2011.10.1. 10Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________

FORM 10-Q
_________
 
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 1, 2011

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
(Address of principal executive offices)
 
(Zip Code)

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

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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.

YESx
NOo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YESx
NOo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large Accelerated Filerx
Accelerated Filero
Non-Accelerated Filero
Smaller Reporting Companyo


1



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YESo
NOx

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 
 
Outstanding at
Class of Common Stock
 
October 1, 2011
$.10 par value
 
23,220,904 shares

2



FRANKLIN ELECTRIC CO., INC.
TABLE OF CONTENTS

 
 
 
Page
PART I.
FINANCIAL INFORMATION
 
Number
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
Condensed Consolidated Statements of Income for the Third Quarter and Nine Months Ended October 1, 2011 and October 2, 2010
 
4
 
 
 
 
 
Condensed Consolidated Balance Sheets as of October 1, 2011 and January 1, 2011
 
5
 
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended October 1, 2011 and October 2, 2010
 
7
 
 
 
 
 
Notes to Condensed Consolidated Financial Statements
 
9
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
23
 
 
 
 
Item 4.
Controls and Procedures
 
33
 
 
 
 
PART II.
OTHER INFORMATION
 
 
 
 
 
 
Item 1.
Legal Proceedings
 
33
 
 
 
 
Item 1A.
Risk Factors
 
34
 
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
34
 
 
 
 
Item 4.
Reserved
 
 
 
 
 
 
Item 6.
Exhibits
 
34
 
 
 
 
Signatures
 
 
35
 
 
 
 
Exhibit Index
 
 
36
 
 
 
 
Exhibits
 
 
37

3



PART I.  FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share amounts)
 
 
 
 
 
 
 
 
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
October 1,
2011
 
October 2,
2010
 
October 1,
2011
 
October 2,
2010
 
 
 
 
As Adjusted
 
 
 
As Adjusted
 
 
 
 
(Note 3)
 
 
 
(Note 3)
Net sales
 
$
224,391

 
$
188,409

 
$
633,841

 
$
538,820

Cost of sales
 
150,674

 
128,970

 
422,381

 
364,139

Gross profit
 
73,717

 
59,439

 
211,460

 
174,681

Selling, general, and administrative expenses
 
44,840

 
39,596

 
132,915

 
118,599

Restructuring expense
 
553

 
242

 
1,473

 
5,343

Operating income
 
28,324

 
19,601

 
77,072

 
50,739

Interest expense
 
(2,917
)
 
(2,254
)
 
(7,529
)
 
(6,745
)
Other income/(expense)
 
1,542

 
763

 
4,110

 
(1,066
)
Foreign exchange income/(expense)
 
(554
)
 
(510
)
 
(1,911
)
 
(200
)
Income before income taxes
 
26,395

 
17,600

 
71,742

 
42,728

Income taxes
 
7,098

 
5,015

 
19,531

 
11,138

Net income
 
$
19,297

 
$
12,585

 
$
52,211

 
$
31,590

Less:  Net income attributable to noncontrolling interests
 
(77
)
 
(253
)
 
(657
)
 
(793
)
Net income attributable to Franklin Electric Co., Inc.
 
$
19,220

 
$
12,332

 
$
51,554

 
$
30,797

Income per share:
 
 

 
 

 
 

 
 

Basic
 
$
0.82

 
$
0.53

 
$
2.20

 
$
1.33

Diluted
 
$
0.80

 
$
0.52

 
$
2.16

 
$
1.31

Dividends per common share
 
$
0.14

 
$
0.13

 
$
0.40

 
$
0.39


See Notes to Condensed Consolidated Financial Statements.

4



FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
                                                                                       (Unaudited)
 
 
 
 
 
 
 
 
 
(In thousands)
 
 
 
 
 
 
October 1,
2011
 
January 1,
2011
 
 
 
 
As Adjusted
 
 
 
 
(Note 3)
ASSETS
 
 
 
 
Current assets:
 
 
 
 
  Cash and equivalents
 
$
128,055

 
$
140,070

  Receivables, less allowances of $2,866 and $2,340, respectively
 
101,654

 
70,829

  Inventories:
 
 

 
 

  Raw material
 
52,966

 
51,468

  Work-in-process
 
15,620

 
12,461

  Finished goods
 
85,501

 
76,303

 
 
154,087

 
140,232

  Deferred income taxes
 
14,349

 
13,182

  Other current assets
 
11,725

 
14,787

  Total current assets
 
409,870

 
379,100

 
 
 
 
 
Property, plant, and equipment, at cost:
 
 

 
 

Land and buildings
 
88,090

 
84,724

Machinery and equipment
 
189,928

 
181,291

Furniture and fixtures
 
23,646

 
20,924

Other
 
11,093

 
6,323

 
 
312,757

 
293,262

Less:  Allowance for depreciation
 
(164,199
)
 
(150,186
)
 
 
148,558

 
143,076

Asset held for sale
 
1,300

 
2,325

Intangible assets
 
95,963

 
89,011

Goodwill
 
170,594

 
165,193

Other assets
 
18,387

 
9,854

Total assets
 
$
844,672

 
$
788,559

 
 
See Notes to Condensed Consolidated Financial Statements.

5



 
 
October 1,
2011
 
January 1,
2011
 
 
 
 
As Adjusted
(Note 3)
LIABILITIES AND EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
49,853

 
$
39,084

Accrued expenses
 
60,119

 
64,714

Income taxes
 
7,499

 
4,268

Current maturities of long-term debt and short-term borrowings
 
11,374

 
1,241

Total current liabilities
 
128,845

 
109,307

Long-term debt
 
154,199

 
151,245

Deferred income taxes
 
24,153

 
17,887

Employee benefit plans
 
50,484

 
65,967

Other long-term liabilities
 
15,313

 
8,313

 
 
 
 
 
Commitments and contingencies
 

 

 
 
 
 
 
Redeemable noncontrolling interest
 
14,047

 
7,291

 
 
 
 
 
Shareowners' equity:
 
 

 
 

Common stock (65,000 shares authorized, $.10 par value) outstanding (23,221 and 23,257, respectively)
 
2,322

 
2,326

  Additional capital
 
137,712

 
129,705

  Retained earnings
 
345,040

 
313,905

  Accumulated other comprehensive loss
 
(30,247
)
 
(19,442
)
Total shareowners' equity
 
454,827

 
426,494

Noncontrolling interest
 
2,804

 
2,055

Total equity
 
457,631

 
428,549

Total liabilities and equity
 
$
844,672

 
$
788,559

 
See Notes to Condensed Consolidated Financial Statements.

6



FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
Nine Months Ended
(In thousands)
 
October 1,
2011
 
October 2,
2010
 
 
 
 
As Adjusted
 
 
 
 
(Note 3)
Cash flows from operating activities:
 
 
 
 
Net income
 
$
52,211

 
$
31,590

Adjustments to reconcile net income to net cash flows from operating activities:
 
 

 
 

  Depreciation and amortization
 
19,277

 
18,638

  Share-based compensation
 
3,256

 
3,434

  Deferred income taxes
 
1,566

 
9,047

  (Gain)/loss on disposals of plant and equipment
 
1,481

 
(1,096
)
  Asset impairment
 
200

 
2,459

  Foreign exchange expense
 
1,911

 

  Excess tax from share-based payment arrangements
 
(930
)
 
(667
)
  Changes in assets and liabilities:
 
 

 
 

     Receivables
 
(23,400
)
 
(10,769
)
     Inventory
 
(5,796
)
 
(2,953
)
     Accounts payable and accrued expenses
 
7,931

 
31,507

     Income taxes
 
7,436

 
1,539

     Employee benefit plans
 
(12,951
)
 
