Business context and reporting period
Franklin Electric Co., Inc. filed this unaudited Form 10-Q for the quarter ended July 4, 2015. The company operates primarily through Water Systems and Fueling Systems. Comparisons below are with the quarter and six months ended June 28, 2014.
Financial results and key metrics
| Metric | Second quarter 2015 | Six months 2015 |
|---|---|---|
| Net sales | $247.4 million, down 13% | $473.2 million, down 8% |
| Gross profit / margin | $80.2 million / 32.4%, versus 34.9% | $151.7 million / 32.1%, versus 34.4% |
| Operating income | $23.2 million, down 41% | $39.0 million, down 40% |
| Net income attributable to Franklin Electric | $16.2 million, versus $27.1 million | $36.0 million, versus $44.0 million |
| Diluted EPS | $0.33, versus $0.55 | $0.74, versus $0.90 |
| Operating cash flow | Not separately provided | $7.0 million, versus cash use of $26.2 million |
For the first half, sales excluding acquisitions and currency effects declined 4%; the comparable second-quarter decline was 8%. Water Systems drove most of the reported sales and operating-income deterioration. First-half adjusted diluted EPS, a non-GAAP measure, was $0.67 versus $0.95; second-quarter adjusted diluted EPS was $0.35 versus $0.60.
At July 4, cash was $63.0 million and total debt was approximately $225.3 million, compared with $177.8 million at January 3; net debt was approximately $162.3 million. Current assets were $489.5 million and current liabilities $160.6 million. First-half capital expenditures were $9.8 million; dividends paid were $9.8 million. Cash and cash equivalents increased $3.9 million during the half.
Material changes versus prior period
- Water Systems second-quarter sales fell 15% to $191.6 million; Fueling Systems sales declined 3% to $55.8 million. For the first half, sales declined 10% in Water Systems and 2% in Fueling Systems.
- Management attributed lower Water Systems sales particularly to reduced North American oil-and-gas-related mobile dewatering demand, unusually wet conditions, customer inventory reductions, and delayed HVAC-season demand. Currency translation reduced second-quarter sales by $22.5 million and first-half sales by $39.1 million.
- Gross margin contracted as lower volume reduced fixed-cost absorption; management also cited higher raw-material costs in the first half. Water Systems adjusted operating margin fell 530 basis points for the first half, while Fueling Systems’ adjusted margin was flat.
- First-half operating cash flow improved year over year, with management citing lower working-capital build than in 2014. Investing cash use also declined, reflecting lower acquisition and capital spending.
- Other income included a $2.7 million first-quarter gain from settling the Pioneer Pump share-purchase liability. The six-month reported effective tax rate was about 5%, including discrete tax benefits; management’s rate before discrete items was about 27%.
Outlook, commentary, risks, and unusual items
- Management expects the ongoing needs for operations, capital expenditures, pension contributions, dividends, and debt service to be funded by cash, operations, and available credit. It projected an approximately 25% effective tax rate after discrete items for the second half of 2015. No specific sales or earnings guidance was provided.
- The company expects approximately $19.4 million of charges for the Wittlich, Germany manufacturing realignment, which began in 2014 and is expected to finish by the end of 2016. First-half 2015 restructuring expense was $1.2 million; the recorded restructuring reserve was $4.3 million.
- Debt facilities include financial covenants requiring maximum leverage of 3.50:1 and minimum interest coverage of 3.00:1. New York Life notes issued in May totaled $75 million, bear a floating rate, and mature in 2025. Available borrowing capacity at quarter-end included $75 million under the New York Life agreement, $100 million under the Prudential agreement, and $142.2 million under the revolver.
- Currency movements materially affected reported sales and comprehensive income; first-half foreign-currency translation loss was $28.2 million before tax. Key risks cited include economic and currency conditions, demand and weather, raw-material costs and availability, competition, acquisitions, and litigation or regulatory actions.
- The California Air Resources Board appealed a prior complete defense verdict in the nozzle-related case; oral argument was scheduled for August 25, 2015. The company said the matter had not affected product certification or sales. Management considered other ordinary-course claims unlikely to cause a material adverse effect.
- After quarter-end, the board authorized an additional 3 million-share repurchase plan. The company had repurchased 72,900 shares for approximately $2.5 million during the quarter.
Important facts for investors to verify
- Whether North American Water Systems demand, customer inventory reductions, and oil-and-gas exposure recover, and how those trends affect volume and margins.
- Whether currency translation and raw-material costs continue to pressure sales and gross margins.
- Compliance with debt covenants and the effect of higher debt and floating-rate borrowing on interest costs and liquidity.
- The sustainability of cash generation after working-capital movements, capital spending, dividends, and share repurchases.
- The impact of discrete tax items: the filing identifies a $4.8 million Pioneer-related tax benefit excluded from adjusted results, alongside other tax benefits and the Pioneer settlement gain.
- Progress and remaining costs of the European manufacturing realignment, and any developments in the CARB appeal.