濱特爾 (PNR) 2002 Q4 法說會逐字稿

Good afternoon.

My name is Marcy, and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Pentair, Inc., fourth quarter year end conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer period.

If you would like to ask a question during this time, simply press star, then the number 1 on your telephone key pad.

If you would like to withdraw your question, press the pound key.

Thank you.

Mr. Harrison, you may begin your conference.

Thank you.

Good morning from St. Paul, and for some of you, good afternoon.

Thank you for joining our conference call today to discuss the results of Pentair for the fourth quarter anticipated financial results.

Our forward-looking statements are subject to future risk and uncertainties, such as but not limited to economic and market risks.

Also, I would like to refer you to the risk outline in our last 10-K as of December 31st, 2001.

Forward-looking statements included herein are made as of today, and the company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances.

Actual results could differ materially from anticipated results.

At this time I'll turn the program over to Randy Hogan.

Hello, everyone.

Thanks for joining us.

As you have seen in this morning's new release, our fourth quarter came in basically as we had projected in our third quarter earnings announcement.

Included among the highlights for the quarter are the following: Fourth quarter net sales totaled $640 million, a 10 percent gain over the same period in 2001.

For the year, sales of 2.58 billion dollars were up slightly from those recorded in 2001.

Fourth quarter 2002 earnings per share was 57 cents, a 33 percent gain year-over-year.

This gives us EPS of $2.61 for the year, an 8 percent gain over 2001 on an equivalent basis.

Operating income for the fourth quarter totaled $54 million, 24 percent higher on an equivalent basis.

The fourth quarter was the second consecutive quarter since the fourth quarter of 2000 that we realized a solid income gain in our European market, all of it driven by currency translation.

And it was the third consecutive quarter company-wide operating income year-over-year.

Given the condition of the economy, this is evidence that our productivity and growth initiatives are working.

Free cash flow totaled $17 million which resulted in $214 million for the year.

Our free cash flow would have been $237 million, where we paid approximately $23 million to bring a synthetic leaf off of the balance sheet, and we have no off balance sheet financing.

All three of our business groups made significant gains in our supply chain management program, collectively achieving savings of nearly $12 million in the fourth quarter.

In fact, we also reported substantial savings in SG&A.

Arlene Enterprise activities, which we now call the Pentair Integrated Management Systems or PIMS, continued as [INAUDIBLE] operations cut ways to reduce inventory levels.

We'll discuss some of the highlights of the PIMS activity in the operating reports, but a great indicator of the overall impact can be seen in our sales per employee, which increased 8 percent year-over-year.

Our Plymouth Products and Oldham Saw acquisitions, which were completed at the beginning of the fourth quarter, were accretive to our earnings in the fourth quarter. made in integrating them into our organization.

We're also expecting that the [INAUDIBLE] organic growth initiatives.

We'll touch on some specifics in this area in just a few minutes.

In our third quarter conference call we said we were intensifying efforts to improve cost productivity in our water businesses and margins in our tools businesses.

We've made good progress in these efforts, and although they aren't fully reflected in our fourth quarter results, they will be in 2003 and beyond.

Now I'll discuss the performances of each of the operating groups.

The tool group's net sales of $279 million was 8 percent ahead of growth quarter sales in 2001.

An operating income of $24.6 million was 12 percent higher on the same comparison.

In the fourth quarter, ROS of 9.1 percent was a 40 basis point improvement over the period in 2001.

Tool sales for 2002 totaled $1.09 billion, up 9 percent from the previous year, while operating income of $98 million was up 35 percent on the same comparison.

These results support our conviction that the tools business has moved beyond recovery and is poised to drive to new levels of performance.

Improved sales in tools in the fourth quarter were driven predominantly by the Oldham Saw acquisition.

Sales gains recorded in Delta stationary and Bench Dot machinery products and at the European and Canadian tools business were offset by lower sales of our high end professional quality tools.

Operating expense was down in the quarter, and that was partially offset by increase in [INAUDIBLE], and increased R&D in support of new product development.

The group's operating income improvement resulted from strong operating executions, supply chain management and lean enterprise activities, somewhat offset by costs sorted with promotional programs.

Total material cost productions in the fourth quarter were almost $6 million, giving us a total savings of more than $25 million for the full year.

We are by no means at the ends of our potential in supply management and tools.

Negotiations are winding down in another wave of commodities and we will see additional savings in this area in 2003.

Lean enterprise efforts in the tools group continue to read out as well.

And 2002 productivity up double digits in most locations.

The offset trend in labor productivity sales and inventory turns increased almost 10% in the fourth quarter.

The group held 140 [INAUDIBLE] in 2002, which freed up approximately 140,000 square feet or 6 percent of our total manufacturing and distribution floor space.

As expected, pricing in the tools group was down almost a full percentage point year-over-year, due to heavy second half promotional discounting and a more competitive marketplace.

As for product mix, we had a successful program with our Delta Shop Master tools, but sales of professional tools lagged in the fourth quarter.

We also had more store-related sales with lower margin generators in the fourth quarter, which added to the pressures.

Future margins will benefit from our accelerated takes in new product introductions.