(8,956
)
     Other
 
253

 
(4,553
)
Net cash flows from operating activities
 
52,445

 
69,220

Cash flows from investing activities:
 
 

 
 

  Additions to property, plant, and equipment
 
(13,607
)
 
(11,326
)
  Proceeds from sale of property, plant, and equipment
 
324

 
1,591

  Additions to other assets
 

 
(333
)
  Cash paid for acquisitions, net of cash acquired
 
(25,143
)
 
(11,771
)
  Additional consideration for prior acquisition
 
(6,623
)
 

  Loan to customer
 
(3,171
)
 

Net cash flows from investing activities
 
(48,220
)
 
(21,839
)
Cash flows from financing activities:
 
 

 
 

  Proceeds from issuance of debt
 
5,080

 

  Repayment of debt
 
(4,258
)
 
(712
)
  Proceeds from issuance of common stock
 
4,246

 
1,913

  Excess tax from share-based payment arrangements
 
930

 
667

  Purchases of common stock
 
(10,629
)
 
(4,390
)
  Dividends paid
 
(9,294
)
 
(9,311
)
Net cash flows from financing activities
 
(13,925
)
 
(11,833
)
Effect of exchange rate changes on cash
 
(2,315
)
 
(274
)
Net change in cash and equivalents
 
(12,015
)
 
35,274

Cash and equivalents at beginning of period
 
140,070

 
86,875

Cash and equivalents at end of period
 
$
128,055

 
$
122,149

 
 
 
 
 
Cash paid for income taxes
 
$
7,450

 
$
(373
)
Cash paid for interest
 
$
7,529

 
$
6,754

 
 
 
 
 

7



Non-cash items:
 
 
 
 
Payable to seller of acquired entities
 
$
5,587

 
$
599

Additions to property, plant, and equipment, not yet paid
 
$
1,339

 
$
1,800

Stock option exercises, forfeitures, or stock retirements
 
$

 
$
599


See Notes to Condensed Consolidated Financial Statements.

8



FRANKLIN ELECTRIC CO., INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying condensed consolidated balance sheet as of January 1, 2011, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements as of October 1, 2011 and for the third quarter and nine months ended October 1, 2011 and October 2, 2010, have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations.  In the opinion of management, all accounting entries and adjustments (including normal, recurring accruals) considered necessary for a fair presentation of the financial position and the results of operation for the interim period have been made. Operating results for the third quarter and nine months ended October 1, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2011. For further information, including a description of the Company’s critical accounting policies, refer to the consolidated financial statements and notes thereto included in Franklin Electric Co., Inc.'s Annual Report on Form 10-K for the year ended January 1, 2011.

2.  NEW ACCOUNTING PRONOUNCEMENTS
In September 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2011-8 Testing Goodwill for Impairment. The new guidance gives companies the option of performing a qualitative assessment before calculating the fair value of the reporting unit. If the results of the qualitative assessment conclude that the fair value of the reporting unit is more likely than not less than the applicable carrying amount, the two-step impairment test would be required. Otherwise, further testing would not be required. ASU 2011-8 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. As the ASU addresses only the assessment of impairment, adoption of ASU 2011-8 is not expected to impact the Company's financial position, results of operations or cash flows.

In June 2011, the FASB issued ASU 2011-5 Statement of Comprehensive Income. The new statement gives companies the option of presenting net income and comprehensive income in one continuous statement of comprehensive income or in two separate but consecutive statements. Currently companies report other comprehensive income and its components in stockholders' equity. ASU 2011-5 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and will impact the financial statement presentation of the Company in the first quarter 2012. As the ASU addresses only disclosure requirements, adoption of ASU 2011-5 is not expected to impact the Company's financial position, results of operations or cash flows.

In May 2011, the FASB issued ASU 2011-4 Fair Value Measurement and Disclosure. The new guidance requires additional disclosures for Level 3 measurements including quantitative information about the significant unobservable inputs used in estimating fair value, a discussion of the sensitivity of the measurement to these inputs, and a description of the Company's valuation process. ASU 2011-4 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. As the ASU addresses only disclosure requirements, adoption of ASU 2011-4 is not expected to impact the Company's financial position, results of operations or cash flows.

3.  SIGNIFICANT ACCOUNTING POLICIES
During the nine fiscal months ended October 1, 2011, the Company did not change any of its existing accounting policies with the exception of the following accounting principle, which was adopted and became effective with respect to the Company on January 2, 2011.

Effective January 2, 2011, the Company elected to change its accounting method of valuing all of its inventories that used the last-in, first-out (“LIFO”) method to the first-in, first-out (“FIFO”) method.  Inventories valued using the LIFO and FIFO methods represented approximately 11% and 85%, respectively, of total inventories as of January 1, 2011 with the remaining inventory recorded using the average cost method. The Company believes the change is preferable because it will (1) more closely reflect current acquisition cost and improve the matching of revenue and expense, (2) conform 96% of the Company’s method of inventory valuation to the FIFO method and (3) enhance comparability with industry peers. The Company applied this change in accounting principle retrospectively to all prior periods presented herein in accordance with FASB Accounting Standards Codification ("ASC") Topic 250, Accounting Changes and Error Corrections. As a result of the accounting change, retained earnings as of January 2, 2010 increased from $285.5 million to $294.1 million.  As of January 2, 2011, the Company converted all LIFO inventory balances in its accounting systems to FIFO inventory which effectively eliminated its LIFO pools prospectively.

9



As a result of the retrospective application of this change in accounting principle, certain financial statement line items in the Company’s condensed consolidated balance sheet as of January 1, 2011, its condensed consolidated statements of income for the three and nine months ended October 2, 2010, and condensed consolidated statement of cash flows for the nine months ended October 2, 2010 were adjusted as presented below:

Condensed Consolidated Statements of Income
 
Third Quarter Ended October 2, 2010
(In thousands, except per share amounts)
 
As Originally
 
 
 
Effect of
 
 
Reported
 
As Adjusted
 
Change
Cost of sales
 
$
129,138

 
$
128,970

 
$
(168
)
Operating income
 
19,433

 
19,601

 
168

Income taxes
 
4,960

 
5,015

 
55

Net income
 
12,472

 
12,585

 
113

Net income attributable to Franklin Electric Co., Inc.
 
12,219

 
12,332

 
113

Income per share:
 
 

 
 

 
 

Basic
 
$
0.53

 
$
0.53

 
$

Diluted
 
$
0.52

 
$
0.52

 
$

 
 
 
 
 
 
 
 
 
Nine Months Ended October 2, 2010
 
 
As Originally
 
 
 
Effect of
 
 
Reported
 
As Adjusted
 
Change
Cost of sales
 
$
364,643

 
$
364,139

 
$
(504
)
Operating income
 
50,235

 
50,739

 
504

Income taxes
 
10,973

 
11,138

 
165

Net income
 
31,251

 
31,590

 
339

Net income attributable to Franklin Electric Co., Inc.
 
