FRANKLIN ELECTRIC CO INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) 2012 vs. 2011 OVERVIEW Sales and earnings in 2012 increased from the prior year. Net sales in 2012 were $891.3 million, an increase of about 9 percent compared to 2011 sales of $821.1 million. The sales increase was primarily from the Company's acquisitions, as well as sales volume and price increases. Sales increases were partially offset by the negative impact of foreign currency translation. The Company's consolidated gross profit was $301.7 million for 2012, an increase of $29.4 million or about 11 percent from 2011. The gross profit as a percent of net sales increased 60 basis points to 33.8 percent in 2012 from 33.2 percent in 2011. The gross profit margin improvement was attributable to leveraging of fixed costs on higher sales, reductions in inventory obsolescence costs, and lower labor and burden cost, partially offset by higher material costs. For 2012, diluted earnings per share were $3.46, an increase of 31 percent compared to 2011 diluted earnings per share of $2.65. Adjusted earnings per share were $3.14, an increase of 16 percent versus the $2.70 adjusted earnings per share in 2011 (see the table below for a reconciliation of the GAAP EPS to the adjusted EPS). For the full year 2012, adjusted net income of $75.3 million compared to $64.3 million and adjusted earnings per share of $3.14 compared to $2.70 were records for any year in the Company's history. During the year, the Company completed the acquisition of a controlling interest of Pioneer Pump, and the acquisition of all of the outstanding stock of Cerus Industrial Corporation and Flex-ing, Incorporated.

RESULTS OF OPERATIONS Net Sales Net sales in 2012 were $891.3 million, an increase of $70.2 million or about 9 percent compared to 2011 sales of $821.1 million. The incremental impact of sales from acquired businesses was $59.1 million or about 7 percent. Sales revenue decreased by $33.0 million or about 4 percent in 2012 due to foreign currency translation. The sales change in 2012, excluding acquisitions and foreign currency translation, was an increase of $44.1 million or about 5 percent.

(In millions) 2012 2011 2012 v 2011 Net Sales Water Systems $ 715.0 $ 654.1 $ 60.9 Fueling Systems 176.3 167.0 9.3 Consolidated $ 891.3 $ 821.1 $ 70.2 Net Sales-Water Systems Water Systems sales were $715.0 million in 2012, an increase of $60.9 million or 9 percent versus 2011. The incremental impact of sales from acquired businesses was $57.9 million or about 9 percent. Foreign currency translation rate changes decreased sales $29.2 million, or about 4 percent, compared to sales in 2011.

The sales change in 2012, excluding acquisitions and foreign currency translation, was an increase of $32.2 million or about 5 percent.

Water Systems sales in the U.S. and Canada were 40 percent of consolidated sales and grew by about 14 percent compared to 2011. Acquisition related sales during 2012 were about $39 million. Foreign currency translation rate changes decreased sales $1 million compared to sales in 2011. The sales change in 2012, excluding acquisitions and foreign currency translation, was an increase of $6 million or about 2 percent. Sales of groundwater pumping equipment in the U.S. and Canada grew by about 7 percent compared to the prior year as the Company continued to gain share in this market. Wastewater pump sales in the U.S. and Canada were lower as drier weather reduced demand for residential sump, sewage, and effluent pumps compared to the prior year.

15 -------------------------------------------------------------------------------- Water Systems sales in EMENA, which is Europe, the Middle East, and North Africa, were 15 percent of consolidated sales and grew by about 2 percent compared to the prior year. Acquisition related sales during 2012 were about $13 million in EMENA. Foreign currency translation rate changes decreased sales $12 million, or about 9 percent, compared to sales in 2011. Excluding acquisitions and foreign currency translation, EMENA sales grew by about 1 percent during 2012. 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 2012 and grew by about 6 percent compared to the prior year. Foreign currency translation rate changes decreased sales $11 million, or about 10 percent, compared to sales in 2011. Excluding foreign currency translation, sales in Latin America grew by about 16 percent during 2012. Sales continued to be strong in Brazil and Mexico with sales increases in these regions at about 20 percent. An important contributor to this growth was the launch of our groundwater pump and motor product line in Brazil. Sales gained in Mexico as ongoing dry weather increased the demand of irrigation pumping systems. In addition Latin America benefited from a new distribution center in Chile.

