Franklin Electric Co., Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Franklin Electric manufactures and distributes water systems, fueling systems, and related products, including through its Distribution segment. Financial statements are unaudited.
Financial performance and key metrics
- Second quarter: Net sales were $344.0 million, up 13% from $305.3 million. Operating income increased 18% to $40.5 million. Net income attributable to Franklin Electric was $30.5 million versus $29.9 million; diluted EPS was $0.64, unchanged.
- First six months: Net sales were $639.6 million, up 22%; operating income was $63.2 million, up $10.4 million. Net income attributable to Franklin Electric rose to $51.7 million from $45.6 million; diluted EPS increased to $1.09 from $0.97.
- Margins: Q2 gross margin held at 33.7%. First-half gross margin declined to 33.6% from 34.0%. Q2 operating margin was approximately 11.8%, versus 11.2% a year earlier.
- Segment performance: Q2 Water Systems sales rose 6% to $210.4 million, while operating income declined $0.5 million to $32.3 million amid product and geographic mix shifts. Fueling Systems sales rose 21% to $74.1 million and operating income rose 27% to $18.9 million. Distribution sales rose to $79.5 million, including $16.6 million from acquired businesses; operating income was $4.0 million.
- Cash flow: First-half operating cash flow was $5.2 million, compared with $12.5 million used in the prior-year period. Capital expenditures were $11.4 million, making operating cash flow less capital expenditures approximately negative $6.3 million. Investing cash outflow was $19.4 million; financing cash inflow was $17.5 million. Cash increased $2.8 million to $70.0 million.
- Balance sheet and liquidity: Total debt was approximately $262.7 million, versus $226.1 million at year-end 2017; $167.8 million was classified as current. Cash was $70.0 million, including $59.9 million held abroad for foreign operations. The $300 million revolving credit agreement had $160.6 million available after borrowings and letters of credit. The company reported compliance with financial covenants.
- Other metrics: First-half dividends were $0.2275 per share. The company repurchased 46,399 shares in Q2 for approximately $2.0 million.
Material changes versus comparable periods
- Acquisitions contributed $16.6 million to Q2 sales and $72.8 million to first-half sales. Valley Farms Supply was acquired in Q1 2018 for approximately $9.2 million. Distribution sales also reflect prior-year acquisitions, including the Headwater distributors.
- Q2 sales growth reflected acquisitions, higher volume and price across all three segments; currency translation added less than 1%. First-half currency translation added approximately 2% to sales.
- First-half operating cash flow improved from negative $12.5 million to positive $5.2 million, while investing outflows fell from $70.6 million to $19.4 million, largely due to lower acquisition and capital spending.
- Q2 net income was slightly lower despite higher operating income. Prior-year results included a $4.8 million gain on previously held equity investments in acquired distributors; that gain did not recur in 2018. Q2 2018 also included a $1.0 million foreign-exchange loss.
- First-half comprehensive income attributable to Franklin Electric was $27.1 million, down from $61.8 million, principally reflecting a $25.8 million negative currency translation adjustment.
Outlook, management commentary, and risks
- Management expects 2018 effective tax rate after discrete items of 13%–17%; it cited the Tax Act, an estimated $3 million FDII benefit, and a $5.4 million release of a state tax valuation allowance. Tax accounting remained provisional at quarter-end.
- Management expected second-half selling-price increases of approximately 250–300 basis points, partly from announced pricing actions, to offset projected inflation, including tariffs. No specific revenue or EPS guidance is provided in the filing text.
- Management said liquidity was adequate for foreseeable needs. After quarter-end, amendments extended the New York Life and Prudential facilities through July 2021 and increased their maximum/undrawn borrowing capacity, respectively, to $200 million and $150 million.
- Business risks cited include economic and currency conditions, weather and demand, raw-material costs and availability, tariffs, pricing effectiveness, supply constraints, competition, acquisition integration, and litigation or regulatory actions. The filing adds IT disruption, cybersecurity, data-protection compliance, and ERP implementation risks. The global ERP conversion was ongoing; management stated disclosure controls were effective.
- Ordinary-course legal claims were not expected by management to have a material effect. Warranty estimates may differ from actual claims; the warranty accrual was $9.4 million at June 30.
Important facts for investors to verify
- Whether price increases offset inflation and tariffs, and how margins develop after the first-half gross-margin decline.
- Whether working-capital demands—particularly receivables and inventory—continue to constrain operating cash generation.
- Debt maturities, borrowing needs, covenant compliance, and the terms and availability of the amended facilities.
- Organic growth and profitability by segment, including Water Systems mix pressure and Distribution’s lower reported margins and seasonality.
- Final Tax Act accounting and the realized effective tax rate; currency translation and transaction losses; and execution of acquisitions and ERP implementation.