Business context and reporting period
Franklin Electric Co., Inc. filed this unaudited Form 10-Q for the quarter ended October 3, 2015. The company operates primarily through Water Systems and Fueling Systems. Comparisons are with the third quarter and first nine months of 2014; the filing cautions that interim results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $232.5m | $278.1m | $705.6m | $793.9m |
| Gross profit | $76.8m | $89.2m | $228.5m | $266.7m |
| Gross margin | 33.0% | 32.1% | 32.4% | 33.6% |
| Operating income | $27.8m | $32.4m | $66.8m | $97.5m |
| Net income attributable to Franklin Electric | $20.8m | $22.7m | $56.8m | $66.7m |
| Diluted EPS | $0.43 | $0.46 | $1.17 | $1.36 |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $60.3m | $3.5m |
Third-quarter sales fell 16%; management attributed the decline to lower volume and $27.4m of unfavorable currency translation, partly offset by $2.6m from acquisitions. Excluding currency and acquisitions, sales declined about 7%. For the first nine months, sales fell 11%; currency reduced sales by $66.4m and acquisitions added $20.0m, while underlying sales declined about 5%.
Water Systems drove most of the decline: Q3 sales decreased 20% to $173.5m, including weakness in North American mobile dewatering, groundwater and surface-water products. Fueling Systems sales fell 4% to $59.0m; excluding currency and acquisitions, they increased about 1%. Q3 gross margin improved on lower direct material costs and Water Systems mix. The nine-month margin contracted because of higher raw-material costs and lower fixed-cost absorption on reduced sales. Q3 operating margin was 12.0% versus 11.7%; nine-month operating margin was 9.5% versus 12.3%.
Balance sheet, liquidity and capital allocation
At October 3, 2015, cash and equivalents were $84.9m, total debt including current maturities was approximately $243.2m, and net debt was approximately $158.3m. Current maturities and short-term borrowings were $55.1m; long-term debt was $188.2m. Cash was $59.1m at January 3, 2015. Total assets were $1.04bn and total equity was $553.5m.
Nine-month operating cash flow was $60.3m, compared with $3.5m in 2014, reflecting substantially smaller working-capital increases than in the prior period. Investing activities used $18.4m, including $15.5m of capital expenditures; financing activities used $10.1m. Cash increased by $25.8m to $84.9m.
Available borrowing capacity at quarter-end included $125.5m under the revolving credit agreement, $100m under the Prudential agreement and $75m under the uncommitted New York Life agreement. The company reported compliance with financing requirements and said cash, operations and existing credit agreements should adequately fund operating needs, capital expenditures, pension obligations, dividends and debt service. Debt agreements include maximum leverage and minimum interest-coverage covenants.
The company repurchased approximately 1.4m shares during the first nine months and paid $14.4m in dividends. The filing reports a $43.3m common-stock purchase in the cash-flow statement, while MD&A describes $41.3m of repurchases; verify the differing amounts. Q3 repurchases were 1.275m shares for approximately $37.1m. Quarterly dividends per share increased to $0.0975 from $0.0900.
Outlook, management commentary, risks and unusual items
- The filing provides no quantified revenue or earnings guidance. Management stated that liquidity sources were expected to be adequate for anticipated obligations.
- Management cited weak oil-and-gas demand affecting mobile dewatering, agricultural-market weakness, high precipitation and excess customer inventories affecting pumping equipment, and lower North Sea-related tank sales. Currency translation was a significant headwind.
- Q3 reported net income included $1.3m of restructuring charges and other transition/realignment costs. Company-defined adjusted diluted EPS was $0.45 versus $0.50 a year earlier. Nine-month adjusted diluted EPS was $1.12 versus $1.45; the company excluded a $4.8m tax benefit related to the prior Pioneer equity gain from its adjusted measure.
- Nine-month other income included a $2.7m gain from settling the remaining Pioneer Pump Holdings share-purchase liability. The company bought the remaining 29.5% interest for $20.2m and now owns 100% of PPH.
- The effective tax rate was about 21% for Q3 and 12% for the nine-month period; the nine-month rate was about 27% before discrete items. Management attributed the lower reported rate partly to tax benefits and favorable audit resolutions. Foreign earnings are intended to be indefinitely reinvested.
- A European Water Systems manufacturing transfer from Wittlich, Germany, to Brno, Czech Republic, was ongoing and expected to conclude by the end of 2016. Total anticipated costs were approximately $19.4m; $2.5m was incurred in the first nine months of 2015, with $3.6m in restructuring reserves at quarter-end.
- CARB appealed a complete defense verdict in litigation concerning a nozzle component. Oral argument occurred September 29, 2015, and an appellate ruling was pending. The company said the matter had not affected product certification or sales. Management considered other ordinary-course legal matters resolvable without material financial effect.
- Key stated risks include economic and currency conditions, demand and weather, competition, raw-material costs and availability, acquisition integration, litigation and regulatory actions. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether demand in Water Systems’ key end markets stabilizes, and how much sales and earnings pressure persists after separating currency effects from underlying volume.
- Whether gross-margin improvement in Q3 is durable given the nine-month decline tied to raw-material costs and fixed-cost deleverage.
- The company’s debt, covenant headroom and liquidity, including the availability and terms of the uncommitted New York Life facility and upcoming debt maturities.
- The cash-flow statement’s $43.3m share-purchase figure versus MD&A’s $41.3m repurchase description, and the ongoing pace of buybacks.
- The outcome of the CARB appeal, restructuring costs through completion, and the sustainability of the unusually low reported tax rates and related tax benefits.