濱特爾 (PNR) 2003 Q2 法說會逐字稿

Good afternoon, my name is Jamie and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Pentair 2nd quarter 2003 earnings release 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 one on your telephone keypad.

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

Thank you.

Mr. Harrison, you may begin your conference.

Good morning and thank you for joining us for this conference call to discuss Pentair's results for the 2nd quarter of 2003.

I'm Dave Harrison, Chief Financial Officer and I'm your host for this call.

With me this morning is Randy Hogan, our Chairman and Chief Executive Officer.

Before we begin this call, I would like to remained each of you that any statements made about the company's anticipated financial results are forward-looking statements 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 risks outlined in our 10K as of December 31, 2002.

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

Actually results could differ materially from anticipated results.

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

Hello, and thanks for joining us. 2nd quarter was a challenge, the weather patterns that prevailed for the first two months of the quarter, delayed the start of the pool season and kept pressure washer sales to a minimum.

In addition, our tools business overall was soft, seeing lower volume, even tougher price competition and higher promotional costs.

Enclosures markets also continued weak in the 2nd quarter.

Last year's 2nd quarter was tough to beat.

At that time our pool business was breaking records.

The tiger claw had just been introduced in the industrial channel.

We introduced Delta Shopmaster sub-brand and we wer enjoying a very strong sell in our pressure washers to the Home Center Channel.

But beat it we did.

Pentair's 2nd quarter net sales totaled $719 million, up 1.5% from sales slightly more than $708 million a year ago.

Sales excluding acquisitions were down approximately 3%, reflecting the difficult environment.

Operating income totalled 76.3 million, 2.3% greater than last year.

In the 2nd quarter of 2003, EPS of 88 cents was 2% higher than the EPS of 86 cents in the same period last year.

While external conditions were far from ideal, there are a number of positive developments underlying our 2nd quarter.

Our first half EPS of $1.44 is a 12% increase over EPS of $1.29 in the first half of 2002.

This quarter marked our 5th consecutive quarter or favorable year-over-year EPS comparisons.

Given the state of the economy, we are pleased with the progress we are making in our efforts to strengthen the businesses and improve margins.

Our margins were up 10 basis points at 10.6% in the 2nd quarter compared to the same period last year.

The Enclosures group realized it's 6th quarter of sequential margin improvement with a 100 basis point gain over the 1st quarter of this year.

And it bears noting that the water technologies group continues to close the margin gap as it works its way back to its traditionally high margin levels.

In the quarter, we generated $68.8 million of free cashflow, defined as cash from operations less capital expenditures.

This gives us positive year to date free cashflow of $58.7 million.

Our 12-month moving return on invested capital was 13.7% in the 2nd quarter of this year, a 240 basis point improvement from the same period a year ago.

We continue to build our water technologies group with two recent small acquisitions, Twin Pumps and K&M Plastics, that I'll talk more about that a little later.

In the second quarter, it was the 4th consecutive quarter that we recognized a solid income gain in our European markets, even excluding the effect of currency translation.

Equally pleasing is the fact that our investments in Asia and India are now profitable.

All things considered, that's a decent list of accomplishments.

We're continuing to improve our businesses and positioning them to take full advantage of any strengthening in the economic environment in the months ahead.

Now, let's address the performance of each of the operating groups.

The tools groups second quarter net sales of $283 million were down $20 million or 7% compared to the 2nd quarter of 2002.

Excluding the contribution of the Oldham Saw acquisition, the group sales were down approximately 10%.

This was due to the effects of the slow economy, unfavorable weather conditions and hampered our sell of certain product lines in both the industrial and retail channels.

And the impact of the home center compressor skews we lost in the first quarter of 2003.

Operating income of $23.1 million was 25% lower than in the same period last year.

This is attributed to lower volume, more competitive pricing, promotional costs and expenses related to the capacity reductions we talked about before.

Despite the margin decline, the tools group continues to work hard to reduce costs.

On a quarter-over-quarter basis, material cost savings and direct labor productivity savings totalled more than $9 million in 2nd quarter.

We redoubled our efforts by shifting more engineering effort to our integrated cost reduction initiative.

This group has already conducted more than a dozen product evaluations, identifying over 200 long and short-term ideas for further cost improvement.

During June, Porter Cable introduced three new pneumatic framing nailers and a new roofing nailer, all targeted at contractors.

Also during the second quarter, Porter Cable shipped the opening order to a new customer called Prime Source.

Prime Source is a 39 location fastener distributor that is now suppling quarter cable nail guns to the hardware and lumber yard channels.

Delta's X-5 program kicked off in June with great success in our professional channels.

This program, which focuses on the high-end Delta customer, just the Shopmaster targeted the DI wire, offers industrial quality made in the USA woodworking equipment with a best-in-class five-year warranty.

The 2nd quarter, however, continued to be a struggle for Delta in the industrial channel.

We're aggressively driving new products and promotions.

In the second half we're introducing new Delta products into both the retail and industrial channels with an average of 2 new products per month for the remainder of the year.

The DeVilbiss business launched several new products in June, including a line of innovative wheeled, oil free and oil lube Porter Cable compressors, named Job Boss, that targets the contractor market.

This product line has been well received and already has gained placement in the home center and industrial distribution channels.

Other significant new product introductions include a new 2750 PSI Excel branded pressure washer that was the highlight of the 2003 pressure washer offering this year.

We also launched an enhanced generator line for the industrial channel and several air tool kits.