New products launched in the fourth quarter include the Twin Laser Miter Saw, with earnings from both Delta and Porter Cable.

It offers the capacity of a 12-inch blade with laser markers that precisely indicate where both sides of the blade curve will cut through the material.

This is an industry first.

Also introduced in the market was a new series of cordless gear drivers and hammer drills, featuring rugged metal gear boxes, higher energy batteries, and an industry-exclusive drip to fit handle that is adjustable to fit the user's hand size.

As in 2002, our updated line of Excel pressure washers will once again be available this year at the Home Depot.

The group ended the year with a number of positive product development highlights, including improved time to market, as much as a 50 percent reduction in our product development cycles from 2001 levels.

New products, defined as products launched in the last 12 months, accounted for 30 percent of our 2002 sales.

And patent applications, which we are now tracking as an indicator of results in R&D, were up by 71 percent in 2002.

We have exciting new products in the pipeline for 2003, which we think will enhance our reputation, as well as the most innovative power tools manufacturers on earth.

New products are one of several growth initiatives adopted by the group as a means of achieving organic sales growth.

The other initiatives include service branch expansion.

Our network of service branch is on important link to the professional tool user, providing us direct contact with the most demanding consumer we serve.

Service branches were a significant driver of sales in 2002, and we will establish more Porter Cable/Delta branches in under-represented areas, increasing our opportunity to interact with consumers and grow our sales.

Industrial channel growth:

In this area the Porter Cable and Delta brands are well positioned in the premium and professional market.

We refocused on this channel about 18 months ago, and are already delivering results.

During 2002, our sales in the industrial channel were up almost 10 percent versus 2001.

And we expect to improve upon that number in 2003.

In accessories, our newly-acquired Oldham Saw business has performed well and will serve as the platform for organic growth in the accessory area.

Home Depot recognized Oldham's outstanding performance, naming the company vendor of the year for the hardware department, which is the second time in three years Oldham has been recognized with this reward.

We believe that the combination of Oldham's strong capabilities together with our position in the tools business, will fuel growth in accessories going forward.

While we may be facing a tougher environment for housing starts and retail, we expect these initiatives in total to drive stronger organic growth in the tools group.

In water technologies, sales were good, but our earnings reflected the margin compression we expected.

Fourth quarter sales were $232 million, which was 20 percent above the same period in 2001.

The increase is primarily due to contributions from the Plymouth Products acquisition and a shift in pool order volume from the third quarter to the fourth quarter.

Overall, the pump business was flat for the quarter, but retail sales remained strong.

Bid activity [INAUDIBLE] held steady, but the project releases have been slow.

Our new [INAUDIBLE] once again enjoyed double-digit growth, despite a soft market due to greater acceptance of package products and market share gains.

Water treatment sales, excluding the Plymouth Products acquisition, were up slightly in both the U.S. and Europe.

For the full year, sales were $932 million.

A 6 percent increase over last year.

The pump business increased in the mid single digits, while most of the growth is coming from the municipal and retail markets.

The pool business has a -- had good growth and is now the leading supplier of pool and spa equipment in North America.

And our Asian operations continue to enjoy double digit sales growth.

Operating income for the fourth quarter was $23.1 million, a 5 percent increase over the same period last year.

ROS for the quarter was 10 percent versus 11.5 percent last year.

This is due to declining retail pump margins, resulting from productivity short falls and unfavorable product mix to retail sales.

The water treatment business suffered margin erosion, due to competitive pricing [INAUDIBLE].

For the full year, operating income totaled $127 million, compared to 2001 income of $128 million.

In the pump business, we've taken aggressive actions to improve profitability.

In the Ashland operations are getting margins pack in line through workforce reductions to supply chain initiatives.

We've accelerated our lean enterprise development with more lean events planned in the first quarter of 2003 than in all of last year.

We've also put in place improved profitability tracking to better manage the mix in this business.

We expect to see the full benefit of these actions as we exit the first quarter.

In the water treatment business, we rationalized a reverse osmosis [INAUDIBLE] product line, and a lower cost redesigned product will start shipping in the first quarter.

Furthermore, we're increasing to utilize our low cost Indian operations for large local projects.

So we're getting margins back in shape.

And as 2002 sales show, we're beginning to rev up our water technology group's growth.

To that point, we've launched six new strategic growth initiatives in the water group.

These include initiatives expanding our role in the in the currently underserved industrial water treatment equipment market, and pursuing the rapidly developing Asian markets.

In addition, one of our growth initiatives is addressing the packaged system concept.

To date, our efforts have been focused on package fire systems, where we've double sales from 2001 to 2002.

Now we intend to double them again by introducing the next series of integrated systems.

These include custom domestic water booster systems, municipal pumping stations, and irrigation systems.

Other new products, commercial [INAUDIBLE], industrial and fire protection market segments, will also support the growth objectives.

In the pool segment, we continue to introduce new products, like the Intellitouch Automated Control Systems.

The initial market reaction which controls this business has been quite favorable, and when the full offering becomes available at the end of the first quarter we expect additional sales.

We also expect to add new product lines through Bolt-On acquisitions.

In addition, we are aggressively expanding the pool business overseas with a broader European product line and deeper tail penetration.

