Franklin Electric Co., Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter ended October 1, 2011; comparisons are with the quarter ended October 2, 2010. Nine-month figures cover the same respective periods. Interim financial statements are unaudited. Comparative figures were retrospectively adjusted for the change from LIFO to FIFO inventory accounting.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $224.4m | $188.4m | $633.8m | $538.8m |
| Gross profit / margin | $73.7m / 32.9% | $59.4m / 31.5% | $211.5m / 33.4% | $174.7m / 32.4% |
| Operating income | $28.3m | $19.6m | $77.1m | $50.7m |
| Net income attributable to Franklin Electric | $19.2m | $12.3m | $51.6m | $30.8m |
| Diluted EPS | $0.80 | $0.52 | $2.16 | $1.31 |
- Q3 sales rose 19%; management attributed the increase to acquired businesses, higher volume and pricing, and currency translation. Excluding acquisitions and currency, sales grew about 7%.
- Nine-month sales rose 18%; excluding acquisitions and currency, growth was about 6%. Gross-margin gains reflected fixed-cost leverage, pricing and productivity, partly offset by higher material costs.
- Nine-month operating cash flow was $52.4m, versus $69.2m. Receivables and inventory used $29.1m of cash; pension-plan contributions were $15.9m. Capital expenditures were $13.6m.
- At October 1, cash was $128.1m, current assets $409.9m and current liabilities $128.8m. Total debt was $165.6m, including $11.4m current maturities; long-term debt was $154.2m. The principal $150m note facility bears 5.79%, with scheduled principal payments beginning in 2015.
- Nine-month investing cash use was $48.2m, including $25.1m for acquisitions, $6.6m of prior-acquisition consideration and a $3.2m customer-related loan. Financing cash use was $13.9m, including $9.3m in dividends and $10.6m in share repurchases. Cash declined $12.0m to $128.1m.
Segments and material changes
- Water Systems: Q3 sales of $179.4m, up 17%; nine-month sales of $510.1m, up 14%. Q3 organic growth excluding acquisitions and currency was about 7%. Management cited strong U.S. industrial and irrigation demand; EMENA sales excluding acquisition and currency effects declined about 9% in Q3 amid regional uncertainty.
- Fueling Systems: Q3 sales of $45.0m, up 27%; nine-month sales of $123.7m, up 35%. Excluding acquisition and currency effects, nine-month sales increased about 7%.
- Impo, a Turkish groundwater-pumping equipment supplier, was acquired in Q2; Franklin acquired 80% for approximately $26.1m. The acquisition added sales and debt, and includes contingent consideration subject to performance criteria.
- The company reported record Q3 sales. Q3 operating income increased to $28.3m; nine-month operating income increased to $77.1m. The 2010 comparison included higher restructuring charges and different legal and asset-sale items, so reported comparisons include unusual-item effects.
- Effective January 2, 2011, the company changed certain inventory valuation from LIFO to FIFO and restated prior periods. Management estimated that using LIFO instead would have reduced nine-month 2011 net income by $0.9m and diluted EPS by $0.03; operating cash flow would not have changed.
Outlook, risks and unusual items
- Management estimated a 27.3% effective tax rate for 2011, citing foreign earnings and tax-structure effects. It did not provide quantified revenue or earnings guidance; it cautioned that interim results are not necessarily indicative of full-year results.
- Phase IV of the manufacturing realignment is expected to cost $2.6m–$5.2m pretax. It includes transferring manufacturing work from Oklahoma City, with related transfers expected to be completed by Q1 2012; the overall program is expected to run through Q4 2012.
- A proposed 110,000-square-foot headquarters and engineering center is estimated to cost $25m–$32m, with completion expected by mid-2013. No formal commitments had been made as of quarter-end.
- California air-quality agencies’ lawsuits concerning a Healy nozzle diaphragm seek penalties of at least $25.0m, $5.0m and $12.5m, respectively. The company denies liability, says the claimed amounts lack a reasonable basis, and warns that a sufficiently large penalty or settlement could materially affect results. Product certification and continuing sales were not affected, according to the filing.
- Pentair and Sta-Rite’s claims seeking more than $10m each were dismissed on summary judgment; the plaintiffs appealed. The company also disclosed routine tax audits and other ordinary-course claims.
- The company had $120m available under its then-current revolving credit agreement and $50m under the Prudential facility, and was in compliance with debt covenants. It was negotiating renewal of the revolving facility; an October 5, 2011 commitment letter for a $150m credit facility was listed as an exhibit.
- Management cited risks including economic and currency conditions, demand and weather, raw-material costs, competition, acquisition integration, regulation and litigation. A long-term motor-supply agreement representing about 1% of consolidated sales was due to expire in Q4 2011 and would not be renewed.
Key facts for investors to verify
- Whether organic growth and margin improvements persist after separating acquisition, currency, pricing and unusual-item effects.
- Integration progress and final purchase accounting, earn-out exposure and financing related to Impo.
- Renewal and final terms of the revolving credit facility, as well as future debt maturities and liquidity needs.
- Developments, potential financial exposure and timing in the California air-quality litigation and the Pentair/Sta-Rite appeal.
- Actual costs and execution of Phase IV restructuring, and any formal commitments or updated costs for the proposed headquarters project.
- Cash conversion and working-capital trends, including receivables, inventory and pension contributions.