2011.12.31. 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________

FORM 10-K
_________

ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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)

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, $0.10 par value
 
NASDAQ Global Select 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  o
NO x

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

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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 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).

 YES x
NO o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) 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, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer x
Accelerated Filer o
Non-Accelerated Filer o
Smaller Reporting Company 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 2, 2011 (the last business day of the registrant’s most recently completed second quarter) was $1,085,986,258.  The stock price used in this computation was the last sales price on that date, as reported by NASDAQ Global Select Market. For purposes of this calculation, the registrant has excluded shares held by executive officers and directors of the registrant, including restricted shares and except for shares owned by the executive officers through the registrant's 401K Plan. Determination of stock ownership by non-affiliates was made solely for the purpose of responding to this requirement and the registrant is not bound by this determination for any other purpose.

Number of shares of common stock outstanding at February 15, 2012:
23,348,669 shares

DOCUMENTS INCORPORATED BY REFERENCE

A portion of the Proxy Statement for the Annual Meeting of Shareholders to be held on May 4, 2012 (Part III).



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FRANKLIN ELECTRIC CO., INC.
TABLE OF CONTENTS

 
 
 
Page
PART I.
 
 
Number
 
 
 
 
Item 1.
 
Item 1A.
 
Item 1B.
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
 
 
PART II.
 
 
 
 
 
 
 
Item 5.
 
Item 6.
 
Item 7.
 
Item 7A.
 
Item 8.
 
Item 9.
 
Item 9A.
 
Item 9B.
 
 
 
 
 
PART III.
 
 
 
 
 
 
 
Item 10.
 
Item 11.
 
Item 12.
 
Item 13.
 
Item 14.
 
 
 
 
 
PART IV.
 
 
 
 
 
 
 
Item 15.
 
 
 
 
 
 
 
 
 
 
 
 
 



 


3


PART I

ITEM 1. BUSINESS
 
General
Franklin Electric Co., Inc. is an Indiana corporation founded in 1944 and incorporated in 1946. Except where the context otherwise requires, “Franklin Electric” or the “Company,” shall refer to Franklin Electric Co., Inc. and its consolidated subsidiaries.

The Company, together with its subsidiaries, designs, manufactures and distributes water and fuel pumping systems, composed primarily of submersible motors, pumps, electronic controls and related parts and equipment. The Company's business consists of two reporting segments based on the principal end market served: the Water Systems segment and the Fueling Systems segment. The Company includes unallocated corporate expenses in an “Other” segment that together with the Water Systems and Fueling Systems segments, represent the Company.

The Company's products are sold worldwide. The Company's products are sold by its employee sales force and independent manufacturing representatives. The Company offers normal and customary trade terms to its customers, no significant part of which is of an extended nature. Special inventory requirements are not necessary, and customer merchandise return rights do not extend beyond normal warranty provisions.

The market for the Company's products is highly competitive and includes diversified accounts by size and type. The Company's Water Systems and Fueling Systems products and related equipment are sold to specialty distributors and some original equipment manufacturers (“OEMs”), as well as industrial and petroleum equipment distributors and major oil and utility companies.

Business Segments and Products
Segment and geographic information appears in Note 16, “Segment and Geographic Information,” to the consolidated financial statements.

Water Systems Segment
Water Systems is a global leader in the production and marketing of water pumping systems and is a technical leader in submersible motors, pumps, drives, electronic controls, and monitoring devices. The Water Systems segment designs, manufactures and sells motors, pumps, electronic controls and related parts and equipment primarily for use in groundwater, wastewater, and fuel transfer applications.

Water Systems motors and pumps are used principally for pumping fresh water and wastewater in a variety of residential, agricultural, and industrial applications. Water Systems also manufactures electronic drives and controls for the motors which control functionality and provide protection from various hazards, such as electric surges, over-heating, or dry wells or tanks.

The Water Systems business has grown from a domestic submersible motor manufacturer to a global manufacturer of systems and components for the movement of water and automotive fuels. Highlights of the Water Systems business transformation, from its origins to the present, are as follows:
1950s - Domestic submersible motor manufacturer
1990s - Global manufacturer of submersible motors, electronic drives and controls selling to pump OEMs
2004 - Began to change the business model to include pumps and sell directly to wholesale distributors
2006 - Added adjacent pumping systems, acquired Little Giant Pump Company
2007 - Expanded globally, acquired Pump Brands (Pty) Limited, South Africa
2008 - Continued global expansion, acquired Industrias Schneider SA, Brazil
2009 - International acquisition, Vertical, S.p.A., Italy

During the second quarter of 2011, Franklin Electric acquired eighty percent of the outstanding shares of Impo Motor Pompa Sanayi ve Ticaret A.S. ("Impo") of Izmir, Turkey. Impo is the leading supplier of groundwater pumping equipment in Turkey and has sales of approximately $28.0 million per year. The Impo acquisition, combined with the Company's current presence in the region, provides Franklin Electric with a leading position in the rapidly growing market for groundwater pumping systems throughout the Middle East. It also provides a low cost manufacturing base for supplying the region.

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Water Systems products are sold in highly competitive markets. Water Systems competes in each of its targeted markets based on product design, quality of products and services, performance, availability, and price. The Company's principal competitors in the specialty water products industry are Grundfos Management A/S, Pentair, Inc., and Xylem, Inc. (formerly part of the ITT Corporation).

2011 Water Systems research and development expenditures were primarily related to the following activities:

Pumping system for extracting natural gas from coal seams
Solar powered groundwater pumping system
Improved efficiency effluent and sewage pump product line
New and improved wastewater product offering
Submersible motor technology
Reduced diameter 4-inch submersible pump line

Fueling Systems Segment
Fueling Systems is a global leader in the production and marketing of fuel pumping systems, fuel containment systems, and monitoring and control systems. The Fueling Systems segment designs, manufactures and sells pumps, pipe, sumps, fittings, vapor recovery components, electronic controls, monitoring devices and related parts and equipment primarily for use in submersible fueling system applications.

Fueling Systems has expanded its product offerings through internal development and acquisitions. Highlights of the Fueling Systems history are as follows:

1990s - Domestic manufacturer of submersible turbine pumping systems
2000 - Acquired Advanced Polymer Technology, Inc., a manufacturer of underground pipe for fueling applications, and EBW, Inc., a manufacturer and distributor of fueling hardware components
2006 - Acquired Healy Systems, Inc., a manufacturer of fueling nozzles and vapor recovery systems
2010 - Acquired PetroTechnik Limited, a United Kingdom distributor that designs and sources flexible and lightweight underground pipe
 
Fueling Systems products are sold in highly competitive markets. Fueling Systems competes in each of its targeted markets based on product design, quality of products and services, performance, availability, and price. The Company's principal competitors in the petroleum equipment industry are Danaher Corporation and Dover Corporation.

2011 Fueling Systems research and development expenditures were primarily related to the following activities:

Expansion of the product offering with products designed specifically for use with biofuels such as E85 and biodiesel
Development of a new FMS tank gauge, TS 550 EVO™, an evolution in tank gauge monitoring
Development of the Gemini™ fusion welded secondary containment system
Expansion of the capability of the Incon Optimizer® circuit breaker monitor to include SF6 Gas Monitoring
Development of a vapor recovery nozzle for the European and Asian markets

Research and Development
The Company incurred research and development expense as follows:

(In millions)
2011
 
2010
 
2009
Research and development expense
$
8.2

 
$
7.5

 
$
6.9


Expenses incurred were for activities related to the development of new products, improvement of existing products and manufacturing methods, and other applied research and development.

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

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Raw Materials
The principal raw materials used in the manufacture of the Company’s products are coil and bar steel, stainless steel, copper wire, and aluminum ingot. Major components are 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 supply source 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.

Employees
The Company employed approximately 3,800 persons at the end of 2011.

Major Customers
No single customer accounted for over 10 percent of net sales in 2011, 2010, or 2009. No single customer accounted for over 10 percent of gross accounts receivable in 2011 or 2010.

Backlog
The dollar amount of backlog by segment was as follows:

(In millions)
February 14,
2012
 
February 18,
2011
Water Systems
$
46.5

 
$
41.6

Fueling Systems
6.0

 
10.9

Consolidated
$
52.5

 
$
52.5


The backlog is composed of written orders at prices adjustable on a price-at-the-time-of-shipment basis for products, primarily standard catalog items. All backlog orders are expected to be filled in fiscal 2012.  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, subject to the disclosure in Item 3 - Legal Proceedings, does not believe that such compliance will have any material effect upon the financial position, results of operations, cash flows, or competitive position of the Company.

Available Information
The Company’s website address is www.franklin-electric.com. The Company makes available free of charge on or through its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. Additionally, the Company’s website includes the Company’s corporate governance guidelines, its Board committee charters, and the Company’s code of business conduct and ethics. Information contained on the Company’s website is not part of this annual report on Form 10-K.

ITEM 1A. RISK FACTORS

The following describes the principal risks affecting the Company and its business.  Additional risks and uncertainties, not presently known to the Company or currently deemed immaterial, could negatively impact the Company’s results of operations or financial condition in the future.

The Company’s acquisition strategy entails expense, integration risks, and other risks that could affect the Company’s earnings and financial condition.  One of the Company’s continuing strategies is to increase revenues and expand market share through acquisitions that will provide complementary Water and Fueling Systems products, add to the Company's global reach, or both.  The Company spends significant time and effort expanding existing businesses through identifying, pursuing, completing, and integrating acquisitions, which generate expense whether or not the acquisitions are actually completed. Competition for acquisition candidates may limit the number of opportunities and may result in higher acquisition

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prices.  There is uncertainty related to successfully acquiring, integrating and profitably managing additional businesses without substantial costs, delays or other problems.  There can also be no assurance that acquired companies will achieve revenues, profitability or cash flows that justify the investment in them.  Failure to manage or mitigate these risks could adversely affect the Company’s results of operations and financial condition.
 
The Company’s products are sold in highly competitive markets, by numerous competitors whose actions could negatively impact sales volume, pricing and profitability.  The Company is a global leader in the production and marketing of groundwater and fuel pumping systems.  End user demand, distribution relationships, industry consolidation, new product capabilities of the Company’s competitors or new competitors, and many other factors contribute to a highly competitive environment.  Additionally, some of the Company’s competitors have substantially greater financial resources than the Company.  Although the Company believes that consistency of product quality, timeliness of delivery, service, and continued product innovation, as well as price, are principal factors considered by customers in selecting suppliers, competitive factors previously described may lead to declines in sales or in the prices of all the Company’s products which could have an adverse impact on its results of operations and financial condition.
 
Reduced housing starts adversely affect demand for the Company’s products, thereby reducing revenues and earnings.  Demand for certain Company products is affected by housing starts.  Continuation of the decline in housing starts over the last few years or a continuation or deepening of the 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.  The Company and its suppliers also use natural gas and electricity in manufacturing products and natural gas and electricity prices have historically been volatile.  The Company does not generally engage in commodity hedging for raw materials and energy.  Significant increases in the prices of commodities, sourced components, finished goods, energy or other commodities could cause product prices to increase, which may reduce demand for products or make the Company more susceptible to competition.  Furthermore, in the event the Company is unable to pass along increases in operating costs to its customers, margins and profitability may be adversely affected.
 
The Company is exposed to political, economic and other risks that arise from operating a multinational business.  The Company has significant operations outside the United States, including Europe, South Africa, Brazil, Mexico 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
Inability to obtain raw materials and finished goods in a timely manner from foreign suppliers
Imposition of tariffs, exchange controls or other restrictions
Difficulty in staffing and managing widespread operations and the application of foreign labor regulations
Compliance with foreign laws and regulations
Changes in general economic and political conditions in countries where the Company operates
 
Additionally, the Company’s operations outside the United States could be negatively impacted by changes in treaties, agreements, policies and laws implemented by the United States.
 
