Franklin Electric - 10-Q quarterly report FY

Sales for the third quarter of 2007 were up compared to the third quarter of 2006. The sales increase was primarily attributable to sales from acquisitions and foreign exchange rate changes. Third quarter 2007 sales increases were partially offset by a significant decline of Water Systems product sales in the United States and Canada, primarily related to small submersible motor products sold to large pump OEMs. While sales to large pump OEMs decreased, sales of small submersible motor and pump products and related accessories to distributors and small pump manufacturers in the United States and Canada increased. This change in customer base is consistent with the Company’s strategic change in its distribution channel for Water Systems products in this region. Water Systems sales in international markets increased during the quarter primarily due to acquisitions. Water Systems acquisitions include Pump Brands, Ltd. (South Africa), completed in June 2007, and the pump division of Monarch Industries (Canada), completed in September 2007.  Fueling Systems sales increased during the third quarter compared to the same period a year ago with a significant amount of the increased sales attributable to the September 2006 acquisition of Healy Systems. Sales increased across all fueling product lines in both domestic and international markets. Earnings declined in third quarter 2007 primarily due to the significant decline in Water Systems small submersible motor product sales volume. The Company’s earnings were also reduced by material, freight and other cost increases and promotional sales discounting net of sales price increases.

Net sales for the third quarter were $165.3 million, an increase of $9.1 million or up 6 percent compared to $156.2 million in 2006. Acquisitions increased sales by about 12 percent during the quarter and foreign exchange rate changes increased sales about 2 percent. Third quarter sales, excluding acquisitions and foreign exchange rate changes, declined by 8 percent from the same period a year ago. Global Water Systems sales for third quarter 2007 decreased by $0.9 million or 1 percent compared to a year ago. While Water Systems sales in the United States and Canada declined by about $16 million or 18 percent, sales in regions outside the United States and Canada grew by about $15 million or 36 percent. The decline in 2007 sales of Water Systems in the United States and Canada was attributable to the Company’s decision to discontinue the distribution of its Water Systems products in the United States and Canada through large pump OEMs in favor of selling direct to the water systems industry professional distribution channel. Prior year sales to the large pump OEMs in the United States and Canada for the third quarter of 2006 represented about $30 million of Water Systems sales in the region. In the third quarter of 2007, the Company did not have any sales to large integrated pump OEMs, but Franklin submersible motor products continued to flow into the market from the OEM channel. Another key factor adversely affecting the Company’s Water Systems sales in the United States and Canada during the third quarter of 2007 was the weakness in industry demand. In the third quarter, based upon trade association data, the Company believes that North American Water Systems industry demand was down about 8 percent compared to last year. Global Fueling Systems sales, which represent about 20 percent of the Company’s total sales, increased by 48 percent in the third quarter of 2007 compared to the same period a year ago. Organic growth during the third quarter for Fueling sales was about 29 percent. Product sales increased across all product lines, including vapor recovery and fuel management systems. Healy Systems (vapor recovery) products had strong organic growth during the third quarter of 2007 compared to prior year.

Cost of sales as a percent of net sales for third quarter 2007 and 2006 was 71.0 percent and 65.8 percent, respectively. The gross profit margin declined to 29.0 percent for the third quarter of 2007 from 34.2 percent in the third quarter of 2006. Gross profit for the Company declined $5.4 million or 10 percent versus the third quarter 2006. In the United States and Canada, 2006 gross profits benefited from unusually high sales of submersible motors to large pump OEMs as their purchases were in excess of market demand. The loss of gross profit on sales of submersible motors to these OEMs in 2007 was partially offset by increased gross profit on sales of Water Systems products to distributors and other customers throughout North America.  Global Water Systems gross profit margins declined about 540 basis points in the third quarter of 2007 compared to the third quarter of 2006. The gross profit margin decline pertained to sales in the United States and Canada market with three principal causal factors. First, approximately one-third was attributed to product mix changes. Pumps have become a higher percentage of sales and they generally carry a lower gross profit margin than submersible motors. Second, approximately one-third was attributed to fixed cost coverage as the Company’s North American submersible motor plants operated at lower capacity utilization rates during the third quarter of 2007 compared to the third quarter of 2006. Third, about 30 percent was due to increased costs of material and freight and promotional price discounts net of market price increases. Fueling Systems gross profit increased by $3.0 million or 43 percent versus the third quarter of 2006. Fueling Systems gross profit margins declined modestly during the quarter due to an unusually high mix of international tender sales during the third quarter of 2007.