30,458

 
30,797

 
339

Income per share:
 
 
 
 
 
 

Basic
 
$
1.32

 
$
1.33

 
$
0.01

Diluted
 
$
1.30

 
$
1.31

 
$
0.01

 
 
 
 
 
 
 
Condensed Consolidated Balance Sheet
 
Year Ended January 1, 2011
(In thousands)
 
As Originally
 
 

 
Effect of
 
 
Reported
 
As Adjusted
 
Change
Inventories
 
$
126,007

 
$
140,232

 
$
14,225

Deferred income taxes
 
18,762

 
13,182

 
(5,580
)
Retained earnings
 
305,260

 
313,905

 
8,645

 
 
 
 
 
 
 
Condensed Consolidated Statement of Cash Flows
 
Nine Months Ended October 2, 2010
(In thousands) 
 
As Originally
 
 

 
Effect of
 
 
Reported
 
As Adjusted
 
Change
Net income
 
$
31,251

 
$
31,590

 
$
339

Changes in assets and liabilities:
 
 

 
 

 
 

Inventory
 
(2,449
)
 
(2,953
)
 
(504
)
Income taxes
 
1,374

 
1,539

 
165


10




As a result of the conversion described above it is necessary to estimate the effect of the change in accounting method on the current period. The estimated impact of this accounting change on the condensed consolidated statements of income as computed under LIFO for the three and nine months ended October 1, 2011 would be an increase in cost of sales of $0.4 million and $1.2 million, respectively; a decrease in operating income of $0.4 million and $1.2 million, respectively; a decrease in income taxes of $0.1 million and $0.3 million, respectively; a decrease in net income of $0.3 million and $0.9 million, respectively; a decrease in net income attributable to Franklin Electric Co., Inc. of $0.3 million and $0.9 million, respectively; and a decrease in both basic and diluted income per share of $0.01 and $0.03, respectively.

The estimated impact of this change to the condensed consolidated balance sheet as computed under LIFO as of October 1, 2011, would be a decrease in inventories of $15.4 million, an increase in deferred income taxes of $5.9 million, and a decrease in retained earnings of $9.5 million.

The estimated impact to the condensed consolidated statement of cash flows for the nine months ended October 1, 2011 would be a reduction of cash provided by net income of $0.9 million offset by a $1.2 million source of cash from the reduction in inventory and a $0.3 million use of cash from the reduction in income taxes.  There would be no impact to net cash flows from operating activities in the nine months ended October 1, 2011.

4. ACQUISITIONS
In an agreement dated May 2, 2011, between Franklin Electric BV (a wholly owned subsidiary of the Company) and Impo Motor Pompa Sanayi ve Ticaret A.S. ("Impo"), the Company acquired 80 percent of the outstanding shares of Impo, net of debt acquired plus working capital adjustments, for approximately 40.0 million Turkish lira ("TL"), $26.1 million at the then current exchange rate, subject to certain terms and conditions.

Impo, located in Izmir, Turkey, is the leading supplier of groundwater pumping equipment in Turkey. The Impo acquisition, combined with the Company's current presence in the region, will provide the Company with the leading position in the rapidly growing market for groundwater pumping systems in Turkey and throughout the Middle East. It will also provide a low cost manufacturing base for supplying the entire region.

The preliminary intangible assets of $15.3 million consist primarily of customer relationships, which will be amortized over 13 years, and trademarks. All of the goodwill was recorded as part of the Water Systems segment and is not expected to be deductible for tax purposes.

The purchase agreement for Impo includes an earn-out provision payable to the sellers if certain performance criteria are achieved in any year from 2011 to 2013. Additional payments will not exceed TL 10.0 million. As of the acquisition date, the Company recorded contingent consideration of TL 8.5 million ($5.5 million) as determined by the income approach.

The preliminary purchase price assigned to each major identifiable asset and liability was as follows:

(In millions)
 
 
 
Assets:
 
  Cash acquired
$
0.9

  Current assets
26.4

  Property, plant, and equipment
11.5

  Intangible assets
15.3

  Goodwill
5.9

  Other assets
2.8

Total assets
62.8

Contingent consideration
(5.5
)
Liabilities
(24.7
)
Total identifiable net assets
32.6

Noncontrolling interest
(6.5
)
Total purchase price
$
26.1


11




Preliminary goodwill decreased by $1.4 million in the third quarter ended October 1, 2011, due to additional information provided for the provisional valuation. The fair value of the identifiable intangible assets and property, plant, and equipment are provisional amounts pending final valuations and purchase accounting adjustments. The Company utilized management estimates and consultation with an independent third-party valuation firm to assist in the valuation. Acquisition-related costs, primarily included in selling, general, and administrative expenses in the Company's statement of income, were $0.2 million for the nine months ended October 1, 2011.

The results of operations of Impo were included in the Company's consolidated statements of income from its acquisition date through the third quarter ended October 1, 2011. The difference between actual sales for the Company and proforma annual sales including Impo as if it were acquired at the beginning of 2010 was not material as a component of the Company's consolidated sales for the nine months ending October 1, 2011 and October 2, 2010, respectively.

5. REDEEMABLE NONCONTROLLING INTERESTS
In the first quarter of 2009, the Company completed the acquisition of 75 percent of Vertical S.p.A.  The 25 percent noncontrolling interest was recorded at fair value as of the acquisition date.  The noncontrolling interest holders have the option, which is embedded in the noncontrolling interest, to require the Company to redeem their ownership interests between November 17, 2013 and January 16, 2014.  The combination of a noncontrolling interest and a redemption feature resulted in a redeemable noncontrolling interest.

In the second quarter of 2011, the Company completed the acquisition of 80 percent of Impo. The 20 percent noncontrolling interest was recorded at fair value as of the acquisition date. The noncontrolling interest holders have the option, which is embedded in the noncontrolling interest, to require the Company to redeem their ownership interests by May 2, 2014, three years after the original agreement was signed. The combination of a noncontrolling interest and a redemption feature resulted in a redeemable noncontrolling interest.

These noncontrolling interests are redeemable at other than fair value as the redemption value is determined based on a specified formula.  The noncontrolling interests become redeemable after the passage of time, and therefore the Company records the carrying amount of the noncontrolling interests at the greater of (1) the initial carrying amount, increased or decreased for each noncontrolling interest’s share of net income or loss and its share of other comprehensive income or loss and dividends (“carrying amount”) or (2) the redemption value which is determined based on the greater of the redemption floor value or the then-current specified earnings multiple.  As of October 1, 2011, the Vertical redeemable noncontrolling interest is recorded at the redemption value and the Impo redeemable noncontrolling interest is recorded at the carrying amount.

According to FASB ASC Topic 810 Consolidation and Emerging Issues Task Force ("EITF") Topic No. D-98 Classification and Measurement of Redeemable Securities, redeemable noncontrolling interests issued in the form of common securities, to the extent that the noncontrolling interest holder has a contractual right to receive an amount upon share redemption that is other than the fair value of such shares, then the noncontrolling interest holder has, in substance, received a dividend distribution that is different from other common shareholders. Therefore, adjustments to the noncontrolling interest to reflect the redemption amount should be reflected in the computation of earnings per share using the two-class method. Under the two-class method, the Company has elected to treat as a dividend only the portion of the periodic redemption value adjustment (if any) that reflects a redemption value in excess of fair value.  The Company adjusted the recorded amount of the redeemable noncontrolling interest for Vertical by $0.5 million for the nine months ended October 1, 2011. A resulting adjustment to the earnings per share computation was necessary in the third quarter 2011 (see Note 13). No adjustments were necessary for Vertical in 2010. As the redeemable noncontrolling interest for Impo is recorded at the carrying amount, no adjustments were necessary for the nine months ended October 1, 2011.

