Franklin Electric Co., Inc. (FELE) Q1 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Franklin Electric Quarter 1 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn your conference over to your host for today, Mr. Patrick Davis, Treasurer. Sir, you may begin.

Thank you, Ben, and welcome, everybody to Franklin Electric's first quarter 2012 earnings conference call. With me today are Scott Trumbull, our Chairman and CEO; John Haines, our CFO; Robert Stone, SVP of America's Water; and Greg Sengstack, President and COO. On today's call, Scott will review our first quarter business results and John will review our first quarter financial results. When John is through, we will have some time for questions and answers. Before we begin, let me remind you that any forward-looking statements contained herein, including those relating to market conditions or the company's financial results, costs, expenses, expense reductions, profit margins, inventory levels, foreign currency translation rates, liquidity expectations, business goals and sales growth, involve risks and uncertainties. These risks and uncertainties include, but are not limited to, general economic and currency conditions, various conditions specific to the company's business and industry, new housing starts, weather conditions, market demand, competitive factors, changes in distribution channels, supply constraints, effective price increases, raw material costs, technology factors, integration of acquisitions, litigation, the government and regulatory actions, the company's accounting policies and future trends and other risks, which are detailed in the company's SEC filings, and are included in Item 1A of Part 1 of the company's annual report on Form 10-K for the fiscal year ending December 31, 2011, Exhibit 99.1 attached thereto, and in Item 1A of Part 2 of the company's quarterly reports on Form 10-Q. These risks and uncertainties may cause actual results to differ materially from those indicated by the forward-looking statements. All forward-looking statements made herein are based on information currently available, and except as required by law, the company assumes no obligation to update any forward-looking statements. I will now turn the call over to our Chairman and CEO. Scott?

