Good morning, ladies and gentlemen, and welcome to the Franklin Electric Reports Third Quarter 2018 Sales and Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I will now turn the call over to Mr. John Haines, our Chief Financial Officer. Please go ahead.

Thank you, Charlie. And welcome, everyone, to Franklin Electric's Third Quarter 2018 Earnings Conference Call. With me today are Gregg Sengstack, our Chairman and Chief Executive Officer; and Robert Stone, Senior Vice President and President of our International Water Systems unit. On today's call, Gregg will review our third quarter business results, and I will review our third quarter financial results. When we're through, we'll have some time for questions and answers. Before we begin, let me remind you that as we conduct this call, we would 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 the 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 as except -- and as -- except as required by law, the company assumes no obligation to update any forward-looking statements. With that, I will now turn the call to our Chairman and CEO, Gregg Sengstack.

Thank you, John. I am pleased to report that strong organic growth drove record sales and earnings for the third quarter of 2018. Our Water Systems units in the U.S. and Canada grew organically by about 10%, Fueling Systems organic revenue growth was 22% and Distribution revenue, somewhat muted by unfavorable weather, grew 2% organically in the quarter. With consolidated organic growth of 8%, our operating leverage -- and tight expense control, our operating results were up over 20% compared to the third quarter of last year, and a record for any third quarter in our history. Our financial results were negatively impacted by translation declines and transactional losses due to the mid-quarter strengthening of the U.S. dollar against many currencies. We estimate this decline resulted in our third quarter earnings per share being about $0.05 lower than we had forecasted. Based on current exchange rates and the continued political uncertainty in Latin America and the Middle East, we believe the fourth quarter will be negatively impacted as well. Accordingly, we're taking the midpoint of our 2018 earnings guidance down $0.08. In the U.S. and Canada Water Systems business, Pioneer-branded dewatering pumps revenue was up 70% from last year. Due to sustained sales growth, particularly outside of the oil and gas end market and increased backlog, we're expanding capacity in this important product line. Other surface pumping equipment revenue accelerated and was up 6% in the quarter. Groundwater pumping systems sales declined about 5% in the quarter due to a decline in intercompany sale through our Distribution segment. You may recall that the third quarter of last year, we replaced products no longer supplied by other pump companies. Our manufacturing unit sales to our Distribution business increased dramatically. This year, our manufacturing and Distribution business units were able to focus…

Thank you, Gregg. Our fully diluted earnings per share were $0.63 for the third quarter of 2018 versus $0.52 for the third quarter of 2017. Restructuring expenses were $0.3 million and relate to branch consolidations and other assets rationalization in the Headwater Distribution segment. In total, these efforts will result in total restructuring charges of about $2 million by the end of 2019 and have a $0.01 impact on the earnings per share in the third quarter of 2018. Third quarter earnings per share before the impact of restructuring expenses were $0.64 compared to 2017 third quarter earnings per share before restructuring of $0.53. These earnings per share results were a record high for any third quarter in the company's history. Third quarter 2018 sales were $341.9 million compared to 2017 third quarter sales of $311.1 million, an increase of 10%. The sales increase was from acquired entities as well as organic sales of about 8%. Sales revenue decreased by $11.2 million or about 4% in the third quarter of 2018 due to foreign currency translation. Water Systems sales were $198.3 million in the third quarter of 2018, an increase of $2.3 million or about 1% versus the third quarter of 2017 sales of $196 million. In the third quarter of 2018, sales from businesses acquired since the third quarter of 2017 were $3.9 million. Water System sales were reduced by $10.6 million or about 5% in the quarter due to foreign currency translation. Water Systems organic sales were up about 5% compared to the third quarter 2017. Water Systems operating income was $28.4 million in the third quarter 2018, flat compared to $28.3 million in the third quarter of 2017. Operating income growth in the U.S. and Canada was offset by declines in international regions, in part due to…

[Operator Instructions]. Our first question comes from the line of Edward Marshall from Sidoti & Company.

