GORMAN RUPP CO - Quarter Report: 2022 September (Form 10-Q)

THE GORMAN-RUPP COMPANY

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

See notes to consolidated financial statements (unaudited).

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

See notes to consolidated financial statements (unaudited).

THE GORMAN-RUPP COMPANY

CONSOLIDATED BALANCE SHEETS

See notes to consolidated financial statements (unaudited).

THE GORMAN-RUPP COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

See notes to consolidated financial statements (unaudited).

THE GORMAN-RUPP COMPANY

CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED)

See notes to consolidated financial statements (unaudited).

(Amounts in tables in thousands of dollars, except for per share amounts)

NOTE 1 - BASIS OF PRESENTATION OF FINANCIAL STATEMENTS

The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The Consolidated Financial Statements include the accounts of The Gorman-Rupp Company (the “Company” or “Gorman-Rupp”) and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the reported results. In the opinion of management of the Company, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2022 are not necessarily indicative of results that may be expected for the year ending December 31, 2022. For further information, refer to the Consolidated Financial Statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, from which related information herein has been derived.

Acquisitions

The Company allocates the purchase price of its acquisitions to the assets acquired, liabilities assumed, and noncontrolling interests based upon their respective fair values at the acquisition date. The Company utilizes management estimates and inputs from an independent third-party valuation firm to assist in determining these fair values.

The Company uses the income, market or cost approach (or a combination thereof) for the valuation as appropriate. The valuation inputs in these models and analyses are based on market participant assumptions. Management values property, plant and equipment using the cost approach supported where available by observable market data, which includes consideration of obsolescence. Management values acquired intangible assets using the relief from royalty method or excess earnings method, which are forms of the income approach supported by observable market data for peer companies. The significant assumptions used to estimate the value of the acquired intangible assets include discount rates and certain assumptions that form the basis of future cash flows (such as revenue growth rates, customer attrition rates, and royalty rates), which are considered Level 3 assets as the assumptions are unobservable inputs developed by the Company. Acquired inventories are recorded at fair value. For certain items, the carrying value is determined to be a reasonable approximation of fair value based on information available to the Company.

The excess of the acquisition price over estimated fair values is recorded as goodwill. Goodwill is adjusted for any changes to acquisition date fair value amounts made within the measurement period. Acquisition-related transaction costs are recognized separately from the business combination and expensed as incurred. Refer to “Note 2 – Acquisitions” for additional details.

Recently Issued Accounting Standards

The Company considers the applicability and impact of all Accounting Standard Updates (“ASUs”). All recently issued ASUs were assessed and determined to be not applicable or are expected to have minimal impact on the Company’s Consolidated Financial Statements.

NOTE 2 - ACQUISITIONS

On May 31, 2022, the Company acquired the assets of Fill-Rite and Sotera (“Fill-Rite”), a division of Tuthill Corporation, for cash consideration of $526.3 million. The acquisition was funded with new debt consisting of $350.0 million from a senior secured term loan, $90.0 million from a subordinated unsecured loan, $5.0 million from the new revolving Credit Facility, and $81.3 million of cash on hand. Refer to “Note 10 – Financing Arrangements” for further details related to the financing completed as part of the transaction.

The Company accounted for the Fill-Rite acquisition in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 805 “Business Combinations”. The results of operations for Fill-Rite are included in the accompanying Consolidated Statements of Income from the acquisition date. Fill-Rite had $40.1 million in net sales and $3.6 million in operating income and $53.7 million in net sales and $3.7 million in operating income included in the Company’s consolidated financial statements for the three and nine months ended September 30, 2022, respectively. Operating income for the three months ended September 30, 2022 included $0.6 million of acquired customer backlog amortization and $3.0 million in amortization on customer relationships and developed technology. Operating income for the nine months ended September 30, 2022 included $1.4 million of inventory step-up amortization, $0.8 million of acquired customer backlog amortization, and $4.0 million in amortization on customer relationships and developed technology.

Under the acquisition method of accounting, the assets and liabilities have been recorded at their respective estimated fair values as of the date of completion of the acquisition and included in the Company’s Consolidated Balance Sheets. These preliminary estimates may be revised during the measurement period as third-party valuations are finalized, additional information becomes available and as additional analyses are performed, and any such revisions could have a material impact on our results of operations and financial position.

The following table presents the preliminary fair value of assets acquired and liabilities assumed and will be finalized upon completion of purchase accounting matters:

For tax purposes, the Fill-Rite acquisition was treated as an asset purchase. As such, the Company received a step-up in tax basis of the net Fill-Rite assets, equal to the purchase price, including goodwill which is deductible for tax purposes.

