good strength across the globe. I mean, we had really nice results year-over-year in Europe, Africa, the Middle East. Asia was up a little bit. China was up a lot.
And it's up because of the initiative underway in China to re-pipe fuel stations in China. We're always a little cautious with China because these things can turn on and turn off pretty quickly, but it looks to be a multi-quarter, if not multi-year initiative. Our margins on products like piping and containment and hardware are lower than our margins on electronics and pumping systems. That explains in part the lower margins in our results compared to last quarter, but still—I mean, last year, but still, you know, very strong in the 24% range. So, we've seen with EMV, you know, we've had continued good single digit organic growth in the U.S. with EMV being delayed.
Internationally, we're seeing a nice rebound and strengthening in all the major theaters for us with the exception of Latin America.
Ryan Casill (Analyst)
Okay, great. Thanks for the call.
Operator (participant)
Thank you. Our next question comes from the line of Matt Somerville with Olympic Global Advisors. Your line is now open.
Matt Summerville (Analyst)
Thank you. Good morning. I want to ask a couple of follow-up questions just on the Headwater group of businesses. Greg, I thought it was interesting, you mentioned that some of Headwater's suppliers have decided that they no longer want to do business with that entity. I'd be curious as to what you think their logic and rationale behind that might be. And then conversely, have you had other distributor customers that you don't own, come back to Franklin and say the same thing? "We don't want to do business with Franklin anymore." And I guess, at the end of the day, what does all of that net out to? Nothing, a slight positive, a slight negative? What's your view there?
Gregg C Sengstack (Chairman and CEO)
Yeah, Matt, I'm not in a position to comment about other companies' strategies for why or why not they want to continue to do business or not do business or expand their relationship with Headwater. You know, it's interesting, specifically, as Xylem decided to discontinue supplying Headwater, we got that news in early May. And the interesting thing there is we had 10 other suppliers step up to the plate to replace them. So, you know, Franklin had to drop and replace them for about a third to 40% of that product line. And we have a number of other suppliers that have products that heretofore, in that case, Western Hydro wasn't able to really promote or pursue because they had this relationship with Xylem; now they can.
We're viewing it as being, you know, maybe in the short term, there'll be a little bit of disruption, although we're not seeing a whole lot. Longer term, it's going to be good for us because Headwater can have more options to supply to the end user. We have not heard of anything from our other customers or people saying they're not going to do business with us. That I can report on, but I really can't get into the strategies of other companies.
Matt Summerville (Analyst)
And then with respect to the cost synergy side of the equation, are you able to put a number and a time frame on how much you anticipate to be able to pull out through integration, consolidation, et cetera, of these entities? And then similarly, Greg, maybe moving over to the top line with the acquired businesses, what's your sort of trajectory on being able to start to see, which are always harder to get, top-line synergies as a result of these moves?
Gregg C Sengstack (Chairman and CEO)
Yeah, Matt, I'll take the second portion of your question first, and you're exactly right. Top-line synergies are tough. And you think about acquisitions, often you think about integrating them into your existing base business. Here, we're creating a new platform, and so the synergies we're looking for on the top line are really kind of across these different distribution businesses, some of which have specialties in on areas like turf or commercial, or water treatment, and others didn't have those types of expertise. That's where we see some nice cross synergies. I don't want to put a number on it to your point, because they're really can be elusive. But, we're optimistic that there's quite a bit of opportunity on the top line.
With respect to OpEx synergies, I'll turn the call over to John, who will do that, take you through that math, to the degree that we have visibility to it. John?
John J Haines (CFO)
Yeah, Matthew, one of the challenges of, you know, trying to give some targets on any kind of synergy, synergy. So you have top line, as Greg's describing, also sourcing, potential for sourcing synergies, OpEx synergies. You know, we're dealing with an historical basis here that, you know, where companies that were run in a very different way than the way we're going to run these companies. So it's a little bit hard for us to capture a range of numbers and say, "Okay, here's what we think they are." That's why we're going to stick with the 4-6. You know, the 4%-6% on operating income margin, we think is the way to think about the profitability of this. There are some synergy assumptions in that, as Greg said, so far, so good on those synergy assumptions.
But, you know, I don't, I don't want to get out in front of ourselves here until we get through, you know, a few quarters of operating this entity and kind of get some history of our own behind us, where we can really understand the cost base, really understand the sourcing processes, as an example, and establish a better baseline that is a Franklin baseline, and not one that we're relying on, you know, kind of what the past was, which was... You know, could have been anything, really. So the 4-6 is, I think, you know, an appropriate, you know, guidance measure right now on profitability for that segment, and that's what we'll stick to for the, for the moment.
Matt Summerville (Analyst)
And then, lastly, maybe just a question on pricing versus raw material costs. Can you comment on what your sort of pricing realization, expectation is in the water business, or what you've seen thus far in 2017? And maybe if you could bifurcate that North America versus International, and then the same question with respect to fueling overall.
John J Haines (CFO)
Yeah, the achieved second quarter pricing was similar in both segments, water and fueling. Matt, it was about 175 basis points. Our expectation is closer to 200 in both segments. We are seeing more raw material inflation year to date in 2017 than we saw last year. But we are also seeing some inflation on other variable components. We mentioned freight as an example, as fueling chases these opportunities in China, you know, getting the supply chain straight there and making sure that we're optimizing that, an important part of their margins. But overall, I would say we're slightly behind on pricing.
Generally, the international units are ahead, and the US unit, water unit anyway, is a bit behind, is the way we think about that, geographically.
Matt Summerville (Analyst)
Understood. Thank you.
Operator (participant)
Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question at this time, please press star one on your telephone keypad. Again, that is star one to ask a question. Our next question comes from the line of Jose Garza with Gabelli & Company. Your line is now open.
Jose Garza (Analyst)
Hey, good morning, guys.
John J Haines (CFO)
Morning, Jose.
Jose Garza (Analyst)
I guess you just kind of answered my question, but I guess if you want to just give context and I guess in terms of the fueling segment, you know, relative to the water segment, guys, and just in terms of the pricing.
John J Haines (CFO)
Yeah, you know, the pricing, as I said, they, they've achieved about 175 basis points, Jose, for the quarter. And they have some raw material inflation that they're facing into as well. The bigger issue is, as Gregg pointed out on the fueling margins in the quarter, and, you know, I don't... We've said all along, you know, to not expect high 20s kind of margins out of the fueling segment. It's really more about product and geography mix. We had a really good product mix in the second quarter of 2016, and it kind of drove that 27%. We have a decent mix in 2017, and it's kind of lowered it down to that 24% range this year.
So, you know, more fuel management systems is always good. We have less fuel management systems than we had last year, as an example. So the fueling margin, yeah, I wouldn't say we're real concerned about price, commodity, inflation there. It's, it's really more about, geography and, and product mix right now.
Jose Garza (Analyst)
Okay, so I guess, do you expect that to pick up a little bit more in the second half relative to water?
John J Haines (CFO)
On price realization?
Jose Garza (Analyst)
Yeah.
John J Haines (CFO)
Well, yeah, I would expect fueling price realization to be ahead of water. Yes.
Jose Garza (Analyst)
Okay. Thanks very much, guys.
John J Haines (CFO)
Thank you.
Operator (participant)
Thank you, and I'm showing no further questions at this time. I would now like to turn the call back to Mr. Gregg Sengstack, Chief Executive Officer, for any closing remarks.
Gregg C Sengstack (Chairman and CEO)
We thank you for joining us on this second quarter conference call and look forward to speaking with you at the end of our third quarter. Have a good day.
Operator (participant)
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.