UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
____________________
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 30, 2006

OR

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)

Indiana
 
35-0827455
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
400 East Spring Street
   
Bluffton, Indiana
 
46714-3798
(Address of principal executive offices)
 
(Zip Code)

(260) 824-2900
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.10 par value
 
The NASDAQ Stock Market
Preference Stock Purchase Rights
 
The NASDAQ Stock Market
(Title of each class)
 
(Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
None
(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.
YES x
NO o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
YES o
NO x

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.
YES x
NO o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer x
Accelerated Filer o
Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
YES o
NO x

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant at July 1, 2006 (the last business day of the registrant’s most recently completed second quarter) was $1,184,796,556. The stock price used in this computation was the last sales price on that date, as reported by The Nasdaq Stock Market. 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 December 30, 2006:
23,009,513 shares

- 1 -


DOCUMENTS INCORPORATED BY REFERENCE

A portion of the Proxy Statement for the Annual Meeting of Shareholders to be held on April 27, 2007 (Part III).


- 2 -



TABLE OF CONTENTS
Part I
 
Page
     
Item 1.
Business
4-6
Item 1A.
Risk Factors
6-8
Item 1B.
Unresolved Staff Comments
8
Item 2.
Properties
8
Item 3.
Legal Proceedings
8
Item 4.
Submission of Matters to a Vote of Security Holders
8
 
Supplemental Item - Executive Officers of the Registrant
9
     
Part II
   
     
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
 
10
Item 6.
Selected Financial Data
11
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
12-19
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
20
Item 8.
Financial Statements and Supplementary Data
21-46
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
47
Item 9A.
Controls and Procedures
47
Item 9B.
Other Information
49
     
Part III
   
     
Item 10.
Directors, Executive Officers and Corporate Governance
49
Item 11.
Executive Compensation
49
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
49
Item 13.
Certain Relationships and Related Transactions, and Director Independence
50
Item 14.
Principal Accounting Fees and Services 
50
     
Part IV
   
     
Item 15.
Exhibits and Financial Statement Schedules
51
Signatures
 
53
Exhibit Index
 
54-55

- 3 -


PART I

ITEM 1. BUSINESS 

Franklin Electric Co., Inc. is an Indiana corporation founded in 1944 and incorporated in 1946 that, together with its subsidiaries, conducts business as a single reportable segment: the design, manufacture and distribution of groundwater and fuel pumping systems, submersible pumps, motors, electronic controls and related parts and equipment. The Company’s business consists of two operating segments based on the principal end market served: the Water Systems segment and the Fueling Systems segment. Except where the content otherwise requires, “Franklin Electric” or the “Company”, shall refer to Franklin Electric Co., Inc. and its consolidated subsidiaries.

Description of Business

Franklin Electric is a global leader in the production and marketing of groundwater and fuel pumping systems and is a technical leader in submersible pumps, motors, drives, electronic controls, and monitoring devices. The Company is the world’s largest manufacturer of Water and Fueling Systems motors, a leading manufacturer of Water and Fueling Systems pumps, underground Fueling Systems hardware and flexible piping systems. In 2006, the Company acquired a business specializing in vapor recovery systems and components.

During 2006, the Company acquired two companies and divested its Engineered Motor Products Division. In the second quarter of 2006, the Company acquired Little Giant Pump Company (“Little Giant”) in a stock purchase transaction. Little Giant was a wholly-owned subsidiary of Tecumseh Products Company, and a leading worldwide provider of commercial and consumer water transfer solutions. Little Giant’s products include sump, sewage, effluent, condensate and industrial submersible pumps and broaden the pump product offerings of Franklin Electric, as well as expand the Company’s customer base. Little Giant’s 2006 annual pro forma sales represented about 25 percent of the Company’s prior year sales. In the third quarter of 2006 the Company acquired Healy Systems, Inc., (“Healy Systems”) in a stock purchase transaction. Healy Systems is a worldwide provider of Stage II Vapor Recovery Systems and Components used primarily at gasoline stations to reduce gasoline vapor emissions during vehicle refueling. The Healy Systems product line is complementary to Franklin’s existing fuel management products and presents cross selling opportunities for the Company. Healy Systems’ 2006 annual pro forma sales represented less than 10 percent of the Company’s prior year sales. In the fourth quarter of 2006, the Company divested its Engineered Motor Products Division (“EMPD”), which manufactured and sold fractional horsepower electric motors primarily to original equipment manufacturers for specialty applications such as ice cream dispensers, electric hoists, paint mixing machines, and food processing. The Engineered Motor Products Division’s revenue represented less than 10 percent of Franklin Electric’s consolidated sales for 2006.

Franklin Electric’s motors and pumps are used principally in submersible applications for pumping fresh water, wastewater, fuel, and other liquids in a variety of applications, including residential, industrial, agricultural, fueling, off-shore drilling, and mining. Franklin Electric also manufactures electronic drives and controls for the motors which control functionality and provide protection from various hazards, such as electric surges, over-heating, or dry wells and tanks. Along with the fueling motor and pump applications, the Company supplies a variety of products to the petroleum equipment industry included with the submersible pumping systems, such as flexible piping, vapor recovery systems and components, electronic tank monitoring equipment, and fittings.

The Company’s products are sold in North America, Europe, the Middle East, South Africa, Australia, Mexico, Japan, China, and other world markets. The Company’s products are sold by its sales force, manufacturing representatives, and repair shops.

The Company changed its marketing strategy in late 2004 and began selling certain Water Systems products directly to specialty Water Systems distributors, as well as original equipment manufacturers (OEMs) of pumps. This change in marketing strategy has resulted in a broader customer base with fewer sales to pump OEMs. The Company has also announced that, beginning in 2007, Water Systems product sales to integrated pump manufacturers will be significantly curtailed. The market for the Company’s products is highly competitive and includes large and small accounts. The Company’s Water Systems and Fueling Systems products and related equipment are sold to pump OEMs and specialty Water Systems distributors, as well as, industrial equipment distributors, major oil and utility companies.

ITT Industries, Inc. and its various subsidiaries and affiliates, accounted for 11 percent, 16 percent, and 20 percent of the Company’s consolidated sales in 2006, 2005, and 2004, respectively. Pentair Corporation and its various subsidiaries and affiliates, accounted for 12 percent, 14 percent, and 22 percent of the Company’s consolidated sales in 2006, 2005, and 2004, respectively.

- 4 -



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.

The principal raw materials used in the manufacture of the Company’s products are steel in coils and bars, stainless steel, copper wire, and aluminum ingot. Major components are capacitors, motor protectors, forgings, gray iron castings and bearings. Most of these raw materials are available from multiple sources in the United States and world markets. In the opinion of management, no single source of supply is critical to the Company's business. Availability of fuel and energy is adequate to satisfy current and projected overall operations unless interrupted by government direction or allocation.

The Company employed approximately 3,100 persons at the end of 2006.

Segment and Geographic Information

The segment and geographic information set forth below under Note 15, “Segments and Geographic Information,” to the consolidated financial statements is incorporated herein by reference.

Research and Development

The Company spent approximately $8.1 million in 2006, $5.6 million in 2005, and $4.2 million in 2004 on activities related to the development of new products, improvement of existing products and manufacturing methods, and other applied research and development.

In 2006, the Company continued developing new pump products (including jet, centrifugal and turbine pumps), extending current product offerings, and improving the functional performance of all products. The Company introduced new hydraulic technology (patent pending) which improved performance of residential submersible pumps. The Company also continued to develop its motor drives and controls systems improving performance in harsh environments. The Company introduced the MonodriveXT system for single phase, 3-wire motors which added to the already extensive motor drives product line. Fueling Systems added bio-diesel and ethanol (E85) fuel product offerings and established the next generation tank gauge platform products. Further, the Company introduced new electronics with liquid density monitoring equipment for the fueling industry. Research continued on new materials and processes designed to achieve higher quality and more cost-effective construction of the Company’s high volume products.

The Company owns a number of patents, trademarks and licenses. In aggregate, these patents are of material importance in the operation of the business; however, the Company believes that its operations are not dependent on any single patent or group of patents.

Backlog

The dollar amount of backlog at the end of 2006 and 2005 was as follows:

   
(In millions)
 
   
2006
 
2005
 
Backlog
 
$
24.1
 
$
21.1
 

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 2007. The Company's sales in the first quarter are generally less than its sales in other quarters due to generally lower construction activity during that period 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.

Environmental Matters

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 adverse effect upon the financial position, capital expenditures, earnings, or competitive position of the Company.

- 5 -


Available Information

The Company’s website address is http://www.fele.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 also includes the Company’s corporate governance guidelines, its Board committee charters, and the Company’s code of 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 or currently deemed material, could negatively impact the Company’s results of operations or financial condition in the future.

The Company must successfully implement its new marketing and operating strategies.

From 2004 through 2006, the Company implemented significant new marketing and operating strategies as follows:
-  
During 2004, the Company began selling its Water Systems products directly to wholesale specialty Water Systems distributors, as well as original equipment manufacturers (OEMs) of pumps. Previously, the Company sold its Water Systems products primarily to pump OEMs (i.e., the Company was primarily a supplier of submersible motors and controls to the OEMs) who then re-sold the Water Systems products, usually combined with pumps and related products, to the wholesale specialty Water Systems distributors. As a result of this change, the Company became a competitor, as well as a supplier to many of the pump OEMs.
-  
Also in 2004, the Company purchased a pump manufacturer. The acquisition of certain assets of JBD, Inc. (formerly the Jacuzzi brand pump manufacturer) was completed in the fourth quarter of 2004.
-  
During 2006, the Company acquired Little Giant Pump Company, a manufacturer of sump, sewage, effluent, condensate and industrial submersible pumps, further expanding its pump product offerings and further increasing its competition with pump OEMs.
-  
Also in 2006, the Company announced a new general sales policy, effective January 1, 2007. The new general sales policy, effective for the Water Systems Industry in North America, will be to sell all of its products, including 2HP and smaller submersible electric motors and associated products, only on a direct basis to wholesale Water Systems distributors. Exceptions will be made only where the Company determines, on a case-by-case basis, that sales to a particular pump OEM will add significant customer value to the distribution of its products.
The Company believes that these strategic changes will result in increased sales and earnings; however, actual results may vary.

