Franklin Electric - Q3 2015

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to the Franklin Electric Company third quarter 2015 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance, please press star then zero on your touch-tone telephone. And as a reminder, this conference call is being recorded. I would now like to turn the conference over to Mr. Jeff Taylor. You may begin.

Jeffery Taylor (Head of Investor Relations)

Thank you, Latoya, and welcome, everyone, to Franklin Electric's third quarter 2015 earnings conference call. With me today are Gregg Sengstack, our CEO; Robert J. Stone, Senior Vice President and President of our International Water Systems Unit; and John J. Haines, our CFO. On today's call, Gregg will review our third quarter business results, and then John will review our third quarter financial results. When John is through, we will have some time for questions and answers. Before we begin, let me remind you that as we conduct this call, we will be making forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements are subject to various risks and uncertainties, many of which could cause actual results to differ materially from such forward-looking statements. A discussion of these factors may be found in the company's annual report on Form 10-K and in today's earnings release. All forward-looking statements made during this call are based on information currently available, and except as required by law, the company assumes no obligation to update any forward-looking statements. During this call, we will also discuss certain non-GAAP financial measures, which the company believes help investors understand underlying trends in the company's business more easily. A full reconciliation of non-GAAP to GAAP financial measures is included in today's earnings release, which you can find on Franklin Electric's website. With that, I will now turn the call over to our CEO, Gregg Sengstack.

Gregg Sengstack (CEO)

Thank you, Jeff. Third quarter revenue, down 16%, was a couple of percent weaker than anticipated due to two factors: first, the translation impact from the further weakening of emerging market currencies, and second, the further weakening in the price of oil and gas, which depressed demand for Pioneer brand pumping equipment and for mud tanks manufactured in the U.K. by our fueling business and used in North Sea oil production. However, with reduced input costs, restructuring, and other cost takeout initiatives, better mix, and some price, we were able to hold the reduction in adjusted operating income to 17%, and our operating income margin of 12.7% was equal to Q3 last year. This is a marked improvement from our second quarter.

On a sequential basis, while our third quarter revenue declined 6% from the second quarter, our adjusted operating earnings increased 18%, and our earnings per share increased 29% as compared to the second quarter. Now turning to end markets. With more "normal weather" in the U.S., we have seen our groundwater business stabilize, and we are gaining traction with the reset of our distribution as residential pump sales are approaching last year's level. However, with the record rainfall in the second quarter, irrigation pumping system sales, while recovering a little from Q2, remain depressed, down over 20%, and inventory levels in the central region of the country, while improved, are, in our view, still above normal. Demand for our surface pumps in the U.S. and Canada market continued to be weak.

Our wastewater and water transfer pump sales were below last year, in part due to a tough comparison and also due to a weak demand in Canada exacerbated by the weak Canadian dollar. We really didn't see the normal season for this business this year. In Europe, water system sales in local currency continued to be flat last year, with no real catalyst driving the market. In the Near East, after a solid first half, our business in Turkey has been negatively impacted with the political. Asia-Pacific water businesses had another solid quarter of 7% organically. Turning to fueling, excluding the impact of foreign currency translation and reduced demand for storage tanks to support North Sea oil production, Fueling Systems sales grew organically in the quarter.

In the U.S. and Canada, Fueling Systems sales growth accelerated from mid-single digits in the first half of the year to 8% in the third quarter. In the rest of the world, sales were up slightly, with weakness in China, India, and Europe being offset by growth in other regions. With tight expense control, our Fueling Systems operating margin expanded, even with the 4% decline in reported revenue. Looking forward, we anticipate fourth quarter revenue to be down 10%-12% as compared to the fourth quarter last year. Similar to the third quarter, we expect the decline to be directly attributable to the impact of exchange rates and weak demand for oil and gas drilling. Outside of these two factors, we are expecting continued organic growth across both segments.

