Franklin Electric Co., Inc. — Q1 2015 Form 10-Q
Business context and reporting period. The filing covers the first quarter ended April 4, 2015, compared with the first quarter ended March 29, 2014. Franklin Electric operates Water Systems and Fueling Systems businesses. Results are unaudited; management cautions that quarterly results are not necessarily indicative of full-year results.
Key financial results
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $225.7 million | $231.4 million | Down $5.7 million, about 2% |
| Gross profit / gross margin | $71.5 million / 31.7% | $78.1 million / 33.8% | Down $6.6 million; margin down 210 basis points |
| Operating income / margin | $15.9 million / 7.0% | $26.0 million / 11.2% | Down $10.1 million, about 39% |
| Net income attributable to Franklin Electric | $19.8 million | $17.0 million | Up about 16% |
| Diluted EPS | $0.41 | $0.35 | Up $0.06 |
| Operating cash flow | $(21.8) million | $(35.4) million | Cash use improved by $13.6 million |
Reported earnings included significant non-operating and tax effects. Management reported adjusted net income of $15.2 million and adjusted diluted EPS of $0.32, versus $16.9 million and $0.35, respectively, in Q1 2014. The 2015 adjustment primarily removes a $4.8 million Pioneer-related tax benefit, as well as restructuring and other items.
Cash and equivalents were $69.6 million at quarter-end, compared with $59.1 million at January 3, 2015. Total debt was $246.4 million, including $103.2 million classified as current and $143.2 million long-term. Current assets were $499.6 million and current liabilities were $221.5 million. The company had $69.9 million drawn on its $150 million revolving credit facility, with $75.1 million of capacity remaining after letters of credit; it also disclosed $50 million of borrowing capacity under its Prudential Agreement.
Material changes and operating performance
- Reported sales declined primarily because foreign currency translation reduced revenue by $16.5 million, partly offset by $8.9 million of acquired-business sales. Excluding acquisitions and currency, sales increased about 1%.
- Water Systems sales were $179.2 million, down about 3%; excluding acquisitions and currency, they were flat. U.S. and Canada sales declined about 10%, including a roughly 50% drop in mobile pumping equipment sales, attributed mainly to weaker oil and gas demand. Latin America grew 21% reported, while Europe declined 11% reported, but rose about 15% excluding currency.
- Fueling Systems sales were $46.5 million, down about 1% reported and up about 5% excluding acquisitions and currency. Segment operating income increased to $9.6 million from $9.1 million; adjusted margin was 21.1%, up from 19.7%.
- Water Systems operating income fell to $19.4 million from $29.2 million. Management cited currency effects, lower Pioneer-branded oil-and-gas equipment sales, higher fixed and raw-material costs, and increased U.S. promotional activity.
- Gross margin declined as currency, sales mix and costs weighed on results. Lower direct labor and variable costs provided a partial offset. SG&A rose 6% to $55.2 million, including $2.0 million from acquired businesses.
- Operating cash use remained seasonal, but improved from the prior-year quarter, mainly due to higher receivables collections. Investing cash use was $7.8 million, including $4.2 million of capital expenditures and $3.6 million for acquisitions. Financing provided $43.4 million, including increased revolver borrowings and payment for the remaining Pioneer Pump shares.
Outlook, risks and unusual items
- The filing gives no full-year revenue or EPS guidance. Management projected a second-quarter tax rate of about 27% before discrete items, below the 35% U.S. statutory rate, mainly due to foreign earnings and tax credits. Management said operating needs, capital expenditures, pension obligations, dividends and debt service are expected to be funded by cash, operations and existing credit facilities.
- In Q1, Franklin acquired the remaining 29.5% of Pioneer Pump for $20.2 million, bringing ownership to 100%. Settlement of the related share-purchase liability generated a $2.7 million gain; the transaction also produced material tax benefits. These items boosted reported results, while adjusted EPS declined year over year.
- The company’s European manufacturing realignment, including moving Wittlich, Germany manufacturing to Brno, Czech Republic, is expected to conclude by the end of 2016. Total charges are estimated at about $19.4 million; $0.5 million was recorded in Q1 and $6.4 million remained in restructuring reserves at quarter-end.
- Foreign currency movements, weaker oil-and-gas demand, raw-material costs, price increases, regional economic conditions, market demand, acquisition integration and regulatory or litigation matters are identified risks. A California air-regulator appeal remained pending; the company had prevailed at trial, and stated that the matter had not affected product certification or sales. Management believes other ordinary-course claims can be resolved without material adverse effect.
- Debt agreements include a maximum leverage ratio of 3.50 to 1.00 and minimum interest coverage ratio of 3.00 to 1.00. Amendments executed May 5, 2015 provided for certain subsidiary debt guarantees and waived specified non-financial covenants. The filing reports no significant change in market-risk exposure; disclosure controls were concluded effective.
Investor verification priorities
- Confirm how much of reported earnings growth reflects Pioneer-related gains and tax benefits versus operating performance; compare reported EPS of $0.41 with adjusted EPS of $0.32.
- Track whether Water Systems margins stabilize and whether oil-and-gas-related demand and foreign-currency pressures persist.
- Review operating cash conversion, revolver usage, near-term debt maturities and compliance with financial covenants.
- Monitor the costs and timing of the Wittlich-to-Brno realignment and the remaining restructuring reserve.
- Check for developments in the CARB appeal and any material change in the company’s assessment of legal or other contingencies.