So I just wanted to touch on the Water segment. As I look back through the first 9 months of the last sort of 3 years, the sales have grown, but they've grown with about a 50% margin headwind each year as you step down. I am just trying to get a sense as to what might be happening there? I mean it was 15.4 and 14.9 and 14.4 on a year-by-year basis. I am just to trying to get a sense as to why the margin in -- within Water -- I mean is there more competition? Is there something to do with the distribution units? Anything you can help.

Yes. I think there's several things that I'll put some thoughts in and then Gregg do the same. I think overall what you see in our Water Systems segment is the mix shift that's gone on over that time. As we've talked in the past, we know that as our product sales move from groundwater and motor-based products to more pumping products and surface pumping products, like Pioneer is, pioneer is all surface pumping product. That mix shift in and of itself will cause some margin deterioration because as you know, our surface pumping products are not as vertically integrated as our groundwater pumping products are as well. Another factor that we see happening is that because of some of our International Water units underlying market condition, we're losing leverage on -- in certain of those businesses. Asia-Pacific and Brazil are good examples of that. So there's a fixed cost. They serve to support a certain revenue level, and as that revenue varies or declines in certain periods, then you're going to see a lost fixed cost leverage impact margins. The final point that I'll say, and we feel good about this, although in the third quarter, we were basically kind of breakeven or slightly below, is the raw material inflation versus achieved price. No question as to your point that our individual water markets are highly competitive. And no question, that is extremely true in many of the international -- or especially true in many of the international markets that we compete in. So we see raw material inflation, there's no question that, that's happening. And we -- a constant thing that we're focused on and paying attention to is this ability to get price to offset that. And we feel pretty good about that on a consolidated in a global basis. But in certain markets, that's more difficult because of the competition of the -- of that particular market or those underlying competitors in that market. Those would be probably the big things I would point to, Gregg might have other thoughts.

Yes. Ed, I think you mentioned the word distribution. Again, you're looking at the water manufacturing segment, that's what we're reporting. So our foray into distribution would -- that wouldn't impact those numbers other than driving top line growth because of the share gains we're seeing. And I'd say to echo on John's point. In the last couple of years until this year, commodity prices, input costs have been fairly benign. And so the price realization has been net greater or positive, say in '15, '16, '17 and '18. And yes, we've been able to maintain parity with input costs this year whereas the last couple of years before that, there was probably some tailwind. So that's a combination of factors. But it's really in our developing regions. It's where all the people are. It's part of our overall strategy. But they have certainly been under -- there's been economic malaise -- actually a recession, even more in Brazil we certainly have seen in Asia-Pacific particularly, Thailand, which is a large market for us, has fallen off. And as -- so that's where we've been delevered, but we're getting operating leverage, it's been our North American business or Fueling business, and even -- and we're seeing that now in the Distribution as well.

Got it. I think when I was referring to the acquisitions of Headwater, I was referring to the recognition of kind of intercompany revenue, maybe the impact on the margin from that perspective, and maybe it was more optics than structural, but I think what you have explained is it's more structural in nature. Could you kind of talk about maybe the mix in surface versus ground over the past couple of years where was it? Where has it gone? And is that by design, I assume, Pioneer really linked to oil and gas. So with the resurgence in that market, maybe that helped the mix shift to surface? But has there been -- have you also seen increased composition within ground?

So Ed, I think, first on the Distribution, again, the Water segment sells to the Headwater business just like a third-party. That's how it's reported in our results. So for example -- that was a point I wanted to make about how our revenue and our operating income in the Water segment would have been actually higher in the quarter if the transfers from the Water segment to Distribution segment had been on parity to last year, okay? So the relationship, the intersegment relationship is this, it was the third-party. So just to be clear on that. Moving to the other question. Certainly, Pioneer has been lifted by this -- the resurgence in oil and gas prices. At the same time, it's been a conscious decision to diversify the customer base for Pioneer, and that's happening and that has been a contributor to the diversification also away from the groundwater space. And the groundwater business, we are doing very well in our tradition markets. But in the emerging markets, what we're seeing is that there's just been an overall lessening in demand in each market. So it's just that the markets have been soft. We've come from a multiyear, if you go back 5 years ago, in United States, when you had crop prices, corn was at $7 a bushel, today it is $3.5. You've seen that in the irrigation companies are reporting lower sales over that time period. So that would indicate there's been less investment generally, groundwater over a multiyear horizon. Those things will change over time. And certainly, it's been tougher in the international markets. And so our surface business, which we've been consciously growing is a bigger aspect -- bigger portion of our mix. And then as John pointed out, the price competition in developing regions has been tougher because of that and because of the price, the inflation, the input cost we were seeing.

