Franklin Electric Co., Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; comparisons are with the second quarter and six months ended July 2, 2016. Amounts are U.S. dollars unless noted.
Business context and results
Franklin Electric operates Water Systems and Fueling Systems businesses. After acquiring three U.S. groundwater distributors, the company added a Distribution segment. Management attributed most of the quarter’s consolidated sales growth to these acquisitions.
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $305.3m | $252.1m | $525.6m | $470.5m |
| Gross profit | $102.8m | $90.7m | $178.6m | $164.9m |
| Gross margin | 33.7% | 36.0% | 34.0% | 35.0% |
| Operating income | $34.2m | $32.7m | $52.7m | $53.8m |
| Net income attributable to Franklin Electric | $29.9m | $24.0m | $45.6m | $37.4m |
| Diluted EPS | $0.64 | $0.50 | $0.97 | $0.78 |
Q2 sales rose 21%; the acquired Distribution businesses contributed $59.1m. Excluding currency effects, Water Systems sales increased about 6% and Fueling Systems about 8%. Q2 gross margin fell 230 basis points, reflecting Distribution’s lower margin and higher direct material costs. For the first half, sales rose 12%, while operating income declined about $1.1m; management cited higher material costs in Water Systems and unfavorable product and geographic mix in Fueling Systems.
Cash flow, balance sheet, and liquidity
- Operating cash flow was negative $12.5m for the first half, versus positive $29.3m a year earlier. The company attributed the decline chiefly to higher inventory, receivables, payments of accounts payable and accrued items, and taxes.
- Investing cash outflow was $70.6m, including $52.3m of acquisition cash payments and $18.6m of capital expenditures. Financing provided $31.6m, primarily from increased borrowings. Cash declined $49.2m to $55.1m from year-end 2016.
- Total debt was $271.4m at June 30, 2017, versus $190.2m at December 31, 2016; $145.4m was classified as current. Revolver borrowings were $111.3m. The $300m revolving facility had $182.7m of available capacity after $6.0m of letters of credit.
- Current assets were $579.6m and current liabilities $279.5m. Cash held in foreign jurisdictions was $44.6m and was intended to fund foreign operations. Management said liquidity was adequate for foreseeable needs; the company was in compliance with debt covenants.
Material developments, outlook, and risks
- The company acquired controlling interests in 2M Company, Drillers Service, and Western Hydro for a combined purchase price of approximately $57.9m, funding the transactions with cash and short-term revolver borrowings. The businesses added $59.1m in revenue and $1.9m in net income from acquisition dates through June 30. Revaluation of prior equity interests generated a one-time $4.8m gain; preliminary acquisition goodwill was $34.4m.
- The effective tax rate was 18.6% in Q2 and 13.4% for the first half, including discrete tax benefits. Management projected a full-year 2017 tax rate of 25%–28% before discrete adjustments. The filing gives no specific revenue or earnings guidance.
- Risks identified include economic and currency conditions, weather and demand, competition, distribution-channel changes, supply constraints and raw-material costs, and acquisition integration. Management said ordinary-course claims and legal actions were not expected to materially affect results or financial condition. Product warranty estimates may differ from actual claims; commitments were $7.2m.
- Management reported effective disclosure controls. A multiyear global ERP implementation is underway. The company expects adoption of lease accounting guidance to put most operating lease assets and liabilities on the balance sheet, with a significant balance-sheet effect; the effect on results was still under evaluation.
Investor facts to verify
- Whether acquisition-driven growth and the new Distribution segment generate sustainable sales and margins, given Distribution’s 6.3% Q2 operating margin.
- Whether inventory and working-capital requirements normalize after the first-half operating cash outflow.
- Debt maturities and borrowing needs, particularly the $145.4m of current debt and acquisition-related revolver use.
- Whether gross-margin pressures, discrete tax benefits, and the $4.8m acquisition remeasurement gain affect future earnings comparability.
- Final acquisition purchase-price allocations and the eventual balance-sheet and operating effects of lease-accounting adoption.