Last quarter we mentioned we lost some compressure skews in the home center channel and that we expect to eventually replace most of those loss sales through new replacements.

While we did gain new floor space for our air compressor products in the 2nd quarter, it's not yet offset what we lost.

And we're not likely to make up the entire difference this year.

Our tools accessory platform introduced the variable two-saw blade during the quarter.

The initial launch of this Porter Cable branded Oldham made innovation has progressed well.

Earning excellent response from both store personnel and customers.

This is encouraging as it represents the first major accessory program linking Oldham and Porter Cable.

As I mentioned before, last year's second quarter for the tools group presents a tough comparison with the introduction of the tiger claw, the launch of Delta Shopmaster sub-brand, and the record pressure washer sells in the Home Center.

This year most of our new products introduction benefit the second half.

So we expect to have more opportunity to capture a higher level of sales in the next two quarters.

In addition, we'll have more comprehensive promotion programs than we had in the second half last year.

In our water technologies businesses, they delivered an all-time record quarter in terms of both sales and operating income.

In addition, the 2nd quarter provided evidence that our investments to grow are beginning to show promising results, with new growth in pumps, filtration, the European pool business and Asia, combining to offset declines in the water treatment business.

Sales for the second quarter grew nearly 10%, resulting from acquisitions and the effects of foreign currency translation.

Pump sales grew in the 2nd quarter reflecting continued success in the retail business, growth of ur residential pumps and share gains in the commercial fire and HVAC pump market.

Unfavorable weather conditions in much of the country result in a very slow start to the pool season.

And our pool equipment sales in the beginning of the quarter were off considerably from a year ago.

Our business rebounded once the weather broke, and we did set a June sales record.

Water treatment sales in North America continue to be very soft.

Sales of Arisos Oosmosis membrane housing in the industrial municipal markets were down significantly compared to last year.

European sales were down in local currency due to the timing of shipments of some large water system projects.

However, return on sales reached a record high for the quarter.

Though still a small part of our business, the success of our European pool equipment initiative resulted in a double-digit sales increase in the quarter.

Meanwhile, sales in the developing markets of Asia and India grew dramatically in the quarter.

The group's operating income for the quarter grew 5% over the prior year, while ROS declined by 70 basis points, a much more narrow gap than in previous quarters.

As we've said before, we're taking aggressive actions in pumps to improve profitability via work force reduction, supply chain initiatives and improving retail channel profitability.

During the 1st quarter we reduced labor costs by 10% in our Ashland operation and accelerated our Pentair integrated management system, which we call PIMs, and supply management initiatives.

In the second quarter we saw the results of these efforts begin to hit the bottom line. 2nd quarter margins were affected by the downsizing in the Shardon, Ohio operation and the transfer of our reverse osmosis product line to our Indian operation.

This process is well underway and is scheduled to be complete in August 2003.

In addition, we're streamlining and pruning the balance of the tank product line in Shardon.

We expect to see the benefits of these actions beginning next year.

As I mentioned earlier, we recently made two small acquisitions.

Twin Pumps, designs and manufactures Vortex and Chopper pumps for municipal wastewater applications, while K&M Plastics designs and manufactures blow molding Brian tanks and pressures vessels for residential and commercial watering conditioning and filtration applications.

The Twin Pumps product will be combined with Pentair's existing Fairbanks Morris pump business to pursue replace parts, replacement pumps, and new projects in the municipal wastewater business.

We're also developing new innovative pump products to supplement our offering on the process side of the wastewater business, which are expected to generate incremental sales beginning in 2004.

Meanwhile, the K&M Plastic acquisition will allow us to better serve the fast-growing Asian water markets.

In fact, we'll be in a position to accelerate our schedule for production of water tanks and pressure vessels at our Suzhou, China operations from mid 2005 to early 2004.

The K&M Plastic purchase will also increase blow molding capacity in the U.S. while expanding the products we offer.

Speaking of acquisitions, the Plymouth products water filtration business we acquired last year is performing very well indeed.

The integration of this business into the water technologies group is progressing nicely, and the cost synergies expected as a result of the acquisition are also on track.

One of the key strategies behind the Plymouth acquisition was that we would be able to broaden the company's market reach and start selling filtration products to entirely new OEM customers, that Plymouth products wasn't previously able to serve.

Recent wins by Plymouth products have validated that strategy.

For example, we recently won a supply agreement to provide Procter & Gamble's PUR Division with a variety of filtration products.

We made similar inroads with other OEM's and expect more success in the future.

At last quarter's conference call we were in the midst of transferring Plymouth Product's carbon block operation to China.

Not the whole operation, just the low end piece of carbon block.

That transfer is now complete and the production line is already up and running.

We're very encouraged by the contributions Plymouth Products has made to our organization.

In short, the business is fulfilling our expectations.

Turning to the Enclosures Group, markets continue to be weak, with some of them declining even further in the 2nd quarter.

The group has managed to offset the declines by successfully pursuing growth initiatives targeting the commercial, defense and security and medical markets.

As a result, group sales of $145.2 million in the 2nd quarter of 2003 were essentially flat compared to the same period in 2002 after the effects of currency translation.

Operating income in the group totalled $11.7 million, with ROS of 8.1%, an improvement of 310 basis points over last year's 2nd quarter, and a 100 basis point gain compared to the 1st quarter of 2003.

The 2nd quarter was the group's 6th sequentially quarterly margin improvement.