The Company’s acquisition strategy entails expense, integration risks, and other risks.

One of the Company’s continued strategies is to increase revenues and expand market share through acquisitions that will provide complementary Water and Fueling Systems products. The Company will spend significant time and effort expanding existing businesses through identifying, pursuing, completing, and integrating acquisitions. Competition for acquisition candidates may limit the number of opportunities and may result in higher acquisition prices. There is uncertainty related to successfully acquiring and profitably managing additional companies and integrating additional companies without substantial costs, delays or other problems. There can also be no assurances that acquired companies will achieve revenues, profitability or cash flows that justify the investment in them. The Company believes that these strategic acquisitions will result in increased sales and earnings; however, actual results may vary.

The Company’s sales have historically been dependent on a limited number of customers.

As of the end of fiscal year 2004, approximately 42 percent of the Company’s consolidated sales were attributable to two customers, both of which were pump OEMs. With the Company’s changes in marketing and operating strategies, the Company reduced its dependency on the pump OEMs, which lowered the potential sales loss if one of these customers reduced its purchases from the Company. At the end of fiscal year 2006, these two pump OEM customers accounted for approximately 23 percent of the Company’s consolidated sales. The Company believes that the strategic initiatives announced in 2004 through 2006 will continue to reduce the potential sales risk associated with customer concentration; however, actual results may vary.

- 6 -



The Company faces increased competition due to industry consolidation and new entrants into the Company’s existing markets.

The Company is a global leader in the production and marketing of groundwater and fuel pumping systems. The industry in which the Company operates has experienced significant consolidation in recent years, primarily in the pump OEM companies but increasingly at the distributor level, as well as the addition of submersible motor manufacturing by pump OEMs. 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, continued product innovation, as well as price, are the principal factors considered by customers in selecting suppliers. The Company further believes that successful implementation of the strategic initiatives, previously mentioned, will enhance its competitive position; however, actual results may vary.

Competitive pressures may lead to declines in sales or in the prices of submersible electric motor products.

Pump OEMs have acquired the ability to produce submersible electric motors and have purchased significant quantities of the Company submersible electric motors during 2006, possibly in excess of 2006 requirements. Their ability to produce these motors and the potential excess inventory supply of motors as of the beginning of 2007 may result in a decline in motor unit sales or motor unit prices during 2007. The Company cannot assure that these or other competitive pressures will not adversely affect profitability or performance, which could in turn have materially adverse effects on the results of operations and financial condition.

A decline in housing starts could lead to reduced demand for the Company’s products, thereby reducing revenues and earnings.

Demand for certain Company products is affected by housing starts. Many economic and other factors outside the Company’s control, including housing starts, could impact operating results. A decline in housing starts or general slowdown in the United States or other economies in the international markets the Company serves could reduce demand and adversely impact gross margins 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. Natural gas and electricity prices have historically been volatile. The Company does not generally engage in commodity hedging for raw materials. Significant increases in the prices of commodities, sourced components, finished goods, 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 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, Mexico and China. 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
·  
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

Business success depends in part on the ability to anticipate and effectively manage these risks. The Company cannot assure that these and other factors will not have a material adverse impact on its international operations or on the business as a whole.

- 7 -



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 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. The Company believes that the successful introduction of new products will enhance competitive position; however, actual results may vary.

Additional Risks to the Company

The Company is subject to various risks in the normal course of business. Exhibit 99.1 sets forth a list of risks, including those identified above, that may adversely affect the Company and is incorporated herein by reference.


ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES 

The Company maintains its principal executive offices in Bluffton, Indiana. Manufacturing plants or primary distribution centers are located in the following countries: Australia, China, The Czech Republic, Germany, Italy, Japan, Mexico, South Africa, and the United States. Within the United States, manufacturing facilities are located in Grant County, Indiana; Little Rock, Arkansas; Siloam Springs, Arkansas; Wilburton, Oklahoma; Oklahoma City, Oklahoma; Madison, Wisconsin; Saco, Maine; and Hudson, New Hampshire. The Company also maintains warehouse facilities in Orange, California; Sanford, Florida; and Bolton, Ontario, Canada. All principal properties are owned or held under operating leases.

In the Company’s opinion, its facilities are suitable for their intended use, adequate for the Company’s business needs, and in good condition.


ITEM 3. LEGAL PROCEEDINGS 

The information set forth below under Note 16, “Contingencies and Commitments,” to the consolidated financial statements is incorporate herein by reference.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

- 8 -



EXECUTIVE OFFICERS OF THE REGISTRANT

The names, ages, and all positions and offices held by the executive officers of the Company as of December 30, 2006 are:

 
Name
 
Age
 
Positions and Offices
 
In This Office Since
       
R. Scott Trumbull
58
Chairman of the Board and Chief Executive Officer
2003
Peter C. Maske
56
Senior Vice President and President of Europa
1999
Gregg C. Sengstack
48
Senior Vice President, International & Fueling Systems
2005
Thomas J. Strupp
53
Vice President, Chief Financial Officer, Secretary, Water Transfer Systems
2005
Thomas A. Miller
57
Vice President, Engineering and Electronic Technology
2005
Kirk M. Nevins
63
Vice President, Office of the Chairman
2005
Robert J. Stone
42
Vice President, Sales, Marketing and Technology
2005
Daniel J. Crose
58
Vice President, North American Submersible Operations
2003
Gary D. Ward
51
Vice President, Human Resources
2004

All executive officers are elected annually by the Board of Directors at the Board meeting held in conjunction with the annual meeting of shareowners. All executive officers hold office until their successors are duly elected or until their death, resignation, or removal by the Board. All executive officers have been in executive or management positions of Franklin Electric for the last five years with the exception of R. Scott Trumbull and Thomas J. Strupp.

R. Scott Trumbull has been a Director of Franklin for the last seven years and was Executive Vice President and Chief Financial Officer of Owens-Illinois, Inc. prior to joining Franklin Electric as Chairman of the Board and Chief Executive Officer in 2003.

Thomas J. Strupp was Vice President of Sales and Marketing at Pentair Water Group, Inc. prior to joining Franklin Electric in 2005. Previously, he held other executive positions in finance and general management with Sta-Rite Industries, Inc.

- 9 -



PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES 

The number of shareowners of record as of January 12, 2007 was 935. The Company's stock is traded on Nasdaq National Market: Symbol FELE.

All share and per share data included in this Form 10-K reflects the Company’s two-for-one stock split effected in the form of a 100 percent stock distribution made on June 15, 2004. Dividends paid and the price range per common share as quoted by the Nasdaq National Market for 2006 and 2005 were as follows:

DIVIDENDS PER SHARE
 
PRICE PER SHARE
 
   
2006
 
2005
 
2006
 
2005
 
           
Low
 
High
 
Low
 
High
 
1st Quarter
 
$
.10
 
$
.08
 
$
38.70
 
$
55.72
 
$
37.36
 
$
44.31
 
2nd Quarter
 
$
.11
 
$
.10
 
$
46.37
 
$
62.95
 
$
34.54
 
$
40.82
 
3rd Quarter
 
$
.11
 
$
.10
 
$
45.70
 
$
54.19
 
$
37.01
 
$
45.29
 
4th Quarter
 
$
.11
 
$
.10
 
$
49.50
 
$
57.35
 
$
39.20
 
$
44.75
 

Issuer Purchases of Equity Securities:

The Company did not purchase, under the Company’s stock repurchase program, any shares of its common stock during the three months ended December 30, 2006.

- 10 -



ITEM 6. SELECTED FINANCIAL DATA 

The following selected financial data should be read in conjunction with our consolidated financial statements. The information set forth below is not necessarily indicative of future operations.


FIVE YEAR FINANCIAL SUMMARY (a)

FRANKLIN ELECTRIC CO., INC.
 
(In thousands, except per share amounts and ratios)
 
   
2006
 
2005
 
2004
 
2003
 
2002
 
   
(b)
 
(c)
 
(d)
     
(e)
 
Operations:
                               
Net sales
 
$
557,948
 
$
403,413
 
$
370,070
 
$
325,529
 
$
319,025
 
Gross profit
   
191,557
   
142,821
   
126,191
   
106,670
   
99,707
 
Interest expense
   
3,373
   
766
   
488
   
1,107
   
1,317
 
Income taxes
   
30,671
   
24,953
   
21,126
   
16,950
   
17,730
 
Income from continuing operations
   
56,762
   
45,796
   
38,368
   
34,649
   
31,318
 
Depreciation and amortization
   
17,989
   
14,971
   
15,143
   
13,748
   
12,878
 
Capital expenditures
   
23,190
   
17,845
   
21,110
   
15,261
   
15,568
 
Balance sheet:
                               
Working capital (f)
 
$
123,833
 
$
138,998
 
$
111,697
 
$
82,640
 
$
62,762
 
Property, plant and equipment, net
   
115,976
   
95,732
   
95,924
   
83,916
   
76,033
 
Total assets
   
526,925
   
379,762
   
333,473
   
281,971
   
258,583
 
Long-term debt
   
51,043
   
12,324
   
13,752
   
14,960
   
25,946
 
Shareowners’ equity
   
345,831
   
267,562
   
234,333
   
192,938
   
153,138
 
Other data:
                               
Income, from continuing operations, to sales
   
10.2
%
 
11.4
%
 
10.4
%
 
10.6
%
 
9.8
%
Income, from continuing operations, to average total assets
   
12.5
%
 
12.8
%
 
12.5
%
 
12.8
%
 
13.8
%
Current ratio (g)
   
2.3
   
3.2
   
3.1
   
2.8
   
2.2
 
Number of common shares outstanding
   
23,009
   
22,485
   
22,041
   
21,828
   
21,648
 
Per share:
                               
Market price range
                               
High
 
$
62.95
 
$
45.29
 
$
43.48
 
$
32.80
 
$
30.27
 
Low
   
38.70
   
34.54
   
29.01
   
23.00
   
19.95
 
Income, from continuing operations, per weighted-average common share
   
2.49
   
2.06
   
1.75
   
1.60
   
1.45
 
Income, from continuing operations, per weighted-average common share, assuming dilution
   
