Franklin Electric Co., Inc. — Q2 2020 Form 10-Q
Business context and reporting period. Unaudited results cover the quarter and six months ended June 30, 2020. Franklin Electric operates Water Systems, Fueling Systems, and Distribution businesses. Management attributed weaker sales primarily to lower volume and disruption related to the COVID-19 pandemic, along with unfavorable foreign-currency translation.
Financial performance
- Second quarter: Net sales were $308.3 million, down 13% from $355.3 million. Gross profit was $107.1 million, down 11%; gross margin improved to 34.7% from 33.7%. Operating income fell 22% to $33.9 million. Net income attributable to Franklin Electric was $24.7 million versus $32.7 million; diluted EPS was $0.52 versus $0.70.
- First six months: Net sales were $575.0 million, down 11% from $646.1 million. Gross profit was $197.4 million, down 6%, while gross margin increased to 34.3% from 32.4%. Operating income declined 14% to $47.8 million. Net income attributable to Franklin Electric was $35.3 million versus $41.8 million; diluted EPS was $0.75 versus $0.89.
- Segments, Q2: Water Systems sales decreased 13% to $178.4 million; operating income was $28.7 million. Fueling Systems sales declined 28% to $56.0 million; operating income fell to $13.5 million. Distribution sales increased 6% to $92.1 million and operating income rose to $6.8 million.
- Cash flow, first half: Operating cash flow was $47.0 million versus $4.1 million in 2019, reflecting lower working-capital requirements, partly offset by lower net income. Investing cash outflow was $15.2 million; financing cash outflow was $48.6 million. Cash decreased $21.3 million to $43.1 million.
- Balance sheet and liquidity: At June 30, cash was $43.1 million; total debt, including current maturities, was $96.7 million, down from $115.0 million at year-end 2019. The company had $294.1 million available under its $300 million revolving credit agreement and $150 million available under its Prudential Agreement. It reported compliance with financial covenants and said liquidity was adequate for foreseeable needs.
Material changes and management commentary
- COVID-related market impacts included lower dewatering equipment demand, customer inventory reductions in the U.S. and Canada plumbing channel, and delayed or canceled new filling-station construction. Nearly all manufacturing and distribution operations remained open, with products generally considered essential.
- Q2 consolidated sales included $3.3 million from acquisitions and were reduced by $12.2 million from currency translation; organic sales declined about 10%. For the first half, acquisition sales were $7.2 million and currency translation reduced sales by $20.3 million.
- Higher gross margins reflected improved pricing and product/geographic mix. SG&A declined as the company reduced spending and from currency effects. Lower Fueling Systems sales weakened fixed-cost absorption; Distribution benefited from stronger sales and more favorable weather.
- Foreign-currency translation adjustments produced a $35.7 million loss before tax in first-half other comprehensive income. The company acquired a line-shaft turbine and adjacent-products business for $6.3 million in Q1; preliminary purchase accounting was reported, and the acquisition’s results were immaterial.
Outlook, risks, and contingencies
- Management estimated a 2020 effective tax rate of about 20% after discrete items. It did not provide specific revenue or earnings guidance in the supplied filing text.
- Key uncertainties include pandemic effects, demand and economic conditions, currency movements, weather, housing starts, competition, supply constraints, raw-material costs, and acquisition integration. Management cautioned that interim results are not necessarily indicative of full-year results.
- The company recorded a $1.4 million valuation allowance expense on foreign deferred tax assets and a $1.2 million tax benefit from releasing a deferred tax liability related to foreign exchange on an intercompany loan.
- Management said ordinary-course legal claims were not expected to have a material financial effect. Commitments, primarily for capital expenditures and raw materials, totaled $8.5 million. Product warranty accrual was $9.1 million.
Important facts for investors to verify
- Whether pandemic-related demand weakness, particularly in Fueling Systems and dewatering products, persisted or improved after June 30.
- Whether higher gross margins and lower SG&A were sustainable as volumes and product mix changed.
- Cash conversion and working-capital trends, given the large year-over-year increase in first-half operating cash flow.
- Debt maturities and refinancing capacity: the revolving credit agreement matures October 28, 2021, and the Prudential Agreement expires July 30, 2021.
- Foreign-exchange exposure and the realization of foreign deferred tax assets; the filing reports substantial translation losses in accumulated other comprehensive income.