Document

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

FORM 10-Q
_________

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 1, 2016

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.)
 
 
 
9255 Coverdale Road
 
 
Fort Wayne, Indiana
 
46809
(Address of principal executive offices)
 
(Zip Code)

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

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 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

1



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

YES  o
NO x

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

 
 
Outstanding at
Class of Common Stock
 
October 24, 2016
$.10 par value
 
46,305,492 shares





2


FRANKLIN ELECTRIC CO., INC.
TABLE OF CONTENTS

 
 
 
Page
PART I.
FINANCIAL INFORMATION
 
Number
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
 
 
 
 
PART II.
OTHER INFORMATION
 
 
 
 
 
 
Item 1A.
 
Item 2.
 
Item 6.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



 


3


PART I - FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
Third Quarter Ended
 
Nine Months Ended
(In thousands, except per share amounts)
October 1, 2016
 
October 3, 2015
 
October 1, 2016
 
October 3, 2015
 
 
 
 
 
 
 
 
Net sales
$
239,755

 
$
232,485

 
$
710,266

 
$
705,640

Cost of sales
154,286

 
155,693

 
459,883

 
477,150

Gross profit
85,469

 
76,792

 
250,383

 
228,490

Selling, general, and administrative expenses
55,373

 
47,722

 
165,672

 
159,160

Restructuring (income)/expense
(1,715
)
 
1,304

 
(850
)
 
2,525

Operating income
31,811

 
27,766

 
85,561

 
66,805

Interest expense
(1,983
)
 
(2,604
)
 
(6,631
)
 
(7,717
)
Other income, net
1,446

 
1,616

 
2,787

 
6,025

Foreign exchange income/(expense)
399

 
(96
)
 
637

 
(39
)
Income before income taxes
31,673

 
26,682

 
82,354

 
65,074

Income tax expense
7,926

 
5,656

 
20,840

 
7,634

Net income
$
23,747

 
$
21,026

 
$
61,514

 
$
57,440

Less: Net income attributable to noncontrolling interests
(83
)
 
(201
)
 
(411
)
 
(656
)
Net income attributable to Franklin Electric Co., Inc.
$
23,664

 
$
20,825

 
$
61,103

 
$
56,784

Income per share:
 
 
 
 
 
 
 
Basic
$
0.51

 
$
0.44

 
$
1.29

 
$
1.18

Diluted
$
0.50

 
$
0.43

 
$
1.28

 
$
1.17

Dividends per common share
$
0.1000

 
$
0.0975

 
$
0.2975

 
$
0.2850


See Notes to Condensed Consolidated Financial Statements.

4


FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
(Unaudited)
 
Third Quarter Ended
 
Nine Months Ended
(In thousands)
October 1, 2016
 
October 3, 2015
 
October 1, 2016
 
October 3, 2015
 
 
 
 
 
 
 
 
Net income
$
23,747

 
$
21,026

 
$
61,514

 
$
57,440

Other comprehensive income/(loss), before tax:
 
 
 
 
 
 
 
     Foreign currency translation adjustments
(1,837
)
 
(26,305
)
 
12,096

 
(54,500
)
     Employee benefit plan activity
742

 
988

 
2,227

 
2,963

Other comprehensive income/(loss)
(1,095
)
 
(25,317
)
 
14,323

 
(51,537
)
Income tax expense related to items of other comprehensive income/(loss)
(266
)
 
(333
)
 
(798
)
 
(1,000
)
Other comprehensive income/(loss), net of tax
(1,361
)
 
(25,650
)
 
13,525

 
(52,537
)
Comprehensive income/(loss)
22,386

 
(4,624
)
 
75,039

 
4,903

Less: Comprehensive income/(loss) attributable to noncontrolling interests
47

 
(47
)
 
409

 
7

Comprehensive income/(loss) attributable to Franklin Electric Co., Inc.
$
22,339

 
$
(4,577
)
 
$
74,630

 
$
4,896



See Notes to Condensed Consolidated Financial Statements.

5



FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
October 1, 2016
 
January 2, 2016
 
 
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
78,981

 
$
81,561

Receivables, less allowances of $3,860 and $3,801, respectively
152,093

 
127,251

Inventories:
 
 
 
Raw material
82,621

 
82,223

Work-in-process
18,308

 
18,384

Finished goods
114,138

 
93,987

Total inventories
215,067

 
194,594

Other current assets
31,289

 
34,715

Total current assets
477,430

 
438,121

 
 
 
 
Property, plant, and equipment, at cost:
 
 
 

Land and buildings
116,614

 
117,753

Machinery and equipment
246,147

 
233,834

Furniture and fixtures
46,936

 
39,639

Other
25,300

 
19,845

Property, plant, and equipment, gross
434,997

 
411,071

Less: Allowance for depreciation
(236,322
)
 
(221,032
)
Property, plant, and equipment, net
198,675

 
190,039

Asset held for sale

 
1,613

Deferred income taxes
4,897

 
3,461

Intangible assets, net
138,256

 
141,357

Goodwill
202,037

 
199,847

Other assets
23,322

 
21,673

Total assets
$
1,044,617

 
$
996,111






6


 
October 1, 2016
 
January 2, 2016
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
60,695

 
$
57,822

Accrued expenses and other current liabilities
61,003

 
52,109

Income taxes
3,353

 
1,794

Current maturities of long-term debt and short-term borrowings
33,418

 
32,946

Total current liabilities
158,469

 
144,671

Long-term debt
156,712

 
187,806

Deferred income taxes
38,950

 
33,404

Employee benefit plans
40,799

 
47,398

Other long-term liabilities
19,899

 
16,511

 
 
 
 
Commitments and contingencies (see Note 14)

 

 
 
 
 
Redeemable noncontrolling interest
7,597

 
6,856

 
 
 
 
Shareowners' equity:
 
 
 
Common stock (65,000 shares authorized, $.10 par value) outstanding (46,305 and 46,219, respectively)
4,630

 
4,622

Additional capital
225,547

 
216,472

Retained earnings
538,501

 
498,214

Accumulated other comprehensive loss
(148,081
)
 
(161,608
)
Total shareowners' equity
620,597

 
557,700

Noncontrolling interest
1,594

 
1,765

Total equity
622,191

 
559,465

Total liabilities and equity
$
1,044,617

 
$
996,111


See Notes to Condensed Consolidated Financial Statements.



7


FRANKLIN ELECTRIC CO., INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine Months Ended
(In thousands)
October 1, 2016
 
October 3, 2015
 
 
 
 
Cash flows from operating activities:
 
 
 

Net income
$
61,514

 
$
57,440

Adjustments to reconcile net income to net cash flows from operating activities:
 
 
 
Depreciation and amortization
26,752

 
26,804

Share-based compensation
5,912

 
4,579

Deferred income taxes
2,585

 
(5,569
)
Loss on disposals of plant and equipment
200

 
202

Realized gain on share purchase liability

 
(2,723
)
Foreign exchange income/(expense)
(637
)
 
39

Excess tax from share-based payment arrangements

 
(819
)
Changes in assets and liabilities, net of acquisitions
 
 
 
Receivables
(22,088
)
 
(527
)
Inventory
(14,910
)
 
(3,366
)
Accounts payable and accrued expenses
9,333

 
(10,345
)
Income taxes
3,451

 
9,561

Employee benefit plans
(4,825
)
 
(4,020
)
Other, net
3,578

 
(10,915
)
Net cash flows from operating activities
70,865

 
60,341

Cash flows from investing activities:
 
 
 
Additions to property, plant, and equipment
(30,109
)
 
(15,528
)
Proceeds from sale of property, plant, and equipment
5,839

 
959

Cash paid for acquisitions, net of cash acquired
(1,007
)
 
(3,761
)
Additional consideration for prior acquisition, net

 
(127
)
Other, net
174

 
99

Net cash flows from investing activities
(25,103
)
 
(18,358
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of debt
63,984

 
231,615

Repayment of debt
(94,610
)
 
(165,828
)
Proceeds from issuance of common stock
3,192

 
1,240

Excess tax from share-based payment arrangements

 
819

Purchases of common stock
(6,193
)
 
(43,330
)
Dividends paid
(14,483
)
 
(14,393
)
Share purchase liability payment

 
(20,200
)
Net cash flows from financing activities
(48,110
)
 
(10,077
)
Effect of exchange rate changes on cash
(232
)
 
(6,149
)
Net change in cash and equivalents
(2,580
)
 
25,757

Cash and equivalents at beginning of period
81,561

 
59,141

Cash and equivalents at end of period
$
78,981

 
$
84,898

 

8


 
Nine Months Ended
 
October 1, 2016
 
October 3, 2015
Cash paid for income taxes, net of refunds
$
16,673

 
$
10,288

Cash paid for interest
$
7,139

 
$
8,092

 
 
 
 
Non-cash items:
 
 
 

Additions to property, plant, and equipment, not yet paid
$
591

 
$
193

Payable to seller of Bombas Leao
$
24

 
$
24


See Notes to Condensed Consolidated Financial Statements.