Okay. I guess -- and finally, as we look into 2019 and not to get on your guidance quite yet, but would you anticipate kind of the trends that we've seen within the Water margins kind of continue as we move into 2019? I know it's difficult with mix, but -- to predict mix and I know your plan's not in place. But just kind of getting a sense as to the overall kind of high-level view of the business?

No, we would not, Ed. We would expect in 2019 and going forward that Water operating income margins will be in the 15% to 18% range, so part -- some of the factors that we mentioned here will continue but some, we expect to lesson, one of which is our business units in Asia-Pacific and Brazil having some recovery in revenue. And therefore, this lost leverage coming back to be a positive in those end markets as an example. We also expect to get more price than we have seen inflation overall for 2018, so that'll give us a bit of a tailwind going into 2019 as well. So now we do not expect continued water systems operating income margin deterioration.

Got it. And just to be clear, you anticipate inflation will start to plateau or that your pricing will accelerate?

More of a latter, I would say, is the indication that we have right now. When we look at our raw material inflation, Ed, on an input basis, what we're buying period-to-period, that is still inflating pretty significantly versus last year's average price paid. So in terms of indication of what inflation is doing in the current period, we -- our indications are that we're still seeing raw material input inflation, so as you've heard others say that the price actions we know about, we think, will offset that. But if they don't, then we've prepared to go back out into the markets and try to get additional price in those markets to offset that inflation.

Got it. And you mentioned Asia-Pacific and Brazil. Coming off a quarter where was it 9% down in the particular quarter. I mean some of that was currency. But are there any signs that you see that give you confidence that Asia-Pacific and/or Brazil will begin to turn around? I mean are there chilies there that are sprinkled there that give you the confidence?

Well, Ed, we're hopeful that once the election is done this Sunday in Brazil, there will be some more stability there and customer confidence, consumer confidence, all along the route will be improved. And we'll start to spend a bit more money. I mean one of the other things happens when you have situations like that is that everybody's budgets are cut, and they tend to go for lower-end products. Oftentimes, the our lower-end products, but that also puts some little bit of a squeeze on some of those margins. Not necessarily that there's share loss but the markets decrease and they tend to go toward lower-margin products. In Asia, there are some promising signs, particularly in Thailand with weather, but we have yet to see that actually materialize. But usually when that situation occurs, the government releases funds, and they'll start to buy more parts of our products.

Our next question comes from the line of Walter Liptak from Seaport Global.

Just tell me -- a follow-on to the discussion about Latin America. With the inflation having sort of ticked up in the last quarter or so and specifically around Brazil, is there anything you can do to hedge, or what are you doing to hedge, if you can go to pricing in U.S. dollars. I guess how you plan on mitigating that curbs the headwind?

