Franklin Electric Co., Inc. — Q2 2013 Form 10-Q
Reporting period: Second quarter and six months ended June 29, 2013; comparative periods ended June 30, 2012. Amounts are in U.S. dollars. Per-share data reflects the March 2013 two-for-one stock split.
Business context and results
Franklin Electric operates Water Systems and Fueling Systems businesses. Q2 sales rose 7% to $263.4 million, reflecting acquisitions, price and volume growth, partly offset by currency translation. Organic growth excluding acquisitions and currency was approximately 4%. First-half sales increased 8% to $486.0 million, or approximately 5% excluding acquisitions and currency.
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $263.4m | $246.7m | $486.0m | $448.6m |
| Gross profit | $94.6m | $84.3m | $168.5m | $150.6m |
| Gross margin | 35.9% | 34.2% | 34.7% | 33.6% |
| Operating income | $40.7m | $37.5m | $63.9m | $58.5m |
| Net income attributable to Franklin Electric | $28.1m | $24.8m | $43.6m | $47.9m |
| Diluted EPS | $0.58 | $0.52 | $0.90 | $1.00 |
Segment performance and material changes
- Water Systems: Q2 sales grew 5% to $213.7 million; reported operating income was $42.7 million. Organic sales growth excluding acquisitions and currency was 3%. Residential and wastewater demand supported North American sales, while Pioneer mobile pumping products weakened amid slower upstream oil-and-gas demand. Asia Pacific and Latin America grew; Southern and Western Europe remained sluggish.
- Fueling Systems: Q2 sales rose 13% to $49.7 million; reported operating income was $10.8 million. Growth was led by international markets; U.S. and Canadian organic sales grew 4%.
- Q2 consolidated operating income increased 9%. Management cited improved fixed-cost leverage, lower material and conversion costs, and favorable product mix. SG&A rose 14% year over year, including acquisition costs and increased spending on marketing, research and development, and growth initiatives.
- First-half GAAP net income attributable to Franklin Electric fell 9% and diluted EPS fell to $0.90 from $1.00. The 2012 period included a $12.2 million pre-tax ($0.19 per diluted share after tax) one-time gain on the previously held Pioneer Pump investment. On the company’s non-GAAP adjusted basis, first-half diluted EPS rose to $0.93 from $0.83.
Cash flow, balance sheet and liquidity
- First-half operating cash flow was negative $5.6 million, versus negative $19.2 million in 2012. Receivables increased cash use by $48.4 million and inventory by $20.1 million.
- Investing cash outflow was $36.6 million, including $37.0 million of capital expenditures, primarily for the new headquarters and engineering center and a Brazil manufacturing facility. Financing provided $18.6 million, including $45.8 million of debt proceeds; cash declined $26.3 million to $77.1 million.
- At June 29, 2013, total debt was approximately $192.3 million, including $150.0 million under the Prudential agreement, $25.0 million of headquarters-related tax increment financing debt, and foreign subsidiary borrowings. Long-term debt was $174.8 million; current maturities and short-term borrowings were $17.5 million.
- Cash was $77.1 million; current assets were $457.3 million and current liabilities $137.2 million. The company reported $50.0 million of unused Prudential capacity and $145.4 million available under its $150.0 million revolving facility, net of letters of credit. It reported compliance with debt covenants.
- Capital expenditures were substantially higher than the prior-year first half, when investing cash use primarily included the $29.6 million Pioneer Pump acquisition. The company expects operating needs, capital spending, pension obligations, dividends and debt service to be funded by cash, operations and existing credit agreements.
Outlook, risks and unusual items
- No formal company-wide revenue or earnings guidance is provided. Management estimated that Pioneer mobile pump sales could grow at a double-digit rate in the second half, based on order backlogs, and described approximately 28% as a reasonable full-year effective tax-rate estimate before discrete items.
- Management identified weather, housing starts, regional economic conditions, demand, currency movements, competition, distribution channels, supply constraints, raw-material costs, acquisition integration, and regulatory or litigation matters as factors that could affect results. Eastern U.S. distributors expressed concern that inventories could be high if weather and demand do not normalize.
- Q2 restructuring expense was $0.7 million; first-half expense was $1.4 million, primarily severance and costs associated with the Fort Wayne headquarters relocation and facility realignment. First-half legal and advisory costs were also identified as non-GAAP adjustments.
- On July 25, 2013, after quarter-end, the court issued a complete defense verdict for Franklin Electric in the California Air Resources Board and South Coast Air Quality Management District case concerning a nozzle component. An appeal remained possible; the related Sacramento settlement required no payment following the verdict.
- Other exposures include $21.6 million of commitments, product warranty estimates (reserve of $9.8 million at quarter-end), and possible tax payments of up to $2.9 million related to audits or statute expirations. The filing reported no material change in risk factors or market-risk exposure.
Important facts for investors to verify
- Whether sales and margin improvements persist after separating acquisition contributions, currency effects, and non-GAAP adjustments.
- Whether operating cash flow improves as receivables and inventory unwind, and how elevated capital spending affects cash and borrowing needs.
- Progress and total cost of the Fort Wayne headquarters and engineering center and the Brazil manufacturing facility.
- Pioneer Pump demand trends, especially exposure to upstream oil-and-gas activity, and the extent to which management’s second-half expectation is realized.
- Debt covenant headroom, scheduled repayments, potential tax exposures, and the final status of appeals in the California litigation.