 

9


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

1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying condensed consolidated balance sheet as of January 2, 2016, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements as of October 1, 2016, and for the third quarters and nine months ended October 1, 2016 and October 3, 2015 have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations.  In the opinion of management, all accounting entries and adjustments (including normal, recurring adjustments) considered necessary for a fair presentation of the financial position and the results of operations for the interim period have been made. Operating results for the third quarter and nine months ended October 1, 2016 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2016. For further information, including a description of the critical accounting policies of Franklin Electric Co., Inc. (the "Company"), refer to the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended January 2, 2016.

2. ACCOUNTING PRONOUNCEMENTS

Adoption of New Accounting Standards
In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This standard simplifies several aspects of the accounting for employee share-based payment transactions including the recognition of excess tax benefits and deficiencies, the classification of those excess tax benefits on the statement of cash flows, an accounting policy election for forfeitures, the amount an employer can withhold to cover income taxes and still qualify for equity classification, and the classification of those taxes paid on the statement of cash flows. This ASU is effective for annual and interim periods beginning after December 15, 2016 with early adoption permitted.

The Company early adopted ASU 2016-09 during the second quarter ended July 2, 2016. The primary impact of adoption was the recognition of excess tax benefits or deficiencies in the provision for income taxes rather than paid-in capital for all periods in fiscal year 2016. The Company has elected to continue its current policy of estimating forfeitures rather than recognizing forfeitures when they occur.

Under ASU 2016-09, excess income tax benefits from stock-based compensation arrangements are classified as cash flows from operations, rather than as cash flows from financing activities. The Company elected to apply the cash flow presentation requirements prospectively.

The standard also clarifies that cash flows related to employee taxes paid by withheld shares should be classified as a financing activity. This provision had no impact to the Company, because these cash flows have historically been presented as financing activities.

Early adoption of the standard requires reflected adjustments as of January 3, 2016, the beginning of the annual period that includes the interim period of adoption. As such, previously reported first quarter 2016 results were impacted as follows:


10


(In thousands, except per share amounts)
First Quarter Ended April 2, 2016
 
As previously reported
 
Adjustment
 
As adjusted
Income statements:
 
 
 
 
 
Income tax expense
$
4,955

 
$
12

 
$
4,967

Net income attributable to Franklin Electric Co., Inc.
$
13,457

 
$
(12
)
 
$
13,445

 
 
 
 
 
 
Basic earnings per share
$
0.28

 
$

 
$
0.28

Diluted earnings per share
$
0.28

 
$

 
$
0.28

 
 
 
 
 
 
Diluted weighted average shares outstanding
46,445

 
60

 
46,505

 
 
 
 
 
 
Cash flow statements:
 
 
 
 
 
Net cash from operating activities
$
(437
)
 
$
53

 
$
(384
)
Net cash from financing activities
$
3,572

 
$
(53
)
 
$
3,519

 
 
 
 
 
 
Balance sheets:
 
 
 
 
 
Additional capital
$
219,400

 
$
12

 
$
219,412

Retained earnings
$
502,512

 
$
(12
)
 
$
502,500

 
In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability instead of a deferred asset. The standard does not change the amortization of debt issuance costs, which will continue to follow the existing accounting guidance. The Company adopted ASU 2015-03 during the first quarter ended April 2, 2016. The retrospective adoption of this ASU required a total of approximately $0.3 million of unamortized debt issuance costs as of year-end 2015 to be reclassified from "Other assets" and "Other current assets" to a direct deduction from "Long-term debt" in the Company's condensed consolidated balance sheet as of January 2, 2016. In addition, there were no impacts to the Company's results of operations, retained earnings, or cash flows in the current or previous interim and annual reporting periods.

Accounting Standards Issued But Not Yet Adopted
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which supersedes existing guidance on accounting for leases found in Accounting Standards Codification ("ASC") Topic 840. This ASU requires lessees to present right-of-use assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months. The guidance is to be applied using a modified retrospective approach at the beginning of the earliest comparative period in the financial statements and is effective for interim and annual periods beginning after December 15, 2018 with early adoption permitted. The Company is still in the process of analyzing the effect of this new standard to determine the impact on the Company's consolidated financial position, results of operations, cash flows, and related disclosures.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes current revenue recognition guidance. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). ASU 2016-08 clarifies the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. ASU 2016-10 clarifies the implementation guidance on identifying performance obligations. These ASUs are effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, but not before interim and annual reporting periods beginning after December 15, 2016. Entities have the option of using either a full retrospective or a modified retrospective approach to adopt these standards. The Company is still in the process of analyzing the effect of these new standards, including the transition method, to determine the impact on the Company's consolidated financial position, results of operations, cash flows, and related disclosures.


11


3. FAIR VALUE MEASUREMENTS
FASB ASC Topic 820, Fair Value Measurements and Disclosures, provides guidance for defining, measuring, and disclosing fair value within an established framework and hierarchy. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The standard established a fair value hierarchy which requires an entity to maximize the use of observable inputs and to minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value within the hierarchy are as follows:

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

Level 2 – Quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and

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

As of October 1, 2016 and January 2, 2016, the assets measured at fair value on a recurring basis were as set forth in the table below:
 
 
 
(In millions)
October 1, 2016
Quoted Prices in Active Markets for Identical Assets (Level 1)
Significant Other Observable Inputs
(Level 2)
Significant Unobservable Inputs (Level 3)
Cash equivalents
$
3.4

$
3.4

$

$

 
 
 
 
 
 
January 2, 2016
Quoted Prices in Active Markets for Identical Assets (Level 1)
Significant Other Observable Inputs (Level 2)
Significant Unobservable Inputs (Level 3)
Cash equivalents
$
3.9

$
3.9

$

$


The Company's Level 1 assets consist of cash equivalents which are generally made up of foreign bank guaranteed certificates of deposit.

Total debt, including current maturities, have carrying amounts of $190.1 million and $220.7 million and estimated fair values of $194 million and $225 million as of October 1, 2016 and January 2, 2016, respectively. 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 debt, the Company uses estimates based on rates currently available to the Company for debt with similar terms and remaining maturities. Accordingly, the fair value of debt is classified as Level 2 within the valuation hierarchy.

As of October 1, 2016, the Company had no assets held for sale. At January 2, 2016, $1.6 million of assets were held for sale, recorded at carrying value in the Water Systems segment relating to an idle facility in Brazil. The sale of the facility in Brazil was completed during the third quarter of 2016.

4. FINANCIAL INSTRUMENTS
The Company’s deferred compensation stock program is subject to variable plan accounting and, accordingly, is adjusted for changes in the Company’s stock price at the end of each reporting period. The Company has entered into share swap transaction agreements ("the swap") to mitigate the Company’s exposure to the fluctuations in the Company's stock price. The swap has not been designated as a hedge for accounting purposes and is cancellable with 30 days' written notice by either party. As of October 1, 2016, the swap had a notional value based on 205,000 shares. For the third quarter and nine months ended October 1, 2016, the swap resulted in gains of $1.5 million and $2.6 million, respectively. For the third quarter and nine months ended October 3, 2015, the swap resulted in losses of $0.9 million and $1.9 million, respectively. Gains and losses on the swap were primarily offset by gains and losses on the fair value of the deferred compensation stock liability. All gains or losses and expenses related to the swap are recorded in the Company's condensed consolidated statements of income within the “Selling, general, and administrative expenses” line.