2.43
   
1.97
   
1.67
   
1.53
   
1.38
 
Book value (h)
   
14.84
   
11.54
   
10.17
   
8.53
   
6.74
 
Dividends per common share
   
0.43
   
0.38
   
0.31
   
0.27
   
0.26
 

____________________________________________________________________________________________________
(a) The five year financial presentation excludes the sales and earnings of the Engineered Motor Products Division (EMPD) which was sold during the fourth quarter of 2006, for all periods presented.
(b) Includes the results of operations of the Company’s wholly-owned subsidiary, Little Giant Pump Company and Healy Systems, Inc., since their acquisition in the second and third quarter of 2006, respectively.
(c) Includes the results of operations of the Company’s wholly-owned subsidiary, Phil-Tite Enterprises, and the effect of an equity investment in Pioneer Pump, Inc., both acquired in the third quarter of 2005.
(d) Includes the results of operations of the Company’s wholly-owned subsidiary, Franklin Pump Systems, since the acquisition of certain assets of JBD, Inc. in the third quarter of 2004.
(e) Includes the results of operations of the Company’s wholly-owned subsidiaries, Coverco S.r.l. and Intelligent Controls, Inc., since their acquisition in the first and third quarters of 2002, respectively.
(f) Working capital = Current assets minus Current liabilities
(g) Current ratio = Current assets divided by Current liabilities
(h) Book value = Shareowners equity divided by weighted average common shares, assuming full dilution

- 11 -



ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

2006 // 2005

OVERVIEW

Sales and earnings from continuing operations for 2006 were up from 2005. The increase in sales was primarily related to sales from acquisitions. Sales growth benefited from selling price realization gains and organic growth in Water Systems motor and pump unit shipments as well as organic growth in Fueling Systems product shipments, primarily flexible pipe. Earnings improved in 2006 primarily due to the increased sales as well as reduced manufacturing costs from the Company’s growing production base in Mexico, The Czech Republic, and China. These improvements were partially offset by higher commodity costs and increased fixed costs incurred in connection with selling, general and administrative spending resulting from the Company’s strategy of selling to a more diversified customer base by marketing its Water Systems products directly to distributors. Included in the results for 2006 are stock-based compensation expenses recorded under the new accounting guidelines of Statement of Financial Accounting Standards (SFAS) No. 123(R). The accounting pronouncement was adopted as of January 1, 2006.

During the fourth quarter of 2006, the Company divested its Engineered Motor Products Division (EMPD). For financial statement purposes, EMPD has been classified as a discontinued operation for all periods presented. As a discontinued operation, EMPD’s sales and operational impact are excluded from the Company’s continuing operations results and reported in the income statement section as “discontinued operations”. EMPD’s sales for 2006 through the date of divestiture and for full years 2005 and 2004 represented less than 10 percent of the Company’s total sales. EMPD’s net earnings for 2006 through the date of divestiture and for full year 2005 were about $0.01 per share in both years. EMPD had a net loss for full year 2004 of about $0.02 per share. Unless otherwise indicated, the following discussion relates to continuing operations only.


RESULTS OF OPERATIONS

Net sales from continuing operations for fiscal year 2006 were a record $557.9 million, an increase of $154.5 million or 38 percent compared to 2005 sales of $403.4 million. Incremental sales related to acquisitions for fiscal year 2006 were about $86 million or 21 percent of prior year sales. The majority of the sales growth from acquisitions resulted from the Little Giant Pump Company. Sales growth benefited from price realization gains and organic growth in Water Systems motor and pumps. Sales increased by gains in price realization of approximately $20.6 million or 5 percent in 2006 resulting from increases in product selling prices, changes in customer sales discount programs and greater direct sales to distribution customers.
Water Systems product sales worldwide were up about 37 percent for fiscal year 2006 compared to 2005. Sales revenue increased in all of Water Systems’ major product categories during the year (including submersible motors, pumps, and drives and controls). Fueling Systems worldwide sales increased approximately 43 percent in 2006 from fiscal year 2005.

Cost of sales from continuing operations as a percent of net sales for 2006 and 2005 was 65.7 percent and 64.6 percent, respectively. Cost of sales as a percent of net sales increased in 2006 from 2005 primarily as a result of product mix changes as Fueling Systems’ products and complete Water Systems pumps (including Little Giant product lines) represented a higher percentage of overall sales and these product lines carry a higher cost of sales than submersible motor products.

Selling and administrative (“SG&A”) expense as a percent of net sales for 2006 and 2005 was 18.4 percent and 17.6 percent, respectively. Incremental increases in SG&A expense were about $31.7 million in 2006 over 2005 primarily due to acquisitions $15.5 million, stock-based compensation expense $2.7 million, and increased fixed costs incurred in connection with selling, general and administrative spending resulting from the Company’s strategy of selling to a more diversified customer base by marketing its Water Systems products directly to distributors.

Interest expense for 2006 and 2005 was $3.4 million and $0.8 million, respectively. Interest expense increased in 2006 due to the debt incurred for the acquisitions of the Little Giant Pump Company and Healy Systems.

Included in other income for 2006 and 2005 was interest income of $1.9 million and $1.4 million, respectively, primarily derived from the investment of cash balances in short-term U.S. treasury and agency securities. Also, included in other income for 2006 and 2005 was income from equity investments of $0.7 million and $0.1 million, respectively.

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Foreign currency-based transactions produced a loss for 2006 of about $0.1 million primarily due to euro rate changes relative to other currencies in Europe and the U.S. dollar.  Foreign currency-based transactions produced a gain for 2005 of $0.2 million primarily due to fluctuations between the U.S. dollar and the Chinese Yuan and Mexican Peso.

The provision for income taxes for continuing operations in 2006 and 2005 was $30.7 million and $25.0 million, respectively. The effective tax rates were 35.1 and 35.3 percent for 2006 and 2005, respectively. The effective tax rate differs from the United States statutory rate of 35 percent, generally due to foreign income exclusion and R&D credits and due to the effects of state and foreign income taxes, net of federal tax benefits.

Income from continuing operations for 2006 was $56.8 million, or $2.43 per diluted share, compared to 2005 income from continuing operations of $45.8 million or $1.97 per diluted share.


CAPITAL RESOURCES AND LIQUIDITY

Cash flows from operations provide the principal source of current liquidity. Net cash flows provided by operating activities were $55.4 million and $74.2 million in 2006 and 2005, respectively. The primary source of cash from operations was earnings. Significant uses of operating cash flow in 2006 and 2005 were increases in inventory, $11.0 million and $10.6 million, respectively. Inventories increased significantly in 2006 and 2005 as the Company increased finished goods availability for pump products and distribution customers as a part of its new distribution channel strategy. Accounts receivable and accounts payable and other accrued expenses were significant sources of operating cash flow in 2005. Accounts receivable increases were primarily attributable to the timing of payments received from customers and increased sales during 2005. Accounts payable increases were primarily attributable to the timing of payments made to vendors and increased inventories during 2005.

Net cash flows used in investing activities were $131.6 million and $63.5 million in 2006 and 2005, respectively. In 2006, the Company paid an aggregate of $159.2 million for acquisitions in 2006, net of cash acquired. The acquisitions consisted of Little Giant Pump Company for $123.9 million and Healy Systems for $35.3 million. In 2005, the Company paid $36.0 million for short-term investment securities, net of short-term investment securities sold. The Company paid an aggregate of $8.5 million for acquisitions in 2005, net of cash acquired. The acquisitions consisted of $5.6 million for Phil-Tite and $2.9 million for an equity investment in Pioneer.

Cash flows from financing activities in 2006 were $54.8 million primarily from long-term debt. Net cash flows used in financing activities were $9.0 million in 2005. The Company paid $9.8 million and $8.5 million in dividends on the Company’s common stock in 2006 and 2005, respectively. In 2005, another principal use of cash was purchases of Company common stock under the Company’s repurchase program. During 2005, the Company repurchased 366,308 shares of its common stock for $13.8 million.

Cash and cash equivalents at the end of 2006 were $34.0 million compared to $52.1 million at the end of 2005. Working capital decreased $15.2 million in 2006 and the current ratio of the Company was 2.3 for 2006 compared to a current ratio of 3.2 at the end of 2005. The Company’s working capital and current ratio decreased in 2006 as the Company invested its excess cash in acquisitions during the year.

Principal payments of $1.0 million per year on the Company’s $20.0 million of unsecured long-term debt began in 1998 and will continue until 2008 when a balloon payment of $10.0 million will fully retire the debt. In September 2004, the Company entered into an unsecured, 60-month $80.0 million, amended and restated to $120.0 million during December 2006, revolving credit agreement (the “Agreement”). The Agreement includes a facility fee of one-tenth of one percent on the committed amount. The Company had outstanding borrowings under the Agreement of $50 million at December 30, 2006. The Company had no outstanding borrowings under the Agreement at December 31, 2005. The Company is subject to certain financial covenants with respect to borrowings, interest coverage, working capital, loans or advances, and investments. The Company was in compliance with all debt covenants at all times in 2006 and 2005.

At December 30, 2006, the Company had $5.9 million of commitments primarily for the purchase of machinery and equipment, and building expansions. Management believes that internally generated funds and existing credit arrangements provide sufficient liquidity to meet these current commitments and existing debt, and finance business growth.

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2005 // 2004

OVERVIEW

Sales and earnings for 2005 were up from 2004. The increase in sales was primarily related to sales from acquisitions. Sales growth was benefited by price realization gains and organic growth in Water Systems pump unit shipments. Earnings improved in 2005 primarily due to the increased sales as well as reduced manufacturing costs from the Company’s growing production base in Mexico, The Czech Republic, and China. These improvements were partially offset by higher commodity costs and increased fixed costs incurred in connection with the Company’s channel strategy change for Water Systems product distribution. Included in the results for 2005 are restructuring expenses of $1.9 million pre-tax, down from $5.5 million pre-tax in 2004.


