SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 0-362
FRANKLIN ELECTRIC CO., INC.
(Exact name of registrant as specified in its charter)
|(State or other jurisdiction of incorporation or organization)|| ||(I.R.S. Employer Identification No.)|
|9255 Coverdale Road|| || |
|Fort Wayne, ||Indiana|| ||46809|
|(Address of principal executive offices)|| ||(Zip Code)|
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
|Common Stock, $0.10 par value|| ||FELE||NASDAQ||Global Select Market|
|(Title of each class)|| ||(Trading symbol)||(Name of each exchange on which registered)|
Securities registered pursuant to Section 12(g) of the Act:
(Title of each class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
|Large Accelerated Filer||☒||Accelerated Filer||☐||Non-Accelerated Filer||☐||Smaller Reporting Company||☐|
|Emerging Growth Company||☐|
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant at June 30, 2020 (the last business day of the registrant’s most recently completed second quarter) was $2,399,426,619. The stock price used in this computation was the last sales price on that date, as reported by NASDAQ Global Select Market. For purposes of this calculation, the registrant has excluded shares held by executive officers and directors of the registrant, including restricted shares and except for shares owned by the executive officers through the registrant’s 401(k) Plan. Determination of stock ownership by non-affiliates was made solely for the purpose of responding to this requirement and the registrant is not bound by this determination for any other purpose.
Number of shares of common stock outstanding at February 9, 2021:
DOCUMENTS INCORPORATED BY REFERENCE
A portion of the Proxy Statement for the Annual Meeting of Shareholders to be held on May 7, 2021 (Part III).
FRANKLIN ELECTRIC CO., INC.
TABLE OF CONTENTS
ITEM 1. BUSINESS
Description of the Business
Franklin Electric Co., Inc. (“Franklin Electric” or the “Company”) is an Indiana corporation founded in 1944 and incorporated in 1946. Named after America’s pioneer electrical engineer, Benjamin Franklin, Franklin Electric manufactured the first water-lubricated submersible motor for water systems, and the first submersible motor for fueling systems. With 2020 revenue of about $1.2 billion, the Company designs, manufactures and distributes water and fuel pumping systems, composed primarily of submersible motors, pumps, electronic controls and related parts and equipment.
The Company’s water pumping systems move fresh and wastewater for the residential, agricultural, and other industrial end markets. The Company also sells various groundwater equipment products to well installation contractors, including water pumping systems, through its distribution branches located in the U.S. With a growing global footprint, the Company has also evolved into a top supplier of submersible fueling systems at gas stations, making pumps, pipes, electronic controls, and monitoring devices.
The Company’s products are sold worldwide by its employee sales force and independent manufacturing representatives. The Company offers normal and customary trade terms to its customers, no significant part of which is of an extended nature. Special inventory requirements are not necessary, and customer merchandise return rights do not extend beyond normal warranty provisions.
Franklin Electric’s Key Factors for Success
While maintaining a culture of safety and lean principles, Franklin Electric promises to deliver quality, availability, service, innovation, and cost in every encounter the Company has with stakeholders, including direct or indirect customers, employees, shareholders, and suppliers. These key factors for success are a roadmap for the Company's growth as a global provider of water and fuel systems, through geographic expansion and product line extensions, leveraging its global platform and competency in system design, all while consistently offering the best value to its customer.
Markets and Applications
The Company’s business consists of three reportable segments based on the principal end market served: Water Systems, Fueling Systems, and Distribution segments. The Company includes unallocated corporate expenses in an “Intersegment Eliminations/Other” segment that, together with the Water Systems, Fueling Systems, and Distribution segments, represent the Company. Segment and geographic information appears in Note 15 - Segment and Geographic Information to the consolidated financial statements.
The market for the Company’s products is highly competitive and includes diversified accounts by size and type. The Company’s Water Systems and Fueling Systems products and related equipment are sold to specialty distributors and some original equipment manufacturers (“OEMs”), as well as industrial and petroleum equipment distributors and major oil and utility companies. The Company’s Distribution segment sells products primarily to water well contractors.
Water Systems Segment
Water Systems is a global leader in the production and marketing of water pumping systems and is a technical leader in submersible motors, pumps, drives, electronic controls, and monitoring devices. The Water Systems segment designs, manufactures and sells motors, pumps, drives, electronic controls, monitoring devices, and related parts and equipment primarily for use in groundwater, water transfer and wastewater.
Water Systems motors, pumps and controls are used principally for pumping clean water and wastewater in a variety of residential, agricultural, municipal and industrial applications. Water Systems also manufactures electronic drives and controls for the motors which control functionality and provide protection from various hazards, such as electrical surges, over-heating and dry wells or dry tanks. In the last two years, the Company acquired First Sales, LLC and Waterite, Inc., expanding its portfolio to include water treatment systems.
Water Systems products are sold in highly competitive markets. Water Systems contributes about 60 percent of the Company’s total revenue. Significant portions of segment revenue come from selling groundwater and surface pumps, motors, and controls for residential and commercial buildings, as well as agricultural sales which are more seasonal and subject to commodity price changes. The Water Systems segment generates approximately 35 to 40 percent of its revenue in developing markets, which often lack municipal water systems. As those countries install water systems, the Company views those markets as an
opportunity. The Company has had 6 to 9 percent compounded annual sales growth in developing regions in recent years. Water Systems competes in each of its targeted markets based on product design, quality of products and services, performance, availability, and price. The Company’s principal competitors in the specialty water products industry are Grundfos Management A/S, Pentair, Inc., and Xylem, Inc.
2020 Water Systems research and development expenditures were primarily related to the following activities:
•Electronic variable frequency drives and controls for Pump and HVAC applications, including SubDrive Connect Plus, SubDrive Utility 3 Phase, and Cerus X-Drive including HES (High Efficiency Systems) motor support
•Greywater pumping equipment, including the new High Temperature Condensate Pump Series and expanded FPS Non-Clog products up to 20 horsepower
•Submersible and surface pumps for residential, commercial, municipal, and agricultural applications including the development of a standard global 4” pump family and the integration our new recently acquired lineshaft turbine product offerings
•Submersible motor technology and motor protection, including expanded scope of the MagForce™ HES (High Efficiency Systems) from 1-335 horsepower
•Water Treatment products focused on a new commercial valve and IOT enabled sensing systems
Fueling Systems Segment
Fueling Systems is a global leader in the production and marketing of fuel pumping systems, fuel containment systems, and monitoring and control systems. The Fueling Systems segment designs, manufactures and sells pumps, pipe, sumps, fittings, vapor recovery components, electronic controls, monitoring devices and related parts and equipment primarily for use in fueling system applications.
Fueling Systems offers a complete array of components between the tank and the dispenser, including submersible pumps, station hardware, piping, sumps, vapor recovery and electronic controls. The Fueling Systems segment growth has been sustained by a commitment to protecting human health and the environment while delivering the lowest total cost of ownership. Fueling Systems takes steps to ensure its products are installed and maintained properly through robust global certification tools for their third-party contractors. The segment serves other energy markets such as power reliability systems and includes intelligent electronic devices that are designed for online monitoring for the power utility, hydroelectric, and telecommunication and data center infrastructure.
Fueling Systems products are sold in highly competitive markets. Rising vehicle use is leading to more investment in fueling stations which, in turn, leads to increased demand for the Company’s Fueling Systems products. The Company believes there is growth opportunity in developing markets. Fueling Systems competes in each of its targeted markets based on product design, quality of products and services, performance, availability, and value. The Company’s principal competitors in the petroleum equipment industry are Vontier Corporation, formerly a part of Fortive Corporation, and Dover Corporation.
2020 Fueling Systems research and development expenditures were primarily related to the following activities:
•Developed and launched a Corrosion Control System to reduce corrosion in diesel tanks
•Developed products to monitor retail fueling sites, tank corrosion, and vapor recovery systems
•Developed and launched a Battery Monitoring System for Telecommunication, Data Centers, and Power Utilities back up battery systems
•Developed a Distribution Transformer Monitor to analyze distribution transformer health
The Distribution Segment is operated as a collection of wholly owned leading groundwater distributors known as the Headwater Companies. Headwater Companies deliver quality products and leading brands to the industry, providing contractors with the availability and service they demand to meet their application challenges. The Distribution segment operates within the U.S. professional groundwater market. Highlights of the Distribution Segment are as follows:
•2017 - Acquired controlling interests in three distributors in the U.S. professional groundwater market, creating the new Distribution Segment
•2018 - Acquired Valley Farms Supply, Inc., a professional groundwater distributor operating in the mid-west
•2019 - Acquired Milan Supply Company, a professional groundwater distributor operating in the mid-west
•2020 - Acquired Gicon Pumps & Equipment, Inc., a professional groundwater distributor operating in the south
Information Regarding All Reportable Segments
Research and Development
The Company incurred research and development expense as follows:
|Research and development expense||$||21.7 ||$||20.8 ||$||22.1 |
Expenses incurred were for activities related to the development of new products, improvement of existing products and manufacturing methods, and other applied research and development.
The Company owns a number of patents, trademarks, and licenses. In the aggregate, these patents are of material importance to the operation of the business; however, the Company believes that its operations are not dependent on any single patent or group of patents.