The transaction costs related to the acquisition approximated $0.1 million and $7.0 million for the three and nine months ended September 30, 2022. These costs were expensed as incurred and recorded within selling, general, and administrative expenses

The following is a supplemental presentation of our pro-forma net sales, operating income, net income, and earnings per share had the Fill-Rite acquisition occurred as of January 1, 2021 (in millions):

The supplemental pro forma information presented above is being provided for information purposes only and may not necessarily reflect the future results of operations of the Company or what the results of operations would have been had the Company owned and operated Fill-Rite since January 1, 2021. The proforma results for the nine months ended 2021 include $3.4 million in non-recurring costs related to inventory step up amortization and customer backlog amortization.

NOTE 3 – REVENUE

Disaggregation of Revenue

The following tables disaggregate total net sales by major product category and geographic location:

International sales represented approximately 25% and 33% of total net sales for the third quarters of 2022 and 2021, respectively, and were made to customers in many different countries around the world.

On September 30, 2022, the Company had $266.7 million of remaining performance obligations, also referred to as backlog. The Company expects to recognize as revenue substantially all of its remaining performance obligations within one year.

The Company’s contract assets and liabilities as of September 30, 2022 and December 31, 2021 were as follows:

Revenue recognized for the nine months ended September 30, 2022 and 2021 that was included in the contract liabilities balance at the beginning of the periods was $8.9 million and $6.0 million, respectively.

NOTE 4 - INVENTORIES

LIFO inventories are stated at the lower of cost or market and all other inventories are stated at the lower of cost or net realizable value. Replacement cost approximates current cost and the excess over LIFO cost was approximately $79.9 million and $70.1 million at September 30, 2022 and December 31, 2021, respectively. Allowances for excess and obsolete inventory totaled $6.3 million and $6.0 million as of September 30, 2022 and December 31, 2021, respectively. An actual valuation of inventory under the LIFO method is made at the end of each year based on the inventory levels and costs at that time. Interim LIFO calculations are based on management’s estimate of expected year-end inventory levels and costs, and are subject to the final year-end LIFO inventory valuation.

Inventories are comprised of the following:

NOTE 5 – PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment, net consist of the following:

NOTE 6 - PRODUCT WARRANTIES

A liability is established for estimated future warranty and service claims based on historical claims experience and specific product failures. The Company expenses warranty costs directly to Cost of products sold. Changes in the Company’s product warranties liability are:

NOTE 7 - PENSION AND OTHER POSTRETIREMENT BENEFITS

The Company sponsors a defined benefit pension plan (“Plan”) covering certain domestic employees. Benefits are based on each covered employee’s years of service and compensation. The Plan is funded in conformity with the funding requirements of applicable U.S. regulations. The Plan was closed to new participants effective January 1, 2008. Employees hired after this date, in eligible locations, participate in an enhanced 401(k) plan instead of the defined benefit pension plan. Employees hired prior to this date continue to accrue benefits.

Additionally, the Company sponsors defined contribution pension plans made available to all domestic and Canadian employees. The Company funds the cost of these benefits as incurred.

The Company also sponsors a non-contributory defined benefit postretirement health care plan that provides health benefits to certain domestic and Canadian retirees and eligible spouses and dependent children. The Company funds the cost of these benefits as incurred.

The following tables present the components of net periodic benefit costs:

During the three and nine months ended September 30, 2022, the Company recorded a settlement loss relating to retirees that received lump-sum distributions from the Company’s defined benefit pension plan totaling $4.8 million and $6.4 million, respectively. The Company recorded settlement losses of $0.4 million and $2.1 million for the three and nine month periods ended September 30, 2021, respectively. These charges were the result of lump-sum distributions to retirees exceeding the Plan’s actuarial service and interest cost thresholds.

As part of the agreement to purchase the assets of Fill-Rite, the Company is required to establish a defined benefit pension plan for certain Fill-Rite employees as of June 1, 2022. No pension or other postretirement benefit plan liabilities existing as of the acquisition date were assumed as part of the transaction. The obligation under the new plan as of September 30, 2022 is not material.