RESULTS OF OPERATIONS

Net sales from continuing operations for fiscal year 2005 were $403.4 million, an increase of $33.3 million or 9 percent compared to 2004 sales of $370.1 million. Incremental sales related to acquisitions for fiscal year 2005 were about $17.5 million or 4 percent of sales. The majority of the sales growth from acquisitions resulted from the JBD, Inc. (the former Jacuzzi Brand) pump company. Sales growth was benefited by price realization gains and organic growth in Water Systems pump unit shipments. Water Systems product sales worldwide were up about 10 percent for fiscal year 2005 compared to 2004. Sales revenue increases in all of our Water Systems product categories during the year (including submersible motors, pumps, and drives and controls) were partially offset by slightly lower unit volumes of motors and controls due to customers buying ahead of announced price increases in 2004. The sales increase in 2005 for water related products by customers principally in the North American market accounted for about $33.6 million or 15 percent. The sales increase by European customers was about $1.8 million for 2005 or 2 percent (when comparing both years at the current year exchange rate). Sales increased by gains in price realization of approximately $25 million in 2005 resulting from increases in product selling prices, changes in customer sales discount programs and greater direct sales to distribution customers. Incremental sales for 2005 related to the acquisition of the assets of JBD, Inc. were about $16.1 million. Fueling Systems product sales worldwide were up about 2 percent compared to the prior year, mostly related to an acquisition in the third quarter. Sales related to the acquisition of Phil-Tite Enterprises (Phil-Tite), a manufacturer of fuel containment systems, were about $1.4 million in 2005.

Cost of sales from continuing operations as a percent of net sales for 2005, and 2004 was 64.6 percent, and 65.9 percent, respectively. Cost of sales as a percent of net sales decreased in 2005 from 2004 primarily as a result of increased sales volume, leveraging fixed costs, and improving profit margin. The improvement in gross profit from sales volume was offset by increased costs for certain commodities used in the manufacture of the electric motors, primarily steel and copper, of $5.2 million for 2005. Manufacturing costs in 2005 were reduced as approximately 23 percent of global Water Systems manufacturing man-hours were in relatively low-cost countries (Mexico, The Czech Republic, and China) versus about 13 percent in 2004. Gross profit was further improved by increases in selling prices.

Selling and administrative (“SG&A”) expense as a percent of net sales for 2005 and 2004 was 17.6 percent and 16.3 percent, respectively. SG&A costs increased about $10.4 million in 2005 over 2004 partially due to increased selling and marketing expenses of about $3.4 million related to the change in the Company’s strategy of selling to a more diversified customer base by marketing its Water Systems products direct to distributors. The Company expanded its sales force and increased other selling expenses related to a broader customer base with the addition of the specialty Water Systems distributors as customers. Incremental SG&A expenses related to acquisitions were about $2.7 million for 2005.

Restructuring expenses of $1.9 million and $5.5 million were incurred during 2005 and 2004, respectively. The expenses (included in “Restructure Expense” on the income statement) related to the Global Manufacturing Realignment Program. The costs were primarily for severance and other employee related expenses, as well as, equipment transfers and travel. The Company completed phase one of the ongoing program in 2005 and incurred pre-tax restructuring expense of about $7.5 million over the two year period.

Interest expense for 2005 and 2004 was $0.8 million and $0.5 million, respectively. Interest expense increased in 2005 due to increased interest rates.

Included in other income for 2005 and 2004 was interest income of $1.4 million and $0.5 million, respectively, primarily derived from the investment of cash balances in short-term U.S. treasury and agency securities. Also, included in other income for 2005 was income from equity investments of $0.1 million.

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Foreign currency-based transactions produced a gain for 2005 of $0.2 million primarily due to fluctuations between the U.S. dollar and the Chinese Yuan and Mexican Peso.  The foreign currency-based transaction loss, $0.5 million, in 2004 was due primarily to the euro rate changes relative to other currencies in Europe.

The provision for income taxes from continuing operations in 2005 and 2004 was $25.0 million, and $21.1 million, respectively. The effective tax rates were 35.3 and 35.5 percent for 2005 and 2004, respectively. The effective tax rate differs from the United States statutory rate of 35 percent, generally due to foreign income exclusion and R&D credits and due to the effects of state and foreign income taxes, net of federal tax benefits.

Income from continuing operations for 2005 was $45.8 million, or $1.97 per diluted share, compared to 2004 income from continuing operations of $38.4 million, or $1.67 per diluted share. Per share data for 2004 reflects the Company’s two-for-one stock split effected in the form of a 100 percent stock distribution made on June 15, 2004.


CAPITAL RESOURCES AND LIQUIDITY

Cash flows from operations provide the principal source of current liquidity. Net cash flows provided by operating activities were $74.2 million and $57.5 million in 2005 and 2004, respectively. The primary source of cash from operations was earnings. Significant uses of operating cash flow in 2005 and 2004 were related to increases in inventory, $10.6 million and $1.2 million, respectively. Inventories increased significantly in 2005 as the Company increased finished goods availability for distribution customers as a part of its new distribution channel strategy. Accounts receivable and accounts payable and other accrued expenses were significant sources of operating cash flow in 2005. Accounts receivable increases were primarily attributable to the timing of payments received from customers and increased sales during 2005. Accounts payable increases were primarily attributable to the timing of payments made to vendors and increased inventories during 2005. In 2004, a payment of $4.0 million was made to qualified employee benefit plans.

Net cash flows used in investing activities were $63.5 million and $30.4 million in 2005 and 2004, respectively. The Company paid $36.0 million for short-term investment securities, net of short-term investment securities sold in 2005. The Company paid an aggregate of $8.5 million for acquisitions in 2005, net of cash acquired. The acquisitions consisted of $5.6 million for Phil-Tite and $2.9 million for an equity investment in Pioneer. The primary use of cash for investing activities in 2004 was additions to property, plant and equipment. Another use of cash in 2004 was for the acquisition of certain assets of JBD, Inc. for $9.3 million.

Net cash flows used in financing activities were $9.0 million and $7.1 million in 2005 and 2004, respectively. The Company paid $8.5 million and $6.8 million in dividends on the Company’s common stock in 2005 and 2004, respectively. Another principal use of cash was purchases of Company common stock under the Company’s repurchase program. During 2005 and 2004, the Company repurchased 366,308 shares of its common stock for $13.8 million and 102,800 for $3.1 million, respectively.

Cash and cash equivalents at the end of 2005 were $52.1 million compared to $50.6 million at the end of 2004. Working capital increased $27.3 million in 2005 and the current ratio of the Company was 3.2 for 2005 compared to a current ratio of 3.1 at the end of 2004.

Principal payments of $1.0 million per year on the Company’s $20.0 million of unsecured long-term debt began in 1998 and will continue until 2008 when a balloon payment of $10.0 million will fully retire the debt. In September 2004, the Company entered into an unsecured, 60-month $80.0 million revolving credit agreement (the “Agreement”). The Agreement includes a facility fee of one-tenth of one percent on the committed amount. The Company had no outstanding borrowings under the Agreement at December 31, 2005. The Company is subject to certain financial covenants with respect to borrowings, interest coverage, working capital, loans or advances, and investments. The Company was in compliance with all debt covenants at all times in 2005 and 2004.

At December 31, 2005, the Company had $3.6 million of commitments primarily for the purchase of machinery and equipment, and building expansions. Management believes that internally generated funds and existing credit arrangements provide sufficient liquidity to meet these current commitments and existing debt, and finance business growth.
 

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2006

AGGREGATE CONTRACTUAL OBLIGATIONS
Most of the Company’s contractual obligations to third parties are debt obligations. In addition, the Company has certain contractual obligations for future lease payments, as well as, purchase obligations. The payment schedule for these contractual obligations is as follows:

(In millions)
 
       
Less Than
         
More Than
 
   
Total
 
1 Year
 
2-3 Years
 
4-5 Years
 
5 Years
 
Debt
 
$
61.3
 
$
11.0
 
$
50.3
 
$
-
 
$
-
 
Debt interest
   
5.7
   
3.3
   
2.4
   
-
   
-
 
Capital leases
   
1.1
   
0.3
   
0.8
   
-
   
-
 
Operating leases
   
22.4
   
5.3
   
7.1
   
3.1
   
6.9
 
Contingency from Healy acquisition
   
0.4
   
0.4
   
-
   
-
   
-
 
Purchase obligations
   
5.9
   
5.9
   
-
   
-
   
-
 
   
$
96.8
 
$
26.2
 
$
60.6
 
$
3.1
 
$
6.9
 

Debt interest includes interest on the balance outstanding under the Company’s fixed-to-variable interest rate swap. Per the swap contract, the Company receives interest at a fixed rate of 6.3 percent and pays interest at a variable rate based on the three month London Interbank Offered Rates (LIBOR) rate plus a spread. The average variable rate paid in 2006 was 7.9 percent. Debt interest also includes interest under the Company’s current credit agreement. The average interest rate for 2006 was 5.5 percent based on the LIBOR plus an interest spread. The remaining interest is calculated based on the fixed rate of 6.3 percent for the Company’s long-term insurance company debt.

The Healy Systems stock purchase agreement provided for additional contingent payments of 5 percent of certain Healy Systems product sales over the next five years, of which only one year could be estimated, therefore recognized and presented above.

The Company also has pension and other post-retirement benefit obligations not included in the table above which will result in future payments.


ACCOUNTING PRONOUNCEMENTS

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 “Accounting For Uncertain Tax Positions” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statements of Financial Accounting Standards (SFAS) No. 109 “Accounting for Income Taxes”. It prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company reviewed the impact of FIN 48 on its financial statements and does not believe the adoption of this standard will have a significant impact on the Company’s results of operations, financial position, or statement of cash flows.
 
In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements”. SFAS No. 157 gives guidance for measuring assets and liabilities using fair value. Fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets. The fair value measurements are disclosed by level within that hierarchy. While the Statement does not add any new fair value measurements, it does change current practice. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, although earlier application is encouraged. The Company is currently evaluating the impact of adopting SFAS No. 157 on its financial statements, but does not believe the adoption of this standard will have a significant impact on the Company’s results of operations, financial position, or statement of cash flows.