If the Company does not anticipate and effectively manage these risks, these factors may have a material adverse impact on its international operations or on the business as a whole.
 
Transferring operations of the Company to lower cost regions may not result in the intended cost benefits.  The Company is continuing its rationalization of manufacturing capacity between all existing manufacturing facilities and the manufacturing complexes in lower cost regions such as Mexico, the Czech Republic and China.  To implement this strategy, the Company must complete the transfer of assets and intellectual property between operations.  Each of these transfers involves the risk of disruption to the Company’s manufacturing capability, supply chain and, ultimately, to the Company’s ability to service customers and generate revenues and profits.

7



The Company has significant investments in foreign entities and has significant sales and purchases in foreign denominated currencies creating exposure to foreign currency exchange rate fluctuations. The Company has significant investments outside the United States, including Europe, South Africa, Brazil, Mexico and China.  Further, the Company has sales and makes purchases of raw materials and finished goods in foreign denominated currencies.  Accordingly, the Company has exposure to fluctuations in foreign currency exchange rates relative to the U.S. dollar.  Foreign currency exchange rate risk is 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. To the extent that these mitigating strategies are not successful, foreign currency rate fluctuations can have a material adverse impact on its international operations or on the business as a whole.
 
Delays in introducing new products or the inability to achieve or maintain market acceptance with existing or new products may cause the Company’s revenues to decrease.  The industries to which the Company belongs are characterized by intense competition, changes in end-user requirements, and evolving product offerings and introductions.  The Company believes future success will depend, in part, on the ability to anticipate and adapt to these factors and offer, on a timely basis, products that meet customer demands.  Failure to successfully develop new and innovative products or to enhance existing products could result in the loss of existing customers to competitors or the inability to attract new business, either of which may adversely affect the Company’s revenues.
 
Certain Company products are subject to regulation and government performance requirements in addition to the warranties provided by the Company.  The Company’s product lines have expanded significantly and certain products are subject to government regulations and standards for manufacture, assembly, and performance in addition to the warranties provided by the Company.  The Company’s failure to meet all such standards or perform in accordance with warranties could result in significant warranty or repair costs, lost sales and profits, damage to the Company’s reputation, fines or penalties from governmental organizations, and increased litigation exposure.  The claims made by the California Air Resources Board and certain local air districts in California, described in Item 3-Legal Proceedings, are examples of the issues and litigation that can arise under these laws and regulations.  Changes to these regulations or standards may require the Company to modify its business objectives and incur additional costs to comply, and any liabilities or penalties actually incurred could have a material adverse effect on the Company's earnings and operating results.
 
The growth of municipal water systems and increased government restrictions on groundwater pumping could reduce demand for private water wells and the Company’s products, thereby reducing revenues and earnings.  Demand for certain Company products is affected by rural communities shifting from private and individual water well systems to city or municipal water systems. Many economic and other factors outside the Company’s control, including Federal and State regulations on water quality, tax credits and incentives, could adversely impact the demand for private and individual water wells. A decline in private and individual water well systems in the United States or other economies in the international markets the Company serves could reduce demand for the Company’s products and adversely impact sales, gross margins and operating results.
 
Demand for Fueling Systems products is impacted by environmental legislation which may cause significant fluctuations in costs and revenues after meeting compliance requirements.  Environmental legislation related to air quality and fueling containment may create demand for certain Fueling Systems products which must be supplied in a relatively short time frame to meet the governmental mandate, as occurred in California in the 2007 - 2009 time period.  During periods of increased demand the Company’s revenues and profitability could increase significantly, although the Company can also be at risk of not having capacity to meet demand or cost overruns due to inefficiencies during ramp up to the higher production levels.  After the Company’s customers have met the compliance requirements, the Company’s revenues and profitability may decrease significantly as the demand for certain products declines substantially.  The risk of not reducing production costs in relation to the decreased demand and reduced revenues could have a material adverse impact on gross margins and the Company's results of operations.
 
Changes in tax legislation regarding our foreign earnings could materially affect our future results. Since the Company operates in different countries and is subject to taxation in different jurisdictions, the Company’s future effective tax rates could be impacted by changes in such countries’ tax laws or their interpretations.  Both domestic and international tax laws are subject to change as a result of changes in fiscal policy, changes in legislation, evolution of regulation and court rulings.  The application of these tax laws and related regulations is subject to legal and factual interpretation, judgment and uncertainty.  Changes to the U.S. international tax laws could limit U.S. deductions for expenses related to un-repatriated foreign-source income and modify the U.S. foreign tax credit and “check-the-box” rules.  The Company cannot predict whether any proposed changes in U.S. tax laws will be enacted into law or what, if any, changes may be made to any such proposals prior to their being enacted into law.  If the U.S. tax laws change in a manner that increases the Company’s tax obligation, it could have a

8


material adverse impact on the Company’s results of operations and financial condition.

The Company has significant goodwill and intangible assets and future impairment of the value of these assets may adversely affect operating results and financial condition. The Company's total assets reflect substantial intangible assets, primarily goodwill. Goodwill results from the Company's acquisitions, representing the excess of the purchase price paid over the fair value of the net assets acquired. Goodwill and indefinite-lived intangible assets are tested annually for impairment during the fourth quarter or as warranted by triggering events. If future operating performance at one or more of the Company's operating segments were to decline significantly below current levels, the Company could incur a non-cash charge to operating earnings for an impairment. Any future determination requiring the recognition of an impairment of a significant portion of the Company's goodwill or intangible assets could have a material adverse impact on the Company's results of operations and financial condition.
The Company's business may be adversely affected by the seasonality of sales and weather conditions. The Company experiences seasonal demand in a number of markets within the Water Systems segment. End-user demand in primary markets follows warm weather trends and is at seasonal highs from April to August in the Northern Hemisphere. Demand for residential and agricultural water systems are also affected by weather-related disasters including heavy flooding and drought. Changes in these patterns could reduce demand for the Company's products and adversely impact sales, gross margins, and operating results.
Additional Risks to the Company. The Company is subject to various risks in the normal course of business. Exhibit 99.1 sets forth risks and other factors that may affect future results, including those identified above, and is incorporated herein by reference.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

The Company maintains its principal executive offices in Bluffton, Indiana (leased).

Manufacturing plants or primary distribution centers in the Water Systems segment are located in Australia (leased), Brazil (owned), Canada (leased), China (leased), the Czech Republic (owned), Germany (owned), Italy (leased), Japan (leased), Mexico (owned), Republic of Botswana (leased), South Africa (owned), Turkey (owned), and the United States (primarily owned).  Within the United States, significant manufacturing and primary distribution facilities are located in Little Rock, Arkansas (leased); Oklahoma City, Oklahoma (owned); and Wilburton, Oklahoma (owned).

Manufacturing plants or primary distribution centers in the Fueling Systems segment are located in China (leased), Germany (leased), and the United States.  Within the United States, a significant manufacturing facility is located in Madison, Wisconsin (leased).

The Company also maintains leased warehouse facilities in Bluffton, Indiana; Fresno, California; Sanford, Florida; Winnipeg, Manitoba, Canada; and Bolton, Ontario, Canada.

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

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 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.

9


 
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 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 and the consolidated CARB and SCAQMD cases are set for trial on May 7, 2012.

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.
 
On July 31, 2009, Sta-Rite Industries, LLC and Pentair, 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 has denied liability, is defending the case vigorously, and has filed a counterclaim alleging Sta-Rite and Pentair's breach of the same Settlement Agreement.  Both the Company and Sta-Rite/Pentair filed Motions for Summary Judgment. The judge granted the Company's motion and dismissed Sta-Rite/Pentair's claims against it in September 2011. The judge also granted Sta-Rite/Pentair's motion for summary judgment and dismissed the Company's counterclaim. Sta-Rite/Pentair is appealing the dismissal of its claims.  The Company cannot predict the ultimate outcome of this litigation, and any settlement or adjudication of this matter, depending on the amount, could have a material effect on the Company's results of operations.

ITEM 4. MINE SAFETY DISCLOSURES

None.

10



EXECUTIVE OFFICERS OF THE REGISTRANT

Current executive officers of the Company, their ages, current position, and business experience during at least the past five years as of December 31, 2011, are as follows:

 
Name
 
Age
 
Position Held
Period Holding Position
R. Scott Trumbull
63
Chairman of the Board of Directors and Chief Executive Officer
2003 - present
Gregg C. Sengstack
53
President and Chief Operating Officer
2011 - present
 
 
Senior Vice President and President, Fueling and International Water Group
2005 - 2011
Robert J. Stone
47
Senior Vice President and President, Americas Water Systems Group
2007 - present
Daniel J. Crose
63
Vice President, Global Water Product Supply
2011 - present
 
 
Vice President, Water Supply
2010 - 2011
 
 
Vice President and Director, North American Operations
2003 - 2010
DeLancey W. Davis
46
Vice President and President, US/Canada Business Unit
2011 - present
 
 
Vice President and President, US/Canada Commercial Business Unit
2010 - 2011
 
 
Vice President and Director of Americas Water Systems
2008 - 2010
 
 
Vice President and Director of Sales, Western Hemisphere Water Systems
2005 - 2008
John J. Haines
48
Vice President, Chief Financial Officer, and Secretary
2008 - present
 
 
Managing Director and Chief Executive Officer, HSBC Auto Finance, a provider of consumer automobile financing
2004 - 2008
Thomas J. Strupp
58
Vice President, Global Human Resources
2010 - present
 
 
Vice President, Franklin Electric and President, Consumer and Specialty Markets Business  Unit
2009 - 2010
 
 
Vice President, Franklin Electric and President, Water Transfer Systems
2008 - 2009
 
 
Vice President, Chief Financial Officer, Secretary, and President Water Transfer Systems
2005 - 2008
Steven W. Aikman
52
Vice President, Global Water Systems Engineering
2010 - present
 
 
Chief Engineer – Fuel Handling Products, Delphi Corporation, a global supplier for the automotive, computing, communications, energy, and consumer accessories markets
2003 - 2010

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.

11



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 February 15, 2012 was 1,024. The Company's stock is traded on the NASDAQ Global Select Market under the symbol FELE.

Dividends paid and the price range per common share as quoted by the NASDAQ Global Select Market for 2011 and 2010 were as follows:

 
Dividends per Share
 
Price per Share
 
2011
 
2010
 
2011
 
2010
 
 

 
 

 
Low
 
High
 
Low
 
High
1st Quarter
$
.130

 
$
.125

 
$
38.62

 
$
46.89

 
$
24.93

 
$
30.95

2nd Quarter
.135

 
.130

 
40.76

 
48.23

 
27.04

 
36.59

3rd Quarter
.135

 
.130

 
32.82

 
51.18

 
27.62

 
34.40

4th Quarter
.135

 
.130

 
34.10

 
52.18

 
32.43

 
41.79


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 31, 2011.

Stock Performance Graph
The following graph compares the Company's cumulative total stockholder return (Common Stock price appreciation plus dividends, on a reinvested basis) over the last five fiscal years with the Palisades U.S. Water Index and the Russell 2000 Index.

 
Hypothetical $100 invested on December 29, 2006 in Franklin Electric common stock, Palisades U.S. Water Index, and Russell 2000 Index, assuming reinvestment of dividends.
 