Thank you, Patrick. The first quarter provided a solid start to the year as we reported earnings per share after non-GAAP adjustments of $0.60, a 30% increase over the first quarter of prior year. And our adjusted operating income margin improved by 130 basis points. The adjustments included eliminating the $0.37 per share gain that we booked during the quarter in conjunction with the acquisition of a controlling interest in Pioneer Pump. Our CFO, John Haines, will provide an explanation of the first quarter non-GAAP adjustments in a few minutes. During the fourth quarter last year, our Fueling business drove much of our earnings improvement. But during the first quarter of this year, it was our Global Water business that led the way. Our Global Water System sales grew by 12% and adjusted operating income grew by 24% compared to the first quarter of prior year. Our Water Systems business in the U.S. and Canada performed particularly well during the first quarter. Water System sales in the U.S. and Canada represented 36% of our consolidated sales and grew by 6% compared to the first quarter last year. Our U.S./Canada Water Systems team continues to achieve strong double-digit sales growth of groundwater pumps for agricultural irrigation applications, as well as residential and light commercial applications. However, these gains were partially offset by reduced residential wastewater pump sales; the relatively mild and dry winter and spring weather in large portions of the country; the cost of demand for sump pumps to decline compared to the prior year. But the major story for the quarter was the sharp increase in profitability achieved by our U.S./Canada Water Systems business. While we experienced rapid raw material cost inflation in 2011 and contribution margins were reduced, the inflation rate abated during the first quarter this year and the price increases that we recently implemented in the U.S. and Canada have started to restore margins. As a result, our U.S./Canada margins improved sharply compared to the first quarter last year. Our Water Systems businesses in Latin America and Asia Pacific also had strong first quarters. Latin American Water Systems represented 15% of our consolidated sales and grew by 7% overall and by 12% organically, which excludes the impact of foreign exchange rates. Foreign exchange translation FX reduced our Latin America sales by 5% during the first quarter. We achieved strong sales growth of pumping systems for industrial and mine dewatering applications as a result of the successful startup of our distribution center in Chile. We also achieved sales growth from a number of new product and marketing initiatives that we've launched over the past few years including 10-inch and 12-inch submersible motors in Mexico and South America and 4-inch submersible pumping systems in Brazil. Our Water Systems business in Asia Pacific represented 8% of our consolidated sales during the quarter and grew by a healthy 20% compared to the first quarter prior year. We're progressively adding sales personnel and expanding our distribution throughout the region and this effort resulted in solid sales growth during the quarter as we achieved double-digit gains in virtually all of our product lines and geographic territories in the Asia Pacific region. Our Water Systems business in Europe, the Middle East and Africa represented 19% of our consolidated sales during the quarter and grew by 9% over all, but declined by 4% organically. We attribute the organic sales decline to generally weak economic conditions in Europe and to political turmoil disrupting our export shipments to several key market areas in Northern Africa. Our Fueling Systems business represented 18% of our consolidated sales during the quarter and declined by 3%. As was the case in our Water business, our Fueling sales grew in the U.S., Latin America and China, but declined in Europe, the Middle East and Africa. While general economic conditions were a factor in our Fueling sales decline in Europe, Middle East and Africa, we believe a major factor was the timing of orders between the first and second quarter by a few large distributors in Africa and the Middle East. As a result, we do not believe that the 3% first quarter sales decline for our Fueling business is indicative of a major slowdown and we expect our fueling sales growth will be 9% to 11% in the second quarter versus the same period of 2011. We are concerned, however, that our Fueling growth in the back half of 2012 could be impacted by availability of nylon 12 resin material, which is a component of a portion of our underground pipe product line. The affected portions of this product line represent less than 3% of our consolidated sales. The world supply of nylon 12 has been curtailed by a major disruption in one of the largest refining facilities for this resin. We believe we have sufficient supplies to last through most of the third quarter and we're exploring a number of options for obtaining more or utilizing an alternative material. During the first quarter, we completed the previously announced acquisition of a controlling interest in the Pioneer Pump Company. Pioneer produces mobile pumping systems which are used in a number of growing applications such as: the oil and gas industry to transfer water and frac-ing liquids; by the mineral extraction industry to dewater mining sites; by municipalities for wastewater bypass and flood control applications; and by the construction industry for dewatering building sites. We acquired roughly 1/3 of Pioneer in 2005. We were originally attracted to Pioneer because we felt the company had know-how that enabled it to produce products that are best in class for the markets they serve and we wanted to have access to their centrifugal pump design capability. The superior efficiency and durability of their products have played an instrumental role in Pioneer's rapid growth over the past 6 years. In 2005, when we originally invested in Pioneer, their sales were $15 million. Last year, their sales approached $70 million. Going forward, we believe that Franklin will help Pioneer to expand in international markets and control costs through global sourcing of components. We believe that our additional investment in Pioneer will be immediately accretive to Franklin's 2012 earnings. As we look forward to the second quarter, we're mindful of the ongoing weak economic conditions in Europe and the negative impact that foreign currency translation rates will likely have on our reported sales and earnings. During the first quarter, foreign currency translation rates caused our consolidated sales in U.S. dollars to decline by about 2% compared to the first quarter last year. If today's exchange rates remain in place for the balance of the second quarter, the translation effect would reduce our second quarter consolidated sales in U.S. dollars by 5% compared to the prior year. In spite of these headwinds, we currently expect our Water segment sales to grow by 10% to 13%, driven primarily by the Pioneer acquisition and the strength of our business in the U.S. and Canada. We expect our water operating income after non-GAAP adjustments will grow by 8% to 12%. We believe that Water Systems' operating income will grow at a modestly slower rate in sales due to a shift in sales mix. During the second quarter last year, we had surging sales of large agricultural and irrigation pumps and motors, which generally carry a higher-than-average profitability. While we are receiving indications from the market that our agricultural and irrigation sales will remain strong through 2012, we realized that these indications are at least partially weather-dependent and therefore feel that it's prudent to base our guidance on an assumption of a more normalized demand pattern. While our Fueling segment got off to a relatively slow start in the first quarter, as I mentioned, we're expecting a nice second quarter rebound. We believe Fueling sales will increase by 9% to 11% and the operating income after non-GAAP adjustments will increase by 13% to 15% compared to the second quarter prior year. We're expecting solid Fueling shipment growth in Asia Pacific, Latin America and the U.S. and Canada. Overall, we believe that our EPS after non-GAAP adjustments will increase by 10% to 13%, compared to the second quarter last year. Noting that during the second quarter last year, we reported the highest earnings per share for any quarter in the company's history. I'll now turn the call over to John Haines, our CFO, who will provide additional information regarding the companies financial performance.