With this revenue profile and with cost improvements, more favorable mix, and some price, we believe adjusted operating income will be up significantly, and adjusted earnings per share will be in the range of $0.34-$0.37. I would now like to turn the call over to John J. Haines, our CFO.

John J. Haines (CFO)

Thank you, Gregg. Our fully diluted earnings per share as reported were $0.43 for the third quarter 2015 versus $0.46 for the third quarter of 2014. As we note in the tables in the earnings release, the company adjusts the as-reported GAAP operating income and earnings per share for items we consider not operational in nature. We believe presenting these matters in this way gives our investors a more accurate picture of the actual operational performance of the company.

Non-GAAP expenses for the third quarter of 2015 were $1.7 million and included $1.3 million in restructuring costs primarily related to the continuing European restructuring and the realignment in Brazil. There were $0.4 million of other non-GAAP expenses related to business realignment costs, primarily severance in targeted fixed cost reduction actions and retired executive pension costs. The third quarter 2015 non-GAAP adjustments had a net EPS impact of reduced earnings by $0.02. There was a $0.04 reduction in EPS for non-GAAP items in the third quarter of 2014. So, after considering these non-GAAP items, third quarter 2015 adjusted EPS is $0.45, which is down 10% compared to the $0.50 adjusted EPS the company reported in the third quarter of 2014.

It is worth noting that the company estimates its 3Q 2015 adjusted earnings per share was negatively impacted by $0.06 due to the translation impacts alone of foreign exchange. As Gregg noted, we saw a significant deterioration versus the U.S. dollar of many key currencies which we do business in, including the euro, the Brazilian real, the South African rand, and the Turkish lira during the quarter. This deterioration causes the earnings of these units to be translated back to fewer U.S. dollars. Water Systems sales were $173.5 million in the third quarter of 2015, a decrease of $43.1 million or about 20% versus the third quarter of 2014 sales of $216.6 million. Sales from businesses that were acquired since the third quarter of 2014 were $2.4 million or about 1%.

Water Systems sales were reduced by $24.2 million or about 11% in the quarter due to foreign currency translation. Excluding acquisitions and foreign currency translation, Water Systems sales declined about 10% compared to the third quarter of 2014. Water Systems operating income after non-GAAP adjustments was $24.5 million in the third quarter of 2015, down $6.5 million versus the third quarter of 2014. The third quarter operating income margin after non-GAAP adjustments was 14.1%, down 20 basis points from 14.3% in the third quarter of 2014. Fueling Systems sales represented 25% of consolidated sales and were $59 million in the third quarter of 2015, a decrease of $2.5 million or about 4% versus the third quarter of 2014 sales of $61.5 million. Fueling Systems sales decreased by $3.2 million or about 5% in the quarter due to foreign currency translation.

Fueling Systems sales were up about 1% after excluding foreign currency. Fueling Systems operating income after non-GAAP adjustments was $15.4 million in the third quarter of 2015 compared to $15.7 million after non-GAAP adjustments in the third quarter of 2014, a decrease of about 2%. The third quarter operating income margin after non-GAAP adjustments was 26.1%, an increase of 60 basis points from the 25.5% of net sales in the third quarter of 2014. The company's consolidated gross profit was $76.8 million for the third quarter of 2015, a decrease of $12.4 million or about 14% from the third quarter of 2014 gross profit of $89.2 million. The gross profit, as a percent of net sales, was 33% in the third quarter of 2015 and increased about 90 basis points versus 32.1% during the third quarter of 2014.

The gross profit margin increase was primarily due to lower direct material costs and an improved sales mix of water systems products. Selling, general, and administrative or SG&A expenses were $47.7 million in the third quarter of 2015 compared to $55.6 million in the third quarter of the prior year, a decrease of $7.9 million or about 14%. The company's SG&A expenses decreased in the quarter primarily due to lower marketing and selling-related expenses as well as lower costs for incentive compensation. Approximately half of the lower SG&A expenses was related to foreign exchange. The tax rate before discrete events was 27% in the third quarter of 2015, and we believe 27% is a good estimate for the full year 2015. The company ended the third quarter of 2015 with a cash balance of $84.9 million, which was $25.8 million higher than at the end of 2014.