12


5. OTHER ASSETS
The Company has equity interests in various companies for various strategic purposes. The investments are accounted for under the equity method and are included in “Other assets” on the Company’s condensed consolidated balance sheets. The carrying amount of the investments is adjusted for the Company's proportionate share of earnings, losses, and dividends. The investments are not considered material to the Company’s financial position, neither individually nor in the aggregate. The Company’s proportionate share of earnings from its equity interests, included in the "Other income, net" line of the Company's condensed consolidated statements of income, were immaterial for the third quarters and nine months ended October 1, 2016 and October 3, 2015.

6. GOODWILL AND OTHER INTANGIBLE ASSETS
The carrying amounts of the Company’s intangible assets are as follows:
(In millions)
 
October 1, 2016
 
January 2, 2016
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
Gross Carrying Amount
 
Accumulated Amortization
Amortized intangibles:
 
 

 
 

 
 

 
 

Patents
 
$
7.5

 
$
(6.4
)
 
$
7.4

 
$
(6.2
)
Technology
 
7.5

 
(5.2
)
 
7.5

 
(4.8
)
Customer relationships
 
135.0

 
(48.4
)
 
132.6

 
(42.3
)
Software
 
2.5

 
(1.8
)
 
2.5

 
(1.7
)
Other
 
0.3

 
(0.3
)
 
1.0

 
(1.0
)
Total
 
$
152.8

 
$
(62.1
)
 
$
151.0

 
$
(56.0
)
Unamortized intangibles:
 
 
 
 
 
 
 
 
Trade names
 
47.6

 

 
46.4

 

Total intangibles
 
$
200.4

 
$
(62.1
)
 
$
197.4

 
$
(56.0
)
 
Amortization expense related to intangible assets for the third quarters ended October 1, 2016 and October 3, 2015 was $2.2 million and $2.1 million, respectively and $6.3 million and $6.5 million for the nine months ended October 1, 2016 and October 3, 2015, respectively.

Amortization expense for each of the five succeeding years is projected as follows:
(In millions)
 
2016
 
2017
 
2018
 
2019
 
2020
 
 
$
8.6

 
$
8.5

 
$
8.4

 
$
8.3

 
$
8.2


The change in the carrying amount of goodwill by reporting segment for the nine months ended October 1, 2016, is as follows:
(In millions)
 
 
 
 
Water Systems
 
Fueling Systems
 
Consolidated
Balance as of January 2, 2016
 
$
136.8

 
$
63.0

 
$
199.8

Acquisitions
 

 
0.8

 
0.8

Foreign currency translation
 
1.7

 
(0.3
)
 
1.4

Balance as of October 1, 2016
 
$
138.5

 
$
63.5

 
$
202.0


7. EMPLOYEE BENEFIT PLANS
Defined Benefit Plans - As of October 1, 2016, the Company maintained two domestic pension plans and three German pension plans. The Company used a January 2, 2016 measurement date for these plans. One of the Company's domestic pension plans covers two management employees (one active employee and one former employee), while the other domestic plan covers all other eligible employees. The two domestic and three German plans collectively comprise the 'Pension Benefits' disclosure caption.

Other Benefits - The Company's other postretirement benefit plan provides health and life insurance to domestic employees hired prior to 1992.

13



The following table sets forth the aggregated net periodic benefit cost for all pension plans for the third quarters and nine months ended October 1, 2016 and October 3, 2015:
(In millions)
Pension Benefits
 
Third Quarter Ended
 
Nine Months Ended
 
October 1, 2016
 
October 3, 2015
 
October 1, 2016
 
October 3, 2015
Service cost
$
0.3

 
$
0.2

 
$
0.8

 
$
0.8

Interest cost
1.6

 
1.9

 
4.7

 
5.5

Expected return on assets
(2.3
)
 
(2.4
)
 
(7.0
)
 
(7.4
)
Amortization of loss
0.6

 
0.8

 
1.9

 
2.4

Net periodic benefit cost
$
0.2

 
$
0.5

 
$
0.4

 
$
1.3

Settlement cost
0.3

 
0.3

 
0.9

 
0.9

Total net periodic benefit cost
$
0.5

 
$
0.8

 
$
1.3

 
$
2.2

 
 
 
 
 
 
 
 
In the nine months ended October 1, 2016, the Company made contributions of $2.1 million to the funded plans. The amount of contributions to be made to the plans during the calendar year 2016 were finalized by September 15, 2016, based upon the plans' year-end valuation at January 2, 2016, and the funding level required for the plans' year ended January 2, 2016.

The following table sets forth the aggregated net periodic benefit cost for the postretirement benefit plan for the third quarters and nine months ended October 1, 2016 and October 3, 2015, respectively:

(In millions)
Other Benefits
 
Third Quarter Ended
 
Nine Months Ended
 
October 1, 2016
 
October 3, 2015
 
October 1, 2016
 
October 3, 2015
Service cost
$

 
$

 
$

 
$

Interest cost
0.1

 
0.1

 
0.3

 
0.3

Expected return on assets

 

 

 

Amortization of prior service cost
0.1

 
0.1

 
0.3

 
0.3

Amortization of loss

 
0.1

 

 
0.3

Net periodic benefit cost
$
0.2

 
$
0.3

 
$
0.6

 
$
0.9

Settlement cost

 

 

 

Total net periodic benefit cost
$
0.2

 
$
0.3

 
$
0.6

 
$
0.9

 
 
 
 
 
 
 
 

8. INCOME TAXES
The Company’s effective tax rate from continuing operations for the nine month period ended October 1, 2016 was 25.3 percent as compared to 11.7 percent for the nine month period ended October 3, 2015.

The effective tax rate continues to be lower than the U.S. 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 U.S. incentives and 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.

In addition during the three month period ended April 4, 2015, the Company settled the liability for the noncontrolling interest of a subsidiary during the first quarter. This transaction created additional accretive benefits for the Company from the reversal of a deferred tax liability created in 2012 when the Company acquired the controlling interest and realized a gain on the then equity investment in such subsidiary. The Company also realized a gain on the mandatorily redeemable noncontrolling interest liability.


14


9. DEBT
Debt consisted of the following:
(In millions)
 
October 1, 2016
 
January 2, 2016
Prudential Agreement
 
$
90.0

 
$
120.0

Tax increment financing debt
 
21.8

 
22.8

New York Life
 
75.0

 
75.0

Capital leases
 
0.1

 
0.1

Foreign subsidiary debt
 
3.5

 
3.1

Less: unamortized debt issuance costs
 
(0.3
)
 
(0.3
)
 
 
$
190.1

 
$
220.7

Less: current maturities
 
(33.4
)
 
(32.9
)
Long-term debt
 
$
156.7

 
$
187.8


Debt outstanding, excluding unamortized debt issuance costs, at October 1, 2016 matures as follows:
(In millions) 
 
Total
 
Year 1
 
Year 2
 
Year 3
 
Year 4
 
Year 5
 
More Than 5 Years
Debt
 
$
190.3

 
$
33.4

 
$
31.1

 
$
31.3

 
$
1.3

 
$
1.2

 
$
92.0

Capital leases
 
0.1

 

 
0.1

 

 

 

 

 
 
$
190.4

 
$
33.4

 
$
31.2

 
$
31.3

 
$
1.3

 
$
1.2

 
$
92.0


10. EARNINGS PER SHARE
The Company calculates basic and diluted earnings per common share using the two-class method. Under the two-class method, net earnings are allocated to each class of common stock and participating security as if all of the net earnings for the period had been distributed. The Company's participating securities consist of share-based payment awards that contain a nonforfeitable right to receive dividends and therefore are considered to participate in undistributed earnings with common shareholders.

Basic earnings per common share excludes dilution and is calculated by dividing net earnings allocable to common shares by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share is calculated by dividing net earnings allocated to common shares by the weighted-average number of common shares outstanding for the period, as adjusted for the potential dilutive effect of non-participating share-based awards.