Thank you, Scott, and good morning. Our fully diluted earnings per share were $0.96 for the first quarter of 2012, 113% higher than the $0.45 fully diluted earnings per share the company reported in the first quarter of 2011. But as Scott mentioned, this amount includes $0.37 related to a $12.2 million one-time gain on the Pioneer transaction that is presented in the income statement in the Other Income section. As we noted in the tables in the earnings release, this is one of 4 items we consider non-GAAP adjustments in the first quarter of 2012 that impacted operating income or EPS that were 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. The gain on the original investment the company had held in Pioneer arises as a result of a new enterprise valuation of the Pioneer entity that is then compared to the book value of the equity investment Franklin Electric had previously made in Pioneer. Again, in total, the gain was $12.2 million and added $0.37 to the company's first quarter 2012 EPS. This gain is nonoperational in nature and not repeatable. There are 2 additional items related to the Pioneer transaction we are considering non-GAAP, and it resulted in adjustments to both operating income and EPS. The first is approximately $200,000 in costs to complete the transaction, and the second is approximately $200,000 in the amortization of increased inventory value as required by GAAP. Together, these items resulted in a $0.01 addition to the non-GAAP EPS. Again, both are onetime in nature and do not reflect the actual operational performance of the company. Finally, there was a $100,000 offsetting restructuring item that resulted from a gain on the sale of land the company had previously held for development but that was subsequently sold in the first quarter of 2012. So after considering each of these non-GAAP items, the first quarter of 2012 EPS is $0.60, which is 30% higher than the $0.46 non-GAAP EPS the company reported in the first quarter of 2011. Overall, the 2012 first quarter revenue, gross profit, operating income, net income and earnings per share were records for any first quarter in the company's history. Water Systems revenues were $165 million in the first quarter of 2012, an increase of $17.8 million or about 12% versus the first quarter of 2011. Sales from businesses acquired during the last 12 months were $13.1 million or 9%. Excluding sales from acquisitions, first quarter 2012 sales were $151.9 million or an increase of about 3%. Water System sales were reduced by $3.9 million in the quarter due to foreign exchange impacts as the U.S. dollar strengthened against many international currencies when compared to the first quarter 2011. Water Systems' organic growth excluding sales from acquisitions and the impact of foreign currency translation was 6%. As Scott indicated, sales growth in the first quarter was led by the U.S. and Canada where demand for both irrigation and residential ground-water pumping systems remained strong and in Asia Pacific which experienced strong broad-based growth throughout the entire region. Water Systems operating income after non-GAAP adjustments was $27.1 million in the first quarter of 2012, an increase of 24% versus the first quarter of 2011. The first quarter operating income margin after non-GAAP adjustments was 16.4% and increased by 150 basis points compared to the 14.9% in the first quarter of 2011. This increase was primarily a result of operating leverage on higher sales and selling price increases more than offsetting the impact of increased raw material cost. Fueling Systems sales were $36.9 million or 18% of consolidated sales in the first quarter of 2012 and decreased about 3% from the first quarter of 2011. As Scott indicated, Fueling Systems sales increased in the U.S. and Canada, Latin America and China, but declined in Europe, the Middle East and Africa. Fueling Systems operating income after non-GAAP adjustments was $5.6 million in the first quarter of 2012 compared to $6 million after non-GAAP adjustments in the first quarter of 2011, a decrease of 7%. So the first quarter operating income margin after non-GAAP adjustments was 15.2% and decreased by 50 basis points compared to the 15.7% of net sales in the first quarter of 2011. Operating income declined in Fueling Systems primarily due to lower sales volume. The company's consolidated gross profit were $66.3 million for the first quarter of 2012, an increase of $5.8 million or about 10% from the first quarter of 2011. The gross profit as a net -- as a percent of net sales increased to 32.8% for the first quarter of 2012, from 32.7% for the first quarter 2011. Selling, general and administrative expenses were $45.3 million in the first quarter of 2012, compared to the $44.1 million from the first quarter of 2011, an increase of $1.2 million, or about 3%. All of the increases is attributable to businesses acquired in the last 12 months. The effective tax rate for Q1 2012 is about 27%, which the company believes is also a reasonable estimate for the full year 2012. The projected tax rate is consistent with the 2011 tax rate and lower than the statutory rate of 35%, primarily due to the indefinite reinvestment of foreign earnings and reduced taxes on foreign and repatriated earnings after the restructuring of certain foreign entities. The company has the ability to indefinitely reinvest these foreign earnings, based on the earnings and cash projections of its other operations, current, cash-on-hand and available credit. The company ended the first quarter of 2012 with a cash balance of about $99 million, which was $54 million less than the end of 2011. The cash balance decreased primarily as a result of the Pioneer acquisition and the normal seasonal working capital increases we'd see in the first quarter of every year. The company had no outstanding balance on its primary revolving debt agreement at the end of the first quarter of 2012 or 2011. Some additional comments further to the acquisition of Pioneer and accounting for the remaining 30% interest held by non-F.E. shareholders, consistent with the terms of the stock purchase agreement between FD and the minority shareholders, which commits the company to purchase the minority shares and current GAAP guidance, FD has included the liability to purchase the remaining shares of about 30% of outstanding Pioneer stock in other long-term liabilities. Until the liability is settled in 2015, adjustment to the liability will be included in interest expense in Franklin Electric's income statement. To the extent there are significant period-over-period variances relative to interest expense or other long-term liability as a result of this accounting, the company will address them in it's financial reporting. This concludes our prepared remarks, and we'd now like to open the call up for questions.