NOTE 8 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)          

The reclassifications out of Accumulated other comprehensive income (loss) as reported in the Consolidated Statements of Income are:

The components of Accumulated other comprehensive income (loss) as reported in the Consolidated Balance Sheets are:

NOTE 9 – COMMON SHARE REPURCHASES

The Company has a share repurchase program with the authorization to purchase up to $50.0 million of the Company’s common shares. During the nine-month period ended September 30, 2022 the Company repurchased 24,546 shares for $0.9 million. No shares were repurchased during the three-month period ending September 30, 2022 nor the nine-month period ended September 30, 2021. As of September 30, 2022, the Company had $48.1 million available for repurchase under the share repurchase program.

NOTE 10 – FINANCING ARRANGEMENTS

Debt consisted of:

Maturities of long-term debt in the next five fiscal years, and the remaining years thereafter, are as follows:

Senior Secured Credit Agreement

On May 31, 2022, the Company entered into a Senior Secured Credit Agreement with several lenders, which provides a term loan of $350.0 million (“Senior Term Loan Facility”) and a revolving credit facility up to $100.0 million (“Credit Facility”). The Credit Facility has a letter of credit sublimit of up to $15.0 million, as a sublimit of the Credit Facility, and a swing line subfacility of up to $20.0 million, as a sublimit of the Credit Facility. The Company borrowed $5.0 million under the Credit Facility, which, along with the Senior Term Loan Facility, and cash-on-hand and the proceeds of the Subordinated Credit Facility described below, was used to purchase the assets of Fill-Rite as described in “Note 2 – Acquisitions”. The Company has agreed to secure all of its obligations under the Senior Secured Credit Agreement by granting a first priority lien on substantially all of its personal property, and each of Patterson Pump Company, AMT Pump Company, National Pump Company and Fill-Rite Company (collectively, the “Guarantors”) has agreed to guarantee the obligations of the Company under the Senior Secured Credit Agreement and to secure the obligations thereunder by granting a first priority lien in substantially all of such Guarantor’s personal property.

The Senior Secured Credit Agreement has a maturity date of May 31, 2027, with the Senior Term Loan Facility requiring quarterly installment payments commencing on September 30, 2022 and continuing on the last day of each consecutive December, March, June and September thereafter.

At the option of the Company, borrowings under the Senior Term Loan Facility and under the Credit Facility bear interest at either a base rate or at an Adjusted Term SOFR Rate, plus the applicable margin, which ranges from 0.75% to 1.75% for base rate loans and 1.75% to 2.75% for Adjusted Term SOFR Rate loans. The applicable margin is based on the Company’s senior leverage ratio. As of September 30, 2022, the applicable interest rate under the Senior Secured Credit Agreement was Adjusted Term SOFR plus 2.75%.

The Senior Secured Credit Agreement requires the Company to maintain a consolidated senior secured net leverage ratio not to exceed 4.50 to 1.00 for each of the four consecutive fiscal quarter periods ending June 30, 2022, September 30, 2022, December 31, 2022 and March 31, 2023, decreasing to 4.00 to 1.00 for each of the four consecutive fiscal quarter periods ending June 30, 2023 and September 30, 2023, and decreasing to 3.50 to 1.00 for the four consecutive fiscal quarter period ending December 31, 2023 and each of the four consecutive fiscal quarter periods ending thereafter.

The Senior Secured Credit Agreement requires the Company to maintain a consolidated total net leverage ratio not to exceed 5.75 to 1.00 for each of the four consecutive fiscal quarter periods ending June 30, 2022, September 30, 2022, December 31, 2022 and March 31, 2023, decreasing to 5.25 to 1.00 for each of the four consecutive fiscal quarter periods ending June 30, 2023 and September 30, 2023, and decreasing to 4.75 to 1.00 for the four consecutive fiscal quarter period ending December 31, 2023 and each of the four consecutive fiscal quarter periods ending thereafter.

The Senior Secured Credit Agreement requires the Company to maintain a fixed charge coverage ratio (commencing with the fiscal quarter ending June 30, 2022) of not less than 1.20 to 1.00 for any four consecutive fiscal quarter period.

The Senior Secured Credit Agreement contains customary affirmative and negative covenants, including among others, limitations on the Company and its subsidiaries with respect to incurrence of liens and indebtedness, disposition of assets, mergers, transactions with affiliates, and the ability to make or pay dividends in excess of certain thresholds.

The Senior Credit Agreement also contains customary provisions requiring mandatory prepayments, including among others, annual prepayments (beginning with the fiscal year ending December 31, 2023) of a percentage of excess cash flow, prepayments of the net cash proceeds from any non-ordinary course sale of assets, and net cash proceeds of any non-permitted indebtedness.