The cash balance increase is attributable to cash generated from operations of about $60.3 million or 105% of the year-to-date reported net income. The company had about $20.5 million of borrowing on its revolving debt facilities at the end of the third quarter of 2015 and had about $45.7 million of borrowings at the end of the third quarter of 2014. The company purchased about 1.3 million shares of its common stock for approximately $37.1 million in the open market during the third quarter of 2015. Currently, the total remaining authorized shares that may be repurchased is about 2.5 million. This concludes our prepared remarks, so we would now like to turn the call over for questions.

Operator (participant)

Thank you. Ladies and gentlemen, if you have a question at this time, please press the star then one key on your touchscreen telephone. If your question has been answered or you wish to remove yourself from the queue, you may press the pound key. And once again, if you do have a question, please press star then one. And the first question is from Joe Radigan of KeyBanc Capital Markets. Your line is now open.

Shane Rourke (Senior Research Associate)

Good morning. This is Shane Roark on for Joe.

Gregg Sengstack (CEO)

Morning, Shane.

John J. Haines (CFO)

Hey, Shane.

Shane Rourke (Senior Research Associate)

Good morning. I guess so first in the water business, how much of the decline was agriculture versus the residential business?

Gregg Sengstack (CEO)

Yeah. As we discussed a little bit earlier, the residential is down. Single-digit ag is down a little over 20.

Shane Rourke (Senior Research Associate)

Okay.

Gregg Sengstack (CEO)

That's in the U.S. market. Excuse me. I think your question related to the U.S., not to the U.S. market.

Shane Rourke (Senior Research Associate)

Yeah. That was what I'm most interested in. And then I understand typically you see some pull forward into the end of the year as distributors look to hit volume and discount targets. What are your expectations there this year? Do you think that could be a little softer since it's been a weaker year?

Gregg Sengstack (CEO)

Sure. At the end of the year, people are looking at their overall volume and targets. But as you point out, certainly for this year, it's not been robust in the markets, so there's just generally less incentive for people to do that.

Shane Rourke (Senior Research Associate)

Okay. And then I guess the last one I have here, you had some really strong fueling margins. I'm curious, how much of that is mix versus what's kind of sustainable going forward? How should we think about that?

John J. Haines (CFO)

Yeah. Shane, this is John J. Haines. The fueling businesses we've been discussing for the last several quarters have done a really nice job at leveraging their fixed costs. And so even though their revenues after the impact of currency aren't up significantly this year, they haven't grown their fixed costs in a dramatic way. So we would say that the margin improvement that you see there is a combination of some mix-shift for sure, but it's also a combination of leverage on fixed costs. I'd remain cautious about fueling margins above 25%. That's not where we think for the long term they will be. But somewhere in the low 20s is a reasonable expectation for that business unit.

Shane Rourke (Senior Research Associate)

Okay. That's really helpful. Thanks a lot.

Operator (participant)

Thank you. The next question is from Mike Halloran of Robert W. Baird. Your line is open.

Michael Halloran (Senior Research Analyst)

Morning, everyone.

Gregg Sengstack (CEO)

Hey, Mike.

John J. Haines (CFO)

Hey, Mike.

Michael Halloran (Senior Research Analyst)

So, on the fourth quarter here, the underlying trend's expected to turn positive on a year-over-year basis, excluding FX, excluding the oil and gas side for your water segment. Maybe you could talk about what you're seeing underneath the portfolio that would suggest some growth there as you hit the fourth quarter and maybe parse it out by some of the end markets. It seems like, is it better than normal sequentials, or are we just at the point where it's normal sequentials as you get to next quarter? Just a little more color there would be helpful.

