Franklin Electric Co., Inc. — 2018 Form 10-K
Reporting period: Year ended December 31, 2018. This is an annual filing, not a standalone fourth-quarter filing; unaudited Q4 figures are noted below. Franklin Electric designs, manufactures, and distributes water and fuel pumping systems and related equipment through Water Systems, Fueling Systems, and Distribution segments.
Financial performance and condition
| Metric | 2018 | 2017 |
|---|---|---|
| Net sales | $1,298.1 million | $1,124.9 million |
| Gross profit / gross margin | $432.4 million / 33.3% | $377.0 million / 33.5% |
| Operating income | $132.0 million | $107.2 million |
| Net income attributable to Franklin Electric | $105.9 million | $78.2 million |
| Diluted EPS | $2.23 | $1.65 |
| Cash from operating activities | $128.4 million | $66.8 million |
| Capital expenditures | $23.4 million | $33.4 million |
| Cash and cash equivalents at year-end | $59.2 million | $67.2 million |
| Total debt, including current maturities | $206.4 million | $226.0 million |
| Working capital / current ratio | $324.0 million / 2.3 | $343.2 million / 2.4 |
Sales grew about 15%; excluding acquisitions and foreign exchange, sales increased about 8%. Gross margin declined 20 basis points, mainly from product and geographic mix. Operating income rose about 23%. Effective tax rate was 12.4%, compared with 24.8% in 2017; management attributes the lower rate primarily to the Tax Act, foreign earnings taxed at lower rates, the Foreign Derived Intangible Income deduction, and discrete tax benefits. The 2017 comparison included a $10.2 million net Tax Act expense.
Segments: Water Systems sales were $796.5 million and operating income $112.9 million; Fueling Systems sales were $288.2 million and operating income $70.4 million; Distribution sales were $269.6 million and operating income $3.4 million. Distribution sales included $87.4 million from acquisitions; organic sales increased about 3%.
Q4 2018, unaudited: Sales were $316.6 million versus $288.2 million in Q4 2017; net income attributable to Franklin Electric was $24.2 million versus $8.1 million; diluted EPS was $0.51 versus $0.17.
Material changes and capital allocation
- Acquisitions contributed $99.2 million, or about 9%, to the 2018 sales increase. 2018 acquisitions included Valley Farms Supply, Industrias Rotor Pump, and substantially all assets of Midtronics’ Stationary Power Division. A further groundwater distributor acquisition closed January 2, 2019.
- Fueling Systems sales increased 17%; China sales were about $52 million, up from about $25 million, primarily due to the underground piping upgrade initiative.
- Operating cash flow improved substantially, supported by higher earnings and lower working-capital requirements, partly offset by Tax Act payments. Investing cash outflow was $66.3 million, including $45.0 million net cash paid for acquisitions.
- Financing cash outflow was $66.8 million, including $34.2 million of common-stock repurchases and $22.6 million of dividends. The annual dividend per share increased to $0.4675 from $0.4225.
- The company issued $75 million of fixed-rate senior notes at 4.04%, due in 2025, using proceeds to repay variable-rate debt. Year-end revolver borrowings were $76.3 million, with $218.2 million of available capacity; the company reported compliance with debt covenants.
Outlook, risks, and unusual items
- Management estimated a 2019 effective tax rate of approximately 18%–20%. The filing does not provide clear quantified 2019 revenue or earnings guidance.
- Management said available cash, operating cash flow, and existing credit agreements should fund operating needs, capital spending, pension obligations, dividends, and debt service.
- Key risks include economic weakness affecting housing, agriculture, energy and mining markets; weather and seasonality; raw-material and component cost increases; foreign exchange and geopolitical exposure; competition; dependence on certain suppliers; acquisition integration; product regulation and warranty claims; and cybersecurity/IT and ongoing ERP implementation risks.
- Foreign currency translation reduced 2018 sales by about 1% and contributed to a $34.7 million translation loss in other comprehensive income. The company estimated that a 10% adverse movement in raw-metal prices could reduce gross margin as a percentage of sales by about 1%; a 100-basis-point LIBOR increase would have raised 2018 interest expense by about $1.4 million.
- Goodwill was $248.7 million. The annual impairment test found fair values substantially above carrying values; management stated a 10% decrease in fair-value estimates would not change that conclusion. Adoption of lease accounting in 2019 was expected to add approximately $22 million of operating lease liabilities and corresponding assets, without a cash impact.
- Ordinary-course legal claims were not expected by management to materially affect the company. The filing reports $17.8 million of remaining U.S. Tax Act transition-tax payments and $1.1 million of unrecognized tax benefits; management said up to $0.4 million of tax payments could result from current audits or statute expirations.
Important facts for investors to verify
- How much of sales and earnings growth is sustainable organically versus acquisition-driven, particularly in Distribution and Fueling Systems?
- Whether gross-margin pressure from mix, input costs, and currency persists, and whether price increases can offset it.
- Near-term debt maturities, refinancing plans, covenant headroom, and the effect of interest-rate changes.
- Cash conversion and working-capital trends, including inventory and receivables, as sales grow.
- Execution and integration of acquisitions, ERP implementation, and the expected balance-sheet effect of lease adoption.
- Tax-rate assumptions and the timing of transition-tax payments, audits, and potential tax settlements.