The principal raw materials used in the manufacture of the Company’s products are coil and bar steel, stainless steel, copper wire, and aluminum ingot. Major components are electric motors, capacitors, motor protectors, forgings, gray iron castings, plastic resins, and bearings. Most of these raw materials are available from multiple sources in the United States and world markets. Generally, the Company believes that adequate alternative sources are available for the majority of its key raw material and purchased component needs; however, the Company is dependent on a single or limited number of suppliers for certain materials or components. The Company believes that availability of fuel and energy is adequate to satisfy current and projected overall operations unless interrupted by government direction, allocation or other disruption.
No single customer accounted for over 10 percent of net sales in 2020, 2019, or 2018. No single customer accounted for over 10 percent of gross accounts receivable in 2020 and 2019.
The dollar amount of backlog by segment was as follows:
|(In millions)||February 9,|
|Water Systems||$||69.2 ||$||53.2 |
|Fueling Systems||17.4 ||16.6 |
|Distribution||11.9 ||4.7 |
|Consolidated||$||98.5 ||$||74.5 |
The backlog is composed of written orders at prices adjustable on a price-at-the-time-of-shipment basis for products, primarily standard catalog items. All backlog orders are expected to be filled in fiscal 2021. The Company’s sales in the first quarter are generally less than its sales in other quarters due to less water well drilling and overall product sales during the winter months in the Northern hemisphere. Beyond that, there is no seasonal pattern to the backlog and the backlog has not proven to be a significant indicator of future sales.
The Company believes that it is in compliance with all applicable federal, state, and local laws concerning the discharge of material into the environment, or otherwise relating to the protection of the environment. The Company has not experienced any material costs in connection with environmental compliance, and does not believe that such compliance will have any material effect upon the financial position, results of operations, cash flows, or competitive position of the Company.
Human Capital Resources
As of December 31, 2020, the Company had approximately 5,400 employees. The Company is committed to safety, ethical compliance with established policies, care for the well-being of employees, and has a history of innovation, environmental protection, continuous improvement and lean manufacturing practices. Further information regarding our human capital details and initiatives can be found in the 2020 Franklin Electric Sustainability Report available for download on the Company's website.
The Company’s website address is www.franklin-electric.com. The Company makes available free of charge on or through its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. Additionally, the Company’s website includes the Company’s corporate governance guidelines, its Board committee charters, and the Company’s code of business conduct and ethics. Information contained on the Company’s website is not part of this annual report on Form 10-K.
ITEM 1A. RISK FACTORS
The following describes the principal risks affecting the Company and its business. Additional risks and uncertainties, not presently known to the Company, could negatively impact the Company’s results of operations or financial condition in the future.
Risks Related to the Industry
Reduced housing starts adversely affect demand for the Company’s products, thereby reducing revenues and earnings. Demand for certain Company products is affected by housing starts. Variation in housing starts due to economic volatility both within the United States and globally could adversely impact gross margins and operating results.
The Company’s results may be adversely affected by global macroeconomic supply and demand conditions related to the energy and mining industries. The energy and mining industries are users of the Company’s products, including the coal, iron ore, gold, copper, oil, and natural gas industries. Decisions to purchase the Company’s products are dependent upon the performance of the industries in which our customers operate. If demand or output in these industries increases, the demand for our products will generally increase. Likewise, if demand or output in these industries declines, the demand for our products will generally decrease. The energy and mining industries’ demand and output are impacted by the prices of commodities in these industries which are frequently volatile and change in response to general economic conditions, economic growth, commodity inventories, and any disruptions in production or distribution. Changes in these conditions could adversely impact sales, gross margin, and operating results.
Increases in the prices of raw materials, components, finished goods and other commodities could adversely affect operations. The Company purchases most of the raw materials for its products on the open market and relies on third parties for the sourcing of certain finished goods. Accordingly, the cost of its products may be affected by changes in the market price of raw materials, sourced components, or finished goods. The Company and its suppliers also use natural gas and electricity in manufacturing products both of which have historically been volatile. The Company does not generally engage in commodity hedging for raw materials and energy. Significant increases in the prices of commodities, sourced components, finished goods, energy or other commodities could cause product prices to increase, which may reduce demand for products or make the Company more susceptible to competition. Furthermore, in the event the Company is unable to pass along increases in operating costs to its customers, margins and profitability may be adversely affected.
The growth of municipal water systems and increased government restrictions on groundwater pumping could reduce demand for private water wells and the Company’s products, thereby reducing revenues and earnings. Demand for certain Company products is affected by rural communities shifting from private and individual water well systems to city or municipal water systems. Many economic and other factors outside the Company’s control, including governmental regulations on water quality, and tax credits and incentives, could adversely impact the demand for private and individual water wells. A decline in private and individual water well systems in the United States or other economies in the international markets the Company serves could reduce demand for the Company’s products and adversely impact sales, gross margins, and operating results.
Demand for Fueling Systems products is impacted by environmental legislation which may cause significant fluctuations in costs and revenues. Environmental legislation related to air quality and fuel containment may create demand for certain Fueling Systems products which must be supplied in a relatively short time frame to meet the governmental mandate. During periods of increased demand the Company’s revenues and profitability could increase significantly, although the Company can also be at risk of not having capacity to meet demand or cost overruns due to inefficiencies during ramp up to the higher production levels. After the Company’s customers have met the compliance requirements, the Company’s revenues and profitability may decrease significantly as the demand for certain products declines substantially. The risk of not reducing production costs in relation to the decreased demand and reduced revenues could have a material adverse impact on gross margins and the Company’s results of operations.
Changes in tax legislation regarding the Company’s U.S. or foreign earnings could materially affect future results. Since the Company operates in different countries and is subject to taxation in different jurisdictions, the Company’s future effective tax rates could be impacted by changes in such countries’ tax laws or their interpretations. Both domestic and international tax laws are subject to change as a result of changes in fiscal policy, legislation, evolution of regulation and court rulings. The application of these tax laws and related regulations is subject to legal and factual interpretation, judgment, and uncertainty. The Company cannot predict whether any proposed changes in tax laws will be enacted into law or what, if any, changes may be made to any such proposals prior to their being enacted into law. If the tax laws change in a manner that increases the Company’s tax obligation, it could have a material adverse impact on the Company’s results of operations and financial condition.
Risks Related to the Business
The Company is exposed to political, economic and other risks that arise from operating a multinational business. The Company has significant operations outside the United States, including Europe, South Africa, Brazil, Mexico, India, China, Turkey, Canada and Argentina. Further, the Company obtains raw materials and finished goods from foreign suppliers. Accordingly, the Company’s business is subject to political, economic, and other risks that are inherent in operating a multinational business. These risks include, but are not limited to, the following:
•Difficulty in enforcing agreements and collecting receivables through foreign legal systems
•Trade protection measures and import or export licensing requirements
•Inability to obtain raw materials and finished goods in a timely manner from foreign suppliers
•Imposition of tariffs, exchange controls or other restrictions
•Difficulty in staffing and managing widespread operations and the application of foreign labor regulations
•Compliance with foreign laws and regulations
•Changes in general economic and political conditions in countries where the Company operates
Additionally, the Company’s operations outside the United States could be negatively impacted by changes in treaties, agreements, policies, and laws implemented by the United States.
If the Company does not anticipate and effectively manage these risks, these factors may have a material adverse impact on its international operations or on the business as a whole.
The Company’s acquisition strategy entails expense, integration risks, and other risks that could affect the Company’s earnings and financial condition. One of the Company’s continuing strategies is to increase revenues and expand market share through acquisitions that will provide complementary Water and Fueling Systems products, add to the Company’s global reach, or both. The Company spends significant time and effort expanding existing businesses through identifying, pursuing, completing, and integrating acquisitions, which generate expense whether or not the acquisitions are actually completed. Competition for acquisition candidates may limit the number of opportunities and may result in higher acquisition prices. There is uncertainty related to successfully acquiring, integrating and profitably managing additional businesses without substantial costs, delays or other problems. There can also be no assurance that acquired companies will achieve revenues, profitability or cash flows that justify the investment. Failure to manage or mitigate these risks could adversely affect the Company’s results of operations and financial condition.
The Company’s products are sold in highly competitive markets, by numerous competitors whose actions could negatively impact sales volume, pricing and profitability. The Company is a global leader in the production and marketing of groundwater and fuel pumping systems. End user demand, distribution relationships, industry consolidation, new product capabilities of the Company’s competitors or new competitors, and many other factors contribute to a highly competitive environment. Additionally, some of the Company’s competitors have substantially greater financial resources than the Company. The Company believes that consistency of product quality, timeliness of delivery, service, and continued product innovation, as well as price, are principal factors considered by customers in selecting suppliers. Competitive factors previously described may lead to declines in sales or in the prices of the Company’s products which could have an adverse impact on its results of operations and financial condition.
The Company’s products are sold to numerous distribution outlets based on market performance. The Company may, from time to time, change distribution outlets in certain markets based on market share and growth. These changes could adversely impact sales and operating results.
Transferring operations of the Company to lower cost regions may not result in the intended cost benefits. The Company is continuing its rationalization of manufacturing capacity between all existing manufacturing facilities and the manufacturing
complexes in lower cost regions. To implement this strategy, the Company must complete the transfer of assets and intellectual property between operations. Each of these transfers involves the risk of disruption to the Company’s manufacturing capability, supply chain, and, ultimately, to the Company’s ability to service customers and generate revenues and profits and may include significant severance amounts.
