Franklin Electric Co., Inc. (FELE) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Franklin Electric Quarter 2 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to your host for today, Mr. John Haines, CFO. Sir, you may begin.

Thank you, Vam, and welcome, everyone, to Franklin Electric's Second Quarter 2012 Earnings Conference Call. With me today are Scott Trumbull, our Chairman and Chief Executive Officer; Gregg Sengstack, President and Chief Operating Officer; and Robert Stone, Senior Vice President and President International Water Systems. On today's call, Scott will review our second quarter business results and then I will review our second quarter financial results. When we're 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, effect of price increases, raw material costs and availability, technology factors, integration of acquisitions, litigation, government and regulatory actions, the company's accounting policies and future trends and other risks which are detailed by 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 Chief Executive Officer, Scott Trumbull. Scott?

Thank you, John. Recall that during the second quarter last year, we achieved the highest sales and earnings for any quarter in the company's history. So we're pleased to announce that despite significant foreign currency translation headwinds, we exceeded this difficult comparison by double-digit amounts on both the top and bottom lines. Our organic sales growth rate, which excludes both acquisitions and foreign currency translation, was about 6% during the quarter, reflecting solid increases in our North American and South American Water businesses as well as our Fueling business. Our growth was driven by a combination of Water Systems market share gains in the United States, price increases across many of our global product lines, continued robust demand for agricultural irrigation pumps and the success of recently launched new products. While both our global Water and Fueling businesses achieved double-digit operating income growth during the quarter, we were particularly pleased with our Fueling team's 23% year-over-year operating income growth. Our Fueling operating income margin was 20.5% during the quarter, an increase of 250 basis points compared to the prior year. Our Fueling profit improvement can be attributed to a combination of solid sales growth, expense control and effective first quarter pricing actions. While our reported second quarter Fueling sales growth was 8%, our organic sales growth was a healthy 12% in Fueling, driven primarily by strong shipments of fuel pumping systems in the Asia-Pacific region, continued mid-single-digit sales growth in the U.S. and Canada and strong customer demand for a number of our new products, including the Colibri and TS 550 evo fuel management systems and our new Gemini fuel containment systems. Our Water Systems business in the U.S. and Canada represented 39% of our consolidated sales during the quarter and grew by 23% compared to the prior year. U.S. Canada organic sales growth was 5%, which excludes foreign exchange in the Pioneer acquisition. Our sales of residential Water Systems In the U.S. and Canada grew by about 14% during the quarter as our residential groundwater pumps and motors continued to gain share. In addition, we're seeing an ongoing increase in the demand for variable speed drives in groundwater applications where end users want to control water pressure, reduce energy costs and increase system life. Our electronic drive sales were up about 28% in the quarter. This is a very positive trend for us because when a drive is included, it more than doubles our revenue per installation. Only about 6% of the U.S. groundwater pump industry's new installations are currently equipped with electronic drives, but this percentage is increasing. So drive penetration rates continue to increase, we anticipate solid growth for our electronic drive and control product lines into the foreseeable future. Our U.S. Canada sales of industrial and irrigation pumps, motors, drives and controls continued growing at over an 18% rate during the second quarter. The ongoing hot and dry conditions in several agricultural regions of the country were an important contributor to this growth. In addition, Franklin has launched a new line of turbine pumps for the agricultural irrigation market that have superior resistance to abrasion from pumping water with sand and other minerals. These pumps are being extremely well received by our customers and are enabling us to grow at a faster rate than the overall market. Our sales of residential and light