Franklin Electric Co., Inc. — Q1 2014 Form 10-Q
Business and period: Franklin Electric designs and sells water-pumping and fueling systems through its Water Systems and Fueling Systems segments. This unaudited report covers the first quarter ended March 29, 2014; comparisons are with the first quarter ended March 30, 2013 unless stated otherwise.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $231.4 million | $222.5 million | Up 4%; up approximately 7% excluding acquisitions and currency |
| Gross profit / margin | $78.1 million / 33.8% | $73.9 million / 33.2% | Profit up about 6%; margin +60 basis points |
| Operating income / margin | $26.0 million / 11.2% | $23.2 million / 10.4% | Up about 12% |
| Net income attributable to Franklin Electric | $17.0 million | $15.5 million | Up about 10% |
| Diluted EPS | $0.35 | $0.32 | Up 9% |
| Operating cash flow | $(35.4) million | $(30.8) million | Greater cash use |
Gross-margin improvement reflected higher sales and fixed-cost leverage and productivity gains, partly offset by higher raw-material costs. SG&A was $52.0 million, or 22.5% of sales, approximately unchanged as a percentage of sales. Interest expense rose to $2.8 million from $2.6 million. The effective tax rate was approximately 25%, including discrete benefits; before discrete items it was 28%. Reported dividends were $0.0775 per share.
Segments and material changes
- Water Systems: Sales increased 5% to $184.6 million; excluding acquisitions and currency, growth was about 9%. Segment operating income was $29.2 million versus $28.7 million. After the company’s non-GAAP adjustments, operating income was essentially flat at $29.3 million, and adjusted margin declined to 15.9% from 16.6%, primarily due to U.S. and Canadian sales mix. Severe winter weather weighed on groundwater and wastewater channels; March sales improved as weather moderated. Middle East and Africa sales grew strongly, while Latin America declined 2% reported but rose about 9% excluding currency.
- Fueling Systems: Sales rose 2% to $46.8 million, but were up less than 1% excluding currency and acquisitions. Excluding a $4.7 million prior-year Indian tender shipment, management said sales grew about 12%. Segment operating income increased to $9.1 million from $6.2 million; adjusted income was $9.2 million versus $6.8 million, with adjusted margin rising to 19.7% from 14.8%, driven by mix, productivity, pricing, and Flex-ing acquisition synergies.
- Foreign-currency translation reduced consolidated sales by $8.0 million. The company reported $0.4 million of foreign-exchange expense, compared with $0.2 million in the prior-year quarter.
Cash, debt, and liquidity
Cash and equivalents were $102.1 million at March 29, 2014, down from $134.6 million at December 28, 2013. The $35.4 million operating cash outflow reflected seasonal inventory accumulation, higher receivables alongside sales growth, and extended customer terms. Investing used $9.0 million, including $8.2 million for property and equipment and $2.4 million for a minority equity investment. Financing provided $11.4 million, including $21.2 million of debt proceeds and $6.6 million of debt repayments.
Total debt was $204.3 million, including $30.6 million classified as current; long-term debt was $173.7 million. The company had $130.7 million of availability under its $150 million revolving credit agreement and $50 million of stated capacity under its $200 million Prudential private shelf agreement. Cash was geographically dispersed, with approximately 24% in the U.S. and readily accessible. Management stated that expected operating, capital, pension, dividend, and debt-service needs should be funded from cash, operations, and existing credit agreements. The company reported compliance with debt covenants, including maximum leverage and minimum interest-coverage requirements.
Outlook, risks, and unusual items
- Management projected a second-quarter 2014 tax rate of about 28% and an average second-half rate of about 25%, subject to discrete items. The filing does not provide a clear full-year sales or earnings forecast and cautions that first-quarter results are not necessarily indicative of full-year results.
- Non-GAAP adjustments were small in Q1 2014: $0.1 million of restructuring charges and $0.1 million of acquisition-related items. The prior-year quarter included $0.7 million of restructuring charges and $0.4 million for legal matters. Adjusted diluted EPS was $0.35 versus $0.33.
- California regulators appealed a court decision that had ruled in the company’s favor in litigation concerning a component used in its Healy 900 Series nozzle. The company said product certification and continuing sales were unaffected. Management viewed other ordinary-course claims as resolvable without material adverse effect.
- Product warranties remain subject to estimation uncertainty; the warranty accrual was $8.9 million at quarter-end. The company also reported $18.5 million of commitments, primarily for equipment purchases and building expansions.
- Other disclosed risks include potential adverse effects from changes to distribution outlets and additional risks described in the company’s annual report. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the working-capital cash outflow reverses as seasonal inventory is sold and receivables are collected.
- Whether Water Systems’ U.S. channel weakness and margin pressure persist, and whether Fueling Systems can sustain its margin gains.
- Actual tax rates versus management’s quarterly projections, including discrete tax adjustments and treatment of foreign earnings.
- Cash accessibility by geography, debt maturities beginning in 2015, revolver usage, and ongoing covenant compliance.
- Developments in the CARB appeal, warranty claims, and the company’s disclosed commitments.