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Franklin Electric Co Inc (NASDAQ:FELE)
Q3 2020 Earnings Call
Oct 27, 2020, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by and welcome to Franklin Electric Reports thirdquarter 2020 Sales and Earnings Conference Call. At this time, [Operator Instructions]. I would now like to turn the conference over to your host, Mr. John Haines, our Chief Financial Officer. Please go ahead.

John J. Haines -- Vice President, Chief Financial Officer

Thank you, Rudy, and welcome everyone to Franklin Electric's third quarter 2020 Earnings Conference Call. With me today is Gregg Sengstack, our Chairman and CEO. On today's call, Gregg will review our third quarter business results and the impacts our company is experiencing from a global pandemic, and I will review our third quarter financial results. When I'm through, we'll 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. With that I will now turn the call over to our Chairman and CEO, Gregg Sengstack.

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Thank you, John. Thank you all for joining us. As I noted in our press release, I am consistently impressed with how our company and my 5500 colleagues were dealing with the pandemic. Our global product supply leadership and facilities teams continue to do a great job, maintaining protocols to keep our people safe. We continue to follow the guidelines of health authorities around the globe, including the CDC and National State and Local Government requirements. Even with these new protocols, guidelines and requirements, our operating performance continues to improve, both sequentially and year-over-year. With the benefit of price, mix and thoughtful expense control, the recovery in our third quarter revenue drove record consolidated operating income and earnings per share for any quarter in our history. Water Systems product demand strengthened through the quarter driving double-digit organic growth outside the US and excluding our large dewatering pumps in the US as well. While our business in Brazil and Turkey experienced a strongest organic growth, driven in part by price increases to offset inflation, generally, our business is strong at all end markets with the exception of the Middle East and North Africa. Large dewatering pump sales are stable. albeit at depressed levels, given the lack of demand by pump rental customers.

Our Fueling Systems business is recovering slowly. Outside of China, revenue was down 7% in the quarter. In the US and Canada, fueling declined 5% compared to the third quarter last year. Our business in China improved slightly, but the run rate is currently sub $20 million, more like it was in 2017. Our US distribution business continues to perform well. Demand is strong, while it is dry in the Western US, which is generally favorable for our groundwater manufacturing and distribution businesses, it has been wetter than average East of the Mississippi. However, overall sales gains are uniform across the country, except for the Upper Midwest where we've seen strong post lockdown recovery and share gains. Although, we continue to experience some challenges in our supply chain, our product availability continues to improve. Across the company, we continue to make progress on reducing working capital, driving record free cash flow. Turning to the fourth quarter, we see groundwater demand remaining strong in the US both for our manufacturing and distribution segments. As a result of the second quarter lockdowns and generally favorable weather conditions, contractor backlogs are significant for this time of the year. We also see the plumbing HVAC business is steady with good end market demand and channel inventories recovery. We expect largely watering pump demand to be steady. Outside the US, except for the Middle East and North African, demand is solid.

Outside of China, we expect our Fueling Systems business see a small sequential improvement. Gasoline consumption in the US, where we have good data is getting closer to pre-pandemic levels. We expected outside US consumption rates are growing as well. In China, our visibility into the funding of government mandated programs has always been a challenge. We remain optimistic that with the recovery of the Chinese economy, we will see some additional double wall pipe upgrades and installation of a meaningful number of fuel vapor monitoring systems and gas station. However, we do not currently see that happening this year. Overall with a continued drag of lower dewatering pump sales, we are forecasting fourth quarter Water Systems revenue down mid-single digits, Fueling Systems revenue down around 10% and Distribution Revenue up around 10%. With our improved overall operating performance, we believe our fourth quarter operating earnings will be up 10% to 15% for the fourth quarter last year. So we are increasing our annual guidance for earnings per share from a midpoint of $1.82 to a midpoint of $2.12. Also, with our strong free cash flow performance, we are increasing our estimate of annual free cash flow to 170% of net income. I will now turn the call back over to John. John.