Gregg Sengstack (CEO)

Yes, Mike. I think maybe a little better than normal. I'd say a little bit better than normal of last year. As we're going into the fourth quarter of last year, currencies were changing dramatically, and markets were changing for us in the U.S. marketplace. And so that's what we're saying. The business has really stabilized now, and we're seeing a recovery of our North American residential business. We're seeing ag is not down as much. It wasn't down as much as the center pivot guys were talking about for us. Again, we're more of a replacement market there. We're seeing the European business stabilizing or been relatively flat. But the Middle East has been a lot of disruption over the years. And so again, if there's kind of near-normal conditions there, we expect that to kind of continue to be okay. Brazil slowed down in the second quarter.

We begin to see that picking up a little bit activity coming back to half the year. Our groundwater business in Brazil has continued to post record revenue, the one we acquired, Bombas Leão. Again, Southern Africa has been relatively soft because of commodities. We would expect that to, again, be balanced to recovering slightly. So really, what we're doing is we're lapping a lot of the headwinds. In currency, we're lapping the headwind in oil. We're lapping the headwind in our distribution reset. And we're expecting something more of a normal weather year next year.

Michael Halloran (Senior Research Analyst)

When you look at that distributor reset, I know you mentioned inventory level's still a little bit above normal. How close are you guys, do you think, bleeding through the remaining of that inventory so that whatever incremental demand is out there starts flowing through a lot more quickly?

Gregg Sengstack (CEO)

Well, I think that generally, distribution given the year has been pretty cautious about buying. And so there is still end demand that's pulling through. I think outside of the center of the country, inventory levels are normal. So it's really in the center, and I would think that would bleed through here yet this year. If there's a carryover in the first quarter, it's a little tough for us to have that visibility. But I think that with everybody with the dramatic decline in irrigation, I think everyone's been cautious. So I don't think there's a whole lot of interest in building inventory. I do think there's been an orderly bleed down of it.

Michael Halloran (Senior Research Analyst)

That's very helpful. Thank you.

Operator (participant)

Thank you. The next question is from David Rose of Wedbush Securities. Your line is open.

David Rose (Research Analyst)

Good morning, gentlemen. Thank you for taking my call. I was wondering if you can walk us through the cost savings for 2015 so far and 2016, if you can kind of quantify the benefit from the cost actions and give us an update on what your expectations are for the savings in 2016.

John J. Haines (CFO)

Yeah, David. What we've said on the fixed costs, as you saw, when we talk about fixed costs in the corporation, we're talking about the combination of those fixed costs that are in our cost of goods sold, fixed manufacturing costs plus SG&A. That in its entirety is down about 14% when you look at it in the third quarter, quarter-over-quarter. That improvement is a combination of some of the restructuring actions that we've taken, including discrete fixed cost actions. So some of our business units that have had the most significant revenue challenge have taken actions relative to their fixed costs, selling and marketing, and other costs. And then, of course, a portion of it is FX as well. So we estimate around 50% or thereabouts of that 14% reduction is related to FX.

As we look forward for the full year and then beyond, we're hopeful to be in a fixed cost range a combination, again, of those two categories. Somewhere in the $302 million-$305 million annual run rate is kind of how we see ourselves ending this year. So now there's going to be some give-back in 2016, right? There's a portion of that that's variable compensation that we'll have to add back. You'll start to lap some of this FX. That will have some impact. But when you compare that to the 2014 total of about $324 million, we're significantly below, and we feel like we'll be positioned significantly below that. So the key question for us is what will what are the right things to add back?

Perhaps, for example, on R&D, we cut back a little bit on some of the R&D effort that we had intended this year simply because of the year we were having. Some of that'll come back. But the point is we feel like in a much better run-rate position as we end 2015 and enter into 2016 on that total fixed cost base.

David Rose (Research Analyst)

That's helpful. And then maybe kind of quantifying a little bit more as we think about next year, I know you haven't provided any guidance, and you won't really provide a ton of guidance on that matter. But how should we start thinking about the assumptions to get to revenue growth next year, excluding FX? You need a recovery in oil and gas. Maybe you can kind of walk us through some of the same items that you talked about fourth quarter but think about next year.