The Company has significant investments in foreign entities and has significant sales and purchases in foreign denominated currencies creating exposure to foreign currency exchange rate fluctuations. The Company has significant investments outside the United States, including Europe, South Africa, Brazil, Mexico, India, China, Turkey, Canada and Argentina. Further, the Company has sales and makes purchases of raw materials and finished goods in foreign denominated currencies. Accordingly, the Company has exposure to fluctuations in foreign currency exchange rates relative to the U.S. dollar. Foreign currency exchange rate risk is partially mitigated through several means: maintenance of local production facilities in the markets served, invoicing of customers in the same currency as the source of the products, prompt settlement of intercompany balances, limited use of foreign currency denominated debt, and application of derivative instruments when appropriate. To the extent that these mitigating strategies are not successful, foreign currency rate fluctuations can have a material adverse impact on the Company’s international operations or on the business as a whole.
Delays in introducing new products or the inability to achieve or maintain market acceptance with existing or new products may cause the Company’s revenues to decrease. The industries to which the Company belongs are characterized by intense competition, changes in end-user requirements, and evolving product offerings and introductions. The Company believes future success will depend, in part, on the ability to anticipate and adapt to these factors and offer, on a timely basis, products that meet customer demands. Failure to successfully develop new and innovative products or to enhance existing products could result in the loss of existing customers to competitors or the inability to attract new business, either of which may adversely affect the Company’s revenues.
Certain Company products are subject to regulation and government performance requirements in addition to the warranties provided by the Company. The Company’s product lines have expanded significantly and certain products are subject to government regulations and standards for manufacture, assembly, and performance in addition to the warranties provided by the Company. The Company’s failure to meet all such standards or perform in accordance with warranties could result in significant warranty or repair costs, lost sales and profits, damage to the Company’s reputation, fines or penalties from governmental organizations, and increased litigation exposure. Changes to these regulations or standards may require the Company to modify its business objectives and incur additional costs to comply. Any liabilities or penalties actually incurred could have a material adverse effect on the Company’s earnings and operating results.
The Company has significant goodwill and intangible assets and future impairment of the value of these assets may adversely affect operating results and financial condition. The Company’s total assets reflect substantial intangible assets, primarily goodwill. Goodwill results from the Company’s acquisitions, representing the excess of the purchase price paid over the fair value of the net assets acquired. Goodwill and indefinite-lived intangible assets are tested annually for impairment during the fourth quarter or as warranted by triggering events. If future operating performance at one or more of the Company’s operating segments were to decline significantly below current levels, the Company could incur a non-cash charge to operating earnings for an impairment. Any future determination requiring the recognition of an impairment of a significant portion of the Company’s goodwill or intangible assets could have a material adverse impact on the Company’s results of operations and financial condition.
The Company’s business may be adversely affected by the seasonality of sales and weather conditions. The Company experiences seasonal demand in a number of markets within the Water Systems segment. End-user demand in primary markets follows warm weather trends and is at seasonal highs from April to August in the Northern Hemisphere. Demand for residential and agricultural water systems are also affected by weather-related disasters including heavy flooding and drought. Changes in these patterns could reduce demand for the Company’s products and adversely impact sales, gross margins, and operating results.
The Company depends on certain key suppliers, and any loss of those suppliers or their failure to meet commitments may adversely affect business and results of operations. The Company is dependent on a single or limited number of suppliers for some materials or components required in the manufacture of its products. If any of those suppliers fail to meet their commitments to the Company in terms of delivery or quality, the Company may experience supply shortages that could result in its inability to meet customer requirements, or could otherwise experience an interruption in operations that could negatively impact the Company’s business and results of operations.
The Company’s operations are dependent on information technology infrastructure and failures could significantly affect its business. The Company depends on information technology infrastructure in order to achieve business objectives. If the Company experiences a problem that impairs this infrastructure, such as a computer virus, a problem with the functioning of an important IT application, or an intentional disruption of IT systems by a third party, the resulting disruptions could impede the Company's ability to record or process orders, manufacture and ship products in a timely manner, or otherwise carry on business in the ordinary course. Any such events could cause the loss of customers or revenue and could cause significant expense to be incurred to eliminate these problems and address related security concerns.The Company is also subject to certain U.S. and international data protection and cybersecurity regulations. Complying with these laws may subject the Company to additional costs or require changes to the Company’s business practices. Any inability to adequately address privacy and security concerns or comply with applicable privacy and data security laws, rules and regulations could expose the Company to potentially significant liabilities.
Additional Risks to the Company. The Company is subject to various risks in the normal course of business as well as catastrophic events including severe weather events, earthquakes, fires, acts of war, terrorism, civil unrest, epidemics and pandemics and other unexpected events. Exhibit 99.1 sets forth risks and other factors that may affect future results, including those identified above, and is incorporated herein by reference.
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
Franklin Electric serves customers worldwide with over 175 manufacturing and distribution facilities located in over 20 countries. The Global Headquarters is located in Fort Wayne, Indiana, United States and houses sales, marketing, and administrative offices along with a state of the art research and engineering facility. Besides the owned corporate facility, the Company considers the following to be principal properties:
|Location / Segment||Purpose||Own/Lease|
|Santa Catarina, Brazil / Water & Fueling||Manufacturing/Distribution/Sales||Own|
|Sao Paulo, Brazil / Water & Fueling||Manufacturing/Distribution/Sales||Own|
|Jiangsu Province, China / Water & Fueling||Manufacturing||Own|
|Brno, Czech Republic / Water||Manufacturing||Own|
|Vicenza, Italy / Water||Manufacturing||Own|
|Nuevo Leon, Mexico / Water & Fueling||Manufacturing||Own|
|Edenvale, South Africa / Water||Manufacturing||Own|
|Izmir, Turkey / Water||Manufacturing/Distribution/Sales/R&D||Own|
|Montana, United States / Distribution||Distribution||Own|
|North Carolina, United States / Distribution||Distribution||Own|
|Oklahoma, United States / Water||Manufacturing||Own|
|Oregon, United States / Water||Manufacturing/Distribution/Sales/R&D||Lease|
|Wisconsin, United States / Fueling||Manufacturing/Distribution/Sales/R&D||Own|
The Company also owns and leases other smaller facilities which serve as manufacturing locations and distribution warehouses. The Company does not consider these facilities to be principal to the business or operations. In the Company’s opinion, its facilities are suitable for their intended use, adequate for the Company’s business needs, all currently utilized, and in good condition.
ITEM 3. LEGAL PROCEEDINGS
The Company is defending various claims and legal actions which have arisen in the ordinary course of business. For a description of the Company's material legal proceedings, refer to Note 16 - Commitments and Contingencies, in the Notes to Consolidated Financial Statements included in Part II, Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K, which is incorporated into this Item 3 by reference. In the opinion of management, based on current knowledge of the facts and after discussion with counsel, other claims and legal actions can be defended or resolved without a material effect on the Company’s financial position, results of operations, and net cash flows.
INFORMATION ABOUT OUR EXECUTIVE OFFICERS
Current executive officers of the Company, their ages, current position, and business experience during at least the past five years as of December 31, 2020, are as follows:
|Period Holding Position|
|Gregg C. Sengstack||62||Chairperson of the Board and Chief Executive Officer||2015 - present|
|President and Chief Executive Officer||2014 - 2015|
|DeLancey W. Davis||55||Vice President and President, Headwater Companies||2017 - present|
|Vice President and President, North America Water Systems||2012 - 2017|
|Donald P. Kenney||60||Vice President and President, Global Water||2019 - present|
|Vice President and President, North America Water Systems||2017 - 2019|
|Vice President and President, Energy Systems||2014 - 2017|
|John J. Haines||57||Vice President, Chief Financial Officer||2008 - present|
|Dr. Paul N. Chhabra||47||Vice President, Global Product Supply||2018 - present|
|Vice President, Global Supply Chain - Applied Materials||2015 - 2018|
|Jonathan M. Grandon||45||Vice President, Chief Administrative Officer, General Counsel and Corporate Secretary||2016 - present|
|Vice President, Integration - Zimmer Biomet||2015 - 2016|
|Jay J. Walsh||51||Vice President and President, Fueling Systems||2019 - present|
|President, Fueling Systems||2017 - 2019|
|Executive Vice President, Fueling Systems||2013 - 2017|
All executive officers are elected annually by the Board of Directors at the Board meeting held in conjunction with the annual meeting of shareholders. All executive officers hold office until their successors are duly elected or until their death, resignation, or removal by the Board.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
The number of shareholders of record as of February 9, 2021 was 661. The Company’s stock is traded on the NASDAQ Global Select Market under the symbol FELE. Broadridge Corporate Issuer Solutions, Inc. 1155 Long Island Avenue, Edgewood, New York, 11717 serves as the registrar, record keeper, and stock transfer agent.
Dividends paid per common share as quoted by the NASDAQ Global Select Market for 2020 and 2019 were as follows:
|Dividends per Share|
| || || |
|1st Quarter||$||.1550 ||$||.1450 |
|2nd Quarter||.1550 ||.1450 |
|3rd Quarter||.1550 ||.1450 |
|4th Quarter||.1550 ||.1450 |
The Company has increased dividend payments on an annual basis for 28 consecutive periods. The payment of dividends in the future will be determined by the Board of Directors and will depend on business conditions, earnings, and other factors.
Issuer Purchases of Equity Securities
In April 2007, the Company’s Board of Directors unanimously approved a plan to increase the number of shares remaining for repurchase from 628,692 to 2,300,000 shares. There is no expiration date for this plan. On August 3, 2015, the Company’s Board of Directors approved a plan to increase the number of shares remaining for repurchase by an additional 3,000,000 shares. The authorization was in addition to the 535,107 shares that remained available for repurchase as of July 31, 2015. The Company did not repurchase any shares under this plan during the fourth quarter of 2020. The maximum number of shares that may still be purchased under this plan as of December 31, 2020 is 933,823.