To reduce the exposure to changes in the market rate of interest, effective October 31, 2022, the Company entered into interest rate swap agreements for a portion of the Senior term loan facility. Terms of the interest rate swap agreements require the Company to receive a fixed interest rate and pay a variable interest rate. The interest rate swap agreements are expected to be designated as a cash flow hedge, and as a result, the mark-to-market gains or losses will be deferred and included as a component of accumulated other comprehensive income (loss) and reclassified to interest expense in the period during which the hedged transactions affect earnings. 

Subordinated Credit Agreement

On May 31, 2022, the Company entered into an unsecured subordinated credit agreement (“Subordinated Credit Agreement”) with one lender, which provides for a term loan of $90.0 million (the “Subordinated Credit Facility”). Each of the Guarantors has agreed to guarantee the obligations of the Company under the Subordinated Credit Agreement. The proceeds from the Subordinated Credit Facility, along with cash-on-hand and the proceeds of the Senior Term Loan Facility described above, were used to purchase the assets of Fill-Rite as described in “Note 2 – Acquisitions”.

The Subordinated Credit Agreement has a maturity date of December 1, 2027. If the Subordinated Credit Facility is prepaid prior to the second anniversary, such prepayment must be accompanied by a make-whole premium. If the Subordinated Credit Facility is prepaid after the second anniversary but prior to the third anniversary, such prepayment requires a prepayment fee of 2%, and if the Subordinated Credit Facility is prepaid after the third anniversary but prior to the fourth anniversary, such prepayment requires a prepayment fee of 1%.

At the option of the Company, borrowings under the Subordinated Credit Facility bear interest at either a base rate plus 8.0%, or at an Adjusted Term SOFR Rate plus 9.1%. As of September 30, 2022 borrowings under the Subordinated Credit Facility bear interest at an Adjusted Term SOFR Rate plus 9.1%.

The Subordinated Credit Agreement requires the Company to maintain a consolidated senior secured net leverage ratio not to exceed 5.40 to 1.00 for each of the four consecutive fiscal quarter periods ending June 30, 2022, September 30, 2022, December 31, 2022 and March 31, 2023, decreasing to 4.80 to 1.00 for each of the four consecutive fiscal quarter periods ending June 30, 2023 and September 30, 2023, and decreasing to 4.20 to 1.00 for the four consecutive fiscal quarter period ending December 31, 2023 and each of the four consecutive fiscal quarter periods ending thereafter.

The Subordinated Credit Agreement requires the Company to maintain a consolidated total net leverage ratio not to exceed 6.90 to 1.00 for each of the four consecutive fiscal quarter periods ending June 30, 2022, September 30, 2022, December 31, 2022 and March 31, 2023, decreasing to 6.30 to 1.00 for each of the four consecutive fiscal quarter periods ending June 30, 2023 and September 30, 2023, and decreasing to 5.70 to 1.00 for the four consecutive fiscal quarter period ending December 31, 2023 and each of the four consecutive fiscal quarter periods ending thereafter.

The Subordinated Credit Agreement contains customary affirmative and negative covenants, including among others, limitations on the Company and its subsidiaries with respect to incurrence of liens and indebtedness, disposition of assets, mergers, transactions with affiliates, and the ability to make or pay dividends in excess of certain thresholds.

The Subordinated Credit Agreement also contains customary provisions requiring mandatory prepayments, including among others, annual prepayments (beginning with the fiscal year ending December 31, 2023) of a percentage of excess cash flow, prepayments of the net cash proceeds from any non-ordinary course sale of assets, and net cash proceeds of any non-permitted indebtedness.

Credit Facilities

With the opening of the Senior Term Loan Facility, which included the revolving Credit Facility, the Company terminated as of May 31, 2022 its previously existing $20.0 million line of credit maturing in February 2024, $6.5 million unsecured bank line of credit maturing in May 2024, and $3.0 million bank guarantee dated June 2016.

The Company incurred total issuance costs of approximately $15.2 million related to the Senior Secured Credit Agreement and Subordinated Credit Agreement. Of this amount, the Company determined that $12.8 million related to the Senior Term Loan facility and the Subordinated Credit Facility and $2.4 million related to the Credit Facility. The portion of the issuance costs related to the Credit Facility is included in Other assets in the Consolidated Balance Sheet. These costs are being amortized to interest expense over the respective terms.

The Company was in compliance with all debt covenants as of September 30, 2022.

