Franklin Electric Co., Inc. — Q1 2012 Form 10-Q
Reporting period: First quarter ended March 31, 2012; comparisons are with the first quarter ended April 2, 2011, unless otherwise noted. Amounts are in U.S. dollars.
Business context and financial performance
Franklin Electric manufactures water pumping systems and fueling systems. Sales and earnings increased year over year, supported by acquisitions, higher sales volume and pricing. The quarter included consolidation of Pioneer Pump Holdings (PPH) after Franklin acquired control on March 7, 2012.
- Revenue: $201.9 million, up 9% from $185.3 million. Acquisitions contributed $13.1 million; foreign currency translation reduced sales by $4.2 million. Growth excluding both effects was 4%.
- Segment sales: Water Systems revenue was $165.0 million, up 12% (6% organic growth excluding acquisitions and currency). Fueling Systems revenue was $36.9 million, down 3%.
- Profit and margins: Gross profit was $66.3 million, up about 10%; gross margin improved to 32.8% from 32.7%. Operating income was $21.0 million, up 31%, and operating margin was approximately 10.4%, versus 8.6%. Net income was $23.2 million, compared with $10.9 million; net income attributable to Franklin was $23.0 million. Diluted EPS was $0.96, versus $0.45.
- Important earnings item: Net income included a $12.2 million pretax, non-cash gain from remeasuring Franklin’s previously held PPH investment when it acquired control. Management estimated this added about $0.37 per share.
- Cash flow: Operating activities used $29.0 million, compared with $31.1 million used in the prior-year quarter. Receivables and inventory together used $43.6 million of cash. Investing activities used $30.8 million, including $27.9 million net cash paid for PPH; financing activities provided $2.2 million. Cash declined by $54.4 million to $98.9 million.
- Liquidity and debt: At March 31, cash was $98.9 million and total debt, including capital leases, was $171.7 million (about $72.8 million net debt). The company had $147.0 million available under its committed revolver and $50.0 million available under its Prudential facility. It reported compliance with debt covenants.
- Dividends: $0.14 per common share, versus $0.13 in the prior-year quarter.
Changes versus the prior comparable period
- Water Systems operating income rose to $26.8 million from $21.5 million; Fueling Systems operating income rose to $5.6 million from $5.3 million. Corporate and other operating losses widened to $11.4 million from $10.8 million.
- Interest expense increased to $2.6 million from $2.2 million. Other income increased to $13.5 million from $1.6 million, principally because of the PPH remeasurement gain.
- PPH acquisition accounting increased goodwill by $25.0 million and added $45.2 million of provisional intangible assets. Franklin also recorded a $22.9 million long-term liability related to an agreement to purchase PPH’s remaining shares by March 31, 2015, at a formula-based price.
- Cash used for investing increased from $3.2 million to $30.8 million, primarily due to the PPH acquisition. Total assets increased to $931.7 million from $829.5 million at year-end 2011.
Outlook, management commentary and risks
- No specific consolidated revenue or earnings guidance was provided. Management said the approximately 27% Q1 effective tax rate was a reasonable estimate for full-year 2012.
- Management expects elevated investment in 2012 and 2013, primarily for a new global headquarters and engineering center, estimated at $32–$36 million, and a new manufacturing facility in Brazil. The headquarters was expected to be completed by mid-2013.
- Availability of Nylon 12 resin could affect Fueling Systems sales in the second half of 2012. Affected products represented less than 3% of consolidated sales; existing supplies were expected to last into Q3, and the company was exploring alternative sources or materials.
- Management cited weak European conditions and political disruption to some North African export shipments affecting Water Systems, as well as weather-related weakness in North American wastewater pumps. Higher material costs partly offset sales leverage and pricing benefits.
- California air-quality proceedings concerning a nozzle diaphragm seek penalties of at least $25.0 million from CARB, $12.5 million from SCAQMD and $5.0 million from SMAQMD. The company disputes liability and the claimed penalty amounts; it said outcomes could materially affect results. The consolidated CARB/SCAQMD cases were set for trial in December 2012. The filing states that product certification and ongoing sales were not affected.
- Sta-Rite and Pentair litigation remained subject to appeal after the court dismissed their claims; they had sought damages exceeding $10 million each. The company said it could not predict the outcome. Management reported no material changes to the risk factors in the 2011 Form 10-K.
- Phase IV manufacturing realignment was expected to generate total pretax charges of $2.6–$5.2 million, substantially ending in Q4 2012; 50%–60% of charges were expected to be non-cash. Q1 recorded restructuring income of $0.1 million, primarily from a land sale.
Key facts for investors to verify
- How much of future earnings growth is supported by underlying operations versus the one-time PPH remeasurement gain and acquisition contributions.
- PPH’s post-acquisition operating performance, final purchase-price valuations, and the eventual cost and timing of buying the remaining minority interest.
- Working-capital trends and the company’s ability to convert earnings into operating cash flow, given continued cash use by receivables and inventories.
- Progress on the headquarters and Brazil facility, related spending, and any use of project financing.
- Availability of Nylon 12 or substitutes, and any effect on Fueling Systems production and sales.
- Developments and potential financial exposure in the environmental and commercial litigation, including any settlements or rulings.