Franklin Electric Co., Inc. — Q3 2018 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2018, compared with the same periods in 2017. Franklin Electric operates Water Systems, Fueling Systems and Distribution businesses.
Financial results and key metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $341.9 million | $311.1 million | $981.5 million | $836.7 million |
| Gross profit | $113.0 million | $103.8 million | $328.0 million | $282.4 million |
| Gross margin | 33.0% | 33.4% | 33.4% | 33.8% |
| Operating income | $40.1 million | $32.0 million | $103.3 million | $84.8 million |
| Net income attributable to Franklin Electric | $30.0 million | $24.5 million | $81.7 million | $70.1 million |
| Diluted EPS | $0.63 | $0.52 | $1.72 | $1.48 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $60.4 million | $40.4 million |
Balance sheet and liquidity at September 30, 2018: Cash and equivalents were $41.2 million; current assets were $589.8 million and current liabilities $265.8 million. Total debt was approximately $217.0 million, comprising $122.8 million current and $94.2 million long-term. The company had $205.3 million of available capacity under its $300 million revolving credit agreement, after $89.1 million drawn and $5.6 million of letters of credit. Management said liquidity was adequate for projected needs. About $34.2 million of cash was held in foreign jurisdictions for foreign operations.
For the first nine months, investing cash outflow was $56.4 million, including $42.1 million for acquisitions and $15.1 million for capital spending. Financing cash outflow was $28.5 million, including $16.96 million of dividends, $12.08 million of share repurchases, and net debt repayments. Cash declined $26.1 million from year-end 2017 to $41.2 million.
Material changes versus comparable periods
- Q3 sales rose 10% and nine-month sales rose 17%. Management attributed growth to acquisitions, higher volume and pricing; currency translation reduced Q3 sales by about 4% and nine-month sales by less than 1%.
- Acquired businesses contributed $13.4 million of Q3 sales and $86.2 million of nine-month sales. Distribution growth was especially acquisition-driven; its organic sales rose about 2% in Q3 and 4% year to date.
- Operating income increased 25% in Q3 and 22% year to date. Fueling Systems and Distribution contributed to the improvement; Water Systems operating income was nearly flat in Q3. Gross margin declined 0.4 percentage points in both comparisons, with management citing raw-material inflation and business/product mix.
- Q3 net income included a $1.6 million foreign-exchange loss, versus a $0.2 million gain in Q3 2017. Nine-month foreign-exchange results were a $3.2 million loss versus a $0.3 million gain. Nine-month 2017 other income included a $5.2 million gain on previously held equity investments, making that comparison less favorable for 2018.
- The nine-month effective tax rate fell to 11.9% from 15.4%, primarily reflecting the Tax Act, an estimated $3 million FDII benefit, and a $5.4 million release of a state tax valuation allowance. The company issued $75 million of fixed-rate notes at 4.04%, due 2025, and used the proceeds to repay variable-rate debt.
Outlook, commentary, risks and unusual items
- Management expected 2018 full-year tax expense to produce an effective rate of 13%–17% after discrete items; it separately estimated about 20% before discrete items. The filing notes that Tax Act accounting remained provisional and was expected to be completed in 2018.
- For the remainder of 2018, management expected price increases of about 250–300 basis points to offset projected inflation, including tariffs. In Q3, raw-material inflation slightly exceeded achieved price increases; year to date, management said pricing had offset inflation.
- Q3 acquisitions included substantially all assets of Midtronics’ Stationary Power Division and all of Industrias Rotor Pump in Argentina; their combined preliminary purchase price was about $36 million. Earlier 2018 acquisitions included Valley Farms Supply. Management said the acquisitions’ reported-period results were not material individually or in aggregate.
- Key stated risks include foreign-exchange and regional economic conditions, demand and weather, raw-material costs and availability, tariffs, pricing execution, competition, supply constraints, acquisition integration, litigation and regulatory actions. The filing added risks relating to IT disruption, cybersecurity, data-protection compliance and the ongoing multiyear ERP implementation.
- The company was in compliance with financial covenants at September 30, 2018. A material scheduled debt item is the $30 million Prudential principal installment due April 30, 2019; the debt maturity table shows $122.8 million of total debt due within one year. Management stated it expected operating cash, available credit and other resources to fund requirements.
- Other notable items: $0.3 million Q3 loss from writing off a tax indemnification asset; $0.3 million of nine-month restructuring expense in Distribution, with $1.0 million total restructuring expense; and $4.1 million of commitments, primarily for capital expenditures and raw materials. Management considered ordinary-course legal claims defensible or resolvable without material financial effect.
Investor facts to verify
- How much future growth and profitability depends on acquired businesses versus organic demand, particularly in Distribution.
- Whether announced pricing actions offset raw-material inflation and tariffs without weakening demand or margins.
- The timing and funding of near-term debt maturities, including the 2019 Prudential payment, and the company’s access to revolving-credit capacity.
- Final 2018 tax effects of the Tax Act, FDII provisions, valuation allowances and other discrete items.
- Exposure to currency movements and economic weakness in Brazil, Asia Pacific and other international markets, plus progress and execution risks in the ERP conversion.