In the water treatment business [INAUDIBLE] for our financial products by adding distributors and developing new products.

In the fourth quarter of 2002 alone, we added 29 distributors.

Well on our way to adding 75 new distributors in 2003.

We're also very pleased with the start-up of our Plymouth Products acquisition.

We are on schedule with the integration process, and the fit with our water treatment business looks very promising.

Turning to the enclosures group, the fourth quarter market situation is much the same as it was the first three quarters of the year.

There were no significant signs of rebound in industrial markets in the fourth quarter.

Electronic market indicators remain lackluster and indicate a slow start in 2003.

As a result ,fourth quarter sales were down 2 percentage points from the same period in 2001.

Despite this, operating income totaled $9.5 million, up 176 percent from the same period in 2001, while margins have improved by 450 basis points, making this quarter the group's fourth consecutive quarter of sequential market improvement on essentially flat sales.

This excellent progress comes from achievements in many areas.

Significant reductions in working capital have been made.

The group's lean activities, which include more than 45 throughout the world in the fourth quarter, continue to support facility rationalization.

For example, one of the enclosures business absorbed the contents of an 80,000 square foot warehouse into its main facility.

These activities are also making room for the capacity that will be required as the various growth initiatives, begin to bear fruit later.

Supply management activities yielded more than $10 million in sales for the year.

The group continues to re-size according to its market, reducing head count in the fourth quarter at Pentair enclosures in Europe and Pentair Electronic Packaging by another 12 percent and 5 percent, respectively.

On the cost side, enclosures has not only gotten the results we expected from the restructuring but has cut cost even further.

Our enclosures businesses also put into action several strategic growth initiatives.

These included a focus on targeted end market segments.

We identified key customer sets with unique needs and aligned our marketing and product lines sales resources to serve them.

They include security, defense, medical and food and beverage.

In addition to targeted sales and distribution efforts, we are providing unique products geared to address the needs of users in these key segments.

Best of all, this initiative has led to several significant wins, including a cabinet program for a U.S.

Coast Guard communications system and a similar program for a statewide security emergency communication system.

We are also getting strong orders for our water shed product for the food and beverage market.

This product made the cover of several trade publications, including Industrial Automation News, Product Design, and Control News.

Continuing the pursuits of strategic OEMs is a second initiative that the enclosures group has put into action.

Specific examples include a supply relationship with a major control and industrial automation manufacturer, whose Mexican operations are served directly out of ours in Renosa, and one of the world's largest medical equipment manufacturers whose global production we also serve.

We are also leveraging our engineering and channel management capabilities by broadening our traditional product offering.

For example, we've greatly expanded our range of composite enclosures for applications that require corrosion resistance on light weight enclosures.

Coupled with other recent successes, we can now provide a greater range of solutions for our established channels, such as new fiberglass enclosures, thermal management products, and [INAUDIBLE] for the networking sections.

Finally, we continue to globalize our enclosures business.

We already have the broadest product range in the business and we are capitalizing on that position to follow our end customers to expanding markets.

And thereby strengthening our existing relationships with them which, of course, drives higher sales for us.

In summary, enclosures team is driving executing on the cost side, has redeployed to go after growth where it's available.

We are confidence the business is on its way to double digit ROS and good ROIC performance.

Let me turn the conference call back over to Dave for some additional details on our fourth quarter.

Dave?

As Randy indicated, we finished the fourth quarter in line with the revised expectations that we gave you at the end of the third quarter.

Our cash flow remains strong in the quarter, allowing us to exceed our $200 million free cash flow goal for the year.

Free cash flow was net of the U.S. and foreign pension contributions of $19 million, and buying out a 1999 [INAUDIBLE] lease for $23 million.

Even with these payments, we recorded a record cash flow of $214 million for 2002.

Financial highlights for the fourth quarter and total year mark a change for Pentair in both market stability and business performance, a change that emphasizes growth and improved productivity.

First and foremost, our top line sales increased 9.6 percent in the fourth quarter over the prior year, with the total year increasing slightly.

The sales increase in the fourth quarter was driven by tools, up 7.7 percent, and water, up 20.3 percent.

On a full year basis, sales for tools were up 9.1 percent with water up 5.6 percent.

Offsetting the gains made by tools and water, the tough comparison for enclosures coming off a record first quarter 2001, which resulted in a drop of 19.4 percent for the total year.

Even without the two acquisitions, our tools business was up in the high single digits and water was up in the mid single digits for the full year.

Secondly, we continued to make progress during the year with productivity in various areas.

Cost of goods sold was down by down by 30 basis points driven by supply management.

General and administrative expenses declined by 20 basis points, as program costs and staffing declined.

Selling and service increased by 20 basis points, as we directed more effort to branch expansion and marketing in our tools business.

It's important to note that SG&A expenses reported in our press release includes the impact of the succession of good will amortization changes made in the 2002 accounting period.

Interest costs declined by $18 million in 2002, due to lower average debt and lower interest rates.

The 2002 income tax rate was 32.5 percent, and was down from 38.3 percent from 2001 for two primary reasons: The succession of good will and amortization in 2002, most of which was not tax deductible, reduced the rate.