Water Systems sales in the Asia Pacific region were 7 percent of consolidated sales and grew by about 15 percent compared to the prior year. Acquisition related sales during 2012 were about $4 million in Asia. Foreign currency translation rate changes had little impact in 2012 compared to sales in 2011 in the Asia Pacific region. Excluding acquisitions and foreign currency translation sales grew by about 7 percent during 2012. The year-on-year sales increased 22 percent in the Southeast Asian region, with strong sales in Thailand, Philippines and Indonesia. Sales increased by about 10 percent in Australia due to sales growth in both agricultural and residential pumps and motors, one of the largest regions partially offset by lower sales in China from the prior year.

Water Systems sales in Southern Africa represented 5 percent of consolidated sales and declined by 3 percent compared to the prior year. Acquisition related sales during 2012 were about $2 million in Southern Africa. Foreign currency translation rate changes decreased sales $6 million, or about 13 percent, compared to sales in 2011. Excluding acquisitions and foreign currency translation, Southern Africa sales grew by about 6 percent during 2012.

Net Sales-Fueling Systems Fueling Systems sales which represented 20 percent of consolidated sales were $176.3 million in 2012, an increase of $9.3 million or about 6 percent versus 2011. The incremental impact of sales from businesses acquired during the fourth quarter of 2012 was $1.2 million or about 1 percent. Foreign currency translation rate changes decreased sales $3.8 million, or about 2 percent, compared to sales in 2011. The sales change in 2012, excluding acquisitions and foreign currency translation, was an increase of $11.9 million or about 7 percent.

Fueling Systems achieved solid organic sales gains. Fueling Systems revenue growth was balanced across markets growing by about 5 percent in both the U.S.

and Canadian market as well as in the rest of the world, with particular strength in India and the Asia Pacific region. Pumping systems sales grew by 15 percent during 2012 as station owners worldwide continue their conversion from suction to pressure pumping technology for dispensing gasoline.

Cost of Sales Cost of sales as a percent of net sales for 2012 and 2011 was 66.2 percent and 66.8 percent, respectively. Correspondingly, the gross profit margin increased to 33.8 percent from 33.2 percent, a 60 basis point improvement. The gross profit margin improvement was due to leveraging fixed costs on higher sales, lower obsolescence, lower labor and burden costs, partially offset by higher material costs. Direct materials as a percentage of sales increased by 90 basis points compared to last year. The Company's consolidated gross profit was $301.7 million for 2012, up $29.4 million from 2011.

Selling, General and Administrative ("SG&A") Selling, general, and administrative (SG&A) expenses were $188.5 million in 2012 and increased by $11.2 million or about 6 percent in 2012 compared to last year.

In 2012, increases in SG&A attributable to acquisitions were $8.9 million.

Additional year over year changes in SG&A costs were increases in marketing and selling-related expenses and higher research, development, and engineering expenses.

Restructuring Expenses Restructuring expenses for 2012 were $0.2 million and had less than $0.01 impact to diluted earnings per share. Restructuring expenses incurred in 2012 included $0.5 million of Phase III costs primarily related to the final site cleanup and sale of the Siloam Springs facility offset by $0.4 million in a gain on the sale of land the Company had previously held for development. There were also $0.1 million of restructuring costs related to Phase IV of the Global Manufacturing Realignment Program in 2012. Restructuring expenses in 2012 included asset write-downs and manufacturing equipment relocation costs.

16 -------------------------------------------------------------------------------- Restructuring expenses in 2011 were $1.6 million and reduced diluted earnings per share by approximately $0.05. Restructuring expenses incurred in 2011 were $1.1 million 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-downs, severance costs 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 $13.0 million in Phase III expenses, from December 2008 through the end of 2012. Approximately $9.1 million of the $13.0 million was for non-cash items.

With the sale of the Siloam Springs facility Phase III is considered complete.

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 were substantially completed by the end the first quarter of 2012, with the majority of the manufacturing moves completed. Phase IV will continue until the closing and disposition of the Oklahoma City manufacturing facility is complete. Phase IV costs include severance, pension curtailments, asset write-offs, and equipment relocation. The Company has to date incurred $0.6 million in Phase IV, none of which was related to non-cash items.

Additionally, the Company currently estimates that total non-GAAP adjustments to full year earnings in 2013 will be approximately $2.0 to $2.8 million resulting primarily from restructuring activities related to the Flexi-ing acquisition, the relocation of the Company's headquarters and other miscellaneous manufacturing facility realignments in North America and certain international locations. The Company will continue to provide quarterly reconciliations and explanations of all non-GAAP related items.

Operating Income Operating income was $113.0 million in 2012, up $19.6 million from $93.4 million in 2011.

