濱特爾 (PNR) 2005 Q1 法說會逐字稿

At this time I would like to welcome everyone to Pentair's first quarter 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. [OPERATOR INSTRUCTIONS] Thank you.

Mr. Harrison, you may begin your conference.

Thank you.

Good morning everyone.

Thank you for joining us today to discuss Pentair's results for the first quarter of 2005.

I'm Dave Harrison, Chief Financial Officer and with me this morning is Randy Hogan, our Chairman and Chief Executive Officer.

Before we begin this call, I would like to remind each of you that any statements made about the Company's anticipated financial results are forward-looking statements subject to future risks and uncertainties.

Such as but not limited to; the ability to integrate the WICOR acquisition successfully and the risk that expected synergies may not fully be realized or may take longer to realize than expected; the seasonality of our business; and the cash flows; as well as other economic and market risks.

In addition I would like to refer you to the risks outlined in the 10-K as of December 31, 2004 and our news releases.

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 will turn the program over to Randy Hogan.

Thanks, Dave, and welcome all to our conference call.

Let's get right to it and review the headlines for our first quarter of 2005.

We realized a 45% gain in sales to $710 million, a 52% improvement in operating income to $76 million, a 50% increase in earnings per share to $0.42 cents, and a 50 basis point expansion in margins to 10.8%.

It's a great way to start the year.

Organic growth of 5% was by buoyed by strong North American and Asian sales that more than offset declines in Europe.

Our supply management successes coupled with continued gains in applying our Pentair Integrated Management System, or what we PIMS, which is our lean enterprise process.

These two things are mitigating the impact of rising raw material costs.

We continue to more than offset rising costs with price increases and the productivity from those two programs.

Cash flow of minus $98 million was driven by the shift from tools to water, with seasonal increases in working capital and capital expenditures for factories we're building in China and Mexico.

Integration of our newer water businesses is progressing smoothly and we're seeing the benefits.

It's evident that our integration process is proceeding well and that we are on track and in many instances ahead of our plan.

Our results for the first quarter of 2005 clearly demonstrate that we're building upon our strengths in several key areas of our business.

We are capturing solid organic growth in those markets where we've executed our new growth initiatives.

The main task ahead of us is to execute plans that will replicate those successes in all our markets.

Now, let's look at the groups in greater detail.

In water; first quarter 2005 sales were 63% higher than in the same period last year reflecting the impact of the WICOR acquisition.

Organic growth in North America was in the single digits, while growth in Europe contracted.

While we are not satisfied with this performance, we are gaining traction in pump, filtration and pool markets.

This is coming as a result of building a stronger customer focus, more effectively managing the channels of distributions, entering some new geographies and integrating some new innovative products.

First quarter was the biggest quarter in history for our Aurora pumps, with shipments up substantially compared to last year.

Sales of Aurora pumps were up in all regions with the largest growth in the Pacific Rim, South America and in North America.

Overall, bid activity continued strong for Aurora's HVAC and fire pump products.

Fairbanks Morse pumps also performed very well in the first quarter setting a new record for quarterly shipments.

We've won several new projects related to municipal pump rebuilds.

And orders for the Twin Pump product line, which we acquired in 2003, are up more than 50% over those of the prior year first quarter.

By the way, I'd like to add that during the first quarter our Kansas City operations, where the Fairbanks Morse pumps are made, achieved a milestone of 1 million hours worked without a lost time accident.

That's a stellar achievement of which our employees can be duly proud.

As part of the WICOR acquisition we acquired a specialty pump line called Hypro, which offers pumping solutions to agriculture and specialty equipment markets, First quarter performance saw sales growth exceeding 20%, driven largely by the global demand for agriculture spring equipment.

We are looking to grow at double the market rate in this area by: One focusing on low share geographies, particularly Latin America.

Two, expanding the agricultural product offering to include all components and accessories from the pump to the wet end.

And three, focusing Hypro's marine pump applications on other marine segments like the workboat market.

Our first quarter product line acquisition at Delta Environmental represents another growth opportunity for our water.

Delta offers a range of waste water treatment products for the residential and commercial on -site treatment markets, which we expect to grow nicely.

In the pool and spa equipment operations, sales synergies between Pentair and StaRite continue to exceed our expectations.

We have identified and are now pursuing approximately $20 million of incremental sales opportunities resulting from our ability to cross sell products.

Our effort to institute operational excellence continues to produce results in our pool operations, as customers on-time shipment have moved from less than 70% a year ago to 96% in the first quarter of 2005, as PIMS takes root.

A good example of our success in leveraging acquisition synergies is reflected in the Ecolab alliance we announced in mid February.

Although we're just a few short weeks into the relationship, we've already received some healthy orders for filtration cartridges and we took our first orders for softeners in March.

In fact, overall the food service segment of the filtration market delivered strong growth driven by demand for both SHURflo and Everpure products.

Marine RV and aviation filtration fields grew as well, again due to strong SHURflo orders.

SHURflo's, RV and marine segments were both honored with Supplier of the Year Awards from several important customers.

The group's first quarter operating income improved 49% over the same period last year.

As expected, water operating margins were 12.1% in the first quarter.

We continue to close the gap on the margin differential between the new water group and our heritage water group from a gap of 230 basis points in the fourth quarter of 2004 to a gap of only 110 basis points in the first quarter this year.

This accomplishment reflects our success with the post acquisition integration.

We are now in the ninth month of the integration process and we continue to track on or ahead of our plan.

Of the 15 facilities we've announced, will be closed or consolidated, we've completed 10 and have another 5 well underway.

We anticipate completing those five projects by year end.

In addition, we've added to our low cost manufacturing base with two new factories, one in Mexico and one in China.