This deduction was offset somewhat by the tax effect of foreign operations as a percent of earnings in 2002 versus 2001.

At the end of the fourth quarter, we recorded a $29.2 million charge to shareholder equity to recognize the impact of the lower investment performance and lower forward-looking discount rate on our pension liabilities.

In 2003, we will continue our conservative expected asset return rate of 8.5 percent.

And based on consistent practices, lower the discount rate to 6.25 percent, based on long term AA utility rates. 2002 pension costed increased by $2.3 million for the total company, and is expected to increase approximately $4 million in 2003.

This higher cost is reflected in our guidance for 2003.

As we have discussed for several quarters, working capital continues to decrease with greater emphasis being placed on Pentair integrated management system.

On a 13-month average basis, DSO has declined 9 percent, or 6 days.

Inventory turns are up nearly 20 percent, one full turn better than the prior year.

In fact, working capital as a percent of sales dropped during the year from 15.5 percent to 11.8 percent.

Capital spending for the year continued to reflect the results of our lean enterprise initiative.

For the year, we spent a total of $33.7 million compared to last year's $53.7 million.

We did have spending in 2001 for expansion of a facility in Mexico, which was started in 2000.

We expect capital spending to remain in the $45 million range for the next couple of years.

Depreciation for the year was $58.8 million, $3.9 million lower than last year, which reflects the lower level of capital requirements.

Depreciation is expected to be in the range of $65 million in 2003, up from 2002 due to the two acquisitions in the fourth quarter of last year.

We are pleased to report that our year-end debt to total capital came in at 39.9 percent, which is now within our target range.

This is down from 41.6 percent at the end of 2001, and reflects the strength of our cash flow.

During the course of the year, our cash flow allowed us to return $36.4 million to shareholders in the form of dividends. 26 consecutive years of dividend increases.

We invested $170 million to grow the business with two accretive acquisitions.

And we funded internal growth initiatives.

To sum up our financial results: Improved earnings performance, along with a working capital productivity, has combined to boost our return on investment capital from 10 percent in 2001 to almost 14 percent in 2002.

Now I'd like to turn the conference back to Randy.

Thanks, Dave.

The fourth quarter has given us added confidence in our abilities to execute on several different levels.

The programs we've put in place over the last two years, specifically our cash flow focus and lean enterprise and supply management programs, continue to improve our cost position and cash flow.

We built a solid management team that operates ethically and with a concrete understanding of our need to build value for shareholders.

That management team is now more cohesive, more connected and more determined to succeed, a fact that is reflected in our cash flow performance, among other things.

And now, rather than waiting passively for our economic fortune to change, we are making our own way by creating top line growth opportunities that will match and perhaps exceed growth gain through acquisitions.

Considering the current economic environment, we think Pentair should deliver EPS of between 50 cents and 60 cents in the first quarter of 2003, compared to earnings per share of 43 cents last year.

And between $2.90 and $3.05 for full year 2003.

Thanks for your attention.

I now ask the operator to come on the line and priest provide our audience with instructions for the Q&A portion of the call.

At this time, I would like to remind everyone in order to ask a question please press star and then the number 1 on your telephone key pad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Dean Dray of Goldman Sachs.

Hi, Randy and Dave.

Hi.

First question is in the tools area, and one of the issues, or several of the issues, we were bracing for in the tools side, you had rattled a couple of them off back in the conference in November.

The West Coast Dock strike, the $99 price points, and maybe some tepid buying by customers in tools for the holiday season.

Where did those -- how did those impact the total top line in the quarter?

Well, they really came in, Dean, as we thought they would.

The shop master program, the $99 program, was a big hit.

We had a lot of volume of those.

We don't have the margin on that product line up to where we will have it in the future.

And so that clearly -- that was a negative issue to our margins overall.

And then, you know, the Porter Cable brand and the higher end Delta did not sell through as well as that lower end Delta program.

So that was what we expected when we gave our fourth quarter outlook.

Volume actually was only up slightly if you exclude Oldham, which is what I said in the script.

And that was about -- probably a little weaker than what we thought but pretty close.

But pretty close.

Pretty close.

And price was about where we thought it would be, too.

So I'd say the tool business came in just about where we expect.

And how did Oldham contribute in the quarter?

Can you be any more specific?

Well, I mean, they gave us most of our sales.

And they were a little bit accretive.

But excluding Oldham, organically, tools were up high single digits?

You know, about 1 percent.

Okay.

All right.

And then in water, what is the status on quote activity in the muni business?

How should we be thinking about that into '03?

The quote activity in the last couple of months is up a little bit.

It's the closeure rate that's pushing out.

The closeure rate is down.

We haven't lost share about we track that separately.

I would call about it flat right now.

That's our outlook.

And the jobs tend to be smaller the ones that are closing.

The big ones -- we had Bowry Bay, about eighteen months ago, that we shipped this last year, that was a big order.

The bigger orders are fewer and far between.

But our outlook is municipal is going to continue on at about the rate it is now.

And what happened with the pool order being shifted from the third quarter to the fourth quarter?

That was really customer timing.

It was, you know, between about maybe about $15 million.

