Business context and reporting period
Franklin Electric designs, manufactures and distributes water- and fuel-pumping systems through its Water Systems and Fueling Systems segments. This Form 10-K covers the 52-week fiscal year ended December 31, 2011; comparisons are with fiscal 2010. The filing also reports fourth-quarter results.
Financial results and key metrics
| Metric | 2011 | 2010 |
|---|---|---|
| Net sales | $821.1 million | $713.8 million |
| Gross profit / margin | $272.3 million / 33.2% | $230.2 million / 32.2% |
| Operating income | $93.4 million | $64.0 million |
| Net income attributable to Franklin Electric | $63.1 million | $38.9 million |
| Diluted EPS | $2.65 | $1.65 |
| Cash from operating activities | $99.9 million | $94.6 million |
| Cash and cash equivalents at year-end | $153.3 million | $140.1 million |
Sales increased 15%; about $43.3 million came from acquisitions, $18.8 million from foreign-currency translation, and $45.2 million from organic growth excluding those effects. Water Systems sales were $654.1 million (+12%); Fueling Systems sales were $167.0 million (+28%). Reported gross margin improved 100 basis points, reflecting higher volume and productivity, partly offset by material costs. The effective tax rate was 26.9%.
In fourth-quarter 2011, sales were $187.2 million versus $175.0 million; net income attributable to Franklin Electric was $11.5 million versus $8.1 million, and diluted EPS was $0.50 versus $0.34.
Liquidity, debt and capital allocation
Working capital was $276.4 million and the current ratio was 3.2 at year-end. Total debt was approximately $163.7 million, including $13.7 million of current maturities; long-term debt was $150.0 million. The company had no borrowings under its revolving credit agreement, with $147.0 million of availability under that facility and $50.0 million available under its private shelf agreement. It reported compliance with debt covenants.
Investing cash outflow was $65.8 million, including acquisitions and $21.8 million of capital expenditures. Financing cash outflow was $15.5 million; dividends paid were $12.9 million. The annual dividend was $0.54 per share. The filing states that the company expects operating needs, capital expenditures, pension obligations, dividends and debt service to be funded by cash, operations and existing credit facilities.
Material changes, outlook and risks
- Growth and acquisitions: The company acquired an 80% interest in Turkish pump maker Impo and bought the remaining 25% of Vertical, bringing its ownership to 100%. Management attributed growth to acquisitions, organic volume and pricing, and currency translation.
- Margins and costs: Operating income rose to $93.4 million from $64.0 million. Reported 2011 results included $1.6 million of restructuring charges and $0.7 million of Fueling Systems legal expense; 2010 included $5.3 million of restructuring charges, $4.3 million of legal expense, and a $1.2 million property-sale gain.
- Accounting change: The company retrospectively changed inventory valuation from LIFO to FIFO. It estimated that 2011 LIFO accounting would have reduced net income attributable to Franklin Electric by $1.8 million, or $0.08 per diluted share. Prior periods in the filing were adjusted.
- Investment and restructuring: A new Fort Wayne-area headquarters and engineering center was expected to be completed by mid-2013, at estimated land, improvement and construction costs of $32–$36 million. Capital expenditures were expected to be elevated in 2012 and 2013. Phase IV manufacturing realignment was estimated to cost $2.6–$5.2 million, with charges expected to substantially end in fourth-quarter 2012.
- Legal contingency: California regulators and air districts sought penalties of at least $25.0 million, $5.0 million and $12.5 million in lawsuits concerning a nozzle diaphragm retrofit. The company denied liability, said it could not predict the outcome, and warned that penalties or settlement payments could materially affect results. The EVR system remained certified and sales were not disrupted. Pentair/Sta-Rite claims exceeding $10 million per claimant were dismissed in September 2011; the plaintiffs appealed.
- Principal business risks: Competition and pricing, housing and construction activity, weather and agricultural demand, commodity and energy costs, foreign exchange and international operations, acquisition integration, regulatory requirements, and potential goodwill impairment. Goodwill was $168.8 million; the 2011 annual impairment test found reporting-unit fair values substantially above carrying values.
- Other watch items: Backlog was $52.5 million, unchanged from the prior comparable date, and was expected to be filled in 2012; management cautioned that backlog was not a significant indicator of future sales. Pension plans were frozen or closed to new accruals effective January 1, 2012, subject to limited exceptions.
Important facts for investors to verify
- Track organic sales, especially the durability of Water Systems growth and Fueling Systems gains excluding acquisitions and currency effects.
- Review the outcome and financial exposure from the California regulatory litigation and the appeal in the Pentair/Sta-Rite case.
- Monitor Phase IV restructuring costs, execution of manufacturing transfers, and actual spending on the headquarters project.
- Assess cash conversion, working-capital needs, acquisition-related obligations, and the company’s capacity to fund planned investment and shareholder returns.
- Consider the effects of the FIFO accounting change when comparing reported results with earlier periods.