NOTE 11 – GOODWILL AND OTHER INTANGIBLE ASSETS

Changes in the carrying value of goodwill and other intangible asset during the nine months ended September 30, 2022:

The major components of Goodwill and other intangible assets are:

Amortization expense was $3.1 million and $0.1 million for the third quarter of 2022 and 2021, respectively. Amortization expense was $4.5 million and $0.4 million for the nine months ended 2022 and 2021, respectively. The following table summarizes the future estimated amortization expense relating to our intangible assets as of September 30, 2022 (in thousands):

(Dollars in thousands, except for per share amounts)

The following discussion and analysis of the Company’s financial condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements, and notes thereto, and the other financial data included elsewhere in this Quarterly Report on Form 10-Q. The following discussion should also be read in conjunction with the Company’s audited Consolidated Financial Statements and accompanying notes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in its Annual Report on Form 10-K for the year ended December 31, 2021. The coronavirus (COVID-19) pandemic had an adverse effect on the Company’s reported results in 2021 and while our supply chains continue to face challenges, our reported results have continued to improve. The extent to which the Company’s operations will continue to be impacted by the pandemic will depend largely on future developments, which are highly uncertain and cannot be accurately predicted, including new information which may emerge concerning the severity of the pandemic and actions by government authorities to contain the pandemic or treat its impact, among other things.

Executive Overview

On May 31, 2022, the Company completed its acquisition of Fill-Rite and Sotera (“Fill-Rite”), a division of Tuthill Corporation, for $526.3 million. When adjusted for approximately $80.0 million in expected tax benefits, the net acquisition value is approximately $446.3 million.  The Company funded the acquisition with cash on-hand and new debt.  The Company incurred $7.0 million of one-time acquisition costs during the nine months ended September 30, 2022 and does not expect to incur material acquisition costs going forward. The results of operations for Fill-Rite from the acquisition date are included in the Company’s Consolidated Statements of Income for the three and nine months ended September 30, 2022. 

The following discussion of Results of Operations includes certain non-GAAP financial data and measures such as (1) adjusted earnings per share, which is earnings per share excluding non-cash pension settlement charges per share, one-time acquisition costs per share, amortization of step-up in value of acquired inventories per share and amortization of customer backlog per share and (2) adjusted earnings before interest, taxes, depreciation and amortization, which is net income (loss) excluding interest, taxes, depreciation and amortization, adjusted to exclude non-cash pension settlement charges, one-time acquisition costs, amortization of step up in value of acquired inventories, and amortization of customer backlog. Management utilizes these adjusted financial data and measures to assess comparative operations against those of prior periods without the distortion of non-comparable factors. The inclusion of these adjusted measures should not be construed as an indication that the Company’s future results will be unaffected by unusual or infrequent items or that the items for which the Company has made adjustments are unusual or infrequent or will not recur. The Company believes that these non-GAAP financial data and measures also will be useful to investors in assessing the strength of the Company’s underlying operations from period to period. These non-GAAP financial measures are not intended to replace GAAP financial measures, and they are not necessarily standardized or comparable to similarly titled measures used by other companies. Provided below is a reconciliation of adjusted earnings per share and adjusted earnings before interest, taxes, depreciation and amortization.

The Gorman-Rupp Company (“we”, “our”, “Gorman-Rupp” or the “Company”) is a leading designer, manufacturer and international marketer of pumps and pump systems for use in diverse water, wastewater, construction, dewatering, industrial, petroleum, original equipment, agriculture, fire protection, heating, ventilating and air conditioning (HVAC), military and other liquid-handling applications. The Company attributes its success to long-term product quality, applications and performance combined with timely delivery and service, and continually seeks to develop initiatives to improve performance in these key areas.

We regularly invest in training for our employees, in new product development and in modern manufacturing equipment, technology and facilities all designed to increase production efficiency and capacity and drive growth by delivering innovative solutions to our customers. We believe that the diversity of our markets is a major contributor to the generally stable financial growth we have produced historically.

As a result of the Fill-Rite acquisition, the Company’s cash position decreased $114.9 million during the first nine months of 2022 to $10.3 million. The Company generated $50.4 million in adjusted earnings before interest, taxes, depreciation and amortization during the same period.

Capital expenditures for the first nine months of 2022 were $11.3 million and consisted primarily of machinery and equipment. Capital expenditures for the full-year 2022 are presently planned to be in the range of $15-$18 million primarily for machinery and equipment purchases, and are expected to be financed through internally-generated funds.

