Franklin Electric Co., Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Franklin Electric operates in Water Systems, Fueling Systems, and Distribution. Amounts below are in U.S. dollars; financial figures are in millions except per-share data.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $355.3 | $344.0 | $646.1 | $639.6 |
| Gross profit / margin | $119.7 / 33.7% | $116.1 / 33.7% | $209.2 / 32.4% | $215.1 / 33.6% |
| Operating income | $43.7 | $40.5 | $55.8 | $63.2 |
| Net income attributable to Franklin Electric | $32.7 | $30.5 | $41.8 | $51.7 |
| Diluted EPS | $0.70 | $0.64 | $0.89 | $1.09 |
Q2 sales rose about 3%, with acquisition-related sales and pricing offsetting lower volume and unfavorable currency translation. Q2 operating income increased about 8%; reported diluted EPS increased about 9%. First-half sales rose about 1%, but operating income fell about 12% and diluted EPS declined about 18%. First-half operating margin was approximately 8.6%, versus 9.9% a year earlier.
Cash flow and liquidity: First-half operating cash flow was $4.1, compared with $5.2 in 2018. Investing cash outflow was $16.3, primarily for capital spending and acquisitions; financing cash outflow was $5.2. Cash declined $18.2 to $41.0. Cash capital expenditures were $10.4, and cash paid for acquisitions was $6.7. The company reported $38.5 of cash held in foreign jurisdictions, intended to support foreign operations.
Debt and balance sheet: Total debt was approximately $223.0 at June 30, versus $206.4 at year-end 2018; $129.3 was classified as current maturities and short-term borrowings. The $300.0 revolving credit facility had $123.3 drawn, $5.0 in letters of credit, and $171.7 available. Total assets were $1,269.7 and shareholders’ equity was $759.2. The company was in compliance with financial covenants.
Material changes and segment trends
- Water Systems: Q2 sales declined 3% to $205.0 and operating income fell to $30.9. First-half sales declined 3% to $393.4 and operating income fell to $50.1, mainly reflecting weaker volume, product/geographic mix, and currency effects. North American groundwater sales were affected by adverse weather and lower sales to the company’s Distribution segment.
- Fueling Systems: Q2 sales increased 7% to $78.0 and operating income rose 14% to $21.7, supported by North American demand and improved mix. First-half sales increased 5% to $138.3 and operating income rose to $34.0.
- Distribution: Q2 sales increased 10% to $87.1, including acquired businesses; operating income was $4.5. First-half sales increased 3% to $140.4, but operating income fell to $0.2 as lower organic volume, including weather effects, offset acquisitions.
- Q2 gross margin was unchanged year over year; first-half gross margin declined 1.2 percentage points. Management cited lower sales, mix shifts, and reduced fixed-cost leverage. Selling, general and administrative costs excluding acquired businesses declined year over year in both the quarter and first half.
Outlook, risks, and notable items
- Management said liquidity and capital resources were adequate for foreseeable needs, including operations, capital expenditures, pensions, dividends, share repurchases, and debt service. No specific full-year sales or EPS guidance was provided.
- Management estimated a 2019 effective tax rate of about 20% after discrete items and about 21% before discrete items; the first-half 2019 effective rate was 18.1%, compared with 9.2% in 2018. The prior-year rate benefited from a $5.4 valuation-allowance release.
- Identified risk factors include economic and currency conditions, weather, housing starts, market demand, competition, distribution channels, supply and raw-material costs, pricing, acquisition integration, litigation, and regulatory actions. The company reported no material change to its previously disclosed risk factors.
- Management stated ordinary-course legal claims are not expected to materially affect financial position, results, or cash flows. Product warranty estimates may differ from actual claims; the warranty accrual was $8.9 at June 30. Capital and raw-material commitments totaled $9.2.
- The company adopted lease accounting in 2019, recording a $25.7 right-of-use asset and current and long-term lease liabilities. It also acquired Milan Supply for approximately $6.1 in Q1 and acquired the remaining Pluga Pumps and Motors interest in Q2; the latter transaction was immaterial.
Key facts for investors to verify
- Whether the first-half weakness in Water Systems and Distribution reflects temporary weather and mix effects or sustained demand deterioration.
- Whether operating cash flow improves as receivables and inventories normalize; both were significant uses of cash in the first half.
- Debt maturities, refinancing needs, and covenant headroom, particularly given $129.3 of current maturities and borrowings.
- Whether pricing continues to offset inflation and whether margins recover after the first-half decline.
- Actual tax-rate outcomes versus management’s approximate 20% full-year estimate, and the impact of currency movements and acquisition integration.