Franklin Electric Co., Inc. — Q3 2010 Form 10-Q
Reporting period: Third quarter ended October 2, 2010; year-to-date figures cover the first nine months of 2010. Comparisons are with the third quarter and nine months ended October 3, 2009. Amounts are U.S. dollars; financial statement figures are in millions unless noted.
Business context
Franklin Electric operates Water Systems and Fueling Systems businesses. Q3 growth reflected higher sales in both segments, with Water Systems contributing most of the year-to-date increase. On September 3, the company acquired UK-based Petrotechnik for approximately $12.9 million, net of debt assumed; its sales contributed $2.4 million in the quarter and nine-month period.
Financial performance
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $188.4 | $166.0 | $538.8 | $481.1 |
| Gross profit | $59.3 | $50.2 | $174.2 | $142.6 |
| Gross margin | 31.5% | 30.3% | 32.3% | 29.6% |
| Operating income | $19.4 | $15.5 | $50.2 | $34.1 |
| Net income attributable to Franklin Electric | $12.2 | $8.6 | $30.5 | $18.3 |
| Diluted EPS | $0.52 | $0.37 | $1.30 | $0.79 |
- Q3 sales increased 13%; management attributed $20.4 million of the increase to organic growth, excluding acquisitions and currency effects. Water Systems sales grew 11%, and Fueling Systems sales grew 25%, including Petrotechnik.
- Year-to-date sales rose 12%; organic growth excluding acquisitions and currency was 9%. Water Systems grew 16%, while Fueling Systems sales declined 3%.
- Q3 operating margin was approximately 10.3%, compared with 9.3% a year earlier. Year-to-date operating margin was approximately 9.3%, versus 7.1%.
- Operating cash flow was $69.2 million for nine months, versus $88.3 million. Capital expenditures were $11.3 million; investing cash outflow was $21.8 million, including the Petrotechnik acquisition.
- Cash and equivalents were $122.1 million at October 2, versus $86.9 million at January 2. Total debt was $153.9 million, including $150.0 million under the Prudential Agreement; cash less total debt was approximately negative $31.8 million. Current assets were $371.8 million and current liabilities $124.4 million.
- Available borrowing capacity was $116.6 million under the revolving agreement and $50.0 million under the Prudential Agreement. The company reported compliance with all covenants and no scheduled principal payments on the Prudential Agreement until 2015.
- Dividends were $0.13 per share in Q3 and $0.39 per share year to date. The company repurchased approximately 157,900 shares for $4.4 million during the first nine months.
Material changes and management commentary
- Q3 gross-margin improvement was primarily attributed to higher sales and fixed-cost leverage. Management said rising raw-material costs reduced Water Systems’ Q3 operating margin by 180 basis points; material costs had increased about 4% versus the prior-year quarter.
- Management said price increases were being implemented in most global Water Systems markets over the next 90 days to offset raw-material and other cost increases. It also expected raw-material costs to be a higher share of sales in Q4 than in the prior-year quarter.
- Petrotechnik was expected to be accretive to 2010 EPS but dilutive to operating margins. Management cited approximately $40 million in its most recent annual sales.
- Fueling Systems’ nine-month operating income declined 19%, primarily due to $3.8 million of legal expense and $1.4 million of related legal and professional fees recognized in Q2. Q3 Fueling Systems margins improved with higher sales and operating leverage.
- The company projected a 32.5% full-year effective tax rate before discrete items. Its Q3 effective rate was 28.5%; the filing notes discrete tax adjustments.
- Nine-month restructuring expense was $5.3 million, including $2.4 million of asset impairment. The Siloam Springs facility closure was substantially complete; remaining assets were classified as held for sale.
Risks, contingencies, and unusual items
- CARB sued the company and its Fueling Systems subsidiary over a component in the Healy 900 Series nozzle and related retrofit. The complaint seeks penalties of at least $25 million; the company disputed that amount and said it could not predict the outcome. The company stated the suit did not affect product certification or ongoing sales. Any penalties or settlement, depending on amount, could materially affect results.
- Air-district matters concerning the same diaphragm issue remain unresolved. Former Healy owner James Healy also sued over withheld purchase-price and earn-out funds; trial was scheduled for December 2010. The company said it could not predict the outcome.
- The company recorded $3.8 million of expense for legal matters in Q2 and stated that final claim outcomes are uncertain. It believed the expense recognized was appropriate based on facts then known.
- A $2.9 million reversal of a pre-acquisition uncertain tax position affected both other income/expense and income taxes but, according to management, had no impact on net income.
- Other cited risks include economic and currency conditions, housing starts, weather, demand, competition, supply constraints, raw-material costs, acquisition integration, litigation, and government or regulatory actions. The filing reported no material changes to the prior annual report’s risk factors.
Investor facts to verify
- Progress and financial impact of the CARB and air-district proceedings, and the Healy indemnification litigation.
- Whether announced Water Systems price increases offset continued raw-material inflation and how margins develop.
- Petrotechnik’s ongoing contribution, purchase-price valuation, and expected margin dilution.
- Cash conversion and working-capital movements, particularly receivables, inventory, and accrued liabilities.
- Final sale proceeds and any further impairment or restructuring costs related to Siloam Springs assets held for sale.