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In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108, “Financial Statements — Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements”. SAB No. 108 addresses how a registrant should quantify the effect of an error on the financial statements. The SEC concludes that a dual approach should be used to compute the amount of a misstatement. Specifically, the amount should be computed using both a “rollover” (current year income statement perspective) and “iron curtain” (year-end balance sheet perspective) methods. SAB 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB 108 did not have a material impact on the Company’s results of operations, financial position, or statement of cash flows.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”, which required recognition of the funded status of defined benefit pension and other postretirement plans, with a corresponding after-tax adjustment to accumulated other comprehensive loss. In 2006, the Company adopted SFAS No. 158. The adoption of SFAS No. 158, together with the annual remeasurement of our pension plans, resulted in a net of tax, $1.3 million, decrease in Shareholders’ equity. This decrease does not affect cash flows or the funded status of our benefit plans.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted provided the entity also elects to apply the provisions of SFAS No. 157. The Company is currently evaluating the impact of adopting SFAS No. 159 on its financial statements.


CRITICAL ACCOUNTING POLICIES AND 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. On an on-going basis, management evaluates its estimates, including those related to revenue recognition, allowance for doubtful accounts, accounts receivable, inventories, recoverability of long-lived assets, intangible assets, income taxes, warranty obligations, stock-based compensation, pension and other employee benefit plan obligations, and contingencies. Management bases its estimates 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.

The Company’s critical accounting policies are identified below:

Revenue Recognition:
Products are shipped utilizing common carriers direct to customers or, for consignment products, to customer-specified warehouse locations. Sales are recognized when the Company’s products are shipped direct or, in the case of consignment products, transferred from the customer-specified warehouse location to the customer, at which time transfer of ownership and risk of loss pass to the customer. The Company records net sales revenues after discounts at the time of sale based on specific discount programs in effect, historical data, and experience.

Warranty Obligations:
Warranty terms are generally two years from date of manufacture or one year from date of installation. Warranty liability is recorded when revenue is recognized and is based on actual historical return rates from the most recent warranty periods. While the Company’s warranty costs have historically been within its calculated estimates, it is possible that future warranty costs could exceed those estimates.

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Stock-Based Compensation:
Prior to January 1, 2006, the Company accounted for stock-based employee compensation plans under the measurement and recognition provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.” Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), using the modified prospective transition method. Under that transition method, compensation expense recognized includes: (a) compensation expense for all stock-based payments granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123; and (b) compensation expense for all stock-based payments granted on or after January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R).

The fair value of each option award, both before and after the adoption of SFAS No. 123(R), is estimated on the date of grant using the Black-Scholes option valuation model with a single approach and amortized using a straight-line attribution method over the option’s vesting period. Options granted to retirement eligible employees were immediately expensed. In 2005, this amount was disclosed in the pro-forma exhibit while in 2006 it was recognized as an expense. The Company uses historical data to estimate the expected volatility of its stock; the weighted average expected life, the period of time options granted are expected to be outstanding; and its dividend yield. The risk-free rates for periods within the contractual life of the option are based on the U.S. Treasury yield curve in effect at the time of the grant.

The assumptions used for the Black-Scholes model to determine the fair value of options granted during 2006 is as follows:

Risk-free interest rate
4.54%
Dividend yield
.70-.74%
Weighted-average dividend yield
.707%
Volatility factor
.3553-.3768
Weighted-average volatility
.359
Expected term
4-5 years
Forfeiture rate
5.44%

In accordance with SFAS No. 123, for periods prior to January 1, 2006, the Company disclosed pro forma net income or loss and pro forma net income or loss per share as if the fair value-based method in measuring compensation expense for its stock-based incentive programs had been applied. For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes option-pricing formula and amortized to expense over the options’ vesting periods.

Accounts Receivable and Allowance for Uncollectible Accounts:
Accounts receivable is comprised of balances due from customers net of estimated allowances for uncollectible accounts. In determining allowances, historical trends are evaluated and economic conditions and specific customer issues are reviewed to arrive at appropriate allowances. Allowance levels change as customer-specific circumstances and the other analysis areas noted above change. Differences may result in the amount for allowances if actual experience differs significantly from management estimates; such differences have not historically been material.

Inventory Valuation:
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 and management’s evaluation of estimated future demand, market conditions and alternative uses for possible excess or obsolete parts, reserves are recorded or changed. Significant fluctuations in demand or changes in market conditions could impact management’s estimates of necessary reserves. Excess and obsolete inventory is periodically disposed through sale to third parties, scrapping or other means, and the reserves are appropriately reduced. Differences may result in the amount for reserves if actual experience differs significantly from management estimates; such differences have not historically been material.

Business Combinations:
The Company follows the guidance under SFAS No. 141, “Business Combinations.” The acquisition purchase price is allocated to the assets acquired and liabilities assumed based upon their respective fair values and subject to change during the twelve month period subsequent to the acquisition date. The Company utilizes management estimates and independent third-party valuation firms 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.

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Goodwill and Other Intangible Assets:
Goodwill is not amortized; however it is tested for impairment annually or more frequently whenever events or changes in circumstances indicate that the asset may be impaired. The Company performs impairment testing for its reporting units using future cash flows based on management’s judgments and assumptions. An asset’s value is impaired if the estimate of the aggregate future cash flows, undiscounted and without interest charges, to be generated are less than the carrying amount of the reporting unit including goodwill. Such cash flows consider factors such as expected future operating income and historical trends, as well as the effects of demand and competition. To the extent impairment has occurred, the loss will be measured as the excess of the carrying amount of the reporting unit including goodwill over the fair value. Such estimates require the use of judgment and numerous subjective assumptions, which, if actual experience varies, could result in material differences in the requirements for impairment charges.

Income Taxes:
Under the requirements of SFAS No. 109, “Accounting for 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. 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 deferred tax assets and liabilities. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

Pension and Employee Benefit Obligations:
With the assistance of the Company’s actuaries, the discount rate used to determine pension and post-retirement plan liabilities is selected using a yield-curve approach. The yield-curve approach discounts each expected cash flow of the liability stream at an interest rate based on high quality corporate bonds. The present value of the discounted cash flows is summed and an equivalent weighted-average discount rate is calculated. A change in the discount rate selected by the Company of 25 basis points would result in a change of about $0.1 million of employee benefit expense. The Company consults with actuaries, asset allocation consultants and investment advisors to determine the expected long-term rate of return on plan assets based on historical and projected rates of return on the types of assets in which the plans have invested. 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.

Contingencies:
The Company is subject to the possibility of various loss contingencies arising in the ordinary course of business resulting from litigation, claims and other commitments, and from a variety of environmental and pollution control laws and regulations. The Company considers the likelihood of loss or the incurrence of a liability, as well as the ability to reasonably estimate the amount of loss, in determining loss contingencies. The Company accrues an estimated loss contingency when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. The amount of the reserves is determined, if any, with the assistance of outside legal counsel or other governmental regulatory agencies. The Company regularly evaluates current information available to determine whether the accruals should be adjusted.

FACTORS THAT MAY AFFECT FUTURE RESULTS
Any forward-looking statements contained herein involve risks and uncertainties, including, but not limited to, general economic and currency conditions, various conditions specific to the Company’s business and industry, market demand, competitive factors, changes in distribution channels, supply constraints, technology factors, litigation, government and regulatory actions, the Company’s accounting policies, future trends, and other risks, all as described in Item 1A and Exhibit 99.1 of this Form 10-K. These risks and uncertainties may cause actual results to differ materially from those indicated by the forward-looking statements. 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.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to market risk associated with changes in foreign currency exchange rates and interest rates. Foreign currency exchange rate risk is 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 inter-company balances utilizing a global netting system and limited use of foreign currency denominated debt.

The results of operations are exposed to changes in interest rates primarily with respect to borrowings under the Company’s revolving credit agreement (credit facility), where interest rates are tied to the prime rate or LIBOR. The average interest rate associated with borrowings against the credit facility paid by the Company in 2006 was 5.5 percent. As of December 30, 2006, the Company had $50.0 million outstanding under the credit facility. The Company does not, as a matter of policy, enter into derivative contracts for speculative purposes. The interest rate swap agreement entered into by the Company on September 24, 2003, had a notional amount of $10.0 million under which the Company receives a fixed rate of interest of 6.3 percent and pays interest at a variable rate based on a three month LIBOR rate plus a spread. The average rate associated with the swap agreement paid by the Company in 2006 was 7.9 percent. The fixed-to-variable interest rate swap is accounted for as a fair value hedge, per SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, with effectiveness assessed based on changes in the fair value of the underlying debt using incremental borrowing rates currently available on loans with similar terms and maturities. The effective gain or loss on the interest rate swap and that of the underlying debt are equal and offsetting resulting in no net effect to earnings. Based on the Company’s variable rate debt at December 30, 2006, a hypothetical 1.0 percent increase in interest rates would result in an annual increase in interest expense of approximately $0.6 million.

- 20 -



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED STATEMENTS OF INCOME

FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES

(In thousands, except per share amounts)
 
2006
 
2005
 
2004
 
               
Net sales
 
$
557,948
 
$
403,413
 
$
370,070
 
Cost of sales
   
366,391
   
260,592
   
243,879
 
Gross profit
   
191,557
   
142,821
   
126,191
 
Selling and administrative expenses
   
102,478
   
70,799
   
60,413
 
Restructure expense
   
-
   
1,920
   
5,536
 
Operating income
   
89,079
   
70,102
   
60,242
 
Interest expense
   
(3,373
)
 
(766
)
 
(488
)
Other income
   
1,791
   
1,200
   
219
 
Foreign exchange income/(loss)
   
(64
)
 
213
   
(479
)
Income before income taxes
   
87,433
   
70,749
   
59,494
 
Income taxes
   
30,671
   
24,953
   
21,126
 
Income from continuing operations
   
56,762
   
45,796
   
38,368
 
                     
Discontinued operations
   
381
   
344
   
(460
)
Income taxes
   
145
   
131
   
(175
)
Income/(loss) from discontinued operations
   
236
   
213
   
(285
)
                     
Net income
 
$
56,998
 
$
46,009
 
$
38,083
 
                     
Income per share
                   
Basic continuing operations
 
$
2.49
 
$
2.06
 
$
1.75
 
Basic discontinued operations
   
0.01
   
0.01
   
(0.02
)
   
$
2.50
 
$
2.07
 
$
1.73
 
                     
Diluted continuing operations
 
$
2.43
 
$
1.97
 
$
1.67
 
Diluted discontinued operations
   
0.01
   
0.01
   
(0.02
)
   
$
2.44
 
$
1.98
 
$
1.65
 
                     
Dividends per common share
 
$
0.43
 
$
0.38
 
$
0.31
 


See Notes to Consolidated Financial Statements.