6.  FAIR VALUE MEASUREMENTS
FASB ASC Topic 825, Financial Instruments, provides a framework for measuring fair value under generally accepted accounting principles.  Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  Disclosures about instruments measured at fair value were expanded and a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value was established.  The standard describes three levels of inputs that may be used to measure fair value:

Level 1 – Quoted prices for identical assets and liabilities in active markets;

Level 2 – Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and

12



liabilities in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and

Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

The Company designates the cash equivalents as Level 1, as they are Money Market accounts backed by Treasury Bills. As of October 1, 2011, and January 1, 2011, these assets measured at fair value on a recurring basis were as follows:

(In millions)
 
October 1, 2011

 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
Cash equivalents
 
$
14.6

 
$
14.6

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
January 1, 2011

 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
Cash equivalents
 
$
20.0

 
$
20.0

 
$

 
$


The following table summarizes information regarding the Company’s non-financial assets and liabilities measured at fair value on a nonrecurring basis:

(In millions)
 
October 1, 2011
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
 
Recognized Loss
Asset held for sale
 
$
1.3

 
$

 
$

 
$
1.3

 
$
3.4

Impo contingent consideration
 
4.9

 

 

 
4.9

 
0.3

 
 
$
6.2

 
$

 
$

 
$
6.2

 
$
3.7

 
 
 
 
 
 
 
 
 
 
 
 
 
January 1, 2011
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
 
Recognized Loss
Asset held for sale
 
$
2.3

 
$

 
$

 
$
2.3

 
$
2.4


During the second quarter of 2010, the Company recorded the impairment as a restructuring expense on property, plant, and equipment relating to the Siloam Springs facility which is classified as held for sale.  The fair value was based on appraised values and management estimates less costs to sell. During the third quarter of 2011, the Company agreed upon the terms of a letter of intent to sell its Siloam Springs facility. As a result, the Company reduced the carrying amount of the held for sale asset to approximate the agreed upon sales price less costs to sell. The transaction is expected to close during the first quarter of 2012.

During the second quarter of 2011, the Company recorded $5.5 million (TL 8.5 million) of contingent consideration relating to the second quarter 2011 acquisition of Impo. The fair value of $4.9 million (TL 9.0 million) as of October 1, 2011 was based on the income approach. The Company recognized the additional accretion charge in the "Interest expense" line of the income statement. An additional impact of $0.9 million was attributed to foreign exchange translation.

7. OTHER ASSETS
The Company holds a 35 percent equity interest in Pioneer Pump, Inc., which is accounted for using the equity method and included in “Other assets” on the consolidated balance sheet.  The carrying amount of the investment is adjusted for the Company’s proportionate share of earnings, losses, and dividends.  The carrying value of the investment was $10.6 million as of October 1, 2011 and $8.8 million as of January 1, 2011.  The Company’s proportionate share of Pioneer Pump, Inc. earnings,

13



included in “Other income/(expense)” in the Company’s statements of income, was $0.8 million and $0.3 million for the third quarter ended October 1, 2011 and October 2, 2010, respectively, and $1.9 million and $0.7 million for the nine months ended October 1, 2011 and October 2, 2010, respectively.

During the second quarter, the Company entered into a loan agreement with a parent of a customer.  The current maturity is included in "Receivables" and the long term portion is included in "Other assets" on the consolidated balance sheet. The agreement provides for interest on the loan at a variable market interest rate with the customer to repay the loan plus interest in semi-annual installments throughout the seven year term.  The Company has a long term relationship with the customer and considers the loan fully collectible.

8. INTANGIBLE ASSETS AND GOODWILL
The carrying amounts of the Company’s intangible assets are as follows:

(In millions)
 
October 1, 2011
 
January 1, 2011
 
 
Gross Carrying
 
Accumulated
 
Gross Carrying
 
Accumulated
 
 
Amount
 
Amortization
 
Amount
 
Amortization
Amortized intangibles:
 
 
 
 
 
 
 
 
Patents
 
$
7.9

 
$
(5.2
)
 
$
7.9

 
$
(4.8
)
Supply agreements
 
4.4

 
(4.4
)
 
4.4

 
(3.9
)
Technology
 
7.5

 
(2.6
)
 
7.5

 
(2.2
)
Customer relationships
 
79.8

 
(16.3
)
 
70.7

 
(13.1
)
Other
 
1.2

 
(1.1
)
 
1.1

 
(1.1
)
Total
 
$
100.8

 
$
(29.6
)
 
$
91.6

 
$
(25.1
)
Unamortized intangibles:
 
 
 
 

 
 

 
 

Trade names
 
24.8

 

 
22.5

 

Total intangibles
 
$
125.6

 
$
(29.6
)
 
$
114.1

 
$
(25.1
)

Amortization expense related to intangible assets for the third quarter ended October 1, 2011 and October 2, 2010 was $1.6 million and $1.3 million, respectively, and for the nine months ended October 1, 2011 and October 2, 2010, was $4.5 million and $3.8 million, respectively.

Amortization expense is projected as follows:

(In millions)
 
2011
 
2012
 
2013
 
2014
 
2015
 
 
$
5.6

 
$
5.6

 
$
5.4

 
$
5.3

 
$
5.3


The change in the carrying amount of goodwill by reporting segment for the nine months ended October 1, 2011, is as follows:

(In millions)
 
Water Systems
 
Fueling Systems
 
Consolidated
Balance as of January 1, 2011
 
$
107.0

 
$
58.2

 
$
165.2

Acquisitions
 
5.9

 

 
5.9

Adjustments to prior year acquisitions
 

 
0.7

 
0.7

Foreign currency translation
 
(1.3
)
 
0.1

 
(1.2
)
Balance as of October 1, 2011
 
$
111.6

 
$
59.0

 
$
170.6


The 2006 purchase agreement for Healy Systems, Inc. provides for additional payments of 5 percent of certain Healy Systems, Inc. product sales through August 31, 2011.  Adjustments to prior year acquisitions primarily include those contingency commitments to the former owners of Healy Systems, Inc.

14




9. EMPLOYEE BENEFIT PLANS
Defined Benefit Plans – As of October 1, 2011, the Company maintained three domestic pension plans and three German pension plans (collectively, the "Plans").  The Company uses a December 31 measurement date for its Plans.

The following table sets forth aggregated net periodic benefit cost and other benefit cost for the third quarter and nine months ended October 1, 2011 and October 2, 2010, respectively: 

(In millions)
 
Pension Benefits
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
October 1, 2011
 
October 2, 2010
 
October 1, 2011
 
October 2, 2010
Service cost
 
$
0.7

 
$
0.8

 
$
2.6

 
$
2.3

Interest cost
 
2.0

 
2.1

 
7.2

 
6.5

Expected return on assets
 
(2.3
)
 
(2.2
)
 
(8.8
)
 
(7.4
)
Loss
 
0.8

 
0.4

 
2.7

 
1.4

Prior service cost
 

 
0.1

 
0.1

 
0.2

Settlement cost
 

 

 

 
0.4

Curtailment cost
 

 

 

 
0.9

Total net periodic benefit cost
 
$
1.2

 
$
1.2

 
$
3.8

 
$
4.3


(In millions)
 
Other Benefits
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
October 1, 2011
 
October 2, 2010
 
October 1, 2011
 
October 2, 2010
Interest cost
 
$
0.2

 
$
0.2

 
$
0.5

 
$
0.6

Loss
 
0.1

 

 
0.1

 

Prior service cost
 
0.1

 

 
0.1

 

Obligation
 

 

 
0.1

 

Curtailment cost
 

 

 

 
0.2

Total net periodic benefit cost
 
$
0.4

 
$
0.2

 
$
0.8

 
$
0.8


In the nine months ended October 1, 2011, the Company made contributions to the Plans of $15.9 million.  The amount of contributions to be made to the Plans during calendar year 2011 was finalized September 15, 2011 based upon the Plans' year-end valuation at January 1, 2011 and the desired funding level to be achieved as of January 1, 2011.

10. INCOME TAXES
The effective tax rate on income before income taxes in 2011 and 2010 varies from the United States statutory rate of 35 percent primarily due to the indefinite reinvestment of foreign earnings and reduced taxes on foreign and repatriated earnings after the restructuring of certain foreign entities. The Company has the ability to indefinitely reinvest these foreign earnings based on the earnings and cash projections of its other operations as well as cash on hand and available credit.

