Franklin Electric Co., Inc. — Q1 2017 Form 10-Q
Business context and reporting period: Unaudited results for the first quarter ended March 31, 2017, compared with the first quarter ended April 2, 2016. The company reports Water Systems and Fueling Systems.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $220.3 million | $218.4 million | Up 1%; organic growth 1% |
| Gross profit / margin | $75.8 million / 34.4% | $74.2 million / 34.0% | Margin up 40 basis points |
| Operating income | $18.5 million | $21.1 million | Down $2.6 million |
| Net income | $15.9 million | $13.6 million | Up $2.4 million |
| Net income attributable to Franklin Electric | $15.7 million; diluted EPS $0.33 | $13.5 million; diluted EPS $0.28 | EPS up $0.05 |
| Cash from operating activities | $(24.6) million | $(0.4) million | Greater cash use |
Segment results: Water Systems sales were $167.2 million, down about 1%; operating income was $21.4 million versus $24.2 million, and margin fell to 12.8% from 14.3%. Fueling Systems sales were $53.1 million, up about 7%; operating income rose to $11.0 million from $10.2 million, with margin of 20.7% versus 20.6%.
Gross-margin improvement reflected favorable pricing and lower direct material costs, partly offset by higher fixed costs. SG&A increased 9% to $57.0 million, including higher sales and marketing support costs and about $0.8 million of distributor-acquisition-related costs. Operating income declined about 12%.
Cash, debt, and liquidity
- Cash and equivalents were $70.7 million at March 31, 2017, down from $104.3 million at year-end 2016. Operating and investing cash use totaled $29.5 million, while financing activities used $5.3 million.
- Operating cash use reflected inventory build for seasonality and expected demand, higher incentive-bonus payments, and reductions in income-tax liabilities and reserves. Capital expenditures were $4.9 million.
- Total debt was approximately $190.0 million, including $33.8 million current maturities. The company had no revolver borrowings, $6.0 million of letters of credit, and $294.0 million of available capacity under its $300 million revolving facility.
- Cash held in foreign jurisdictions was $49.9 million and was intended to fund foreign operations. The company said liquidity was adequate for projected needs and it complied with debt covenants.
Outlook, changes, and risks
- Management projected a 2017 full-year effective tax rate of about 27% before discrete adjustments, versus about 26% for 2016. Q1’s reported rate was 1.3%, versus 26.7% a year earlier; Q1 benefited from a $1.7 million discrete tax benefit and release of a $1.9 million deferred-tax valuation allowance. The lower tax expense helped lift net income despite lower operating income.
- After quarter-end, the company agreed to acquire controlling interests in three U.S. professional groundwater distributors for approximately $89 million, including assumed debt. The businesses will be consolidated from their acquisition dates and reported in a new Distribution segment.
- Management cited market demand, weather, currency, raw-material costs and availability, distribution-channel changes, supply constraints, competition, and acquisition integration among factors that could affect results. It reported no material changes to the risk factors in its 2016 Form 10-K.
- Legal claims arising in the ordinary course were not expected by management to have a material effect. Commitments were $15.6 million, primarily for capital expenditures and raw materials. Management considered the warranty reserve appropriate, while noting actual claims could differ from estimates.
- The company was implementing a multi-year global ERP system; implementation may affect internal-control processes. Management reported disclosure controls were effective and no identified control change, apart from ERP implementation, materially affected or was reasonably likely to materially affect internal control over financial reporting.
- Adoption of the new lease standard was expected to put most operating leases on the balance sheet, significantly affecting the balance sheet but not cash; operating-results effects were still under evaluation. Management did not expect the revenue-recognition standard to have a material impact.
Key facts for investors to verify
- Whether the seasonal inventory build converts to sales and operating cash flow, and how channel inventory affects Water Systems demand.
- Whether higher SG&A and Water Systems costs moderate, and whether Fueling Systems growth and margins persist.
- The final acquisition terms, funding, integration costs, and contribution of the new Distribution segment.
- Whether the projected full-year tax rate and foreign-earnings assumptions hold, given Q1’s discrete tax benefits.
- Debt maturities, available borrowing capacity, and cash needs after the distributor acquisitions.
Management cautioned that first-quarter results are not necessarily indicative of full-year results.