commercial wastewater pumps in the U.S. and Canada declined sharply during the quarter. While hot and dry weather conditions help our groundwater business, they hurt our wastewater pump business. Based upon trade association data, from surveys of the leading producers of Sump Sewage effluent and utility pumps in the U.S., we are aware that industry unit shipments of these products during the first quarter declined by over 30% compared to the prior year while our shipments declined at a significantly lower rate. We believe we will see a similar trend when the industry shipments data are available for the second quarter. During the second quarter, we started the process of integrating the Pioneer Pump acquisition in our water segment. Pioneer performed well during the quarter. We're focusing on building the Pioneer sales base in international markets and helping the Pioneer products supply team to reduce costs by leveraging Franklin's global supplier relationships. Our Water Systems sales in Latin America represented about 11% of our consolidated sales during the second quarter and were flat in dollars compared to the prior year. However, our organic sales growth in Latin America, excluding the impact of foreign exchange, and we have no acquisitions during the quarter, was about 9% as the Brazilian real declined significantly versus the U.S. dollar. We are achieving good growth in Brazil from the recent launch of Franklin's line of residential groundwater pumps and motors in that country. Also, our newly opened distribution center in Chile for mine dewatering equipment and other industrial and irrigation pump products is also contributing to our sales growth in Latin America. Our water sales in the Asia-Pacific region represented about 5% of our consolidated sales during the quarter and declined by 8% compared to the prior year. The organic sales decline was also about 8%. Recall that our sales in Asia-Pacific were up by 20% in the first quarter of 2012, so we believe much of the second quarter sales decline in the region was the result of sales pulled forward to avoid price increases that took place during the second quarter. On a year-to-date basis, our Asia-Pacific sales are up by about 6%. Our Water Systems sales in Europe, the Middle East, the North Africa represented about 16% of our consolidated sales during the quarter, an increase by about 1% versus the prior year. I should point out that our sales in Western Europe represent about 9% of our consolidated sales and our sales in the Middle East and North Africa represent about 7%. Excluding acquisitions and foreign exchange, our organic sales growth in EMENA was about 5% compared to the second quarter prior year. The organic growth was driven by sales increases in the Middle East and North Africa, which more than offset an organic sales decline in Europe. We were encouraged that our business in North Africa grew by nearly 20% after several quarters of decline due to the political turmoil in that area. Our water sales in Southern Africa represented 4% of consolidated sales during the quarter and were down about 7% compared to the same quarter prior year. The entire sales reduction was caused by foreign currency translation as the second quarter organic sales growth in Southern Africa was 11%. In recent quarters, the company has invested in equipment to improve the quality and availability of our line of progressive cavity pumps in South Africa, and sales of these products grew sharply during the second quarter. As we look forward to the third quarter, we remain 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. Our press release referenced the foreign currency translation rates that underlie our third quarter sales and earnings guidance. These translation rate assumptions reduce our consolidated sales by about 5% and our earnings per share after non-GAAP adjustments by about 8% compared to the third quarter last year. John will discuss our exchange rate assumptions in his comments in a few minutes. In spite of these foreign currency headwinds, during the third quarter, we expect that our Water Systems sales and operating income after non-GAAP adjustments will grow by 7% to 11%, driven primarily by the Pioneer acquisition and our water businesses in the U.S. and Canada. We are forecasting that our Fueling Systems sales will grow by 9% to 13% compared to the third quarter prior year and that our Fueling operating income will grow by 12% to 16%. Overall, we believe that our EPS after non-GAAP adjustments will increase by 9% to 13% compared to the third quarter of 2011. I'll now turn the call back over to John Haines.