The Company’s backlog of orders was $266.7 million at September 30, 2022 compared to $156.5 million at September 30, 2021 and $186.0 million at December 31, 2021. Fill-Rite added $14.6 million to the backlog at September 30, 2022. Incoming orders during the third quarter of 2022 increased 50.2% when compared to the same period last year, and 10.4% excluding Fill-Rite. Incoming orders increased 35.5% for the first nine months of 2022 compared to the same period in 2021, and 18.7% excluding Fill-Rite. The increase in backlog for the first nine months of 2022 was primarily driven by strong incoming orders during the first nine months, large municipal orders which are longer term in nature, and the acquisition of Fill-Rite. The backlog aging has remained consistent with historical levels.

On October 27, 2022, the Board of Directors authorized the payment of a quarterly dividend of $0.175 per share on the common stock of the Company, payable December 9, 2022, to shareholders of record as of November 15, 2022. This will mark the 291st consecutive quarterly dividend paid by The Gorman-Rupp Company.

The Company currently expects to continue its exceptional history of paying regular quarterly dividends and increased annual dividends. However, any future dividends will be reviewed individually and declared by our Board of Directors at its discretion, dependent on our assessment of the Company’s financial condition and business outlook at the applicable time.

Outlook

The Company looks for additional improvement in gross margin as the pricing actions that have taken place during the year are realized and leverage on fixed costs continues.  The Company is well positioned for both the fourth quarter and 2023 with strong backlog and continued integration and synergies from Fill-Rite.

Three Months Ended September 30, 2022 vs. Three Months Ended September 30, 2021

Net Sales

Net sales for the third quarter of 2022 were $153.8 million compared to net sales of $102.1 million for the third quarter of 2021, an increase of 50.6% or $51.7 million. Domestic sales increased 68.0% or $46.8 million and international sales increased 14.8% or $4.9 million compared to the same period in 2021. Fill-Rite sales, which are primarily domestic, were $40.1 million for the third quarter of 2022.

Excluding Fill-Rite, sales in our water markets increased 12.2% or $9.0 million in the third quarter of 2022 compared to the third quarter of 2021. Sales increased $6.2 million in the municipal market, $1.6 million in the fire protection market, $1.5 million in the repair market, and $0.5 million in the construction market. Partially offsetting these increases was a sales decrease of $0.8 million in the agriculture market.

Excluding Fill-Rite, sales in our non-water markets increased 9.0% or $2.6 million in the third quarter of 2022 compared to the third quarter of 2021. Sales increased $4.1 million in the industrial market. Partially offsetting this increase were sales decreases of $0.8 million in the OEM market and $0.7 million in the petroleum market.

Cost of Products Sold and Gross Profit

Gross profit was $40.6 million for the third quarter of 2022, resulting in gross margin of 26.4%, compared to gross profit of $25.8 million and gross margin of 25.3% for the same period in 2021. The improvement in gross margin was due primarily to leverage from increased sales volume and sales mix which includes a full quarter of Fill-Rite results. The 110 basis point increase in gross margin was driven by a 250 basis point improvement from labor and overhead leverage due to increased sales volume. The increase was partially offset by a 140 basis point increase in cost of material, which included an unfavorable impact of 40 basis points related to the amortization of acquired Fill-Rite customer backlog. The Fill-Rite customer backlog will be amortized within the next three quarters.

Selling, General and Administrative (SG&A) Expenses

Selling, general and administrative (“SG&A”) expenses were $22.1 million and 14.4% of net sales for the third quarter of 2022 compared to $14.2 million and 13.9% of net sales for the same period in 2021. The increase in SG&A expenses and as a percentage of sales is primarily due to a $6.4 million increase in SG&A expenses related to a full quarter of Fill-Rite results.

Amortization Expense

Amortization expense was $3.2 million for the third quarter of 2022 compared to $0.1 million for the same period in 2021. The increase in amortization expense was due to $3.0 million in amortization attributable to the Fill-Rite acquisition.

Operating Income

Operating income was $15.3 million for the third quarter of 2022, resulting in an operating margin of 10.0%, compared to operating income of $11.5 million and operating margin of 11.3% for the same period in 2021. Operating margin decreased 130 basis points primarily due to increased amortization expense, increase in cost of material, and increased SG&A, but was partially offset by improvement from labor and overhead leverage.

Other Income (Expense), net

Other income (expense), net was $5.3 million of expense for the third quarter of 2022 compared to expense of $0.5 million for the same period in 2021. The increase in expense was due primarily to increased non-cash pension settlement charges of $4.8 million in the third quarter of 2022 compared to $0.4 million in the third quarter of 2021. The pension settlement charge is the result of retirees who elect the lump sum payment upon retirement.

