FRANKLIN ELECTRIC CO INC (FELE)

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

Discussion of the year-over-year comparison of changes in the Company's financial condition and results of operation as of and for the fiscal years ended December 31, 2023 and December 31, 2022 can be found in Part II, Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2023.

2024 vs. 2023

OVERVIEW

Net sales in 2024 decreased 2 percent compared to the prior year. The sales decrease in 2024 was primarily due to lower volumes and the negative impact of foreign currency translation, partially offset by the incremental sales impact from recent acquisitions. The Company's consolidated gross profit was $717.3 million for 2024, an increase of $20.3 million from the prior year. Diluted earnings per share was $3.86 for 2024, a decrease of $0.25 or 6 percent from the prior year.

RESULTS OF OPERATIONS

Net Sales

Net sales in 2024 were $2.0 billion and decreased 2 percent compared to the prior year. Sales were negatively impacted by changes in foreign exchange rates, principally due to the strengthening of the U.S. Dollar relative to the Argentine Peso, Turkish Lira and Brazilian Real. However, the Company increases prices in the local currency to offset the impact of currency devaluation in the Argentina and Turkey highly inflationary economies. As a result, the net negative impact of foreign currency exchange rates on net sales was 1 percent in 2024.

Net Sales-Water Systems

Water Systems net sales decreased 2 percent in 2024, as compared to the prior year. This sales decline was primarily due to lower volumes, which decreased due to weaker end market demand for large dewatering equipment. Additionally, net sales decreased 2 percent in 2024 due to the negative impact from foreign exchange rates, as compared to prior year while the incremental sales impact from recent acquisitions favorably impacted sales 1 percent in 2024.

Water Systems net sales in the U.S. and Canada decreased 5 percent in 2024, as compared to the prior year. In 2024, sales of large dewatering equipment decreased 41 percent, sales of water treatment products increased 11 percent, sales of groundwater pumping equipment increased 4 percent and sales of all other surface pumping equipment increased 5 percent compared to 2023.

Water Systems net sales in markets outside the U.S. and Canada increased 4 percent in 2024, as compared to the prior year. Sales decreased 4 percent in 2024 due to the negative impact from foreign exchange rates, as compared to prior year. In 2024 excluding the impact of foreign currency translation, sales increased in all three major regions: EMEA, Latin America and Asia Pacific.

Net Sales-Energy Systems

Energy Systems net sales decreased 8 percent in 2024, as compared to the prior year. This sales decline was primarily due to lower volumes.

Energy Systems net sales in the U.S. and Canada decreased 3 percent in 2024, as compared to the prior year. Outside the U.S. and Canada, Energy Systems sales decreased 18 percent in 2024, as compared to the prior year. The decreases were across all product lines.

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Net Sales-Distribution

Distribution net sales increased 2 percent in 2024, as compared to the prior year. The Distribution segment sales increase was primarily due to the incremental sales impact from a recent acquisition, which favorably impacted net sales by 3 percent, partially offset by the negative impact of commodity pricing declines and unfavorable weather.

Gross Profit and Expense Ratios

Gross Profit

The gross profit margin ratio was 35.5 percent and 33.8 percent in 2024 and 2023, respectively. The gross profit margin was favorably impacted in 2024 by cost management, including lower freight costs in Water Systems and Energy Systems, and a favorable product and geographic sales mix shift.

Selling, General and Administrative (“SG&A”)

SG&A expenses were $470.1 million in 2024 compared to $433.5 million in 2023. SG&A expenses increased in 2024 primarily due to higher employee compensation costs, including incremental expenses associated with the Company's CEO transition, and the incremental expense impact of recent acquisitions. The SG&A expenses ratio was 23.3 percent and 21.0 percent in 2024 and 2023, respectively.

Restructuring Expenses

Restructuring expenses were $3.5 million and $1.1 million in 2024 and 2023, respectively. Restructuring actions in 2024 were primarily related to headcount reductions and facility closures to optimize the Company's cost structure. Restructuring expenses in 2023 were primarily from continued miscellaneous manufacturing realignment activities, branch closings and consolidations.

Operating Income

Operating income decreased 7 percent in 2024, as compared to the prior year.

Operating Income-Water Systems

Water Systems operating income in 2024 was $197.9 million, an increase of $1.3 million as compared to the prior year. The 2024 operating income margin was 16.7 percent, an increase of 40 basis points from 16.3 percent in 2023. Operating income and operating margin increased in 2024 primarily due to price realization, cost management and a favorable product and geographic sales mix shift.

Operating Income-Energy Systems

Energy Systems operating income in 2024 was $93.6 million, an increase of $0.9 million as compared to the prior year. The 2024 operating income margin was 34.2 percent, an increase of 290 basis points from 31.3 percent in 2023. Operating income and operating margin increased primarily due to a favorable geographic mix of sales, price realization and cost management.

Operating Income-Distribution

Distribution operating income in 2024 was $24.3 million, a decrease of $10.0 million as compared to the prior-year period. The 2024 operating income margin was 3.5 percent, a decrease of 160 basis points from 5.1 percent in 2023. Operating income and operating income margin decreased in 2024 primarily due to the negative impact on sales from wet weather across much of the United States, decreases in pricing of commodity-based products sold through the business and increased SG&A costs.

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Operating Income-Corporate Expenses and Eliminations

Operating income-corporate expenses and eliminations is composed primarily of intersegment sales and profit eliminations and unallocated general and administrative expenses. The intersegment profit elimination impact in 2024 compared to 2023 was an unfavorable $2.7 million. The intersegment elimination of operating income effectively defers the operating income on sales from Water Systems to Distribution in the consolidated financial results until such time as the transferred product is sold from the Distribution segment to its end third party customer. General and administrative expenses increased $8.3 million, compared to the prior year. The increase was primarily driven by to higher employee compensation costs, including incremental expenses associated with the Company’s CEO transition.

Interest Expense

Interest expense was $6.3 million in 2024 and $11.8 million in 2023, respectively. The decrease in 2024 was primarily driven by lower average borrowings in 2024.

Other Income or Expense

Other income (expense), net was a benefit of $1.3 million in 2024 and $3.7 million in 2023. The benefit in 2024 was lower than 2023 due to lower interest income realized in Argentina as excess cash balances and interest rates have declined in 2024 compared to 2023.

Foreign Exchange

Foreign currency-based transactions produced an expense of $6.8 million in 2024 and $12.1 million in 2023, respectively. The expense in 2024 and 2023 was primarily due to transaction losses associated with the Turkish Lira and Argentine Peso relative to the U.S. dollar. The Company reports the results of its subsidiaries in Argentina and Turkey using highly inflationary accounting, which requires that the functional currency of the entity be changed to the reporting currency of its parent.

Income Taxes

The provision for income taxes in 2024 and 2023 were $50.2 million and $47.5 million, respectively. The effective tax rate for 2024 was about 22 percent and included a favorable benefit from discrete events of 1 percent. The effective tax rate for 2023 was about 20 percent and included a favorable benefit from discrete events of 1 percent. The effective tax rate differs from the U.S. statutory rate of 21 percent, primarily due to U.S. states taxes, foreign earnings taxed at rates higher than the U.S. statutory rate, and nondeductible officer’s compensation, partially offset by the recognition of the U.S. foreign-derived intangible income (FDII) provisions, certain incentives, and discrete events.

Net Income

Net income for 2024 was $181.6 million compared to 2023 net income of $194.7 million. Net income attributable to Franklin Electric Co., Inc. for 2024 was $180.3 million, or $3.86 per diluted share, compared to 2023 net income attributable to Franklin Electric Co., Inc. of $193.3 million, or $4.11 per diluted share.