 
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
FELE
 
$
100

 
$
76

 
$
56

 
$
57

 
$
78

 
$
88

Palisades U.S. Water
 
100

 
120

 
83

 
96

 
108

 
96

Russell 2000
 
100

 
98

 
65

 
83

 
105

 
101


12



ITEM 6. SELECTED FINANCIAL DATA

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

Five Year Financial Summary (a)
(In thousands, except per share amounts and ratios)
2011
 
2010
 
2009
 
2008
 
2007
 
(b)
 
(c)
 
(d)
 
(e)
 
(f)
Operations:
 
 
 
 
 
 
 
 
 
Net sales
$
821,077

 
$
713,792

 
$
625,991

 
$
745,627

 
$
602,025

Gross profit
272,305

 
230,197

 
183,555

 
226,623

 
173,027

Interest expense
10,502

 
9,692

 
9,548

 
10,968

 
8,147

Income tax expense
23,412

 
15,057

 
10,625

 
22,823

 
15,513

Net income attributable to Franklin Electric Co., Inc.
63,099

 
38,914

 
23,245

 
43,911

 
28,811

Depreciation and amortization
25,295

 
24,040

 
25,385

 
24,164

 
20,359

Capital expenditures
21,144

 
12,776

 
13,889

 
26,860

 
28,797

Balance sheet:
 
 
 
 
 
 
 
 
 
Working capital (g)
$
276,386

 
$
269,793

 
$
237,149

 
$
247,688

 
$
230,470

Property, plant, and equipment, net
146,409

 
143,076

 
147,171

 
144,535

 
134,931

Total assets
829,530

 
788,559

 
726,997

 
705,497

 
673,877

Long-term debt
150,000

 
151,245

 
151,242

 
185,528

 
151,287

Shareowners’ equity
448,135

 
426,494

 
396,872

 
360,377

 
390,184

Other data:
 
 
 
 
 
 
 
 
 
Net income attributable to Franklin Electric Co., Inc., to sales
7.7
%
 
5.5
%
 
3.7
%
 
5.9
%
 
4.8
%
Net income attributable to Franklin Electric Co., Inc., to average total assets
7.8
%
 
5.1
%
 
3.2
%
 
6.4
%
 
4.8
%
Current ratio (h)
3.2

 
3.5

 
3.9

 
4.0

 
3.5

Number of common shares outstanding
23,339

 
23,257

 
23,128

 
23,018

 
23,091

Per share:
 
 
 
 
 
 
 
 
 
Market price range
 
 
 
 
 
 
 
 
 
High
$
52.18

 
$
41.79

 
$
34.50

 
$
54.55

 
$
52.55

Low
$
32.82

 
$
24.93

 
$
17.12

 
$
23.76

 
$
36.07

Net income attributable to Franklin Electric Co., Inc., per weighted average common share
$
2.71

 
$
1.68

 
$
1.01

 
$
1.91

 
$
1.25

Net income attributable to Franklin Electric Co., Inc., per weighted average common share, assuming dilution
$
2.65

 
$
1.65

 
$
1.00

 
$
1.89

 
$
1.23

Book value (i)
18.92

 
18.14

 
17.04

 
15.51

 
16.62

Dividends per common share
$
0.54

 
$
0.52

 
$
0.50

 
$
0.50

 
$
0.47

(a)
Prior year presentation has been adjusted to comply with the retrospective application of the Company's inventory accounting principle change since its adoption on January 2, 2011.
(b)
Includes the results of operations of the Company's 80% owned subsidiary, Impo Motor Pompa Sanayi ve Ticaret A.S., since its acquisition in the second quarter of 2011, and 100% of the wholly owned subsidiary, Vertical S.p.A., since the Company's acquisition of the remaining 25% in the fourth quarter of 2011.
(c)
Includes the results of operations of the Company’s wholly owned subsidiary, PetroTechnik Limited, since its acquisition in the third quarter of 2010.
(d)
Includes the results of operations of the Company’s 75% owned subsidiary, Vertical S.p.A., since its acquisition in the first quarter of 2009.

13


(e)
Includes the results of operations of the Company’s wholly owned subsidiaries, Industrias Schneider SA and Western Pump LLC, since their acquisitions in the first and second quarter of 2008, respectively.
(f)
Includes the results of operations of the Company’s wholly owned subsidiaries, Pump Brands (Pty) Limited and the pump division of Monarch Industries Limited, since their acquisitions in the second and third quarter of 2007, respectively.
(g)
Working capital = Current assets minus current liabilities.
(h)
Current ratio = Current assets divided by current liabilities.
(i)
Book value = Shareowners’ equity divided by weighted average common shares, assuming full dilution.

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

The Company changed the accounting principle by which it values certain inventory from the last-in, first-out ("LIFO") method to the first-in, first-out ("FIFO") method 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 consolidated balance sheet as of January 1, 2011, and its consolidated statements of income and statements of cash flows for the years ended January 1, 2011 and January 2, 2010, were adjusted.

2011 vs. 2010

OVERVIEW

Sales and earnings in 2011 were up from last year.  The sales increase was related to the Company's acquisitions, as well as sales volume and price increases and the impact of foreign currency translation. The Company's consolidated gross profit was $272.3 million for 2011, an increase of $42.1 million or about 18 percent from 2010. The gross profit as a percent of net sales increased 100 basis points to 33.2 percent in 2011 from 32.2 percent in 2010. The gross profit margin improvement was due to leveraging fixed costs on higher sales and lower labor and burden cost, partially offset by higher material costs.
 
RESULTS OF OPERATIONS

Net Sales
Net sales in 2011 were $821.1 million, an increase of $107.3 million or 15 percent compared to 2010 sales of $713.8 million.  The incremental impact of sales from acquired businesses was $43.3 million or about 6 percent.  Sales revenue increased by $18.8 million or about 3 percent in 2011 due to foreign currency translation. The sales change in 2011, excluding acquisitions and foreign currency translation, was an increase of $45.2 million or about 6 percent.

(In millions)
2011
 
2010
 
2011 v 2010
 
Net Sales
Water Systems
$
654.1

 
$
583.3

 
$
70.8

Fueling Systems
167.0

 
130.5

 
36.5

Consolidated
$
821.1

 
$
713.8

 
$
107.3


During the fourth quarter 2011, a long term submersible motor supply agreement with a major fueling equipment competitor expired and was not 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-Water Systems
Water Systems sales were $654.1 million in 2011, an increase of $70.8 million or 12 percent versus 2010. The incremental impact of sales from acquired businesses was $18.9 million or about 3 percent.  Foreign currency translation rate changes increased sales $17.8 million, or about 3 percent, compared to sales in 2010. The sales change in 2011, excluding acquisitions and foreign currency translation, was an increase of $34.1 million or about 6 percent.

Water Systems sales in the U.S. and Canada were 39 percent of consolidated sales and grew by 9 percent compared to 2010. Leading the Company's growth in the U.S. and Canada were sales of pumping systems for industrial and irrigation applications, which increased sales by about 28 percent during 2011. 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, has 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 8 percent compared to the prior year as the Company continued to gain

14


share in this market. The 8 percent increase includes an increase in submersible motor sales under the supply agreement mentioned above.

Water Systems sales in EMENA, which is Europe, the Middle East, and North Africa, were 15 percent of consolidated sales and grew by 29 percent compared to the prior year. Acquisition related sales during 2011 were about $19 million. Excluding acquisitions, EMENA sales grew by about 10 percent during 2011. EMENA sales have been impacted by the political and financial uncertainty throughout the region.

Water Systems sales in Latin America were about 13 percent of consolidated sales for 2011 and grew by 14 percent compared to the prior year. Sales continued to be strong in Brazil, Mexico, Argentina and Chile with sales increases in these regions at about 16 percent.

Water Systems sales in the Asia Pacific region were 7 percent of consolidated sales and grew by 12 percent compared to the prior year. Sales in China continued to grow, increasing about 25 percent from the prior year. The year-on-year sales increased 19 percent in the Southeast Asian region. Australia, one of the largest regions, increased at a slower growth rate of 6 percent.

Water Systems sales in Southern Africa represented 6 percent of consolidated sales and declined by 7 percent compared to the prior year. Heavy rains and flooding in South Africa's farm belt and reduced large pump sales in African export markets resulted in lower agricultural and industrial pump and motor sales this year.

Net Sales-Fueling Systems
Fueling Systems sales were $167.0 million in 2011 and increased $36.5 million or about 28 percent from 2010. The incremental impact of sales from acquired businesses was $24.4 million or about 19 percent.  Foreign currency translation rate changes increased sales $1.0 million, or less than 1 percent, compared to sales in 2010. The sales change in 2011, excluding acquisitions and foreign currency translation, was an increase of $11.1 million or about 9 percent.

Fueling Systems achieved solid organic sales gains. Pumping systems sales grew by 15 percent during 2011 as station owners worldwide continue their conversion from suction to pressure pumping technology for dispensing gasoline. Pipe and containment sales grew by 16 percent, excluding the Petrotechnik acquisition, and by 70 percent including the acquisition.

Cost of Sales
Cost of sales as a percent of net sales for 2011 and 2010 was 66.8 percent and 67.8 percent, respectively. Correspondingly, the gross profit margin increased to 33.2 percent from 32.2 percent, a 100 basis point improvement. The gross profit margin improvement was due to leveraging fixed costs on higher sales, lower labor and burden costs, partially offset by higher material costs.  Direct materials as a percentage of sales increased by 150 basis points compared to last year.  The Company's consolidated gross profit was $272.3 million for 2011, up $42.1 million from 2010.

Selling, General and Administrative (“SG&A”)
Selling, general, and administrative (SG&A) expenses were $177.3 million in 2011 and increased by $16.4 million or about 10 percent in 2011 compared to last year. During 2010, Fueling Systems incurred $4.3 million in SG&A expenses for various legal matters. Also in 2010, SG&A was reduced by a $1.2 million gain on the sale of land and building in South Africa. In 2011, increases in SG&A attributable to acquisitions were $8.3 million. Additional increases in SG&A costs during 2011 resulted from information technology ("IT") related expenditures for acquisition integrations, higher research, development, and engineering ("RD&E") expenses, and increased costs for marketing and selling-related expenses. There were also additional Fueling Systems legal matters expenses in 2011 of $0.7 million.

Restructuring Expenses
Restructuring expenses for 2011 were $1.6 million and reduced diluted earnings per share by approximately $0.05. Restructuring expenses in 2011 included $1.1 million in Phase III costs primarily related to the closing of the Siloam Springs facility and $0.5 million in costs related to Phase IV of the Global Manufacturing Realignment Program announced in the second quarter of 2011. Restructuring expenses in 2011 included asset write-down, severance cost and manufacturing equipment relocation costs.  

In total, the Company had previously estimated the cost for Phase III to be between $10.0 million and $12.8 million. The Company actually incurred $12.9 million in Phase III expenses, from December 2008 through the third quarter of 2011.  Approximately $9.1 million of the $12.9 million was for non-cash items.

15



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. The charges began in the second quarter of 2011 and will substantially end in the fourth quarter 2012 and include severance, pension curtailments, asset write-offs, and equipment relocation. The Company incurred $0.5 million in Phase IV, none of which was related to non-cash items.

Restructuring expenses in 2010 were $5.3 million and reduced diluted earnings per share by approximately $0.15. Restructuring expenses last year included asset write-down expenses, severance expenses, pension curtailment and manufacturing equipment relocation costs primarily related to the closing of the Siloam Springs facility.

Operating Income
Operating income was $93.4 million in 2011, up $29.4 million from $64.0 million in 2010.

(In millions)
 
2011
 
2010
 
2011 v 2010
 
 
 
 
As Adjusted
(Note 3)
 
 
 
 
Operating income (loss)
Water Systems
 
$
105.3

 
$
84.0

 
$
21.3

Fueling Systems
 
31.3

 
17.4

 
13.9

Other
 
(43.2
)
 
(37.4
)
 
(5.8
)
Consolidated
 
$
93.4

 
$
64.0

 
$
29.4


There were specific items in 2011 and 2010 that impacted operating income that were not operational in nature.  2011 included $1.6 million of restructuring charges and $0.7 million for certain legal matters. In 2010 there were three such items: a pre-tax expense of $5.3 million in restructuring charges; $4.3 million of expenses for certain legal matters; and a reduction in SG&A of $1.2 million in expenses from the gain on sale of land and building in South Africa.