Stock Performance Graph
The following graph compares the Company’s cumulative total shareholder return (Common Stock price appreciation plus dividends, on a reinvested basis) over the last five fiscal years with the Guggenheim S&P Global Water Index and the Russell 2000 Index.
Hypothetical $100 invested on January 2, 2016 (fiscal year-end 2015) in Franklin Electric common stock (FELE), Guggenheim S&P Global Water Index, and Russell 2000 Index, assuming reinvestment of dividends:
|FELE||$||100 ||$||144 ||$||170 ||$||159 ||$||212 ||$||257 |
|Guggenheim S&P Global Water||100 ||107 ||149 ||134 ||177 ||201 |
|Russell 2000||100 ||121 ||137 ||122 ||151 ||179 |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Discussion of the year-over-year comparison of changes in the Company's financial condition and results of operation as of and for the fiscal years ended December 31, 2019 and December 31, 2018 can be found in Part II, Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
2020 vs. 2019
Sales in 2020 were down from the prior year. The sales decrease was primarily from lower volumes, in part created by uncertainty and general disruptions around the global pandemic relating to the transmission of COVID-19 and governmental and societal reactions thereto in the second quarter. The impact of foreign currency translation decreased sales by about 3 percent. The Company's consolidated gross profit was $433.1 million for 2020, an increase of $5.0 million or about 1 percent from 2019. The gross profit as a percent of net sales increased 210 basis points to 34.7 percent in 2020 from 32.6 percent in 2019. For 2020, diluted earnings per share were $2.14, up from 2019 diluted earnings per share of $2.03.
EFFECTS OF THE GLOBAL PANDEMIC
The top priority of the Company is the health and welfare of its employees and partners around the world. In response to the health risks posed by the Global Pandemic, the Company implemented and has been following the recommended hygiene and social distancing practices promulgated by the United States Centers for Disease Control and the World Health Organization.
The Company’s products and services are generally viewed as essential in most jurisdictions in which the Company operates. All the Company’s global manufacturing and distribution operations are operating with limited disruption.
The primary impacts of the Global Pandemic on the Company’s end markets remain consistent with prior disclosures. Large dewatering equipment sales in the Water Systems segment continue to be depressed and the deferral or cancellation of the construction of new filling stations in the Fueling Systems segment continues. The Company’s financial results are also impacted negatively by continuing government mandated closures and related customer behaviors.
RESULTS OF OPERATIONS
Net sales in 2020 were $1,247.3 million, a decrease of $67.3 million or about 5 percent compared to 2019 sales of $1,314.6 million. The incremental impact of sales from acquired businesses was $12.8 million. Sales revenue decreased by $39.6 million or 3 percent in 2020 due to foreign currency translation. The sales change in 2020, excluding acquisitions and foreign currency translation, was a decrease of about 3 percent.
|(In millions)||2020||2019||2020 v 2019|
|Water Systems||$||734.7 ||$||781.5 ||$||(46.8)|
|Fueling Systems||245.1 ||293.6 ||(48.5)|
|Distribution||328.4 ||291.8 ||36.6 |
|Consolidated||$||1,247.3 ||$||1,314.6 ||$||(67.3)|
Net Sales-Water Systems
Water Systems sales were $734.7 million in 2020, a decrease of $46.8 million or about 6 percent versus 2019. The incremental impact of sales from acquired businesses was $12.8 million. Foreign currency translation changes decreased sales $40.0 million, or about 5 percent, compared to sales in 2019. The Water Systems sales change in 2020, excluding acquisitions and foreign currency translation, was a decrease of $19.6 million or about 3 percent.
Water Systems sales in the U.S. and Canada decreased by about 7 percent compared to 2019. The incremental impact of sales from acquired businesses was $12.8 million. Sales revenue decreased by $0.7 million in 2020 due to foreign currency translation. In 2020, sales of dewatering equipment decreased by about 54 percent due to lower sales in rental channels and
substantial uncertainty in oil production end markets. Sales of groundwater pumping equipment increased by 12 percent versus 2019. Sales of other surface pumping equipment decreased by about 3 percent.
Water Systems sales in markets outside the U.S. and Canada decreased by about 4 percent compared to 2019. Sales revenue decreased by $39.3 million or about 11 percent in 2020 due to foreign currency translation. Sales change in 2020, excluding foreign currency translation, was an increase of about 7 percent. Sales growth in Latin America and EMENA were partially offset by lower sales in the Asia Pacific markets.
Net Sales-Fueling Systems
Fueling Systems sales were $245.1 million in 2020, a decrease of $48.5 million or about 17 percent from 2019. Foreign currency translation changes increased sales $0.4 million or less than 1 percent compared to sales in 2019. The Fueling Systems sales change in 2020, excluding foreign currency translation, was a decrease of $48.9 million or about 17 percent.
Fueling Systems sales in the U.S. and Canada declined by about 9 percent during 2020. The decrease was in all product lines and due to declining demand for new filling stations. Internationally, Fueling Systems revenues declined by about 28 percent, driven by lower sales in Asia Pacific, primarily China and India. China sales were about $18 million in 2020 compared to 2019 Fueling Systems China sales of about $45 million.
Distribution sales were $328.4 million in 2020, versus 2019 sales of $291.8 million. Distribution segment organic sales increased about 13 percent compared to 2019. More favorable weather conditions in most of the United States versus the prior year contributed to the revenue growth.
Cost of Sales
Cost of sales as a percent of net sales for 2020 and 2019 was 65.3 percent and 67.4 percent, respectively. Correspondingly, the gross profit margin was 34.7 percent and 32.6 percent, respectively. The Company's consolidated gross profit was $433.1 million for 2020, up $5.0 million from the gross profit of $428.1 million in 2019. The increase in gross profit and gross profit margin was primarily driven by price realization, product sales mix and cost management.
Selling, General and Administrative (“SG&A”)
Selling, general, and administrative expenses were $300.1 million in 2020 and increased by $1.6 million or less than one percent overall compared to $298.5 million last year. SG&A expenses from acquired businesses was $2.2 million and excluding the acquired entities, the Company’s SG&A expenses in 2020 were $297.9 million, a decrease from the prior year. SG&A expenses were lower versus the prior year due to companywide efforts to lower spending in response to the impacts of the Global Pandemic and in part because of foreign currency translation.
Restructuring expenses for 2020 were $2.5 million. Restructuring expenses were $2.3 million in the Water segment and $0.1 million in each of the Fueling and Distribution segments. Restructuring expenses were primarily from continued miscellaneous manufacturing realignment activities and branch closings and consolidations in the Distribution segment. Restructuring expenses for 2019 were $2.5 million. Restructuring expenses were $1.7 million in the Water segment and $0.8 million in the Distribution segment. Restructuring expenses were primarily from continued miscellaneous manufacturing realignment activities and branch closings and consolidations in the Distribution segment.
Operating income was $130.5 million in 2020, up $3.4 million or 3 percent from $127.1 million in 2019.
|Operating income (loss)|
|(In millions)||2020||2019||2020 v 2019|
|Water Systems||$||114.4 ||$||103.0 ||$||11.4 |
|Fueling Systems||63.4 ||75.8 ||(12.4)|
|Distribution||11.5 ||3.6 ||7.9 |
|Consolidated||$||130.5 ||$||127.1 ||$||3.4 |
Operating Income-Water Systems
Water Systems operating income was $114.4 million in 2020 compared to $103.0 million in 2019, an increase of 11 percent. The operating income margin was 15.6 percent compared to the 2019 operating income margin of 13.2 percent. Operating income margin increased in Water Systems primarily driven by price realization, product sales mix and cost management.
Operating Income-Fueling Systems
Fueling Systems operating income was $63.4 million in 2020 compared to $75.8 million in 2019. The operating income margin was 25.9 percent compared to 25.8 percent of net sales in 2019. Operating income decreased in Fueling Systems primarily due to lower sales volumes. The increase in margin was primarily driven by cost management.
Distribution operating income was $11.5 million in 2020 and operating income margin was 3.5 percent. Distribution operating income was $3.6 million in 2019 and operating income margin was 1.2 percent. Operating income and operating income margin increased in Distribution due to higher sales volumes.
Operating income-Eliminations/Other is composed primarily of inter-segment sales and profit eliminations and unallocated general and administrative expenses. The inter-segment profit elimination impact in 2020 increased operating loss about $0.2 million. The inter-segment elimination of operating income effectively defers the operating income on sales from Water Systems to Distribution in the consolidated financial results until the transferred product is sold from the Distribution segment to its third-party customer. Unallocated general and administrative expenses were higher by $3.3 million or about 6 percent to last year, primarily due to higher variable performance-based compensation expenses.
Interest expense for 2020 and 2019 was $4.6 million and $8.2 million, respectively, and decreased primarily as a result of lower debt levels.
Other Income or Expense
Other income or expense was a loss of $0.8 million and $0.4 million, respectively in 2020 and 2019.
Foreign currency–based transactions produced a loss for 2020 of $1.4 million, primarily due to changes in the value of the Argentinian Peso relative to the U.S. dollar. Foreign currency–based transactions produced a loss for 2019 of $1.6 million, primarily due to changes in the value of the Argentinian Peso relative to the U.S. dollar.