CAPITAL RESOURCES AND LIQUIDITY

Sources of Liquidity

The Company's primary sources of liquidity are cash on hand, cash flows from operations, revolving credit agreements, and long-term debt funds available. The Company believes its capital resources and liquidity position at December 31, 2024 is adequate to meet projected needs for the foreseeable future. The Company expects that ongoing requirements for operations, capital expenditures, pension obligations, dividends, share repurchases, and debt service will be adequately funded from cash on hand, operations, and existing credit agreements.

As of December 31, 2024, the Company had a $350.0 million revolving credit facility. The facility is scheduled to mature on May 13, 2026. As of December 31, 2024, the Company had $304.1 million borrowing capacity under the Credit Agreement as $4.5 million in letters of commercial and standby letters of credit were outstanding and undrawn and $41.4 million in revolver borrowings were drawn or outstanding.

In addition, the Company maintains an uncommitted and unsecured private shelf agreement with NYL Investors LLC, an affiliate of New York Life, and each of the undersigned holders of Notes (the "New York Life Agreement"). On May 15, 2024, the Company entered into Amendment No. 1 that increased the total available facility amount from lenders to $250.0 million from $200.0 million. As of December 31, 2024, the remaining borrowing capacity on the New York Life Agreement was $175.0 million. The Company also maintains an uncommitted and unsecured note purchase and private shelf agreement with PGIM, Inc. and its affiliates (the "Prudential Agreement"). On May 15, 2024, the Company entered into Amendment No. 1 that increased the total available facility amount from lenders to $250.0 million from $150.0 million. The maturity dates of both agreements were extended from July 30, 2024 to May 15, 2027.

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At December 31, 2024, the Company had $47.1 million of cash and cash equivalents held in foreign jurisdictions, which the Company intends to use to fund foreign operations. There is currently no need to repatriate these funds in order to meet domestic funding obligations or scheduled cash distributions.

Cash Flows

The following table summarizes significant sources and uses of cash and cash equivalents:

Cash Flows from Operating Activities

2024 vs 2023

Net cash provided by operating activities was $261.4 million for 2024 compared to $315.7 million for 2023. The change in operating cash flow was primarily attributable to changes in working capital and lower earnings. In 2023, the Company's cash flow benefited from actions it took to improve working capital including inventory reductions as its supply chain resiliency and lead times improved significantly compared to 2022.

Cash Flows from Investing Activities

2024 vs. 2023

Net cash used in investing activities was $45.6 million in 2024 compared to $74.3 million in 2023. The change in investing cash flow was primarily attributable to decreased acquisition activity in 2024.

In February 2025, the Company acquired 100 percent of the ownership interests of PumpEng for a purchase price of AUD 24.0 million (approximately $15 million), subject to working capital and net debt closing adjustments. Also in February 2025, the Company signed a definitive agreement to acquire Barnes for an enterprise value of $110.0 million, subject to working capital and net debt closing adjustments. The acquisition is subject to customary closing conditions, including Colombian antitrust clearance, and is expected to close on or about March 1, 2025.

Cash Flows from Financing Activities

2024 vs. 2023

Net cash used by financing activities was $74.1 million in 2024 compared to $192.2 million in 2023. The change in financing cash flow was primarily due to net borrowings under the Company's credit facility in 2024 compared to net repayments in 2023, partially offset by lower proceeds from option exercises, increased share repurchase activity and higher dividends.

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 and purchase obligations. The payment schedule for these contractual obligations is as follows:

Interest payments on debt obligations are calculated for future periods using interest rates in effect at the end of 2024. Certain of these projected interest payments may differ in the future based on interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2024.

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The Company has pension and other post-retirement benefit obligations not included in the table above which will result in estimated future payments of approximately $7.3 million in 2025. In addition, due to the timing of funding in future periods being uncertain and dependent on future movements in interest rates, investment returns, changes in laws and regulations and other variables, the table above excludes the non-current liability of $24.1 million for cash outflows related to the Company's pension plans.

The Company also has unrecognized tax benefits, none of which are included in the table above. The unrecognized tax benefits of approximately $1.3 million have been recorded as liabilities and the Company is uncertain as to if or when such amounts may be settled. Related to the unrecognized tax benefits, the Company has also recorded a liability for potential penalties and interest of $0.1 million.

ACCOUNTING PRONOUNCEMENTS

For information regarding recent accounting pronouncements, refer to Note 2 - Accounting Pronouncements, in the Notes to Consolidated Financial Statements in the sections entitled ""Adoption of New Accounting Standards" and "Accounting Standards Issued But Not Yet Adopted", included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.

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 estimates on an ongoing basis. Estimates are based on historical experience and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. There were no material changes to estimates or methodologies used to develop those estimates in 2024. The Company’s critical accounting estimates are identified below:

Inventory Valuation

The Company uses certain estimates and judgments to value inventory. Inventory is recorded at the lower of cost or net realizable value. 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 and Valuation of Acquired Intangible Assets

The Company follows the guidance under FASB 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 utilizes management estimates and may use an independent third-party valuation firm to assist in determining the fair values of assets acquired, including intangible assets, and liabilities assumed. The identifiable intangible assets acquired typically include customer relationships and trade names. Identifiable intangible assets are initially valued using a methodology commensurate with the intended use of the asset. The fair value of customer relationships is measured using the multi-period excess earnings method ("MPEEM"). The fair value of trade names is measured using a relief-from-royalty ("RFR") approach, which assumes the value of the trade name is the discounted amount of cash flows that would be paid to third parties had the Company not owned the trade name and instead licensed the trade name from another company. Higher royalty rates are assigned to premium brands within the marketplace based on name recognition and profitability, while other brands receive lower royalty rates. The basis for future sales projections for both the RFR and MPEEM are based on internal revenue forecasts which the Company believes represents reasonable market participant assumptions. The future cash flows are discounted using an applicable discount rate as well as any potential risk premium to reflect the inherent risk of holding a standalone intangible asset. The key uncertainties in the RFR and MPEEM calculations, as applicable, are the selection of an appropriate royalty rate, assumptions used in developing estimates of future cash flows, including revenue growth and expense forecasts, assumed customer attrition rates, as well as the perceived risk associated with those forecasts in determining the discount rate and risk premium. There is inherent uncertainty in forecasted future cash flows and therefore, actual results may differ and could result in subsequent impairment charges of acquired intangible assets and/or goodwill.

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Indefinite-Lived Intangible Asset and Goodwill Impairment Evaluation

According to FASB ASC Topic 350, Intangibles - Goodwill and Other, 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 has the option to assess goodwill and other indefinite-lived intangible assets for impairment by initially performing a qualitative assessment to determine whether it is more-likely-than-not that the fair value of a reporting unit or indefinite-lived intangible asset is less than its carrying amount. If the Company determines that it is not more-likely-than-not that the fair value of a reporting unit or indefinite-lived intangible asset is less than its carrying amount, then a quantitative impairment test is not required to be performed. If the Company determines that it is more-likely-than-not that the fair value of a reporting unit or indefinite-lived intangible asset is less than its carrying amount, or if it does not elect the option to perform an initial qualitative assessment, it performs a quantitative impairment test.

The Company uses a variety of methodologies in conducting impairment assessments including qualitative reviews as well as quantitative reviews using the income and market 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 is required to record an impairment if these assumptions and estimates change whereby the fair value of the reporting units or indefinite-lived intangible assets are below their associated carrying values.

During the fourth quarter of 2024, the Company completed its annual impairment tests of goodwill and indefinite-lived trade names. The Company determined it was not more likely than not that the fair values of its reporting units were lower than their carrying values. The Company also determined the fair value of all other indefinite-lived intangible assets were in excess of their respective carrying values. 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 estimated fair value of any of the indefinite-lived trade names would not have changed this determination. The sensitivity analysis required the use of 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 an 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’s operations involve dealing with uncertainties and judgments in the application of complex tax regulations in multiple jurisdictions. These jurisdictions have different tax rates, and the Company 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. The final taxes paid are dependent upon many factors, including negotiations with taxing authorities in the various jurisdictions and resolution of disputes arising from federal, state, and international tax audits. Although the Company has recorded all 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. 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 tax expense and/or deferred tax assets and liabilities.