The group's done a very good job with working capital as well.

The group has reduced working capital by $20 million, or more than 20% since last June, and sales by employees increased by 7% compared to the same period last year.

PIM's is alive and well at the Enclosures Group.

The business is held in excess of 100 tie-in events in the second quarter bringing the total number of events in the first half to over 180.

Supply chain management is progressing equally well, with recent contracts for raw materials delivering solid gains.

As for sales wins, we have a number of them.

In the safety, security and defense arena, we landed a cabinet project for a federally funded program to upgrade security and communications systems in federal prisons.

We also received an order for Schroff Euronet cabinets that will be installed on European naval vessels.

During the quarter, Enclosures was granted preferred supplier status by both GE Medical and Abbott Labs and was immediately awarded some programs.

With the anticipation of much more activity in the future.

We continue to pursue the Telecom business wherever and whenever it is available.

In fact, we've recently received a multimillion euro project from a European telecom equipment supplier to upgrade a fixed wire system for a major Telecom provider.

We also received a new order from Siemens for digital describer line systems in their Chinese market, and we're fulfilling this order from our Chinese enclosure operation .

In summary, our Enclosures businesses are persevering in what is perhaps the longest downturn ever experienced in their markets.

In fact they're doing much more than just persevering, they're taking share, setting new standards of performance and making life uncomfortable for the competition.

As challenging as these last 9 quarters have been for our Enclosures businesses, they're proving that they really do know how to make money.

Now, let me turn the conference call over to Dave for some additional details on our 2nd quarter.

Thank you, Randy.

As Randy indicated, the 2nd quarter again reflected gains in many key ratios.

We finished the 2nd quarter in line with the EPS range that we gave you earlier in the quarter.

Our debt-to-total capital ratio which was 40.9% at the end of the 1st quarter of 2003, ended the 2nd quarter at 38.3%.

This is below our target level of 40%, while supporting dividends, seasonal fluctuations and working capital, and four acquisitions over the last three quarters.

Free cashflow for the 2nd quarter was $68.8 million, as compared to $72.4 million last year.

On a year-to-date basis, our free cashflow s $58.7 million, versus $87.2 million in 2002.

Lower cashflow in the 1st half is primarily due to variances and tax payments.

We paid $10 million in taxes in the first half of last year as compared to $27 million in tax payments in the same period this year, a $17 million increase.

Tax payment differences between the two years reflect higher income.

We again expect to achieve our cashflow goal of $200 million in 2003.

As Randy mentioned, we're continuing to improve our financial performance in a challenging business environment.

Our operating margin in the 2nd quarter was 10.6%, up slightly from 10.5% in the 2nd quarter of 2002.

Through the first half of 2003, operating income margins were up 30 basis points over the first half of 2002.

Our gross margin in the 2nd quarter increased 60 basis points from the 2nd quarter of last year and is up 110 basis points through the first half.

All of our businesses were able to obtain incremental material savings and are realizing cost reductions from productivity improvements related to our lean manufacturing activities.

These important ongoing efforts are necessary to more than offset competitive pressures in the marketplace.

In addition, they help mitigate increased costs in the areas of pension and insurance, while improving our margins.

Our SG&A and R&D costs were intentionally higher compared to last year.

This is due to increased promotional costs in the tools businesses.

Expenses for downsizing relating to capacity reductions and product transfers as well as strategic investments or growth innovation.

Interest expense was lower by more than $4 million compared to the first half of last year, due to more favorable interest rates. offset somewhat by the interest expense related to our recent acquisitions.

We continue to have a 50% split on fixed versus variable rates in order to take advantage of the continued lower rates.

The 2003 effective income tax rate of 34% is 1 point higher than 33% in the first half of last year.

The higher rate is due to the anticipated mix of our 2003 U.S. and foreign earnings and the fact that many of our tax savings programs are relatively fixed.

As our profitability improves, the effective tax rate trends higher.

We are continuing to pursue tax rate reduction opportunities which can improve our effective rate in the future.

We continue to make progress on working capital productivity.

However, the inventory levels were up, primarily in our tools business, due to lower than anticipated sales in the 1st half, and preparations for 2nd half new product introductions.

We expect a correction to inventories throughout the coming months.

Total working capital days at the end of the 2nd quarter were the same as the 1st quarter on a 13-month rolling average basis.

Working capital is better by 7 days compared to the end of the first half of 2002, driven by PIM's process improvement and receivable management.

Receivable days are down 5, inventory days are down 3, and accounts payable also are down 3 from the prior year on 13-month rolling average.

Finally, the 12-month average return on investor capital which reflects the combination of productivity from asset management and operational results has improved from 11.3% at the end of the first quarter 2002 to 13.7% today.

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

Thanks, Dave.

To summarize, our supply management, lean enterprise and cashflow initiatives continue to improve our performance in the 2nd quarter, despite the impact of the slow economy, unfavorable weather conditions and a challenging comparison against the very strong 2nd quarter in 2002.

Growth initiatives in both the Enclosures and water technologies group are showing promising results.

And our tools business bolstered by new products, better promotions and broader placement, should realize improved sales in the 3rd quarter.

Looking forward, with continued gains in our water technologies and Enclosures businesses and a cautious outlook for tools, we expect 3rd quarter 2003 EPS in the range of 70 to 80 cents.

Thanks for your attention.

Now I'd like to ask Jamie to come back on the line and provide our audience with instructions for the Q & A portion of this call.