The following table sets forth the computation of basic and diluted earnings per share:

15


 
Third Quarter Ended
 
Nine Months Ended
(In millions, except per share amounts)
October 1, 2016
 
October 3, 2015
 
October 1, 2016
 
October 3, 2015
Numerator:
 
 
 
 
 
 
 
Net income attributable to Franklin Electric Co., Inc.
$
23.7

 
$
20.8

 
$
61.1

 
$
56.8

Less: Undistributed earnings allocated to participating securities
0.2

 
0.2

 
0.6

 
0.5

Less: Undistributed earnings allocated to redeemable noncontrolling interest
0.1

 
0.2

 
0.8

 
0.4

 
$
23.4

 
$
20.4

 
$
59.7

 
$
55.9

Denominator:
 

 
 

 
 
 
 
Basic
 

 
 

 
 
 
 
Weighted average common shares
46.3

 
46.9

 
46.2

 
47.4

Diluted
 

 
 

 
 
 
 
Effect of dilutive securities:
 

 
 

 
 
 
 
Non-participating employee stock options and performance awards
0.6

 
0.4

 
0.5

 
0.4

Adjusted weighted average common shares
46.9

 
47.3

 
46.7

 
47.8

Basic earnings per share
$
0.51

 
$
0.44

 
$
1.29

 
$
1.18

Diluted earnings per share
$
0.50

 
$
0.43

 
$
1.28

 
$
1.17

Anti-dilutive stock options
0.2

 
0.5

 
0.6

 
0.3


11. EQUITY ROLL FORWARD
The schedule below sets forth equity changes in the nine months ended October 1, 2016:
(In thousands)
Common Stock
 
Additional Paid in Capital
 
Retained Earnings
 
Minimum Pension Liability
 
Cumulative Translation Adjustment
 
Noncontrolling Interest
 
Total Equity
 
Redeemable Noncontrolling Interest
Balance as of January 2, 2016
$
4,622

 
$
216,472

 
$
498,214

 
$
(51,558
)
 
$
(110,050
)
 
$
1,765

 
$
559,465

 
$
6,856

Net income
 
 
 
 
61,103

 
 
 
 
 
458

 
61,561

 
(47
)
Adjustment to Impo redemption value
 
 
 
 
(834
)
 
 
 
 
 
 
 
(834
)
 
834

Dividends on common stock
 
 
 
 
(13,810
)
 
 
 
 
 
 
 
(13,810
)
 
 
Common stock issued
16

 
3,176

 
 
 
 
 
 
 
 
 
3,192

 
 
Common stock repurchased
(21
)
 
 
 
(6,172
)
 
 
 
 
 
 
 
(6,193
)
 
 
Share-based compensation
13

 
5,899

 
 
 
 
 
 
 
 
 
5,912

 
 
Noncontrolling dividend
 
 
 
 
 
 
 
 
 
 
(673
)
 
(673
)
 
 
Currency translation adjustment
 
 
 
 
 
 
 
 
12,098

 
44

 
12,142

 
(46
)
Pension liability, net of tax
 
 
 
 
 
 
1,429

 
 
 
 
 
1,429

 
 
Balance as of October 1, 2016
$
4,630

 
$
225,547

 
$
538,501

 
$
(50,129
)
 
$
(97,952
)
 
$
1,594

 
$
622,191

 
$
7,597



16


12. ACCUMULATED OTHER COMPREHENSIVE INCOME/(LOSS)
Changes in accumulated other comprehensive income/(loss) by component for the nine months ended October 1, 2016 and October 3, 2015, are summarized below:
(In millions)
 
 
 
 
 
For the nine months ended October 1, 2016:
Foreign Currency Translation Adjustments
 
Pension and Post-Retirement Plan Benefit Adjustments
 
Total
Balance as of January 2, 2016
$
(110.1
)
 
$
(51.5
)
 
$
(161.6
)
Other comprehensive income/(loss) before reclassifications:
 
 
 
 
 
Pre-tax income/(loss)
12.1

 

 
12.1

Income tax (expense)/benefit

 

 

Other comprehensive income/(loss) before reclassifications, net of income taxes
12.1

 

 
12.1

Amounts reclassified from accumulated other comprehensive income/(loss):
 
 
 
 
 
Pre-tax income/(loss)

 
2.2

(1)
2.2

Income tax (expense)/benefit

 
(0.8
)
 
(0.8
)
Amounts reclassified from accumulated other comprehensive income/(loss), net of income taxes

 
1.4

 
1.4

Net current period other comprehensive income/(loss), net of income taxes
12.1

 
1.4

 
13.5

Less: Other comprehensive income/(loss) attributable to noncontrolling interests

 

 

Balance as of October 1, 2016
$
(98.0
)
 
$
(50.1
)
 
$
(148.1
)
 
 
 
 
 
 
For the nine months ended October 3, 2015:
 
 
 
 
 
Balance as of January 3, 2015
$
(51.8
)
 
$
(56.1
)
 
$
(107.9
)
Other comprehensive income/(loss) before reclassifications:
 
 
 
 
 
Pre-tax income/(loss)
(54.4
)
 

 
(54.4
)
Income tax (expense)/benefit

 

 

Other comprehensive income/(loss) before reclassifications, net of income taxes
(54.4
)
 

 
(54.4
)
Amounts reclassified from accumulated other comprehensive income/(loss):
 
 
 
 
 
Pre-tax income/(loss)

 
2.9

(1)
2.9

Income tax (expense)/benefit

 
(1.0
)
 
(1.0
)
Amounts reclassified from accumulated other comprehensive income/(loss), net of income taxes

 
1.9

 
1.9

Net current period other comprehensive income/(loss), net of income taxes
(54.4
)
 
1.9

 
(52.5
)
Less: Other comprehensive income/(loss) attributable to noncontrolling interests
(0.6
)
 

 
(0.6
)
Balance as of October 3, 2015
$
(105.6
)
 
$
(54.2
)
 
$
(159.8
)

(1) This accumulated other comprehensive income/(loss) component is included in the computation of net periodic pension cost (refer to Note 7 for additional details) and is included in the "Selling, general, and administrative expenses" line of the Company's condensed consolidated statements of income.

17


13. SEGMENT INFORMATION
Financial information by reportable business segment is included in the following summary:
 
Third Quarter Ended
 
Nine Months Ended
(In millions)
October 1, 2016
 
October 3, 2015
 
October 1, 2016
 
October 3, 2015
 
Net sales to external customers
Water Systems
$
182.0

 
$
173.5

 
$
545.4

 
$
544.3

Fueling Systems
57.8

 
59.0

 
164.9

 
161.3

Other

 

 

 

Consolidated
$
239.8

 
$
232.5

 
$
710.3

 
$
705.6

 
 
 
 
 
 
 
 
 
Third Quarter Ended
 
Nine Months Ended
 
October 1, 2016
 
October 3, 2015
 
October 1, 2016
 
October 3, 2015
 
Operating income/(loss)
Water Systems
$
30.0

 
$
23.1

 
$
85.6

 
$
66.8

Fueling Systems
15.2

 
15.4

 
40.9

 
37.4

Other
(13.4
)
 
(10.7
)
 
(40.9
)
 
(37.4
)
Consolidated
$
31.8

 
$
27.8

 
$
85.6

 
$
66.8

 
 
 
 
 
 
 
 
 
October 1, 2016
 
January 2, 2016
 
 
 
 
 
Total assets
 
 
 
 
Water Systems
$
706.4

 
$
677.6

 
 
 
 
Fueling Systems
250.1

 
248.5

 
 
 
 
Other
88.1

 
70.0

 
 
 
 
Consolidated
$
1,044.6

 
$
996.1

 
 
 
 

Property, plant, and equipment is the major asset group in "Other" of total assets as of October 1, 2016 and January 2, 2016.

14. COMMITMENTS AND CONTINGENCIES
The Company is defending various claims and legal actions which have arisen in the ordinary course of business. In the opinion of management, based on current knowledge of the facts and after discussion with counsel, these claims and legal actions can be defended or resolved without a material effect on the Company’s financial position, results of operations, and net cash flows.

At October 1, 2016, the Company had $20.3 million of commitments primarily for capital expenditures and purchase of raw materials to be used in production.