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 percent operating income to net sales after non-GAAP adjustments to net sales (operating income margin after non-GAAP adjustments).  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:


16


Operating Income and Margins
 
 
 
 
Before and After Non-GAAP Adjustments
 
 
 
 
(in millions)
For the Full Year of 2011
 
Water
Fueling
Corporate
Consolidated
Reported Operating Income
$
105.3

$
31.3

$
(43.2
)
$
93.4

% Operating Income To Net Sales
16.1
%
18.7
%
 
11.4
%
 
 
 
 
 
Non-GAAP Adjustments:
 
 
 
 
Restructuring
$
1.5

$
0.1

$

$
1.6

Legal matters
$

$
0.7

$

$
0.7

Gain on sale of land and building
$

$

$

$

Operating Income after Non-GAAP Adjustments
$
106.8

$
32.1

$
(43.2
)
$
95.7

% Operating Income to Net Sales after Non-GAAP Adjustments (Operating Income Margin after Non-GAAP Adjustments)
16.3
%
19.2
%
 
11.7
%
 
 
 
 
 
 
For the Full Year of 2010
 
Water
Fueling
Corporate
Consolidated
Reported Operating Income
$
84.0

$
17.4

$
(37.4
)
$
64.0

% Operating Income To Net Sales
14.4
%
13.3
%
 
9.0
%
 
 
 
 
 
Non-GAAP Adjustments:
 
 
 
 
Restructuring
$
5.3

$

$

$
5.3

Legal matters
$

$
4.3

$

$
4.3

Gain on sale of land and building
$
(1.2
)
$

$

$
(1.2
)
Operating Income after Non-GAAP Adjustments
$
88.1

$
21.7

$
(37.4
)
$
72.4

% Operating Income to Net Sales after Non-GAAP Adjustments (Operating Income Margin after Non-GAAP Adjustments)
15.1
%
16.6
%
 
10.1
%

Operating Income-Water Systems
Water Systems operating income, after non-GAAP adjustments, was $106.8 million in 2011, an increase of 21 percent versus 2010. The 2011 operating income margin after non-GAAP adjustments was 16.3 percent and increased by 120 basis points compared to 2010. This increased profitability was the result of operating leverage, increases in pricing, and productivity improvements.

Operating Income-Fueling Systems
Fueling Systems operating income after non-GAAP adjustments was $32.1 million in 2011 compared to $21.7 million after non-GAAP adjustments in 2010, an increase of 48 percent. The 2011 operating income margin after non-GAAP adjustments was 19.2 percent and increased by 260 basis points compared to the 16.6 percent of net sales in 2010.
 
Operating Income-Other
Operating income-other is composed primarily of unallocated general and administrative expenses.  General and administrative expenses were higher due to IT expenses and higher RD&E spending.

Interest Expense
Interest expense for 2011 and 2010 was $10.5 million and $9.7 million, respectively.

Other Income or Expense
Other income or expense was a gain of $5.7 million in 2011 and a loss of $0.3 million in 2010.  Included in other income in 2011 was income from equity investments of $2.3 million and interest income of $2.6 million, primarily derived from the investment of cash balances in short-term securities. In conjunction with the Impo acquisition, the Company entered into a forward purchase contract for Turkish lira for a portion of the estimated acquisition price.  The contract was outstanding as of the end of the first quarter of 2011 and resulted in a pre-tax gain included in other income of approximately $0.6 million.  

17



Included in other income/(expense) in 2010 was income from equity investments of $1.0 million and interest income of $1.5 million, primarily derived from the investment of cash balances in short-term securities. Other income or expense in 2010 also included the reversal of indemnification receivables related to contingent tax liabilities for $2.9 million related to an acquisition in a prior year.  The adjustment for the reversal of the uncertain tax position did not have an impact on net income.  The uncertain tax position was originally recorded as a receivable from the sellers pursuant to the terms of the purchase agreement.  The receivable and the tax liability related to the uncertain tax position were reversed in 2010 as the statutory limit for audit of the tax return expired.  Excluding the reversal of the uncertain tax position, “other income or expense” in 2010 would have been about $2.6 million income.

Foreign Exchange
Foreign currency-based transactions produced a loss for 2011 of $1.4 million, primarily due to the Turkish lira.  Foreign currency-based transactions produced a gain in 2010 of $1.0 million, primarily due to the Canadian dollar and South African rand.

Income Taxes
The provision for income taxes in 2011 and 2010 was $23.4 million and $15.1 million, respectively. The tax rate for 2011 was 26.9 percent, however, excluding the impact of discrete events the tax rate was 27.2 percent.  The projected tax rate will continue to be lower than the statutory rate primarily due to the indefinite reinvestment of foreign earnings taxed at rates below the U.S. statutory rate as well as recognition of foreign tax credits.  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. The tax rate for 2010 was 27.4 percent, however, excluding the impact of discrete events the tax rate was 30.2 percent. 

Net Income
Net income for 2011 was $63.7 million compared to 2010 net income of $39.9 million.  Net income attributable to Franklin Electric Co., Inc. for 2011 was $63.1 million, or $2.65 per diluted share, compared to 2010 net income attributable to Franklin Electric Co., Inc. of $38.9 million or $1.65 per diluted share.

2010 vs. 2009

OVERVIEW

Sales and earnings for 2010 were up from 2009. 2010 sales increased 14 percent compared to 2009 sales and 2010 diluted earnings per share increased 65 percent. Earnings for the year increased primarily due to the increased revenue and leveraging of fixed manufacturing costs on the higher sales. The Company generated $94.6 million in cash from operations during 2010 compared to $112.6 million in 2009 and ended 2010 with about $140 million of cash and equivalents compared to about $87 million at year-end 2009. Inventory was $140.2 million at year end 2010, $8.5 million or 6 percent less than at year end 2009. In September of 2010, Franklin Fueling Systems acquired all of the outstanding stock of PetroTechnik Limited for about $12.9 million. The Company purchased approximately $6.9 million, or about 226 thousand shares, of Company stock pursuant to its authorized stock repurchase program during 2010. The Company had no outstanding balance on its revolving debt agreement at year-end 2010 or 2009.

RESULTS OF OPERATIONS

Net Sales

(In millions)
 
2010
 
2009
 
2010 v 2009
 
 
Net Sales
Water Systems
 
$
583.3

 
$
504.8

 
$
78.5

Fueling Systems
 
130.5

 
121.2

 
9.3

Consolidated
 
$
713.8

 
$
626.0

 
$
87.8


Net sales for 2010 were $713.8 million, an increase of $87.8 million or about 14 percent compared to 2009 sales of $626.0 million. Sales revenue increased by $11.7 million or about 2 percent in 2010 due to foreign exchange. The incremental impact of sales from businesses acquired during 2010 was $11.3 million. The sales change for 2010, excluding acquisitions and foreign exchange, was an increase of $64.8 million or about 10 percent.


18


Net Sales-Water Systems
Water Systems sales worldwide were $583.3 million, up $78.5 million or about 16 percent for 2010 compared to 2009. Water Systems revenues represent about 80 percent of the Company's total sales. All of the Water Systems sales growth was organic. Changes in selling price increased net sales by $13.0 million or about 2.5 percent. Sales revenue increased by $12.2 million or about 2 percent in 2010 due to foreign currency translation.

Water Systems sales in the U.S. and Canada represent about half of global Water Systems sales and grew by 17 percent in 2010 versus 2009. In the U.S. and Canada, sales of groundwater pumping systems for residential applications increased by about 22 percent as a result of market share gains. Sales of large groundwater pumping systems for industrial and agricultural applications in the U.S. and Canadian market grew by about 15 percent during the year, and appear to be primarily from farm spending despite relatively wet weather in several important agricultural regions of the U.S. Internationally, Water Systems sales in the developing markets of Latin America, Asia Pacific and Southern Africa, represented about 33 percent of total Water Systems sales and increased by 23 percent in 2010 versus 2009. Sales in Europe, Middle East and North Africa grew by about 5 percent.

In response to rising commodity costs (e.g., aluminum, copper and steel), the Company implemented market price increases for all of the Water Systems businesses globally. The price increases did not apply to all sales and varied by market and product but generally averaged between 3 and 5 percent.

Net Sales-Fueling Systems
Fueling Systems sales worldwide were $130.5 million, an increase of $9.3 million or about 8 percent for 2010 compared to 2009. Fueling Systems revenues represent about 20 percent of the Company's total revenues. Sales from businesses acquired during 2010 were $11.3 million or 9 percent of total sales. Excluding the acquisition, 2010 sales were $119.2 million a decline of about 2 percent. Changes in selling price increased net sales by $2.4 million or about 2 percent. Sales revenue decreased by $0.5 million in 2010 due to foreign currency translation.

Fueling Systems sales in the U.S. and Canada fell by about $11 million. The decline was caused entirely by reduced sales of the Company's vapor recovery products in the State of California, a reduction of 61 percent compared to the prior year or about $16 million in sales revenue in 2010 compared to the prior year. 2010 Fueling Systems sales in the U.S and Canada outside of California grew by about 9 percent. The first quarter 2010 was the last quarter which included significant sales in California to meet that state's regulatory mandates. Fueling Systems sales in international markets increased by about 30 percent during 2010 primarily due to continued demand for vapor control systems in China. Fueling Systems implemented price increases for a portion of its global products averaging approximately 5 percent to offset raw material costs inflation.

Cost of Sales
Cost of sales as a percent of net sales for 2010 and 2009 was 67.8 percent and 70.7 percent, respectively. Correspondingly, the gross profit margin was 32.2 percent for 2010 compared to 29.3 percent for 2009. The Company's gross profit was $230.2 million, an increase of $46.6 million from the $183.6 million in 2009. The gross profit margin improvement was primarily due to leveraging fixed costs on lower fixed cost spending and higher sales. The second largest improvement in gross profit was a result of reduced direct labor and burden costs due to the consolidation of portions of North American manufacturing into the factory complex in Linares, Mexico. The benefit from earnings attributable to acquisitions was about $3.2 million.

Selling, General and Administrative (“SG&A”)
Selling, general, and administrative (“SG&A”) expenses increased by $27.2 million or about 20 percent in 2010 compared to 2009. The Petrotechnik acquisition added $3.1 million of SG&A expenses to the Fueling Systems segment in 2010. SG&A expense as a percent of net sales for 2010 and 2009 was 22.5 percent and 21.3 percent, respectively. The increase in SG&A expenses was primarily a result of higher sales commissions and expenses related to performance-based compensation of $12.7 million. Other increases in SG&A included $7.4 million for various legal matters primarily recognized in the Fueling Systems segment. During the second quarter 2010, Fueling Systems incurred $3.8 million in SG&A expenses for various legal matters. Fueling Systems incurred an additional $1.4 million of SG&A expense principally for legal fees related to these matters. The expenses result from an agreement with a key competitor to settle numerous patent, licensing and fair trade disputes; claims by both the California Air Resources Board and individual air districts in that state relating to components of Fueling Systems' Vapor Recovery Systems products, and other claims involving litigation with James Healy, who sold Healy Systems to the Company in 2006, regarding payments from an escrow fund and earn-out fees under the purchase agreement. Certain of the amounts incurred in these matters, which are subject to indemnification provisions in the Healy purchase agreement, were not expensed and were also at issue in the Healy litigation. During the fourth quarter 2010, the ongoing litigation between Fueling Systems and James Healy was adjudicated in Federal court and as a result Fueling Systems incurred charges of $0.5 million in SG&A expenses. The Healy litigation was fully resolved by agreement of the parties in 2011. Additionally, research, development and engineering expenditures increased in 2010 by $0.8 million.