Jamie?

Thank you, Sir.

At this time I would like to remind everyone in order to ask a question, please press star one on your telephone keypad.

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

Your first question comes from Jim Lucas of Janney Montgomery Scott.

Good morning, or afternoon, guys.

A couple questions.

If we look at the tools operating income decline, you cited a number of different factors, including increased promotional costs, as well as pricing pressures.

Could you kind of breakdown into the different buckets of what comprise that large income decline?

Yeah, there were a number of factors.

First, the price decline year over year was larger than in the 1st quarter, it was over 2 1/2 points.

Okay.

2nd, our mix wasn't very favorable.

This is a -- in the 2nd quarter, pressure washer's big quarter.

We get a lot of operating leverage on that volume, and the selling volume was not what we needed it to be.

In fact, it was down slightly from last year.

We had the costs of -- we began the cost of downsizing and then ultimately shutting down Tupelo.

That will be an ongoing cost for us every quarter for a little bit.

And we did spend more in R&D and we're spending more in promotions, so those are the buckets.

Okay.

Dave, did I leave anything out?

That's pretty well it.

Okay.

And the increased promotional activity, is there any specific market area that you're targeting?

Well, in particular, equipment is the area that we have had the biggest setback in the [inaudible] business, because we lost the compressors and then pressure washers Is part of that.

If you take a look, for instance, at Home Depot, you'll see there's a promotional unit at $499, which is the one I was talking about, the 2750 PSI, Excel pressure washer, it's a home run, it's doing really well.

But it's a, we have special promotions on that.

So it's doing well from a volume standpoint.

Similarly we're doing a lot of combo kits, the replacement business we've done in compressors, a lot of it is what we call value packs, compressors plus some accessory pack.

And so there's promotions on that.

It's skewed more toward the equipment side.

When I talk about promotions going-forward, however, you may recall we really didn't have an aggressive Porter Cable program in the 2nd half last year.

We will have a more aggressive, more successful promotion program for them in the second half coming.

Are you seeing any indication of any potential rebound that phenomenon that has occurred over the last two years that has been consumers continuing to trade down?

You talked about the fact if we switch this would apply, also the Porter Cable but as well to Delta, in terms of the new program that you cited, the --

X-5?

Yeah.

You know, where is that being manufactured in the U.S., and are you seeing -- what kind of traction are you getting with it?

Well, we -- talking about X-5.

And again, it's wholly focused on the professional channel.

It's the higher end Delta product, it's the complimentary program to the Shopmaster program that we launched last year.

Okay.

And we've got some initial placement right on target.

But the base level business in the industrial and the professional arena is down.

But the X-5 program -- it's product we make in Tupelo that we'll be transitioning to Jackson.

We'll continue to make products in the U.S. even after we shutdown Tupelo.

And the five-year warranty, as well as some new features on some of those products.

A lot of the products we'll be rolling out will be focused on the professional side as well as the Shopmaster side.

So, to your broader question, in terms of the shiftdown, I don't have any evidence, because the decline in the 2nd quarter was broad based.

Okay.

Shopmaster was not a home run in the 2nd quarter the way it was last year.

And that's, if you will, our DIY program.

Right.

So -- but I think we're cautious but optimistic that we're going to see better results from that program in the 2nd half too.

Okay.

And a housekeeping question, actually two of them.

One on the inventory of the roughly $30 million increase.

Was that half tools, 2/3 tools?

Kind of a ballpark of how much tools comprise that inventory increase?

Yeah, it was primarily tools?

Greater than 2/3?

Yeah.

And the rest of it was pool, really.

The both of it was the fact that we didn't make the sales number that we were targeting for the 2nd quarter.

A lot of the tools inventory comes from overseas.

We haven't given up on our lean enterprise activity, Jim.

Okay.

It's hard to stop the flow from Asia.

And we intend to sell it.

Right.

And in terms of the sales breakdown per segment, could you provide some color on acquisitions, FX and core by the three segments?

Yeah.

If you -- in terms of where we stand with same store sales, is that what you're talking about?

Right.

We're looking at, on a same store sales basis, if you look at the tools business, roughly down 10%.

And the water segment was in the lower single digits positive.

Okay.

And on a same store basis with Enclosures up roughly 5%.

And then after a fact, the Enclosures was flat?

There's not much FX in tools?

It's not very big, and the water is probably about flat.

Right.

Okay.

All right.

Thank you.

Thank you.

Your next question comes from Dan Whang of Lehman brothers.

Good morning.

Good morning.

Or good afternoon.

Right there on the cuff.

Right.

Just a question related to tools, you talked about the organic sales being down about 10%.

Can you provide a little bit more detail as to how that might breakout between the three different effects, the weather conditions, loss of compressors and the economy?

I would tell you about half of it is the lack of home runs we had last year, when I talk about -- that's why I mentioned the year-over-year change in the -- I think I mentioned in the 1st quarter that one of our ambitions was to match that, because we have the load in the Shopmaster, we have the load in the tiger claw which was probably the most exciting industrial product that we had a Porter Cable for the industrial channel for a while.

And then pressure washers were -- we really had a great quarter last year, so I'd say -- would you say, David, about half of it.

About half of it is the lack of those.

I think that's right.

We're looking at the load-in value from last year being something in excess of what, $15 million?

Oh, yes, definitely.

And then the loss of skews was probably half of the rest, and compressors?

Right.

