Business context and reporting period
Franklin Electric Co., Inc. designs and manufactures water pumping equipment and fuel-system products. This unaudited Form 10-Q covers the third quarter and first nine months ended October 1, 2016, compared with the periods ended October 3, 2015.
Financial results and liquidity
- Third-quarter revenue: $239.8 million, up 3% year over year. Water Systems revenue rose 5% to $182.0 million; Fueling Systems revenue declined 2% to $57.8 million.
- Third-quarter profitability: Gross profit was $85.5 million, up 11%; gross margin expanded to 35.6% from 33.0%. Operating income increased 14% to $31.8 million. Net income attributable to Franklin Electric was $23.7 million; diluted EPS was $0.50 versus $0.43.
- Nine-month results: Revenue was $710.3 million, up 1% reported and about 4% excluding currency and acquisitions. Gross margin improved to 35.3% from 32.4%; operating income rose 28% to $85.6 million. Net income attributable to Franklin Electric was $61.1 million and diluted EPS was $1.28, versus $56.8 million and $1.17.
- Cash flow: Nine-month operating cash flow was $70.9 million, compared with $60.3 million. Investing used $25.1 million, including $30.1 million of capital expenditures; financing used $48.1 million. Cash declined $2.6 million from year-end to $79.0 million.
- Debt and liquidity: Debt carrying value, including current maturities, was $190.1 million at October 1, down from $220.7 million at January 2. Cash was $79.0 million. The company reported no revolver borrowings and $144.5 million of availability under its then-current revolver; it was in compliance with financial covenants.
- Dividends: $0.10 per common share for the quarter, versus $0.0975 a year earlier.
Material changes and management commentary
- Higher pricing, lower direct material costs, and improved Water Systems mix lifted gross margins. Nine-month sales growth excluding currency and acquisitions was primarily volume and price driven; currency reduced reported sales by $21.8 million.
- Water Systems growth was strongest in Latin America and Asia Pacific in the quarter. U.S. and Canadian groundwater sales increased, while mobile dewatering demand weakened, particularly in oil and gas-related markets. Fueling Systems growth in North America was offset by softer overseas sales and shipment timing.
- Quarterly SG&A rose 16% to $55.4 million, mainly from approximately $4.0 million of higher variable compensation, along with increased marketing and product-development spending. Interest expense declined as average borrowings fell.
- The effective tax rate for the first nine months was 25.3%, versus 11.7% in 2015. The prior-year rate benefited from discrete tax items related to the Pioneer transaction; 2016 also included a favorable share-based compensation tax effect. Management cited lower-tax foreign earnings and incentives as reasons the projected rate remains below the U.S. statutory rate.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific revenue or earnings guidance. Management said it expects operating needs, capital spending, pension obligations, dividends, and debt service to be funded by cash, operations, and available credit.
- On October 28, 2016, after quarter-end, the company amended its credit agreement, increasing commitments from $150 million to $300 million and extending maturity to October 2021. The agreement permits a further increase of up to $150 million, subject to conditions, and includes financial covenants. Amendments also aligned private-note covenants.
- Quarterly restructuring income of $1.7 million included a $2.0 million gain on sale of a Brazilian facility, partly offset by relocation and other costs. The longer-running Wittlich, Germany manufacturing realignment was expected to conclude by year-end 2016; no restructuring reserve remained at quarter-end.
- Legal claims arising in the ordinary course were not expected by management to materially affect financial position, results, or cash flows. Product warranty estimates may differ from actual claims; the warranty accrual was $8.6 million. Commitments, primarily capital expenditures and raw materials, totaled $20.3 million.
- Risks cited include economic and currency conditions, demand and weather, competition, raw-material costs and availability, supply constraints, acquisitions, litigation, and regulatory actions. The company began a multi-year global ERP implementation; management expects improved controls but noted the implementation will require ongoing effectiveness testing. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether margin improvement and Water Systems growth persist, particularly amid weaker mobile dewatering and uneven regional markets.
- How much of reported earnings reflects underlying operations versus restructuring gains, variable compensation, and tax items; reconcile reported and company-presented non-GAAP measures.
- Cash conversion and capital spending trends, including the effect of working-capital increases in receivables and inventory.
- Debt maturities, borrowing availability, covenant compliance, and the terms and use of the amended credit facilities.
- Progress and costs of the manufacturing realignment and ERP rollout, as well as developments in warranty claims and other contingencies.