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

The changes in the carrying amount of the warranty accrual, as recorded in the "Accrued expenses and other current liabilities" line of the Company's condensed consolidated balance sheet for the nine months ended October 1, 2016, are as follows:


18


(In millions)
 
 
Balance as of January 2, 2016
 
$
9.3

Accruals related to product warranties
 
4.6

Reductions for payments made
 
(5.3
)
Balance as of October 1, 2016
 
$
8.6


15. SHARE-BASED COMPENSATION
The Company maintains the Franklin Electric Co., Inc. 2012 Stock Plan (the "2012 Stock Plan"), which is a stock-based compensation plan that provides for discretionary grants of stock options, stock awards, and stock unit awards to key employees and non-employee directors.

The 2012 Stock Plan authorized 2,400,000 shares for issuance as follows:

2012 Stock Plan
 
Authorized Shares
Stock Options
 
1,680,000
Stock/Stock Unit Awards
 
720,000

The Company also maintains the Amended and Restated Franklin Electric Co., Inc. Stock Plan (the "2009 Stock Plan") which, as amended in 2009, provided for discretionary grants of stock options and stock awards. The 2009 Stock Plan authorized 4,400,000 shares for issuance as follows:
2009 Stock Plan
Authorized Shares
Stock Options
3,200,000
Stock Awards
1,200,000

All options in the 2009 Stock Plan have been awarded.

The Company currently issues new shares from its common stock balance to satisfy option exercises and the settlement of stock awards and stock unit awards made under the 2009 Stock Plan and/or the 2012 Stock Plan.

Stock Options:
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.  

The assumptions used for the Black-Scholes model to determine the fair value of options granted during the nine months ended October 1, 2016 and October 3, 2015 are as follows:
 
 
October 1, 2016
 
October 3, 2015
Risk-free interest rate
 
1.21
%
 
1.59
%
Dividend yield
 
1.32
%
 
0.95
%
Volatility factor
 
0.377

 
0.379

Expected term
 
5.5 years

 
5.5 years

Forfeiture rate
 
3.77
%
 
3.67
%

There were no stock options granted during the third quarters ended October 1, 2016 or October 3, 2015.

A summary of the Company’s outstanding stock option activity and related information for the nine months ended October 1, 2016 and October 3, 2015 is as follows:

19


(Shares in thousands)
 
October 1, 2016
 
October 3, 2015
 
 
Stock Options
 
Shares
 
Weighted-Average Exercise Price
 
Shares
 
Weighted-Average Exercise Price
Outstanding at beginning of period
 
1,472

 
$
23.26

 
1,397

 
$
21.17

Granted
 
265

 
29.08

 
185

 
36.67

Exercised
 
(167
)
 
19.09

 
(70
)
 
17.63

Forfeited
 
(5
)
 
33.94

 
(2
)
 
34.93

Outstanding at end of period
 
1,565

 
$
24.66

 
1,510

 
$
23.22

Expected to vest after applying forfeiture rate
 
1,539

 
$
24.53

 
1,491

 
$
23.04

Vested and exercisable at end of period
 
1,082

 
$
20.96

 
1,144

 
$
19.13


A summary of the weighted-average remaining contractual term and aggregate intrinsic value as of October 1, 2016 is as follows:
 
 
Weighted-Average Remaining Contractual Term
 
Aggregate Intrinsic Value (000's)
Outstanding at end of period
 
5.61 years
 
$
25,360

Expected to vest after applying forfeiture rate
 
5.56 years
 
$
25,126

Vested and exercisable at end of period
 
4.23 years
 
$
21,494


The total intrinsic value of options exercised during the nine months ended October 1, 2016 and October 3, 2015 was $3.0 million and $1.3 million, respectively.

As of October 1, 2016, there was $1.9 million of total unrecognized compensation cost related to non-vested stock options granted under the 2012 Stock Plan and the 2009 Stock Plan. That cost is expected to be recognized over a weighted-average period of 2.34 years.

Stock/Stock Unit Awards:
A summary of the Company’s restricted stock/stock unit award activity and related information for the nine months ended October 1, 2016 and October 3, 2015 is as follows:

(Shares in thousands)
 
October 1, 2016
 
October 3, 2015
Restricted Stock/Stock Unit Awards
 
 
Shares
 
Weighted-Average Grant-
Date Fair Value
 
 
Shares
 
Weighted-Average Grant-
Date Fair Value
Non-vested at beginning of period
 
510

 
$
34.43

 
554

 
$
32.72

Awarded
 
172

 
29.45

 
134

 
36.28

Vested
 
(174
)
 
28.30

 
(169
)
 
30.39

Forfeited
 
(27
)
 
34.09

 
(9
)
 
32.31

Non-vested at end of period
 
481

 
$
34.89

 
510

 
$
34.44


As of October 1, 2016, there was $9.2 million of total unrecognized compensation cost related to non-vested restricted stock/stock unit awards granted under the 2012 Stock Plan and the 2009 Stock Plan.  That cost is expected to be recognized over a weighted-average period of 2.38 years.

16. RESTRUCTURING
On July 1, 2014, the Company announced a plan to close its Wittlich, Germany manufacturing facility. As part of this action, the Company is transferring the existing Wittlich manufacturing activity to its Brno, Czech Republic facility. The Company will maintain its European Water Systems headquarters and distribution center in Wittlich, only the manufacturing operations are relocating. The realignment began in the third quarter of 2014 and is expected to conclude by the end of 2016. Charges for the realignment are expected to be approximately $19.4 million and will include severance expenses, professional service fees, asset write-offs, and temporarily leased facilities costs.

20



Costs incurred in the third quarter and nine months ended October 1, 2016, included in the “Restructuring (income)/expense” line of the Company's condensed consolidated statements of income, are as follows:
 
 
Third Quarter Ended
 
 
October 1, 2016
(In millions)
 
Water Systems
 
Fueling Systems
 
Other
 
Consolidated
Employee severance
 
$
0.1

 
$

 
$

 
$
0.1

Equipment relocation
 

 
0.1

 

 
0.1

Asset write-off
 
(2.0
)
 

 

 
(2.0
)
Other
 
0.1

 

 

 
0.1

Total
 
$
(1.8
)
 
$
0.1

 
$

 
$
(1.7
)

 
 
Nine Months Ended
 
 
October 1, 2016
(In millions)
 
Water Systems
 
Fueling Systems
 
Other
 
Consolidated
Employee severance
 
$
0.1

 
$

 
$

 
$
0.1

Equipment relocation
 

 
0.1

 

 
0.1

Asset write-off
 
(2.0
)
 
0.4

 

 
(1.6
)
Other
 
0.5

 

 

 
0.5

Total
 
$
(1.4
)
 
$
0.5

 
$

 
$
(0.9
)

The $2.0 million gain disclosed above within the "asset write-off" caption relates to the sale of a facility in Brazil that was completed during the third quarter of 2016.

Restructuring expenses for the third quarter and nine months ended October 3, 2015 were approximately $1.3 million and $2.5 million, primarily for the Water Systems realignment.

As of October 1, 2016, there were no restructuring reserves. As of October 3, 2015, there were $3.6 million of restructuring reserves. The restructuring reserves were primarily for severance.

17. SUBSEQUENT EVENT
On October 28, 2016, the Company entered into the Third Amended and Restated Credit Agreement among Franklin Electric Co., Inc., Franklin Electric B.V., a Netherlands private company with limited liability (“Franklin B.V”, and together with Franklin Electric Co., Inc., the “Borrowers”), JPMorgan Chase Bank, N.A. (“JPMorgan”), as administrative agent, and Bank of America, N.A., as Syndication Agent, and the lenders identified therein (the “Third Amended and Restated Credit Agreement”. JPMorgan and Bank of America Merrill Lynch were joint bookrunners and joint lead arrangers. The Third Amended and Restated Credit Agreement extended the maturity date of the Company’s Second Amended and Restated Credit Agreement, as amended (which is referred to in this footnote as the “Previous Credit Agreement”) to October 28, 2021 and increased the commitment amount from $150.0 million to $300.0 million.