And the rest would be spread around.

All right.

In terms of the loss of compressors, you talked about you expect to gain back most of that.

So I guess, can you provide a little more detail?

Yeah, what I said in the script was, I don't think we're going to replace the -- we have additional placement.

We have some of the Husky business at Home Depot, and so we've got additional placement and we've got good programs coming, but as I look out, and I mentioned in the script, I don't think we'll get -- I don't think we'll replace the dollars, I think we'll replace the skews, but I don't think we'll replace the dollars lost in the year, it will take us a little longer.

I hope we do better than that, but --

in terms of the pressure washer, the weather the first couple months in the quarter had an impact.

Do you see that as sales that can be sort of recovered?

We're targeting and working with our channel partners to do just that.

And I think you may have seen Depot run some infomercials on the electrics, and by the way, our comments are about our sell-in, I'm not making comments about the tell-through.

The opportunity to do more promotions in the 3rd quarter in pressure washers, I think is there.

And regarding the entire tools business, moving into the 2nd half of the year, what are your expectations in terms of operating margins?

I guess on a sequential or year-over-year basis?

Well, let me just say this.

I think we're going to be, I think we're going to be challenged.

Our goal is to get it back to double-digits.

We did it in the 2nd quarter last year, we haven't been there since.

I think until we get our volume normalized which I'm expecting to make some progress on in the 2nd half, and we get the cost, we get the product moved to China that we have under way, and we get Tupelo shutdown, I think double-digits are going to be difficult to get to.

And just a final question, in terms of the competitive position right now, I know -- maybe this focuses on the various brands, Porter Cable, Delta, but what is the feeling in terms of sort of market positioning and market share gains and so on.

I feel really good about Delta?

I think they're not -- the margins aren't where we want them to be, as we talked about before.

But in terms of the positioning now with Shopmaster and with now programs targeting the higher end as well.

We revitalized the new product pipeline for Delta, I feel really good about it.

I think the quarter cable brand strategy is coming together nicely, we've had some great new products, I think the pneumatic side is doing really well.

We have work to do in the cordless side, cordless electric.

And then in terms of equipment.

I mean, the setback in compressors is a disappointment, and we are the largest maker of compressors, we have great technology and I think we need to redouble our efforts to get that business back ASAP.

Great.

Thank you very much.

Thank you.

Your next question comes from Deane Dray of Goldman Sachs.

Question on the water side of the business, and the first would be, just like we were trying to calibrate the impact of whether on pressure washers, what's the -- could we size that impact on the pool and spa business?

Take us through the quarter, what it looked like the first couple months and what kind of make-up in June?

Yeah.

Let me give you a little historical perspective.

If you recall, we had organic growth in the water business that was mid single digits, and in the 2nd quarter we're basically saying it was flat.

The biggest difference there was the fact that the pool business had a really sharp growth in the 1st quarter, and the 2nd quarter had none to maybe a little down.

And that was all weather.

Because you could see, I mean, April and may were rough, as soon as the weather broke - and if you look at backlogs, you look at the pool backlogs, we have some pool builders that are renting those highway lights they use so they can construct pools at night.

And they're people putting pools in, so I would say I'd rather not put a dollar number on it, but essentially, I think we should have been able to expect a strong 5 to 10% growth in the pool business in the 2nd quarter, it didn't happen because of the weather.

That was earlier in the quarter?

Right.

June we started to see --

June was a record, it was double-digits year-over-year.

How much pent-up demand should we expect to see that got pushed into the 3rd quarter, and then, is there any sense that there is business that's just lost or are these pools that just got delayed on the installation and eventually the equipment gets ordered?

You know, we don't really have that split.

I think, clearly some probably will have gotten delayed until next year, but we do expect to get some pickup in the 3rd quarter from it.

That's already anticipated in the guidance we gave.

Okay.

And then just quickly on the Enclosures side, is there any concern that -- is anything changing competitively in the Enclosures piece?

There was a large competitor who went bankrupt and then has emerged from bankruptcy, and when that happens, suddenly they're free of debt, and there's a little less -- a little more pricing pressure potentially.

So are you bumping into that competitor?

And are there -- what about the big contract manufacturers that have Enclosures businesses as well?

So what has changed competitively over the last year or so.

I actually think the competitive position has improved despite the fact that that guy came out of bankruptcy.

We still win business against them, because we're more stable and we have the depth in engineering.

So I'm not particularly concerned about competing with them.

In terms of the contract manufacturers, I think we mentioned before that a lot of them have pulled in their horns in terms of focusing on this, and they're really focused back on higher volume.

They turn out to be customers for us more often than they are competitors, and finally in terms of the other comments, we think, for us, anyway, Telecom and industrial was down again in the 2nd quarter, it was the focus on medical and security and defense that basically offset that.

And that's why I'm encouraged by the growth actions we're taking.

Industrial won't be down again, and we're bumping on the bottom.

And the fact that it's only down a little more.

I should mention too, commercial was up for us, even though the commercial, and that's just straight share gain.

So I really like our competitive position.

I think we're getting stronger, relative to everybody else.

On the enclosure side, give us a little background in the potential in getting qualified for GE Medical, and then secondly, the end market size for Enclosures.

How does that shape up now, you mentioned a couple different end markets, could you size those for us?

Yeah.

In terms of -- I don't have the numbers right in front of me, so rather than give you the wrong numbers, I'll just give you some texture.