19



Restructuring Expenses
There were $5.3 million of restructuring expenses in 2010 compared to $6.2 million in 2009. Restructuring expenses include asset impairments, severance expenses, pension charges and manufacturing equipment relocation costs.  The majority of these expenses were related to the previously announced Phase III of the Company's Global Manufacturing Realignment Program which primarily related to the consolidation of the Siloam Springs, Arkansas facility with the Linares, Mexico operation. In 2010, there were additional restructuring expenses of about $1.9 million that were related to acquisitions and other restructuring consistent with the goals of the Company's Global Manufacturing Realignment Program.

As of the end of 2010, Phase III was considered complete.  In total, the Company had previously estimated the cost for Phase III to be between $10.0 million and $12.8 million. The Company actually incurred $11.8 million in Phase III expenses, from December 2008 through the third quarter of 2010.  Approximately $8.2 million of the $11.8 million was for non-cash items.

Operating Income
Operating income was $64.0 million in 2010, up $20.3 million or 46 percent from 2009 operating income of $43.7 million.

(In millions)
 
2010
 
2009
 
2010 v 2009
 
 
As Adjusted
(Note 3)
 
As Adjusted
(Note 3)
 
 
 
 
Operating income (loss)
Water Systems
 
$
84.0

 
$
55.9

 
$
28.1

Fueling Systems
 
17.4

 
20.9

 
(3.5
)
Other
 
(37.4
)
 
(33.1
)
 
(4.3
)
Consolidated
 
$
64.0

 
$
43.7

 
$
20.3


Operating Income-Water Systems
Water Systems operating income was $84.0 million for 2010, up $28.1 million or about 50 percent versus 2009. Operating margins were up 30 percent at 14.4 percent of sales in 2010 versus 11.1 percent in 2009. Operating margins improved primarily as a result of higher sales volume.

Operating Income-Fueling Systems
Fueling Systems operating income was $17.4 million, a decrease of $3.5 million or about 17 percent versus 2009. Operating margins were 13.3 percent of sales versus 17.2 percent in 2009. Fueling Systems operating income declined primarily as a result of higher legal expenses.

Operating Income-Other
Operating income-other is composed primarily of unallocated general and administrative expenses.  General and administrative expense increases were primarily due to higher performance based compensation expenses.

Interest Expense
Interest expense for 2010 and 2009 was $9.7 million and $9.5 million, respectively. Interest expense on outstanding debt in 2010 was lower, due primarily to decreases in debt, and was offset by $0.7 million of interest settlements awarded by the court in the Healy matter described above.

Other Income or Expense
Other income or expense for 2010 was a loss of $0.3 million and was not significant for 2009. Included in other income/ (expense) for 2010 and 2009 was interest income of $1.5 million and $1.1 million, respectively, primarily derived from the investment of cash balances in short-term U.S. treasury and agency securities. Also, included in other income in 2010 and 2009 was income from equity investments of $1.0 million and $0.1 million, respectively. In 2010 and 2009, other expenses included the reversal of indemnification receivables related to contingent tax liabilities for $2.9 million and $1.5 million, respectively.

Foreign Exchange
Foreign currency-based transactions for 2010 and 2009 were gains of $1.0 million and $0.5 million, respectively. The gains in 2010 were primarily due to foreign currency translation gains in the Canadian dollar and South African rand to the U.S. dollar.

20



Income Taxes
The provision for income taxes in 2010 and 2009 was $15.1 million and $10.6 million, respectively. The effective tax rates for 2010 and 2009 were 27.4 and 30.7 percent, respectively. The effective tax rate differs from the United States statutory rate of 35 percent, generally due to foreign income exclusion and due to the effects of state and foreign income taxes, net of federal tax benefits. The Company recorded adjustments in 2010 for uncertain tax positions relating to acquisitions occurring prior to 2010 for which indemnification was provided for in the respective purchase agreements and the reversal of the indemnification asset was recorded in “Other income/(expense)” in the Company's statements of income, a benefit of $2.9 million; and adjustments to the state deferred tax rates due to domestic restructuring, a benefit of $1.6 million. The Company further recorded a valuation allowance of $3.4 million against certain state deferred tax assets as restructuring both domestically and internationally has reduced taxable earnings in the U.S. and the realization of the deferred tax assets cannot be projected with a reasonable amount of certainty. The full year 2010 effective tax rate from operations was about 29.2 percent, higher than the actual tax rate of 27.4 percent, excluding the impact of the reversal of uncertain tax positions, adjustments for domestic state taxes, and other non-operational tax adjustments during 2010.

Net Income
Net income for 2010 was $39.9 million compared to 2009 net income of $24.0 million. Net income attributable to Franklin Electric Co., Inc. for 2010 was $38.9 million, or $1.65 per diluted share, compared to 2009 net income attributable to Franklin Electric Co., Inc. of $23.2 million or $1.00 per diluted share.

CAPITAL RESOURCES AND LIQUIDITY

The Company's primary sources of liquidity are cash on hand, cash flows from operations and funds available under its committed, unsecured, revolving credit agreement maturing on December 14, 2016 (the “Agreement”) in the amount of $150.0 million, and its amended and restated uncommitted note purchase and private shelf agreement (the “Prudential Agreement”) in the amount of $200.0 million, with $150.0 million of notes issued thereunder beginning to mature in 2015. The Company recently renewed the Agreement with an increased borrowing capacity and also an increased allowable leverage ratio, but with otherwise similar terms and conditions that reflected market conditions at the time of renewal. To achieve consistency with the increased allowable leverage ratio under the renewed Agreement, the Company simultaneously amended the comparable provision of the Prudential Agreement. The Company has no scheduled principal payments under the Prudential Agreement until 2015 at which time it amortizes for 5 years at an amount of $30.0 million per year. As of December 31, 2011, the Company had $147.0 million borrowing capacity under the Agreement as $3.0 million in letters of credit were outstanding, and $50.0 million borrowing capacity under the Prudential Agreement.

The Agreement contains customary affirmative and negative covenants. The affirmative covenants include financial statements, notices of material events, conduct of business, inspection of property, maintenance of insurance, compliance with laws and most favored lender obligations. The affirmative covenants also include financial covenants with a maximum leverage ratio of 3.50 to 1.00 and an interest coverage ratio equal to or greater than 3.00 to 1.00. The negative covenants include limitations on loans or advances, investments, and the granting of liens by the Company or its subsidiaries, as well as prohibitions on certain consolidations, mergers, sales and transfers of assets. As of December 31, 2011, the Company was in compliance with all covenants.

Recent volatility in the financial and credit markets has generally not adversely impacted the liquidity of the Company and the Company expects that ongoing requirements for operations, capital expenditures, pension obligations, dividends, and debt service will be adequately funded from cash on hand, operations, and existing credit agreements.

The Company has announced preliminary plans to construct a new Global Corporate Headquarters and Engineering Center of Excellence on property it has acquired in the Fort Wayne, Indiana, metropolitan area.  The approximately 110,000 square foot building is expected to be completed by mid-2013.  Preliminary estimates for the land acquisition and improvement and building construction costs, without giving effect to any economic development incentives, are in the range of approximately $32.0 to $36.0 million.

Regarding liquidity, at December 31, 2011, the Company had $153.3 million of cash on hand at various locations worldwide. Approximately half of the cash on hand was in the U.S. and readily accessible. On a regular basis the Company reviews international cash balances and, if appropriate based on forecasted expenditures and considerations for the post-tax economic efficiency, will reposition cash among its global entities. Cash investments worldwide are invested according to a written policy and are generally in bank demand accounts and bank time deposits with the preservation of principal as the highest priority. Also, historically the Company has generally sourced inputs and sold outputs both in the local currency of operations on a country by country basis, thereby insulating local cash balances from currency volatility.

21



Net cash flows from operating activities were $99.9 million for 2011 compared to $94.6 million in 2010 and $112.6 million in 2009. Net income was up significantly over 2010 primarily due to the sales increase. Cash provided in 2010 was primarily a result of emphasis on reducing inventories, offset by higher accounts receivable due to increased sales. The operating cash flow in 2009 was primarily a result of lower accounts receivable, due to lower sales and the timing of customer payments, reduced inventories, as management focused on reducing inventory levels due to economic and business conditions including the reduced year over year sales, and the timing of tax payments in 2009.  Income taxes were a source of cash in 2009 as tax payments were decreased in 2009, consistent with estimated payment requirements. Operationally, the Company generally experiences a higher working capital investment in the second and third quarter of each year as a result of stronger seasonal activity in the building, agricultural, and other industries in the northern hemisphere. To the extent the Company potentially grows further in the southern hemisphere, this historical pattern may moderate.

Net cash used in investing activities was $65.8 million for 2011 compared to $24.2 million in 2010 and $28.7 million in 2009. The primary increases in investing activities were related to acquisitions and capital spending. During 2011 the Company purchased an 80 percent interest in Impo for $25.1 million, net of cash acquired. The acquisition was funded with cash on hand. The Company also purchased the remaining outstanding 25 percent interest of Vertical S.p.A. for $7.1 million cash paid. Additionally, $21.8 million was spent on property, plant and equipment including the purchase of land for the new Global Corporate Headquarters and Engineering Center of Excellence and a new communications system. During 2010 the Company acquired PetroTechnik Limited for $11.8 million, net of cash acquired. The acquisition was funded with cash on hand. Additionally, $13.7 million was used for property, plant and equipment additions in 2010. During 2009 the Company acquired 75 percent of Vertical S.p.A. for $16.8 million, net of acquired cash. The acquisition was funded with cash on hand. Additionally, $12.0 million was used for property, plant and equipment additions in 2009. In recent history, capital expenditures have been approximately $15.0 to $25.0 million per annum. The Company expects 2012 and 2013 amounts to be elevated primarily due to the Global Corporate Headquarters and Engineering Center of Excellence project. The Company has available to it an attractive source of project related financing that it may choose to use to partially finance this project. Regarding rationale and strategy for potential future acquisitions that impact cash from investing, generally speaking the Company reviews opportunities with an emphasis on increasing global distribution and also with an emphasis on complementary product lines that can be effectively marketed through existing global distribution.

Net cash used in financing activities was $15.5 million in 2011 compared to $14.5 million in 2010 and $47.3 million in 2009. During 2011 the Company completed the repurchase of approximately 250,000 shares of the Company's common stock for $10.6 million pursuant to the Company's stock repurchase program. Dividends in the amount of $12.9 million were paid to shareholders, of which $0.4 million were paid to minority shareholders. During 2010 the Company completed the purchase of approximately 226,500 shares of the Company's common stock for $6.9 million. Dividends in the amount of $12.3 million were paid to shareholders. In 2009, the cash used in financing activities was primarily related to debt repayments, net of debt proceeds, and dividends of $11.9 million paid to shareholders. At least annually the dividend policy is reviewed, and the Company attempts to purchase shares annually to offset dilution of equity awards, but market conditions may prompt a perceived more efficient alternate use of cash. The Company in recent history has not looked to the public capital markets for financing, and under current circumstances the Company does not foresee a need to do so in the near future.

Effective for 2012, the Company redesigned certain retirement plan offerings. The redesign was completed in order to increase standardization of retirement plans among U.S. salaried employees and to reduce the expected cash funding volatility of retirement plans, while at the same time keeping in place a competitive retirement plan offering to attract and retain talent. The Company achieved this by freezing both the Basic Pension Plan and the Cash Balance Plan as of January 1, 2012, with the exception of a certain limited number of Basic Pension Plan participants who will still accrue benefits over a limited sunset period. Also effective January 1, 2012, the Cash Balance Plan was closed (the Basic Pension Plan was previously closed). As of January 1, 2012, the Company instituted a new service-based contribution, supplemental to the existing Company match for employees, into the defined contribution retirement plan offering.