Selling and administrative expense as a percent of net sales for third quarter 2007 and 2006 was 17.1 percent and 17.8 percent, respectively. The Company’s overall selling and administrative expenses for the third quarter of 2007 increased by $0.4 million from the same period in the prior year. Acquisitions increased selling and administrative expenses in the third quarter of 2007 compared to last year by about $2.6 million. The incremental acquisition expenses were offset by reduced spending in the base operations related primarily to incentive compensation and commissions.

During the third quarter of 2007, the Company continued to execute its Global Manufacturing Realignment program. Phase 2 includes the recent expansion of motor manufacturing in Linares, Mexico to include all 4-inch Super Stainless products (small submersible motor); the construction and start-up of a new pump manufacturing plant in Linares; the consolidation of Fueling Systems operations into the recently enlarged Madison, Wisconsin plant; and, the streamlining of motor manufacturing operations in Siloam Springs, Arkansas and Wittlich, Germany. The Company has also announced the phased relocation of the Little Rock, Arkansas Water Systems pump manufacturing to the new pump plant in Linares, Mexico over the next three to nine months. Restructuring expenses year to date 2007 were approximately $1.9 million (pre-tax) and reduced diluted earnings per share by approximately $0.05 per share for the nine months ending September 2007. Full year 2007 restructuring expenses are estimated to be $4.0 million (pre-tax) and will include severance and other employee expenses as well as manufacturing equipment relocation costs. The estimated full year restructuring expenses have decreased from our prior estimate of $6.0 million as actual expenses for equipment relocation and severance are less than previously estimated and a small portion of these expenses will not be incurred until 2008.

Interest expense for third quarter 2007 and 2006 was $2.3 million and $1.1 million, respectively. Interest expense increased by $1.2 million during the third quarter versus the same period in the prior year due to the debt incurred to fund acquisitions and increased working capital requirements.  

Interest income of $0.6 million and $0.4 million, included in “Other income” for third quarter 2007 and 2006 respectively, was primarily derived from cash investments in short-term U.S. treasury and agency securities. Also, included in “Other income” for third quarter 2007 and 2006 was income from equity investments of $0.1 million and $0.2 million, respectively.

Foreign currency-based transactions produced a loss for third quarter 2007 of about $0.2 million.  Foreign currency-based transactions resulted in a gain in the third quarter 2006 of about $0.2 million.

The provision for income taxes in 2007 and 2006 was $6.0 million and $8.8 million, respectively. The effective tax rates for the third quarter of 2007 and 2006 were 33.8 and 35.0 percent, respectively. The effective tax rate differs from the United States statutory rate of 35 percent, generally due to foreign income exclusion, research and development credits and the effects of state and foreign income taxes, net of federal tax benefits. The income tax rate for the third quarter of 2007 was less than the prior year primarily due to one-time tax adjustments, including an income tax rate reduction passed in Germany in the third quarter of 2007.

Net income, from continuing operations, for third quarter 2007 was $11.7 million, or $0.50 per diluted share, compared to third quarter 2006 net income of $16.2 million or $0.70 per diluted share.

Sales for the first nine months of 2007 were up from the same period last year. The increase in sales was primarily related to sales from the Company’s acquisitions. Earnings declined in 2007 primarily due to the significant decline in Water Systems small submersible motor product sales volume. The contribution margin of small submersible motors in the prior year was more than other Water Systems products, resulting in a further decline of earnings due to the product mix change. The Company also incurred increased fixed costs in connection with acquisitions and higher selling, general and administrative spending from the Company’s strategy of selling to a more diversified customer base by marketing its Water Systems products directly to distributors.

