Franklin Electric Co., Inc. — FY2012 Form 10-K
Business context and period. Franklin Electric designs, manufactures and distributes water- and fuel-pumping systems. Its Water Systems and Fueling Systems segments serve global markets. Fiscal 2012 comprised 52 weeks and ended December 29, 2012; figures below are in U.S. dollars unless noted.
Financial performance
- Revenue and margins: Net sales were $891.3 million, up 9% from $821.1 million in 2011. Acquisitions contributed $59.1 million; foreign-currency translation reduced sales by $33.0 million. Gross profit was $301.7 million, with gross margin rising to 33.8% from 33.2%. Operating income was $113.0 million, up from $93.4 million; operating margin was 12.7%, versus 11.4%.
- Segments: Water Systems sales were $715.0 million, up 9%; Fueling Systems sales were $176.3 million, up 6%. Reported segment operating income increased to $124.1 million for Water Systems and $36.6 million for Fueling Systems. Management cited operating leverage, pricing and productivity improvements.
- Profit and earnings: Net income attributable to Franklin Electric was $82.9 million, versus $63.1 million. Diluted EPS was $3.46, compared with $2.65. Adjusted diluted EPS, a non-GAAP measure, was $3.14, versus $2.70; adjusted net income was $75.3 million, versus $64.3 million.
- Unusual earnings item: Reported results included a $12.2 million pretax, one-time gain from remeasuring Franklin’s existing investment when it acquired control of Pioneer Pump Holdings (PPH). The company’s adjusted figures exclude this gain and certain other identified items.
- Fourth quarter: Sales were $205.1 million versus $187.2 million in Q4 2011; net income attributable to Franklin Electric was $13.2 million versus $11.5 million; diluted EPS was $0.55 versus $0.50.
- Cash flow and investment: Cash from operations was $70.2 million, down from $99.9 million. Inventory increased $23.7 million, primarily as the company sought to improve product availability; receivables also used cash. Investing cash outflow was $101.6 million, including $64.4 million for acquisitions and $39.3 million of property and equipment additions. Capital expenditures were $42.1 million, versus $21.1 million.
- Liquidity and debt: Cash and equivalents were $103.3 million, down from $153.3 million. Working capital was $283.3 million; the current ratio was 2.9, compared with 3.2. Debt was $165.9 million, including $150.0 million of 5.79% notes and $14.9 million of current foreign-subsidiary debt. There were no year-end borrowings under the $150 million revolver; $146.1 million of capacity remained after letters of credit. The private shelf agreement had $50 million of remaining capacity. The company reported compliance with debt covenants.
Changes, outlook and material matters
- Sales growth reflected acquisitions, higher volume and pricing, partly offset by currency effects. On a basis excluding acquisitions and currency translation, sales increased about 5%. Both segments reported higher sales and operating income.
- During 2012, Franklin increased its PPH ownership to 70.5%, acquired Cerus Industrial Corporation and acquired Flex-ing, Incorporated. The acquired businesses contributed $48.4 million of revenue and $1.7 million of earnings from their respective acquisition dates through year-end. A $22.9 million liability was recorded for the required future purchase of the remaining PPH shares, to be completed by March 31, 2015 under a formula tied to PPH earnings and net debt.
- Management expected 2013 capital spending of approximately $63 million, including completion of the new headquarters and engineering center and a Brazil manufacturing facility; it expected spending to decline sharply in 2014. The new headquarters project was estimated at $32–$36 million before incentives. Management also estimated $2.0–$2.8 million of 2013 non-GAAP adjustments, primarily for restructuring and realignment activities.
- A $25 million project-note financing was entered into December 31, 2012, after fiscal year-end, at 3.6% interest, with semiannual payments beginning July 2013 and ending in January 2033. A two-for-one stock split was authorized in February 2013.
- Litigation: California air-quality agencies’ cases concern a component retrofit in Healy 900 Series nozzles. After trial, CARB requested $15.8 million and SCAQMD $2.1 million in penalties; the separate SMAQMD case was scheduled for trial in May 2013. The company disputed the claims and said penalties or settlement could materially affect financial results and cash flows. The filing states the cases did not affect product certification or continuing sales. Pentair and Sta-Rite were appealing dismissal of their claims seeking damages exceeding $10 million for each claimant.
- Principal risks: Acquisition integration and execution; competition and pricing; housing and weather-related demand; raw-material and energy costs; foreign-currency and international exposure; supply constraints; regulatory requirements; and potential goodwill or intangible-asset impairment. Goodwill was $208.1 million; the company reported no impairment in 2012 and said reporting-unit fair values substantially exceeded carrying values.
Investor verification points
- Track operating cash flow and working-capital conversion, particularly inventory following its $23.7 million increase.
- Assess the execution, integration and returns of the PPH, Cerus and Flex-ing acquisitions, including the formula-based PPH share purchase obligation.
- Check the outcomes and any financial-statement impact of the California air-district litigation and the Pentair/Sta-Rite appeal.
- Compare actual 2013 capital spending and restructuring costs with management’s estimates, and monitor the new financing and liquidity position.
- Distinguish reported earnings from adjusted earnings, especially the effect of the $12.2 million Pioneer remeasurement gain.