And it was just the timing of when the order came last year versus this year.

As we look at the year to smooth that out, we were actually up in the pool business for the second half in 2002 over 2001.

Because that movement of $15 million obviously distorted it.

And within the pool business, every statistic I see, every industry forecast I see, is showing that the pool business continues to grow on the residential side.

Do you see any letup there?

We haven't.

We think the business has grown.

We grew last year.

We think the business has grown.

Demographics still favor more pools, not less.

Plus, 60 percent of it is a replacement business.

It has a nice firm base.

Okay.

Last question going back to the organic growth, Dave had put some of that color on the organic growth between tools and water.

What was it for the company as a whole?

In the fourth quarter?

Yes.

Dave?

For organic, we were looking at something close to the mid single digits for the company.

Great.

Thank you.

Your next question comes from Daniel Wong of Lehman brothers.

Yes, good morning.

Hi, Dan.

How are you?

My question relates to the tools business.

Can you tell us, for 2002 what the tools group sales contribution was from the various channels such as home centers and industrial channels and so forth?

We don't break that specifically but if we add up what we call the national players, Depot and Lowe's and Sears, it is a little over 50 percent of our sales.

And that hasn't changed.

All right.

And I guess you know, with all the developments at Home Depot, and I guess there is a -- one point of view that Lowe's might be gaining share from Home Depot.

As a supplier, what is your view in that respect and how do you think that would impact Pentair?

Well, we participate at both Lowe's and Home Depot.

Right.

What we want to do is make sure that we have the best presence in both locations.

So I'm not in a position to comment about which of them is -- which one is is up or down at any particular point in time.

I'll pass on that one.

Okay.

And also with regard to your guidance for the first quarter and '03 and the low end and the high end of the range.

Can you provide sort of a description of your outlook in term of the macroeconomic trends and how the different business groups might do in that area?

Sure.

You know, our overall outlook is that basically we are presenting our outlook -- excuse me.

Presenting our estimates based upon no real change up or down -- -- in the economic environment.

We think -- let me start with the easiest one.

Enclosures.

We've had flat sales there for four quarters in a row.

We think that's pretty much bottomed out.

We're seeing more upside potential there than downside, frankly.

I don't think telecom is going to go down anymore or dateo com, and [INAUDIBLE] capital spending and industrial is going to go up.

And so as we look at the business we think, one, we'll continue to get benefits from productivity, and two, probably more upside on order -- on volume than not give prepositions we've done in that business.

In terms of water.

The water business has been growing.

And we're very excited about organic growth initiatives that I mentioned.

So we think we'll see growth.

Nothing outsized.

The economic downturn did not affect water as much.

So any recovery that might happen won't affect it as much on the upside either is how we're looking at it.

And we expect to see benefits from the improvement in our productivity and our pump business and that RO housing business.

And then for tools, housing starts have been high.

Retail has been pretty good.

You know, both of the big boxes are still growing.

You know, they are adding stores.

So I think they will continue to gain share.

And we intend to win space by, one, serving them well, and two, introducing more innovative products, and then, three, driving the three areas that I talked about which were service on the industrial side, the professional side, and the accessories side.

Okay.

So it seems like from the release that -- let's see, if the economy stays the same for the year, obviously not including the war scenario, and I'm wondering, although it may be difficult, how that may impact your forecast going forward or the results?

You know, I'm no politician, but I figure if that happens, it's going to happen.

And it's going to get over fast.

So I would think over the course of the year we'd find a way to get back to our numbers.

That's the way I'm thinking about it, if it's protracted, you know, I'll rethink that.

But I -- as we set those targets -- one, we -- you know, some companies aren't giving guidance.

We looked at it, we said we would give guidance and broaden the range because it is an uncertain world.

That's why the ranges are broader than you might have seen before.

And secondly, we tried to factor in everything we know about in terms of what could happen up or down.

So in the long range, that may include some impact from the -- any sort of military activity overseas?

It could.

In the month it happens, probably not.

Right -- happens, probably not.

But I'm not a [INAUDIBLE].

I just try to develop our forecast based on the things we can do.

In the final question, in the release you talked about how the operating initiatives have taken root.

And based upon that thinking, can we expect the same rate of growth in productivity going forward as we've seen in the past?

Yeah.

Our goal is to get 5 percent total cost productivity every year.

And I think we still have the opportunity to keep that up for a sustained level.

We are not even at that level yet.

So I think we -- you can count on us to continue to focus on that.

The pricing environment is tough.

So it all won't go to the bottom line.

Nevertheless, that's why we need to get that productivity.

Okay.

Thank you very much.

Your next question comes from Jim Lucas of Jenny Montgomery Scott.

Thanks, good morning.

Hi, Jim.

First question on the water side.

Looking at -- You commented in the pump business that you plan on doing more lean events in the first quarter than all of '02.

In the Ashland operations.

That's just the ashland?

Yes.

So if we step back, and maybe I'll rephrase it a little differently then.

If you look at PIMS and how it's being distributed throughout the organization, being embraced as part of the culture, one, who is leading this?

And two, can you talk about -- do you have enough bench strength to deploy this?

Uh-huh.

Okay.