Pension and Employee Benefit Obligations

The Company consults with its actuaries to assist with the calculation of discount rates used in its pension and post retirement plans. The discount rates used to determine domestic pension and post-retirement plan liabilities are calculated using a full yield curve approach. Market conditions have caused the weighted-average discount rate to move from 4.90 percent last year to 5.48

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percent this year for the domestic pension plans and from 4.88 percent last year to 5.47 percent this year for the postretirement health and life insurance plan. A change in the discount rate selected by the Company of 25 basis points would result in a change of about $0.1 million to employee benefit expense and a change of about $2.4 million of liability.

The Company consults with actuaries and investment advisors in making its determination of the expected long-term rate of return on plan assets. Using input from these consultations such as long-term investment sector expected returns, the correlations and standard deviations thereof, and the plan asset allocation, the Company will use an expected long-term rate of return on plan assets of 5.75 percent in measuring net periodic cost for 2025. Market conditions have caused the expected long-term rate or return to decrease from 6.20 percent as used in measuring net periodic cost for 2024. 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.

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, epidemics and pandemics, 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.

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

Discussion of the year-over-year comparison of changes in the Company's financial condition and results of operation as of and for the fiscal years ended December 31, 2022 and December 31, 2021 can be found in Part II, Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

2023 vs. 2022

OVERVIEW

Net sales in 2023 increased 1 percent compared to the prior year. The sales increase in 2023 was primarily due to price realization, partially offset by the negative impact of foreign currency translation and lower volumes. The Company's consolidated gross profit was $697.0 million for 2023, an increase of $5.6 million from the prior year. Diluted earnings per share was $4.11 for 2023, an increase of $0.14 or 4 percent from the prior year.

RESULTS OF OPERATIONS

Net Sales

Net sales increased 1 percent in 2023 compared to the prior year. Foreign currency unfavorably impacted net sales by 3 percentage points during 2023, principally due to the strengthening of the U.S. Dollar relative to the Turkish Lira and Argentine Peso.

Net Sales-Water Systems

Water Systems sales increased 4 percent in 2023, as compared to the prior year. This sales growth was primarily due to price realization. Partially offsetting the increase, sales decreased 5 percent in 2023 due to the negative impact from foreign exchange rates, as compared to prior year.

Water Systems sales in the U.S. and Canada increased 4 percent in 2023, as compared to the prior year. Sales decreased less than 1 percent in 2023 due to the negative impact from foreign exchange rates, as compared to prior year. In 2023, sales of large dewatering equipment increased 63 percent, sales of groundwater pumping equipment decreased 10 percent and sales of all other surface pumping equipment decreased 1 percent compared to 2022.

Water Systems sales in markets outside the U.S. and Canada increased 3 percent in 2023, as compared to the prior year. Sales decreased 11 percent in 2023 due to the negative impact from foreign exchange rates, as compared to prior year. In 2023 excluding the impact of foreign currency translation, sales increases in EMEA and Latin America more than offset sales declines in the Asia Pacific markets.

Net Sales-Fueling Systems

Fueling Systems sales decreased 11 percent in 2023, as compared to the prior year. This sales decline was primarily due to lower volumes driven by customer inventory destocking as well as higher interest rates, labor constraints, and permitting delays causing some new station build plans to move into 2024.

Fueling Systems sales in the U.S. and Canada decreased 9 percent in 2023, as compared to the prior year. The decrease was primarily in dispensing and piping equipment. Outside the U.S. and Canada, Fueling Systems sales decreased 19 percent in 2023, as compared to the prior year, due primarily to the divestiture of the above ground storage tank business in 2022 and lower sales in China.

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Net Sales-Distribution

Distribution sales increased 1 percentage point in 2023, as compared to the prior year. The Distribution segment sales increase was primarily due to higher volumes, partially offset by lower commodity-driven pricing.

Gross Profit and Expense Ratios

Gross Profit

The gross profit margin ratio was 33.8 percent in 2023 and 2022. The gross profit margin was favorably impacted in 2023 by price realization, product mix and lower freight costs in Water Systems and Fueling, partially offset by margin compression from unfavorable pricing of commodity-based products sold through the Distribution business.

Selling, General and Administrative (“SG&A”)

SG&A expenses were $433.5 million in 2023 compared to $432.1 million in 2022. SG&A expenses increased by less than 1 percent in 2023 primarily due to higher compensation costs, partially offset by lower advertising and marketing expenses. The SG&A expenses ratio was 21.0 percent and 21.1 percent in 2023 and 2022, respectively.

Restructuring Expenses

Restructuring expenses were $1.1 million and $2.2 million in 2023 and 2022, respectively. Restructuring expenses were primarily from continued miscellaneous manufacturing realignment activities, branch closings and consolidations.

Operating Income

Operating income increased 2 percent in 2023, as compared to the prior year.

Operating Income-Water Systems

Water Systems operating income increased $24.3 million in 2023, as compared to the prior-year period, primarily due to price realization and cost management, including lower freight costs. The 2023 operating income margin was 16.3 percent compared to 2022 operating income margin of 14.9 percent of net sales. Operating income margin increased in Water Systems primarily due to price realization and operating leverage on higher sales.

Operating Income-Fueling Systems

Fueling Systems operating income decreased $4.1 million in 2023, as compared to the prior-year period. Operating income decreased in Fueling Systems primarily due to lower sales volumes, partially offset by a favorable product and geographic mix of net sales and disciplined cost management. The 2023 operating income margin was 31.3 percent compared to 29.0 percent of net sales in 2022. Operating income margin increased in Fueling Systems primarily due to price realization, a favorable product and geographic sales mix shift and disciplined cost management.

Operating Income-Distribution

Distribution operating income decreased $20.2 million in 2023, as compared to the prior-year period. The 2023 operating income margin was 5.1 percent compared to 8.2 percent of net sales in 2022. Operating income and operating income margin decreased primarily due to unfavorable pricing of commodity-based products sold through the business.

Operating Income-Eliminations/Other

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Operating income-eliminations/other is composed primarily of intersegment sales and profit eliminations and unallocated general and administrative expenses. The intersegment profit elimination impact in 2023 compared to 2022 was a favorable $6.2 million. The intersegment elimination of operating income effectively defers the operating income on sales from Water Systems to Distribution in the consolidated financial results until such time as the transferred product is sold from the Distribution segment to its end third party customer. General and administrative expenses increased $1.0 million, compared to the prior year.

Interest Expense

Interest expense was $11.8 million in 2023 and $11.5 million in 2022, respectively. The increase in 2023 was primarily driven by higher interest rates, partially offset by lower average borrowings in 2023.

Other Income or Expense

Other income (expense), net was a benefit of $3.7 million in 2023 and an expense of $3.2 million in 2022. The favorable benefit in 2023 was due to higher interest income as a result of favorable interest rates and lower benefit costs related to the Company’s employee benefit plans.

Foreign Exchange

Foreign currency-based transactions produced an expense of $12.1 million in 2023 and $7.2 million in 2022, respectively. The expense in 2023 was primarily due to transaction losses associated with the Turkish Lira, Argentine and Mexican Peso relative to the U.S. dollar. The expense in 2022 was primarily due to transaction losses associated with the Argentine Peso and Turkish Lira. The Company reports the results of its subsidiaries in Argentina and Turkey using highly inflationary accounting, which requires that the functional currency of the entity be changed to the reporting currency of its parent.

