Franklin Electric Co., Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012; comparative periods ended July 2, 2011. Figures are unaudited. Dollar amounts are in millions except per-share data.
Business context and performance
Franklin Electric reports Water Systems and Fueling Systems. Sales and earnings increased year over year, with growth from acquisitions, higher volume and pricing partly offset by unfavorable currency translation. The March acquisition of control of Pioneer Pump Holdings (PPH) added a pump business serving oil and gas, municipal, construction and mining markets.
Key financial metrics
| Metric | Q2 2012 | Q2 2011 | H1 2012 | H1 2011 |
|---|---|---|---|---|
| Net sales | $246.7 | $224.1 | $448.6 | $409.4 |
| Gross profit / margin | $84.3 / 34.2% | $77.2 / 34.5% | $150.6 / 33.6% | $137.7 / 33.6% |
| Operating income | $37.5 | $32.8 | $58.5 | $48.7 |
| Net income | $25.2 | $22.0 | $48.4 | $32.9 |
| Net income attributable to Franklin / diluted EPS | $24.8 / $1.04 | $21.7 / $0.91 | $47.9 / $2.00 | $32.3 / $1.35 |
| Operating cash flow | Not presented by quarter | $(19.2) | $5.9 |
Q2 sales rose 10%; excluding acquisitions and currency effects, sales increased about 6%. H1 sales rose 10%; excluding those effects, they increased about 5%. Q2 operating income increased 14%; H1 operating income increased $9.8 million. The H1 effective tax rate was about 28.5%, versus 27.4% a year earlier. H1 results included a one-time, noncash $12.2 million pretax gain from remeasuring Franklin’s previously held PPH investment, equivalent to about $0.37 per share.
By segment, Q2 sales were $202.8 million for Water Systems and $43.9 million for Fueling Systems. H1 sales were $367.8 million and $80.8 million, respectively. H1 adjusted operating margins, as presented by the company, were 18.5% for Water Systems and 18.1% for Fueling Systems; consolidated adjusted operating margin was 13.3%. These non-GAAP figures exclude specified items.
Balance sheet, cash flow and capital
- Cash was $86.3 million at June 30, down from $153.3 million at year-end 2011. H1 operating cash use was $19.2 million, primarily reflecting a $70.4 million use of cash from receivables and inventory, including acquisition-related, growth and seasonal working-capital needs.
- H1 investing cash use was $39.7 million, including $29.6 million net cash paid for PPH and $11.5 million of capital expenditures. Financing cash use was $5.4 million; the company paid $6.5 million of dividends and repurchased $8.7 million of stock, partly offset by debt proceeds.
- Total debt was $172.0 million, including $21.2 million current maturities; long-term debt was $150.8 million. Cash less total debt was approximately $(85.8) million. The $150 million Prudential notes carry a 5.79% rate.
- The $150 million revolving facility had no borrowings and $146.5 million available after letters of credit; the Prudential agreement had $50 million remaining capacity. The company reported compliance with debt covenants.
- Current assets were $437.5 million and current liabilities $137.4 million (current ratio about 3.2). Receivables and inventory rose substantially from year-end; inventory increased to $193.9 million from $141.7 million.
Material changes, outlook and risks
- PPH became a consolidated subsidiary after Franklin acquired an additional 39.5% interest, bringing ownership to 70.5%. Franklin recorded $26.3 million of preliminary goodwill and a $22.9 million liability for a mandatory purchase of remaining shares, expected by March 2015 at a price formula tied to PPH earnings and net debt.
- Management estimated a full-year 2012 tax rate of about 28.5%; this is the filing’s stated estimate, not earnings or sales guidance. The company expected elevated investing cash use in 2012 and 2013 for a new headquarters/engineering center and a Brazil manufacturing facility. The headquarters project was estimated at $32–$36 million and expected to be completed in summer 2013.
- Management said Nylon 12 inventory and supply arrangements had been restored and expected no adverse Fueling Systems sales impact in the second half of 2012, assuming supplier production resumed as anticipated in Q4.
- Demand trends were mixed: agricultural and clean-water pumping were strong in North America, while dry-weather-sensitive wastewater products were weaker; China sales were down about 25% in H1. Currency translation reduced Q2 sales by $12.0 million and H1 sales by $16.2 million.
- California regulators’ complaints concerning a nozzle diaphragm seek penalties of at least $25.0 million (CARB), $5.0 million (SMAQMD) and $12.5 million (SCAQMD). The company denied liability, said the claimed amounts lacked reasonable basis, and warned an award or settlement could materially affect results, financial position and cash flows. The consolidated CARB/SCAQMD case was set for trial in December 2012; the filing stated the matters did not affect product certification or ongoing sales.
- Sta-Rite/Pentair litigation remained on appeal after the court dismissed plaintiffs’ claims; the plaintiffs had sought damages exceeding $10 million per claimant. The company could not predict the outcome. Other forward-looking risks include economic and currency conditions, weather and demand, competition, input availability and costs, acquisition integration, and regulatory or litigation outcomes.
Most important facts for investors to verify
- How much reported earnings growth reflects the $12.2 million PPH remeasurement gain, and how PPH performs after consolidation.
- Whether working-capital investment reverses and operating cash flow returns to positive territory; monitor receivables, inventory and cash balances.
- Progress on PPH’s remaining-share purchase obligation, acquired debt and related liquidity needs.
- Developments, potential exposure and timing in the California regulatory cases and the Sta-Rite/Pentair appeal.
- Execution and total cost of the headquarters and Brazil projects, and whether Nylon 12 supply normalizes as management expected.