Franklin Electric Co., Inc. — Form 10-Q summary
Reporting period: Third quarter ended September 29, 2012; comparisons are with the third quarter ended October 1, 2011. Year-to-date figures cover the first nine months of each year. Franklin Electric reports Water Systems and Fueling Systems segments, including pumping equipment and fuel-management products.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $237.6 million | $224.4 million | $686.2 million | $633.8 million |
| Gross profit | $82.6 million | $73.7 million | $233.2 million | $211.5 million |
| Gross margin | 34.8% | 32.8% | 34.0% | 33.4% |
| Operating income | $33.5 million | $28.3 million | $92.0 million | $77.1 million |
| Operating margin | 14.1% | 12.6% | 13.4% | 12.2% |
| Net income attributable to Franklin Electric | $21.9 million | $19.2 million | $69.7 million | $51.6 million |
| Diluted EPS | $0.91 | $0.80 | $2.91 | $2.16 |
Revenue and margins: Q3 sales rose about 6%; excluding acquisitions and currency translation, sales increased about 6%. For the first nine months, sales rose about 8%, or about 5% excluding acquisitions and currency. Higher productivity, pricing, expense control and fixed-cost leverage supported margin improvement; raw-material costs remained a partial offset. Q3 sales included $13.8 million from businesses acquired since the prior-year quarter. Year-to-date acquired-business sales were $47.6 million, while currency translation reduced sales by $29.2 million.
Segments: Q3 Water Systems sales were $189.8 million and operating income was $35.1 million; Fueling Systems sales were $47.8 million and operating income was $11.4 million. For nine months, Water Systems sales and operating income were $557.5 million and $102.0 million; Fueling Systems recorded $128.7 million and $26.0 million. Water Systems benefited from U.S. groundwater pumping and Latin American growth; dry weather weighed on North American wastewater demand, while guarded European conditions constrained EMEA. Fueling Systems growth reflected fuel-pumping shipments and demand for new products.
Cash flow, balance sheet and liquidity
- Nine-month cash flows: Operating activities provided $26.1 million, down from $52.4 million. Investing used $71.9 million, including $54.0 million net cash paid for the PPH and Cerus acquisitions. Financing used $13.1 million. Cash declined $57.6 million to $95.7 million.
- Working capital: Receivables and inventory together used $57.4 million of operating cash, compared with $29.2 million in the prior-year period. Management said inventory was elevated in anticipation of demand and sales growth.
- September 29, 2012 balance sheet: Total assets were $964.8 million; current assets $451.1 million; current liabilities $145.8 million; total debt $168.5 million, including $17.7 million current maturities; and equity $515.3 million.
- Borrowing capacity: The $150 million revolving credit agreement had no borrowings and $146.1 million available after letters of credit. The Prudential agreement had $150 million outstanding and $50 million remaining capacity. The company reported compliance with all debt covenants. About 15% of cash was located in the U.S. and readily accessible.
- Shareholder returns: Nine-month dividends paid were $10.4 million; approximately 319,800 shares were repurchased or withheld for stock-related obligations for $16.5 million. The quarterly dividend was $0.15 per share.
Material changes, outlook and unusual items
- Franklin acquired an additional 39.5% of Pioneer Pump Holdings (PPH), raising ownership to 70.5% and bringing PPH into consolidation. It acquired Cerus, a motor-controls and drives business, in August. Acquisition-related goodwill and intangibles were recorded at preliminary values.
- The PPH transaction generated a one-time, noncash $12.2 million gain from remeasuring Franklin’s previously held investment. This materially contributed to nine-month other income of $14.4 million and should be distinguished from recurring operating performance.
- Franklin recorded a $22.9 million long-term liability for its contractual purchase of PPH’s remaining shares, expected on or before March 31, 2015, at a price based on PPH’s adjusted average earnings for 2013 and 2014, less net indebtedness.
- Management estimated a 28.1% effective tax rate, excluding discrete items, as a reasonable estimate for full-year 2012. No specific full-year revenue or earnings guidance is provided in the filing.
- Management expected investing cash use to remain elevated in 2012 and 2013 due to a new global headquarters and engineering center and a new Brazilian manufacturing facility. The headquarters project was estimated at $32–$36 million, with expected completion and occupancy in summer 2013. Capital commitments were $29.8 million.
- The Phase IV manufacturing realignment was expected to substantially conclude in Q4 2012, apart from possible asset dispositions. Estimated total pretax charges were $2.6–$5.2 million; $0.1 million was recorded in the first nine months of 2012.
- Contingencies: California air-quality lawsuits concerning a nozzle diaphragm seek penalties of at least $25.0 million from CARB, $5.0 million from SMAQMD and $12.5 million from SCAQMD. The company denied liability, disputed the claimed amounts and said the outcome could materially affect results, financial position and cash flows. The consolidated CARB/SCAQMD cases were set for trial in December 2012; the filing states that the suits did not affect product certification or ongoing sales.
- Sta-Rite and Pentair appealed dismissal of their claims alleging breach of a settlement agreement and seeking damages exceeding $10 million for each claimant; oral argument was scheduled for November 29, 2012. Franklin said it could not predict the outcome. Management reported no material changes to the previously disclosed risk factors.
Important facts for investors to verify
- How much of reported sales and earnings growth is sustainable organically, apart from acquisitions, currency effects and the one-time PPH remeasurement gain.
- Whether receivables and elevated inventory convert to cash, given the sharp year-over-year decline in operating cash flow.
- Final acquisition valuations, performance of PPH and Cerus, and the eventual price and funding needs for purchasing PPH’s remaining shares.
- Progress and total costs of the headquarters, engineering center and Brazil facility, alongside debt maturities and available liquidity.
- Developments and potential financial exposure in the air-quality and Sta-Rite/Pentair litigation; the filing does not establish a clear ultimate liability amount.