In terms of the size of Medical, we think it's not as big as Telecom, but we think it's substantial.

We think it's at least in the hundreds of millions.

And our focus has been good.

It's a longer process to get qualified in the medical arena.

But they're very disciplined, they're very professional customers.

Their programs ramp up slower than the Telecom 1.

But, once we're on the programs, we think the programs will last longer too.

We can see actual improvements in, say since the end of last year to the 2nd quarter of probably a million dollars worth of sales.

I'm not saying just from those two customers.

We have some other medical customers.

So it's ramping up nicely.

In terms of security and defense, we continue to dance with the Iraq rebuild, and we think there's some promising thing there's.

We don't know how big it will be for us in Enclosures, but we're still going after that.

In terms of security and defense, again, I think that's hundreds of millions kind of opportunity market, you know, not a 10.

And how about the GE Medical process?

Getting qualified?

Well, they have both a technical process and a purchasing process, and again, it was fairly disciplined.

I'm not sure exactly what details you want and how much I can give.

They do use the auction process, we've gone through that, and -- but the technical qualification is equally important.

Great.

Thank you.

Okay.

Your next question comes from Don MacDougall of JP Morgan.

Good afternoon.

Kind of a very basic question, Randy.

It's on tools, and I realize there are a lot of factors impacting tools business this quarter.

But, you could argue that a tough comp against product introductions last year is the norm, you've always got to be coming out with product in that business.

If I went back a year and looked forward, I would have hoped the margins would have been better, I'm just wondering, big picture.

Has there been a change in the industry here that's made this business just perhaps less of a good business than it's been in the past?

Or is this something you think can be turned around?

I think, Don, that's a question that I work on every day.

And my view is, it's a bit of both.

And I think the environment right now is tougher, and there are factors related to that, but I do think that we can improve the margins.

I think it's going to take us a little longer because of the volume situation.

But it's also tougher, too, you're seeing more focus on the part of the big retailers on their own brands.

Which puts more of a premium on us spending on our brands.

And I think that is a change.

I think the other two factors that need to be considered here, is the fact that we have cycles with our new product development in terms of how it gets introduced.

We talked about this recently at one of our operations meetings.

The 2nd quarter was a down cycle in terms of not introducing as many as what we normally have been doing on a quarterly basis.

We have new products coming out in the balance of the year, which is going to help that.

One of the reasons why it was a down cycle is because it was a fair amount of focus historically on development of cordless.

And as Randy said, that's a tough environment out there in the cordless line because a lot of that is coming from low cost, lower price kinds of companies that are introducing lower prices.

So I think that all came together impacting the new product introductions in the 2nd quarter.

We are focused on developing new products.

We have some very good ones.

I think it's in the channel which will really help us as we go forward for the balance of the year.

Okay.

Turning to Enclosures, I think a better story, you've had flat volumes now for some time, but you're consistently bringing up the margins here.

I would say that's running well ahead of my expectations and has actually enabled us to keep our estimates where they thought they should be.

What are your thoughts there on where the margins can go, once we get revenue growth occurring again.

Could you give us a sense for what incremental margins on those enclosure volumes are?

Yeah, in terms of the growth, what I said before, and I'm even more confident now, if we get 10% growth in this business, we'll be back in double-digit operating margin in no time.

That's the kind of leverage we have.

Particularly if it's sort of the mix we have today of industrial, which is our highest margin, commercial, which is our second highest margin, electronics is 3rd highest, and Telecom's the lowest.

Our biggest leverage is on what I think will come back first.

I think that really will help margins.

If you recall, we got this business up to, what was it? 11% two years ago?

I think we can do better than that.

Okay.

Final question, just on what your priorities for cash in capital allocation are here, dividends, share repurchase, debt paydown acquisitions.

My first priority is to invest in growth and the priority there is water number one and water number two.

I'm really excited about the opportunities we have in water, and I mentioned Plymouth, that really puts us firmly in the filtration arena of water, and we're really -- we're having fun and we're having success.

And I think there's a lot more we can do there, and that's our first priority.

And our second would be depth and our third would be dividends.

And I think we'd run out of money before then.

Okay.

Thanks, guys.

Thank you.

Your next question comes from Debra Coy of Schwab Capital Marketing.

Hi, Debra.

Hi, Randy and Dave.

How are you doing?

Very well.

Following up on the water side, you just talked about some of the exciting opportunities that you see there, and you mentioned that internal growth in the quarter was in the low single digits.

Can you give us a sense of where you see that building to.

Obviously you are getting some delays, as you said, on the pool side.

You're shifting the tank production to India.

That should be building up.

Just starting to look at some of the top line opportunities, perhaps, coming out of Plymouth.

Could you give us a little bit of an outlook going into the rest of this year and even into '04 in terms of where you think the organic growth in the overall water business can be, should be, and then how margins follow along with that as well.

Sure.

We've always seen the water business as a business that's going to have margins at 15% or above, and I still believe that.

In terms of growth, we're targeting five-day percent organic growth.

And the place we see that is going to be in filtration.

That's really, once we get the water treatment, the commercial side and project side of water treatment is a boat anchor right now on growth.

But those are the declines year-over-year.

Once we get those behind us, I think those are going to be a source for us, we're interested in municipal as well, and we see that the spending in municipal is going to come back.

In fact, right now, quote activity is up in municipal.

Orders -- sales won't be, because there's a long lead time on those things, but for us, we see an increase in order activity, so --

on the pump side.