Income Taxes

The provision for income taxes in 2023 and 2022 were $47.5 million and $46.4 million, respectively. The effective tax rate for 2023 was about 20 percent and before the impact of discrete events was about 21 percent. The effective tax rate for 2022 both before and after the impact of discrete events was about 20 percent. The effective tax rate differs from the U.S. statutory rate of 21 percent primarily due to the recognition of the U.S. foreign-derived intangible income (FDII) provisions, foreign earnings taxed at rates below the U.S. statutory rate, certain incentives, and discrete events partially offset by state taxes.

Net Income

Net income for 2023 was $194.7 million compared to 2022 net income of $188.8 million. Net income attributable to Franklin Electric Co., Inc. for 2023 was $193.3 million, or $4.11 per diluted share, compared to 2022 net income attributable to Franklin Electric Co., Inc. of $187.3 million, or $3.97 per diluted share.

CAPITAL RESOURCES AND LIQUIDITY

Sources of Liquidity

The Company's primary sources of liquidity are cash on hand, cash flows from operations, revolving credit agreements, and long-term debt funds available. The Company believes its capital resources and liquidity position at December 31, 2023 is adequate to meet projected needs for the foreseeable future. The Company expects that ongoing requirements for operations, capital expenditures, pension obligations, dividends, share repurchases, and debt service will be adequately funded from cash on hand, operations, and existing credit agreements.

As of December 31, 2023, the Company had a $350.0 million revolving credit facility. The facility is scheduled to mature on May 13, 2026. As of December 31, 2023, the Company had $335.4 million borrowing capacity under the Credit Agreement as $3.6 million in letters of commercial and standby letters of credit were outstanding and undrawn and $11.0 million in revolver borrowings were drawn and outstanding, which were primarily used for funding working capital requirements.

In addition, the Company maintains an uncommitted and unsecured private shelf agreement with NYL Investors LLC, an affiliate of New York Life, and each of the undersigned holders of Notes (the "New York Life Agreement") with a remaining borrowing capacity of $125.0 million as of December 31, 2023. The New York Life Agreement matures on July 30, 2024. The Company also has other long-term debt borrowings outstanding as of December 31, 2023. See Note 10 - Debt for additional specifics regarding these obligations and future maturities.

At December 31, 2023, the Company had $69.6 million of cash and cash equivalents held in foreign jurisdictions, which the Company intends to use to fund foreign operations. There is currently no need to repatriate these funds in order to meet domestic funding obligations or scheduled cash distributions.

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Cash Flows

The following table summarizes significant sources and uses of cash and cash equivalents:

Cash Flows from Operating Activities

2023 vs 2022

Net cash provided by operating activities was $315.7 million for 2023 compared to $101.7 million for 2022. The increase in cash provided by operating activities was primarily due to actions the Company took to improve working capital including inventory reductions as its supply chain resiliency and lead times improved during the back half of the year.

Cash Flows from Investing Activities

2023 vs. 2022

Net cash used in investing activities was $74.3 million in 2023 compared to $43.1 million in 2022. The increase was primarily attributable to increased acquisition activity in 2023.

Cash Flows from Financing Activities

2023 vs. 2022

Net cash used by financing activities was $192.2 million in 2023 compared to $48.5 million in 2022. The change in financing cash flow was primarily attributable to net borrowings under the Company's revolving credit facility in 2022 compared to net repayments in 2023.

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 and purchase obligations. The payment schedule for these contractual obligations is as follows:

Interest payments on debt obligations are calculated for future periods using interest rates in effect at the end of 2023. Certain of these projected interest payments may differ in the future based on interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2023.

The Company has pension and other post-retirement benefit obligations not included in the table above which will result in estimated future payments of approximately $0.8 million in 2024. In addition, due to the timing of funding in future periods being uncertain and dependent on future movements in interest rates, investment returns, changes in laws and regulations and other variables, the table above excludes the non-current liability of $29.5 million for cash outflows related to the Company's pension plans.

The Company also has unrecognized tax benefits, none of which are included in the table above. The unrecognized tax benefits of approximately $0.8 million have been recorded as liabilities and the Company is uncertain as to if or when such amounts may be settled. Related to the unrecognized tax benefits, the Company has also recorded a liability for potential penalties and interest of $0.1 million.

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ACCOUNTING PRONOUNCEMENTS

For information regarding recent accounting pronouncements, refer to Note 2 - Accounting Pronouncements, in the Notes to Consolidated Financial Statements in the sections entitled ""Adoption of New Accounting Standards" and "Accounting Standards Issued But Not Yet Adopted", included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.

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 estimates on an ongoing basis. Estimates are based on historical experience and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. There were no material changes to estimates or methodologies used to develop those estimates in 2023. The Company’s critical accounting estimates are identified below:

Inventory Valuation

The Company uses certain estimates and judgments to value inventory. Inventory is recorded at the lower of cost or net realizable value. 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 and Valuation of Acquired Intangible Assets

The Company follows the guidance under FASB 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 utilizes management estimates and may use an independent third-party valuation firm to assist in determining the fair values of assets acquired, including intangible assets, and liabilities assumed. The identifiable intangible assets acquired typically include customer relationships and trade names. Identifiable intangible assets are initially valued using a methodology commensurate with the intended use of the asset. The fair value of customer relationships is measured using the multi-period excess earnings method ("MPEEM"). The fair value of trade names is measured using a relief-from-royalty ("RFR") approach, which assumes the value of the trade name is the discounted amount of cash flows that would be paid to third parties had the Company not owned the trade name and instead licensed the trade name from another company. Higher royalty rates are assigned to premium brands within the marketplace based on name recognition and profitability, while other brands receive lower royalty rates. The basis for future sales projections for both the RFR and MPEEM are based on internal revenue forecasts which the Company believes represents reasonable market participant assumptions. The future cash flows are discounted using an applicable discount rate as well as any potential risk premium to reflect the inherent risk of holding a standalone intangible asset. The key uncertainties in the RFR and MPEEM calculations, as applicable, are the selection of an appropriate royalty rate, assumptions used in developing estimates of future cash flows, including revenue growth and expense forecasts, assumed customer attrition rates, as well as the perceived risk associated with those forecasts in determining the discount rate and risk premium. There is inherent uncertainty in forecasted future cash flows and therefore, actual results may differ and could result in subsequent impairment charges of acquired intangibles and/or goodwill.

Indefinite-Lived Intangible Asset and Goodwill Impairment Evaluation

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. 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.

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.

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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 is 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 year ended December 31, 2023 was $342.4 million.

During the fourth quarter of 2023, the Company completed its annual impairment test of goodwill and indefinite-lived trade names and determined the fair value of all intangibles were substantially in excess of the respective carrying values. 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 estimated fair value of any of these intangible assets would not have changed this determination. The sensitivity analysis required the use of 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 an 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’s operations involve dealing with uncertainties and judgments in the application of complex tax regulations in multiple jurisdictions. These jurisdictions have different tax rates, and the Company 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. The final taxes paid are dependent upon many factors, including negotiations with taxing authorities in the various jurisdictions and resolution of disputes arising from federal, state, and international tax audits. Although the Company has recorded all 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. 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 tax expense and/or deferred tax assets and liabilities.

Pension and Employee Benefit Obligations

The Company consults with its actuaries to assist with the calculation of discount rates used in its pension and post retirement plans. The discount rates used to determine domestic pension and post-retirement plan liabilities are calculated using a full yield curve approach. Market conditions have caused the weighted-average discount rate to move from 5.15 percent last year to 4.90 percent this year for the domestic pension plans and from 5.08 percent last year to 4.88 percent this year for the postretirement health and life insurance plan. A change in the discount rate selected by the Company of 25 basis points would result in a change of about $0.1 million to employee benefit expense and a change of about $2.4 million of liability.