- 21 -


CONSOLIDATED BALANCE SHEETS
FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
ASSETS
         
(In thousands, except per share amounts)
 
2006
 
2005
 
           
Current assets:
             
Cash and equivalents
 
$
33,956
 
$
52,136
 
Investments
   
-
   
35,988
 
Receivables (less allowances of $2,786 and $2,204, respectively)
   
52,679
   
30,165
 
Inventories:
             
Raw materials
   
39,195
   
25,267
 
Work-in-process
   
14,414
   
10,647
 
Finished goods
   
76,661
   
51,754
 
LIFO reserve
   
(18,707
)
 
(17,287
)
     
111,563
   
70,381
 
               
Other current assets (including deferred income taxes of $14,914 and $10,744, respectively)
   
19,592
   
14,350
 
Total current assets
   
217,790
   
203,020
 
               
Property, plant and equipment, at cost:
             
Land and buildings
   
56,352
   
53,106
 
Machinery and equipment
   
169,119
   
164,926
 
     
225,471
   
218,032
 
Less allowance for depreciation
   
(109,495
)
 
(122,300
)
     
115,976
   
95,732
 
               
Other assets (including deferred income taxes of $1,269 and $0, respectively)
   
14,375
   
13,064
 
Intangible assets
   
45,257
   
9,964
 
Goodwill
   
133,527
   
57,982
 
Total assets
 
$
526,925
 
$
379,762
 
               
LIABILITIES AND SHAREOWNERS' EQUITY
             
               
Current liabilities:
             
Accounts payable
 
$
30,832
 
$
26,409
 
Accrued liabilities
   
40,166
   
34,223
 
Income taxes
   
11,649
   
2,087
 
Current maturities of long-term debt and short-term borrowings
   
11,310
   
1,303
 
Total current liabilities
   
93,957
   
64,022
 
               
Long-term debt
   
51,043
   
12,324
 
Deferred income taxes
   
4,597
   
4,296
 
Employee benefit plan obligations
   
25,969
   
25,830
 
Other long-term liabilities
   
5,528
   
5,728
 
               
Contingencies and commitments (note 16)
             
               
Shareowners' equity:
             
Common shares (45,000 shares authorized, $.10 par value)
             
outstanding (23,009 and 22,485, respectively)
   
2,301
   
2,249
 
Additional capital
   
94,356
   
74,717
 
Retained earnings
   
236,780
   
190,381
 
Loan to ESOP trust
   
(200
)
 
(432
)
Accumulated other comprehensive income
   
12,594
   
647
 
Total shareowners' equity
   
345,831
   
267,562
 
Total liabilities and shareowners' equity
 
$
526,925
 
$
379,762
 
See Notes to Consolidated Financial Statements.

- 22 -


CONSOLIDATED STATEMENTS OF CASH FLOWS

FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES

   
2006
 
2005
 
2004
 
(In thousands)
             
               
Cash flows from operating activities:
                   
Net income
 
$
56,998
 
$
46,009
 
$
38,083
 
Adjustments to reconcile net income to net cash flows from operating activities:
                   
Depreciation and amortization
   
17,989
   
14,971
   
15,143
 
Stock based compensation
   
3,206
   
147
   
-
 
Deferred income taxes
   
(9,933
)
 
284
   
1,219
 
Gain/loss on divestiture and disposals of plant and equipment
   
(4,637
)
 
174
   
187
 
Changes in assets and liabilities, before the effect of acquisitions
                   
Receivables
   
(5,380
)
 
7,354
   
(1,243
)
Inventories
   
(10,978
)
 
(10,642
)
 
(1,167
)
Accounts payable and other accrued expenses
   
(4,540
)
 
5,930
   
2,276
 
Accrued income taxes
   
15,012
   
8,076
   
5,029
 
Excess tax from share-based compensation arrangements
   
(5,743
)
 
-
   
-
 
Employee benefit plans
   
4,956
   
2,420
   
(3,491
)
Other, net
   
(1,561
)
 
(559
)
 
1,471
 
Net cash flows from operating activities
   
55,389
   
74,164
   
57,507
 
Cash flows from investing activities:
                   
Additions to plant and equipment
   
(23,190
)
 
(17,845
)
 
(21,110
)
Proceeds from sale of plant and equipment
   
343
   
1,073
   
29
 
Additions to other assets
   
-
   
(2,184
)
 
(10
)
Purchase of securities
   
(63,500
)
 
(236,773
)
 
-
 
Proceeds from sale of securities
   
99,488
   
200,785
   
-
 
Cash paid for acquisitions, net of cash acquired
   
(159,205
)
 
(8,509
)
 
(9,307
)
Proceeds from sale of business
   
14,470
   
-
   
-
 
Net cash flows from investing activities
   
(131,594
)
 
(63,453
)
 
(30,398
)
Cash flows from financing activities:
                   
Proceeds from long-term debt
   
130,000
   
-
   
-
 
Repayment of long-term debt
   
(81,296
)
 
(1,280
)
 
(1,553
)
Proceeds from issuance of common stock
   
10,120
   
14,298
   
4,110
 
Excess tax from share-based compensation arrangements
   
5,743
   
-
   
-
 
Purchases of common stock
   
(198
)
 
(13,775
)
 
(3,091
)
Reduction of loan to ESOP Trust
   
232
   
233
   
232
 
Dividends paid
   
(9,833
)
 
(8,447
)
 
(6,815
)
Net cash flows from financing activities
   
54,768
   
(8,971
)
 
(7,117
)
                     
Effect of exchange rate changes on cash
   
3,257
   
(208
)
 
650
 
Net change in cash and equivalents
   
(18,180
)
 
1,532
   
20,642
 
Cash and equivalents at beginning of year
   
52,136
   
50,604
   
29,962
 
Cash and equivalents at end of year
 
$
33,956
 
$
52,136
 
$
50,604
 
                     
(In millions)
                   
Cash paid for income taxes
 
$
24.4
 
$
19.3
 
$
19.0
 
Cash paid for interest
 
$
3.1
 
$
0.7
 
$
0.6
 
                     
Non-cash items:
                   
Payable to seller of Healy Systems, Inc.
 
$
3.0
 
$
-
 
$
-
 
Additions to property, plant, and equipment, not yet paid
 
$
0.5
 
$
0.5
 
$
0.1
 
Receivable from sale of EMPD
 
$
2.2
 
$
-
 
$
-
 

See Notes to Consolidated Financial Statements.

- 23 -



CONSOLIDATED STATEMENTS OF SHAREOWNERS’ EQUITY AND COMPREHENSIVE INCOME

FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES

(In thousands)
 
   
 
Common Shares Outstanding
 
 
Common Stock
 
 
Additional Capital
 
 
Retained Earnings
 
Loan to ESOP Trust
 
Accumulated Other Comprehensive Income (Loss)
 
 
Comprehensive Income
 
                               
Balance year end 2003
   
21,828
 
$
2,182
 
$
45,826
 
$
139,057
 
$
(897
)
$
6,770
       
Net income
                     
38,083
             
$
38,083
 
Currency translation adjustment
                                 
6,935
   
6,935
 
Minimum pension liability adjustment, net of tax $141
                                 
(211
)
 
(211
)
Comprehensive income
                                     
$
44,807
 
Dividends on common stock
                     
(6,815
)
                 
Common stock issued
   
337
   
35
   
4,495
                         
Common stock repurchased or received for stock options exercised
   
(124
)
 
(13
)
       
(3,768
)
                 
Tax benefit of stock options exercised
               
2,422
                         
Loan payment from ESOP 
   
______
   
______
   
______
   
________
   
232
   
_______
       
Balance year end 2004
   
22,041
 
$
2,204
 
$
52,743
 
$
166,557
 
$
(665
)
$
13,494
       
                                             
Net income
                     
46,009
             
$
46,009
 
Currency translation adjustment
                                 
(9,405
)
 
(9,405
)
Minimum pension liability adjustment, net of tax $2,295
                                 
(3,442
)
 
(3,442
)
Comprehensive income
                                     
$
33,162
 
Dividends on common stock
                     
(8,447
)
                 
Common stock issued
   
795
   
81
   
14,855
                         
Stock-based compensation
   
15
   
1
   
147
                         
Common stock repurchased or received for stock options exercised
   
(366
)
 
(37
)
       
(13,738
)
                 
Tax benefit of stock options exercised
               
6,972
                         
Loan payment from ESOP 
   
______
   
______
   
______
   
________
   
233
   
____
       
Balance year end 2005
   
22,485
 
$
2,249
 
$
74,717
 
$
190,381
 
$
(432
)
$
647
       
                                             
Net income
                     
56,998
             
$
56,998
 
Currency translation adjustment
                                 
8,306
   
8,306
 
Minimum pension liability adjustment, net of tax $(3,278)
                                 
4,917
   
4,917
 
Comprehensive income
                                     
$
70,221
 
SFAS 158 transition amount, net of tax $851
                                 
(1,276
)
     
Dividends on common stock
                     
(9,833
)
                 
Common stock issued
   
513
   
50
   
10,690
                         
Stock-based compensation
   
26
   
3
   
3,206
                         
Common stock repurchased or received for stock options exercised
   
(15
)
 
(1
)
       
(766
)
                 
Tax benefit of stock options exercised
               
5,743
                         
Loan payment from ESOP 
   
______
   
______
   
______
   
________
   
232
   
_______
       
Balance year end 2006
   
23,009
 
$
2,301
 
$
94,356
 
$
236,780
 
$
(200
)
$
12,594
       

See Notes to Consolidated Financial Statements.