The leader of PIMS is myself and the operating leaders of the company.

What we have is we have a council of the leaders, if you will, the operating leaders in each of the businesses, so that the lead of operations manufacturing and tools, the lead in enclosures, and the lead in water, and they meet on a quarterly basis and we have a web site -- actually a piece of Lotus notes -- that's set up to do best practice sharing.

And it's also set up to bring people in plants that are less advanced and have them visit plants that are more advanced and get involved in some of the [INAUDIBLE] there to learn.

We have also consultancies that help us on a fairly regular business when we launch or start a plant or a business, they get very intensive help from the consultants.

And basically we train the people in the businesses it really has caught fire.

The other key to it is local general management has to buy in.

That was an issue in Ashland, frankly, and we are getting that fixed.

And we'll get a much stronger pickup.

If the local management drives it, then we have all the depth in the world because our people are passionate about it when there is alignment.

And we are getting the alignment.

I was trying to be politically correct in asking the question.

And that's where I was going with it in terms of the buy ends at the plant level.

If you were to look at your plants across the organization, I mean, would you say you are at 25 percent? 50 percent? 75 percent in terms of PIMS deployment?

I would say 50.

I think it's -- we need to make more progress, particularly in Europe.

That's not the management team's fault.

It's just getting there and getting it in place.

We're a little bit behind the U.S. in that regard.

We are a little bit behind in Asia for the same reasons.

And then there are some places like Ashland where we want to make a lot more progress faster.

But some of our places, like our Hoffman facilities and our tools facilities and our water treatment facilities, are really well along.

Okay.

And then from a housekeeping standpoint, if we were to look at the year-over-year gain in the water segment in the fourth quarter, could you break out how much of that is organic and kind of splitting out -- well, you quantified there was about $15 million on the pool business.

But then how much was organic growth and how much was acquired growth in the fourth quarter?

Dave?

Yeah, we -- you know, we generally don't go into that type of detail.

But obviously, in the fourth quarter we did have some accretion from the acquisitions.

But it wasn't huge.

And the rest came from organic.

Okay.

And then final question, Randy.

You've done two acquisitions now.

Obviously, the balance sheet is in shape, and opportunities for more -- I guess we could call them strategic acquisitions.

How are you feeling about the integration process?

Could you expand, give us a little color on what kind of integration plans you have in place?

The process we are using, I feel good about.

I actually feel better about it now in a we're executing two acquisitions, the Oldham and the Plymouth acquisition using that process.

We've gotten very disciplined during the evaluation process of an acquisition laying out what we expect the synergies to be, what we expect to change, and put that together in an integration plan.

We assign people to the integration plan and track it monthly or more if we need to.

And I'm very pleased with the oversight that we are getting both in tools and in water on the rollout.

I think that's the key.

And we are pretty disciplined on price, too.

I think that we -- you know, we've looked at some things and we've walked on them because of the price.

And we've just got to make sure we buy right and then execute our plan.

Okay.

Thanks.

Your next question comes from Don McDougal of JP Morgan.

Good afternoon Randy and Dave.

Looks like a good quarter.

Thank you.

Question on tools again.

With the margin that you are leaving this year at, fourth quarter, typically your strongest, I just want to get a sense for how quickly you think some of your efforts to get that cost out can come through going into, you know, a more seasonably challenged period.

And then also a sense for where you see inventory levels at your customers in tools?

In other words, did we get good sellthrough on the stuff you delivered in the fourth quarter?

Uh-huh.

I think -- let me take them in turn.

One of the reasons we have the margin compression was because of the success we had with the Delta Shop Master.

That product is made Taiwan.

And our plan was, and still is, to move it to our joint venture factories on mainland China.

And that program was so successful in the sales of product lines were up, you know, 50 percent, plus or minus.

They were so successful, we couldn't risk moving the product line with the production being so high.

We intend to get that moved over in the next -- over the first half of this year.

That's one of the big benefits that we expect to have.

I think the first quarter is going to remain pretty challenged, the pricing situation is pretty challenged.

But I think we'll see more increase in the second quarter and beyond.

If we go into price in some more detail, you know, we understand the product mix, but I want to understand, just how much of price is mix and how much is pricing pressure on some of the mid to higher end, you know, traditional strength areas of Porter Cable and Delta.

The way we calculate the split may be helpful.

Most -- I'd say the combination of price and mix was less than 2 percent and about, as I said, practically 1 percent was price.

The way we calculate that is on a skew by skew basis.

That's across the line.

All of the issue of selling $99 product versus $199 product that went into the mix.

So I think it's pretty clean.

And maybe it's about a point and a point.

Okay.

Jumping over to enclosures.

We had good progress all year long on, you know, pretty much flat revenues.

Coming close to I think 7 percent here in the fourth quarter.

Uh-huh.

Is there any reason that you shouldn't be able to improve on that run rate into 2003 on a full-year basis?

You are talking about the sales run rate?

No.

I'm talking about the margin run rate.

Oh, I believe we should.

Our exit rate is 6.9 percent in the fourth quarter.

And I think we need to continue to drive it because we are not satisfied with that number.

I think we've got a lot of opportunities still in on our electronics side to continue to drive that margin.