15




11. ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES
As of the beginning of fiscal year 2011, the Company had gross unrecognized tax benefits of $3.6 million, excluding accrued interest and penalties.  The unrecognized tax benefits recorded for state income tax liabilities increased $0.2 million and for federal tax liabilities increased $2.2 million based on evaluations during the first nine months of 2011, primarily related to acquisitions.  The Company had gross unrecognized tax benefits, excluding accrued interest and penalties, of $6.0 million as of October 1, 2011.  Of the unrecognized tax benefits, $3.3 million are related to acquisitions occurring in 2011 and prior to 2011 for which indemnification was provided for in the respective purchase agreements.  The impact of all unrecognized benefits on the effective tax rate, if recognized, would be the net unrecognized tax benefit of $2.4 million, which is net of the federal benefit for state tax of $0.3 million and net of interest and penalty.

The Company recognizes interest and penalties related to unrecognized tax benefits as income tax expense.  The Company’s reserve for interest and penalties as of both October 1, 2011 and as of January 1, 2011 was approximately $0.4 million.  Interest and penalties recorded through the first nine months of 2011 were not considered significant.

The Company is subject to periodic audits by domestic and foreign tax authorities. Currently, the Company is undergoing routine periodic audits in both domestic and foreign tax jurisdictions. It is reasonably possible that the amounts of unrecognized tax benefits could change in the next 12 months as a result of the audits.

For the majority of tax jurisdictions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2008.

12. DEBT
Debt consisted of the following:

(In millions)
 
October 1, 2011
 
January 1, 2011
Prudential Agreement - 5.79 percent
 
$
150.0

 
$
150.0

Capital leases
 
0.2

 
0.7

Foreign subsidiary debt
 
15.4

 
1.8

 
 
165.6

 
152.5

Less current maturities
 
(11.4
)
 
(1.3
)
Long-term debt
 
$
154.2

 
$
151.2


During the second quarter, the Company acquired $13.7 million of debt with the acquisition of the 80 percent interest in Impo. In September 2011, Impo finalized a refinancing plan. As a result of this refinancing, Impo now has approximately $18.5 million of credit available. As of third quarter end, Impo had debt outstanding of approximately $13.9 million, comprised of $10.7 million of current maturities and $3.2 million of long term debt, with interest rates ranging from 3 percent to 13 percent and maturity dates ranging from 2011 to February 2018. The debt at quarter end was denominated in euro, U.S. dollar, and TL currencies and was included in the foreign subsidiary debt line of the above table.

The total estimated fair value of debt was $180.9 million and $162.0 million at October 1, 2011 and January 1, 2011, respectively.  The fair value assumed floating rate debt was valued at par. In the absence of quoted prices in active markets considerable judgment is required in developing estimates of fair value.  Estimates are not necessarily indicative of the amounts the Company could realize in a current market transaction.  In determining the fair value of its long term debt the Company uses estimates based on rates currently available to the Company for debt with similar terms and remaining maturities.

The following debt payments are expected to be paid in accordance with the following schedule:
(In millions)
 
Total
 
Year 1
 
Year 2
 
Year 3
 
Year 4
 
Year 5
 
More than 5 years
Debt
 
$
165.4

 
$
11.2

 
$
1.2

 
$
1.0

 
$
31.0

 
$
31.0

 
$
90.0

Capital leases
 
0.2

 
0.2

 

 

 

 

 

 
 
$
165.6

 
$
11.4

 
$
1.2

 
$
1.0

 
$
31.0

 
$
31.0

 
$
90.0




16



13. EARNINGS PER SHARE
Following is the computation of basic and diluted earnings per share:

(In millions, except per share amounts)
Third Quarter Ended
 
Nine Months Ended
 
October 1, 2011
 
October 2, 2010
 
October 1, 2011
 
October 2, 2010
 
Numerator:
 
 
As Adjusted
(Note 3)
 
 
 
As Adjusted
(Note 3)
Net income attributable to Franklin Electric Co., Inc.
$
19.2

 
$
12.3

 
$
51.6

 
$
30.8

Less: Undistributed earnings allocated to redeemable non-
controlling interest
0.2

 

 
0.5

 

 
$
19.0

 
$
12.3

 
$
51.1

 
$
30.8

Denominator:
 
 
 
 
 
 
 

Basic
 
 
 
 
 
 
 

Weighted average common shares
23.2

 
23.2

 
23.2

 
23.2

Diluted
 
 
 
 
 
 
 

Effect of dilutive securities:
 
 
 
 
 
 
 

Employee and director incentive stock options and awards
0.5

 
0.3

 
0.5

 
0.3

Adjusted weighted average common shares
23.7

 
23.5

 
23.7

 
23.5

Basic earnings per share
$
0.82

 
$
0.53

 
$
2.20

 
$
1.33

Diluted earnings per share
$
0.80

 
$
0.52

 
$
2.16

 
$
1.31

Anti-dilutive stock options
0.3

 
0.9

 
0.3

 
0.9

Anti-dilutive stock options price range – low
$
43.43

 
$
28.82

 
$
43.43

 
$
28.82

Anti-dilutive stock options price range – high
$
48.87

 
$
48.87

 
$
48.87

 
$
48.87




17



14. EQUITY ROLL FORWARD
The schedule below sets forth equity changes in the nine months ended October 1, 2011:

(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Description
 
Common
 
Additional Paid in Capital
 
Retained Earnings
 
Minimum Pension Liability
 
Cumulative Translation Adjustment
 
Non-controlling Interest
 
Total Equity
 
Redeemable Non-controlling Interest
Balance as of January 1, 2011
 
$
2,326

 
$
129,705

 
$
313,905

 
$
(38,485
)
 
$
19,043

 
$
2,055

 
$
428,549

 
$
7,291

As Adjusted (Note 3)
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Net income
 
 

 
 

 
51,554

 
 

 
 

 
393

 
51,947

 
264

Noncontrolling interest accretion
 

 

 
(521
)
 
 

 
 

 
 

 
(521
)
 
521

Dividends on common stock
 

 

 
(9,294
)
 
 

 
 

 
 

 
(9,294
)
 
 

Common stock issued
 
16

 
4,230

 
 

 
 

 
 

 
 

 
4,246

 
 

Common stock repurchased or received for stock options exercised
 
(25
)
 
 

 
(10,604
)
 
 

 
 

 
 

 
(10,629
)
 
 

Share-based compensation
 
5

 
3,251

 
 

 
 

 
 

 
 

 
3,256

 
 

Tax benefit of stock options exercised
 

 
526

 
 

 
 

 
 

 
 

 
526

 
 

Impo acquisition
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
6,521

Currency translation adjustment
 

 

 


 
 

 
(12,462
)
 
356

 
(12,106
)
 
(550
)
Pension liability, net of taxes
 

 

 
 

 
1,657

 
 

 
 

 
1,657

 
 

Balance as of October 1, 2011
 
$
2,322

 
$
137,712

 
$
345,040

 
$
(36,828
)
 
$
6,581

 
$
2,804

 
$
457,631

 
$
14,047


15. OTHER COMPREHENSIVE INCOME
Comprehensive income is as follows:

(In millions)
Third Quarter Ended
 
Nine Months Ended
 
October 1, 2011
 
October 2, 2010
 
October 1, 2011
 
October 2, 2010
 
 
 
As Adjusted
 
 
 
As Adjusted
 
 
 
(Note 3)
 
 
 
(Note 3)
Net income
$
19.3

 
$
12.6

 
$
52.2

 
$
31.6

Other comprehensive income, net of tax:
 
 


 
 
 


Foreign currency translation adjustments
(26.8
)
 
16.8

 
(12.6
)
 
0.2

Pension liability adjustment
0.5

 
0.5

 
1.6

 
1.5

Total other comprehensive income
$
(7.0
)
 
$
29.9

 
$
41.2

 
$
33.3

Less: comprehensive income attributable to noncontrolling interest
1.0

 
(1.0
)
 