Net Income

The Company’s effective tax rate was 8.7% for the third quarter of 2022 compared to 20.6% for the third quarter of 2021.

Net income was $2.2 million, or $0.09 per share, for the third quarter of 2022 compared to net income of $8.8 million in the third quarter of 2021, or $0.34 per share. Adjusted earnings per share for the third quarter of 2022 were $0.25 per share compared to $0.35 per share for the third quarter of 2021. Adjusted earnings per share for the third quarter of 2022 included an unfavorable LIFO impact of $0.11 per share compared to an unfavorable LIFO impact of $0.08 per share in the third quarter of 2021. Adjusted earnings also included incremental non-cash amortization expense related to Fill-Rite of $0.09 per share.

Nine Months Ended September 30, 2022 vs. Nine Months Ended September 30, 2021

Net Sales

Net sales for the first nine months of 2022 were $375.0 million compared to net sales of $284.2 million for the first nine months of 2021, an increase of 32.0% or $90.9 million. Domestic sales increased 39.4% or $77.1 million and international sales increased 15.6% or $13.8 million compared to the same period in 2021. Fill-Rite sales, which are primarily domestic, were $53.7 million from the acquisition date of May 31, 2022 to September 30, 2022.

Excluding Fill-Rite, sales in our water markets increased 13.4% or $27.1 million in the first nine months of 2022 compared to the first nine months of 2021. Sales increased $10.3 million in the fire market, $9.3 million in the municipal market, $4.7 million in the construction market, and $4.2 million in the repair markets. Partially offsetting these increases was a decrease of $1.4 million in the agriculture market.

Excluding Fill-Rite, sales in our non-water markets increased 12.4% or $10.1 million in the first nine months of 2022 compared to the first nine months of 2021. Sales increased $10.5 million in the industrial market and $2.3 million in the OEM market. Partially offsetting these increases was a decrease of $2.7 million in the petroleum market.

Cost of Products Sold and Gross Profit

Gross profit was $94.3 million for the first nine months of 2022, resulting in gross margin of 25.1%, compared to gross profit of $73.5 million and gross margin of 25.9% for the same period in 2021. The 80 basis point decrease in gross margin was driven by a 280 basis point increase in cost of material, which included an unfavorable LIFO impact of 120 basis points, an unfavorable impact of 40 basis points related to Fill-Rite inventory recorded at fair value and recognized during the second quarter, and an unfavorable impact of 20 basis points related to the amortization of acquired Fill-Rite customer backlog. The full amount of the step-up to record Fill-Rite inventory at fair value was recognized during the second quarter and will not recur, while the Fill-Rite customer backlog will be amortized within the next three quarters. The decrease in gross margin was partially offset by a 200 basis point improvement from labor and overhead leverage due to increased sales volume.

Selling, General and Administrative (SG&A) Expenses

Selling, general and administrative (“SG&A”) expenses were $62.1 million for the first nine months of 2022, which included $7.0 million of one-time acquisition costs. Excluding acquisition costs, SG&A expenses were $55.1 million and 14.7% of net sales for the first nine months of 2022 compared to $42.1 million and 14.8% of net sales for the same period in 2021. The decrease in SG&A expenses as a percentage of sales, excluding acquisition costs, is due to increased sales volume.

Amortization expense

Amortization expense was $4.5 million for the first nine months of 2022 compared to $0.4 million for the same period in 2021. The increase in amortization expense was due to $4.0 million in amortization attributable to the Fill-Rite acquisition.

Operating Income

Operating income was $27.7 million for the first nine months of 2022, which included $7.0 million in one-time acquisition costs, $1.4 million of inventory step up amortization, and $0.9 million of acquired customer backlog amortization. Excluding acquisition costs, inventory step-up and backlog amortization, operating income was $37.0 million for the first nine months of 2022, resulting in an operating margin of 9.9%, compared to operating income of $31.1 million and operating margin of 11.0% for the same period in 2021. The decrease of 110 basis points in operating margin was primarily the result of an unfavorable LIFO impact.

Other Income (Expense), net

Other income (expense), net was $7.1 million of expense for the first nine months of 2022 compared to expense of $1.8 million for the same period in 2021. The increase in expense was due primarily to increased non-cash pension settlement charges of $6.4 million for the first nine months of 2022 compared to $2.1 million for the first nine months of 2021.

Net Income

The Company’s effective tax rate was 18.2% for the first nine months of 2022 compared to 20.4% for the first nine months of 2021 with the decrease primarily related to the effect of permanent items on lower income before tax.