John J. Haines (CFO)

Yeah. I'd say, David, that we haven't started to talk about 2016 yet. We'll do that more in our fourth quarter release. We're working on some roll-ups of that right now. I think generally, some of the things that are in our thinking are, one, we are going to lap some FX, specifically the euro, right? We've seen the euro drop but maintain or be pretty steady. The developing region currencies are a little more difficult, as you know, to try to predict. But we will lap some of that FX in 2016. We can't imagine that we would have a weather quarter or a weather year in the United States like we had this year. As we've discussed, it was extreme from our perspective. So hopefully, we're not going to see that in 2016. Fueling, we have a lot of confidence in.

There's some choppiness this year in terms of China, India. But that business is well-positioned for organic growth, at least in the mid-single digits, if not the upper single digits. And then the final thing that you asked about was oil and gas. And we're not real confident there. We don't see an inflection point that is going to drive the growth of that Pioneer branded equipment significantly higher in 2016. So that remains a headwind for us. So absent giving you any specific advice, I would say, unless Gregg has some others, those are the key things that are kind of in our minds right now as we're thinking about 2016's top line.

David Rose (Research Analyst)

Okay. Lastly, with that said, is your thinking then you'll take additional cost actions above and beyond what you've already discussed?

John J. Haines (CFO)

I don't think we'll initiate new cost actions, Dave. But I think what you'll see is sequentially, us get better in cost of goods sold on an input material basis as we sequentially move through the balance of this year and into 2016. Both of the restructuring efforts that we've announced will start to pay back more. We'll complete what's happening over in Europe with the final move of a couple manufacturing areas to the Czech Republic. As Gregg said, the integration and the actions that we're taking in Brazil are on track. And every quarter that we go into the future, we'll get a little bit more benefit from that. So I wouldn't characterize it, though, as incrementally new initiatives to take fixed costs out.

David Rose (Research Analyst)

Okay. Thank you, John. I appreciate it.

Operator (participant)

Thank you. The next question is from Kevin Bennett of Sterne Agee. Your line is open.

Speaker 10

Hey. Good morning, guys.

Gregg Sengstack (CEO)

Morning, Kevin.

Speaker 10

Gregg, first question, and hopefully, this is the last time we have to ask this on the distributor reset. Was wondering if you're pretty much done there and then also if you had regained the lost market share that you had in the central U.S.

Gregg Sengstack (CEO)

Yes, Kevin. It certainly will be hopefully the last time you ask the question. Where we had some pockets of weakness, which were the Upper Midwest, we now have covered. So that's in place. Then in Central Texas was kind of the last piece. And we're working on some things there that'll be in place we expect by the end of the year. So yes, we have the geography covered to our satisfaction, and our team is now focused on regaining some share. We mentioned in our second quarter that we had seen a little bit of share loss. We're seeing the recovery in residential. Ag will come. But it's been clouded, obviously, with the weather conditions that we've had this year.

Speaker 10

Sure. That's perfect and good to hear. Secondly, on Brazil, your sales were up, I guess, organically about 3%, which is certainly nice to see given the well-publicized macro headwinds going on down there. I was wondering if you could provide some more color on what's going on with Franklin specific to kind of offset the economic weakness that Brazil's seeing.

Gregg Sengstack (CEO)

Sure, Kevin. We had a really good business in Brazil. We started in Brazil well, back up. Franklin's been in Brazil through other pump companies back in the 1980s and the 1990s. As a matter of fact, one of the reasons that we were very interested in acquiring Motobomba Schneider in 2008 is because they had at one point about 20% of the Brazilian groundwater market, residential market, with Franklin Motors. So they had distribution reach. And Motobomba Schneider has a great residential and surface water business. And again, they have about 5,000 dealers that they do business with around the country. And so we knew that we could very quickly bring in our products from offshore and take them through that market. So we're gaining share in the Brazilian market with Motobomba Schneider's branded products.