The Third Amended and Restated Credit Agreement provides that the Borrowers may request an increase in the aggregate commitments by up to $150.0 million (not to exceed a total commitment of $450.0 million) subject to the conditions contained therein. All of the Company's present and future material domestic subsidiaries unconditionally guaranty all of the Borrowers' obligations under and in connection with the Third Amended and Restated Credit Agreement. Additionally, the Company unconditionally guaranties all of the obligations of Franklin B.V. under the Third Amended and Restated Credit Agreement.

Under the Third Amended and Restated Credit Agreement, the Borrowers are required to pay certain fees, including a facility fee of .100% to .275% (depending on the Company's leverage ratio) of the aggregate commitment, which fee is payable quarterly in arrears.

The Third Amended and Restated Credit 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 (using net debt in the measure of leverage ratio, whereas the Previous Credit Agreement used gross debt in such measure) and an interest coverage ratio equal to or greater than 3.00 to 1.00 (using EBITDA in the measure, whereas the Previous Credit Agreement used EBIT). Under the Third Amended and Restated Credit Agreement, the priority debt cap is measured as 20 percent of total tangible assets, whereas the Previous Credit Agreement used net equity rather than total tangible assets. 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 (which restrictions on sales and transfers of assets were reduced to some degree versus the Previous Credit Agreement).

As was the case in the Previous Credit Agreement, the Third Amended and Restated Credit Agreement also contains customary events of defaults (with customary grace periods, as applicable, for certain of those events of default). If an event of default occurs, the Third Amended and Restated Credit Agreement provides that (i) the commitments may be terminated and (ii) the loans then outstanding may be declared due and payable. For certain events of default relating to insolvency, bankruptcy or liquidation, the commitments are automatically terminated and the loans outstanding automatically become due and payable. The full amount of the aggregate commitment may be borrowed as multicurrency loans, in Euros, Japanese Yen, Australian Dollars, Pounds Sterling, Canadian Dollars or any other agreed currency.

As in the Previous Credit Agreement, the Third Amended and Restated Credit Agreement also provides for a swingline loan sub-facility of up to $15.0 million (with an additional discretionary amount of up to $15.0 million, which was not included under the Previous Credit Agreement), and a letter of credit subfacility of up to $50.0 million (increased from $25.0 million under the Previous Credit Agreement).

Loans may be made either at (i) a Eurocurrency rate based on LIBOR plus an applicable margin of .75% to 1.60% (depending on the Company's leverage ratio) or (ii) an alternative base rate as defined in the Third Amended and Restated Credit Agreement. The Third Amended and Restated Credit Agreement also includes a competitive bid option that permits the Borrowers to request that the lenders provide bids for the interest rate that will apply to specific loans.

In addition, on October 28, 2016, the Company entered into (1) First Amendment (the “First Amendment”) to Note Purchase and Private Shelf Agreement dated as of May 27, 2015 (the “New York Life Agreement”) by and among NYL Investors LLC and each of the undersigned holders of notes that are signatories thereto, and (2) Amendment No. 1 (“Amendment No. 1” and together with the First Amendment, the “Private Shelf Amendments”) to Third Amended and Restated Note Purchase and Private Shelf Agreement dated as of May 28, 2015 (the “Prudential Agreement”) by and among the Company and PGIM, Inc. (“Prudential”) and the Prudential affiliates party thereto. The Private Shelf Amendments were intended to make the covenants within the New York Life Agreement and Prudential Agreement consistent with those covenants that were modified in the Third Amended and Restated Credit Agreement as compared to the Previous Credit Agreement.


21


The foregoing description is qualified in its entirety by reference to the Third Amended and Restated Credit Agreement and the Private Shelf Amendments, copies of which are filed as Exhibits 10.2 - 10.4 to this Quarterly Report on Form 10-Q and are incorporated herein by reference.

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

Third Quarter 2016 vs. Third Quarter 2015

OVERVIEW
Sales and earnings in the third quarter of 2016 increased from the third quarter last year. The sales increase was due to price and volume partially offset by the negative impact of foreign currency translation. The Company's consolidated gross profit was $85.5 million for the third quarter of 2016, an increase of $8.7 million or about 11 percent from the prior year’s third quarter.

RESULTS OF OPERATIONS

Net Sales
Net sales in the third quarter of 2016 were $239.8 million, an increase of $7.3 million or about 3 percent compared to 2015 third quarter sales of $232.5 million. Sales revenue decreased by $0.5 million in the third quarter of 2016 due to foreign currency translation. The sales change in the third quarter of 2016, excluding foreign currency translation, was an increase of $7.8 million or about 3 percent.

 
Net Sales
(In millions)
Q3 2016
 
Q3 2015
 
2016 v 2015
Water Systems
$
182.0

 
$
173.5

 
$
8.5

Fueling Systems
57.8

 
59.0

 
(1.2
)
Consolidated
$
239.8

 
$
232.5

 
$
7.3


Net Sales-Water Systems
Water Systems sales were $182.0 million in the third quarter 2016, an increase of $8.5 million or about 5 percent versus the third quarter 2015 sales of $173.5 million. Water Systems sales were reduced by $0.2 million in the quarter due to foreign currency translation. Excluding foreign currency translation, Water Systems sales were up about 5 percent compared to the third quarter 2015.

Water Systems sales in the U.S. and Canada represented 37 percent of consolidated sales and increased by about 2 percent compared to the prior year. Water Systems sales in the U.S and Canada were reduced by $0.1 million in the quarter due to foreign currency translation. In the third quarter 2016, sales of groundwater pumping equipment grew by about 13 percent. The growth in groundwater equipment sales was led by a 17 percent increase in residential systems. Sales of groundwater pumping systems for agricultural applications grew by about 2 percent. Third quarter 2016 sales of mobile dewatering equipment in the U.S. and Canada declined sharply due to reduced demand from equipment rental customer.

Water Systems sales in Europe, the Middle East and Africa were about 16 percent of consolidated sales and declined by about 3 percent compared to the third quarter 2015.  Water Systems sales were reduced by about 3 percent in the quarter due to foreign currency translation.  Sales in  the Europe, Middle East and Africa region were flat excluding the impact of foreign currency translation.  Within this region, our business unit in Turkey had increased sales which were offset by lower sales in other regional business units primarily due to the political and economic turmoil in certain parts of the region as well as the lower price of oil.

Water Systems sales in Latin America were about 15 percent of consolidated sales for the third quarter and increased by about 15 percent compared to the third quarter of the prior year. Water Systems sales grew by $0.9 million or about 3 percent in the quarter due to foreign currency translation. Excluding the impact of foreign currency translation, Latin American sales increased by about 12 percent compared to the third quarter 2015. This growth in sales was led by increased sales in Brazil and Mexico. This sales growth is a result of increasing demand for Franklin submersible pumps and motors, customer acceptance of the many product line upgrades that have been implemented over the past two years, and general market conditions.

22



Water Systems sales in the Asia Pacific region were 8 percent of consolidated sales and grew about 19 percent compared to the third quarter prior year. Excluding the impact of foreign currency translation, Asia Pacific sales grew by about 18 percent compared to the third quarter 2015. The Asia Pacific region experienced year over year growth in groundwater product sales of 24 percent due in part to generally favorable weather conditions.

Net Sales-Fueling Systems
Fueling Systems sales represented 24 percent of consolidated sales and were $57.8 million in the third quarter 2016, a decrease of $1.2 million or about 2 percent versus the third quarter 2015 sales of $59.0 million. Fueling Systems sales decreased by $0.3 million or about 1 percent in the quarter due to foreign currency translation. Fueling Systems sales decreased by $0.9 million or about 1 percent after excluding foreign currency translation.

Fueling Systems sales in the U.S. and Canada grew by about 5 percent during the quarter with most of the sales growth coming from fuel pumping products, piping and containment systems. Fueling Systems revenues were down in Europe and Asia Pacific in part due to lower capital spending on new filling station development by major oil companies and due to the timing of customer shipments.