[Operator Instructions] And our first question today comes from the line of Matt Summerville from KeyBanc.

A couple of questions. Scott, in your prepared remarks, you talked about a little bit of a disruption in your Water business and exporting out of Europe and the Northern Africa, has that subsided at this point? Would you characterize it as being material? Is it a couple of million dollars? Is it not? And then also, the timing issue in Fueling, is that geopolitical related as well, given the geography you are mentioning there?

First of all, in Water, it is a couple of million dollars. It's not more than that. And we do not ship into those regions, generally without -- it's basically a cash on advance shipment and it has been for some time. And the problem is just our customers arranging their Letters of Credit and payment to put us in a position to move the product. The markets themselves are still active, but they're not being served very well, and they're not being served by us because of our payment terms. But we -- we're optimistic that, that will normalize and we'll get back to business as usual in these areas that are generally, good growth areas for us. The Fueling story is different than the Water story. Our shortfall in Fueling was because of, basically most regions, even in Europe and the Middle East, were up except the Gulf region and South Africa were down significantly. And there isn't a -- I just -- there isn't an economic reason. It's just a matter of the timing of shipments into those regions based on government contracts, bid business that our distributors may have. In some years, they will order heavily in the first quarter, and then it'll back off a little in the second quarter. And in some years, they'll order vice versa, and it had happened this year. Last year, in 2011, we had fairly substantial orders in those regions in the first quarter. And this year, we would expect to see our sales bounce back and -- in the second quarter. And that's what we're reflecting in our comments.

How much revenue then in Fueling would you say got pushed from Q1 to Q2, if you had to estimate?

It's hard to say. I know that those 2 regions were down several million dollars.

Okay.

But I'm not sure all that's going to come back in the second quarter. But we still stand by our 9% to 11% sales growth guidance in the second quarter.

And then I wanted to spend a couple of minutes talking about Pioneer. How big or how do you size up their addressable market? How would you look at, or consider Pioneer's market share position in that market? And maybe talk about the competitive environment and where, now that you have a controlling interest in the company, you plan on taking their distribution footprint?

Okay, well I'm going to -- I'm going to ask Robert Stone to respond to that, Matt.

Sure.

