Franklin Electric Co., Inc. — FY 2010 Form 10-K
Business context and reporting period. Franklin Electric designs, manufactures and distributes water-pumping and fuel-system equipment through its Water Systems and Fueling Systems segments. This annual report covers the 52 weeks ended January 1, 2011; fiscal 2009 also comprised 52 weeks. The filing includes quarterly data, including Q4 2010, but is not a standalone Q4 report.
Financial performance and liquidity
| Metric | FY 2010 | FY 2009 |
|---|---|---|
| Net sales | $713.8 million | $626.0 million |
| Gross profit / margin | $230.3 million / 32.3% | $187.8 million / 30.0% |
| Operating income | $64.1 million | $48.0 million |
| Net income attributable to Franklin Electric | $39.0 million | $26.0 million |
| Diluted EPS | $1.66 | $1.12 |
| Operating cash flow | $94.6 million | $112.6 million |
| Cash and equivalents at year-end | $140.1 million | $86.9 million |
| Long-term debt | $151.2 million | $151.2 million |
| Working capital / current ratio | $261.1 million / 3.4 | $228.5 million / 3.7 |
Sales rose 14%; excluding acquisitions and foreign exchange, growth was about 10%. Water Systems sales increased 16% to $583.3 million, while Fueling Systems sales rose 8% to $130.5 million, including acquired sales; excluding the acquisition contribution, Fueling Systems sales declined about 2%. Gross-margin expansion reflected higher volume and fixed-cost leverage, as well as manufacturing cost reductions. SG&A increased 20% to $160.9 million, including higher commissions, performance compensation and legal costs. Restructuring expense was $5.3 million, versus $6.2 million.
Operating cash flow decreased from 2009 despite higher earnings, with increased receivables and other working-capital movements partly offset by inventory reductions. Investing cash outflow was $24.2 million, including $11.8 million net cash paid for the PetroTechnik acquisition and $13.7 million of capital expenditures. Financing cash outflow was $14.5 million, including $12.3 million of dividends and $6.9 million of share repurchases. The company reported no revolving-credit borrowings at year-end; it had $116.7 million of capacity under its revolving agreement and $50.0 million under its private shelf agreement. It was in compliance with debt covenants.
For Q4 2010, net sales were $175.0 million, gross profit $56.1 million, net income attributable to Franklin Electric $8.6 million, and diluted EPS $0.36. Q4 2009 comparatives were $144.9 million, $45.2 million, $7.8 million and $0.33, respectively.
Material changes, outlook and key commentary
- Water Systems growth was broad-based: U.S. and Canada sales increased 17%, including 22% growth in residential groundwater systems. Developing-market Water Systems sales increased 23%.
- Fueling Systems faced lower California vapor-recovery demand following completion of mandated conversions; California sales fell 61% year over year. International Fueling Systems sales rose about 30%, largely reflecting demand in China.
- Management announced Water Systems price increases averaging about 4%, generally implemented or planned between Q4 2010 and Q1 2011, amid commodity-cost inflation. Fueling Systems implemented increases averaging about 5% on a portion of products.
- Management projected a 2011 effective tax rate of 28%–30%. The filing does not provide a clear consolidated revenue or earnings forecast.
- Phase 3 of the manufacturing realignment was complete; related costs totaled $11.8 million from December 2008 through Q3 2010. The Siloam Springs facility closure was substantially complete at year-end; $2.3 million of assets remained held for sale.
- PetroTechnik was acquired in September 2010 for approximately $12.9 million. Its reported 2010 sales were not material to consolidated sales.
Risks, contingencies and unusual items
- Three California air-quality agencies brought suits concerning a diaphragm component in Healy vapor-recovery nozzles. Claimed penalties were at least $25 million (CARB), $5 million (SMAQMD) and $12.5 million (SCAQMD). The company denied liability, disputed the claimed amounts and said the matters could materially affect results depending on outcome. CARB certification remained in effect.
- A court ruled against the company in its indemnification dispute with former Healy owner James Healy; the company released withheld funds in January 2011 and recorded a $1.2 million charge in December 2010 for attorneys’ fees and prejudgment interest. The company retained appeal rights.
- Pentair and Sta-Rite alleged breach of a settlement agreement and sought damages exceeding $10 million for each claimant. The company denied liability and filed a counterclaim; summary-judgment motions were pending.
- Other exposures include housing and construction demand, commodity and energy costs, foreign-exchange movements, international operations, acquisition integration, product regulation, and litigation. The company generally does not hedge raw-material costs.
- The company held $165.2 million of goodwill; annual impairment testing found no impairment. Inventory reserves for excess or obsolete items were $16.4 million. The planned change from LIFO to FIFO was expected to reverse an approximately $14 million LIFO reserve, with about $3.2 million of resulting tax liability paid over four years.
Important facts for investors to verify
- Developments, potential financial exposure and any settlement or judgment in the California regulatory litigation and the Healy and Pentair/Sta-Rite disputes.
- Whether Water Systems price increases offset input-cost inflation without weakening demand or margins.
- Fueling Systems performance after California compliance-driven vapor-recovery demand receded, and the sustainability of international growth.
- Cash conversion and working-capital trends, including inventory, receivables and pension contributions; planned 2011 pension contributions were $16.1 million.
- Timing and terms of renewal of the $120 million revolving-credit agreement, which was due to mature in 2011, and the company’s capacity to meet debt and other contractual obligations.