Cost of Sales
Cost of sales as a percent of net sales for the third quarter of 2016 and 2015 was 64.4 percent and 67.0 percent, respectively. Correspondingly, the gross profit margin increased to 35.6 percent from 33.0 percent, a 260 basis point improvement. The Company’s consolidated gross profit was $85.5 million for the third quarter of 2016, an increase of $8.7 million, or about 11 percent, from the third quarter of 2015 gross profit of $76.8 million. The gross profit margin increase was primarily due to favorable pricing, lower direct material costs and an improved sales mix of Water Systems products.

Selling, General, and Administrative (“SG&A”)
Selling, general, and administrative (SG&A) expenses were $55.4 million in the third quarter of 2016 compared to $47.7 million in the third quarter of prior year, an increase of $7.7 million or about 16 percent. The Company’s SG&A expense increase in the quarter was primarily due to higher variable compensation expenses of about $4.0 million. Marketing and Selling related expenses increased about $1.0 million to support sales growth and Research Development & Engineering (RD&E) expense increased by $0.8 million in the quarter.

Restructuring (Income)/Expense
Restructuring income for the third quarter of 2016 was $1.7 million and caused a $0.02 increase in diluted earnings per share. Restructuring income for the third quarter 2016 included a gain of $2.0 million from the sale of land and building in Brazil and $0.3 million in expenses related to equipment transfers, freight and relocation cost related to the transfer of production activities and other restructuring costs from continued manufacturing realignments.

Restructuring expenses for the third quarter of 2015 were $1.3 million and caused a $0.02 reduction in diluted earnings per share. Restructuring expenses for the third quarter 2015 included $0.6 million in severance cost, $0.1 million in expenses related to equipment transfers, freight and relocation cost primarily in Europe related to the transfer of production activities from Germany to the Czech Republic and $0.6 million of other restructuring costs from continued manufacturing realignments.

Operating Income
Operating income was $31.8 million in the third quarter of 2016, up $4.0 million or about 14 percent from $27.8 million in the third quarter of 2015.

 
 
Operating income (loss)
(In millions)
 
Q3 2016
 
Q3 2015
 
2016 v 2015
Water Systems
 
$
30.0

 
$
23.1

 
$
6.9

Fueling Systems
 
15.2

 
15.4

 
(0.2
)
Other
 
(13.4
)
 
(10.7
)
 
(2.7
)
Consolidated
 
$
31.8

 
$
27.8

 
$
4.0


There were specific items in the third quarter of 2016 and 2015 that impacted operating income that were not operational in nature. In the third quarter of 2016 there were two such items: $1.7 million of restructuring income and $0.3 million related to

23


executive transition.

In the third quarter of 2015 there were three such items: $1.3 million of restructuring charges, $0.3 million related to executive transition and $0.1 million related to business realignment cost, primarily severance, in targeted fixed cost reduction actions.

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 (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:

Operating Income and Margins
 
 
 
 
Before and After Non-GAAP Adjustments
 
 
 
 
(In millions)
For the Third Quarter 2016
 
Water
Fueling
Other
Consolidated
Reported Operating Income / (Loss)
$
30.0

$
15.2

$
(13.4
)
$
31.8

% Operating Income To Net Sales
16.5
%
26.3
%
 
13.3
%
 
 
 
 
 
Non-GAAP Adjustments:
 
 
 
 
Restructuring
$
(1.8
)
$
0.1

$

$
(1.7
)
Non-GAAP
$

$

$
0.3

$
0.3

Operating Income / (Loss) after Non-GAAP Adjustments
$
28.2

$
15.3

$
(13.1
)
$
30.4

% Operating Income to Net Sales after Non-GAAP Adjustments (Operating Income Margin after Non-GAAP Adjustments)
15.5
%
26.5
%
 
12.7
%
 
 
 
 
 
 
For the Third Quarter 2015
 
Water
Fueling
Other
Consolidated
Reported Operating Income / (Loss)
$
23.1

$
15.4

$
(10.7
)
$
27.8

% Operating Income To Net Sales
13.3
%
26.1
%
 
12.0
%
 
 
 
 
 
Non-GAAP Adjustments:
 
 
 
 
Restructuring
$
1.3

$

$

$
1.3

Non-GAAP
$
0.1

$

$
0.3

$
0.4

Operating Income / (Loss) after Non-GAAP Adjustments
$
24.5

$
15.4

$
(10.4
)
$
29.5

% Operating Income to Net Sales after Non-GAAP Adjustments (Operating Income Margin after Non-GAAP Adjustments)
14.1
%
26.1
%
 
12.7
%

Operating Income-Water Systems
Water Systems operating income was $30.0 million in the third quarter 2016, up $6.9 million or 30 percent versus the third quarter 2015 as reported and up $3.7 million or 15 percent versus the third quarter 2015 after non-GAAP adjustments. The third quarter operating income margin was 16.5 percent, up 320 basis points from 13.3 percent in the third quarter of 2015. The third quarter operating income margin after non-GAAP adjustments was 15.5 percent, an increase of 140 basis points from the 14.1 percent of net sales in the third quarter of 2015 after non-GAAP adjustments. The increase in basis points was primarily due to improved margins from lower variable costs.

Operating Income-Fueling Systems
Fueling Systems operating income was $15.2 million in the third quarter of 2016, down $0.2 million or about 1 percent compared to $15.4 million in the third quarter of 2015 as reported, and down $0.1 million or 1 percent compared to $15.4 million after non-GAAP adjustments in the third quarter of 2015. The third quarter operating income margin was 26.3 percent, an increase of 20 basis points from the as reported 26.1 percent of net sales in the third quarter of 2015. The third quarter operating income margin after non-GAAP adjustments was 26.5 percent, an increase of 40 basis points from the 26.1 percent of net sales in the third quarter of 2015 after non-GAAP adjustments. The increase in basis points was primarily due to improved

24


margins from lower variable costs.

Operating Income-Other
Operating income-other is composed primarily of unallocated general and administrative expenses. General and administrative expenses after non-GAAP adjustments were higher by about 26 percent, primarily due to higher variable compensation expenses.

Interest Expense
Interest expense for the third quarter of 2016 and 2015 was $2.0 million and $2.6 million, respectively, lower primarily due to reduced average borrowings outstanding.

Other Income or Expense
Other income or expense was income of $1.4 million in the third quarter of 2016 and income of $1.6 million in the third quarter of 2015. Included in other income in the third quarter of 2016 was income from minority interests of $1.2 million and interest income of $0.2 million, primarily derived from the investment of cash balances in short-term securities. Included in other income in the third quarter of 2015 was minority income of $1.0 million and interest income of $0.3 million, primarily derived from the investment of cash balances in short-term securities.

Foreign Exchange
Foreign currency-based transactions produced a gain for the third quarter of 2016 of $0.4 million. Foreign currency-based transactions produced a loss for the third quarter of 2015 of $0.1 million.

Income Taxes
The provision for income taxes in the third quarter of 2016 and 2015 was $7.9 million and $5.7 million, respectively. The effective tax rate for the third quarter of 2016 was about 27 percent, flat to the third quarter 2015 tax rate before discrete adjustments. The tax rate after discrete adjustments as a percentage of pre-tax earnings for the third quarter of 2016 was about 25 percent primarily due to the favorable impact from share based equity compensation payments. The projected tax rate is lower than the statutory rate of 35 percent primarily due to the indefinite reinvestment of foreign earnings and reduced taxes on foreign and repatriated earnings after the restructuring of certain foreign entities. The Company has the ability to indefinitely reinvest these foreign earnings based on the earnings and cash projections of its other operations, current cash on hand and available credit.

Net Income
Net income for the third quarter of 2016 was $23.7 million compared to the prior year third quarter net income of $21.0 million. Net income attributable to Franklin Electric Co., Inc. for the third quarter of 2016 was $23.7 million, or $0.50 per diluted share, compared to the prior year third quarter net income attributable to Franklin Electric Co., Inc. of $20.8 million or $0.43 per diluted share. Earnings after non-GAAP adjustments for the third quarter of 2016 were $22.6 million, or $0.48 per diluted share, compared to the prior year third quarter earnings after non-GAAP adjustments of $21.4 million or $0.45 per diluted share.