Okay, Matt. The markets for Pioneer's products is quite large. And I would say that Pioneer is -- we think we're probably the second largest player in the North American market. On a global basis, we're a little bit further down. Gaiwan [ph] is probably the leading company in this arena on a global basis. International sales are really only about 10% of Pioneer's sales and that's where we think we have an opportunity as Franklin Electric to dramatically grow their sales. As Scott mentioned in the comments, there is a strong market in the Pump Rental Arena and then in the energy markets and commodity markets. Mine dewatering is a large area of supplying frac-ing fluids and removing water from drilling areas as well.

Our next question comes from the line of Michael Rumberg from Ladenburg Thalmann.

I just want to start off with Impo. It looks like a very strong quarter and I know, it's been a little bit, as we come up on the anniversary here, difficult to predict the quarterly seasonality for that business. Yes, but this quarter clearly stands out with $13 million in sales. Can you talk about whether that...

Excuse me, Michael. Michael?

Yes?

Michael, the acquisitions that were identified, include one month of Pioneer's.

Okay. Okay. Okay. That makes up for a good portion of that then obviously.

Yes.

Okay, okay. Well can you talk about the Impo acquisition, how you feel in general about that at this point, on the one year anniversary? And kind of, how you see that business developing in 2012?

We feel very good about it. The Turkish market continues to grow, and Impo continues to grow in the market. The -- they represent a low-cost manufacturing base for supply throughout the region. They give us a -- an additional brand that is positioned at a different level in the market. So we can address markets that we up to now have not been able to address with the premium quality Franklin products. We feel good about it both from a day-to-day business perspective and from a strategic perspective.

Okay, in North America, is it possible to quantify the impact of favorable weather in terms of whether that may pull forward a bit the water well season a bit? And obviously, somewhat offset by the decline in grey water sales? Can you talk about the -- how these 2 play together?

I am sure that the mild winter conditions helped us in our AG irrigation business during the first quarter. It is not clear that -- as I mentioned in my comments, that it pulled a lot of business forward that would have otherwise gone into the second quarter, because it does look like, at least in the U.S. and Canada, the farm economy is strong from an investment perspective. But they're trying to increase crop yields and expand acreage because of favorable general economic conditions and we think that there's a reasonable probability that, that will continue through this year and will be further accelerated if it remains dry, especially in the southeastern part of the United States, and that's the wild card that's hard for anybody to predict. On the other hand, there's also no doubt that the first quarter this year relative to the first quarter last year, what we -- our Wastewater business was hurt rather significantly. Sump pumps, residential sump pumps is a -- is an important product line for Franklin. We're one of the leading suppliers of that product line in the United States. And that product line, unlike our AG irrigation, is helped by wet conditions in regions of the country and so we saw a fairly material decline in our sump pump business during the first quarter.

Okay and then just one last question if I may, kind of a bigger picture question related to R&D. I know that you guys have indicated an interest in stepping up R&D expenditure over time. Can you just talk a little bit more holistically about what's drives -- what drives that, whether it's a bet on where we are in the cycle and whether you think that the gains to be realized from those investments are outsized at this point in time or whether some other development within the competitive environment that leads you to want to take those steps now?

Okay, well most of our RD&E spending is for new product development. We have product a -- we have product roadmaps for essentially all of our product lines. We have a parking lot of pending projects. We've got -- we know what we're working on now. We know at what stage those products are in their development cycle and when they're scheduled to launch, and we can look out and see what is in our backlog of projects in the future. And as we look at it, we like our backlog. But we don't have the resources -- and we're not going to initiate projects and dilute our efforts on existing projects. And so we want to responsibly increase our expenditure in RD&E to take advantage of the -- what we think is the opportunities that are apparent to us on the table and just waiting for us to get the projects initiated. Secondly, I -- we are building a new Tech Center 25 miles or so from our existing Tech Center here in Bluffton, Indiana. And that Tech Center will roughly -- will more than double our testing capacity. A lot of what we do is develop new product designs, but we have to do life testing -- accelerated life testing for those products to demonstrate to ourselves that they meet Franklin durability standards, and we have been limited by our own lab facility in the work that we can take on. We've had to set projects up on a, kind of a sequential -- we had to do them consecutively. Now we can do them simultaneously when we get this new building. So we'll have -- we know we've got the projects and soon we're going to have the capacity to execute faster. And so I think we're not going to -- we're going to do this responsibly and incrementally, but we are going to increase our -- I believe we will increase our RD&E spending as a percentage of sales over time just to capitalize on opportunities.

