Franklin Electric Co., Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; compared with the first quarter of 2017. The company manufactures and distributes water and fueling systems and groundwater products. Results are unaudited and the company cautions that quarterly results are not necessarily indicative of full-year performance.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $295.6 million | $220.3 million |
| Gross profit / margin | $99.0 million / 33.5% | $75.8 million / 34.4% |
| Operating income | $22.7 million | $18.5 million |
| Net income attributable to Franklin Electric | $21.2 million | $15.7 million |
| Diluted earnings per share | $0.45 | $0.33 |
| Cash used in operating activities | $27.2 million | $24.6 million |
Sales rose about 34%, primarily because of acquired distributors; organic growth excluding currency was about 10%, and foreign currency translation added approximately $8.0 million, or 4%, to sales. Gross margin fell 90 basis points, mainly from product and geographic mix; management said realized pricing offset material costs during the quarter. Interest expense declined to $2.4 million from $3.5 million. The income tax provision was a $1.7 million benefit versus $0.2 million expense, contributing to higher net income.
- Segments: Water Systems sales were $191.8 million, up about 14%; operating income was $25.2 million. Fueling Systems sales were $59.4 million, up about 13%; operating income was $13.6 million. Distribution contributed $56.2 million of acquisition-related sales and reported a $0.8 million operating loss. Segment figures include intersegment activity as presented in the filing.
- Balance sheet and liquidity: Cash and equivalents were $67.4 million at March 31, 2018, nearly unchanged from year-end. Total assets were $1.241 billion. Total debt, including current maturities, was approximately $278.0 million, up from $226.1 million at December 31, 2017. Current debt maturities and short-term borrowings were $152.9 million. The company had $175.9 million available under its $300 million revolving credit facility, after borrowings and letters of credit, and reported compliance with financial covenants. Cash held in foreign jurisdictions was $59.6 million.
- Cash flows: Investing activities used $14.1 million, including $8.4 million of net acquisition cash payments and $5.9 million of capital expenditures. Financing activities provided $39.7 million, including net debt proceeds; the company also repurchased $7.9 million of shares and paid $5.0 million in dividends. Working-capital increases, particularly receivables and inventory, were the main operating cash uses.
Material changes and notable items
- The $75.3 million increase in sales was driven chiefly by acquired distribution businesses; the Headwater entities contributed $56.2 million of Q1 2018 revenue and a $0.9 million net loss. Valley Farms Supply was acquired during the quarter for approximately $9.2 million.
- Consolidated operating income increased about 23%, but gross margin declined. Water and Fueling Systems operating income improved, while Distribution recorded a seasonal first-quarter loss.
- The effective tax rate was negative 8.7%. The company cited the Tax Act, an estimated $3.1 million benefit from foreign-derived intangible income provisions, and release of a $5.4 million valuation allowance related to certain state tax assets. Tax accounting for certain Tax Act provisions remained provisional.
- The company adopted revenue-recognition guidance using the modified retrospective method and adopted pension-cost presentation guidance; neither adoption had a material financial-statement impact.
Outlook, risks and contingencies
Management said liquidity should be adequate for foreseeable needs and expects operations, cash on hand and existing credit facilities to fund operating requirements, capital expenditures, pension obligations, dividends, repurchases and debt service. It projected a full-year 2018 tax rate of about 19% before discrete adjustments, compared with about 25% for 2017 on the same basis. No specific sales or earnings guidance is provided in the filing. Management intended pricing actions to address cost increases, including Section 232 steel and aluminum tariffs.
Risks highlighted include economic, currency and market conditions; housing starts and weather; competition and distribution-channel changes; raw-material costs, availability and tariffs; acquisition integration; litigation and regulatory developments; and IT, cybersecurity and ERP implementation risks. Management said ordinary-course legal claims were not expected to materially affect financial position, results or cash flows. Capital expenditure and raw-material commitments totaled $6.2 million. The company was implementing a global ERP system; it expected lease-accounting adoption to add right-of-use assets and lease liabilities to the balance sheet, with the amount still under evaluation.
Important facts for investors to verify
- How much of future growth is organic versus acquisition-related, and whether Distribution sales recover from the supplier disruptions described by management.
- Whether pricing offsets input-cost and tariff pressures without further gross-margin erosion.
- Whether working-capital demands and seasonal inventory builds improve, given negative operating cash flow despite higher earnings.
- Debt maturities, revolver usage and covenant headroom, particularly the $152.9 million classified as current at quarter-end.
- Final Tax Act accounting and the sustainability of the unusually low Q1 effective tax rate, including discrete tax benefits.
- Acquisition integration and provisional purchase-accounting estimates, as well as execution and control risks from the ongoing ERP conversion.