Franklin Electric Co., Inc. — Q3 2019 Form 10-Q
Business context and reporting period. Franklin Electric manufactures and distributes water and fueling systems and related products. This unaudited filing covers the quarter and nine months ended September 30, 2019, compared with the same periods in 2018. Dollar figures below are in millions except per-share data.
Financial results and key metrics
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $348.4 | $341.9 | $994.5 | $981.5 |
| Gross profit / margin | $117.6 / 33.8% | $113.0 / 33.0% | $326.8 / 32.9% | $328.0 / 33.4% |
| Operating income | $42.7 | $40.1 | $98.5 | $103.3 |
| Net income attributable to Franklin Electric | $33.9 | $30.0 | $75.7 | $81.7 |
| Diluted EPS | $0.72 | $0.63 | $1.61 | $1.72 |
| Operating cash flow | Not separately reported | Not separately reported | $90.2 | $60.4 |
Q3 sales rose about 2%, while operating income increased 6% and diluted EPS rose about 14%. For the first nine months, sales increased about 1%, but operating income declined about 5% and diluted EPS declined about 6%. Q3 operating performance benefited from higher sales, price increases exceeding raw-material inflation, and a favorable foreign-exchange transaction gain. The nine-month tax rate was 18.9%, versus 11.9% in 2018; the prior-year rate benefited from a $5.4 million valuation-allowance release.
Cash flow and liquidity. Nine-month operating cash flow was $90.2 million; capital expenditures were $15.6 million, implying operating cash flow less capital expenditures of about $74.6 million. Investing activities used $35.6 million, including $20.9 million for acquisitions. Financing activities used $61.0 million, including $20.9 million of dividends, $10.3 million of share repurchases, and net debt repayments. Cash declined $11.4 million to $47.8 million from year-end 2018; $41.3 million was held in foreign jurisdictions for foreign operations. Current assets were $617.6 million and current liabilities $257.2 million.
Total debt, including current maturities, was $173.9 million, down from $206.4 million at year-end 2018. Current maturities were $80.8 million and long-term debt $93.1 million. The company reported $215.9 million of available capacity under its $300 million revolving credit agreement and said liquidity was adequate for projected needs. It was in compliance with financial covenants at quarter-end. Lease liabilities recognized in 2019 were $24.8 million in total, including current and long-term amounts.
Material changes versus the prior comparable period
- Q3 sales growth included $9.6 million from acquisitions; foreign-currency translation reduced sales by $5.8 million. Organic sales increased across all three operating segments.
- For the first nine months, acquisitions added $30.2 million of sales, while currency translation reduced sales by $29.0 million. Water Systems operating income declined $7.2 million, partly offset by a $2.0 million increase in Fueling Systems.
- Water Systems’ nine-month operating margin fell to 13.2% from 14.2%, reflecting lower volumes and unfavorable product and geographic mix. Fueling Systems’ margin was 25.7%, compared with 25.6%.
- Operating cash flow improved by $29.8 million year over year, principally due to lower working-capital requirements, including better vendor payment terms, and lower tax payments and benefit-plan contributions.
- Debt fell as the company repaid the remaining $30 million under its Prudential Agreement in Q2. The company acquired First Sales, LLC for approximately $15.5 million in Q3 and Milan Supply Company for approximately $6.1 million earlier in 2019.
Outlook, commentary, risks, and unusual items
Management projected a full-year 2019 tax rate of about 21% before discrete items; the filing provides no specific consolidated sales or earnings forecast. Management stated that cash, operating cash flows, and existing credit agreements should fund expected operating needs, capital expenditures, pensions, dividends, repurchases, and debt service.
Management identified exposure to economic and currency conditions, market demand, housing starts, weather, competition, distribution channels, supply constraints, pricing and raw-material costs, technology, acquisition integration, litigation, and regulatory actions. International currency translation reduced sales, while transaction-related foreign exchange produced a $2.2 million gain in the first nine months, primarily from the Argentine peso. The company reported no significant change in market-risk exposure and no material changes to the risk factors in its prior annual report.
Legal claims arising in the ordinary course were not expected by management to have a material effect on financial position, results, or cash flows. The company reported $11.2 million of commitments, primarily for capital expenditures and production raw materials. Warranty reserves were $9.1 million at September 30, 2019. Q3 restructuring expense was $0.4 million; nine-month restructuring expense was $1.7 million. The company adopted lease accounting in 2019, recording right-of-use assets and lease liabilities; management reported no material impact from other newly adopted accounting standards discussed in the filing.
Important facts for investors to verify
- Whether Water Systems’ lower year-to-date operating margin and demand trends improve, particularly in international markets.
- Whether Q3 growth and profit improvement persist after separating organic performance from acquisitions, foreign exchange, and pricing effects.
- Whether working-capital improvements supporting operating cash flow are sustainable, and how cash needs compare with the $80.7 million of debt maturities shown for the next year.
- Whether the approximately 21% full-year tax-rate estimate and management’s liquidity assessment remain valid.
- Whether currency movements, acquisition integration, raw-material costs, weather, and market demand materially affect subsequent results.