I would say that we did see that catch up meaningfully in the second quarter. And that's where I think we said that we got the Brazilian economy caught up with us. But we are seeing Schneider beginning to get more traction. We're moving into the summer, and that product line is doing very, very well. Leão, the company we acquired last year, is right in our tailwind. The groundwater business, we saw the opportunity that with our leadership team in Brazil operating that business, that we could take what has been recognized as a leading brand in Brazil and Bombas Leão and really driving it forward. And we're seeing that today. With the integration and the coordination between the two businesses, the two brands, and one operating team, we're seeing really strong results with Leão bucking the economy.

I don't know details about the agricultural business in general in Brazil, but we're finding our Leão business is doing very well.

Speaker 10

That's perfect. So Gregg, is that something that you're worried about going forward just given the economy in Brazil, or do you think you guys will continue to be able to buck the trend?

Gregg Sengstack (CEO)

Well, yes. Gravity catches all objects. Yeah. But with that said, I think that we're going to see is that the residential business will follow the economy. We are believing that we are, through market share gains, softening that effect on the residential side. With the groundwater business, we have a company, again, that has a great brand, 50-year tradition. It just needed some leadership and some capital and some investment in inventory. And we're doing that. And I think that that, along with the macro trends that Brazil's got this enormous agricultural economy, they have enormous access to groundwater. So it's a natural export for Brazil's water through agricultural goods and also through beef and so on. So we think that we're in a pretty good situation with our businesses there as they are today.

Speaker 10

Great. And then last question for me is on M&A. It's been a quiet year, I guess. And I'm wondering if you kind of have any update if things are progressing, if your pipeline remains full, or if that's kind of cooled off a little bit.

Gregg Sengstack (CEO)

We have an active pipeline. Many of the opportunities we look at are in countries outside the United States and Western Europe. And when you have a major change in exchange rates, people in those countries are often thinking kind of in U.S. dollar terms. So that makes valuations very difficult to have a meeting of the mind. And we expect that that will—it's going to take a little while for people to kind of readjust their thinking to what are the new exchange rate realities. So we have deals in the pipeline. I mean, we have an active pipeline. We continue to look. It has been a little quiet this year with everything else that's been going on.

Speaker 10

That makes sense. Thank you, guys.

Operator (participant)

Thank you. The next question is from Ryan Cassil of Seaport Global Securities. Your line is open.

Ryan Cassil (Analyst)

Good morning, guys.

Gregg Sengstack (CEO)

Morning, Ryan.

Ryan Cassil (Analyst)

Yeah. On the Pioneer side, I think you said you're not really expecting too much of a change in demand there. Perhaps you could talk a little bit about pricing, whether you're seeing any pressure there, whether it's getting incrementally worse as we drag through this period?

Robert J. Stone (Senior VP and President of International Water Systems Unit)

Yeah. Ryan, this is Robert Stone. I'll speak to that. There has been some pricing pressure on Pioneer, particularly as rental fleet companies have tried to liquidate some of their products. Initially, that was outside North America. Now, some of that is coming back into North America. So that's put some pressure on those products. But in truth, those products really are not in high demand now because most of those were oil and gas related. So that business wasn't really going to be there for us anyway.

Ryan Cassil (Analyst)

Okay. Okay. And then on the groundwater side, perhaps you touched on this already, so I apologize. But just on the end customer demand, are you sensing things are turning the corner there and things are improving in the residential side? Any color you could give us there for the fourth quarter?

Gregg Sengstack (CEO)

Yeah. Sure, Ryan. Again, we're seeing that the gap, the weakness in residential has diminished in Q3. Again, we saw a pretty abrupt decline in demand in Q2 with both ag and residential, particularly in the center of the country. So residential, we're seeing is moving back near more normal rates for us. We have addressed a couple holes in our distribution, and we're seeing that's helping us. With the ag business, again, the decline wasn't as dramatic as Q2. It's still down. We're hoping for a little bit more of a season. But effectively, there just wasn't a lot of demand for irrigation as compared to last year, particularly because of the center of the country. With that said, one advantage we have relative to capital equipment providers to this industry, the ag industry, is that we are a replacement item.