On the pump side for municipal, exactly.

So we think the municipal market is attractive longer term, we think filtration is very attractive for us, and our position broadly across filtration, pumping, storage is, with the range of equipment we have is quite -- is unique, and I think our strategy is strong.

So that's why I'm very excited about our water business.

Can you give a little more color on the water treatment?

You said remain soft on the RO housing side and that there were some sales timing issues in Europe?

Can you explain that a little better?

In water treatment, which for us is water conditioning and the equipment for that is our RO vessels, code line vessels, it's our tanks and valves for water conditioning systems, the commercial market in both Europe and North America is very soft for us, and then for RO, we have some very large project, desell projects going into the Middle East a year ago.

And those projects are the year-over-year decline for Europe.

Okay, so it was last year's decline, it's not that you have some stuff you're waiting to pick up in 3Q, 4Q?

Right, it was basically large projects we had last year, and the market is soft there.

So you don't really see much change in that particular side of the market in the 2nd half?

Not near term, no.

Okay.

That helps, thanks.

Thank you.

Your next question comes from Ned Armstrong of Friedman Billings Ramsey.

Hello, Ned.

Good afternoon.

Welcome to coverage of Pentair.

Thank you.

Glad to be here.

A couple quick questions on the cost side.

Can you quantify the impact of some of your lean initiatives on the Enclosures business?

In total for the whole company, I mentioned it for the tools business was $9 million.

That was both lean and supply management, which I like to put together.

Okay.

For the whole company, it was in excess of $20 million for the quarter, and Enclosures was in excess of 5.

Okay.

And then you also mentioned that you incurred some cost from the downsizing of the Chardon facility?

Yeah, we still have some inventory, equipment, people coats and we think we'll be working those through the rest of the year, and they'll be behind us by the beginning of next year.

Behind by year end?

Yes

Okay.

Thank you.

Thank you.

Thank you, your next question comes from Anant Moore of Bain Capital.

Hi, guys.

A couple quick questions.

In the water business, I think you made a comment about the reverse osmosis product line?

Is the problem there the competitive pricing stuff?

Have you guys basically put that behind you?

Yeah, the pricing has stabilized largely because we've moved to India, we're the low-cost producers.

So we're okay.

It shouldn't necessary come back and impact margins like it did in the 1st quarter?

Correct.

You know, just going through, Dave gave some of the numbers on this call revenue growth, just looking at 1st quarter or 2nd quarter, it looks like you guys did see a sequential slowdown, seems like 1st quarter was about flat, and 2nd quarter if you add all the numbers up was about negative 2, 2 1/2%.

Right.

And the cause of that is tools and slow pool, the weather and the pool.

It really is that simple.

That's the way I see the difference between the 1st quarter and the 2nd quarter.

Right.

And the slow pool doesn't really come back, maybe it does and the tools come -- I think it doesn't come back, and you just clarify that for me.

I didn't quite understand your commentary on that.

We're targeting to not have as bad a performance in sales in tools going-forward.

We're expecting strong execution of the programs we have and I trust that our people will do it.

Okay.

And in terms of pool, we may pick up some of it in 3rd quarter, we'll see.

And that's your going in assumption on the tools margin staying at the same level, because they're coming down 90 basis points, if you look at 6 months year on year.

Yeah, I'm taking a cautious view of their margins in tools, I want to work on the top line.

All right.

The receivables, maybe a questions for Dave, the $31 million, looks like approximately give or take, pickup.

What's that related to?

It's not an acquisition, it looks like it was another $30 million pickup and receivables?

Yeah, that was primarily seasonal.

And also based upon the way the strong June sales came in --

Actually, Dave, you might go through that.

Let me rephrase, were you guys fixing at the end of June -- there were some rumors out there that you were on the water side.

I'm sorry, I didn't understand that question.

Were you guys doing kind of more promotional activities than you normally would have done towards the end or middle of June on the water side to move some stuff?

Or that's not what the increase in receivables is?

We had a lot of promotion in pool, because we wanted -- as the market came back, we wanted to get it as much as we could.

So when the weather broke, we were in pretty good position, I feel good about that.

But that's the -- I mean, that's normal.

June is traditionally a strong month in the quarter, and this quarter was, I think, probably even stronger because of probably the pent-up demand with the previous two months, especially due to the weather situation.

So we really saw a very strong June.

In fact, if you look at the backlogs coming out of the first half of the year, for the end of June, our tools business was up approximately 10%, our water business , over the prior year, the same time period, our water business was up approximately 5%.

And overall, we were basically approaching mid single digits for the whole company in terms of the backlog.

So stronger than what we've seen before, the June sales or the June orders came in with tools being up over the prior year by mid single digits.

Water was up very high in the teens in terms of an increase over the prior year, and Enclosures was up approximately 10%.

So we had a very strong order month for June, which gave us the backlog.

And then the other important thing I think to consider is the fact that in the first time for a long time, all of our businesses have been above one with our book-to-bill ratio for June.

So, we ended the first quarter, I think, in a very strong position.

So you should see at least some of that carry through to July to mid-August, so about half of the 3rdt quarter, you should see that carry through.

Well, we're shorter cycle than that.

But yes it will carry through to the 3rd quarter, but we don't have half of the 3rd quarter booked.

We don't typically don't have two months worth of backlog.

Thanks, Randy.

Thanks, Dave.

Your next question comes from James Byrne of Capital International.