So I would agree.

I know Hoffman's traditionally, I mean, Hoffman has been there already in terms of double digit, I think, but how is Schroff coming along?

And I'm guessing you've made some progress there with the way the margins have come up this way.

Obviously, we reduced on fourth quarter loan we reduced employment in Europe another 12 percent and it did make money in the fourth quarter, which is the first quarter in some time that it made money.

So we -- I -- I'm very pleased with what the team has done over there.

And I think Dave and I are going over there next week, so I'll get more detail.

I think even without volume that they will continue to improve.

The other piece of the business is Pentair electronics packaging where, you know, frankly, we need to do more on the cost side and the margin management side.

So we're still focusing very heavily on that side.

We would like to see more of the smaller orders that have always helped news profitability there.

Our larger OEM business has held up better than the smaller project business in Pentair electronics packaging.

So that's one of the main areas where we are shifting that focus to the medical security and defense area.

I'm pleased with the winds, but they are not coming as fast as when we were wrapping up in telecom.

One final one for Dave just on working capital and free cash flow.

You had a very good year, and I think, Dave, you said 11 percent working capital percent of sales.

In the $200 million free cash flow forecast that you have put out for '03, where do you see that percent of sales going?

We've had a lot of internal discussion on that.

And it's interesting coming back from each one of the businesses -- I think all three of them feel that they still have progress to make in terms of working capital.

So we are not in the business of basically forecasting, you know, what it's going to be in the future, but I think we have opportunity to drive that down even lower.

Thanks.

Your next question comes from Jerry Brockman of Credit Suisse First Boston.

Good morning, guys, nice quarter.

Hi, Jerry.

Thanks.

On the enclosure side, just to clarify where the last caller left off here.

In your press release, you said office goal of reaching double digit margins, can you achieve that on a flat top line growth?

I would not make that promise, you know, $137 million in sales.

That would be a stretch.

Okay.

But with 10 percent growth, I think we could.

That was going to be my next question, then with the leverage here, where do you expect these margins to go if you get some reasonable growth?

Based upon the cost takeout that we have experienced both in North America as well as in Europe, we have really improved the leverage we have on both sides of the sales.

So it won't take a lot to really drive the margins up.

If you go back and look at history in that particular business, before the cost takeout and you look at 2000, and look at the increase we had in sales ,which was roughly 18 percent dove a 16 percent increase in profitability.

So even today, we've got much greater leverage in that business, which is going to help drive the margins.

I don't think it will take a big percentage increase to see some pretty good improvement in the bottom line.

On the R&D side of the equation.

Actually, I like the jump up we saw in the fourth quarter.

What does that look like going forward, what sort of benefits do you expect to reap from that?

Well, most of the R&D -- it's up in all three businesses, but the primary increases are in tools and in water.

They are really important to the growth initiatives we have in terms of driving new product development.

We'd like to keep it at that level.

I'd like to actually get more productivity invested in more in it, in R&D.

So I don't think it's appropriate to give you my target, but I do have a target for what I'd like that to be as a percent of sales.

And it's higher than it is right now.

Okay.

But I want to, if you will, pay as we go, get some more productivity and reinvest it in new product development.

Okay.

Great.

What percent of our production is in low cost locales right now and what is our targeted level that we are shooting for?

Today, when we look at our -- if you separate our equipment business -- I'm talking about tools -- separate our equipment business, which is dominantly North America, separate that out --

Right.

That stuff doesn't ship very well.

And if you include Arkansas and Tennessee as low cost manufacturing, it's 1 hundred percent.

But, basically, over 80 percent of Delta is today.

Okay.

And over 50 percent of Porter Cable.

Or let's call about it 50 percent.

And I'm not going to say what the target is, but you know, we invested in a joint venture in Asia to get control of those -- take control of that manufacturing asset so that we could be more aggressive about moving more over there.

And we are committed to doing that.

Okay and how does that look --

So it will -- we expect those numbers will increase.

In water, we have been sourcing aggressively out of Asia for some time.

And establishing manufacturing in China and India.

And as I mentioned, we're starting to utilize those facilities to compete in the more aggressively priced markets.

And then enclosures is the same thing.

We actually -- if you look at our capital spending, you saw a big drop between 2001 and 2002.

That biggest drop was actually not because of lean.

It was actually because of a large project in 2001, where we doubled the size of our Mexican facilities and enclosures.

We also have Brazil.

We also have doubled the size of our Chinese facility.

So more of the business is coming out of those locations than not.

But the percentage actually right now I don't have in front of me.

Okay.

And then --

And -- on the tool side include both finished product as well, as parts that are sourced from low cost areas.

Then just a couple housekeeping.

The Cap Ex you said was 59 in '03?

Is that right, Dave?

The Cap Ex for '03 that we are looking at?

45, I'm sorry.

45.

Right.

And D&A, or depreciation alone?

We are looking in the range of 65.

65?

Is this sustainable that we can spend below our depreciation?

I think it is.

Our target is about that $45 million.

With our lean activities, we don't think we need to put in any bricks and mortar for capacity.

There may be a machine here and there, but actually, today we are even able to find machines on the secondhand market pretty cheap.