Yes. The translational headwinds, Walt, as we've talked about are pretty difficult to hedge. Where we saw that very significantly in the quarter was in Turkey, which had some very significant movements in the lira versus the dollar. We saw it in Brazil. We saw that in Southern Africa in the rand as well. In Turkey, as an example, we do what is effectively spot price to our customers. So we will have a price that will be in Turkish lira, but then when we quote an offer to our customers to buy a product, we'll convert that at today's spot price or either the euro or the dollar, depending on the product that we're selling. So that type of an action does tend to offset, in part, some of the translational impacts that we see. The $0.05 that we called out just to make the point was both the combination of translational FX impact but also transactional. And these sudden movements and quite severe movements that we saw during the course of the third quarter also were below the line, that $1.6 million that you see on our income statement below the operating income line. And that's where you have current liability, account payable positions that just basically get caught in a revaluation. And when you have currencies dropping in a single period by 30% and 35%, that's what drove that loss. So the took-back type of a loss, the transactional type of FX, whilst we can potentially do some hedging and do some other strategies around to try to mitigate. But as you know, that has not historically been any significant amount for Franklin. So you've got -- sometimes you got gains in receivables, you got losses in payables, and they tend to offset one another. While in the -- in this case, in this quarter, those losses prevailed in a pretty meaningful way. So we look at those opportunities. But basically, the transactional is the only place where we think an effective hedging strategy could be deployed.

Okay. All right. And switching over to the Fueling Systems. The growth rates accelerated nicely. I think you guys have talked -- you've been pretty vocal about the U.S. underground business being sustainable. I wonder on the -- if that's the case, going into next quarter? And how do you feel about 2019? But also international, I think you mentioned that there was 20% growth in international as well. And I'd just like to see if we can get a little bit more detail about why international's growing so fast? Is that a sustainable way, the other market share gains? Just some details around international too.

Sure, Walter. As you pointed out, we see continued strength in the U.S. market, U.S., Canada. Teams have done a nice job. We're getting wins from major marketers on tool management that puts more of our product on the truck. And so we also get better discretionary business out of that. I think the U.S. has been in a steady-investment environment in the fueling arena for a number of years, and we really expect that to continue. We don't see that letting up at all in 2019. Internationally, to your point, yes, we've seen really nice recovery kind of Latin America in Fueling business. We're -- it has been soft and depressed. We don't have a big position in Brazil in our Fueling business but the position we have is growing. But we have the fuel business throughout Latin America, and that's recovered nicely and grown nicely in the quarter and the year. Certainly -- obviously, China has driven that but that's outside the 20%, that's what drove a 40% overall growth. The other part is we had a continued good business in India. And we've had continued good business in the -- throughout the Europe and Middle Eastern, When I say Europe, I also included Russia as well, which is a market for us. So it's really been broad-based. And we just see that Franklin Fueling System has continued to be innovative. As you would know, there's a couple of our new products and products ideas here at the most recent show. And so it's broad-based both across the U.S. and Canada and the rest of the world. As to China, as we pointed out, we think it's a multiyear initiative and will carry out through '19, '20. We'll see after that. And we do see, again, that there's probably some growing interest in India to start putting in more systems on western standards that will mitigate the risk of leaks into the environment.

Our next question comes from the line of Matt Summerville from D.A. Davidson.

Couple of questions, and I apologize if these have already been answered. But John, how much price do you anticipate realizing in 2018? And what is your early thoughts in terms of what you believe you need to realize in 2019 if you're going to be covered from both tariff and inflation or if we just want to call it inflation from that sort of perspective?

Yes. Well, year-to-date through 9 periods -- or through September, Matt, our achieved price has been about 200 basis points. That -- we expect that's going to go up before the end of the year, by the end of the year. So I guess I would say something in the 2.25 range for achieved price. And as I said, we expect that will be more than the raw material inflation that we're experiencing. As we go into 2019, I think it's going to have to be at that level or higher to be candid. And that's because of the point that I mentioned earlier, which is when you look at -- and these measures are all on kind of a P&L basis, on an output basis, Matt. When you look at the measures on an input basis, okay, what are we paying for raw materials around the globe versus what we paid on average last year, those inflation indicators are still pretty significant and pretty severe. So we don't have an exact number that I would tell you. But I think that the achieved price in 2019, it's going to have to probably be closer to 230 to 250 basis points than kind of where we are so far in 2018. And that's entirely on the premise that raw material input inflation is continuing.

And then based on your other comments that might -- do we need to assume if you're -- let's just use 250, if you need to get 250, you have to see some stabilization and/or actual out-the-door volume improvement in end demand, that's I guess was really the question, in both Brazil and in Asia for you to be upwards in that 250 range? Is that fair?