The Company consults with actuaries and investment advisors in making its determination of the expected long-term rate of return on plan assets. Using input from these consultations such as long-term investment sector expected returns, the correlations and standard deviations thereof, and the plan asset allocation, the Company will use an expected long-term rate of return on plan assets of 6.20 percent in measuring net periodic cost for 2024. Market conditions have caused the expected long-term rate or return to increase from 5.70 percent as used in measuring net periodic cost for 2023. 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.

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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, epidemics and pandemics, 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.

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

Discussion of the year-over-year comparison of changes in the Company's financial condition and results of operation as of and for the fiscal years ended December 31, 2021 and December 31, 2020 can be found in Part II, Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

2022 vs. 2021

OVERVIEW

Net sales in 2022 increased 23 percent compared to the prior year. The sales increase was primarily due to price and acquisitions. The impact of foreign currency translation decreased sales by about 5 percent. The Company's consolidated gross profit was $691.4 million for 2022, an increase of $115.3 million, or about 20 percent, from 2021. Net income attributable to the Company was $187.3 million, an increase of $33.5 million, or about 22 percent, from 2021.

RESULTS OF OPERATIONS

Net Sales

Net sales in 2022 were $2,043.7 million, an increase of $381.8 million, or about 23 percent, compared to 2021 sales of $1,661.9 million. The incremental impact to sales from acquired businesses was $131.9 million. Sales decreased by $77.1 million, or about 5 percent, in 2022 due to foreign currency translation.

Net Sales-Water Systems

Water Systems sales were $1,157.5 million in 2022, an increase of $193.9 million, or about 20 percent, versus 2021. The incremental impact to sales from acquired businesses was $58.8 million. Foreign currency translation changes decreased sales $71.7 million, or about 7 percent, compared to 2021.

Water Systems sales in the U.S. and Canada increased by about 30 percent compared to 2021. The incremental impact to sales from acquired businesses was $54.1 million. Sales decreased by $3.0 million in 2022 due to foreign currency translation. In 2022, sales of groundwater pumping equipment increased by about 22 percent and sales of all surface pumping equipment increased by about 23 percent versus 2021, due to strong end market demand and pricing.

Water Systems sales in markets outside the U.S. and Canada increased by about 7 percent compared to 2021. The incremental impact to sales from acquired businesses was $4.7 million. Sales decreased by $68.7 million, or 17 percent, in 2022 due to foreign currency translation. Excluding the impact of acquisitions and foreign currency translation, sales increased in all major markets; EMEA, Latin America, and Asia Pacific.

Net Sales-Fueling Systems

Fueling Systems sales were $334.1 million in 2022, an increase of $45.0 million, or about 16 percent, from 2021. Foreign currency translation changes decreased sales $5.4 million, or about 2 percent, compared to 2021.

Fueling Systems sales in the U.S. and Canada increased by about 22 percent during 2022, primarily due to pricing actions and higher demand across all product lines. Outside the U.S. and Canada, Fueling Systems sales increased with sales growth in India more than offsetting lower sales in China. China sales were about $7 million in 2022 compared to about $12 million in 2021.

Net Sales-Distribution

Distribution sales were $668.1 million in 2022, an increase of $170.5 million, or about 34 percent, from 2021. The incremental impact to sales from acquired businesses was $73.1 million. Sales growth was driven by acquisitions, pricing and broad-based demand in all regions and product categories.

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Cost of Sales

Cost of sales as a percent of net sales for 2022 and 2021 was 66.2 percent and 65.3 percent, respectively. Correspondingly, the gross profit margin was 33.8 percent and 34.7 percent, respectively. The gross profit margin decline was primarily a result of supply disruptions causing unfavorable absorption variances and higher inbound freight that was partially offset by realized pricing actions that more than offset inflationary cost increases. The Company's consolidated gross profit was $691.4 million for 2022, up $115.3 million from the gross profit of $576.1 million in 2021. The gross profit increase was primarily due to higher sales.

Selling, General and Administrative (“SG&A”)

SG&A expenses were $432.1 million in 2022 and increased $45.8 million compared to $386.3 million in the prior year. The increase was primarily due to incremental expenses from acquired businesses of $31 million. Additionally, higher travel and advertising expenses were partially offset by lower variable performance-based compensation expenses. SG&A costs as a percent of net sales decreased to 21.1 percent in 2022 from 23.2 percent in 2021.

Restructuring Expenses

Restructuring expenses were $2.2 million and $0.6 million in 2022 and 2021, respectively. Restructuring expenses were primarily from continued miscellaneous manufacturing realignment activities and branch closings and consolidations in the Distribution and Water Systems segments.

Operating Income

Operating income was $257.2 million in 2022, up $68.0 million, or 36 percent, from $189.2 million in 2021.

Operating Income-Water Systems

Water Systems operating income was $172.3 million in 2022 compared to $139.1 million in 2021, an increase of 24 percent. Operating income increased in Water Systems primarily due to higher sales volumes and SG&A cost controls. The 2022 operating income margin was 14.9 percent compared to 2021 operating income margin of 14.4 percent of net sales. Operating income margin increased in Water Systems primarily due to operating leverage on higher sales.

Operating Income-Fueling Systems

Fueling Systems operating income was $96.8 million in 2022 compared to $79.5 million in 2021, an increase of 22 percent. Operating income increased in Fueling Systems primarily due to higher sales volumes. The 2022 operating income margin was 29.0 percent compared to 27.5 percent of net sales in 2021. Operating income margin increased in Fueling Systems primarily due to operating leverage on higher sales.

Operating Income-Distribution

Distribution operating income was $54.5 million in 2022 compared to $35.9 million in 2021, an increase of 52 percent. Operating income increased in Distribution due to higher sales volumes. The 2022 operating income margin was 8.2 percent compared to 7.2 percent of net sales in 2021. The increase in operating income margin was primarily due to sales growth and operating leverage.

Operating Income-Eliminations/Other

Operating income-Eliminations/Other is composed primarily of inter-segment sales and profit eliminations and unallocated general and administrative expenses. The inter-segment profit elimination impact in 2022 decreased operating income by about $3.0 million more compared to 2021. The inter-segment elimination of operating income effectively defers the operating income on sales from Water Systems to Distribution in the consolidated financial results until the transferred product is sold from the Distribution segment to its third-party customer. Additionally, unallocated general and administrative expenses decreased $1.9 million compared to last year.

Interest Expense

Interest expense increased in 2022 to $11.5 million from $5.2 million in 2021 primarily due to higher outstanding debt levels and higher interest rates.

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Other Income or Expense

Other income or expense was a loss of $3.2 million in 2022 compared to income of $8.0 million in 2021. Included in other income or expense in 2022 was a loss of $2.1 million related to a settlement of an indirect tax dispute. Other income or expense in 2021 included a bargain purchase gain of $6.5 million and a gain of $2.5 million related to a settlement of an indirect tax dispute.

Foreign Exchange

Foreign exchange was a loss of $7.2 million and $2.3 million in 2022 and 2021, respectively. The increase in 2022 was primarily due to transaction losses associated with the Argentine Peso and Turkish Lira. The Company reports the results of its subsidiaries in Argentina and Turkey using highly inflationary accounting, which requires that the functional currency of the entity be changed to the reporting currency of its parent.

Income Taxes

The provision for income taxes in 2022 and 2021 was $46.4 million and $34.7 million, respectively. The effective tax rate for 2022 both before and after the impact of discrete events was about 20 percent. The effective tax rate for 2021 was about 18 percent and, before the impact of discrete events, was about 21 percent. The tax rate was lower than the statutory rate of 21 percent primarily due to the recognition of the U.S. deduction for Foreign Derived Intangible Income, certain incentives, and discrete events. The increase in the effective tax rate in 2022 was primarily a result of smaller net favorable discrete events recorded in 2022 compared to 2021, primarily related to excess tax benefits from share-based compensation.