22



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

(In millions)
 
 
Less than
 
 
 
 
 
More than
 
Total
 
1 Year
 
1 - 3 Years
 
3 - 5 Years
 
5 Years
Debt
$
163.7

 
$
13.7

 
$

 
$
60.0

 
$
90.0

Debt interest
48.5

 
9.4

 
17.4

 
13.9

 
7.8

Capital leases
0.3

 
0.3

 

 

 

Operating leases
19.1

 
7.3

 
7.6

 
2.0

 
2.2

Contingent consideration
5.0

 

 
5.0

 

 

Purchase obligations
23.6

 
22.3

 
1.3

 

 

 
$
260.2

 
$
53.0

 
$
31.3

 
$
75.9

 
$
100.0


The calculated interest was based on the fixed rate of 5.79 percent for the Company’s $150.0 million long-term insurance company debt, six month Euro Interbank Offered Rate (“Euribor”) plus one percent paid on subsidiary debt of €0.2 million, $0.2 million at then current exchange rates, maturing in 2012, and $13.5 million of subsidiary debt with interest rates ranging from 3% to 6% with maturity dates ending in 2012.

The Impo Motor Pompa Sanayi ve Ticaret A.S. stock purchase agreement provided for additional contingent payments resulting from an earn-out provision if certain performance criteria are achieved in any year from 2011 to 2013.

Purchase obligations include commitments primarily for the purchase of machinery and equipment, and building expansions.

The Company has pension and other post-retirement benefit obligations not included in the table above which will result in future payments of $7.9 million in 2012.  The Company also has unrecognized tax benefits, none of which are included in the table above.  The unrecognized tax benefits of approximately $5.6 million have been recorded as liabilities and the Company is uncertain as to if or when such amounts may be settled.  Related to the unrecognized tax benefits, the Company has also recorded a liability for potential penalties and interest of $0.5 million.

ACCOUNTING PRONOUNCEMENTS
In December 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2011-12 Comprehensive Income. The new guidance indefinitely defers certain provisions of ASU 2011-5 Statement of Comprehensive Income that required companies to present reclassification adjustments for each component of accumulated other comprehensive income in both net income and the statement in which other comprehensive income is presented. The deferral does not change the primary provisions of ASU 2011-5, as described below. ASU 2011-12 shares the same effective dates as ASU 2011-5 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 2011-12 is not expected to impact the Company's financial position, results of operations or cash flows.
 
In September 2011, the FASB issued 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,

23


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.

CRITICAL ACCOUNTING ESTIMATES
Management’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities.  Management evaluates its estimates on an on-going basis.  Estimates are based on historical experience and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.  There were no material changes to estimates in 2011.

The Company’s critical accounting estimates are identified below:

Allowance for Uncollectible Accounts
Accounts receivable is comprised of balances due from customers net of estimated allowances for uncollectible accounts. In determining allowances, historical collection experience, current trends, aging of accounts receivable, and periodic credit evaluations of customers’ financial condition are analyzed to arrive at appropriate allowances. Allowance levels change as customer-specific circumstances and the other analysis areas previously noted change.  Based on current knowledge, the Company does not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions used to determine the allowance.

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, management’s evaluation of estimated future demand, market conditions and alternative uses for possible excess or obsolete parts, carrying values are adjusted.  The carrying value is reduced regularly to reflect the age and current anticipated product demand. If actual demand differs from the estimates, additional reductions would be necessary in the period such determination is made.  Excess and obsolete inventory is periodically disposed of through sale to third parties, scrapping, or other means.

Business Combinations
The Company follows the guidance under FASB Accounting Standards Codification ("ASC") Topic 805, Business Combinations. The acquisition purchase price is allocated to the assets acquired and liabilities assumed based upon their respective fair values.  The Company shall report in its financial statements provisional amounts for the items for which accounting is incomplete.  Goodwill is adjusted for any changes to provisional amounts made within the measurement period.  The Company utilizes management estimates and an independent third-party valuation firm to assist in determining the fair values of assets acquired and liabilities assumed.  Such estimates and valuations require the Company to make significant assumptions, including projections of future events and operating performance.  The Company has not made any material changes to the method of valuing fair values of assets acquired and liabilities assumed during the last three years.

Redeemable Noncontrolling Interest
The Company held two redeemable noncontrolling interests during 2011. The noncontrolling interests were recorded at fair value as of the respective acquisition dates. The noncontrolling interest holders have the option to require the Company to redeem their ownership interests in the future with cash. The redemption value will be derived using a specified formula based on an earnings multiple adjusted by the net debt position, subject to a redemption floor value at the time of redemption. Impairment assessments are performed on a quarterly basis. The Company made redemption value adjustments of $0.2 million in 2011. As a result, an adjustment to the earnings per share computation was necessary. Redemption value adjustments were not considered material in 2010.

24



Trade Names and Goodwill
According to FASB ASC Topic 350, Intangibles – Goodwill and Other, intangible assets with indefinite lives must be tested for impairment at least annually or more frequently as warranted by triggering events that indicate potential impairment.  The Company uses a variety of methodologies in conducting impairment assessments including income approaches that utilize discounted cash flow models, which the Company believes are consistent with hypothetical market data.  For indefinite-lived assets apart from goodwill, primarily trade names for the Company, if the fair value is less than the carrying amount, an impairment charge is recognized in an amount equal to that excess.  The Company has not made any material changes to the method of evaluating impairments during the last three years.  Based on current knowledge, the Company does not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions used to determine impairment.

In compliance with FASB ASC Topic 350, goodwill is not amortized. Goodwill is tested at the reporting unit level for impairment annually or more frequently as warranted by triggering events that indicate potential impairment.  Reporting units are operating segments or one level below, known as components, which can be aggregated for testing purposes.  The Company’s goodwill is allocated to the Americas Water Systems Group, International Water, and Fueling Systems units.  As the Company’s business model evolves management will continue to evaluate its reporting units and review the aggregation criteria.

In assessing the recoverability of goodwill, the Company determines the fair value of its reporting units by utilizing a combination of both the market value and income approaches. The market value approach compares the reporting units' current and projected financial results to entities of similar size and industry to determine the market value of the reporting unit. The income approach utilizes assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. These cash flows consider factors regarding expected future operating income and historical trends, as well as the effects of demand and competition. The Company may be required to record an impairment if these assumptions and estimates change whereby the fair value of the reporting units is below their associated carrying values. Goodwill included on the balance sheet as of the fiscal year ended 2011 was $168.8 million.

During the fourth quarter of 2011, the Company completed its annual impairment test of indefinite lived trade names and goodwill and determined the fair value of all reporting units were substantially in excess of the respective reporting unit’s carrying value.  Significant judgment is required to determine if an indication of impairment has taken place.  Factors to be considered include the following: adverse changes in operating results, decline in strategic business plans, significantly lower future cash flows, and sustainable declines in market data such as market capitalization.  A 10 percent decrease in the fair value estimates used in the impairment test would not have changed this determination.  The sensitivity analysis required the use of judgment and numerous subjective assumptions, which, if actual experience varies, could result in material differences in the requirements for impairment charges.  Further, an extended downturn in the economy may impact certain components of the operating segments more significantly and could result in changes to the aggregation assumptions and impairment determination.

Income Taxes
Under the requirements of FASB ASC Topic 740, Income Taxes, the Company records deferred tax assets and liabilities for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company analyzes the deferred tax assets and liabilities for their future realization based on the estimated existence of sufficient taxable income.  This analysis considers the following sources of taxable income: prior year taxable income, future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and tax planning strategies that would generate taxable income in the relevant period.  If sufficient taxable income is not projected then the Company will record a valuation allowance against the relevant deferred tax assets.  The Company operates in multiple tax jurisdictions with different tax rates, and determines the allocation of income to each of these jurisdictions based upon various estimates and assumptions. In the normal course of business the Company will undergo tax audits by various tax jurisdictions. Such audits often require an extended period of time to complete and may result in income tax adjustments if changes to the allocation are required between jurisdictions with different tax rates. Although the Company has recorded all probable income tax uncertainties in accordance with FASB ASC Topic 740, these accruals represent estimates that are subject to the inherent uncertainties associated with the tax audit process, and therefore include uncertainties.  Management judgment is required in determining the Company’s provision for income taxes, deferred tax assets and liabilities, which, if actual experience varies, could result in material adjustments to deferred tax assets and liabilities. The Company’s operations involve dealing with uncertainties and judgments in the application of complex tax regulations in multiple jurisdictions. The final taxes paid are dependent upon many factors, including negotiations with taxing authorities in various jurisdictions and resolution of disputes

25


arising from federal, state, and international tax audits.

The Company has not made any material changes to the method of developing the income tax provision during the last three years.  Based on current knowledge, the Company does not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions used to develop the income tax provision.

Pension and Employee Benefit Obligations
With the assistance of the Company’s actuaries, the discount rates used to determine pension and post-retirement plan liabilities are calculated 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. Market conditions have caused the discount rate to move from 5.25 percent last year to 4.75 percent this year for pension plans and from 5.00 percent last year to 4.50 percent this year for postretirement health and life insurance. A change in the discount rate selected by the Company of 25 basis points would result in no change to employee benefit expense and a change of about $4.4 million of liability. The Company consults with actuaries and investment advisors in making its determination of the expected long-term rate of return on plan assets. Using input from these consultations such as long-term investment sector expected returns, the correlations and standard deviations thereof, and the plan asset allocation, the Company has assumed an expected long-term rate of return on plan assets of 8.00 percent as of year-end 2011. This is the result of stochastic modeling showing the 50th percentile median return at least at or above 8.00 percent.  A change in the long-term rate of return selected by the Company of 25 basis points would result in a change of about $0.3 million of employee benefit expense.

Share-Based Compensation
The fair value of each option award 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 are immediately expensed. 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 Company has not made any material changes to the method of estimating fair values during the last three years.  Based on current knowledge, the Company does not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions used to develop the fair value of stock based compensation.
 
FACTORS THAT MAY AFFECT FUTURE RESULTS
This annual report on Form 10-K contains certain forward-looking information, such as statements about the Company’s financial goals, acquisition strategies, financial expectations including anticipated revenue or expense levels, business prospects, market positioning, product development, manufacturing re-alignment, capital expenditures, tax benefits and expenses, and the effect of contingencies or changes in accounting policies.  Forward-looking statements are typically identified by words or phrases such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “may increase,” “may fluctuate,” “plan,” “goal,” “target,” “strategy,” and similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would,” and “could.”  While the Company believes that the assumptions underlying such forward-looking statements are reasonable based on present conditions, forward-looking statements made by the Company involve risks and uncertainties and are not guarantees of future performance. Actual results may differ materially from those forward-looking statements as a result of various factors, including general economic and currency conditions, various conditions specific to the Company’s business and industry, new housing starts, weather conditions, market demand, competitive factors, changes in distribution channels, supply constraints, effect of price increases, raw material costs, technology factors, integration of acquisitions, litigation, government and regulatory actions, the Company’s accounting policies, and other risks, all as described in Item 1A and Exhibit 99.1 of this Form 10-K.  Any forward-looking statements included in this Form 10-K are based upon information presently available. The Company does not assume any obligation to update any forward-looking information, except as required by law.

26



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 currency which the Company is billed for production inputs, prompt settlement of third party and inter-company balances, limited use of foreign currency denominated debt, and maintaining minimal foreign currency denominated cash balances.