(In millions) 2012 2011 2012 v 2011 Operating income (loss)Water Systems $ 124.1 $ 105.3 $ 18.8 Fueling Systems 36.6 31.3 5.3 Other (47.7 ) (43.2 ) (4.5 ) Consolidated $ 113.0 $ 93.4 $ 19.6 There were specific items in 2012 and 2011 that impacted operating income that were not operational in nature. In 2012 there were three such items: $1.3 million of acquisition related expenses, primarily professional fees in SG&A, $0.4 million for certain legal matters and $0.2 million of restructuring charges. 2011 included $1.6 million of restructuring charges and $0.7 million for certain legal matters.

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: 17 -------------------------------------------------------------------------------- Operating Income and Margins Before and After Non-GAAP Adjustments (in millions) For the Full Year of 2012 Water Fueling Other Consolidated Reported Operating Income $ 124.1 $ 36.6 $ (47.7 ) $ 113.0 % Operating Income To Net Sales 17.4 % 20.8 % 12.7 % Non-GAAP Adjustments: Restructuring $ 0.2 $ - $ - $ 0.2 Legal matters $ - $ 0.4 $ - $ 0.4 Acquisition related items $ 1.3 $ - $ - $ 1.3 Operating Income after Non-GAAP Adjustments $ 125.6 $ 37.0 $ (47.7 ) $ 114.9 % Operating Income to Net Sales after Non-GAAP Adjustments (Operating Income Margin after Non-GAAP Adjustments) 17.6 % 21.0 % 12.9 % For the Full Year of 2011 Water Fueling Other 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 Acquisition related items $ - $ - $ - $ - 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 % Operating Income-Water Systems Water Systems operating income, after non-GAAP adjustments, was $125.6 million in 2012, an increase of 18 percent versus 2011. The 2012 operating income margin after non-GAAP adjustments was 17.6 percent and increased by 130 basis points compared to 2011. 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 $37.0 million in 2012 compared to $32.1 million after non-GAAP adjustments in 2011, an increase of 15 percent. The 2012 operating income margin after non-GAAP adjustments was 21.0 percent and increased by 180 basis points compared to the 19.2 percent of net sales in 2011. This increased profitability was the result of operating leverage, increases in pricing, and productivity improvements.

Operating Income-Other Operating income-other is composed primarily of unallocated general and administrative expenses. General and administrative expenses were higher due to increases related to information technology expenditures for software, telephone and other ERP integration costs as well as to higher performance based and stock based compensation expenses.

Interest Expense Interest expense for 2012 and 2011 was $10.2 million and $10.5 million, respectively.

Other Income or Expense Other income or expense was a gain of $14.9 million in 2012 and a gain of $5.7 million in 2011. Included in other income in 2012 was a one-time gain on the Pioneer transaction worth $12.2 million. The gain on the original investment the Company held in Pioneer arose as a the result of a new enterprise valuation of the Pioneer entity compared to the book value of Franklin 18 -------------------------------------------------------------------------------- Electric's equity investment in Pioneer. Also included in other income in 2012 was income from equity investments of $0.6 million and interest income of $2.3 million, primarily derived from the investment of cash balances in short-term securities.

Included in other income or expense 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.

Foreign Exchange Foreign currency-based transactions produced a loss for 2012 of $1.7 million, primarily due to the Mexican peso, the euro, South African rand, Brazilian real and Czech koruna relative to the U.S. dollar, none of which individually were significant. Foreign currency-based transactions produced a loss in 2011 of $1.4 million, primarily due to the Turkish lira.

Income Taxes The provision for income taxes in 2012 and 2011 was $32.2 million and $23.4 million, respectively. The tax rate for 2012 was 27.8 percent and 2011 was 26.9 percent. The projected tax rate may differ from 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.

Net Income Net income for 2012 was $83.7 million compared to 2011 net income of $63.7 million. Net income attributable to Franklin Electric Co., Inc. for 2012 was $82.9 million, or $3.46 per diluted share, compared to 2011 net income attributable to Franklin Electric Co., Inc. of $63.1 million or $2.65 per diluted share. Net income attributable to Franklin Electric Co., Inc. after Non-GAAP adjustments for 2012 was $75.3 million, or $3.14 per diluted share, compared to 2011 net income attributable to Franklin Electric Co., Inc. after Non-GAAP adjustments of $64.3 million or $2.70 per diluted share.