John J. Haines -- Vice President, Chief Financial Officer

Thanks, Gregg. Our fully diluted earnings per share were record for any quarter in the Company's history at $0.82 for the third quarter of 2020 versus $0.72 for the third quarter of 2019. Third quarter EPS before the impact of restructuring expenses was $0.83 compared to 2019 third quarter EPS before restructuring of $0.73. Restructuring expenses in the third quarter of 2020 were $0.4 million and were related to various manufacturing realignment activities in the Water Systems segment and resulted in a $0.01 impact on earnings per share in the third quarter of 2020. Restructuring expenses in the third quarter of 2019 were also $0.4 million related to various manufacturing realignment activities in the Water Systems segment and also resulted in a $0.01 impact on earnings per share in the third quarter of 2019.

Third quarter 2020 sales were $351.2 million compared to 2019 third quarter sales of $348.4 million, an increase of 1%. Sales revenue decreased by $10.4 million or about 3% in the third quarter of 2020 due to foreign currency translation. Water Systems sales in the United States and Canada were flat compared to the third quarter of 2019. Sales of groundwater pumping equipment increased by about 17% and sales of surface pumping equipment increased by about 8% versus the third quarter of 2019 due to strong end market demand. These increases were offset by lower sales of dewatering equipment, which were down by about 54% due to lower sales in the rental channel. Water Systems sales in markets outside the US and Canada increased by 3% overall. Foreign currency translation decreased sales by 12%. Outside the US and Canada, Water Systems Organic sales increased by 15%, primarily driven by higher sales in all 3 major geographic region, Latin America, Europe, the Middle East and Africa and the Asia Pacific markets.

Water Systems operating income was $36.6 million in the third quarter of 2020 compared to $28.4 million in the third quarter of 2019, driven by price realization, product sales mix and cost management. Fueling System sales in the US and Canada decreased by about 5% compared to the third quarter of 2019. The decrease was in all product lines and due to declining demand for new filling stations. Outside the US and Canada, Fueling Systems revenues declined by about 27%, driven by lower sales in Asia Pacific, primarily China. In the third quarter, outside of China, Global Fueling System sales were down about 7%, an improvement from being down about 20% in the second quarter. In China, Fueling System sales improved sequentially, they continue to be less than half of last year's sales. Fueling Systems operating income was $18.9 million in the third quarter of 2020 compared to $21.6 million in the third quarter of 2019, driven almost entirely by lower revenue. Distribution sales were a record at $98 million in the third quarter of 2020 versus third quarter of 2019 sales of 87 million. The Distribution Segment Organic sales increased 13% compared to the third quarter of 2019. Favorable weather condition versus the third quarter of last year contributed to the revenue growth. The Distribution Segment operating income was $6.4 million in the third quarter of 2020 compared to $5.9 million in the third quarter of 2019.

Operating income growth did not keep pace with sales growth, primarily due to unfavorable product sales mix and higher personnel costs in the quarter. The company's consolidated gross profit was $124.3 million for the third quarter of 2020, an increase from the third quarter of 2019 gross profit of $117.6 million. The gross profit as a percentage of net sales was 35.4% in the third quarter of 2020 versus 33.8% in the third quarter of 2019, and improved primarily due to better price realization and product sales mix. Selling, General and Administrative or SG&A expenses were $75.5 million in the third quarter of 2020 compared to $74.5 million in the third quarter of 2019. SG&A expenses were higher, primarily due to variable compensation expense, partially offset by foreign currency translation. In the third quarter of 2020, our effective tax rate, net of discrete events was about 17%, down from about 20% in the third quarter of 2019 due to the net result of favorable discrete events. Our 2020 effective tax rate, net of discrete events should be between 18% and 20% and consistent with our original financial guidance.