- 24 -



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES


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 Company's fiscal year ends on the Saturday nearest December 31. The financial statements and accompanying notes are as of and for the years ended December 30, 2006 (52 weeks), December 31, 2005 (52 weeks), and January 1, 2005 (52 weeks) and referred to as 2006, 2005, and 2004, respectively.

Principles of Consolidation--The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant inter-company balances and transactions are eliminated.

Revenue Recognition--Products are shipped utilizing common carriers direct to customers or, for consignment products, to customer specified warehouse locations. Sales are recognized when the Company’s products are shipped direct or, in the case of consignment products, transferred from the customer specified warehouse location to the customer, at which time transfer of ownership and risk of loss pass to the customer. The Company records net sales revenues after discounts at the time of sale based on specific discount programs in effect, historical data, and experience.

Research and Development Expense--The Company’s research and development activities are charged to expense in the period incurred. The Company spent approximately $8.1 million in 2006, $5.6 million in 2005, and $4.2 million in 2004 on research and development.

Cash Equivalents--Cash equivalents consist of highly liquid investments which are readily convertible to cash, present insignificant risk of changes in value due to interest rate fluctuations, and have original or purchased maturities of three months or less.

Fair Value of Financial Instruments--The carrying amounts for cash and equivalents, and short-term debt approximate fair value. The fair value of long-term debt is estimated based on current borrowing rates for similar issues and current exchange rates for foreign currency denominated amounts, which is not materially different from the recorded value. The Company’s off-balance sheet instruments consist of operating leases and an interest rate swap, which are not significant.

Accounts Receivable and Allowance for Uncollectible Accounts--Accounts receivable are stated at estimated net realizable value. Accounts receivable is 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, historical trends are evaluated and economic conditions and specific customer issues are reviewed to arrive at appropriate allowances. Allowance levels change as customer-specific circumstances and the other analysis areas noted above change. Differences may result in the amount for allowances if actual experience differs significantly from management estimates; such differences have not historically been material.

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 first-in, first-out (FIFO) method; a portion of domestic inventory costs are determined using the last-in, first-out (LIFO) method. Inventories stated on the LIFO method were approximately 15.7 percent and 31.5 percent of total inventories in 2006 and 2005, respectively. 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, reserves are recorded or changed.

- 25 -



Property, Plant and Equipment--Property, plant and equipment are stated at cost. Depreciation of plant and equipment is provided principally on a straight line basis over the estimated useful lives of 5 to 20 years for land improvements and buildings, 2 to 10 years for machinery and equipment. Maintenance, repairs, and renewals of a minor nature are expensed as incurred. Betterments and major renewals which extend the useful lives of buildings, improvements, and equipment are capitalized. Accelerated methods are used for income tax purposes. The Company reviews its property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Company’s depreciation expense was $15.8, $13.5, and $13.0 million in 2006, 2005, and 2004, respectively.

Asset Retirement Obligations--The Company recognizes and reports obligations associated with tangible asset retirements that result from the acquisition, disposal, or normal operation of a long-lived asset. Obligations are recognized and recorded at fair value in the period in which the obligation is incurred and a reasonable estimate made, or recognized when a reasonable estimate can be made.

Goodwill and Other Intangible Assets--The Company performs goodwill impairment testing for its reporting units, annually or more frequently whenever events or a change in circumstances indicate that the asset may be impaired. Goodwill is then adjusted in the event of impairment. Amortization is recorded for other intangible assets with definite lives.
 
Derivatives and Hedging--On September 24, 2003 the Company entered into a fixed-to-variable interest rate swap to achieve a desired proportion of variable vs. fixed rate debt. The fixed-to-variable interest rate swap is accounted for as a fair value hedge, per SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, with effectiveness assessed based on changes in the fair value of the underlying debt using incremental borrowing rates currently available on loans with similar terms and maturities. The effective gain or loss on the interest rate swap and that of the underlying debt are equal and offsetting resulting in no net effect to earnings.

Warranty Obligations--Warranty terms are generally two years from date of manufacture or one year from date of installation. Warranty liability is recorded when revenue is recognized and is based on actual historical return rates from the most recent warranty periods.

Income Taxes --Income taxes are accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes”. Under this method, 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 carryforwards 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.

Stock-Based Compensation-- Prior to January 1, 2006, the Company accounted for stock-based employee compensation plans under the recognition and measurement provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.” Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), “Share-Based Payment,” using the modified-prospective-transition method. Under that transition method, compensation cost recognized in 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). Results for prior periods have not been restated.

For pro forma information regarding net income and earnings per share, the fair value for the options awarded in 2005 and 2004, for all fixed stock option plans was estimated as of the date of the grant using a Black-Scholes option valuation model. The Black-Scholes option valuation model used by the Company was developed for use in estimating the fair value of fully tradable options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility.

Earnings Per Common Share--Basic and diluted earnings per share are computed and disclosed under SFAS No. 128, “Earnings Per Share”. Earnings per share are based on the weighted-average number of common shares outstanding. Diluted earnings per share is computed based upon earnings applicable to common shares divided by the weighted-average number of common shares outstanding during the period adjusted for the effect of other dilutive securities.

- 26 -



Translation of Foreign Currencies--All assets and liabilities of foreign subsidiaries whose functional currency is other than the U.S. dollar are translated at year end exchange rates. All revenue and expense accounts are translated at average rates in effect during the respective period. Adjustments for translating foreign currency assets and liabilities in U.S. dollars are included as a component of other comprehensive income.  Transaction gains and losses that arise from exchange rate fluctuations are included in the results of operations in “Other income”, as incurred.

Significant Estimates and Assumptions--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 accrued expenses, stock-based compensation, pension, goodwill impairment, long-lived assets and inventory valuation.
 

Although the Company regularly assesses these estimates, actual results could differ materially from these estimates. The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances.

Reclassifications--All share and per share data included in these financial statements reflect the Company’s two-for-one stock splits effected in the form of a 100 percent stock distribution made on June 15, 2004.


2. ACCOUNTING PRONOUNCEMENTS

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 “Accounting For Uncertain Tax Positions” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109 “Accounting for Income Taxes”. It prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company reviewed the impact of FIN 48 on its financial statements and does not believe the adoption of this standard will have a significant impact on the Company’s results of operations, financial position, or statement of cash flows.
 
In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements”. SFAS No. 157 gives guidance for measuring assets and liabilities using fair value. Fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets. The fair value measurements are disclosed by level within that hierarchy. While the Statement does not add any new fair value measurements, it does change current practice. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, although earlier application is encouraged. The Company is currently evaluating the impact of adopting SFAS No. 157 on its financial statements, but does not believe the adoption of this standard will have a significant impact on the Company’s results of operations, financial position, or statement of cash flows.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Financial Statements — Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 addresses how a registrant should quantify the effect of an error on the financial statements. The SEC concludes that a dual approach should be used to compute the amount of a misstatement. Specifically, the amount should be computed using both a “rollover” (current year income statement perspective) and “iron curtain” (year-end balance sheet perspective) methods. SAB 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB 108 did not have a material impact on the Company’s results of operations, financial position, or statement of cash flows.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”, which required recognition of the funded status of defined benefit pension and other postretirement plans, with a corresponding after-tax adjustment to accumulated other comprehensive loss. In 2006, the Company adopted SFAS No. 158. The adoption of SFAS No. 158, together with the annual remeasurement of our pension plans, resulted in a net of tax, $1.3 million, decrease in Shareholders’ equity. This decrease does not affect cash flows or the funded status of our benefit plans.

- 27 -



In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted provided the entity also elects to apply the provisions of SFAS No. 157. The Company is currently evaluating the impact of adopting SFAS No. 159 on its financial statements.


3. ACQUISITIONS

During April 2006, the Company completed its acquisition of all of the outstanding shares of capital stock of Little Giant Pump Company (“Little Giant”) from Tecumseh Products Company for a cash purchase price of $120.8 million, excluding direct transaction costs and subject to a final post-closing working capital adjustment. Transaction costs, approximately $2.4 million, and the final post-closing working capital adjustment, approximately $0.7 million, are included in the purchase accounting calculations under the guidance of SFAS No. 141 “Business Combinations”. Accordingly, a portion of the aggregate purchase price has been allocated to net assets acquired based on a fair market valuation. The initial excess purchase price over fair value of the net assets acquired, $82.6 million originally recorded as goodwill, has been adjusted to $47.3 million for the fair market values assigned to fixed assets, customer relationships, technology and other intangible assets. Certain due to values assigned, within property, plant and equipment, are considered preliminary estimates and will be adjusted as additional information is received and valuation assessments are completed. The $47.3 million recorded as goodwill, will be deductible for tax purposes.

The purchase price assigned to each major asset and liability of Little Giant Pump Company is as follows:


(In millions)
       
Assets:
     
Current assets
 
$
45.6
 
Property, plant and equipment
   
13.4
 
Intangible assets
   
31.2
 
Goodwill
   
47.3
 
Other assets
   
0.2
 
Total assets
   
137.7
 
Less liabilities
   
(13.8
)
Total purchase price
 
$
123.9
 


Little Giant’s results of operations were included in the Company’s consolidated statement of income, from the acquisition date through the year ended December 30, 2006.

During September 2006, the Company acquired Healy Systems, Inc. (“Healy Systems”) in a stock purchase transaction for a cash purchase price of $35.1 million, excluding direct transaction costs and a post-closing working capital adjustment. The purchase agreement provides for additional payments of 5 percent of certain Healy Systems product sales over the next five years. The transaction costs, approximately $0.3 million, and the preliminary post closing working capital adjustment, approximately $2.6 million are included in the total purchase accounting calculations under the guidance of SFAS No. 141 “Business Combinations”. The purchase price has been allocated to net assets based on preliminary estimated fair values. The Company will complete an independent fair market valuation in 2007. The excess of purchase price over preliminary estimated fair value of the net assets acquired, $26.4 million, has been recorded as goodwill. No portion of the $26.4 million, recorded as goodwill, will be deductible for tax purposes.