Our next question comes from the line of Roger Rama from Robert W. Baird.

Can you just talk a little bit more about those new product introductions, specifically your progress on the coal seam gas pumping technologies? How are the -- how did the beta test progress, [indiscernible] are positive and maybe a little bit of color about your expectations longer term?

Okay. What we've said about -- we described our coal bed methane product line as a product line that consists of pump, a motor, a drive and control unit, various other sensors that is built off of our Water Systems technology. Normally, a water well may be 40 feet deep, maybe 600 feet deep. The traditional Franklin product line was designed to work in that kind of depth range. These coal seam gas wells are down in roughly a mile deep, in many cases. And so up to now we haven't had a product line that would work at those depths. And as a result, they've been using more expensive oil field type equipment to move the water out of the natural gas wells from those depths. We've now designed a -- what I've describe as a water well-based system, proprietary to Franklin, that we believe will function better than the systems that are out there now, be more durable and provide better gas production, because we can control the water flow better than the systems that are currently on the market, and will cost less. And so, we're pretty excited about it. We see this as roughly $0.5 billion market opportunity over time. The issue is that it's -- these systems are very expensive; not our system, any artificial lift system is very expensive to install and very expensive if it fails. And so any new system that is introduced in the market, a, you need to be very careful that you beta test it thoroughly so that when you do launch it, you're successful, because you only have one chance to make a first impression; and b, it will take a little bit of time just to demonstrate to the market, to the big players in this field that indeed this system is robust enough to meet their needs. Our beta tests are going very well. We've had no surprises. We believe that we'll be able to launch the product line or declare it commercial either late third quarter or early fourth quarter this year. We're focusing our efforts on a few markets geographically around the world. But as I mentioned, the U.S., Canada, Southern Africa and Australia, those markets are large and growing for this type of product line. And so we think we're on track with this. I want to manage expectations. This is going to be a product line we'll declare it commercial and we will have to demonstrate to the market over time that this product line is what we say it is. But I believe that it is and I believe that we will have an opportunity over a period of time to pick up a meaningful share of the market.

That's great. The next question is a little bit on your capital deployment priorities. Last quarter, I think you guys mentioned having $300 million to $400 million available for acquisitions and had Pioneer Pump in March. Can you talk maybe a little bit about what else you're seeing in the pipeline? And then, maybe your thoughts on share repurchases as well?

Well of course, we don't comment on acquisitions -- specific pending acquisitions or -- but generally speaking, we have looked -- we look at acquisitions that will expand our product line. And so that -- but that are -- generally go through the same distribution channels as our existing product line, so that there'll be a synergy where we can expand the -- take a product that's sold locally and sell it globally, or take a product that has limited distribution and put it through the Franklin extensive distribution system. So we look for product lines that are incremental to our existing product line, and we look for platforms for geographic expansion, particularly in developing regions. We're -- we think that our total addressable market now, including some of the new products that we're launching, is over $7 billion. We have 10% or 11% of it, the -- but we're one of the largest players. So it's a pretty fragmented market out there, as far as our segment of the pumping systems' industry is concerned. And so there are a -- there's like a fairly robust list of small but we think accretive and logical acquisitions for the company to pursue.

Just, Roger, on the point of the share repurchase, our intentions for 2012 are similar to what we've done in the previous years, which is basically to offset the dilution of equity awards that we make with share repurchases. And we don't have a different intention than that right now.

Great and then just maybe one more here. Can you guys talk a little bit about what you're seeing in Europe right now? Obviously, trends are still weak. But are you seeing any signs of stabilization out there or certain markets? Have your expectations changed at all, given the persistent headwinds we've seen?

Gregg Sengstack, our President and Chief Operating Officer, will respond to that.

