FRANKLIN ELECTRIC CO INC annual report, FY2019

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Franklin Electric Co., Inc. — FY 2019 Form 10-K

Reporting period: Fiscal year ended December 31, 2019. The filing also reports unaudited fourth-quarter results. Franklin Electric designs, manufactures, and distributes water and fuel pumping systems and related equipment through Water Systems, Fueling Systems, and Distribution segments.

Financial performance and position

  • Revenue: $1,314.6 million, up 1% from $1,298.1 million. Acquisitions added $38.1 million; foreign currency translation reduced sales by $34.8 million. Organic sales, excluding both effects, increased approximately 1%.
  • Profit and margins: Gross profit was $428.1 million, down 1%; gross margin declined to 32.6% from 33.3%. Operating income fell 4% to $127.1 million. Net income attributable to Franklin Electric was $95.5 million, or $2.03 per diluted share, versus $105.9 million, or $2.23, in 2018. Net margin was 7.3%, compared with 8.2%.
  • Segment results: Water Systems sales declined 2% to $781.5 million and operating income fell 9% to $103.0 million. Fueling Systems sales rose 3% to $293.6 million and operating income increased to $75.8 million. Distribution sales rose to $291.8 million, largely reflecting acquisitions; organic sales were nearly flat.
  • Cash flow and investment: Operating cash flow increased to $177.7 million from $128.4 million, principally due to lower working-capital requirements and income tax payments. Investing cash outflow was $41.8 million, including $20.8 million for acquisitions; capital expenditures were $22.1 million. Financing cash outflow was $126.7 million, including $355.3 million of debt repayments and $27.7 million of dividends.
  • Liquidity and debt: Cash and equivalents were $64.4 million; working capital was $381.7 million and the current ratio was 3.1. Total debt, including current maturities, was $115.0 million, down from $206.4 million; long-term debt was $93.1 million. The $300 million revolving facility had $276.5 million available, including consideration of outstanding letters of credit. The company reported compliance with financial covenants.
  • Other metrics: Total assets were $1,194.7 million and shareholders’ equity was $796.5 million. Dividends were $0.58 per share, the company’s 27th consecutive annual dividend increase.

Material changes versus 2018

  • Sales growth was modest and depended on acquisitions and pricing/volume gains, while currency translation was a significant offset. Water Systems’ lower volume—particularly in North America—drove the decline in consolidated gross profit and margin.
  • Fueling Systems improved on stronger North American demand; international Fueling Systems sales declined, including China sales of approximately $45 million versus $52 million in 2018. Distribution growth primarily reflected acquired businesses, including Milan Supply.
  • Net income attributable to the company declined despite lower interest expense. The effective tax rate rose to 17.8% from 12.4%; 2018 benefited from a $4.2 million discrete tax benefit. The 2019 rate included discrete share-based compensation tax benefits.
  • Operating cash flow strengthened, while investing outflow decreased with lower acquisition spending and financing outflow increased, mainly due to higher debt repayments.
  • The company adopted lease accounting in 2019, recognizing right-of-use assets and lease liabilities; year-end operating lease liabilities were $27.6 million. Prior-year balance-sheet amounts were not retrospectively adjusted.

Fourth-quarter results

Q4 2019 sales were $320.1 million versus $316.6 million in Q4 2018. Gross profit was $101.3 million versus $104.3 million; net income attributable to Franklin Electric was $19.8 million versus $24.2 million. Diluted EPS was $0.42 versus $0.51.

Outlook, risks, and unusual items

  • Management estimated a 2020 effective tax rate of approximately 18%–20% and stated that available liquidity and expected operating cash flows should fund operations, capital spending, pension obligations, dividends, and debt service. The filing provides no specific revenue or earnings guidance.
  • Backlog at February 11, 2020 was $74.5 million, down from $90.3 million a year earlier; orders were expected to ship in fiscal 2020. Management cautioned that backlog has not been a significant indicator of future sales and noted typical first-quarter seasonality.
  • Key risks include housing and agricultural demand, weather, commodity and energy-sector conditions, raw-material and component costs, foreign exchange, international operations, competition, supplier concentration, acquisition integration, product regulation and warranty exposure, cybersecurity, and potential goodwill impairment.
  • Foreign currency translation reduced 2019 sales by $34.8 million; foreign-currency transaction losses were $1.6 million, primarily related to the Argentine peso. Management estimated a 10% adverse raw-metal price move could reduce gross margin as a percentage of sales by about 1%; a 2% stronger U.S. dollar would have reduced 2019 sales by about 1%.
  • Goodwill was $256.1 million. No impairment was recorded; management said a 10% decrease in fair-value estimates would not have changed that conclusion. The auditor identified Distribution-unit goodwill impairment testing as a critical audit matter because of judgment in forecasts and discount-rate assumptions.
  • The company is defending ordinary-course legal claims and believes they can be resolved without a material effect. It reported $6.1 million of commitments, primarily for capital expenditures and raw materials, and approximately $0.5 million of possible tax payments related to uncertain tax positions and pending matters.
  • The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. The assessment excluded the 2019 acquisitions Milan Supply and First Sales, which together represented approximately 2.1% of consolidated sales and assets.

Investor verification priorities

  • Assess whether Water Systems demand and gross-margin pressure persist, and whether Fueling Systems’ North American growth offsets international weakness.
  • Separate organic performance from acquisition contributions and currency effects; monitor the returns and integration of Milan Supply and First Sales.
  • Review cash conversion, inventory and working-capital trends, debt maturities, revolving-facility availability, and covenant headroom.
  • Evaluate the assumptions supporting Distribution goodwill valuation and the sensitivity of the $256.1 million goodwill balance to weaker forecasts or higher discount rates.
  • Track tax-rate drivers, foreign-exchange exposure, raw-material costs, backlog conversion, and the company’s ability to manage seasonal demand and supplier risks.