Thank you, Scott. Our fully diluted earnings per share were $1.04 for the second quarter 2012, which is a record for any quarter in the company's history and an increase of 14% compared to the $0.91 fully diluted earnings per share the company reported in the second quarter of 2011. As we note in the tables in the earnings release, there are 2 items collectively referred to as the non-GAAP adjustments in the second quarter of 2012 and 2011 that impacted operating income and 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. In the second quarter of 2012, there was approximately $800,000 included in cost of sales for increased inventory value as required by GAAP that resulted in a $0.02 charge to EPS related to the Pioneer acquisition. In the second quarter of 2011, the company's EPS included $0.01 of restructuring charges. So after considering both of these non-GAAP items, second quarter 2012 EPS is $1.06, which is 15% higher than the $0.92 non-GAAP EPS the company reported in the second quarter 2011. Overall, the 2012 second quarter revenue, gross profit, operating income, net income and earnings per share were records for any quarter in the company's history. Water Systems revenues were $202.8 million in the second quarter 2012, an increase of $19.3 million or about 11% versus the second quarter 2011. Sales from businesses acquired during the last 12 months were $20.7 million or 11%. Water Systems sales were reduced by $10.5 million or a decrease of about 6% in the quarter due to the impact of foreign currency translation when compared to the second quarter 2011. Water Systems organic sales growth, which excludes sales from acquisitions and the impact of foreign currency translation, was 5%. As Scott indicated, sales growth in the second quarter was led by the U.S. and Canada where demand for both irrigation and residential groundwater pumping systems remain strong. Water Systems operating income after non-GAAP adjustments of $41 million in the second quarter of 2012, an increase of 11% versus the second quarter of 2011. The second quarter operating income margin after non-GAAP adjustments was 20.2%. It was up modestly compared to the 20.1% in the second quarter of 2011. Fueling Systems sales were $43.9 million or 18% of consolidated sales in the second quarter of 2012, an increase of about 8% from the second quarter 2011. Fueling Systems sales were reduced by $1.5 million or a decrease of about 4% in the quarter due to the impact of foreign currency translation when compared to the second quarter 2011. Fueling Systems sales growth, excluding the impact of foreign currency translation, was 12%. Fueling Systems operating income after non-GAAP adjustments was $9 million in the second quarter of 2012 compared to $7.3 million after non-GAAP adjustments in the second quarter of 2011, an increase of 23%. The second quarter operating income margin after non-GAAP adjustments was 20.5%, and increase by 250 basis points compared to the 18% of net sales in the second quarter of 2011. Operating income improved in Fueling Systems due to a combination of solid sales growth, expense control and effective first quarter pricing actions. Last quarter, we commented about a shortage in a critical resin material called nylon 12 we use in underground fueling pipe and containment systems. Since then, we have re-established inventory levels and strengthened the supply chain to meet the expected demand through 2012. We also now believe that the Evonik Industries plant that was originally damaged and caused the shortage will resume production sometime in the fourth quarter, restoring the supplier's capacity of nylon 12. As a result, we do not believe our Fueling Systems sales in the back half of 2012 will be impacted negatively by a lack of supply of nylon 12. The company's consolidated gross profit was $84.3 million for the second quarter of 2012, an increase of $7.1 million or about 9% from the second quarter of 2011. The gross profit as a percent of net sales was 34.2% for the second quarter of 2012 from 34.5% for the second quarter of 2011. The decline in percentage terms is entirely due to the acquisition of Pioneer, which has a slightly lower gross profit margin. Selling, general and administrative or SG&A expenses were $46.8 million in the second quarter of 2012 compared to the $43.9 million from the second quarter of 2011, an increase of $2.9 million or about 7%, all of the increase is attributable to the businesses acquired in the last 12 months. The effective tax rate for the second quarter 2012 was about 28.5%, which the company believes is a reasonable estimate for the full year 2012. The projected tax rate is higher than the Q1 2012 tax rate of about 27.3% due to the stronger U.S. dollar, which in effect reduces foreign earnings when translated to U.S. dollars and has increased the percentage of US-based earnings on a consolidated basis. The tax rate continues to be lower than the statutory rate of 35%, primarily due to the indefinite reinvestment of certain 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 second quarter of 2012 with a cash balance of about $86 million, which was $67 million less than the end of 2011. The cash balance decreased from year end primarily as a result of the Pioneer acquisition and normal seasonal working capital needs. During the second quarter, the company repurchased about 161,000 shares of common stock for $7.8 million. The maximum remaining number of shares that may be repurchased under the company plan at the end of the second quarter 2012 is 1.2 million. The company had no outstanding balance on its primary revolving debt agreement at the end of second quarter of 2012 or 2011. As Scott mentioned, as we thought through our guidance for the third quarter 2012, we were mindful of the continuing impact foreign currency translation will have on our results. Due to the strengthening of the U.S. dollar against many international currencies, we currently believe our third quarter sales will be negatively impacted by 5% and our third quarter EPS will be negatively impacted by 8% versus the third quarter of 2011. The primary currencies driving this variancy [ph] and our assumptions for them are USD $1.23 per euro, USD $0.49 U.S. per Brazilian real and USD $0.12 per South African rand. These 3 currencies make up nearly 80% of the total assumed impact of foreign currency translation in the third quarter guidance we have provided. Additionally, regarding the guidance Scott reviewed, it's important to keep in mind that during the second quarter, as we build seasonal inventory levels, we absorb more fixed cost into inventory as these inventory levels increase. In the third quarter, as we start to lower our inventory levels, the fixed cost absorption will reverse and be reflected in the cost of goods sold during the quarter. This impact will be more significant in the third quarter of 2012 as a result of the higher inventory build we experienced in the second quarter. This was one factor that historically has contributed to lower gross profit margins in the third quarter than in the second quarter. This concludes our prepared remarks, and we'd now like to open the call for questions.