There were specific items in 2012 and 2011 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 net income attributable to Franklin Electric Co., Inc. 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: Earnings Before and After Non-GAAP Adjustments For the Full Year (in millions) 2012 2011 Change Net Income attributable to Franklin Electric Co., Inc. Reported $ 82.9 $ 63.1 31 % Non-GAAP adjustments (before tax): Restructuring $ 0.2 $ 1.6 Legal matters $ 0.4 $ 0.7 Acquisition related items $ 1.3 $ - FX gain on forward purchase contract $ - $ (0.6 ) Gain on Pioneer Investment $ (12.2 ) $ - Non-GAAP adjustments, net of tax: Restructuring $ 0.1 $ 1.2 Legal matters $ 0.3 $ 0.5 Acquisition related items $ 0.9 $ - FX gain on forward purchase contract $ - $ (0.5 ) Gain on Pioneer Investment $ (8.9 ) $ - Net Income attributable to Franklin Electric Co., Inc. after Non-GAAP Adjustments (Adjusted Net Income) $ 75.3 $ 64.3 17 % 19 -------------------------------------------------------------------------------- Earnings Per Share Before and After Non-GAAP Adjustments For the Full Year (in millions except per-share data) 2012 2011 Change Fully Diluted Earnings Per Share ("EPS") Reported $ 3.46 $ 2.65 31 % Restructuring Per Share, net of tax $ - $ 0.05 Legal matters Per Share, net of tax $ 0.01 $ 0.02 Acquisition related items Per Share, net of tax $ 0.04 $ - FX gain on forward contract Per Share, net of tax $ - $ (0.02 ) Gain on Pioneer Investment Per Share, net of tax $ (0.37 ) $ - Fully Diluted EPS after Non-GAAP Adjustments (Adjusted EPS) $ 3.14 $ 2.70 16 % 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 20 -------------------------------------------------------------------------------- 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.

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.

21 -------------------------------------------------------------------------------- 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 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: 22 -------------------------------------------------------------------------------- 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 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.

23 -------------------------------------------------------------------------------- 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/(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.

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 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 29, 2012, the Company had $146.1 million borrowing capacity under the Agreement as $3.9 million in letters of credit were outstanding and undrawn, 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 29, 2012, the Company was in compliance with all covenants.

Volatility in the financial and credit markets due to the recent global financial crisis 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 is constructing 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. 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.

On December 31, 2012 (after the Company's fiscal year-end), the Company, Allen County, Indiana and certain institutional investors entered into a Bond Purchase and Loan Agreement. Under the Agreement, Allen County, Indiana issued a series of Project Bonds entitled "Taxable Economic Development Bonds, Series 2012 (Franklin Electric Co., Inc. Project)." The 24 -------------------------------------------------------------------------------- aggregate principal amount of the Project Bonds that were issued, authenticated, and are now outstanding thereunder was limited to $25.0 million. The Company then borrowed the proceeds under the Project Bonds through the issuance of Project Notes to finance the cost of acquisition, construction, installation and equipping of the Project. The Project Notes bear interest at 3.6 percent per annum. Interest and principal balance of the Project Notes are due and payable by the Company directly to the institutional investors in aggregate semi-annual installments commencing on July 10, 2013 and concluding on January 10, 2033.

At December 29, 2012, the Company had $103.3 million of cash on hand at various locations worldwide. Approximately 25% of the cash on hand was in the U.S. and readily accessible. Another approximately 25% was in Germany, Italy, and the Czech Republic combined, and then another 25% was in Mexico & Brazil combined.

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.

Net cash flows from operating activities were $70.2 million for 2012 compared to $99.9 million in 2011 and $94.6 million in 2010. Net income was up significantly over 2011 due to the sales increase and the gain on equity investment in PPH.

Inventory levels in 2012 increased by $23.7 million primarily as a result of the Company's efforts to improve the availability of its products to customers. 2011 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.

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 $101.6 million for 2012 compared to $65.8 million for 2011 and $24.2 million in 2010. The primary increases in investing activities were related to acquisitions and capital spending. During 2012 the Company completed the acquisition of Flex-ing, with cash on hand, Cerus, with cash on hand and short-term borrowings paid back within the period, and increased its ownership percentage in PPH, with cash on hand. Acquisition related activity totaled approximately $64.3 million, net of cash acquired.

Capital spending increased approximately $17.5 million over 2011, $11.3 million of which was spent on the new Global Corporate Headquarters and Engineering Center of Excellence project. In 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. 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. The Company expects 2013 capital spending to be approximately $63 million due to the completion of the Corporate Headquarters and Engineering Center of Excellence, the substantial completion of a new manufacturing facility in Brazil, investments in pump rental equipment in the United Kingdom and other productivity investments made by the Company in its facility in Linares, Mexico. The Company believes that in 2014, capital spending levels will decline sharply. The Company's rationale and strategy for potential future acquisitions that impact cash from investing includes an emphasis on increasing global distribution and complementary product lines that can be effectively marketed through existing global distribution.