(0.4
)
 
(0.3
)
Comprehensive income attributable to Franklin Electric Co., Inc.
$
(6.0
)
 
$
28.9

 
$
40.8

 
$
33.0





18



16.  SEGMENT INFORMATION
Financial information by reportable business segment is included in the following summary:

(In millions)
 
Third Quarter Ended
 
Nine Months Ended
 
 
October 1, 2011
 
October 2, 2010
 
October 1, 2011
 
October 2, 2010
 
Net sales to external customers
Water Systems
 
$
179.4

 
$
152.9

 
$
510.1

 
$
447.2

Fueling Systems
 
45.0

 
35.5

 
123.7

 
91.6

Consolidated
 
$
224.4

 
$
188.4

 
$
633.8

 
$
538.8

 
 
 
 
 
 
 
 
 
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
October 1, 2011
 
October 2, 2010
 
October 1, 2011
 
October 2, 2010
 
 
 
 
As Adjusted
(Note 3)
 
 
 
As Adjusted
(Note 3)
 
 
Operating income (loss)
Water Systems
 
$
29.0

 
$
22.5

 
$
86.7

 
$
66.1

Fueling Systems
 
9.6

 
6.6

 
22.2

 
12.9

Other
 
(10.3
)
 
(9.5
)
 
(31.8
)
 
(28.3
)
Consolidated
 
$
28.3

 
$
19.6

 
$
77.1

 
$
50.7

 
 
 
 
 
 
 
 
 
 
 
October 1, 2011
 
January 1, 2011
 
 
 
 
 
 
 
 
As Adjusted
(Note 3)
 
 
 
 
 
 
Total assets
 
 
 
 
Water Systems
 
$
551.3

 
$
458.9

 
 
 
 
Fueling Systems
 
225.1

 
221.1

 
 
 
 
Other
 
68.3

 
108.6

 
 
 
 
Consolidated
 
$
844.7

 
$
788.6

 
 
 
 

Cash is the major asset group in “Other” of total assets.  Prior year presentation has been reclassified to conform to current year segment presentation.

17.  CONTINGENCIES AND COMMITMENTS

In August 2010, the California Air Resources Board (“CARB”) filed a civil complaint in the Los Angeles Superior Court against the Company and Franklin Fueling Systems, Inc. (a wholly-owned subsidiary of the Company).  The complaint relates to a third-party-supplied component part of the Company's Healy 900 Series nozzle, which is part of the Company's Enhanced Vapor Recovery (“EVR”) Systems installed in California gasoline filling stations.  This part, a diaphragm, was the subject of a retrofit during the first half of 2008.  As the Company has previously reported, in October 2008 CARB issued a Notice of Violation to the Company alleging that the circumstances leading to the retrofit program violated California statutes and regulations.  The Company and CARB worked to resolve the diaphragm matter without court action, but were unable to reach agreement.
 
The claims in the complaint mirror those that CARB presented to the Company in the Notice of Violation, and include claims that the Company negligently and intentionally sold nozzles with a modified diaphragm without required CARB certification.  The Company believes that, throughout the period to which the complaint relates, it acted in full cooperation with CARB and in the best interests of CARB's vapor emissions control program.  Although the complaint seeks penalties of at least $25.0 million, it is the Company's position that there is no reasonable basis for penalties of this amount.

In addition, as the Company has previously reported, the Sacramento Metropolitan Air Quality Management District (“SMAQMD”) issued a Notice of Violation to the Company concerning the diaphragm matter in March 2008.  Discussions with that agency about the circumstances leading to the retrofit in its jurisdiction and the resolution of the agency's concerns did

19



not result in agreement, and in November 2010 SMAQMD filed a civil complaint in the Sacramento Superior Court, mirroring the claims brought by CARB with respect to the diaphragm issue and also alleging violation of SMAQMD rules.  SMAQMD's suit asks for at least $5.0 million in penalties for the violations claimed in its jurisdiction.
 
In July 2010, the Company entered into a tolling agreement with the South Coast Air Quality Management District (“SCAQMD”) and began discussions with that agency about the circumstances leading to the retrofit in its jurisdiction and the resolution of the agency's concerns.  Those discussions did not result in agreement and in December 2010, SCAQMD filed a civil complaint against the Company in Los Angeles Superior Court.  The complaint alleges violations of California statutes and regulations, similar to the complaint filed by CARB, as well as violation of SCAQMD rules, and seeks penalties of at least $12.5 million.  The SCAQMD complaint does not allege an intentional violation of any statute, rule, or regulation. This case has now been consolidated with the CARB case in Los Angeles Superior Court.
 
The Company believes that there is no reasonable basis for the amount of penalties claimed in the SMAQMD and SCAQMD suits.  The Company has answered the SMAQMD and SCAQMD complaints, as well as the CARB complaint, denying liability and asserting affirmative defenses. Discovery in all these cases has commenced.
 
Neither CARB's filing of its suit nor the air district suits have any effect on CARB's certification of the Company's EVR System or any other products of the Company or its subsidiaries, and so do not interfere with continuing sales.  CARB has never decertified the Company's EVR System and does not propose to do so now.
 
The Company remains willing to discuss these matters and work toward resolving them. The Company cannot predict the ultimate outcome of discussions to resolve these matters or any proceedings with respect to them.  Penalties awarded in the CARB or any air district proceedings or payments resulting from a settlement of these matters, depending on the amount, could have a material effect on the Company's results of operations.
 
The Company acquired the Healy product line in September 2006 when it purchased Healy Systems, Inc.  As previously reported, the Company withheld a portion of the purchase price and the earn-out payments otherwise due to James Healy (the principal former owner of Healy Systems) against its claim for indemnification with respect to the diaphragm matter.  Mr. Healy sued the Company in U.S. District Court in New Hampshire, claiming these funds.  In December 2010, the Court ruled, after trial, that the Company was not entitled to indemnification for the diaphragm matter.  The Court also ruled that Mr. Healy was entitled to prejudgment interest on certain of the withheld funds.
 
The Company released the funds withheld on account of the diaphragm matter in January 2011, and in December 2010 recognized a charge of $1.2 million reflecting attorneys' fees for Mr. Healy, on which the Court had not yet ruled, and prejudgment interest.  The Company and Mr. Healy in June 2011 reached an agreement to resolve all their disputes, including Mr. Healy's indemnification obligations with respect to a separate patent matter. The payments for these items closely approximates the prior amounts recognized by the Company.  The New Hampshire litigation has been dismissed and the Company has no pending disputes with Mr. Healy.

On July 31, 2009, Sta-Rite Industries, LLC and Pentair Pump Group, Inc. filed an action against the Company in the U.S District Court for the Northern District of Ohio, alleging breach of the parties' 2004 Settlement Agreement and tortious interference with contract based on the Company's pricing of submersible electric products and seeking damages in excess of $10.0 million for each claimant. The Company denied liability and filed a counterclaim alleging Sta-Rite and Pentair's breach of the same Settlement Agreement. On September 30, 2011 the District Court granted the Company's motion for summary judgment against Sta-Rite and Pentair on both counts of their complaint, and also granted the motion of Pentair and Sta-Rite for summary judgment on the Company's counterclaim. Pentair and Sta-Rite have filed a notice appealing the decision to the U.S. Court of Appeals for the Sixth Circuit. The Company will oppose the appeal and ask that the District Court's decision be affirmed.
The Company is defending various other claims and legal actions, including environmental matters, which have arisen in the ordinary course of business.  In the opinion of management, based on current knowledge of the facts and after discussion with counsel, these claims and legal actions can be successfully defended or resolved without a material adverse effect on the Company’s financial position, results of operations, and net cash flows.

At October 1, 2011, the Company had $6.4 million of commitments primarily for the purchase of machinery and equipment and building expansions.