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

A couple of questions. Scott, in your prepared remarks, you talked about seeing a little bit of a shift towards motors and pumps going out the door with the drives on them. Has there been -- I mean, can you talk about last year what sort of percent of your 4-inch units were being sold with drives versus what percent are being sold with drives now? I would imagine that the economics on that are really favorable for you.

Yes, it's going up at about 1% market -- 1% in terms of percent of penetration. It's going up about 1 percentage point a year. And that's been pretty consistent. So several years ago, it was quite low. It was 3%, then it went to 4%, then it went to 5% and this year, it's about 6%. So it's still a low number, but as you say, it's very favorable for us because, as I mentioned in the call, the drive sales were considerably more than the pump and motor. And so when we can sell a whole system, it's a nice sale for us.

You've talked about market share in the past and kind of what your assessment is of Franklin's market share and you mentioned today in a couple of areas where one being grey water another being residential where you feel that you've been successful in continuing to gain share. So maybe, could you walk through more of a current assessment on what you think your share is in maybe 3 different buckets, one of those being AG, one being construction or res commercial, however, you want to talk about it, and then the other one being the grey water business.

We have some indication, a good indication, of share based on trade association data for the residential market and share based on trade association data for the Sump Sewage effluent and utility pump market in the U.S. and Canada. However, we're not at liberty to share that precise data due to our commitments to these trade associations and the terms under which we provide the data to them and all of our competitors provide the data. So I can't speak about specific numbers, but I can indicate that this is not a gut feel, it's sort of a quantifiable -- when we talk about share gains, it's something that we could see and track on a monthly basis or in the case of Sump Sewage and effluent, on a quarterly basis. But I can tell you that I disclosed for the residential market early on that our goal was to get to 35% of the market, because at that point, we felt that we would be, by a material margin, the largest player in the market. And that's where we wanted to be. We don't aspire to have 100% because we have limited distribution and we give distributors the opportunity to sell in regions of the country. If they do a good job for us, we protect that. And so there is some limit given our philosophy on the market share we can achieve. I can say that we have materially exceeded the goal we set out as far as our share in that market is concerned and that since the Little Giant acquisition in 2006, our share of the Sump Sewage effluent utility market has steadily increased as well. And I think that's as much math as I can give. We do not have good data on industrial and irrigation product sales because we don't get -- there isn't a trade association. There isn't hard data. We can only comment on -- we know what our sales have done and we can pick up from distributors what we believe the industry growth rate is. And it's our subjective feeling that we are continuing to gain share in that region -- in that end-use market, but I don't have hard data to back that up.

Okay. And then I want to talk just about AG for a moment. With respect to behavior or the mentality of these farmers, I mean, at what point do they just sort of say, forget it and they throw in the towel or do water restrictions in places like California and I'm sure there's other places where you're seeing water use restrictions just become overly burdensome and they just kind of shut down for the year. Does that happen?

I'm sure it happens. And crop insurance is also a factor in that sort of decision making. But on the other hand, I'm sure that, that is a fact, we are continuing to see good growth in our -- it's in North America, in our irrigation and industrial business. But you know, Matt, I want to be careful to not give the impression that what we're going through is a period of complete one-sided windfall as a result of the weather. Because in our business, the weather both has gives and takes. On one hand, industrial irrigation business in North America is growing nicely. On the other hand, our wastewater business has declined sharply because of the weather. And it's also true that our southern hemisphere industrial irrigation business, because -- while it's really hot and dry up here, it's not so hot and dry in other regions of the world, is down pretty sharply this year. So it hasn't been a total windfall for us. It's certainly been helpful in North America and in spite of the fact that I believe that there are some individual farmers who have, as you've said, sort of thrown in the towel or elected to opt for crop insurance that on balance, they're trying to salvage the profit, capitalize on these high prices, and so I think that's the overall situation.