Net income was $8.8 million, or $0.34 per share, for the first nine months of 2022 compared to $23.3 million for the first nine months of 2021, or $0.89 per share. Adjusted earnings per share for the first nine months of 2022 were $0.81 per share compared to $0.95 per share for the first nine months of 2021. Adjusted earnings per share for the first nine months of 2022 included an unfavorable LIFO impact of $0.30 per share compared to an unfavorable LIFO impact of $0.12 per share for the first nine months of 2021. Adjusted earnings also included incremental non-cash amortization expense related to Fill-Rite of $0.12 per share.

Liquidity and Capital Resources

Our primary sources of liquidity are cash generated from operations and borrowings under our Credit Facility. Cash and cash equivalents totaled $10.3 million at September 30, 2022. The Company had an additional $93.1million available under the revolving credit facility after deducting $5.0 million drawn and $1.9 million in outstanding letters of credit primarily related to customer orders. During the nine months ended September 30, 2022, our debt obligations increased by $440.6 million as a result of the Senior Term Loan Facility, revolving Credit Facility and Subordinated Credit Facility entered into in connection with the Fill-Rite acquisition. See Note 10 “Financing Arrangements” in the Notes to our Consolidated Financial Statements.

Free cash flow, a non-GAAP measure for reporting cash flow, is defined by the Company as adjusted earnings before interest, income taxes and depreciation and amortization, less capital expenditures and dividends. The Company believes free cash flow provides investors with an important perspective on cash available for investments, acquisitions and working capital requirements.

The following table reconciles adjusted earnings before interest, income taxes and depreciation and amortization as reconciled above to free cash flow:

Financial Cash Flow

The decrease in cash provided by operating activities in the first nine months of 2022 compared to the same period last year was primarily due to interest expense of $9.9 million and acquisition costs of $7.0 million, as well as increases for the nine month period in accounts receivable and inventory as the result of increased sales and backlog. In addition, deferred revenue and customer deposits have decreased in the first nine months of the current year compared to an increase in the same period of the prior year.

During the first nine months of 2022, investing activities of $537.2 million consisted of $526.3 million for the acquisition of Fill-Rite and $11.3 million for capital expenditures primarily for machinery and equipment. During the first nine months of 2021, investing activities consisted of capital expenditures primarily for machinery and equipment of $5.6 million.

Net cash received from financing activities for the first nine months of 2022 of $415.5 million consisted of proceeds from the new Senior Secured loan of $350.0 million, $90.0 million in unsecured subordinated debt, and $5.0 million from the new revolving credit facility. Partially offsetting these proceeds were debt issuance fees paid of $15.2 million, dividend payments of $13.3 million, payments on bank borrowing of $4.4 million and share repurchases of $0.9 million during the first nine months of 2022. Net cash used from financing activities in 2021 primarily consisted of dividend payments of $12.1 million. There were no share repurchases for the first nine months of 2021.

Maturities of long-term debt in the next five fiscal years, and the remaining years thereafter, are as follows:

The Company was in compliance with its debt covenants, including limits on additional borrowings and maintenance of certain operating and financial ratios, at September 30, 2022 and December 31, 2021. We believe we have adequate liquidity from funds on hand and borrowing capacity to execute our financial and operating strategy, as well as comply with debt obligations and financial covenants for the next 12 months.

The Company currently expects to continue its exceptional history of paying regular quarterly dividends and increased annual dividends. However, any future dividends will be reviewed individually and declared by our Board of Directors at its discretion, dependent on our assessment of the Company’s financial condition and business outlook at the applicable time.

The Board of Directors has authorized a share repurchase program of up to $50.0 million of the Company’s common shares. The actual number of shares repurchased will depend on prevailing market conditions, alternative uses of capital and other factors, and will be determined at management’s discretion. The Company is not obligated to make any purchases under the program, and the program may be suspended or discontinued at any time. As of September 30, 2022, the Company had $48.1 million available for repurchase under the share repurchase program.

Critical Accounting Policies

Our critical accounting policies are described in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and in the notes to our Consolidated Financial Statements for the year ended December 31, 2021 contained in our Annual Report on Form 10-K for the year ended December 31, 2021. Any new accounting policies or updates to existing accounting policies as a result of new accounting pronouncements have been discussed in the notes to our Consolidated Financial Statements in this Quarterly Report on Form 10-Q. The application of our critical accounting policies may require management to make judgments and estimates about the amounts reflected in the Consolidated Financial Statements. Management uses historical experience and all available information to make these estimates and judgments, and different amounts could be reported using different assumptions and estimates.