I'm trying to understand your guidance for the rest of the year in light of some of the comments you made about what's going to go on.

What your expectations are in each of the businesses.

I have a flatish 3rd quarter projection out there.

We were 75 cents last year.

Right, so that's -- you're staying roughly flat.

I think you just said that you do not expect -- embedded in your guidance is no recovery in sales of a delayed start of the pool season.

Is that correct?

No, it isn't.

I mean, I -- if that's what I said, I misspoke.

I do think some of it will come into the 3rd quarter.

Okay.

But what I said was, we included that when we were looking at our guidance for the 3rd quarter.

Given that you would expect some of the pools stuff to flop from 2Q to 3Q.

Why is 3Q flat?

That's question number one.

Question two is then the implication for Q4 for what your full-year guidance is and where your 3rd quarter guidance is, it's either a wonderful quarter or a magnificently wonderful quarter.

Relative to what it was last year.

And I'm having a hard time figuring out what business it is that's going to change based on your commentary to drive that type of result in the 4th quarter.

Well, the biggest thing is the issues in water.

Water will be a lot better, and enclosure will be a lot better in the 4th quarter.

We had some issues that are well behind us now, in particularly in our pump business last year, and we expect improvement in water treatment year over year as well.

Plus we like the progress we're making with the other initiatives in Asia, and filtration in particular.

That's a big driver in the 4th quarter.

And Enclosures will be better.

Those are the big drivers in the 4th quarter, and you're right, we do think the 4th quarter will be stronger year over year.

In terms of the 3rd quarter, and the reason I use the word cautious, and the reason the forecast is flat is we're driving to have a better sales performance in tools.

But after the 2nd quarter, I'm being cautious.

So it's that simple, Gene.

Well, sales without margin in tools isn't going to get -- if your margins results are where they're at, the sales growth isn't going to generate any operating income growth.

I understand that.

We intend to make money on our sales.

We don't intend to give it away.

But if you look at the 2nd quarter performance in tools, clearly the top line was my bigger concern.

So that's where our focus is.

Okay.

So for the full year, are you expecting margins to be up in order year-over-year versus last year due to the poor result in the 4th quarter of last year?

For the whole year?

Yes.

Because right now you're down year to date.

Right.

It will be an easy comparison in the 4th quarter?

Yeah, I think we'll be for the year, flat, despite being down year-over-year.

And tools, do you expect that to be down margin or up or flat?

For the pool business?

No, tools, tools.

tools.

No, I'd expect that -- I don't want to put out another press release, I gave the guidance I gave, and so I don't expect improvement in margins, that's for sure.

Okay.

I'm just trying to understand where it's going to come from.

Sure.

Because it's an unusual pattern for you, given the fact that you've outlined -- not that it's not completely out of the realm of reality, but it's a little surprising in light of what you talked about with the pool results.

Pool.

Okay.

Thanks.

I understand.

Thank you, your next question comes from Blair Brumley of American Express Financial.

Good morning, can you talk to me a little bit, guys, about timing going-forward on your lean and your supply chain initiatives?

I mean, clearly if that was 20 million to the good for you in the quarter, that was a very, very important piece of the equation here.

Is this stuff hitting in big discrete chunks or can we expect to see on a run rate basis those same kinds of things or maybe even improvement or detriment going-forward?

Blair, I need you to -- and we have some pretty fine disciplines in all of our businesses in terms of tracking both our PIMs benefits and our supply management benefits.

And so I see this as kind of a run rate thing.

If you recall, I said we've got $9 million in tools in the 2nd quarter, we had about $7 million in the 1st quarter, it's a similar kind of run rate opportunities for us.

These -- and then those are -- when we talk about them they're kind of on a gross level, so you have to cover inflation, you have to cover any pricing you give up.

But that's our discipline, that's the way we track it, and we target -- it's part of our targeting to get 5% total cost productivity in all of our businesses year-over-year, we're not running at 5%, but that's our target.

Given your willingness to talk about how much you're enjoying benefits there in one of the segments, you want to give us one of the other two?

I well, I gave you the whole business, 22 1/2, and I said Enclosures was over 5.

I'm sorry, I missed that.

Okay.

And lastly, when you look at water, water, water, which is the primarily growth initiative you want to pursue, when you kind of take a step back and look at the whole business, on kind of a [INAUDIBLE] matrix basis, -- are there places in this broad category that you don't yet have a presence that you would dearly like to.

A lot of which you have done recently has been smaller pieces that fit nicely on to a couple of the existing areas.

Is there anything out there in this complex that you really want to get involved in that we might see you move on that you really don't have a presence in yet?

In terms of our strategy, which is basically focused on equipment, filtration was the business we really wanted to get into, and Plymouth has put us there.

There may be some other elements of filtration that would be nice to add to that platform, but I think we've got lots of opportunities right in the water equipment arena and in the filtration arena to work on, so we're not looking at a number of the other segments in the business, operations or services at this point.

Thank you very much.

Okay.

Is there one more question, we're --

At this time there are no further questions.

Okay.

Well, then, thank you all for your attention, thank you for your questions, and we'll get back to the 3rd quarter.

Thank you very much.

Jamie, do you want to give instructions on the replay?

Yes, sir, hold one moment.

This call will be available for replay beginning at 3:00 p.m. eastern standard time today.

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Again, that number is 1446120.

What's the 800 phone number.

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Bye, now.

Thank you.

This concludes today's conference.

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