20




The Company provides warranties on most of its products. The warranty terms vary but are generally two years from date of manufacture or one year from date of installation. In 2007, the Company began offering an extended warranty program to certain Water Systems customers which will provide warranty coverage up to five years from the date of manufacture. Provisions for estimated expenses related to product warranty are made at the time products are sold or when specific warranty issues are identified. These estimates are established using historical information about the nature, frequency, and average cost of warranty claims. The Company actively studies trends of warranty claims and takes action to improve product quality and minimize warranty claims. The Company believes that the warranty reserve is appropriate; however, actual claims incurred could differ from the original estimates, requiring adjustments to the reserve.

The changes in the carrying amount of the warranty accrual, as recorded in “Accrued expenses” in the Company’s condensed consolidated balance sheet for the nine months ended October 1, 2011, are as follows:

(In millions)
 
Balance as of January 1, 2011
$
9.4

Accruals related to product warranties
5.6

Reductions for payments made
(5.7
)
Balance as of October 1, 2011
$
9.3


18. SHARE-BASED COMPENSATION
On April 24, 2009, the Amended and Restated Franklin Electric Co., Inc. Stock Plan (the “Stock Plan”) was approved by the Company’s shareholders.  Under the Stock Plan, employees and non-employee directors may be granted stock options or awards. The Stock Plan was amended and restated to, among other things, increase the number of shares available for issuance from 1,300,000 to 2,200,000 shares as follows:

 
Authorized Shares
Options
1,600,000
Awards
600,000

The Company currently issues new shares from its common stock balance to satisfy option exercises under the Stock Plan and a similar prior plan and stock awards under the Stock Plan.

Stock Option Grants
The fair value of each option award for options granted or vesting 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.

The assumptions used for the Black-Scholes model to determine the fair value of options granted during the nine months ended October 1, 2011 and October 2, 2010, are as follows:

 
 
October 1, 2011

 
October 2, 2010

Risk-free interest rate
 
0.05 - 4.84%

 
1.61 - 3.20%

Dividend yield
 
0.65 - 1.23%

 
0.65 – 1.72%

Weighted-average dividend yield
 
1.07
%
 
0.95
%
Volatility factor
 
0.355 - 0.434

 
0.355 – 0.398

Weighted-average volatility
 
0.432

 
0.396

Expected term
 
1.5 years

 
6.3 years

Forfeiture rate
 
3.59
%
 
2.70
%


21



A summary of the Company’s stock option plans activity and related information for the nine months ended October 1, 2011 and October 2, 2010, is as follows:

(Shares in thousands)
 
October 1, 2011
 
October 2, 2010
 
Stock Options
 
Shares
 
Weighted-Average
Exercise Price
 
Shares
 
Weighted-Average
Exercise Price
Outstanding beginning of period
 
1,817

 
$
27.95

 
1,979

 
$
26.80

Granted
 
113

 
43.43

 
157

 
29.03

Exercised
 
(160
)
 
24.49

 
(149
)
 
17.28

Forfeited
 
(14
)
 
39.27

 
(41
)
 
36.05

Outstanding end of period
 
1,756

 
$
29.17

 
1,946

 
$
27.49

Expected to vest after applying forfeiture rate
 
1,736

 
$
29.19

 
1,919

 
$
27.57

Vested and exercisable end of period
 
1,207

 
$
30.38

 
1,194

 
$
30.09


A summary of the weighted average remaining contractual term and aggregate intrinsic value for the nine months ended October 1, 2011 is as follows:

 
 
Stock Options
 
Weighted-Average
Remaining
Contractual Term
 
Aggregate
Intrinsic Value
(000’s)
Outstanding end of period
 
5.38 years
 
$
16,203

Expected to vest after applying forfeiture rate
 
5.35 years
 
$
15,998

Vested and exercisable end of period
 
4.24 years
 
$
10,022


There were no options granted during the third quarter 2011. The total intrinsic value of options exercised during the third quarter October 1, 2011 and October 2, 2010 was $0.8 million and $0.1 million, respectively.  There were no share-based liabilities paid during the third quarter 2011.

As of October 1, 2011, there was $2.7 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Stock Plan in the form of stock options. That cost is expected to be recognized over a weighted-average period of 1.67 years.

Stock Awards
A summary of the Company’s stock award activity and related information for the nine months ended October 1, 2011 and October 2, 2010, is as follows:

(Shares in thousands)
 
October 1, 2011
 
October 2, 2010
 
 
Nonvested Stock Awards
 
Shares
 
Weighted-Average Grant
 Date Fair Value
 
 
 
Shares
 
Weighted-Average Grant
 Date Fair Value
Nonvested at beginning of period
 
128

 
$
31.86

 
72

 
$
40.12

Awarded
 
68

 
43.40

 
101

 
29.89

Vested
 
(3
)
 
39.12

 
(41
)
 
41.31

Forfeited
 
(20
)
 
47.41

 

 
48.87

Nonvested at end of period
 
173

 
$
34.44

 
132

 
$
32.13


There were no stock awards granted during the third quarter of 2011. As of October 1, 2011, there was $3.7 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Stock Plan in the form of stock awards. That cost is expected to be recognized over a weighted-average period of 2.48 years.

22




19.  RESTRUCTURING
Phase III of the Global Manufacturing Realignment Program was substantially complete as of the end of 2010. In 2011, the Company incurred residual asset write-off and severance expenses related to the completion of Phase III.  In June 2011, the Company announced Phase IV of the Global Manufacturing Realignment Program. The Company will transfer approximately 260,000 annual man hours of manufacturing activity from the Oklahoma City, Oklahoma facility primarily to the Linares, Mexico facility with a small portion of the transfer going to another Oklahoma City based facility. Transfers related to the Oklahoma City facility should be completed by the end of the first quarter 2012. The Company also expects to incur miscellaneous expenses associated with realignments and movements of manufacturing and distribution facilities in a variety of international locations, including the relocation to a new manufacturing facility in Joinville, Brazil.

The Company has estimated the pretax charge for Phase IV to be between $2.6 million and $5.2 million, of which $1.2 million to $3.5 million is for closing the Oklahoma City manufacturing facility. Charges related to Phase IV began in the second quarter of 2011 and will end in the fourth quarter 2012 and include severance, pension curtailments, asset write-offs, and equipment relocation.

Costs incurred in the third quarter and nine months ended October 1, 2011 included in the “Restructuring expense” line of the income statement are as follows:

(In millions)
Third Quarter Ended
 
Nine Months Ended
 
October 1, 2011
 
October 1, 2011
Severance and other employee assistance costs
$
0.3

 
$
0.5

Equipment relocations
0.1

 
0.1

Asset write-off
0.2

 
0.9

Total
$
0.6

 
$
1.5


All incurred expenses were attributed to the Water Systems segment.

As of October 1, 2011 and October 2, 2010, there were $0.2 million and $0.2 million, respectively, in restructuring reserves primarily for severance.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Company changed the accounting method by which it values certain inventory from LIFO to FIFO and has adjusted the prior year inventory balances to reflect the change.  As a result of the retrospective application of this change in accounting principle, certain financial statement line items in the Company’s condensed consolidated balance sheet as of January 1, 2011 and its condensed consolidated statements of income for the quarter and nine months ended October 2, 2010 and statement of cash flows for the nine months ended October 2, 2010 were adjusted. See Note 3 to the Condensed Consolidated Financial Statements (unaudited) included in this Quarterly Report on Form 10-Q.