The results of operations are exposed to changes in interest rates primarily with respect to borrowings under the Company’s revolving credit agreement (the “Agreement”), where interest rates are tied to the prime rate or London Interbank Offered Rates (LIBOR). The Company had zero borrowings for the year 2011 under the Agreement.  The Company also has exposure to changes in interest rates in the form of the fair value of outstanding fixed rate debt fluctuating in response to changing interest rates. The Company does not, as a matter of policy, enter into derivative contracts for speculative purposes.

27



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)
2011
 
2010
 
2009
 
 
 
As Adjusted (Note 3)
 
As Adjusted (Note 3)
Net sales
$
821,077

 
$
713,792

 
$
625,991

Cost of sales
548,772

 
483,595

 
442,436

Gross profit
272,305

 
230,197

 
183,555

Selling, general, and administrative expenses
177,320

 
160,864

 
133,629

Restructuring expense
1,587

 
5,334

 
6,195

Operating income
93,398

 
63,999

 
43,731

Interest expense
(10,502
)
 
(9,692
)
 
(9,548
)
Other income/(expense)
5,661

 
(299
)
 
(26
)
Foreign exchange income/(expense)
(1,422
)
 
967

 
451

Income before income taxes
87,135

 
54,975

 
34,608

Income taxes
23,412

 
15,057

 
10,625

Net income
$
63,723

 
$
39,918

 
$
23,983

Less: Net income attributable to noncontrolling interests
(624
)
 
(1,004
)
 
(738
)
Net income attributable to Franklin Electric Co., Inc.
$
63,099

 
$
38,914

 
$
23,245

Income per share:
 

 
 

 
 

Basic
$
2.71

 
$
1.68

 
$
1.01

Diluted
$
2.65

 
$
1.65

 
$
1.00

Dividends per common share
$
0.54

 
$
0.52

 
$
0.50


See Notes to Consolidated Financial Statements.

28


FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(In thousands)
2011
 
2010
 
 
 
As Adjusted (Note 3)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
153,337

 
$
140,070

Receivables, less allowances of $2,964 and $2,340, respectively
78,435

 
70,829

Inventories:
 
 
 

Raw material
49,615

 
51,468

Work-in-process
16,047

 
12,461

Finished goods
76,031

 
76,303

 
141,693

 
140,232

Deferred income taxes
11,853

 
13,182

Other current assets
15,165

 
14,787

Total current assets
400,483

 
379,100

 
 
 
 
Property, plant and equipment, at cost:
 

 
 

Land and buildings
85,623

 
84,724

Machinery and equipment
186,525

 
181,291

Furniture and fixtures
24,332

 
20,924

Other
13,059

 
6,323

 
309,539

 
293,262

Less: Allowance for depreciation
(163,130
)
 
(150,186
)
 
146,409

 
143,076

Asset held for sale
1,300

 
2,325

Intangible assets
94,538

 
89,011

Goodwill
168,846

 
165,193

Other assets
17,954

 
9,854

Total assets
$
829,530

 
$
788,559




29


 
2011
 
2010
 
 
 
As Adjusted (Note 3)
LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
45,481

 
$
39,084

Accrued expenses
58,692

 
64,714

Income taxes
5,946

 
4,268

Current maturities of long-term debt and short-term borrowings
13,978

 
1,241

Total current liabilities
124,097

 
109,307

Long-term debt
150,000

 
151,245

Deferred income taxes
15,348

 
17,887

Employee benefit plans
68,746

 
65,967

Other long-term liabilities
15,494

 
8,313

 
 
 
 
Commitments and contingencies (see Note 17)

 

 
 
 
 
Redeemable noncontrolling interest
5,407

 
7,291

 
 
 
 
Shareowners' equity:
 
 
 

Common stock (65,000 shares authorized, $.10 par value) outstanding (23,339 and 23,257, respectively)
2,333

 
2,326

Additional capital
144,609

 
129,705

Retained earnings
350,457

 
313,905

Accumulated other comprehensive loss
(49,264
)
 
(19,442
)
Total shareowners' equity
448,135

 
426,494

Noncontrolling interest
2,303

 
2,055

Total equity
450,438

 
428,549

Total liabilities and equity
$
829,530

 
$
788,559



See Notes to Consolidated Financial Statements.



30


FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)
2011
 
2010
 
2009
 
 
 
As Adjusted (Note 3)
 
As Adjusted (Note 3)
Cash flows from operating activities:
 
 
 
 
 
Net income
$
63,723

 
$
39,918

 
$
23,983

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

 
 

Depreciation and amortization
25,295

 
24,040

 
25,385

Share-based compensation
3,970

 
4,273

 
4,976

Deferred income taxes
3,867

 
9,699

 
(1,543
)
(Gain)/loss on disposals of plant and equipment
2,781

 
(1,632
)
 
3,283

Asset impairment
200

 
2,420

 

Foreign exchange expense
1,422

 
967

 

Excess tax from share-based payment arrangements
(2,495
)
 
(1,321
)
 
(144
)
Changes in assets and liabilities:
 
 
 

 
 

Receivables
(926
)
 
(3,588
)
 
15,968

Inventory
3,923

 
13,519

 
48,168

Accounts payable and accrued expenses
6,827

 
21,373

 
(6,798
)
Income taxes
3,309

 
(2,923
)
 
7,872

Employee benefit plans
(10,769
)
 
(6,745
)
 
(1,604
)
Other
(1,206
)
 
(5,385
)
 
(6,961
)
Net cash flows from operating activities
99,921

 
94,615

 
112,585

Cash flows from investing activities:
 

 
 

 
 

Additions to property, plant, and equipment
(21,846
)
 
(13,709
)
 
(12,039
)
Proceeds from sale of property, plant, and equipment
324

 
1,769

 
73

Additions to intangibles
(1,216
)
 
(439
)
 
(5
)
Cash paid for acquisitions, net of cash acquired
(25,143
)
 
(11,785
)
 
(16,767
)
Purchase of remaining redeemable noncontrolling shares
(7,056
)
 

 

Additional consideration for prior acquisition
(7,765
)
 

 

Loan to customer
(3,318
)
 

 

Proceeds from loan to customer
265

 

 

Net cash flows from investing activities
(65,755
)
 
(24,164
)
 
(28,738
)
Cash flows from financing activities:
 

 
 

 
 

Proceeds from issuance of debt
19,841

 

 
28,000

Repayment of debt
(19,917
)
 
(1,218
)
 
(64,212
)
Proceeds from issuance of common stock
8,910

 
5,015

 
666

Excess tax from share-based payment arrangements
2,495

 
1,321

 
144

Purchases of common stock
(13,910
)
 
(7,242
)
 

Dividends paid
(12,890
)
 
(12,334
)
 
(11,890
)
Net cash flows from financing activities
(15,471
)
 
(14,458
)
 
(47,292
)
Effect of exchange rate changes on cash
(5,428
)
 
(2,798
)
 
3,386

Net change in cash and equivalents
13,267

 
53,195

 
39,941

Cash and equivalents at beginning of period
140,070

 
86,875

 
46,934

Cash and equivalents at end of period
$
153,337

 
$
140,070

 
$
86,875

 

31


Cash paid for income taxes
$
13,841

 
$
13,901

 
$
15,657

Cash paid for interest
$
10,504

 
$
9,693

 
$
9,522

 
 
 
 
 
 
Non-cash items:
 
 
 

 
 

Payable to seller of Impo Motor Pompa Sanayi ve Ticaret A.S.
$
5,038

 
$

 
$

Payable to seller of Vertical S.p.A.
$
370

 
$

 
$

Payable to seller of Healy Systems, Inc.
$

 
$
970

 
$
1,585

Payable to seller of Western Pump LLC
$


$

 
$
118

Additions to property, plant, and equipment, not yet paid
$
187

 
$
889

 
$
1,822

Stock option exercises, forfeitures, or stock retirements
$

 
$

 
$
291



See Notes to Consolidated Financial Statements.

 

32


FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY AND COMPREHENSIVE INCOME/(LOSS)
 
(In thousands)
Common Shares
Outstanding
 
Common Stock
 
Additional Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income/(Loss)
 
Comprehensive Income/(Loss)
 
Noncontrolling
Interest
 
Redeemable Noncontrolling Interest
Balance as of year end 2008
23,018

 
$
2,302

 
$
113,397

 
$
282,714

 
$
(38,036
)
 
 

 
$
1,170

 
$

Net income
 
 
 

 
 

 
23,245

 
 

 
$
23,245

 
521

 
217

Currency translation adjustment
 
 
 

 
 

 
 

 
23,797

 
23,797

 
696

 
545

Minimum pension liability adjustment, net of tax $2,800
 
 
 

 
 

 
 

 
(4,501
)
 
(4,501
)
 
 

 
 

Comprehensive income
 
 
 

 
 

 
 

 
 

 
$
42,541

 
 

 
 

Dividends on common stock
 
 
 

 
 

 
(11,540
)
 
 

 
 

 
 

 
 

Noncontrolling dividend
 
 
 

 
 

 
 

 
 

 
 

 
(350
)
 
 

Common stock issued
36

 
3

 
625

 
 

 
 

 
 

 
 

 
 

Share-based compensation
88

 
9

 
4,967

 
 

 
 

 
 

 
 

 
 

Common stock repurchased or received for stock options exercised
(14
)
 
(1
)
 
 

 
(253
)
 
 

 
 

 
 

 
 

Adjustment to acquired fair value
 
 
 

 
 

 
 

 
 

 
 

 
 

 
6,631

Tax benefit of stock options exercised
 
 
 

 
144

 
 

 
 

 
 

 
 

 
 

Balance as of year end 2009
23,128

 
$
2,313

 
$
119,133

 
$
294,166

 
$
(18,740
)
 
 

 
$
2,037

 
$
7,393

Net income
 
 
 
 
 
 
38,914

 
 
 
$
38,914

 
565

 
439

Currency translation adjustment
 
 
 
 
 
 
 
 
720

 
720

 
(170
)
 
(541
)
Minimum pension liability adjustment, net of tax $700
 
 
 
 
 
 
 
 
(1,422
)
 
(1,422
)
 
 
 
 
Comprehensive income
 
 
 
 
 
 
 
 
 
 
$
38,212

 
 
 
 
Dividends on common stock
 
 
 
 
 
 
(11,957
)
 
 
 
 
 
 
 
 
Noncontrolling dividend
 
 
 
 
 
 
 
 
 
 
 
 
(377
)
 
 
Common stock issued
271

 
28

 
4,987

 
 
 
 
 
 
 
 
 
 
Share-based compensation
97

 
9

 
4,264

 
 
 
 
 
 
 
 
 
 
Common stock repurchased or received for stock options exercised
(239
)
 
(24
)
 
 
 
(7,218
)
 
 
 
 
 
 
 
 
Adjustment to acquired fair value
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Tax benefit of stock options exercised
 
 
 
 
1,321

 
 
 
 
 
 
 
 
 
 
Balance as of year end 2010
23,257

 
$
2,326

 
$
129,705

 
$
313,905

 
$
(19,442
)
 
 
 
$
2,055

 
$
7,291

 

 

 


33


 
Common Shares
Outstanding
 
Common Stock
 
Additional Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income/(Loss)
 
Comprehensive Income/(Loss)
 
Noncontrolling
Interest
 
Redeemable Noncontrolling Interest
Net income
 
 
 
 
 
 
63,099

 
 
 
$
63,099

 
474

 
150

Currency translation adjustment
 
 
 
 
 
 
 
 
(21,391
)
 
(21,391
)
 
223

 
(1,128
)
Minimum pension liability adjustment, net of tax $5,500
 
 
 
 
 
 
 
 
(8,734
)
 
(8,734
)
 
 
 
 
Comprehensive income
 
 
 
 
 
 
 
 
 
 
$
32,974

 
 
 
 
Dividends on common stock
 
 
 
 
 
 
(12,441
)
 
 
 
 
 
 
 
 
Noncontrolling dividend
 
 
 
 
 
 
 
 
 
 
 
 
(449
)
 
 
Common stock issued
353

 
34

 
8,875

 
 
 
 
 
 
 
 
 
 
Share-based compensation
52

 
5

 
3,965

 
 
 
 
 
 
 
 
 
 
Common stock repurchased or received for stock options exercised
(323
)
 
(32
)
 
 
 
(13,878
)
 
 
 
 
 
 
 
 
Purchase of remaining redeemable noncontrolling interest
 
 
 
 
 
 
 
 
303

 
 
 
 
 
(7,655
)
Adjustment to Vertical redemption value
 
 
 
 
 
 
(228
)
 
 
 
 
 
 
 
228

Adjustment to acquired fair value
 
 
 
 
 
 
 
 
 
 
 
 
 
 
6,521

Tax benefit of stock options exercised
 
 
 
 
2,064

 
 
 
 
 
 
 
 
 
 
Balance as of year end 2011
23,339

 
$
2,333

 
$
144,609

 
$
350,457

 
$
(49,264
)
 
 
 
$
2,303

 
$
5,407


Prior year presentation has been adjusted to comply with the retrospective application of a change in accounting principle for inventory (see Note 3).
 
