Good day. And welcome to the Franklin Electric Reports Fourth Quarter 2022 Sales and Earnings Conference Call. At this time, all participants are in a listen only mode. Please be advised that today’s conference is being recorded. It is now my pleasure to introduce Chief Financial Officer, Jeff Taylor.

Thank you, Andrew. And welcome, everyone, to Franklin Electric's fourth quarter and full year 2022 earnings conference call. On the call with me today is Gregg Sengstack, our Chairperson and Chief Executive Officer. On today's call, Gregg will review our fourth quarter and full year business highlights, fiscal 2023 guidance, progress to date on our long term strategy and our latest global secular trends. I will provide some additional detail on our financial performance. We will then take questions. 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 today's earnings release. All forward-looking statements made during the 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 Gregg Sengstack.

Thank you, Jeff. We delivered a strong finish to 2022. All three reporting segments set fourth quarter sales records and both Water and Fueling systems set records for operating income over the same period. During the quarter, we delivered operating margin expansion in our Water and Fueling businesses, driven by customer demand, pricing sufficient to offset inflation and FX headwinds and a steady operational execution. We experienced solid end market demand throughout 2022, which continued through the fourth quarter, driving top line growth across each business. Our supply chain continued to recover with past due shipments down 50% from last summer's peak. At the same time, due to continued strong order flow, backlog increased to $260 million or up $10 million sequentially. Turning to our segments. Water Systems sales were robust across all end markets with overall revenue growth 9% and operating income growth of 23%. Pricing actions and operating leverage more than offset inflation challenges, driving operating income margin to 15.9%, an increase of 180 basis points compared to last year. Fueling Systems delivered another record quarter with top line growth of 8%, driven by solid sales in US and India and operating income growth of 9%. Favorable price and mix contributed to Fueling Systems fourth quarter operating margin of 28.4%, an increase of 30 basis points compared to the prior year quarter. While delivering record sales in the quarter, the Distribution segment was impacted by normal seasonality and unfavorable weather at quarter end. Revenue increased by 27% while operating income decreased by about 50% due to a significant decline in the price of certain commodity based products. Operating income margin decreased 290 basis points compared to the prior year quarter to 1.9%. These results are a reminder that our distribution segment is more seasonal as more earnings volatility…

Thanks, Gregg, and good morning, everyone. Overall, it was a solid quarter for Franklin Electric. We established new fourth quarter records for consolidated sales and operating income. Our fully diluted earnings per share were $0.84 for the fourth quarter 2022 versus $0.85 for the fourth quarter 2021. Worth noting, the company's fourth quarter 2021 results included a $6.5 million or approximately $0.12 earnings per share bargain purchase gain, which I called out last year as a onetime event and nonoperational in nature. On a pro forma basis, if you exclude the bargain purchase gain impact from EPS, our current quarter EPS would be up 15% over the prior year quarter. Fourth quarter 2022 consolidated sales were a record $489.4 million, a year-over-year increase of 13%. Organic growth was 13% in the quarter while acquisition related sales added 5%, offset by a 5% decline due to foreign currency translation. Water Systems sales in the US and Canada were up about 15% compared to the fourth quarter 2021 due to price, volume and acquisition related sales. In the fourth quarter 2022, sales from businesses acquired since the fourth quarter of 2021 were $3.9 million. Water Systems sales in the US and Canada grew 13% organically in the fourth quarter. Sales of groundwater pumping equipment increased by about 1% and sales of all surface pumping equipment increased by about 28%, all due to strong end market demand. Water Systems sales decreased by $18.2 million or about 7% in the fourth quarter of 2022 due to foreign currency translation. Outside the US and Canada, Water Systems sales increased by about 1% overall and higher sales in Europe, the Middle East and Africa drove organic sales growth of about 16%. Additionally, the company had higher sales in the Latin America and Asia Pacific markets. Water…

Thank you, Jeff. In addition to our track record of successful execution, our growth prospects are also supported by tailwinds that will propel the business forward over the long term. For example, the growth in remote work, particularly in the US and the need for more affordable housing will likely lead to increased demand for homes that maybe beyond the reach of existing municipal water systems, amplifying the need for and use of groundwater pumping systems. And whether one is on a municipal water or a private water system, greater awareness of water quality is driving demand from water treatment. Changing weather conditions across geographies like extended periods of drought require more frequent replacement of current groundwater systems and the need to drill deeper than before. For these deeper sets, contractors are even more focused on high quality pumping systems as the cost of polling and replacing a failed pumping system is considerable. Flood events like what occurred in the West Coast last month and the coastal flooding from hurricanes increases demand for our line of large dewatering and surface pumps. Elevated metal prices and demand for rare earth metals should also drive additional demand for industrial pumping systems. We are intentionally expanding our industrial pump offerings and our global manufacturing, assembly and distribution facilities to provide the foundation to supply this increasing demand. Often, these applications require higher cost materials of construction for the pumping system, increasing our revenue and margin. And as the cost of electricity to operate the pumps is often many times the cost of the equipment, operators are looking for high efficiency systems to lower their total cost of ownership. Further, with continued uncertainty around grain exports, we believe it's reasonable to expect that increased focus on food security will lead to accelerating growth in…

[Operator Instructions] Our first question comes from the line of Mike Halloran with R.W. Baird.