Third Quarter 2011 vs. Third Quarter 2010

OVERVIEW

Sales were $224.4 million, a record for any third quarter in the Company's history.  The sales increase was related to the Company's acquisitions, sales volume and price increases, as well as the impact of foreign currency translation. The Company's consolidated gross profit was $73.7 million for the third quarter of 2011, an increase of $14.3 million or about 24 percent from the third quarter of 2010. The gross profit as a percent of net sales increased to 32.9 percent for the third quarter of 2011 from 31.5 percent for the third quarter of 2010. Gross profit margin improvement was due to leveraging fixed costs on higher sales, quarter over quarter price improvements, and productivity initiatives, partially offset by higher material costs.


23




RESULTS OF OPERATIONS

Net Sales
Net sales for the third quarter of 2011 were $224.4 million, an increase of $36.0 million or 19 percent compared to 2010 third quarter sales of $188.4 million.  The incremental impact of sales from acquired businesses was $16.5 million or about 9 percent.  Sales revenue increased by $6.2 million or about 3 percent in the third quarter of 2011 due to foreign currency translation. The sales increase for the third quarter of 2011, excluding acquisitions and foreign currency translation, was $13.3 million or about 7 percent.

(In millions)
 
Q3 2011
 
Q3 2010
 
2011 v 2010
 
 
Net Sales
Water Systems
 
$
179.4

 
$
152.9

 
$
26.5

Fueling Systems
 
45.0

 
35.5

 
9.5

Consolidated
 
$
224.4

 
$
188.4

 
$
36.0


Net Sales-Water Systems
Water Systems sales were $179.4 million in the third quarter 2011, an increase of $26.5 million or 17 percent versus the third quarter 2010. Acquisition related sales during the third quarter were $9.9 million or about 6 percent of prior year third quarter sales. Excluding acquisitions, Water Systems sales grew by 11 percent. Foreign currency translation rate changes increased sales $5.7 million, or about 4 percent, compared to sales in the third quarter of 2010. The sales increase for the third quarter of 2011, excluding acquisitions and foreign currency translation, was $10.9 million or about 7 percent.

Water Systems sales in the U.S. and Canada were 41 percent of consolidated sales and grew by 13 percent compared to the third quarter prior year. The Company's growth in the U.S. and Canada was led by sales of pumping systems for industrial and irrigation applications, which increased by about 30 percent during the quarter. The combination of high crop prices, which have led to more discretionary capital for farmers, along with dry conditions in portions of the Southwest and Midwest, have resulted in strong demand for agricultural irrigation products. Sales of pumping systems for residential and light commercial and wastewater applications in the U.S. and Canada grew by about 9 percent compared to the third quarter of the prior year as replacement sales for these products remained robust.

Water Systems sales in EMENA, which is Europe, the Middle East, and North Africa, were 16 percent of consolidated sales and grew by 38 percent, or $10.2 million, compared to the third quarter prior year. Acquisition related sales during the third quarter were $9.9 million and foreign currency translation rate changes increased sales $2.7 million. EMENA sales declined by about 9 percent during the quarter when acquisition and foreign currency translation impacts are excluded, primarily due to continued political and financial uncertainty throughout the region.

Water Systems sales in Latin America were about 12 percent of consolidated sales for the quarter and grew by 20 percent compared to the third quarter prior year. Sales in Latin America were led primarily by double digit growth in Brazil, Mexico and Argentina. Foreign currency translation added $1.5 million or about 7 percent to the growth rate.

Water Systems sales in the Asia Pacific region were 5 percent of consolidated sales and grew by 12 percent compared to the third quarter prior year. Asia Pacific sales growth was widespread across the region with solid double digit gains in several of the largest regional markets including Australia, Japan and China, offset by a decline in sales in South Korea.
  
Water Systems sales in Southern Africa represented 5 percent of consolidated sales during the quarter and were flat compared to the same quarter of the prior year.

During the fourth quarter 2011, a long term submersible motor supply agreement with a major fueling equipment competitor will expire and will not be renewed. Over the past several years sales under this agreement have represented about 1 percent of the Company's consolidated sales and these sales have been reflected in the Water Systems segment.

Net Sales-Fueling Systems
Fueling Systems sales were $45.0 million in the third quarter 2011 and increased $9.5 million or about 27 percent from the third quarter 2010. Excluding acquisition sales of $6.6 million, third quarter sales were $38.4 million and grew by about 8 percent, with most of the growth in the U.S. and Canada. This growth was broad based across all product lines in the U.S. and Canada.

24




Cost of Sales
Cost of sales as a percent of net sales for the third quarter of 2011 and 2010 was 67.1 percent and 68.5 percent, respectively. Correspondingly, the gross profit margin increased to 32.9 percent from 31.5 percent. The gross profit margin improvement was due to leveraging fixed costs on higher sales, quarter over quarter price improvements, and productivity initiatives, partially offset by higher material costs.  Direct materials as a percentage of sales increased by 200 basis points compared to the third quarter last year.  The Company's consolidated gross profit was $73.7 million for the third quarter of 2011, up $14.3 million, or 24 percent, from the third quarter of 2010.

Selling, General and Administrative (“SG&A”)
Selling, General and Administrative (SG&A) expenses were $44.8 million in the third quarter of 2011 compared to $39.6 million in the third quarter of 2010, an increase of $5.2 million or about 13 percent. In the third quarter 2011, increases in SG&A attributable to acquisitions were $2.6 million. Additional increases in SG&A costs during the third quarter of 2011 resulted from increased costs for marketing and selling-related expenses, increased research, development and engineering (RD&E) expenses and increased information technology related expenditures for acquisition integrations.

Restructuring Expenses
Restructuring expenses for the third quarter of 2011 were $0.6 million and reduced diluted earnings per share by approximately $0.02. Restructuring expenses in the third quarter of 2011 included severance cost, asset write-down, and manufacturing equipment relocation costs primarily related to the closing of the Siloam Springs facility.  Restructuring expenses for the third quarter of 2010 were $0.2 million and reduced diluted earnings per share by approximately $0.01. Restructuring expenses last year included asset write-down expenses, severance expenses and manufacturing equipment relocation costs and primarily related to the closing of the Siloam Springs facility.

Operating Income
Operating income was $28.3 million in the third quarter of 2011, up $8.7 million from $19.6 million for the third quarter 2010.

(In millions)
 
Q3 2011
 
Q3 2010
 
2011 v 2010
 
 
 
 
As Adjusted
(Note 3)
 
 
 
 
Operating income (loss)
Water Systems
 
$
29.0

 
$
22.5

 
$
6.5

Fueling Systems
 
9.6

 
6.6

 
3.0

Other
 
(10.3
)
 
(9.5
)
 
(0.8
)
Consolidated
 
$
28.3

 
$
19.6

 
$
8.7


There were specific items in the third quarter of 2011 and 2010 that impacted operating income that were not operational in nature.  The third quarter of 2011 included $0.6 million of restructuring charges and in the third quarter of 2010 there were restructuring charges of $0.2 million.

The Company refers to these items as “non-GAAP adjustments” for purposes of presenting the non-GAAP financial measures of operating income after non-GAAP adjustments and operating income margin after non-GAAP adjustments to net sales.  The Company believes this information helps investors understand underlying trends in the Company's business more easily.  The differences between these non-GAAP financial measures and the most comparable GAAP measures are reconciled in the following tables:


25



Operating Income and Margins
 
 
 
 
 
 
 
 
Before and After Non-GAAP Adjustments
 
 
 
 
 
 
 
 
(In millions)
 
 For the Third Quarter 2011
 
 
Water
 
Fueling
 
Corporate
 
Consolidated
Reported Operating Income
 
$
29.0

 
$
9.6

 
$
(10.3
)
 
$
28.3

% Operating Income (Margin) to Net Sales
 
16.2
%
 
21.3
%
 
 
 
12.6
%
Non-GAAP Adjustments:
 
 

 
 

 
 

 
 

Restructuring
 
$
0.6

 
$

 
$

 
$