The company ended the third quarter of 2020 with a cash balance of $114.5 million and generated $118.5 million of free cash flow from continuing operations during the 9 months of 2020 versus free cash flow in the first 9 months of 2019 of $75.5 million. The company's total incremental borrowing capacity was $532 million on September 30, 2020. Yesterday, the company announced a quarterly cash dividend of $0.155 that will be paid, November 19th to the shareholders of record on November 5th. The company made no purchases of its common stock in the open market during the third quarter of 2020. At the end of the third quarter of 2020, the total remaining authorized shares that may be repurchased is about 934,000. This concludes our prepared remarks and we would like to now turn the call over for questions.

Questions and Answers:

Operator

Ladies and gentlemen, [Operator Instructions]

Our first question comes from the line of Mike Halloran from Baird. Your line is open.

Michael Halloran -- Robert W. Baird -- Analyst

Good morning, gentlemen.

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Good morning, Mike.

John J. Haines -- Vice President, Chief Financial Officer

Good morning, Mike.

Michael Halloran -- Robert W. Baird -- Analyst

So, let's just make sure I understand the trends in the fourth quarter on the water side and how are you thinking about sustainability here? If I heard the prepared remarks correctly, it sounds like the underlying dynamics in the third quarter are going to be mirrored in the fourth quarter. But could you give us some granularity on how you're thinking about some of the sustainability of those pieces net, kind of excluding what weather looks like, with the real focus on maybe the Ag market, as well as the other groundwater markets.

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Sure, Mike. So if you look at our North American business, to your point, what we're seeing is it effectively much as Q2 kind of pushed out to Q3, Q4 and it's been a good climate for our business and both in the residential and Ag space for the groundwater business and then we've also seen a nice recovery in the plumbing HVAC business, and we just feel that given the information we get from our distribution side of our business, which is more focused on groundwater that there's good backlog with contractors. So as long as the weather is reasonable the contractors can continue to get out in the field that unlike prior year received more of slowdown in Q4. We think that's going to carry a little bit more into Q4. Outside of the United States, you go around the globe with the exception again of North Africa and like Saudi, or where it’s been impacted by lower oil prices, is that we're seeing generally good demand in Latin America, Africa. Europe is steady, Asia is steady. So we're just seeing good water demand across those end markets as we move into the last quarter of the year.

Michael Halloran -- Robert W. Baird -- Analyst

So could -- maybe touch on what the inventory levels look like through the channel, both within the Water Segment as well as in the Distribution? And then, any thoughts on an early buy this year and whether there is enough out there for some of your customers and try to pull ahead and get some rebates.

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Well with business being basically strong, people got plenty to do and they are plenty busy. I can't really comment to the early buy side. I would just say generally inventory is good, maybe even a little bit skinny because the supply chains for ourselves and others because we see multiple suppliers for our head water distribution company, supply chain struggled actually in third quarter, maybe not as much in the second quarter, but you still have to struggle as people start ramping up their supply chains, and so we saw even in our own case in Franklin, towards the back half of September. Yeah, we are struggling getting some components from key suppliers. We're actually viewing that hope now, but I wouldn't think that inventories are particularly robust, people trying to go for cash in these situations, whenever you have a shock to the system. And so I would not think that inventory levels are particularly robust in the channel.

Michael Halloran -- Robert W. Baird -- Analyst

That makes sense. And then last one really strong cash generation really good cash position. And I'm guessing, not much has changed, but love some thoughts on how you're looking at the M&A landscape out there, what the optionality looks like and any cash usage priorities, excluding the obvious, which is invest in yourself first?

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Yeah, Mike, our view toward M&A really hasn't changed. We have some transactions that we continue to look at. So, you know, the pipeline, I'm not sure I would say it's really robust, but we've got. We're getting looks and we'll see where some of those may take us here. But that continues to be our priority, as you know is accretive acquisitions and from there we'll go and we know we're not, we're not really particular if it's a good opportunity, it's a good opportunity. That may be in water, maybe in fueling, maybe in distribution, it maybe outside the US and in the US. The cash generation is really coming, as you can see from the working capital improvements that we've made largely around the corporation. Our working capital ratio is down to 29% at the end of the quarter, which is a important performance measure for the leadership team here and it's almost 400 basis points better than where we were last year at this time. So, kudos to the team for the great improvements they've made there, as Gregg points out, in not a particularly easy supply chain kind of environment in the third quarter.