The provision for income taxes in 2020 and 2019 was $22.5 million and $20.8 million, respectively. The effective tax rate for 2020 was about 18 percent and before the impact of discrete events was about 21 percent. The effective tax rate for 2019 was about 18 percent and before the impact of discrete events was about 20 percent. The tax rate was lower than the statutory rate of 21 percent primarily due to foreign earnings taxed at lower statutory rates, as well as recognition of the U.S. deduction for Foreign Derived Intangible Income, and certain incentives and discrete events. Discrete events in 2020 include a benefit related to a realized foreign currency translation loss on the settlement of an intercompany loan.
Net income for 2020 was $101.2 million compared to 2019 net income of $96.0 million. Net income attributable to Franklin Electric Co., Inc. for 2020 was $100.5 million, or $2.14 per diluted share, compared to 2019 net income attributable to Franklin Electric Co., Inc. of $95.5 million or $2.03 per diluted share.
CAPITAL RESOURCES AND LIQUIDITY
Sources of Liquidity
The Company's primary sources of liquidity are cash on hand, cash flows from operations, revolving credit agreements, and long-term debt funds available. The Company believes its capital resources and liquidity position at December 31, 2020 is adequate to meet projected needs for the foreseeable future. The Company expects that ongoing requirements for operations, capital expenditures, pension obligations, dividends, share repurchases, and debt service will be adequately funded from cash on hand, operations, and existing credit agreements.
As of December 31, 2020, the Company had a $300.0 million revolving credit facility. The facility is scheduled to mature on October 28, 2021. As of December 31, 2020, the Company had $295.9 million borrowing capacity under the Credit Agreement as $4.1 million in letters of commercial and standby letters of credit were outstanding and undrawn. No revolver borrowings were outstanding as of the end of the year.
In addition, the Company maintains an uncommitted and unsecured private shelf agreement with NYL Investors LLC, an affiliate of New York Life, and each of the undersigned holders of Notes (the "New York Life Agreement") with a remaining borrowing capacity of $125.0 million as of December 31, 2020. The New York Life Agreement matures on September 26, 2025. The Company also has other long-term debt borrowings outstanding as of December 31, 2020. See Note 10 - Debt for additional specifics regarding these obligations and future maturities.
At December 31, 2020, the Company had $75 million of cash and cash equivalents held in foreign jurisdictions, which the Company intends to use to fund foreign operations. There is currently no need to repatriate these funds in order to meet domestic funding obligations or scheduled cash distributions.
The following table summarizes significant sources and uses of cash and cash equivalents:
|Cash flows from operating activities||$||211.9 ||$||177.7 ||$||128.4 |
|Cash flows from investing activities||$||(78.8)||$||(41.8)||$||(66.3)|
|Cash flows from financing activities||$||(66.6)||$||(126.7)||$||(66.8)|
|Impact of exchange rates on cash and cash equivalents||$||(0.1)||$||(4.0)||$||(3.4)|
|Change in cash and cash equivalents||$||66.4 ||$||5.2 ||$||(8.1)|
Cash Flows from Operating Activities
2020 vs 2019
Net cash provided by operating activities was $211.9 million for 2020 compared to $177.7 million for 2019. The increase in cash provided by operating activities was primarily due to increased earnings and a decrease of $30.6 million in working capital requirements related to improved customer collections and inventory management and more favorable payment terms with vendors.
Cash Flows from Investing Activities
2020 vs. 2019
Net cash used in investing activities was $78.8 million in 2020 compared to $41.8 million in 2019. The increase was primarily attributable to increased acquisition activity.
Cash Flows from Financing Activities
2020 vs. 2019
Net cash used in financing activities was $66.6 million in 2020 compared to $126.7 million in 2019. The decrease in cash used in financing activities was primarily attributable to a decrease in net debt repayments, down approximately $70 million in the current year. Other uses of cash in financing activities include an increase in dividend payments of $2.0 million and an increase in common stock repurchases of $8.8 million.
AGGREGATE CONTRACTUAL OBLIGATIONS
The majority of the Company’s contractual obligations to third parties relate to debt obligations. In addition, the Company has certain contractual obligations for future lease payments and purchase obligations. The payment schedule for these contractual obligations is as follows:
|(In millions)|| || || ||More than|
| ||Total||2021||2022-2023||2024-2025||5 years|
|Debt||$||94.6 ||$||2.5 ||$||2.6 ||$||77.8 ||$||11.7 |
|Debt interest||19.7 ||3.8 ||7.2 ||7.0 ||1.7 |
|Operating leases||34.4 ||11.9 ||13.9 ||5.1 ||3.5 |
|Purchase obligations||9.1 ||9.1 ||— ||— ||— |
|Income Taxes-U.S. Tax Cuts and Jobs Act transition tax||$||14.7 ||$||1.5 ||$||4.5 ||$||8.7 ||$||— |
| ||$||172.5 ||$||28.8 ||$||28.2 ||$||98.6 ||$||16.9 |
The Company has pension and other post-retirement benefit obligations not included in the table above which will result in estimated future payments of approximately $1 million in 2021. The Company also has unrecognized tax benefits, none of which are included in the table above. The unrecognized tax benefits of approximately $0.6 million have been recorded as liabilities and the Company is uncertain as to if or when such amounts may be settled. Related to the unrecognized tax benefits, the Company has also recorded a liability for potential penalties and interest of $0.1 million.
For information regarding recent accounting pronouncements, refer to Note 2 - Accounting Pronouncements, in the Notes to Consolidated Financial Statements in the sections entitled ""Adoption of New Accounting Standards" and "Accounting Standards Issued But Not Yet Adopted", included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.
CRITICAL ACCOUNTING ESTIMATES
Management’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. Management evaluates estimates on an ongoing basis. Estimates are based on historical experience and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. There were no material changes to estimates or methodologies used to develop those estimates in 2020.
The Company’s critical accounting estimates are identified below:
The Company uses certain estimates and judgments to value inventory. Inventory is recorded at the lower of cost or market. The Company reviews its inventories for excess or obsolete products or components. Based on an analysis of historical usage, management’s evaluation of estimated future demand, market conditions, and alternative uses for possible excess or obsolete parts, carrying values are adjusted. The carrying value is reduced regularly to reflect the age and current anticipated product demand. If actual demand differs from the estimates, additional reductions would be necessary in the period such determination is made. Excess and obsolete inventory is periodically disposed of through sale to third parties, scrapping, or other means.
The Company follows the guidance under FASB Accounting Standards Codification (“ASC”) Topic 805, Business Combinations. The acquisition purchase price is allocated to the assets acquired and liabilities assumed based upon their respective fair values. The Company shall report in its financial statements provisional amounts for the items for which accounting is incomplete. Goodwill is adjusted for any changes to provisional amounts made within the measurement period. The Company utilizes management estimates and an independent third-party valuation firm to assist in determining the fair values of assets acquired and liabilities assumed. Such estimates and valuations require the Company to make significant assumptions, including projections of future events and operating performance. The Company has not made any material changes to the method of valuing fair values of assets acquired and liabilities assumed during the last three years.
Trade Names and Goodwill
According to FASB ASC Topic 350, Intangibles - Goodwill and Other, intangible assets with indefinite lives must be tested for impairment at least annually or more frequently as warranted by triggering events that indicate potential impairment. The Company uses a variety of methodologies in conducting impairment assessments including income and market approaches. For indefinite-lived assets apart from goodwill, primarily trade names for the Company, if the fair value is less than the carrying amount, an impairment charge is recognized in an amount equal to that excess. The Company has not made any material changes to the method of evaluating impairments during the last three years.
In compliance with FASB ASC Topic 350, goodwill is not amortized. Goodwill is tested at the reporting unit level for impairment annually or more frequently as warranted by triggering events that indicate potential impairment. Reporting units are operating segments or one level below, known as components, which can be aggregated for testing purposes. The Company’s goodwill is allocated to the Global Water Systems, Fueling Systems and Distribution units. As the Company’s business model evolves, management will continue to evaluate its reporting units and review the aggregation criteria.
In assessing the recoverability of goodwill, the Company determines the fair value of its reporting units by utilizing a combination of both the market value and income approaches. The market value approach compares the reporting units’ current and projected financial results to entities of similar size and industry to determine the market value of the reporting unit. The income approach utilizes assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. These cash flows consider factors regarding expected future operating income and historical trends, as well as the effects of demand and competition. The Company may be required to record an impairment if these assumptions and estimates change whereby the fair value of the reporting units is below their associated carrying values. Goodwill included on the balance sheet as of the fiscal year ended 2020 was $266.7 million.
During the fourth quarter of 2020, the Company completed its annual impairment test of goodwill and trade names and determined the fair value of all intangibles were substantially in excess of the respective carrying values. Significant judgment is required to determine if an indication of impairment has taken place. Factors to be considered include the following: adverse changes in operating results, decline in strategic business plans, significantly lower future cash flows, and sustainable declines in market data such as market capitalization. A 10 percent decrease in the fair value estimates used in the impairment test would not have changed this determination. The sensitivity analysis required the use of numerous subjective assumptions, which, if actual experience varies, could result in material differences in the requirements for impairment charges. Further, an extended downturn in the economy may impact certain components of the operating segments more significantly and could result in changes to the aggregation assumptions and impairment determination.