See Notes to Consolidated Financial Statements.

34


FRANKLIN ELECTRIC CO., INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Company--“Franklin Electric” or the “Company” shall refer to Franklin Electric Co., Inc. and its consolidated subsidiaries.

Fiscal Year--The 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 31, 2011 (52 weeks), January 1, 2011 (52 weeks), and January 2, 2010 (52 weeks), and referred to as 2011, 2010, and 2009, respectively.

Principles of Consolidation--The consolidated financial statements include the accounts of Franklin Electric Co., Inc. and its consolidated subsidiaries.  All intercompany transactions have been eliminated.

Business Combinations--The Company allocates the purchase price of its acquisitions to the assets acquired, liabilities assumed, and non-controlling interests acquired based upon their respective fair values at the acquisition date. The Company utilizes management estimates and inputs from an independent third-party valuation firm to assist in determining these fair values. The excess of the acquisition price over these estimated fair values is recorded as goodwill. Goodwill is adjusted for any changes to acquisition date fair value amounts made within the measurement period. Acquisition-related transaction costs are recognized separately from the business combination and expensed as incurred.

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, related 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 incurred expenses of approximately $8.2 million in 2011, $7.5 million in 2010, and $6.9 million in 2009.

Cash and Cash Equivalents--The Company considers cash on hand, demand deposits, and highly liquid investments with an original maturity date of three months or less to be cash and cash equivalents.

Fair Value of Financial Instruments--The carrying amount of long-term debt was $163.7 million at December 31, 2011 and $151.8 million at January 1, 2011.  The estimated fair value of all debt was $179.2 million and $162.0 million at December 31, 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 Company’s off-balance sheet instruments consist of operating leases.

Accounts Receivable, Earned Discounts, and Allowance for Uncollectible Accounts--Accounts receivable are stated at estimated net realizable value. Accounts receivable are comprised of balances due from customers, net of earned discounts and estimated allowances for uncollectible accounts. Earned discounts are based on specific customer agreement terms. In determining allowances for uncollectible accounts, historical collection experience, current trends, aging of accounts receivable, and periodic credit evaluations of customers’ financial condition are reviewed.  The Company believes that the allowance is appropriate; however, actual experience could differ from the original estimates, requiring adjustments to the reserve.

Inventories--Effective January 2, 2011, the Company elected to change its accounting principle of valuing all of its inventories that used the LIFO method to the FIFO method (see Note 3).

Inventories are stated at the lower of cost or market. The majority of the cost of domestic and foreign inventories is determined using the FIFO method with a portion of inventory costs determined using the average cost method. The Company reviews its inventories for excess or obsolete products or components based on an analysis of historical usage and management's evaluation of estimated future demand, market conditions, and alternative uses for possible excess or obsolete parts.

35



Property, Plant, and Equipment--Property, plant, and equipment are stated at cost.  Depreciation of plant and equipment is calculated on a straight line basis over the estimated useful lives of 5 to 20 years for land improvements and buildings, 5 to 10 years for machinery and equipment, and 5 years for furniture and fixtures. Maintenance, repairs, and renewals of a minor nature are expensed as incurred. Betterments and major renewals which extend the useful lives or add to the productive capacity of buildings, improvements, and equipment are capitalized. The Company reviews its property, plant, and equipment for impairment at the asset group level whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Company’s depreciation expense was $19.4 million, $19.5 million, and $20.2 million in 2011, 2010, and 2009, respectively.

Goodwill and Other Intangible Assets--The Company tests goodwill for impairment on an annual basis during the fourth quarter or more frequently as warranted by triggering events that indicate potential impairment. Goodwill is tested at the reporting unit level, which the company has determined to be the Americas Water Systems Group, International Water, and Fueling Systems units. In compliance with Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 350, Intangibles - Goodwill and Other, the Company has evaluated the aggregation criteria and determined that the components within the Americas Water Systems Group and International Water reporting units can be aggregated in 2011.  

In assessing the recoverability of goodwill, the Company determines the fair value of its reporting units by utilizing a combination of both the income and market valuation approaches.  The income approach estimates fair value based upon future revenue, expenses, and cash flows discounted to present value. The market valuation approach estimates fair value using market multipliers of various financial measures compared to a set of comparable public companies.

An indication of impairment exists if the carrying value of the reporting unit is higher than its fair value, as determined by the above approach. The second step of testing as outlined in FASB ASC Topic 350 must be performed to measure the amount of impairment loss. The amount of impairment is determined by comparing the implied fair value of the reporting unit's goodwill to its carrying value in the same manner as if the reporting units were being acquired in a business combination.  The Company would allocate the fair value to all of the reporting unit's assets and liabilities, including any unrecognized intangible assets, in a hypothetical analysis that would calculate the implied fair value of goodwill.  The Company would record an impairment charge for the difference between the implied fair value of goodwill and the recorded goodwill.

The Company also tests indefinite lived intangible assets, primarily trade names, for impairment on an annual basis during the fourth quarter.  In assessing the recoverability of the trade names, the Company determines the fair value using an income approach. The income approach estimates fair value based upon future revenue. An indication of impairment exists if the carrying value of the trade names is higher than the fair value. The Company would record an impairment charge for the difference.

Amortization is recorded and calculated for other definite lived intangible assets on a basis that reflects cash flows over the estimated useful lives.  The weighted average number of years over which each intangible class is amortized is 17 years for patents, 6 years for supply agreements, 15 years for technology, 13 - 20 years for customer relationships, 5 years for software, and 8 years for all others.

Warranty Obligations--Warranty terms are generally two years from date of manufacture or one year from date of installation. The general warranty liability is recorded when revenue is recognized and is based on actual historical return rates from the most recent warranty periods.  In 2007, the Company began offering an extended warranty program to certain Water Systems customers, which provides 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 and expected customer returns. 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.

Income Taxes--Income taxes are accounted for in accordance with FASB ASC Topic 740, Income Taxes.  Under this guidance, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities and net operating loss and credit carry forwards using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.  The Company records a liability for uncertain tax positions by establishing a recognition threshold and measurement attribute for recognition and measurement of a tax position taken or expected to be taken in a tax return.

36



Share-Based Compensation--The Company accounts for compensation costs for all share-based payments based on the grant-date fair value estimated in accordance with fair value provisions.

Pension--The Company makes its determination for pension, postretirement, and post employment benefit plans liabilities based on management estimates and consultation with actuaries, incorporating estimates, and assumptions of future plan service costs, future interest costs on projected benefit obligations, rates of compensation increases, employee turnover rates, anticipated mortality rates, expected investment returns on plan assets, asset allocation assumptions of plan assets, and other factors.

Earnings Per Common Share--Basic and diluted earnings per share are computed and disclosed in accordance with FASB ASC Topic 260, Earnings Per Share. Basic earnings per share are computed based upon earnings available to common shareholders divided by the weighted average number of common shares outstanding. Diluted earnings per share are computed based upon earnings available to common shareholders divided by the weighted average number of common shares outstanding during the period adjusted for the effect of other dilutive securities. The Company utilizes the two-class method to compute earnings available to common shareholders. Under the two-class method, earnings are adjusted by accretion amounts to redeemable noncontrolling interests recorded at redemption value. The adjustments represent dividend distributions, in substance, to the noncontrolling interest holder as the holders have contractual rights to receive an amount upon redemption other than the fair value of applicable shares. As a result, earnings are adjusted to reflect this in substance distribution that is different from other common shareholders.

Translation of Foreign Currencies--All assets and liabilities of foreign subsidiaries in functional currency 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 “Foreign exchange income/(expense)”, as incurred.

Significant Estimates--The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting periods. Significant estimates and assumptions by management affect allowance for uncollectible accounts, inventory valuation, business combinations, redeemable noncontrolling interest, trade names and goodwill, income taxes, pension and employee benefit obligations, and share-based compensation.
 
Although the Company regularly assesses these estimates, actual results could materially differ. The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances.

2. ACCOUNTING PRONOUNCEMENTS
In December 2011, the FASB issued ASU 2011-12 Comprehensive Income. The new guidance indefinitely defers certain provisions of ASU 2011-5 Statement of Comprehensive Income that required companies to present reclassification adjustments for each component of accumulated other comprehensive income in both net income and the statement in which other comprehensive income is presented. The deferral does not change the primary provisions of ASU 2011-5, as described below. ASU 2011-12 shares the same effective dates as ASU 2011-5 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 2011-12 is not expected to impact the Company's financial position, results of operations or cash flows.
 
In September 2011, the FASB issued 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

37


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. CHANGE IN ACCOUNTING PRINCIPLE
During the fiscal year ended December 31, 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 principle of valuing all of its inventories that used the LIFO method to the FIFO method.  As of the fiscal year ended 2010, inventories valued using the LIFO and FIFO methods represented approximately 11% and 85%, respectively, of total inventories with the remaining inventory recorded using the average cost method. The Company believed the change was preferable because it (1) more closely reflected current acquisition cost and improved the matching of revenue and expense, (2) conformed 96% of the Company's method of inventory valuation to the FIFO method and (3) enhanced comparability with industry peers. The Company applied this change in accounting principle retrospectively to all prior periods presented herein in accordance with FASB ASC Topic 250, Accounting Changes and Error Corrections. As a result of the accounting change, retained earnings as of January 2, 2010 and January 3, 2009 increased from $285.5 million to $294.2 million and $271.3 million to $282.7 million, respectively.  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.
 
As a result of the retrospective application of this change in accounting principle, certain financial statement line items in the Company's consolidated balance sheet as of January 1, 2011, and its consolidated statements of income and consolidated statements of cash flows for the fiscal years ended January 1, 2011 and January 2, 2010, were adjusted as presented below:

38


Consolidated Statements of Income
 
Year Ended January 1, 2011
(In thousands, except per share amounts)
 
As Originally
 
 
 
Effect of
 
 
Reported
 
As Adjusted
 
Change
Cost of sales
 
$
483,492

 
$
483,595

 
$
103

Operating income
 
64,102

 
63,999

 
(103
)
Income taxes
 
15,106

 
15,057

 
(49
)
Net income
 
39,972

 
39,918

 
(54
)
Net income attributable to Franklin Electric Co., Inc.
 
38,968

 
38,914

 
(54
)
Income per share:
 
 

 
 

 
 

Basic
 
$
1.68

 
$
1.68

 
$

Diluted
 
$
1.66

 
$
1.65

 
$
(0.01
)
 
 
 
 
 
 
 
 
 
Year Ended January 2, 2010
 
 
As Originally
 
 
 
Effect of
 
 
Reported