Net cash used in financing activities was $19.3 million in 2012 compared to $15.5 million in 2011 and $14.5 million in 2010. During 2012 the Company completed the repurchase of 200,000 shares of the Company's common stock for $10.0 million pursuant to the Company's stock repurchase program. The Company's employees also exercised an increased level of stock options. Dividends in the amount of $13.8 million were paid to shareholders during 2012. During 2011 the Company completed the repurchase of 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 during 2011, 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 during 2010. 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 25 -------------------------------------------------------------------------------- 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 December 31, 2011, with the exception of a certain limited number of Basic Pension Plan participants who will still accrue benefits over a five-year sunset period. Also effective December 31, 2011, the Cash Balance Plan was closed (the Basic Pension Plan was previously closed) and the two plans were merged into a single plan. The portion of the non-guaranteed pension plan related to the Cash Balance Plan was also frozen. 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.

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 $ 164.9 $ 14.9 $ 30.0 $ 60.0 $ 60.0 Debt interest 40.8 10.3 16.5 10.5 3.5 Capital leases 1.0 0.3 0.4 0.3 - Operating leases 16.5 7.4 5.8 2.0 1.3 Contingent consideration 5.6 5.6 - - - Purchase obligations 26.3 25.6 0.7 - - $ 255.1 $ 64.1 $ 53.4 $ 72.8 $ 64.8 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"), and $14.9 million of subsidiary debt (denominated in foreign currencies) with interest rates ranging from 3% to 12% with maturity dates ending in 2013.

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 as well as conditional agreements related to 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 $9.2 million in 2013. The Company also has unrecognized tax benefits, none of which are included in the table above. The unrecognized tax benefits of approximately $6.9 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 $1.1 million.

ACCOUNTING PRONOUNCEMENTS In July 2012, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2012-2 Testing Indefinite-Lived Intangible Assets for Impairment. The new guidance gives companies the option of performing a qualitative assessment before calculating the fair value of the asset. If the results of the qualitative assessment conclude that the fair value of the asset is more likely than not impaired, the quantitative impairment test would be required. Otherwise, further testing would not be required. ASU 2012-2 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company did not early adopt ASU 2012-2 in completing its annual impairment testing. The Company continued to test for impairment utilizing the quantitative method. As ASU 2012-2 was not adopted, no material impact on the Company's results of operations, financial position, or cash flows resulted.

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 26 -------------------------------------------------------------------------------- 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 2012.

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 one redeemable noncontrolling interest during 2012. The noncontrolling interest was recorded at fair value as of the acquisition date.

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. An assessment to compare redemption value to carrying value is performed on a quarterly basis. The carrying value exceeded the redemption value therefore no adjustments were made in 2012. In 2011, the Company had two redeemable noncontrolling interests that resulted in redemption value adjustments of $0.2 million. As a result, an adjustment to the earnings per share computation was necessary.

Mandatory Share Purchase The Company entered into a stock purchase agreement with the non-controlling interest holders of Pioneer Pump Holdings, Inc. ("PPH") to purchase the remaining shares of PPH on or about, but no later than, March 31, 2015. The mandatory share purchase liability was recorded at fair value as of the acquisition date. The actual redemption value to be paid will be derived using a specified formula on a multiple of PPH's adjusted average earnings for 2013 and 2014 less net indebtedness. The mandatory share purchase liability remained at the initial carrying amount as of December 29, 2012. Redemption value assessments are performed on a quarterly basis and no adjustments were considered necessary during 2012.

Trade Names and Goodwill According to FASB ASC Topic 350, Intangibles - Goodwill and Other, intangible assets with indefinite lives must be tested for impairment at least annually or more frequently as warranted by triggering events that indicate potential impairment. The Company uses a variety of methodologies in conducting impairment assessments including income and market approaches 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 27 -------------------------------------------------------------------------------- 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 North America Water Systems, 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 2012 was $208.1 million.

During the fourth quarter of 2012, 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 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 28 -------------------------------------------------------------------------------- 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 4.75 percent last year to 4.00 percent this year for pension plans and from 4.50 percent last year to 3.50 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 $4.9 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 2012.

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. Restricted awards and units granted to retirement eligible employees are expensed over the vesting period as the employee will receive a pro-rata number of shares upon their retirement. 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.

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