Under the requirements of FASB ASC Topic 740, Income Taxes, the Company records deferred tax assets and liabilities for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company analyzes the deferred tax assets and liabilities for their future realization based on the estimated existence of sufficient taxable income. This analysis considers the following sources of taxable income: prior year taxable income, future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and tax planning strategies that would generate taxable income in the relevant period. If sufficient taxable income is not projected then the Company will record a valuation allowance against the relevant deferred tax assets.
The Company’s operations involve dealing with uncertainties and judgments in the application of complex tax regulations in multiple jurisdictions. These jurisdictions have different tax rates, and the Company determines the allocation of income to each of these jurisdictions based upon various estimates and assumptions. In the normal course of business, the Company will undergo tax audits by various tax jurisdictions. Such audits often require an extended period of time to complete and may result in income tax adjustments if changes to the allocation are required between jurisdictions with different tax rates. The final taxes paid are dependent upon many factors, including negotiations with taxing authorities in the various jurisdictions and resolution of disputes arising from federal, state, and international tax audits. Although the Company has recorded all income tax uncertainties in accordance with FASB ASC Topic 740, these accruals represent estimates that are subject to the inherent uncertainties associated with the tax audit process, and therefore include uncertainties. Management judgment is required in determining the Company’s provision for income taxes, deferred tax assets and liabilities, which, if actual experience varies, could result in material adjustments to tax expense and/or deferred tax assets and liabilities.
Pension and Employee Benefit Obligations
The Company consults with its actuaries to assist with the calculation of discount rates used in its pension and post retirement plans. The discount rates used to determine domestic pension and post-retirement plan liabilities are calculated using a full yield curve approach. Market conditions have caused the weighted-average discount rate to move from 3.12 percent last year to 2.31 percent this year for the domestic pension plans and from 2.98 percent last year to 2.12 percent this year for the postretirement health and life insurance plan. A change in the discount rate selected by the Company of 25 basis points would result in a change of about $0.1 million to employee benefit expense and a change of about $4.2 million of liability.
The Company consults with actuaries and investment advisors in making its determination of the expected long-term rate of return on plan assets. Using input from these consultations such as long-term investment sector expected returns, the correlations and standard deviations thereof, and the plan asset allocation, the Company has assumed an expected long-term rate of return on plan assets of 4.00 percent as of the fiscal year ended 2020. Market conditions have caused the expected long-term rate of return to decrease from 4.90 percent as of the fiscal year ended 2019. A change in the long-term rate of return selected by the Company of 25 basis points would result in a change of about $0.4 million of employee benefit expense.
FACTORS THAT MAY AFFECT FUTURE RESULTS
This annual report on Form 10-K contains certain forward-looking information, such as statements about the Company’s financial goals, acquisition strategies, financial expectations including anticipated revenue or expense levels, business prospects, market positioning, product development, manufacturing re-alignment, capital expenditures, tax benefits and expenses, and the effect of contingencies or changes in accounting policies. Forward-looking statements are typically identified by words or phrases such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “may increase,” “may fluctuate,” “plan,” “goal,” “target,” “strategy,” and similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would,” and “could.” While the Company believes that the assumptions underlying such forward-looking statements are reasonable based on present conditions, forward-looking statements made by the Company involve risks and uncertainties and are not guarantees of future performance. Actual results may differ materially from those forward-looking statements as a result of various factors, including general economic and currency conditions, various conditions specific to the Company’s business and industry, new housing starts, weather conditions, epidemics and pandemics, market demand, competitive factors, changes in distribution channels, supply constraints, effect of price increases, raw material costs, technology factors, integration of acquisitions, litigation, government and regulatory actions, the Company’s accounting policies, and other risks, all as described in Item 1A and Exhibit 99.1 of this Form 10-K. Any forward-looking statements included in this Form 10-K are based upon information presently available. The Company does not assume any obligation to update any forward-looking information, except as required by law.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to market risk associated with changes in foreign currency exchange rates, interest rates, and commodity prices. These exposures are actively monitored by management. Exposure to foreign exchange rate risk is due to certain costs, revenue and borrowings being denominated in currencies other than one of the Company’s subsidiaries functional currency. Similarly, the Company is exposed to market risk as the result of changes in interest rates which may affect the cost of financing.
Foreign Currency Exchange Rate Risk
Foreign currency exchange rate risk is mitigated through several means including maintenance of local production facilities in the markets served, invoicing of customers in the currency which the Company is billed for production inputs, prompt settlement of third party and intercompany balances, limited use of foreign currency denominated debt, maintaining minimal foreign currency denominated cash balances, and application of derivative instruments when appropriate. Based on the 2020 mix of foreign currencies, the Company estimates that a hypothetical strengthening of the US Dollar by about 2 percent would have reduced the Company’s 2020 sales by about 1 percent.
Interest Rate Risk
The results of operations are exposed to changes in interest rates primarily with respect to borrowings under the Company’s revolving credit agreement (the “Credit Agreement”). Borrowings under the Credit Agreement may be made either at (i) a Eurocurrency rate based on LIBOR plus an applicable margin or (ii) an alternative base rate as defined in the Credit Agreement. The Company had no borrowings at year-end 2020 under the Credit Agreement. The Company estimates that a hypothetical increase of 100 basis points in the LIBOR rate would have increased interest expense by $0.5 million during 2020. The Company also has exposure to changes in interest rates in the form of the fair value of outstanding fixed rate debt fluctuating in response to changing interest rates.
Additionally, LIBOR, the index administered by the Intercontinental Exchange, will be phased out after 2021. The United States, using the analysis performed by the ARRC (Alternative Reference Rates Committee), elected the Secured Overnight Financing Rate (“SOFR”) as a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury Securities. The New York Fed commenced publishing the SOFR rate daily beginning April 3, 2018. The Company is still analyzing the potential impacts from changing from LIBOR to SOFR based rates.
Commodity Price Exposures
Portions of the Company’s business are exposed to volatility in the prices of certain commodities, such as copper, steel and aluminum, among others. The primary exposure to this volatility resides with the use of these materials in purchased component parts. The Company generally maintain long-term fixed price contracts on raw materials and component parts; however, the Company is prone to exposure as these contracts expire. Based on the 2020 use of commodities, the Company estimates that a hypothetical 10 percent adverse movement in prices for raw metal commodities would result in about a 1 percent decrease of gross margin as a percent of sales.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
|(In thousands, except per share amounts)||2020||2019||2018|
|Net sales||$||1,247,331 ||$||1,314,578 ||$||1,298,129 |
|Cost of sales||814,192 ||886,475 ||865,763 |
|Gross profit||433,139 ||428,103 ||432,366 |
|Selling, general, and administrative expenses||300,122 ||298,451 ||298,706 |
|Restructuring expense||2,506 ||2,519 ||1,666 |
|Operating income||130,511 ||127,133 ||131,994 |
|Other income/(expense), net||(795)||(412)||(1,042)|
|Foreign exchange income/(expense)||(1,392)||(1,641)||(706)|
|Income before income taxes||123,697 ||116,835 ||120,407 |
|Income tax expense||22,540 ||20,836 ||14,890 |
|Net income||$||101,157 ||$||95,999 ||$||105,517 |
|Less: Net loss/(income) attributable to noncontrolling interests||(697)||(516)||360 |
|Net income attributable to Franklin Electric Co., Inc.||$||100,460 ||$||95,483 ||$||105,877 |
|Income per share:|
|Basic||$||2.16 ||$||2.04 ||$||2.25 |
|Diluted||$||2.14 ||$||2.03 ||$||2.23 |
See Notes to Consolidated Financial Statements.
FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
|Net income||$||101,157 ||$||95,999 ||$||105,517 |
|Other comprehensive income/(loss), before tax:|
| Foreign currency translation adjustments||(11,868)||(5,659)||(34,723)|
| Employee benefit plan activity:|
| Net loss arising during period||(7,398)||(5,006)||(2,241)|
| Amortization arising during period||3,709 ||2,913 ||3,327 |
|Other comprehensive income/(loss)||(15,557)||(7,752)||(33,637)|
|Income tax (expense)/benefit related to items of other comprehensive loss||1,112 ||589 ||(307)|
|Other comprehensive income/(loss), net of tax||(14,445)||(7,163)||(33,944)|
|Comprehensive income||86,712 ||88,836 ||71,573 |
|Less: Comprehensive income/(loss) attributable to noncontrolling interests||813 ||544 ||(332)|
|Comprehensive income attributable to Franklin Electric Co., Inc.||$||85,899 ||$||88,292 ||$||71,905 |
See Notes to Consolidated Financial Statements.
FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
|(In thousands, except per share amounts)||2020||2019|
|ASSETS|| || |
|Current assets:|| || |
|Cash and cash equivalents||$||130,787 ||$||64,405 |
Receivables, less allowances of $3,999 and $3,705, respectively
|159,827 ||173,327 |
|Raw material||87,226 ||98,286 |
|Work-in-process||20,565 ||18,392 |
|Finished goods||193,141 ||183,568 |
|Total inventories||300,932 ||300,246 |
|Other current assets||27,708 ||29,466 |
|Total current assets||619,254 ||567,444 |
|Property, plant, and equipment, at cost:|
|Land and buildings||152,323 ||142,189 |
|Machinery and equipment||287,840 ||276,541 |
|Furniture and fixtures||47,890 ||43,631 |
|Other||33,193 ||29,293 |
|Property, plant, and equipment, gross||521,246 ||491,654 |
|Less: Allowance for depreciation||(312,225)||(290,326)|
|Property, plant, and equipment, net||209,021 ||201,328 |
|Right-of-Use Asset, net||31,954 ||27,621 |
|Deferred income taxes||8,824 ||9,171 |
|Intangible assets, net||133,782 ||131,127 |
|Goodwill||266,737 ||256,059 |
|Other assets||2,735 ||1,993 |
|Total assets||$||1,272,307 ||$||1,194,743 |
|LIABILITIES AND EQUITY|| || |
|Current liabilities:|| || |
|Accounts payable||$||95,903 ||$||82,593 |
|Accrued expenses and other current liabilities||89,048 ||68,444 |
|Current lease liability||11,090 ||9,838 |
|Income taxes||5,112 ||3,010 |
|Current maturities of long-term debt and short-term borrowings||2,551 ||21,879 |
|Total current liabilities||203,704 ||185,764 |
|Long-term debt||91,966 ||93,141 |
|Long-term lease liability||20,866 ||17,785 |
|Income taxes payable non-current||11,965 ||11,965 |
|Deferred income taxes||25,671 ||27,598 |
|Employee benefit plans||44,443 ||38,288 |
|Other long-term liabilities||23,988 ||21,769 |
|Commitments and contingencies (see Note 16)||— ||— |
|Redeemable noncontrolling interest||(245)||(236)|
Common stock (65,000 shares authorized, $0.10 par value) outstanding (46,222 and 46,391, respectively)
|4,622 ||4,639 |
|Additional capital||283,420 ||269,656 |
|Retained earnings||764,562 ||712,460 |
|Accumulated other comprehensive loss||(204,771)||(190,210)|
|Total shareholders’ equity||847,833 ||796,545 |
|Noncontrolling interest||2,116 ||2,124 |
|Total equity||849,949 ||798,669 |
|Total liabilities and equity||$||1,272,307 ||$||1,194,743 |
See Notes to Consolidated Financial Statements.
FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
|Cash flows from operating activities:|| || |
|Net income||$||101,157 ||$||95,999 ||$||105,517 |
|Adjustments to reconcile net income to net cash flows from operating activities:|
|Depreciation and amortization||36,488 ||36,977 ||38,604 |
|Non-cash lease expense||11,699 ||11,699 ||— |
|Share-based compensation||10,066 ||8,957 ||8,450 |
|Deferred income taxes||(4,268)||(2,566)||(5,164)|
|Loss on disposals of plant and equipment||1,241 ||891 ||311 |
|Foreign exchange (income)/expense||1,392 ||1,641 ||706 |
|Changes in assets and liabilities, net of acquisitions:|
|Receivables||22,053 ||1,076 ||(8,194)|
|Inventory||13,144 ||17,228 ||(4,775)|
|Accounts payable and accrued expenses||20,519 ||6,770 ||1,677 |
|Operating leases||(11,698)||(11,698)||— |
|Income taxes||2,507 ||6,449 ||(1,771)|
|Income taxes-U.S. Tax Cuts and Jobs Act||— ||— ||(6,510)|
|Employee benefit plans||604 ||(1,443)||(2,291)|
|Other, net||6,950 ||5,696 ||1,875 |
|Net cash flows from operating activities||211,854 ||177,676 ||128,435 |
|Cash flows from investing activities:|
|Additions to property, plant, and equipment||(22,856)||(21,855)||(22,432)|
|Proceeds from sale of property, plant, and equipment||34 ||866 ||724 |
|Cash paid for acquisitions, net of cash acquired||(55,915)||(20,827)||(44,971)|
|Other, net||(74)||10 ||387 |
|Net cash flows from investing activities||(78,811)||(41,806)||(66,292)|
|Cash flows from financing activities:|
|Proceeds from issuance of debt||117,758 ||264,389 ||232,638 |
|Repayment of debt||(138,831)||(355,332)||(251,623)|
|Proceeds from issuance of common stock||3,721 ||3,194 ||8,999 |
|Purchases of common stock||(19,553)||(10,741)||(34,188)|
|Purchase of redeemable noncontrolling shares||— ||(487)||— |
|Net cash flows from financing activities||(66,580)||(126,648)||(66,786)|
|Effect of exchange rate changes on cash||(81)||(3,990)||(3,417)|
|Net change in cash and equivalents||66,382 ||5,232 ||(8,060)|
|Cash and equivalents at beginning of period||64,405 ||59,173 ||67,233 |
|Cash and equivalents at end of period||$||130,787 ||$||64,405 ||$||59,173 |
|Cash paid for income taxes, net of refunds||$||23,869 ||$||16,949 ||$||27,025 |
|Cash paid for interest||$||4,695 ||$||8,388 ||$||10,792 |
|Additions to property, plant, and equipment, not yet paid||$||1,059 ||$||1,509 ||$||1,158 |
|Right-of-Use Assets obtained in exchange for new operating lease liabilities||$||15,421 ||$||4,922 ||$||— |
|Payable to sellers of acquired entities||$||— ||$||845 ||$||1,000 |
See Notes to Consolidated Financial Statements.
FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
|Total Shareholders’ Equity|
|(In thousands)||Common Shares|
|Common Stock||Additional Capital||Retained Earnings||Accumulated Other Comprehensive Income/(Loss)||Noncontrolling|
|Redeemable Noncontrolling Interest|
|Balance as of year end 2017||46,630 ||$||4,663 ||$||240,136 ||$||604,905 ||$||(149,047)||$||1,964 ||$||1,502 |
|Net Income||105,877 ||701 ||(1,061)|
|Currency translation adjustment||(34,751)||(49)||77 |
Minimum pension liability adjustment, net of tax expense $307
Dividends on common stock ($0.4675/share)
|Common stock issued||405 ||40 ||8,959 |
|Share based compensation||103 ||10 ||8,440 |
|Common stock repurchased||(812)||(81)||(34,107)|
|Balance as of year end 2018||46,326 ||$||4,632 ||$||257,535 ||$||654,724 ||$||(183,019)||$||1,955 ||$||518 |
|Net Income||95,483 ||842 ||(326)|
|Currency translation adjustment||(5,687)||(31)||59 |
Minimum pension liability adjustment, net of tax expense $589
|Purchase of redeemable non-controlling shares||(487)|
Dividends on common stock ($0.5800/share)
|Common stock issued||152 ||15 ||3,179 |
|Share based compensation||146 ||15 ||8,942 |
|Common stock repurchased||(233)||(23)||(10,718)|
|Balance as of year end 2019||46,391 ||$||4,639 ||$||269,656 ||$||712,460 ||$||(190,210)||$||2,124 ||$||(236)|
|Net Income||100,460 ||718 ||(21)|
|Currency translation adjustment||(11,984)||104 ||12 |
Minimum pension liability adjustment, net of tax expense $1,112
Dividends on common stock ($0.6200/share)
|Common stock issued||121 ||12 ||3,709 |
|Share based compensation||112 ||11 ||10,055 |
|Common stock repurchased||(402)||(40)||(19,513)|
|Balance as of year end 2020||46,222 ||$||4,622 ||$||283,420 ||$||764,562 ||$||(204,771)||$||2,116 ||$||(245)|
See Notes to Consolidated Financial Statements.
FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
INDEX TO NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Company--“Franklin Electric” or the “Company” shall refer to Franklin Electric Co., Inc. and its consolidated subsidiaries.
Fiscal Year--The financial statements and accompanying notes are as of and for the years ended December 31, 2020, December 31, 2019, and December 31, 2018, and referred to as 2020, 2019, and 2018, respectively.
Principles of Consolidation--The consolidated financial statements include the accounts of Franklin Electric Co., Inc. and its consolidated subsidiaries. All intercompany transactions have been eliminated.
Business Combinations--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 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. Any estimated fair values in excess of the acquisition price represents a bargain purchase gain and is recorded in accrued expenses and other current liabilities on the consolidated balance sheet until the determination of fair values is completed. Acquisition-related transaction costs are recognized separately from the business combination and expensed as incurred.
Revenue Recognition--Revenue is recognized when promised goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. The promise in a contract to transfer goods or services to a customer represents a performance obligation. The Company typically sells its products to customers by purchase order and does not have any additional performance obligations included in contracts to customers other than the shipment of the products. Therefore, the Company allocates the transaction price based on a single performance obligation. The Company typically ships products FOB shipping at which point control of the products passes to the customers. The Company considers the performance obligation satisfied and recognizes revenue at a point in time, the time of shipment.
The Company’s products may include routine assurance-type warranties which do not qualify as separate performance obligations. In the event that significant post-shipment obligations were to exist for the Company’s products, revenue recognition would be deferred until the performance obligations were satisfied.
The Company records net sales revenues after discounts at the time of sale based on specific discount programs in effect, related historical data, and experience.
Shipping and Handling Costs--Shipping and handling costs are considered activities required to fulfill the Company’s promise to transfer goods, and do not qualify as a separate performance obligation. Shipping and handling costs are recorded as a component of cost of sales.
Research and Development Expense--The Company’s research and development activities are charged to expense in the period incurred. The Company incurred expenses of approximately $21.7 million in 2020, $20.8 million in 2019, and $22.1 million in 2018 related to research and development.
Cash and Cash Equivalents--The Company considers cash on hand, demand deposits, and highly liquid investments with an original maturity date of three months or less to be cash and cash equivalents.