And then I guess as we start to think about the season in the southern hemisphere, which we know is opposite of what we have here in North America, is the early read there that the season will start out in more of a sluggish fashion?

Matt, this is Robert Stone. It's a little too early to have a great feel for that, but our expectation is that it'll start up in a normal fashion, not significantly up or down, weather variations and it depends too on the region of the world that we're talking about. Whether we look at South America or Africa, the situations there are different typically.

Our next question comes from the line of Mike Halloran from Robert W Baird.

So could you talk a little bit about the pricing side? I know you guys -- some pricing was gone through somewhat recently, what the acceptance has been like, there's been any pushback since that's gone through. It doesn't sound like it, but just kind of an overall tenor on the competitive dynamic both on the international and the varying water platforms you have here in the North American region?

I would say, generally speaking, we raised prices in the first quarter, early second quarter, and we did not face, in a global sense, any real headwinds as far as implementing the price increases are concerned. There are pockets of more intense competition in regions of the world, but generally speaking, we were able to get the price increases that we had set out to accomplish. And we believe that those increases are consistent with our cost increases and that to the extent that we're able to accomplish our productivity and what we call VIP, value improvement goals, that should fall to the bottom line.

And then on the -- I think in the press release you put out an 18% industrial and irrigation growth rate for the quarter.

In the U.S. and Canada.

In the U.S. and Canada. Did that include the Pioneer Pump acquisition?

No, that did not.

Okay, so that's a clean organic number, exceptionally strong.

Correct.

When you're trending towards the third quarter here, could you just talk about the underlying dynamics in those 2 markets. I know we talked a little bit about the AG already, but specifically also on the industrial side, what you're seeing from a trend line perspective. And also, particularly in the AG side for my benefit, maybe talk about it relative to the last year's strong quarter a little bit and a little bit of the year-over-year comparison as well.

Okay. The -- most of our sales and a very high percent -- the vast majority of our sales are replacement sales and that's true both on the residential and the agricultural and industrial sides of our business. And of course, the thing that's driving our growth we think is if the weather is hot and dry in the AG business, people are running their equipment around the clock. Aquifers are going down there -- so therefore, as the water level in the aquifer falls, there's a tendency on occasion to run the pump dry. So they -- we have more pump failures and need for more replacement, and we suspect that dynamic will continue into the third quarter this year. And we will -- the AG season, from our perspective, will start to fall off as we get into the end of August. But we're -- we would expect to see some continuation of the growth that we're getting in the AG irrigation business. The business on the residential side, again, right now we estimate that over 90% of our residential sales are for replacements. We're not benefiting much at all from new housing starts. It's better than it was last year as far as that goes, but it's still not a major factor in our sales. And emergency replacements are somewhat hard to predict, but we've been seeing a nice growth in our residential business. Our residential business in the U.S. and Canada was up 14%. In the last quarter, it was up nicely in the first quarter. And we think we've got some good momentum. We include our drive -- most of our drive and controlled sales are included in our residential category and that certainly is helping our growth rate as drive penetrations continue to grow in the residential or smaller pump category. Pioneer, we estimate that 25% or so of Pioneer sales end up in oil and gas applications for moving liquids around at the pump site. We're not injecting, we're not producing the high-pressure pumps for frac-ing, but there's a need to move water and other liquids around. That's the well site, they use mobile pumping systems for that. That's been a very good growth area for Pioneer and we're starting to see that slow down as we came into the second quarter moving into the third quarter. We think that's largely due to the slowdown in activity, the drilling activity, in natural gas.