Net Income

Net income for 2022 was $188.8 million compared to 2021 net income of $155.0 million. Net income attributable to Franklin Electric Co., Inc. for 2022 was $187.3 million, or $3.97 per diluted share, compared to 2021 net income attributable to Franklin Electric Co., Inc. of $153.9 million, or $3.25 per diluted share.

CAPITAL RESOURCES AND LIQUIDITY

Sources of Liquidity

The Company's primary sources of liquidity are cash on hand, cash flows from operations, revolving credit agreements, and long-term debt funds available. The Company believes its capital resources and liquidity position at December 31, 2022 is adequate to meet projected needs for the foreseeable future. The Company expects that ongoing requirements for operations, capital expenditures, pension obligations, dividends, share repurchases, and debt service will be adequately funded from cash on hand, operations, and existing credit agreements.

As of December 31, 2022, the Company had a $350.0 million revolving credit facility. The facility is scheduled to mature on May 13, 2026. As of December 31, 2022, the Company had $223.2 million borrowing capacity under the Credit Agreement as $4.0 million in letters of commercial and standby letters of credit were outstanding and undrawn and $122.8 million in revolver borrowings were drawn and outstanding, which were primarily used for funding working capital requirements.

In addition, the Company maintains an uncommitted and unsecured private shelf agreement with NYL Investors LLC, an affiliate of New York Life, and each of the undersigned holders of Notes (the "New York Life Agreement") with a remaining borrowing capacity of $125.0 million as of December 31, 2022. The New York Life Agreement matures on July 30, 2024. The Company also has other long-term debt borrowings outstanding as of December 31, 2022. See Note 10 - Debt for additional specifics regarding these obligations and future maturities.

At December 31, 2022, the Company had $43.4 million of cash and cash equivalents held in foreign jurisdictions, which the Company intends to use to fund foreign operations. There is currently no need to repatriate these funds in order to meet domestic funding obligations or scheduled cash distributions.

Cash Flows

The following table summarizes significant sources and uses of cash and cash equivalents:

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Cash Flows from Operating Activities

2022 vs 2021

Net cash provided by operating activities was $101.7 million for 2022 compared to $129.8 million for 2021. The decrease in cash provided by operating activities was primarily due to increased working capital requirements in support of higher revenues.

Cash Flows from Investing Activities

2022 vs. 2021

Net cash used in investing activities was $43.1 million in 2022 compared to $264.8 million in 2021. The decrease was primarily attributable to decreased acquisition activity in 2022.

Cash Flows from Financing Activities

2022 vs. 2021

Net cash used by financing activities was $48.5 million in 2022 compared to $50.9 million provided by financing activities in 2021. The change in financing cash flows was attributable to decreased net proceeds from debt and common stock issuances, increased stock repurchases, higher dividend payments and deferred payments related to acquisitions.

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 and purchase obligations. The payment schedule for these contractual obligations is as follows:

Interest payments on debt obligations are calculated for future periods using interest rates in effect at the end of 2022. Certain of these projected interest payments may differ in the future based on interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2022.

The Company has pension and other post-retirement benefit obligations not included in the table above which will result in estimated future payments of approximately $0.8 million in 2023. In addition, due to the timing of funding in future periods being uncertain and dependent on future movements in interest rates, investment returns, changes in laws and regulations and other variables, the table above excludes the non-current liability of $24.9 million for cash outflows related to the Company's pension plans.

The Company also has unrecognized tax benefits, none of which are included in the table above. The unrecognized tax benefits of approximately $0.9 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 $0.2 million.

ACCOUNTING PRONOUNCEMENTS

For information regarding recent accounting pronouncements, refer to Note 2 - Accounting Pronouncements, in the Notes to Consolidated Financial Statements in the sections entitled ""Adoption of New Accounting Standards" and "Accounting Standards Issued But Not Yet Adopted", included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.

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 estimates on an ongoing basis. Estimates are based on historical experience and on other

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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 or methodologies used to develop those estimates in 2022. The Company’s critical accounting estimates are identified below:

Inventory Valuation

The Company uses certain estimates and judgments to value inventory. Inventory is recorded at the lower of cost or net realizable value. 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 and Valuation of Acquired Intangible Assets

The Company follows the guidance under FASB 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 utilizes management estimates and an independent third-party valuation firm to assist in determining the fair values of assets acquired, including intangible assets, and liabilities assumed. The identifiable intangible assets acquired typically include customer relationships and trade names. Identifiable intangible assets are initially valued using a methodology commensurate with the intended use of the asset. The fair value of customer relationships is measured using the multi-period excess earnings method ("MPEEM"). The fair value of trade names is measured using a relief-from-royalty ("RFR") approach, which assumes the value of the trade name is the discounted amount of cash flows that would be paid to third parties had the Company not owned the trade name and instead licensed the trade name from another company. Higher royalty rates are assigned to premium brands within the marketplace based on name recognition and profitability, while other brands receive lower royalty rates. The basis for future sales projections for both the RFR and MPEEM are based on internal revenue forecasts which the Company believes represents reasonable market participant assumptions. The future cash flows are discounted using an applicable discount rate as well as any potential risk premium to reflect the inherent risk of holding a standalone intangible asset. The key uncertainties in the RFR and MPEEM calculations, as applicable, are the selection of an appropriate royalty rate, assumptions used in developing estimates of future cash flows, including revenue growth and expense forecasts, assumed customer attrition rates, as well as the perceived risk associated with those forecasts in determining the discount rate and risk premium. There is inherent uncertainty in forecasted future cash flows and therefore, actual results may differ and could result in subsequent impairment charges of acquired intangibles and/or goodwill.

Indefinite-Lived Intangible Asset and Goodwill Impairment Evaluation

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. 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.

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 Global Water Systems, Fueling Systems and Distribution reporting 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 is 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 year ended December 31, 2022 was $328.0 million.

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During the fourth quarter of 2022, the Company completed its annual impairment test of goodwill and indefinite-lived trade names and determined the fair value of all intangibles were substantially in excess of the respective carrying values. 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 tests would not have changed this determination. The sensitivity analysis required the use of 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’s operations involve dealing with uncertainties and judgments in the application of complex tax regulations in multiple jurisdictions. These jurisdictions have different tax rates, and the Company 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. The final taxes paid are dependent upon many factors, including negotiations with taxing authorities in the various jurisdictions and resolution of disputes arising from federal, state, and international tax audits. Although the Company has recorded all 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. 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 tax expense and/or deferred tax assets and liabilities.

Pension and Employee Benefit Obligations

The Company consults with its actuaries to assist with the calculation of discount rates used in its pension and post retirement plans. The discount rates used to determine domestic pension and post-retirement plan liabilities are calculated using a full yield curve approach. Market conditions have caused the weighted-average discount rate to move from 2.68 percent last year to 5.15 percent this year for the domestic pension plans and from 2.57 percent last year to 5.08 percent this year for the postretirement health and life insurance plan. A change in the discount rate selected by the Company of 25 basis points would result in a change of about $0.1 million to employee benefit expense and a change of about $3.7 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 will use an expected long-term rate of return on plan assets of 5.70 percent in measuring net periodic cost for 2023. Market conditions have caused the expected long-term rate or return to increase from 4.50 percent as used in measuring net periodic cost for 2022. 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.

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

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various factors, including general economic and currency conditions, various conditions specific to the Company’s business and industry, new housing starts, weather conditions, epidemics and pandemics, 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.

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

Discussion of the year-over-year comparison of changes in the Company's financial condition and results of operation as of and for the fiscal years ended December 31, 2020 and December 31, 2019 can be found in Part II, Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020.