Net sales for the first nine months of 2007 were $448.3 million, an increase of $38.2 million or 9 percent compared to the same period of 2006 sales of $410.1 million. Incremental sales related to acquisitions for 2007 were $62.9 million or 15 percent of sales. Foreign exchange rate changes increased sales about 1 percent in the first nine months of 2007. Year to date sales, excluding acquisition sales and foreign exchange rate changes, declined by about 7 percent from the same period a year ago. Global Water Systems sales for the first nine months of 2007 increased by 2 percent compared to the same period a year ago. However, excluding acquisitions, primarily Little Giant Pump Company, and a foreign exchange rate benefit, global Water Systems sales decreased by 13 percent versus the first nine months of 2006. Sales of 4-inch submersible motor units in the United States and Canada declined primarily due to the liquidation of Franklin motor inventory held by large pump OEMs and weak overall water systems industry demand in the United States and Canada. The year-to-date industry demand through September 2007 was down in excess of 12 percent, according to trade association data, compared to the same period in the prior year. The industry decline for the first nine months of 2007 period was due to harsh weather conditions in key markets early in the year and a continuing decrease in new housing starts compared to the prior year. Changes in selling prices increased net sales by about 3 percent and foreign exchange rate changes increased net sales by about 1 percent compared to the first nine months of 2006. Global Fueling Systems sales for the first nine months of 2007 increased by 53 percent compared to the same period a year ago due to the acquisition of Healy Systems and organic volume. Excluding the Healy acquisition, the first nine months Fueling System sales increased by 28 percent compared to last year. The volume growth across product lines was led by the fuel management electronics platform products.

Cost of sales as a percent of net sales for the first nine months of 2007 and 2006 was 71.0 percent and 65.5 percent, respectively. Correspondingly, the gross profit margin declined to 29.0 percent from 34.5 percent. The gross profit margin changes in the first nine months of 2007 were consistent with the explanations covered in detail above under the third quarter review. In summary, sales and gross profit of Water Systems products in regions outside the United States and Canada increased, as did the gross profit on Fueling Systems sales, offset by a decline in gross profit on the sale of Water Systems products in the United States and Canada.

Selling and administrative expense for the first nine months as a percent of net sales for 2007 and 2006 was 20.0 percent and 18.2 percent, respectively. Selling and administrative expense for the first nine months increased by $14.7 million in 2007 compared to the first nine months of last year. The increase was primarily due to the inclusion of acquisitions, or about $12.1 million, for the first nine months of 2007 compared to last year. The increase due to higher selling and administrative expenses in support of the Company’s strategy change in the Water Systems channel in the United States and Canada, as discussed above, was approximately $2.6 million.

 

Restructuring expenses under Phase 2 of the Global Manufacturing Realignment program for the first nine months of 2007 were approximately $1.9 million (pre-tax) and reduced EPS by approximately $0.05 per share. 

Interest expense for the first nine months of 2007 and 2006 was $5.7 million and $2.4 million, respectively. Interest expense increased in 2007 due primarily to debt increases associated with funding acquisitions, as well as, increased working capital for inventory and accounts receivable.

Interest income of $1.6 million, included in “Other income” for the first nine months of 2007 and 2006, was primarily derived from cash investments in short-term U.S. treasury and agency securities. Also, included in other income in the first nine months of 2007 and 2006 was income from equity investments of $0.6 million and $0.5 million, respectively.

Foreign currency-based transactions produced a gain for the first nine months of 2007 of $0.4 million primarily due to euro rate changes relative to the U.S. dollar.  Foreign currency-based transactions for the same period in 2006 were neutral.

The provision for income taxes in 2007 and 2006 was $12.2 million and $23.4 million, respectively. The effective tax rates for the first nine months of 2007 and 2006 were 34.5 and 35.6 percent, respectively. The effective tax rate differs from the United States statutory rate of 35 percent, generally due to foreign income exclusion, research and development credits and the effects of state and foreign income taxes, net of federal tax benefits.

Net income, from continuing operations, for the first nine months of 2007 was $23.2 million, or $0.99 per diluted share, compared to the same period for 2006 at $42.5 million or $1.82 per diluted share.