There were specific items in the third quarter of 2016 and 2015 that impacted net income attributable to Franklin Electric Co., Inc. that were not operational in nature.  The Company refers to these items as “non-GAAP adjustments” for purposes of presenting the non-GAAP financial measures of earnings after non-GAAP adjustments and adjusted EPS.  The Company believes this information helps investors understand underlying trends in the Company's business more easily.  The differences between these non-GAAP financial measures and the most comparable GAAP measures are reconciled in the following tables:



25


Earnings Before and After Non-GAAP Adjustments
For the Third Quarter Ended
(In millions)
2016
2015
Change
Net Income attributable to Franklin Electric Co., Inc. Reported
$
23.7

$
20.8

14
%
Allocated Undistributed Earnings
$
(0.3
)
$
(0.4
)
 
Earnings for EPS Calculations
$
23.4

$
20.4

15
%
Non-GAAP adjustments, before tax:
 
 
 
Restructuring
$
(1.7
)
$
1.3

 
Non-GAAP items
$
0.3

$
0.4

 
 
 
 
 
Non-GAAP adjustments, net of tax:
 
 
 
Restructuring
$
(1.0
)
$
0.8

 
Non-GAAP items
$
0.2

$
0.2

 
Earnings after Non-GAAP Adjustments
$
22.6

$
21.4

6
%

Earnings Per Share Before and After Non-GAAP Adjustments
For the Third Quarter Ended
(In millions, except per share data)
2016
2015
Change
Average Fully Diluted Shares Outstanding
46.9

47.3

(1
)%
 
 
 
 
Fully Diluted Earnings Per Share ("EPS") Reported
$
0.50

$
0.43

16
 %
 
 
 
 
Restructuring per Share, net of tax
$
(0.02
)
$
0.02

 
Non-GAAP items, net of tax
$

$

 
 
 
 
 
Fully Diluted EPS after Non-GAAP Adjustments (Adjusted EPS)
$
0.48

$
0.45

7
 %

First Nine Months of 2016 vs. First Nine Months of 2015

OVERVIEW
Sales and earnings in the first nine months of 2016 were up from the same period last year.  The sales increase was related to volume and price increases partially offset by the negative impact of foreign currency translation on sales. The Company's consolidated gross profit was $250.4 million for the first nine months of 2016, an increase of $21.9 million or about 10 percent from the first nine months of 2015.

RESULTS OF OPERATIONS

Net Sales
Net sales in the first nine months of 2016 were $710.3 million, an increase of $4.7 million or about 1 percent compared to sales in the first nine months of 2015 of $705.6 million.  The incremental impact of sales from acquired businesses was $0.7 million. Sales revenue decreased by $21.8 million or about 3 percent in the first nine months of 2016 due to foreign currency translation. The sales change in the first nine months of 2016, excluding acquisitions and foreign currency translation, was an increase of $25.8 million or about 4 percent.



26


(In millions)
YTD
October 1, 2016
 
YTD
October 3, 2015
 
2016 v 2015
 
Net Sales
Water Systems
$
545.4

 
$
544.3

 
$
1.1

Fueling Systems
164.9

 
161.3

 
3.6

Consolidated
$
710.3

 
$
705.6

 
$
4.7


Net Sales-Water Systems
Water Systems sales were $545.4 million in the first nine months 2016, flat versus the first nine months 2015. The incremental impact of sales from acquired businesses was $0.7 million. Foreign currency translation rate changes decreased sales $20.7 million, or about 4 percent, compared to sales in the first nine months of 2015. The Water Systems sales change in the first nine months of 2016, excluding acquisitions and foreign currency translation, was an increase of $21.1 million or about 4 percent.

Water Systems sales in the U.S. and Canada were 37 percent of consolidated sales and increased by about 2 percent compared to the first nine months of 2015. Sales revenue decreased by $1.9 million or about 1 percent in the first nine months of 2016 due to foreign currency translation. Sales of groundwater pumping equipment increased by about 7 percent. The growth in groundwater equipment sales was led by a 10 percent increase in residential systems. Sales of groundwater pumping systems for agricultural applications grew by about 2 percent. Sales of Pioneer branded mobile dewatering equipment declined by about 14 percent. The decline in mobile dewatering equipment is primarily attributed to reduced demand in the oil and gas end markets.

Water Systems sales in Europe, Middle East and Africa were about 18 percent of consolidated sales and declined by about 6 percent compared to the first nine months of 2015. Water Systems in Europe, the Middle East and Africa were reduced by $8.2 million or about 6 percent due to foreign currency translation. Sales in the Europe, Middle East and Africa region were flat excluding the impact of foreign currency translation.  Within this region, our business unit in Turkey had increased sales which were offset by lower sales in other regional business units primarily due to the political and economic turmoil in certain parts of the region as well as the lower price of oil.

Water Systems sales in Latin America were about 13 percent of consolidated sales for the first nine months and declined by about 4 percent compared to the prior year's first nine months. Sales revenue decreased by $10.1 million or about 10 percent in the first nine months of 2016 due to foreign currency translation. The sales change in the first nine months of 2016, excluding foreign currency translation, was an increase of $6.1 million or about 6 percent. The growth in sales was led by increased sales in Mexico and Brazil, in local currency. This sales growth is a result of increasing demand for Franklin submersible pumps and motors, customer acceptance of the many product line upgrades that have been implemented over the past two years, and general market conditions.

Water Systems sales in the Asia Pacific region were 9 percent of consolidated sales and increased by about 15 percent compared to the first nine months of the prior year. Sales revenue decreased by about 1 percent in the first nine months of 2016 due to foreign currency translation. The sales change in the first nine months of 2016, excluding foreign currency translation, was an increase about 16 percent. The Asia Pacific region experienced strong year over year growth in Southeast Asia and Australia.

Net Sales-Fueling Systems
Fueling Systems sales were $164.9 million or about 23 percent of consolidated sales in the first nine months of 2016 and increased $3.6 million or about 2 percent from the first nine months of 2015. Foreign currency translation rate changes decreased sales $1.1 million or about 1 percent compared to sales in the first nine months of 2015. The Fueling Systems sales change in the first nine months of 2016, excluding foreign currency translation, was an increase of $4.7 million or about 3 percent.

Fueling Systems sales in the U.S. and Canada grew by about 6 percent during the first nine months with sales growth coming from most product lines, especially in piping. Outside the U.S. and Canada, Fueling Systems revenues were down overall with increased sales in India more than offset by a sales decline in Europe principally due to a reduction in the sale of storage tanks that support North Sea oil production.



27


Cost of Sales
Cost of sales as a percent of net sales for the first nine months of 2016 and 2015 was 64.7 percent and 67.6 percent, respectively. Correspondingly, the gross profit margin was 35.3 percent and 32.4 percent for the first nine months of both years. The Company's consolidated gross profit was $250.4 million for the first nine months of 2016, up $21.9 million from the gross profit of $228.5 million in the first nine months of 2015. The gross profit margin increase was primarily due to favorable pricing, lower direct material costs and lower fixed costs.

Selling, General, and Administrative (“SG&A”)
Selling, general, and administrative expenses were $165.7 million in the first nine months of 2016 and increased by $6.5 million or 4 percent in the first nine months of 2016 compared to $159.2 million the first nine months of last year. The Company’s SG&A expense increase in the first nine months of 2016 was primarily due to higher variable compensation expenses of about $6.5 million and RD&E spending of $1.2 million on new product development costs. These increases were partially offset by lower fixed cost from the effect of foreign currency translation.

Restructuring (Income)/Expense
Restructuring income for the first nine months of 2016 was $0.9 million and improved diluted earnings per share by approximately $0.01. Restructuring income for the first nine months of 2016 included a gain of $2.0 million from the sale of land and building in Brazil and $1.1 million in expenses related to severance, equipment transfers, freight and relocation cost related to the transfer of production activities and other restructuring costs from continued manufacturing realignments. Restructuring expenses for the first nine months of 2015 were $2.5 million and reduced diluted earnings per share by $0.03. Restructuring expenses were primarily related to the continuing European and Brazilian manufacturing realignments. Restructuring expenses were primarily severance expenses, equipment relocations and other miscellaneous manufacturing realignment activities.


Operating Income
Operating income was $85.6 million in the first n