Michael Halloran -- Robert W. Baird -- Analyst

Great, thanks. Thanks guys, I appreciate your time.

Operator

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

Ryan M. Connors -- Boenning & Scattergood -- Analyst

Great, thanks for taking my question and congrats on the great results. What a difference 6 months makes.

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Thank you, Ryan. Morning Ryan.

Ryan M. Connors -- Boenning & Scattergood -- Analyst

Really remarkable bounce back. So I wanted to talk a little bit about fueling and particularly to start with, on the margins, I mean obviously there is some top line headwinds there, but the margins holding up really well. So can you drill down on that a little more than you did John and a). What's driving that and what's enabling that and b) What are the different scenarios from margins from here.

If we get a topline bump, is there actually upside to that. And if we do get a leg down at some point, can we continue to hold the line on margins there in fueling.

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Yeah. So kind of two factors that work there, Ryan. The first one is, we had nice price realization fueling in the quarter, in the neighborhood of 350 plus basis points. So, the business has done a nice job at managing its supply chain, matching the increases and inflation that's coming out of and then going into the market and getting price, so that's a big impact. The other thing that this business has done really well at is controlled our SG&A expenses. Understood that 2020 was going to be kind of a flattish year and now a down year because of the pandemic and really held the line on SG&A increases. So, as you know, I always get a little uncomfortable when we try to get talked up on fueling OI margins, 27.6% is pretty healthy sequentially, it's up, it's just about even with where we were in the third quarter of 2019. So product mix matters, geography mix matters and I just don't think I'll get too fired up beyond that mid 20 range for very long for Fueling Systems.

Now, as we look forward and we capitalize on some of these opportunities in China, which are just great. other developing world opportunities continue to hopefully see station builds come back in the US. And some of those SG&A costs are going to come back. There is no question about it. Some of the comp, variable comp, those kind of things are going to come back. But overall, I would point to price and the SG&A as the main contributors to that and the leadership team there is doing a really nice job in managing those factors.

Ryan M. Connors -- Boenning & Scattergood -- Analyst

Okay. Now, obviously the election impacts many businesses, but it's hard to imagine a business that's more impacted than fueling, I mean you've got two very different visions thereof kind of the path forward in terms of electric vehicles and so forth. So obviously we can come back 3 months from now and talk about it a little more definitively know what the landscape is, but what's your broad view on the risks and opportunities there? As you look out, is that something that you look at as a risk that if, if there is this movement away from fossil fuels that could impact you real tactically or is that still something that even if that does take place that's still kind of pretty far out there in terms of the tangible impact.

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Yeah Ryan. A couple of observations. With respect to the US market, much of our growth is coming from innovation and solving customer pain points, so they can operate their systems safely with the lowest total cost of ownership. And demand, for example, we've just started shipping some corrosion control systems for underground diesel storage tanks where the problem with corrosion from low-sulfur diesel, which is going to become a bigger problem worldwide as we go to low-sulfur diesel, which is a good thing. And you go to low-sulfur diesel, it’s better for the environment, but it's going to create some corrosion challenges and we have a solution for that. So that's, that's an example of a product that's not being driven by regulation, it's being driven by again the station operators looking for lowest total cost of ownership.