So Greg, you talked a little bit about expectations from economists back half weakness. Maybe talk about what's embedded in your guidance as you work through the year. Is there a slowdown expected in the back half from a conservative perspective, how does that layer in or how does that look by the various product categories or segments that you have? And any kind of direction to help what you're embedding in guidance as far as that goes?

I'm not sure my crystal ball is any better than yours. But see, I suspect yours is probably better because you talk to more companies. As we see it, Mike, we've got a strong backlog coming in the year, which we've talked about now for the last couple of years as being unusual for us because we tend to sell out of stock. We anticipate that will be a kind of fill -- we'll be taking that down kind of out throughout the year. And so that's what we're mindful that maybe the back half of the year might be not as strong as the first half because of what people are saying. That said, as you know, the seasonality of our business is we're very strong in Q2 and 3. If there was destocking or maybe going back to normal order patterns in the US in particular in the back half of 2022, we'll be lapping those. And so that will be a reasonable comparison. Fundamentally, in the Fuel business, again, we see it being steady. It is a little bit seasonal because of the construction nature of the business. But we really see that kind of following on, normal patterns, quote unquote. And then Distribution, again, we would expect the strong seasonalities in Q2 and Q3. So we're just being mindful that the world out there is saying that there maybe a slowdown and economists are saying that. So we just thought it's important to say that we thought through that, and this is how we developed our guidance for the year.

On the pricing side of things, as you look at how things are tracking. How much price is embedded in that thought process or at least loosely, and are you seeing that pricing hold as you look across your product segments?

I would say that our pricing is going to vary a little bit by product and by region, Mike. But in general, I think, consistent with our overall guidance, it's going to be in that kind of low to mid single digit range where you're going to see it kind of in the mid single digit range is where we're also seeing currency impacts, and we're attempting to recover the impact of foreign currency. And so in general, it's going to be more of a return to normal in 2023 versus 2022, which was really characterized by high inflation, high pricing to recover inflation, significant supply chain challenges. I think in general, we see 2023 returning to be more normal, not necessarily saying that looks like kind of pre-COVID years, but certainly less inflation [Technical Difficulty] repricing and continued improvement in supply chain as we move through 2023 overall. So I answered a little more than just pricing there…

Yes, but that helps. And last one on inventory for me. It doesn't sound like there's excess channel inventory, whether it's at Headwater or your own content in the marketplace. Is that true and any thoughts on that side where we stand on inventory from a higher level relative to what you hope the right run rate would be?

I think inventory stayed at relatively healthy levels. I wouldn't say it's exaggerated. I mean, you're going to have places where you have some higher inventory in some places where you have lower inventory. But overall, I think it's in pretty good shape in the supply chain, and that will pull through demand. I think Gregg mentioned this earlier that there was some heavy prebuying in the fourth quarter of '21 due to really longer lead times for supply chains and challenges to procure materials. And so we're seeing a return to more normal buying pattern. And so we expect to see that ramp up really in more in the first quarter and second quarter of this year as we enter the groundwater season.

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

A couple of questions, maybe first with Distribution. As we sit here today, given the seasonality in the business, given the piece that's being impacted by the rollback in commodity pass throughs. What would be a realistic kind of margin bandwidth you would suggest that we think about for '23 for that business relative to the 8% plus margin, I believe you had for '22? And then I have a follow up or two.

Certainly, our goal is always to improve our margins on a go forward basis. Headwater distribution business has really done a nice job over the last five years of building and growing their gross margin as well as operating margins, and they had a really nice performance this year. Having said that, they also had the benefit of a strong inflationary environment, which was giving them a margin boost in 2022. And so we think that returns more to normal, so they won't have that margin boost in 2023. I would say that our range is still in that 5% to 7% range, but we certainly expect them to perform near the higher end of that range.

How much of the distribution revenue -- so you did $670 million, we'll call it last year. How much of that $670 million is impacted by commodity driven adjustments, and how often are those commodity driven adjustments made, if you will?

So in terms of the overall business, I would say that depending on the mix, it's 40% to 50% commodity based products, and the remainder is non-commodity based products. And the commodity adjustment really is it's the flow through of the inventory from the time they purchase it to the time they sell it. And so they're able to price more dynamically. So when costs go up, they're able to price that immediately into their products that they sell, and that's what gives them a little margin boost in the current -- in that environment. And then when commodity prices start to turn over and decline, they have the opposite effect, and so they felt that in the fourth quarter. We would expect that there will be some of that carry over into the first quarter, and then it's going to stabilize as we go through 2023.