- 28 -



The purchase price assigned to each major asset and liability of Healy Systems, Inc. is as follows:


(In millions)
       
Assets:
       
Current assets
 
$
8.1
 
Property, plant and equipment
   
2.0
 
Intangible assets
   
6.0
 
Goodwill
   
26.4
 
Total assets
   
42.5
 
Less liabilities:
       
Current liabilities
   
(1.7
)
Deferred income taxes
   
(2.4
)
Total purchase price
 
$
38.4
 


Healy Systems results of operations were included in the Company’s consolidated statement of income, from the acquisition date through the year ended December 30, 2006.

Pro forma Results of Operations

The following unaudited pro forma statements give effect to the acquisition of Little Giant Pump Company and Healy Systems, by the Company. The unaudited pro forma combined condensed statements of income for 2006 and 2005 give effect to the acquisition of Little Giant Pump Company and Healy Systems as if the acquisitions had occurred at the beginning of the periods reported. These unaudited pro forma combined condensed financial statements are prepared for informational purposes only and are not necessarily indicative of actual results or financial position that would have been achieved had the acquisitions of Little Giant and Healy Systems been consummated on the dates indicated and are not necessarily indicative of future operating results or financial position of the consolidated companies. The unaudited pro forma combined condensed financial statements do not give effect to any cost savings or incremental costs that may result from the integration of Little Giant Pump Company and Healy Systems with the Company.


FRANKLIN ELECTRIC CO., INC.
PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF INCOME


(In millions, except per share amounts)

           
   
2006
 
2005
 
           
Net sales
 
$
615.7
 
$
529.6
 
               
Net income
 
$
59.3
 
$
52.8
 
               
Per share data:
             
               
Basic earnings per share
 
$
2.60
 
$
2.38
 
               
Diluted earnings per share
 
$
2.55
 
$
2.28
 


- 29 -



4. DISCONTINUED OPERATIONS

During December 2006, the Company sold its Engineered Motor Products Division, (“EMPD”) for an approximate $16.6 million selling price. Representing less than 10 percent of the Company’s consolidated sales, the Company no longer considered EMPD to be a part of its core operations. Thus future growth potential would be limited. This transaction was recognized in accordance to the guidance within SFAS No. 144 “Accounting for the Impairment and/or Disposal of Long-Lived Assets.”

The selling price included an initial sales price of $16.0 million and a preliminary working capital adjustment of $0.6 million. Net book value of the disposed assets was $11.9 million, including $14.5 million in total assets offset by $2.5 million in assumed liabilities. The Company realized a net book gain of $4.7 million. Divestiture expenses, incurred by the Company, of $0.8 million and $4.6 million for a one-time pension cost adjustment were recognized, offsetting the $4.7 million gain, resulting in a net pre-tax loss of $0.8 million. The net pre-tax loss is included in the statement of income, as part of discontinued operations.

Net sales for discontinued operations, were $36.8 million, $36.1 million, and 34.2 million, for 2006, 2005, and 2004, respectively. The income/loss before tax, related to discontinued operations, was $0.4 million, $0.3 million, and ($0.5) million, for 2006, 2005, and 2004 respectively.


5. INVESTMENTS

As of December 30, 2006, the Company held no investments in financial securities. As of December 31, 2005, the Company held $36.0 million of investments in financial securities. Income generated from investments was recorded as “Other income”, in the Company’s statement of income. Cash paid for these securities and proceeds from the sale of these securities was included as part of the “Cash flows from investing activities” section in the Company’s statement of cash flows.

The Company holds a 35 percent equity interest, in Pioneer Pump, Inc., which is accounted for using the equity method and is included as part of “Other assets” in the balance sheet. The carrying amount of the investment is adjusted for the Company’s proportionate share of earnings, losses, and dividends. At December 30, 2006, the carrying value of the investment was $6.1 million. At December 31, 2005, the carrying value of the investment was $6.0 million. The Company’s proportionate share of Pioneer Pump, Inc. earnings, included in “Other income” in the Company’s results of operations, was $0.7 million for 2006 and $0.1 for 2005.


- 30 -



6. GOODWILL AND OTHER INTANGIBLE ASSETS

The Company uses the purchase method of accounting for business combinations, in accordance with SFAS Nos. 141 and 142, “Business Combinations” and “Goodwill and Other Intangible Assets”, respectively. During the fourth quarter of each year, the Company performs its annual impairment testing required by SFAS No. 142, unless events or circumstances indicate earlier impairment testing. No impairment loss was recognized for 2006, 2005, or 2004.

The carrying amount of the Company’s intangible assets and goodwill include:

(in millions)
 
2006
 
2005
 
           
Amortized intangibles
             
Patents
 
$
6.3
 
$
5.9
 
Accumulated amortization
   
(2.8
)
 
(2.0
)
Supply agreements
   
7.2
   
10.0
 
Accumulated amortization
   
(4.3
)
 
(6.6
)
Technology
   
3.8
   
2.7
 
Accumulated amortization
   
(0.3
)
 
(0.1
)
Customer relationships
   
26.8
   
0.0
 
Accumulated amortization
   
(0.8
)
 
0.0
 
Other
   
1.7
   
1.5
 
Accumulated amortization
   
(1.6
)
 
(1.4
)
     
36.0
   
10.0
 
Unamortized intangibles
             
Trade names
   
9.3
   
0.0
 
Total intangibles
 
$
45.3
 
$
10.0
 
               
Goodwill
 
$
133.5
 
$
58.0
 

The weighted average years over which each intangible class is amortized is as follows:

Class
Years
   
Patents
17
Supply Agreements
6
Technology
15
Customer Relationships
20
Other
8


Amortization expense related to intangible assets for the twelve months ended December 30, 2006, December 31, 2005, and January 1, 2005 was $2.2, $1.4, and $2.1 million, respectively. Amortization expense for each of the five succeeding years is projected as $2.7 million, $2.7 million, $2.6 million, $2.5 million and $2.4 million for fiscal 2007, 2008, 2009, 2010, and 2011, respectively.

In the second quarter 2006 acquisition of Little Giant Pump Company, $31.2 million was recorded as intangibles ($1.1 million technology, $9.3 million trade name, and $20.8 million customer relationships) and $47.3 million as goodwill. In the third quarter 2006 acquisition of Healy Systems, Inc., $6.0 million was recorded as intangibles, classified as customer relationships and subject to an independent fair market valuation, and $26.4 million as goodwill.

Other changes in the carrying amount of intangibles and goodwill reflect foreign currency fluctuations.

- 31 -



7. EMPLOYEE BENEFIT PLANS

Defined Benefit Plans - As of December 30, 2006, the Company maintained three domestic pension plans and one German pension plan. The Company uses a December 31 measurement date for its plans. In 2006, the Company adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”

The following table sets forth aggregated information related to the Company’s pension benefits and other postretirement benefits, including changes in the benefit obligations, changes in plan assets, funded status, and amounts recognized in the consolidated balance sheet, amounts recognized in Other Comprehensive Income, and actuarial assumptions:


(In millions)
     
   
Pension Benefits
 
Other Benefits
 
   
2006
 
2005
 
2006
 
2005
 
Accumulated benefit obligation, end of year
 
$
150.0
 
$
145.1
 
$
13.0
 
$
14.3
 
                           
Change in benefit obligation:
                         
Projected benefit obligation, beginning of year
 
$
149.0
 
$
141.3
 
$
14.3
 
$
16.0
 
Service cost
   
4.7
   
3.9
   
0.3
   
0.4
 
Interest cost
   
8.1
   
7.7
   
0.8
   
0.8
 
Plan amendments
   
-
   
-
   
-
   
-
 
Actuarial gain (loss) 
   
(2.7
)
 
5.6
   
(0.1
)
 
(1.4
)
Settlements paid
   
(0.2
)
 
(1.0
)
 
-
   
-
 
Benefits paid
   
(9.2
)
 
(7.4
)
 
(1.3
)
 
(1.5
)
Liability (gain)/loss due to curtailment*
   
0.5
   
-
   
(1.2
)
 
-
 
Special termination benefits*
   
1.4
   
-
   
0.2
   
-
 
Exchange
   
1.2
   
(1.1
)
 
-
   
-
 
Projected benefit obligation, end of year
 
$
152.8
 
$
149.0
 
$
13.0
 
$
14.3
 
                           
Change in plan assets:
                         
Fair value of assets, beginning of year
 
$
131.7
 
$
133.9
 
$
-
 
$
-
 
Actual return on plan assets
   
19.9
   
6.2
   
-
   
-
 
Company contributions
   
1.7
   
1.6
   
1.3
   
1.5
 
Settlements paid
   
(0.2
)
 
(1.0
)
 
-
   
-
 
Benefits paid
   
(9.2
)
 
(8.4
)
 
(1.3
)
 
(1.5
)
Exchange
   
0.4
   
(0.6
)
 
-
   
-
 
Fair value of assets, end of year
 
$
144.3
 
$
131.7
 
$
-
 
$
-
 
                           
Funded status
 
$
(8.5
)
$
(17.3
)
$
(13.0
)
$
(14.3
)
                           
Amounts recognized in statement of financial position:
                         
Noncurrent assets
 
$
6.0
   
N/A**
   
-
   
N/A**
 
Deferred tax asset
   
-
   
N/A**
   
1.4
       
Current liabilities
   
(0.3
)
 
N/A**
   
(1.2
)
 
N/A**
 
Noncurrent liabilities
   
(14.2
)
 
N/A**
   
(11.8
)
 
N/A**
 
Net pension asset/(liability) at end of year
 
$
(8.5
)
 
N/A**
 
$
(11.6
)
 
N/A**
 
                           
Amount recognized in other comprehensive income:
                         
Net transition (asset)/obligation
   
-
   
N/A**
   
1.1
   
N/A**
 
Prior service cost (credit)
   
1.5
   
N/A**
   
0.6
   
N/A**
 
Net actuarial (gain)/loss
   
(1.5
)
 
N/A**
   
0.4
   
N/A**
 
Total recognized in other comprehensive income
 
$
-
   
N/A**
 
$
2.1