2021 vs. 2020

OVERVIEW

Sales in 2021 were up from the prior year. The sales increase was led by increases from volume, price, and acquisitions. The impact of foreign currency translation decreased sales by less than 1 percent. The Company's consolidated gross profit was $576.1 million for 2021, an increase of $143.0 million or about 33 percent from 2020. The gross profit as a percent of net sales was changed at 34.7 percent in 2021 and 2020. For 2021, diluted earnings per share were $3.25, up from 2020 diluted earnings per share of $2.14.

RESULTS OF OPERATIONS

Net Sales

Net sales in 2021 were $1,661.9 million, an increase of $414.6 million or about 33 percent compared to 2020 sales of $1,247.3 million. The incremental impact of sales from acquired businesses was $149.8 million. Sales revenue decreased by $2.3 million or less than 1 percent in 2021 due to foreign currency translation. The sales change in 2021, excluding acquisitions and foreign currency translation, was an increase of about 21 percent. Revenue growth was from volume and price across all three segments.

Net Sales-Water Systems

Water Systems sales were $963.6 million in 2021, an increase of $228.9 million or about 31 percent versus 2020. The incremental impact of sales from acquired businesses was $96.7 million. Foreign currency translation changes decreased sales $4.5 million, or about 1 percent, compared to sales in 2020. The Water Systems sales change in 2021, excluding acquisitions and foreign currency translation, was an increase of $136.7 million or about 19 percent. Revenue growth was from volume and price driven by broad-based demand in all regions and product categories.

Water Systems sales in the U.S. and Canada increased by about 41 percent compared to 2020. The incremental impact of sales from acquired businesses was $94.3 million. Sales revenue increased by $4.0 million or about 1 percent in 2021 due to foreign currency translation. In 2021, sales of dewatering equipment increased by about 47 percent due to higher sales in rental channels and in oil production end markets. Sales of groundwater pumping equipment increased by 21 percent versus 2020. Sales of other surface pumping equipment increased by about 9 percent.

Water Systems sales in markets outside the U.S. and Canada increased by about 20 percent compared to 2020. The incremental impact of sales from acquired businesses was $2.4 million. Sales revenue decreased by $8.5 million or about 2 percent in 2021 due to foreign currency translation. Sales change in 2021, excluding acquisitions and foreign currency translation, was an increase of about 21 percent. Sales growth was in all geographic markets; Latin America, EMENA and Asia Pacific markets.

Net Sales-Fueling Systems

Fueling Systems sales were $289.1 million in 2021, an increase of $44.0 million or about 18 percent from 2020. Foreign currency translation changes increased sales $2.2 million or about 1 percent compared to sales in 2020. The Fueling Systems sales change in 2021, excluding foreign currency translation, was an increase of $41.8 million or about 17 percent. Revenue growth was from volume and price driven primarily by the U.S. and Canada regions.

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Fueling Systems sales in the U.S. and Canada increased by about 25 percent during 2021. The growth was broad base across most product lines and due to higher demand from filling stations. Fueling Systems revenues outside the U.S and Canada increased by about 2 percent, driven by higher sales in India, Latin America and most regions in Asia Pacific, partially offset by lower sales in China. China sales were about $12 million in 2021 compared to 2020 Fueling Systems China sales of about $18 million.

Net Sales-Distribution

Distribution sales were $497.6 million in 2021, versus 2020 sales of $328.4 million or about 52 percent from 2020. The incremental impact of sales from acquired businesses was $53.1 million. Distribution segment organic sales increased $116.1 million or about 35 percent compared to 2020. Revenue growth was from volume and price driven by broad-based demand in all regions and product categories.

Cost of Sales

Cost of sales as a percent of net sales for 2021 and 2020 was 65.3 percent for both years. Correspondingly, the gross profit margin was 34.7 percent, respectively. The Company's consolidated gross profit was $576.1 million for 2021, up $143.0 million from the gross profit of $433.1 million in 2020. The increase in gross profit and gross profit margin was primarily driven by price realization, favorable product and geographic sales mix shifts and cost management which were enough to offset inflation.

Selling, General and Administrative (“SG&A”)

Selling, general, and administrative expenses were $386.3 million in 2021 and increased by $86.2 million or 29 percent overall compared to $300.1 million last year. SG&A expenses from acquired businesses were $37.0 million, and excluding the acquired entities, the Company’s SG&A expenses in 2021 were $349.3 million, an increase of 16 percent from the prior year. SG&A expenses were higher versus the prior year due to higher variable performance-based compensation expenses and increased spending to support sales growth.

Restructuring Expenses

Restructuring expenses for 2021 were $0.6 million. Restructuring expenses were $0.5 million in the Water segment and $0.1 million in Distribution segments. Restructuring expenses in Water segment were primarily from Water Treatment realignment activities, and branch closings and consolidations in the Distribution segment. Restructuring expenses for 2020 were $2.5 million. Restructuring expenses were $2.3 million in the Water segment and $0.1 million in each of the Fueling and Distribution segments. Restructuring expenses were primarily from continued miscellaneous manufacturing realignment activities and branch closings and consolidations in the Distribution segment.

Operating Income

Operating income was $189.2 million in 2021, up $58.7 million or 45 percent from $130.5 million in 2020.

Operating Income-Water Systems

Water Systems operating income was $139.1 million in 2021 compared to $114.4 million in 2020, an increase of 22 percent. The operating income margin was 14.4 percent compared to the 2020 operating income margin of 15.6 percent. Operating income increased in Water Systems primarily due to higher sales volumes. Operating income margin decreased in Water Systems due to the dilution from Water Treatment at lower margins, higher inflation, and selling, general, and administrative costs not entirely offset by price realization.

Operating Income-Fueling Systems

Fueling Systems operating income was $79.5 million in 2021 compared to $63.4 million in 2020. The operating income margin was 27.5 percent compared to 25.9 percent of net sales in 2020. Operating income increased in Fueling Systems primarily due to higher sales volumes. The increase in margin was primarily due to leverage on higher sales volumes, favorable product, and geographic sales mix shifts.

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Operating Income-Distribution

Distribution operating income was $35.9 million in 2021 and operating income margin was 7.2 percent. Distribution operating income was $11.5 million in 2020 and operating income margin was 3.5 percent. Operating income increased in Distribution due to higher sales volumes. The increase in operating income margin was primarily due to revenue growth and operating leverage.

Operating Income-Eliminations/Other

Operating income-Eliminations/Other is composed primarily of inter-segment sales and profit eliminations and unallocated general and administrative expenses. The inter-segment profit elimination impact in 2021 on operating income was $0 million. The inter-segment elimination of operating income effectively defers the operating income on sales from Water Systems to Distribution in the consolidated financial results until the transferred product is sold from the Distribution segment to its third-party customer. Unallocated general and administrative expenses were higher by $6.5 million or about 11 percent to last year, primarily due to higher variable performance-based compensation expenses.

Interest Expense

Interest expense for 2021 and 2020 was $5.2 million and $4.6 million, respectively, and increased primarily as a result of higher debt levels.

Other Income or Expense

Other income or expense was a gain of $8.0 million and a loss of $0.8 million in 2021 and 2020, respectively. Other income or expense in 2021 included a bargain purchase gain of $6.5 million and a gain of $2.5 million related to a settlement of an indirect tax dispute.

Foreign Exchange

Foreign currency–based transactions produced a loss for 2021 of $2.3 million, primarily due to changes in the value of the Argentinian Peso relative to the U.S. dollar. Foreign currency–based transactions produced a loss for 2020 of $1.4 million, primarily due to changes in the value of the Argentinian Peso relative to the U.S. dollar.