And then this is just a housekeeping one, probably more for John. John, you said 28.5% about the -- is about the tax rate for the year, was that meant as a run rate for the back half of the year or are you implying the tax rate is going to be a touch higher to get to that 28.5% -- touch higher in the back half of the year to get to that 28.5% average for the year.

No, Mike, it was meant as a run rate for the back half of the year. 28.5%.

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

Can you just provide or maybe quantify the size of the pre-buy we saw in the quarter in Argentina and then also just talk a bit about the nature of the import restrictions and the magnitude of the potential impact of future sales?

Mike, Robert Stone here. The -- we don't have a terribly good feel for the amount of pre-buy in Argentina and we know that our customers there were looking for more product but they were somewhat limited in their ability to get it. So we don't have the feeling that there was a huge pre-buy, if you will, in that period of time. As far as the restrictions on imports go, that's another question, and that remains a question mark for us and for our customers down there. They -- our customers are working on ways to be allowed to import products. And there are a number of schemes, if you will, that will allow them to do that, and they're actively exploring those.

Argentina, while it's a good market for us, and it represented about 3/4 of 1% of our shipments in the water business in the quarter.

Just turning to Pioneer, following up. I'm just kind of wondering, can you quantify the cost synergies in terms of sourcing and other levers that you have to pull and what kind of timeline you're looking at there in terms of achieving those?

We don't have a full handle on the quantifications of those synergies, Mike, but we look to realize those over the next quarters.

Pioneer, we know Pioneer for quite some time. We had an equity investment in them since 2005, I believe. And we know that they source many of their castings, I'm not going to indicate from where, but they source their castings from a region of the world that is not well known for having low-cost castings. And on the other hand, we source a lot of our castings, which are major components for pumps, from regions of the world where we know you can buy these at a lower cost. Now, moving to new casting suppliers, particularly when you're buying a lot of different SKUs, it's something that has to be done carefully over time. It impacts the quality, so I think we have a very good idea of what we're going to move and where we're going to move it. The issue is getting -- we're changing relationships and getting the testing done and the quality control procedures in place and being sure that we're not going to compromise quality as we make these moves.

And we've also been doing some of that over the years even with our limited stake in the business. We've been assisting Pioneer at moving some of that casting, sourcing business, over the years.

The main issue really for us -- well, reducing their costs is clearly important. We want to do that. One of the -- the main opportunity is expanding their sales base internationally. A high percentage of their sales is in the U.S. and Canada. It's a very good market, but we think that we've got pretty good reach into the mining industry around the world with our current product lines and we might -- we should be able to help them. But again, this is a matter of establishing distribution in markets around the world. And we're kind of methodically working with them in selected regions to build out the distribution for their products.

Got it. And Pioneers's sales were -- internationally were about 10% of the total. Is that accurate or?

That's Pioneer's total, yes.

Okay. And then just lastly, can you provide an update on the coal bed methane business and how that's progressing?

Yes. We have indicated that we want -- our objective is to move out of the beta test phase for this product line during the fourth quarter of this year. We have 16 installations in place around the world. We have a weekly conference call on this. I'm happy to say that we got an order for 3 additional full installations and a partial -- and another partial installation today. So we have, I'd say, growing interest from customers in Australia and customers in areas -- portions of Africa and in North America. We think the development, there are still some elements of this that are in development, that the development is coming along pretty much on track and that we should be in a position to move this out of beta test and into commercial rollout during the fourth quarter of this year. I will say, in terms of controlling expectations, that the customers in this arena are understandably risk-averse. The cost of dealing with a artificial lift system that fails is very expensive. And so I anticipate as we bring this to market, we're going have to go through kind of customer by customer a trial installation. They want to see it run in the market or run in the ground for 6 months or so or maybe a year before they'll really have sufficient faith to start moving to it aggressively. So this isn't going to go viral overnight. But the market -- the customers that we've shown it to are very interested, and there's a very nice value proposition here and some very nice functional attributes of the system that we think make it clearly superior.

Our next question comes the line of it Spencer Joyce from Hilliard Lyons.

First question, kind of while we're on the topic is regarding to the national gas dewatering initiative. I know you talked a little bit about managing expectations a little bit just due to the probable slow penetration we might see. But do you all have any sort of targets for penetration there going forward yet? Are we still a little bit early on in the process?