No. They're largely decoupled I think, Matt. We expect volume rebounds in both Asia-Pacific and Brazil. And some of that will be driven by price because they're seeing the inflation in Canada, what we're seeing around the globe. But the 230 to 250 is what I think we can achieve regardless of their end volume situation, the end 2019 volume for Asia-Pacific or Brazil.

Yes, Matt, that's an earlier question. Strengthening in those markets would lift our operating margins into the range that John mentioned earlier. That's where we'll get the operating leverage, but we've been generally able to get the pricing -- sorry, offset the inflation in those markets.

Got it. Okay. That helps. That makes sense. So then just a follow-up just on groundwater specifically here in North America. You mentioned the business seems down I believe in Q3. Can you talk about what you're seeing in terms of channel inventories? I had thought you've been trying to rightsize your own inventories a bit, and then if you are able to loosely quantify what sort of hurricane disruptions you may have felt in either your manufacturing and/or distribution businesses?

Sure, Matt. Again, while we -- our top line in the Water segment, we would say that groundwater was down 5% in the quarter. The sales to third-parties other than Headwater were up 6%. The -- and then Headwater sales of Franklin products were up 6%. So the down -- the 5% negative was a result of the fact that the scorekeeping for an intersegment sale was, yes, we consciously have taken down inventory in the Headwater segment, okay? Because they -- because when downtime reach stability, there's opportunity for greater coordination between manufacturing segment and the Headwater Distribution segment, so we're able to take those inventories down. So what that does though is on an optics point of view as for the Water segment, John can get the numbers, is it reduces the reporting of the Water segment results in the quarter. So we feel very confident about the end markets. We'd say that -- I mean the market's been pretty much kind of flattish through the year. From what we see, it's -- it was a pretty long, cool wet in general. I mean there were pockets of dryness that drove some sales in the areas in the country. But it was a pretty modest from a requirements point of view. So we see that we're encouraged by the increases in -- continuing increase in sales of Franklin product both to third-parties and then through the Headwater segment -- Distribution segment. As your question about hurricanes. Florence, we shut down 4 branches with Florence for up to 2 weeks. We didn't have power. And certainly, that's going to have some impact. We know we've got over 50 branches, but that's going to have some modest impact. And typically, you'll see some recovery in the next quarter because people are going to be repairing systems and so on. So that was the -- I don't want to overplay. It was an event in the quarter. We're glad that nobody was hurt. We didn't have a damage to our business, but we just couldn't get to them and get them operating because of lack of electric power to the sites for a period of time.

Yes, Matt, just a couple of numbers to what Gregg just said. The sales from Water Systems in North America to Headwater in the third quarter were down over 30%. So recall, that last year in the third quarter, Headwater was out in this full-on effort to replace other pump OEMs products with Franklin products. So they were, that demand for Franklin product because of that replacement phenomenon was happening in a large way in last year's third quarter. In this year's third quarter, as Gregg's saying, that has stabilized, right? The replacement influence that was going to happen has effectively happened. And now Headwater is able to step back and say, okay, how do we manage the supply chain -- headwater and Franklin are able to step back and say, how do we manage the supply chain more effectively? And it does no good to transfer inventory to Headwater from Water Systems and then have that inventory sit at Headwater. It only does good when it's sold on through to the end market. The other point is -- we mentioned is the organic growth in Headwater in the quarter was 2%. So yes, we'd like it to be higher. We think it can be higher. But in light of the storms and the hurricanes and in light of the third quarter last year, we think that, that's a respectable achievement. And there's a win in that in and of itself.

We have no further question at this time. I will now turn the call back to Mr. Gregg Sengstack for his closing remarks.

We thank you for participating in our third quarter conference call. We look forward to speaking to you after the end of the year on our fourth quarter and full year 2018 results. Have a great weekend.

Ladies and gentlemen, this concludes today's conference. Thank you for participation. Have a wonderful day. You may disconnect.