So when pumps get turned on, the ones that are already installed, and they fail, then we're going to get that replacement business. And that's where John was commenting earlier, that if we get to some kind of more near-normal weather, people may not be putting in new systems, per se, but they still got to maintain their existing systems. And we've always used as a target our rule of thumb is about 80% of our business is replacement. So we would expect to see more normal volumes in next year.

Ryan Cassil (Analyst)

Okay. Okay. Thanks. And then just last question. Your inventories tick down here sequentially. And as we get through this distributor reset, should we expect to see those inventories continue to work their way down here over the next couple quarters?

John J. Haines (CFO)

Ryan, I think we've seen a nice move, as you pointed out. Sequentially, we went from $220 million in the second quarter of combined consolidated inventories to about $209 million in the third quarter. I don't know that the inventories are necessarily going to be that impacted by the distribution reset. As I'm sure you know, the inventories are a bit seasonal. So you see a run-up in the second quarter and third quarter, generally, to accommodate the northern hemisphere of businesses. I think the more significant thing that you're going to see is that just a better job in terms of managing inputs, managing our finished goods inventories. This concept of availability and emergency replacement parts is very important to the value prop that Franklin has. But I think we all agree that we can manage these inventories a little bit better.

I think you're seeing that in a variety of different ways across the company. We'll continue to see incremental inventory improvement. I don't know if I would attribute it to a particular end market as much as I would just management's attention and effort to manage it a little bit better.

Ryan Cassil (Analyst)

Got it. Okay. Thanks, guys.

Operator (participant)

Thank you. And the next question is from Ryan Connors of Boenning & Scattergood. Your line is open.

Ryan Connors (Analyst)

Great. Thanks for your time this morning. I wanted to get your take on kind of a strategic question for the industry having to do with kind of the supply and demand environment in the energy-related, call it, fluid handling space. Obviously, the market's a collection of niches, but there's some fungibility between applications. And now that we've seen this kind of dramatic decline in volumes, if we assume that the lower energy price environment hangs around for a while, maybe even a number of years, and the industry had been built up to serve a larger market, will we get to a point where there needs to be supply curtailments industry-wide, or is that something that can be managed through shift changes and things like that?

Gregg Sengstack (CEO)

Ryan, as you're talking about energy, I'm thinking about you're talking about oil and gas, and you're talking about the exploration side. So I'm not going to address this from the fuel dispensing part of our business where we are the underground systems related to use of automobiles. So then you look at the oil and gas sector, and you say, "Okay." Where Franklin touches that space, it's principally through our Pioneer branded product line. And we had some challenges, actually, scaling in our own case last year. We saw some costs in scaling last year to address the surge. So in our own case, we sacrificed margins to deliver revenue because we didn't want to expand our footprint beyond what we have in place already so that our footprint is pretty well-sized for the business it is today.

So that piece is now, as you point out, gone maybe years before the industry recovers. But for us, in the case of our Pioneer business, we are looking for the diversification and getting Pioneer deeper into mining, which has also been a little bit weak, as we pointed out and as you all have commented too. But Pioneer also is involved in municipals through a bypass. And these are businesses in the U.S. that are pretty upbeat. I think that there have been others in the industry who have talked about the municipal investment that's required over the next decade. So for us, we're feeling pretty good about the business where it stands today.

I think your broader question related to oil and gas would probably better serve to asking people a little deeper in that business because we're going to continue to put out, again, new products, and we're going to continue to innovate across Franklin, including Pioneer, to address our underlying demand. But your scaling, and as you point out, the niches that people play in, I think it's probably you ought to be directing or somebody that's deeper in that space would have a better answer for you.