We really haven't talked about that. We've talked about the development. We'd be happy to show you, if you do make it out our way, the equipment that we're developing. But we haven't set -- we haven't disclosed or talked publicly about targets as far as this is concerned.

Fair point there. I want to go over to gross margin a little bit. Looks like we compressed a little bit in the quarter, understandably from the Pioneer acquisition. My question is concerning going forward. Do you all expect to see a bit more compression just kind of on a year-over-year basis from the Pioneer acquisition, basically following through there or do you expect maybe to see that compression moderate a bit as potential price increases may be outpace our cost inflation there?

Our third quarter profit, gross profit margin, is likely to be lower than our second quarter gross profit margin as it is essentially every year, at least partially because of this phenomenon that John referenced where during the second quarter, we're building inventories and during the third quarter, we're liquidating inventories. And that, combined with seasonal mix shifts, tend to cause our gross profit margin to be somewhat lower in the third quarter than the second. Having said that, I'm not anticipating any material margin compression year-on-year in the third quarter relative to the third quarter prior year. We have no reason to believe that we're going to see margin compression on a year-on-year basis in the third quarter.

Okay. Yes, good color there. That's good. On operating margin, it looks like SG&A came in pretty nice this quarter, especially with incorporating the Pioneer and all of that and such. Do you see -- do you think maybe Q2 and Q1, it's been pretty good on SG&A. Do you think there's any sort of nonsustainable trends there or do you see any reason for that basically to grow a bit faster in the back half of the year or into '13? Or do you think the current levels we're at are pretty sustainable?

I think we'll see modestly higher SG&A spending in the back half than we have in the first half. And I think that it's our intention, we have a number of new product projects that look very attractive for our future growth. We want to underwrite those, and I would expect that we'll see some modestly higher SG&A spending rates in the back half of the year than in the first half.

Okay. Sounds good. Last little question here. We talked quite a bit about the AG and industrial sales and the strength there. And it's pretty easy with us being here in the U.S. to -- we see the weather, we experience it every day. It's pretty easy to attribute a lot of the strength of the weather. But we've been seeing strength in that segment for a pretty good while now. Do you all think there's some underlying sort of secular trends that are serving as a tailwind to the AG and industrial market on top of just sort of the weather impact there?

I believe as far as our sales are concerned that we are growing a little faster than the market. In the irrigation and industrial space, our submersible motors have -- are very well accepted and have achieved a very significant penetration rate of the market. We are a fairly newcomer to the pump side of that business. I mean, when we acquired JBD as our first acquisition to get into the pump business in 2004, they were not a material player in the irrigation and industrial side and we have had to pretty much self-develop our whole product line and what's happening is we have a basically, a brand-new irrigation and industrial pump line that has been developed recently with excellent sand handling capabilities, excellent overall efficiencies, and it's being recognized in the market. We're starting to gain share on the pump side of our business nicely and I think that is a secular trend, because our share of pumps is so much lower than our share of motors that I think that we're going to see some period of market share gains as more and more contractors try our pump product lines in industrial and irrigation area and like them. So I think that is sustainable. Well, I think that the big driver over the last 2 years in the U.S. and Canada for the rapid growth has been that it's been a pretty favorable weather situation for us.

Okay. That make sense. I just want to make sure we don't write too much of that robust growth off to just weather. I know that will be kind of easy to do.

Well, as I pointed out, you got to bear in mind that while the weather is good, it has some -- there's some negative aspects to it as well. I would say, globally for the first quarter in a long time, globally, our industrial and irrigation sales were down last quarter. So while they were way up in the U.S., on a global basis, our overall industrial and irrigation sales declined somewhat, modestly, but still declined. So I will agree with you it would be wrong to look at this as "Boy, all their growth -- they're a weather play." I don't believe that's true.

Fantastic. One more, just kind of housekeeping. I guess when should we expect the Q out there? And I apologize just from not being too familiar with your...

Spencer, the Q will be middle of next week.

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

Well, that concludes our call for this quarter. Thank you for interest in our company.

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