Excuse me. In Europe, again, we had some softness and, yes, the southern European countries and also around the Mediterranean, North Africa, as Scott pointed out, have had some weakness and some lumpiness to it. But again, we have a large part of our business is for replacement, a large part of our business is necessary for agricultural development, which is going to continue to expand in the region. And so we see our businesses being -- continue to be stable and weather conditions seem to be moderate, so we would expect our business, irrespective kind of the economy, to kind of navigate on its own and continue to flow much like water.

Our next question is a follow-up from the line of Matt Summerville with KeyBanc.

Just a couple of quick follow-up questions. Scott, can you comment a little bit on what you're seeing globally, in terms of inventory levels at your distributors and whether or not, what may have been some de-stocking efforts in Europe has subsided at this point?

I'm -- that really -- so much of our -- as Greg mentioned, so much of our business is replacement and really nondiscretionary replacement business. The ultimate demand for our water well pump is, if it goes -- if your well goes out, you've got to replace it. And at this stage, I would say 80% to 90% of our business is replacement business and not necessarily New Installation business. And that kind of business is inherently stable, and the primary issue if we see a material fluctuation is inventory in the channel, as you -- on your question. I believe that we're seeing some inventory backup and inventory efforts on the part of our distributors and OEM customers in Europe and the Middle East to reduce inventories. I do not believe that we're seeing a -- an inventory build in the U.S. and Canada in any of our businesses or I'm not aware of any material inventory build slowdown in turns on the part of our customers in other regions of the world. So I -- right now, I don't think other than in Europe, that inventory -- that I'm concerned that there's -- we're likely to get whipsawed soon by a major reduction in inventory in other regions.

And then just a question on raw materials versus pricing, you mentioned in Q1 you felt pretty good about that relationship. I guess, can you talk about how you expect that to manifest as you move through the rest of 2012 based on where spot prices are today? And then you mentioned as well, Scott, market share, taking share in North America. Can you talk about what the competitive response to that, if any, has been, kind of folding that into the pricing question I had.

Okay well -- of course we had a major run-up in raw material costs. First, commodities, and then -- so many of the other products that we purchase are made out of these commodities that our raw material costs last year put pressure on our contribution margins. And we were able to have a really nice year from an earnings perspective primarily because of operating leverage on the growth, the sales growth that we've got. Our scenario for this year is that sales growth, because of the issues in Europe and portions of the Middle East, may not be as -- and also because of the currency situation, we may not get as much sales growth this year, but the raw material costs, which represent over 60% of our cost structure, is more favorable. It has leveled off. Although I -- it was down in -- through the first 2 months, our raw material costs were down in the first 2 months. They stepped up a little bit in the third month of the quarter. So we're keeping an eye on that. But they're clearly not growing at the rate that they grew last year and they're really pretty flat. And our forecasts are based on an assumption that they will remain pretty flat through the course. Overall, our material costs will remain pretty flat through the course of the year and that price therefore and our productivity efforts will result in improved margins and that, that's what will drive our earnings improvement through the course of the year. So that's pretty much the scenario that our guidance and our planning right now is based on.

And then, just a comment at all regarding market share gains, how you see your competitive position in North America. You set a target a few years ago, how you've -- you're trending now relative to that target? And over the last couple of quarters, what has been the competitive response?

We accomplished the target. And our share grew markedly in the first quarter, and that -- but our price increases were effective as well. So I think the competitors are -- if for our segment of the industry, at least right now, focused on margins perhaps. I mean, I can't speak for them; I can only give you my impression. And the -- I think that we're not gaining share because we're cutting price. Or we're gaining -- gain -- our share gains are as a result of having really good products, really good salespeople and really good distributors and focusing on this segment of pump business. I mean, that's our lifeblood, and for many of our competitors, that's not the case. And so they have other areas that are very important to them, and -- so I think our situation is this is what we do and we're gaining share and being rewarded for it.

And with no further questions in queue, I'd like to turn the conference back over to Scott Trumbull for any closing remarks.

Well thank you very much for your interest in our company. Goodbye.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you all disconnect. Have a great day.