Income Taxes

The provision for income taxes in 2021 and 2020 was $34.8 million and $22.5 million, respectively. The effective tax rate for both 2021 and 2020 was about 18 percent and before the impact of discrete events was about 21 percent. The tax rate was lower than the statutory rate of 21 percent primarily due to the recognition of the U.S. deduction for Foreign Derived Intangible Income, and certain incentives and discrete events. Discrete events in 2021 include increased excess tax benefits from share-based compensation compared to 2020. Discrete events in 2020 include a benefit related to a realized foreign currency translation loss on the settlement of an intercompany loan.

Beginning in 2022, the Tax Cuts and Jobs Act of 2017 ("TCJA") eliminates the option to deduct research and development expenditures currently and requires taxpayers to amortize them over five years pursuant to IRC Section 174. Although Congress is considering legislation that would defer the amortization requirement to later years, we have no assurance that the provision will be repealed or otherwise modified. If the requirement is not modified, it will reduce our cash flows beginning in 2022 by an amount that is not significant.

Net Income

Net income for 2021 was $155.0 million compared to 2020 net income of $101.2 million. Net income attributable to Franklin Electric Co., Inc. for 2021 was $153.9 million, or $3.25 per diluted share, compared to 2020 net income attributable to Franklin Electric Co., Inc. of $100.5 million or $2.14 per diluted share.

CAPITAL RESOURCES AND LIQUIDITY

Sources of Liquidity

The Company's primary sources of liquidity are cash on hand, cash flows from operations, revolving credit agreements, and long-term debt funds available. The Company believes its capital resources and liquidity position at December 31, 2021 is adequate to meet projected needs for the foreseeable future. The Company expects that ongoing requirements for operations, capital expenditures, pension obligations, dividends, share repurchases, and debt service will be adequately funded from cash on hand, operations, and existing credit agreements.

As of December 31, 2021, the Company had a $250.0 million revolving credit facility. The facility is scheduled to mature on May 13, 2026. As of December 31, 2021, the Company had $149.3 million borrowing capacity under the Credit Agreement as $4.1 million in letters of commercial and standby letters of credit were outstanding and undrawn and $96.6 million in revolver borrowings were drawn and outstanding, which were primarily used for funding recent acquisitions.

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In addition, the Company maintains an uncommitted and unsecured private shelf agreement with NYL Investors LLC, an affiliate of New York Life, and each of the undersigned holders of Notes (the "New York Life Agreement") with a remaining borrowing capacity of $125.0 million as of December 31, 2021. The New York Life Agreement matures on July 30, 2024. The Company also has other long-term debt borrowings outstanding as of December 31, 2021. See Note 10 - Debt for additional specifics regarding these obligations and future maturities.

At December 31, 2021, the Company had $37.4 million of cash and cash equivalents held in foreign jurisdictions, which the Company intends to use to fund foreign operations. There is currently no need to repatriate these funds in order to meet domestic funding obligations or scheduled cash distributions.

Cash Flows

The following table summarizes significant sources and uses of cash and cash equivalents:

Cash Flows from Operating Activities

2021 vs 2020

Net cash provided by operating activities was $129.8 million for 2021 compared to $211.9 million for 2020. The decrease in cash provided by operating activities was primarily due to increased working capital requirements in support of higher revenues.

Cash Flows from Investing Activities

2021 vs. 2020

Net cash used in investing activities was $264.8 million in 2021 compared to $78.8 million in 2020. The increase was primarily attributable to increased acquisition activity in 2021.

Cash Flows from Financing Activities

2021 vs. 2020

Net cash provided by financing activities was $50.9 million in 2021 compared to $66.6 million used in financing activities in 2020. The increase in cash provided by financing activities was attributable to increased debt proceeds and issuance of common stock, primarily through stock option exercises, offset by increased dividend payments and common stock repurchases.

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 and purchase obligations. The payment schedule for these contractual obligations is as follows:

The Company has pension and other post-retirement benefit obligations not included in the table above which will result in estimated future payments of approximately $0.9 million in 2022. The Company also has unrecognized tax benefits, none of which are included in the table above. The unrecognized tax benefits of approximately $0.9 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 $0.1 million.

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ACCOUNTING PRONOUNCEMENTS

For information regarding recent accounting pronouncements, refer to Note 2 - Accounting Pronouncements, in the Notes to Consolidated Financial Statements in the sections entitled ""Adoption of New Accounting Standards" and "Accounting Standards Issued But Not Yet Adopted", included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.

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 estimates on an ongoing basis. Estimates are based on historical experience and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. There were no material changes to estimates or methodologies used to develop those estimates in 2021. The Company’s critical accounting estimates are identified below:

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 and Valuation of Acquired Intangible Assets

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 utilizes management estimates and an independent third-party valuation firm to assist in determining the fair values of assets acquired, including intangible assets, and liabilities assumed. The primary intangible assets acquired typically include customer relationships and trade names. Intangible assets are initially valued using a methodology commensurate with the intended use of the asset. The fair value of customer relationships is measured using the multi-period excess earnings method ("MPEEM"). The fair value of trade names is measured using a relief-from-royalty ("RFR") approach, which assumes the value of the trade name is the discounted amount of cash flows that would be paid to third parties had the Company not owned the trade name and instead licensed the trade name from another company. Higher royalty rates are assigned to premium brands within the marketplace based on name recognition and profitability, while other brands receive lower royalty rates. The basis for future sales projections for both the RFR and MPEEM are based on internal revenue forecasts which the Company believes represents reasonable market participant assumptions. The future cash flows are discounted using an applicable discount rate as well as any potential risk premium to reflect the inherent risk of holding a standalone intangible asset. The key uncertainties in the RFR and MPEEM calculations, as applicable, are the selection of an appropriate royalty rate, assumptions used in developing estimates of future cash flows, including revenue growth and expense forecasts, assumed customer attrition rates, as well as the perceived risk associated with those forecasts in determining the discount rate and risk premium. There is inherent uncertainty in forecasted future cash flows and therefore, actual results may differ and could result in subsequent impairment charges of acquired intangibles and/or goodwill.

Indefinite-Lived Intangible Asset and Goodwill Impairment Evaluation

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. 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.

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 Global Water Systems, Fueling Systems and Distribution reporting units. As the Company’s business model evolves, management will continue to evaluate its reporting units and review the aggregation criteria.

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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 2021 was $329.6 million.

During the fourth quarter of 2021, the Company completed its annual impairment test of goodwill and trade names and determined the fair value of all intangibles were substantially in excess of the respective carrying values. 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 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’s operations involve dealing with uncertainties and judgments in the application of complex tax regulations in multiple jurisdictions. These jurisdictions have different tax rates, and the Company 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. The final taxes paid are dependent upon many factors, including negotiations with taxing authorities in the various jurisdictions and resolution of disputes arising from federal, state, and international tax audits. Although the Company has recorded all 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 tax expense and/or deferred tax assets and liabilities.

Pension and Employee Benefit Obligations

The Company consults with its actuaries to assist with the calculation of discount rates used in its pension and post retirement plans. The discount rates used to determine domestic pension and post-retirement plan liabilities are calculated using a full yield curve approach. Market conditions have caused the weighted-average discount rate to move from 2.31 percent last year to 2.68 percent this year for the domestic pension plans and from 2.12 percent last year to 2.57 percent this year for the postretirement health and life insurance plan. A change in the discount rate selected by the Company of 25 basis points would result in a change of about $0.1 million to employee benefit expense and a change of about $4.3 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 4.50 percent as of the fiscal year ended 2021. Market conditions have caused the expected long-term rate of return to increase from 4.00 percent as of the fiscal year ended 2020. A change in the long-term rate of return selected by the Company of 25 basis points would result in a change of about $0.4 million of employee benefit expense.

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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, epidemics and pandemics, 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.