Franklin Electric Co., Inc. — Q2 2011 Form 10-Q
Reporting period: Second quarter and six months ended July 2, 2011. Comparative 2010 figures were retrospectively adjusted for the company’s change from LIFO to FIFO inventory accounting. Amounts below are in U.S. dollars; financial statement amounts are in millions except per-share data.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $224.1 | $190.4 | $409.4 | $350.4 |
| Gross profit | $77.2 | $64.6 | $137.7 | $115.2 |
| Gross margin | 34.5% | 33.9% | 33.6% | 32.9% |
| Operating income | $32.8 | $18.6 | $48.7 | $31.1 |
| Net income | $22.0 | $11.5 | $32.9 | $19.0 |
| Net income attributable to Franklin Electric | $21.7 | $11.1 | $32.3 | $18.5 |
| Diluted EPS | $0.91 | $0.47 | $1.35 | $0.79 |
Q2 sales rose 18%; six-month sales rose 17%. Management attributed growth to acquisitions, foreign currency translation, higher volume and pricing. Excluding acquisitions and currency effects, sales increased about 6% in both periods. Q2 operating margin was 14.6%, versus 9.8%; the company’s non-GAAP adjusted margin was 14.9%, versus 13.3%. For the first half, reported operating margin was 11.9%, versus 8.9%, and adjusted margin was 12.3%, versus 11.1%.
Water Systems Q2 sales rose 15% to $183.5 million; Fueling Systems sales rose 34% to $40.6 million, including Petrotechnik acquisition sales. Q2 operating income increased in both segments. Fueling Systems’ adjusted margin declined to 18.0% from 18.8%, which management attributed to acquisition mix and higher material costs.
Cash flow, debt and liquidity
- First-half operating cash flow was $5.9 million, down from $22.1 million. Receivables and inventory together used $46.6 million of cash, reflecting higher sales; pension contributions were $11.2 million.
- Investing activities used $42.7 million, including $24.9 million for the Impo acquisition, $6.6 million of additional consideration for a prior acquisition, $8.2 million in capital expenditures and a $3.3 million customer loan.
- Financing activities used $12.8 million, including $6.2 million of dividends and $10.6 million of share repurchases. Cash and equivalents fell to $94.2 million from $140.1 million at year-end.
- Debt was $166.2 million, including $154.4 million long-term debt and $11.8 million current maturities; cash exceeded debt by approximately $72 million. The company reported $118.1 million available under its $120 million revolving credit agreement and $50 million under its Prudential facility, and said it was in compliance with covenants. The revolving agreement was due to mature in 2011; renewal negotiations were underway.
Material developments, outlook and risks
- Franklin acquired 80% of Impo, a Turkish groundwater pumping equipment supplier, in May for approximately $25.8 million net of debt acquired. Impo contributed $4.2 million of Q2 sales. The acquisition included $14.1 million of debt and contingent consideration initially valued at $5.5 million.
- Management cited stronger demand for irrigation and industrial pumping, pricing and productivity improvements, and operating leverage. Higher materials costs partially offset margin gains. No specific full-year revenue or earnings guidance was provided. Management estimated a 27.4% effective tax rate for 2011, citing foreign earnings and tax restructuring.
- Phase IV of the manufacturing realignment is expected to transfer about 260,000 annual manufacturing hours from Oklahoma City primarily to Linares, Mexico, with transfers expected to finish by Q1 2012. Estimated pretax charges are $2.6–$5.2 million through Q4 2012.
- The company announced preliminary plans for a new Indiana headquarters and engineering center, with estimated costs of $25–$32 million and anticipated completion by mid-2013; it had made no formal commitments as of quarter-end.
- California air-quality agencies’ lawsuits over a Healy nozzle diaphragm seek penalties of at least $42.5 million in aggregate. The company disputes liability and says the claimed amounts lack a reasonable basis; adverse outcomes or settlements could materially affect results. Separate Sta-Rite/Pentair litigation seeks damages exceeding $10 million for each claimant, with summary-judgment motions pending. The company said other ordinary-course claims were not expected to have a material adverse effect.
- Other notable items: Q2 foreign-exchange loss was $0.9 million; first-half loss was $1.4 million. The first-half other-income figure included a $0.7 million gain on a Turkish-lira forward contract. The LIFO-to-FIFO accounting change increased reported Q2 and first-half 2011 net income by an estimated $0.3 million and $0.6 million, respectively, versus LIFO accounting.
Important facts for investors to verify
- Whether working-capital requirements normalize and operating cash flow improves after the significant first-half receivables and inventory use.
- Renewal terms and timing for the revolving credit agreement, and the maturity and refinancing profile of debt, including Impo borrowings.
- Impo’s subsequent performance, final purchase accounting valuations and potential earn-out payments.
- Progress and total charges for Phase IV restructuring and the proposed headquarters project.
- Developments in the air-quality and Sta-Rite/Pentair litigation, including any potential financial impact.
- How sustained material-cost inflation, foreign exchange, agricultural demand and regional market conditions affect sales and margins.