Franklin Electric Co., Inc. — Q1 2011 Form 10-Q
Reporting period: First quarter ended April 2, 2011, compared with the first quarter ended April 3, 2010. Franklin Electric reports Water Systems and Fueling Systems. Amounts below are in millions unless stated otherwise; prior-period figures reflect the filing’s retrospective inventory-accounting adjustment.
Financial performance
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net sales | $185.3 | $160.0 | Up 16% |
| Gross profit / margin | $60.5 / 32.7% | $50.6 / 31.6% | Margin up 110 bps |
| Operating income | $16.0 | $12.6 | Up $3.4 |
| Net income | $10.9 | $7.6 | Up $3.4 |
| Net income attributable to Franklin Electric | $10.7 | $7.3 | |
| Diluted EPS | $0.45 | $0.31 | |
| Operating cash flow | $(31.1) | $(12.6) | Greater cash use |
Sales growth included $10.1 million from 2010 acquisitions and $4.3 million from foreign-currency translation; excluding both, sales increased $10.9 million, or about 7%. Water Systems sales rose 10% to $147.2 million, all organic; Fueling Systems sales rose 48% to $38.1 million, including $10.1 million from the PetroTechnik acquisition. Excluding that acquisition, Fueling Systems sales grew about 9%.
Gross margin improved as lower labor and variable manufacturing costs and increased fixed-cost absorption outweighed higher material costs. SG&A rose 23% to $44.2 million, including acquisition costs, higher IT and engineering spending, and a $0.7 million accrual for California regulatory claims. The effective tax rate was 27%; management said it considered this a reasonable estimate for the remainder of 2011. Interest expense was $2.2 million. Other income was $1.6 million, versus a $2.2 million loss in Q1 2010.
Cash, debt and liquidity
- Cash and equivalents were $102.8 million at April 2, down from $140.1 million at January 1. Current assets were $385.4 million and current liabilities $109.8 million.
- Total debt was about $152.4 million, primarily a $150 million note bearing 5.79%; cash exceeded reported debt by approximately $49.6 million. No principal payments on the Prudential notes are scheduled before 2015.
- The company reported $116.8 million of available capacity under its $120 million revolving facility and $50 million under its $200 million Prudential shelf agreement. The revolving facility matures in 2011; management planned to renew it with similar capacity. The company said it was covenant-compliant and expected existing facilities and cash flows to fund operations, capital spending, dividends and debt service.
- Operating cash use reflected a $40.4 million combined use from receivables and inventory, as well as $8.3 million of employee-benefit-plan cash use. Investing cash use was $3.2 million, mainly equipment purchases. Financing cash use was $5.9 million, including $3.0 million of dividends and $4.1 million of share repurchases.
Material changes, outlook and risks
- Inventory accounting: Effective January 2, 2011, the company changed certain inventories from LIFO to FIFO and retrospectively adjusted prior periods. It said Q1 2011 net income would have been about $0.3 million lower, or $0.01 per share lower, under LIFO; operating cash flow would not have changed. The change increased January 1, 2011 inventory by $14.2 million and retained earnings by $8.6 million versus the originally reported amounts.
- Restructuring: Q1 restructuring expense was $0.4 million, compared with $2.2 million a year earlier. Phase III of the global manufacturing realignment was substantially complete; the company intended to develop and announce Phase IV in Q2 2011.
- Legal matters: California CARB seeks penalties of at least $25.0 million over the Healy nozzle diaphragm matter; SMAQMD seeks at least $5.0 million and SCAQMD at least $12.5 million. The company denies liability, disputes the requested amounts and cannot predict outcomes; an adverse result or settlement could materially affect results. The filings said these cases did not affect product certification or ongoing sales. Separately, Pentair and Sta-Rite seek damages exceeding $10 million each in a contract dispute; cross-motions for summary judgment were pending. The company also disclosed a 2010 court ruling against its indemnification claim related to the Healy matter, released withheld funds in January 2011, and recorded a $1.2 million charge in December 2010 for fees and interest.
- Other items: A forward purchase contract for Turkish lira generated about $0.6 million of pretax gain in Q1. A $0.7 million expense was recorded for revised California claims accruals. The company had $3.6 million of gross unrecognized tax benefits and was undergoing routine tax audits; balances could change over the next 12 months.
- Risks and outlook: Management highlighted exposure to economic and currency conditions, demand, weather, competition, raw-material costs, supply constraints, litigation and regulatory action. It provided no quantified sales or earnings forecast in the supplied filing text. It stated that Q1 results are not necessarily indicative of full-year results.
Key facts for investors to verify
- Whether sales growth, margin improvement and operating performance persist after separating acquisition, currency and one-time effects.
- Working-capital trends—especially receivables and inventory—and whether operating cash flow recovers from the Q1 outflow.
- Renewal terms and availability of the revolving credit facility as it approaches maturity, along with debt covenants and cash needs.
- Developments, potential exposure and reserve adequacy for the California air-district cases and the Pentair/Sta-Rite litigation.
- Execution, costs and expected benefits of the planned Phase IV manufacturing realignment, and the continuing effects of the LIFO-to-FIFO change.