Fair Value of Financial Instruments--Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures, provides guidance for defining, measuring, and disclosing fair value within an established framework and hierarchy. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The standard established a fair value hierarchy which requires an entity to maximize the use of observable inputs and to minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value within the hierarchy are as follows:
Level 1 – Quoted prices for identical assets and liabilities in active markets;
Level 2 – Quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and
Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
Accounts Receivable, Earned Discounts, and Allowance for Uncollectible Accounts--Accounts receivable are stated at estimated net realizable value. Accounts receivable are comprised of balances due from customers, net of earned discounts and estimated allowances for uncollectible accounts. Earned discounts are based on specific customer agreement terms. In determining allowances for uncollectible accounts, historical collection experience, current trends, aging of accounts receivable, and periodic credit evaluations of customers’ financial condition are reviewed.
Inventories--Inventories are stated at the lower of cost or market. The majority of the cost of domestic and foreign inventories is determined using the FIFO method with a portion of inventory costs determined using the average cost method. The Company reviews its inventories for excess or obsolete products or components based on an analysis of historical usage and management’s evaluation of estimated future demand, market conditions, and alternative uses for possible excess or obsolete parts.
Property, Plant, and Equipment--Property, plant, and equipment are stated at historical cost. The Company capitalizes certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use, which are included in property, plant, and equipment. Depreciation of plant and equipment is calculated on a straight line basis over the following estimated useful lives:
|Land improvement and buildings|
10 - 40 years
|Machinery and equipment|
5 - 10 years
3 - 7 years
|Furniture and fixtures|
3 - 7 years
Maintenance, repairs, and renewals of a minor nature are expensed as incurred. Betterments and major renewals which extend the useful lives or add to the productive capacity of buildings, improvements, and equipment are capitalized. The Company reviews its property, plant, and equipment for impairment at the asset group level whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If an indicator is present, the Company compares carrying values to undiscounted future cash flows; if the undiscounted future cash flows are less than the carrying value, an impairment would be recognized for the difference between the fair value and the carrying value.
The Company’s depreciation expense was $27.1 million, $27.6 million, and $29.7 million in 2020, 2019, and 2018, respectively.
Leases--The Company determines if an arrangement is a lease, or contains a lease, at the inception of the arrangement and determines whether it is an operating or financing lease. Operating and financing leases result in the Company recording a right-of-use (ROU) asset, current lease liability, and long term lease liability on its balance sheet. The Company has elected to not present leases with an initial term of 12 months or less on the balance sheet. The ROU assets and liabilities are initially recognized based on the present value of lease payments over the lease term. Initial direct costs and lease incentives are not material when measuring the ROU asset present value. Lease expense for operating lease payments is recognized on a straight-line basis over the lease term.
In determining the present value, the Company utilizes interest rates from lease agreements unless the lease agreement does not provide a readily determinable rate. In these instances, the Company utilizes its incremental borrowing rate based on the Company’s borrowing information available at inception. A portion of the Company’s leases include renewal options. The Company excludes these renewal options in the expected lease term unless the Company is reasonably certain that the option will be exercised. In addition, the Company has elected not to separate non-lease components from lease components.
Goodwill and Other Intangible Assets--Goodwill is tested at the reporting unit level, which the Company has determined to be the Global Water Systems, Fueling Systems, and Distribution units.
In assessing the recoverability of goodwill, the Company determines the fair value of its reporting units by utilizing a combination of both the income and market valuation approaches. The income approach estimates fair value based upon future revenue, expenses, and cash flows discounted to present value. The market valuation approach estimates fair value using market multipliers of various financial measures compared to a set of comparable public companies. The fair value calculated for each reporting unit is considered a Level 3 measurement within the fair value hierarchy. An indication of impairment exists if the carrying value of the reporting unit is higher than its fair value, as determined by the above approach. The Company will test goodwill for impairment more frequently if warranted by triggering events that indicate potential impairment. The Company completed its annual goodwill impairment test during the fourth quarter, using balances as of October 1.
The Company also tests indefinite lived intangible assets, primarily trade names, for impairment on an annual basis during the fourth quarter of each year, using balances as of October 1, or more frequently as warranted by triggering events that indicate potential impairment. In assessing the recoverability of the trade names, the Company determines the fair value using an income approach. The income approach estimates fair value based upon future revenue and estimated royalty rates. The fair value calculated for indefinite lived intangible assets is considered a Level 3 measurement within the fair value hierarchy. An indication of impairment exists if the carrying value of the trade names is higher than the fair value. The Company would record an impairment charge for the difference.
Amortization is recorded and calculated for other definite lived intangible assets on a basis that reflects cash flows over the estimated useful lives. The weighted average number of years over which each intangible class is amortized is as follows:
13 - 20 years
5 - 8 years
Warranty Obligations--The Company provides warranties on most of its products. The warranty terms vary but are generally 2 years to 5 years from date of manufacture or 1 year to 5 years from date of installation. Provisions for estimated expenses related to product warranty are made at the time products are sold or when specific warranty issues are identified. These estimates are established using historical information about the nature, frequency, and average cost of warranty claims. The Company actively studies trends of warranty claims and takes actions to improve product quality and minimize warranty claims. The Company believes that the warranty reserve is appropriate; however, actual claims incurred could differ from the original estimates, requiring adjustments to the reserve.
Income Taxes--Income taxes are accounted for in accordance with FASB ASC Topic 740, Income Taxes. Under this guidance, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities and net operating loss and credit carry forwards using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. The Company records a liability for uncertain tax positions by establishing a recognition threshold and measurement attribute for recognition and measurement of a tax position taken or expected to be taken in a tax return.
Defined Benefit Plans--The Company makes its determination for pension, post retirement, and post employment benefit plans liabilities based on management estimates and consultation with actuaries. The Company incorporates estimates and assumptions of future plan service costs, future interest costs on projected benefit obligations, rates of compensation increases, employee turnover rates, anticipated mortality rates, expected investment returns on plan assets, asset allocation assumptions of plan assets, and other factors.
Earnings Per Common Share--Basic and diluted earnings per share are computed and disclosed in accordance with FASB ASC Topic 260, Earnings Per Share. The Company utilizes the two-class method to compute earnings available to common shareholders. Under the two-class method, earnings are adjusted by accretion amounts to redeemable noncontrolling interests recorded at redemption value. The adjustments represent dividend distributions, in substance, to the noncontrolling interest holder as the holders have contractual rights to receive an amount upon redemption other than the fair value of the applicable shares. As a result, earnings are adjusted to reflect this in substance distribution that is different from other common shareholders. In addition, the Company allocates net earnings to each class of common stock and participating security as if all of the net earnings for the period had been distributed. The Company’s participating securities consist of share-based payment awards that contain a non-forfeitable right to receive dividends and therefore are considered to participate in undistributed earnings with common shareholders. Basic earnings per common share excludes dilution and is calculated by dividing net
earnings allocated to common shares by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share is calculated by dividing net earnings allocable to common shares by the weighted-average number of common shares outstanding for the period, as adjusted for the potential dilutive effect of non-participating share-based awards.
Translation of Foreign Currency Financial Statements--All assets and liabilities of foreign subsidiaries in functional currency other than the U.S. dollar are translated at year end exchange rates with the exception of the non-monetary assets and liabilities in countries with highly inflationary economies, which are translated at historical exchange rates. All revenue and expense accounts are translated at average rates in effect during the respective period with the exception of expenses related to the non-monetary assets and liabilities, which are translated at historical exchange rates. Adjustments for translating longer term foreign currency assets and liabilities in U.S. dollars are included as a component of other comprehensive income except for hyperinflation accounting adjustments. Transaction gains and losses that arise from shorter term exchange rate fluctuations and hyperinflation accounting adjustments are included in the “Foreign exchange income/(expense)” line within the Company’s consolidated statements of income, as incurred.
Significant Estimates--The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting periods. Significant estimates and assumptions by management affect inventory valuation, warranty, trade names and goodwill, income taxes, and pension and employee benefit obligations.
Although the Company regularly assesses these estimates, actual results could materially differ. The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances.
2. ACCOUNTING PRONOUNCEMENTS
Adoption of New Accounting Standards
In August 2018, the FASB issued Accounting Standards Update ("ASU") 2018-14, Compensation-Retirement Benefits-Defined Benefit Plans-General (Topic 715-20): Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans, which modifies the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. The amendments remove disclosures that no longer are considered cost beneficial, including the estimated amounts in accumulated other comprehensive income expected to be recognized as components of net periodic expense over the next fiscal year. The amendments clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant, including the reasons for significant gains and losses related to change in the benefit obligation for the period. The ASU should be applied retrospectively and is effective for interim and annual periods beginning after December 15, 2020. The Company adopted the standard in the fourth quarter of 2020, and it did not have a material impact on the consolidated financial position, results of operation, and cash flows.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. ASU 2017-04 removes step two from the goodwill impairment test and instead requires an entity to recognize a goodwill impairment charge for the amount by which the goodwill carrying amount exceeds the reporting unit's fair value. The ASU is effective on a prospective basis for interim and annual periods beginning after December 15, 2019 with early adoption permitted. The Company adopted the standard effective January 1, 2020. The standard did not have a material impact on the Company's consolidated financial position, results of operations, or cash flows.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which modifies the measurement of expected credit losses on certain financial instruments, including trade receivables. ASU 2016-13 is effective for interim and annual periods beginning after December 15, 2019 with early adoption permitted. Amendments should be applied using a modified retrospective approach except for debt securities, which require a prospective transitions approach. The Company adopted the standard effective January 1, 2020. The standard did not have a material impact on the Company's consolidated financial position, results of operations, or cash flows.
Accounting Standards Issued But Not Yet Adopted
In December 2019, the FASB issued ASU 2019-12,