Franklin Electric Co., Inc. — Q3 2017 Form 10-Q
Reporting period: Third quarter and nine months ended September 30, 2017, compared with the corresponding periods ended October 1, 2016. Unaudited interim results; amounts below are in millions except per-share data.
Financial highlights
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $311.1 | $239.8 | $836.7 | $710.3 |
| Gross profit | $103.8 | $85.5 | $282.4 | $250.4 |
| Gross margin | 33.4% | 35.6% | 33.8% | 35.3% |
| Operating income | $31.8 | $31.8 | $84.6 | $85.6 |
| Net income attributable to Franklin Electric | $24.5 | $23.7 | $70.1 | $61.1 |
| Diluted EPS | $0.52 | $0.50 | $1.48 | $1.28 |
- Sales growth: Q3 sales rose 30%; management attributed $19.3 million, or about 8%, to growth excluding acquisitions and currency. Nine-month sales rose 18%; excluding acquisitions and currency, they increased $36.3 million, or about 5%.
- Profitability: Q3 operating income was flat despite higher sales. Gross margin fell 220 basis points in Q3 and 150 basis points year to date, reflecting acquired Distribution sales, product and geographic mix, and higher raw-material costs. Nine-month operating income declined about 1%.
- Cash flow: Nine-month operating cash flow was $40.4 million, down from $70.9 million. Investing cash use was $73.9 million, including $51.8 million of acquisition payments; financing cash use was $14.2 million. Cash declined $44.2 million to $60.1 million.
- Balance sheet and liquidity: Total debt was $229.7 million versus $190.2 million at year-end 2016; cash was $60.1 million. The $300 million revolver had $69.5 million drawn and $225.0 million available after letters of credit. Management said liquidity was adequate for foreseeable needs. $54.6 million of cash was held abroad for foreign operations.
- Other metrics: Total assets were $1,179.5 million and total equity was $700.3 million at September 30, 2017. The company paid $15.2 million in dividends during the first nine months.
Business changes and material items
- Franklin acquired controlling interests in three U.S. groundwater distributors, 2M, DSI, and Western Hydro, for a combined purchase price of approximately $57.4 million. The acquisitions created a Distribution segment and provided a broader U.S. groundwater distribution channel. They contributed $127.2 million in revenue and $2.8 million in net income from acquisition dates through September 30.
- The company recognized a $5.2 million gain from remeasuring its previously held investments in the acquired distributors. This contributed to nine-month other income of $6.8 million. The acquisitions’ preliminary purchase accounting included $34.0 million of goodwill.
- Water Systems Q3 sales increased about 8% organically; Fueling Systems sales rose about 10%, with growth across regions and product lines. Distribution sales were acquisition-related, while management estimated underlying Distribution sales declined about 6%, citing supply-chain disruptions and weak Southeast U.S. end markets.
- Q3 restructuring expense was $1.0 million, primarily related to Brazilian manufacturing realignments. The prior-year quarter included a $1.7 million net restructuring gain, mainly from a property sale.
Outlook, risks, and contingencies
- Management projected a full-year 2017 effective tax rate of 25% to 28% before discrete adjustments. The nine-month reported rate was 15.4%, reduced by discrete tax items, including stock-based compensation benefits and acquisition-related tax effects.
- No specific revenue or earnings guidance was provided. Management expected cash on hand, operating cash flow, and credit facilities to fund operations, capital expenditures, pension obligations, dividends, share repurchases, and debt service.
- Risks cited include economic and currency conditions, demand and weather, competition, distribution-channel changes, supply constraints, raw-material costs, acquisition integration, litigation, and regulatory actions. Management reported no material changes to the risk factors in its 2016 Form 10-K.
- The company was in compliance with significant debt covenants. It reported ordinary-course legal claims that management believed could be resolved without a material financial effect, $8.7 million of commitments primarily for capital expenditures and raw materials, and a $10.0 million warranty accrual. Actual warranty claims may differ from estimates.
- Adoption of the lease accounting standard was expected to put most operating leases on the balance sheet, with a significant balance-sheet effect; the company said the change would be noncash. Disclosure controls were assessed as effective.
Investor verification points
- Separate acquisition-driven growth from organic growth, and assess the acquired distributors’ underlying sales and margins.
- Track whether gross-margin pressure from mix and material costs persists and whether operating income improves as sales grow.
- Review working-capital needs, especially inventory, and the effect on operating cash flow and debt.
- Verify final purchase accounting, integration performance, and the sustainability of the acquisition-related gain and discrete tax benefits.
- Monitor debt maturities, revolver availability, covenant compliance, and the company’s use of foreign-held cash.