So from a -- we don't view most of that capital needed for capacity.

We're really skewing that capital towards new product and new services, new branches, for instance.

Great.

And then just tax rate for '03 should stay at 34 percent?

34 percent, right.

Okay.

Great.

Thanks a lot.

Good quarter, guys.

Thank you.

Your next question comes from Larry Baker of Legg Mason.

Good morning.

Hey, Larry.

Hey, Larry.

Can you just talk about in enclosures, the competitive situation with the contract electronic manufacturers?

Are they moving more into your market or away from you?

Actually, I think one of the benefits of this downturn that enclosures face is a clarifying of capabilities that has led a lot of the CMS to hunker down and focus more on what they are good at.

What we are good at is called lower volume, higher content enclosures.

And what they are good at is higher volume, smaller custom enclosures.

So, actually, we think that we have improved our competitive position against those folks.

And, in fact,, if you lock at a lot of them, you will see a lot of the facilities they are closing are some of the enclosures facilities that they bought over the last three years.

And sticking with enclosures, can you quantify the restructuring benefits from your layoffs in Europe?

Well, the overall, our target was to get $5 million in benefit from restructuring when we took the charge last year.

And we are getting that.

We have a further benefit, which is not really restructuring, beyond that, that's a few million dollars.

But if you look on an annualized basis, Europe is a little more than half of the $20 million of annualized benefit we expect to get from the restructuring charge we took.

Okay.

And then just the material cost reduction has the you were talking about in the fourth quarter and for the full year at the -- in the tools segment, can you provide some guidance for what you have incremental in 2003?

The -- I don't have the number right in front of me.

But our goal -- I can tell you your goal is to drive for 5 percent reduction in our material costs.

So -- reductions in our material costs.

And we need that because we think the pricing environment is going to stay tough like it is.

And we've got to get that just to help hold our own.

And then this final.

Would you sort of comment in the tool business on changes in the competitive landscape, either with the retail market or your competitors?

Well, I mean -- well, everything is well written about the retail environment.

Again, I'm going to stand off of that question.

In term of the competitive landscape, I think black and decker is doing a good job and they are the big dog of moving to low cost manufacturing.

And I think they did a really good job on their promotions in the second half this year.

So I think that, you know, the competitive environment hasn't changed much.

There is continued -- looks like there is going to be continued school dation and that's not surprising in a business as fragmented as tools.

Great, thank you, Randy.

Okay.

Your next question comes from Steve McNeil of SSRM.

Hi.

How are you guys?

Good.

Actually most of my questions have been answered by our savvy -- asked most of what I wanted to ask.

But just a couple of questions.

In I guess sort of overall '03 organic growth, I mean, is it sort of a low single digit number?

I would be comfortable with that.

In terms of our outlook for earnings, yes.

No, the top line, yeah.

I know.

Okay.

That's what drives the earnings.

Yeah.

Okay.

Have you guys -- on the tool side I know Home Depot has talked about tool rental centers.

Yes.

Are you guys participating in that at all?

Yeah.

Our tools are at the professional level.

And typically what they have in their rentals is obviously the professional tools that hold up.

So for instance, our drywall sanders and the special have been um cleaner that goes along with that, routers and sanders are typically in there.

I mean, is that something you would sell and then they would rent out and they would be sort of a potential replacement cycle?

That's correct.

As they wear out, right.

Yeah.

Okay.

Very good.

Thank you.

Thanks.

You have a follow-up question from Dean Dray of Goldman Sachs.

Just a follow-up, make sure I understood the factors that you attributed the water margin compression.

I think you said there were two factors, a retail pump margins and then within water treatment, the reverse osmosis membrane housing.

Yes.

So first --

I appreciate that, Dean.

Let me clarify it.

It's -- the retail margins, but it's also productivity in that same general business.

That was the Ashland operations.

And so those are part of the same thing.

Hey, Randy?

Yes.

Are we talking about sump pumps, submersible pumps?

Yes.

Okay and is there --

We're talking about the operations in ashland where we didn't get the productivity and then we had the compression from the greater retail sales and we weren't managing the mix real well.

That's one.

And the other one was in the RO housings, which is an important business to us where the prices over the last 18 months have continued to go down.

And we have the Cadillac of the industry.

So we've redesigned to make the Honda of the industry and then we're sourcing another unit out of India.

And is there any price issue with the retail pump side as well?

You know, we are trying to manage that better.

You know, I think -- I think what we found was with the growth of retail that we can do a lot better job with the elements of price below price.

Things like rebates and volume rebates, co-op advertising, returns, warranty.

And so we've got a lot of focus on managing those better.

And then the last question is, what should we take away from the change in management that you made midstream in the tools business last quarter?

I think the key takeaway is that -- you know, over the last 18 months we built, I think the best team in the industry in the tools -- in our tools business.

I had someone who could step in on an interim basis to be President.

He is doing a great job.

All the other managers stayed the course and are focused on getting the strategy done.

The strategy was one that I participated in fully, and frankly, we didn't miss a beat.

Okay.

Thank you.

At this time, there are no further questions.

Okay.

No further questions.

I appreciate the comments, and your attention.

Thanks for participating.

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