And then maybe just a follow-up question. On the groundwater business, I thought you said in your prepared remarks, Jeff, that the groundwater was up -- this is US and Canada, groundwater was up 1% in Q4. If I have that number right, and I could have jotted it down wrong, that would imply that volume was down. Can you guys touch on that, provide a little more color, please?

Let me take a quick look. I think that volume would have been flat, but possibly slightly down in the fourth quarter in the groundwater business.

I guess what I'm trying to understand is, based on your kind of remarks and overall bullishness on the business, I guess I'm a little bit surprised that groundwater was down, but maybe that was a prebuy phenomenon in the prior year. Can you just kind of flush all that out?

I think that you hit the nail on the head there. Some of it was prebuying earlier in the year, or in Q4 of 2021 versus Q4 of in 2022. And so that was certainly a driver in groundwater. And I would say that while they're improving, we still do have some supply challenges that are impacting us in various locations as well.

Matt, I would add that, again, a meaningful portion of that business -- of those sales are from the manufacturing segment of the Distribution segment. And so as Headwater was looking at their forecasted needs that they were able to turn down a little bit quicker on replenishment, but their out the door sales were still very strong. So that's where we get the information of why we think the market is strong as we have that level of transparency and distribution level, but yet the intercompany sales or inter segment sales can be more volatile because of the large component of that business going through Headwater.

And our next question comes from the line of Walter Liptak with Seaport Global.

I wanted to ask the 2023 price/cost dynamics, understanding that things look like they're going to be normalizing. Are you -- in your guidance, is it largely volume, or is there -- or could you give us an idea of how much you're expecting from price in 2023? Is there some carryover price from 2022?

And I would say in our guidance, it's really like we've talked about the business a couple of years ago. The overall guidance is kind of mid single digits overall, that comprises price and volume. And so we would expect a couple of points of price, a couple of points of volume, some growth from new products and market share in there. But we also have built in there an offset for continued foreign exchange headwinds in 2023, and so that helps bring the average down overall.

And you also called out a couple of things, I think, Gregg, during some of your prepared remarks, that sounded like growth investments going into industrial pumps and into Fueling systems. And is this sort of -- I wonder if you could just give us an idea of sort of the market opportunities, is this something that you expect to see revenue growth from this year and how -- is this a new initiative, or is this something that the company tends to do?

So I'll take the second one first. So embedded in our Fueling business, I guess we could describe it more as an energy business is that we have a product line that we've been developing over the years that is used to -- these are products that are used to monitor the condition of transformers in electric utility space as well as high and now medium voltage circuit breakers as well as backup system for telco, like think about cell tower backups and railroad crossing backup power and also for server farms. And the -- with regards to where you land on demand for liquid fuels going forward, there's no question -- or in my mind that we're going to see an increased demand for electricity. And I think it's already been pretty well documented in the United States about some of the challenges with the electrical grid, they just built the grid, the creekiness, I'll call it, of the grid and the need to monitor assets more discretely across that grid. And so given our experience in critical asset monitoring that we developed in the fueling space, we've used that capability and we put it to focusing on more broadly monitoring critical assets in an area that we expect to see growth. And so we're going to continue to invest there. And again, it's a small part of that segment, but we think it's growing 25% a year and we are looking forward to continued growth. One of the challenges we've been actually hampered by over the last couple of years, more in that small product line than in the other areas is the availability of chips that should improve more in '23, and we should see less constraint on top line activity because of that. In industrial pumps…

And then maybe a last one for me. I think in the prepared remarks, you guys talked about how through productivity and other things, you've increased your operating leverage. I wonder if you could tell us what's embedded in the 2023 guidance?

Well, we net that out with our cost increases. So we're looking to offset at a minimum a piece of the overall inflation that we see in our cost piece. I don't have a specific number for you in terms of the impact there, but we're always looking to drive productivity improvements. I would comment that you'll notice on the statement of cash flows that for CapEx, we've invested in 2022, just north of $40 million, that's an increase from approximately $30 million in the prior year. That's really driving those productivity improvement projects as well as bringing capacity in house and helping to improve the resiliency of our supply chain. And so we're focused on investing CapEx to drive that improvement annually year-over-year, and it's intended to improve our margin but also offset inflationary pressures.

I'm showing no further questions. So with that, I'll hand the call back over to CEO, Gregg Sengstack for any closing remarks.

Thank you, Andrew. And we thank you all for listening in this morning to our fourth quarter earnings conference call. We look forward to speaking to you after the first quarter with our first quarter results. Have a good week.

Thank you for participating. This concludes today's program. You may now disconnect.