Yeah. Also, I would keep in mind that within the United States or even outside the United States, of vehicles sold today, it is a liquid fuel vehicle, is most likely going to be on the road for 20 years. So while there's, yeah, no question it’s going to be a conversion EV vehicles over time, no question it’s going to come in developing regions first, but there is a long build out. And if you look at various data around energy consumption across the globe, without massive conversion to some type of solar wind and so on is that we're going to get energy from all sources, and liquid fuels are really a great way to move the vehicles around, aircraft around. And so that's going to be a part of the energy solution for decades. And so we will see, the fueling business, our growth rates actually inside the United States have often exceeded our growth rates outside the United States, as we see major marketers consolidating the smaller stores and building out new stores and as they get more sophisticated stores, they like our equipment. Outside the United States, which would not be so impacted by the US elections, again, some of the environmental initiatives that you're looking at in China and India around the gas stations are really simple solutions that can really help with the cleaning up the environment, stage II vapor recovery, which was started in China and then they subsided. But now, we want to put in in-station diagnostics to confirm that these stage II systems are working correctly, and that will be good for the environment to do that. Similarly in India, where we know there are real, real air pollution problems, again as long as we have liquid fuel vehicles, these vapor recovery systems are very effective way to capture significant amount of DLC [Phonetic]. So we see these as being, as long as we have liquid fuels in the world that we're going to have those for decades. We see our systems being relevant and we’re seeing it as being a good driver of growth for our fuel business.

Ryan M. Connors -- Boenning & Scattergood -- Analyst

Got it. No, that's really -- that's really great commentary. Thanks, Gregg. And my last one was, and I apologize if I missed this, a little choppy, you're a little choppy towards the end of your answer to the last question. But when you talked about M&A and sort of acquisitions, it seems like distribution has really gotten its legs under it and is in a good place here. The growing pain has kind of past and that business is really doing well. But yet, it's still smallish in the overall mix. Is that a particular area where you would be looking to maybe build through acquisition. I know that space needs to consolidate anyway.

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Yeah. Ryan, it is. We're going to be thoughtful and patient and a couple of more comments. We don't see anybody else out there kind of consolidating the space, we've done several acquisitions. So we think we know the ins and outs and the key factors when it comes to valuation, evaluating these kind of entities. So, yeah, there is going to be more opportunities and we're going to be thoughtful and consider those, we think about geographic presence and where certain parts of the country, it might be better to own a platform there that we don't have. So the answer is, the short answer is yes and we'll consider opportunities as they come out of and be very thoughtful on how we execute those.

Ryan M. Connors -- Boenning & Scattergood -- Analyst

Super. Well thanks, I appreciate your time.

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Thank you, Ryan.

Operator

Thank you. Our next question comes from the line of Matt Summerville from DA Davidson. Your line is open.

Matt Summerville -- D.A. Davidson -- Analyst

Thanks. Hey, guys. With respect to the two pieces of the business that are pretty soft for you right now. First with dewatering, where do you think Pioneer’s business comes in from a revenue standpoint in 2020, and do you have an initial preliminary sort of view on how that might shape up in '21.

John J. Haines -- Vice President, Chief Financial Officer

Yeah, 2020 Matt $60-ish million or $65 million top line there. We're doing our work right now on 2021. I'm a little hesitant to share something there, but as you know, big impact this equipment is sold to rental houses, and then in the US where they put those out on rent to O&G activity including fracking activity. So, I think that there is differing views on that, but we're not -- we're not real bullish on that at least in North America at the moment. So the good news is the business continues to pick up traction internationally, really good applications for mining or dewatering applications, other types of things like that and we see some traction in Latin America, Australia, we see some traction in Southern Africa with this product. So it's much smaller, of course, than kind of the bulk that’s in the US, that there are some positives in this product line as well, and we'll continue to try to push that.

Matt Summerville -- D.A. Davidson -- Analyst

Just sticking with that theme. If I recall correctly, your dewatering business, I think was down like 50% in the fourth quarter of '19. And if I heard you guys correct in your prepared remarks, you're thinking water is going to be down, kind of mid-single digits in Q4 and unless I didn't hear you correctly. So I guess some, maybe a little surprised that you're anticipating water to be down in Q4. Can you expand on that?