Ryan Connors (Analyst)

Okay. So Jeffrey, I mean, just if I could paraphrase for yourselves, do you feel like there's enough alternative avenues to kind of redirect your volume that it shouldn't be an issue?

Gregg Sengstack (CEO)

Oh, absolutely. And again, in the case of Pioneer, again, we had a tremendous volume run in the last couple of years and the top blown off of that. But now we got a business that, because of the lack of revenue in the oil and gas space, is a much more diversified business. And it's a sustainable base that we can grow from, and we're going to grow with it across the globe and as a municipal in the construction industry and mining industry. And again, we have a number of new products. Robert's not even here across the table. You can't see him, but a number of new product initiatives we have in Pioneer as well.

Ryan Connors (Analyst)

Okay. Great. Well, that's great. And then the other question I had was regarding forex and exchange rates. You used the term new exchange rate reality when you were talking with Kevin a minute ago about the M&A environment there. And I wonder, a lot of these, yourselves and others, are kind of look when you kind of back out the forex stuff to give us a better picture of the organic run rate of the business. But if we truly are in an environment for a number of years where the dollar's going to be a lot stronger, how does that structural shift in the currency environment impact your business or your strategy or how you're running the company, if at all?

Gregg Sengstack (CEO)

Well, I think there's a couple of things. John pointed out earlier, I mean, from the standpoint of comps, that we're going to be lapping on many of these comps. From our point of view, that made these developing regions less expensive to buy businesses going forward. Again, there's got to be a meeting of the minds. But we're patient, and we know a lot of people in this industry, and people know us as a good acquirer. So it makes those businesses less expensive in dollar terms, potentially, to acquire. It also reduces the cost base for our company because you may know that and you tracked this for a couple of years. You know that we've moved a lot of our manufacturing in the lower-cost regions and made it even more competitive.

So we don't have as big a cost footprint in the U.S. or even in Western Europe. So that helps us from a cost point of view. But at the end of the day, 5 billion people are in the developing or growth regions of the world. They need water. They need fuel. They're going to move into the middle class over time. And when they do that, they consume more water. They consume more fuel. And that's all good for us. So yeah, I don't know if it's going to be a year or 5 years or 10 years, but we feel we're well-positioned. We have a good cost base that's been helped by this situation. We can potentially move some manufacturing around to even further help it. And we're inside these countries doing business, not trying to import into them. And that's also good for our business.

Ryan Connors (Analyst)

Great. Well, that's very, very helpful. Thanks for your time this morning.

Gregg Sengstack (CEO)

Thank you.

Operator (participant)

Thank you. And the next question is from Matt Somerville of Alembic Global Advisors. Your line is open.

Speaker 11

Good morning. This is actually Nick Chen from Matt this morning. Thanks so much for taking our question. You guys had already provided some commentary just surrounding the new Preferred footprint. I was hoping you could give a little bit more color about how the company's actually been received by the new distributors and just sort of what that relationship is like.

Gregg Sengstack (CEO)

I think that you're talking about our new distribution footprint?

Speaker 11

Yes.

Gregg Sengstack (CEO)

Yeah. Because we're no longer doing business with Preferred. So we are doing business with other distributors. And if you go back in history, these are individuals that have our owners, operators that have known us over the years. We've done business with them in the past. We maintained relationships with these people in the past. And they have maintained relationships with the end market. In this industry in the U.S., there's not a whole lot of examples of exclusive distribution. Distributors carry often more than one line, and contractors often buy from more than one distributor. So we maintain these relationships. We reestablished business with several partners. We expanded business with several partners. And we believe that they've also expanded their business. We're seeing it in our numbers with the end contractors. So the short answer is that it's been well-received.

Speaker 11

That's great. Thank you so much. I'll jump back into the queue.

Operator (participant)

Thank you. There are no further questions in queue at this time. I'd like to turn the call back over for any closing remarks.

Gregg Sengstack (CEO)

We thank you for following the company and look forward to speaking to you after the first of the year on our Q4 results. Have a good day.

Operator (participant)

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day.