John J. Haines -- Vice President, Chief Financial Officer

Yeah, I think the key thing, Matt, is just, you know, seasonally as you know, we’re going into the fourth quarter. As Gregg pointed out, we saw a really nice quarter in both groundwater and surface pumping. In the US groundwater was up 17 and surface was up 8. Some of that surface is recovery of the stock team, we believe that was happening in the second quarter. That's going to trail off, right. As seasonally we get into the winter months that's going to start to decline. And then groundwater is really, it's difficult to predict. As Gregg said, right now the weather conditions have been in our favor, at least in this country. We definitely think that there is this resurgence of demand that's coming out of the second quarter when a lot of areas where suppressed and a lot of that's going to depend on contractors being able to get out there due to work. We're still hearing a lot of positive things from our distributors and in the head water business we're hearing positive things that there is more work than there is time. So that's a tailwind for the fourth quarter, but there's lots of puts and takes and we don't expect the water into change that much. And then second quarter, dewatering was down 70%, it was down 54%. Now the comps get easier. But as I said, we're not expecting much out of that product group in the fourth quarter.

Matt Summerville -- D.A. Davidson -- Analyst

Got it and then over to fueling the other piece of the business that is kind of soft for you guys. Where do you think China fueling comes in from a top line standpoint in '20 and similar to my dewatering question, how should we be thinking about how this -- the next wave of environmental related stuff BISD sort of revenue. How should we think about that in the context of 2021 at this point?

John J. Haines -- Vice President, Chief Financial Officer

Yeah, the top line number for 2020, Matt, 17 to 20 somewhere in that range. 17 to 19 we keep kind of inching it down a bit here. In terms of looking forward, again, a little hesitant to give too much on '21, just cheer up that the reality is, is that these environmental mandates in China are real, there's lots of volume and/or it's competitive for sure, but our product and our technical solution fits with what is needed there. So we continue to be optimistic. We think 2020 was a highly unsettled year in China with the pandemic and floods and other issues there. So, I think generally, our view is that it will stabilize and we'll see more volume traction in 2021 in China for our Fueling Systems business.

Matt Summerville -- D.A. Davidson -- Analyst

Got it. And then just last real quick, you mentioned the price realization in fueling, can you give the same figure for your water business. Thanks, John.

John J. Haines -- Vice President, Chief Financial Officer

Yeah. Water, it was a nice quarter as well. Now some of that as Gregg pointed out is, our developing region, some of our developing region businesses, price on spot rate. So as effect starts to go up, then they go get more price. In Water Systems, we're in the 2.25 to kind of 2.50 range, Matt. And in distribution, we're in half a point to a full point kind of range of price realization. And for a year-to-date through the three quarters, and water in the 200 basis point range and fueling in the 300 basis point range. So it's been a nice, it's been a good year and the teams have done a nice job at getting price to stick.

Matt Summerville -- D.A. Davidson -- Analyst

Great. Thank you guys.

John J. Haines -- Vice President, Chief Financial Officer

Thanks, Matt.

Operator

And ladies and gentlemen, [Operator Instructions]

John J. Haines -- Vice President, Chief Financial Officer

Rudy, I think we're ready to wrap up the call with some final comments there from Mr. Sengstack.

Operator

Thank you. I will now turn the call over to Mr. Gregg Sengstack for the closing remarks.

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Thank you, Rudy. Before we end this call, I would like to call your attention to the 2020 Franklin Electric sustainability report that will be issued today and available for download on our website. While this report is our first public disclosure of some important environmental and social measurements, principles of sustainability are the foundational tenets of Franklin Electric's Culture and long contributed to our success. The commitment to safety, ethical compliance with established policies, here for the well-being of our employees and a history of innovation, environmental protection, continuous improvement and lean manufacturing practices. Thank you for joining us this morning. We look forward to your joining us on our conference call following our fourth quarter earnings release. Take care and stay safe.

Operator

[Operator Closing Remarks]

Duration: 36 minutes

Call participants:

John J. Haines -- Vice President, Chief Financial Officer

Gregg C. Sengstack -- Chairman of the Board and Chief Executive Officer

Michael Halloran -- Robert W. Baird -- Analyst

Ryan M. Connors -- Boenning & Scattergood -- Analyst

Unidentified Participant

Matt Summerville -- D.A. Davidson -- Analyst

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