The Mexico factory was built in world class time, 84 days from ground breaking to occupancy.

Already 90% of our spa jet production manufacturing has been relocated to this new facility.

In addition we'll be making valves and tanks in support of our filtration customers in this facility.

In China we've refurbished the Suzhou factory and are already producing pumps, tanks and valves for both the domestic Chinese market and for export.

Importantly, the cultures and people have merged into one organization called Pentair Water.

At recent national and international trade shows, Pentair Water is a preeminent presence with all our brands incorporated under the Pentair Water umbrella.

There's no doubt we've become a major player in all three of our served markets, pumps, pools, and filtration.

Sales in our enclosures group during the first quarter grew 13% against a strong year ago quarter.

Excluding the impact of foreign currency, sales still gained 12%, driven by above market growth in North American industrial, commercial and networking markets, which were somewhat offset by the effects of soft economic conditions in European markets.

First quarter was the group's ninth consecutive quarter of sequential sales growth.

Operating income for the group increased 34% as PIMS’ improved pricing and supply management continued to read out.

First quarter operating margins of 13.1% expanded 200 basis points compared to the same period last year.

And it was our thirteenth consecutive quarter of sequential ROS expansion.

Enclosure's revenue story is not a market recovery story alone.

Rather, it's about new customers, new products, improved flexibility and delivery and the resulting market share gains achieved through these actions.

For example, adding new customers in targeted vertical markets resulted in higher sales to industrial OEMs, telecom customers both in North American and abroad and the transportation, medical, security and defense markets as well.

We successfully sold our new proprietary server rail product line to a broader base of customers in the datacom market, not only increasing volumes for this product but reducing our reliance on any single customer.

The telecom market is growing well in North America and we continue to score wins with several major players.

International telecom is also growing, albeit a slower rate.

But we are working with new customers in Israel, Japan and China.

In security and defense, Hoffman won a program to provide enclosures related products for biodetection systems to be used in secure facilities.

Other security related wins include a variety of programs for European defense customers.

In addition we continue to explore new markets.

With insights from our water group, the enclosures group is now targeting the waste water treatment market and is analyzing the needs and opportunities that exist in that market for enclosures' products.

In the new product arena, we can cite successes with four new side mount air conditioner cabinets introduced by Hoffman and targeted at the automotive market.

The new watershed product line where sales are up substantially in the second year after introduction.

The new cable management products.

A new line of WiFi enclosures for the networking market.

The growing ATCA product platform.

And new cabinets offering higher electromagnetic shielding capability.

Our delivery excellence is also a factor in market share gains.

For example, Hoffman's success in growing the non-standard enclosures business over the last several years hit a new high in the first quarter.

Hoffman's increased flexibility, made possible largely by the adoption of PIMS, dramatically increased sales of nonstandard product from about 12% of sales in 2000 to nearly 25% of sales today.

This reflects the fact that we're taking nonstandard product share away from the smaller local fabricators, who have previously leveraged their shorter delivery cycles and customization capabilities to achieve their market share.

Thanks to Hoffman's lean discipline and the greater flexibility it provides, the cycle times from our front office through shipping usually meet and often beat the speed of the local fabricators that make up the bulk of the competition in Hoffman's industrial and commercial markets.

These actions; focusing on new customers, new products, and improved flexibility and deliverability, have built our enclosures group's market share and were the major drivers of our organic growth in the quarter.

It's a great example of what we are talking about when we say we intend to grow faster than the market.

Expansion of our Reynosa enclosures' facility continues on schedule.

Installation of a new paint system is underway and we expect to be in test production in the first week of May.

The Minnesota Manufacturers Alliance named Hoffman Enclosures as manufacturer of the year for 2005.

This award program recognizes Minnesota companies that share best practices and information to support and strengthen other manufacturers.

This award is a testament to the quality of our Hoffman people and the excellent work they have accomplished in affecting process improvements across the organization.

In summary, our enclosures business continues to perform well.

Supporting more and broader markets with new products, delivering products with greater speed and accuracy than ever before, and taking business from the competition.

This group is setting new standards of performance within Pentair and their industry.

Now I'll ask Dave to address the financials.

Dave?

As Randy mentioned, we had an excellent first quarter with good results on many fronts.

We are particularly pleased with the EPS at $0.42 up 50% from the prior year on a continuing operations basis.

But even more importantly, we have now crossed over the point of completely replacing the earnings from the divested tool business in 2004.

As we stated in the news release, we used a net $98 million of cash in the first quarter to support the new seasonality of the combined StaRite and Pentair pool operations.

Working capital increases related to the rationalization of water operations, various customer rebates and employee bonus plans and capital expenditures for construction of facilities in Mexico and China.

However, we expect our cash flow will turn positive for the first half of 2005 as we anticipate a significant reduction in working capital in the second quarter.

Average working capital finished the quarter at 35 days.

The same as the first quarter 2004.

Rest assured that we anticipate free cash flow of $200 million or more in 2005.

Our debt to total capital ratio of 37% at the end of the first quarter reflects additional debt incurred as a result of our cash flow position at the end of the first quarter.

This is still below our target level of 40% and it will be further reduced as cash flow builds in the remainder of the year.

Our gross profit margin in the first quarter increased 10 basis points from the first quarter of last year.

This was due to the lower initial margins of the former WICOR businesses being offset by the excellent progress made on PIMS, supply management, and the traction we are getting in realizing the synergies from the WICOR acquisition.

Despite a tremendous amount of factory rationalization activity, we had our first net synergy benefit in the first quarter of 2005.

It is also significant to note that; compared to the as reported numbers including tools in the first quarter of 2004, we have improved our gross margin by 250 basis points.

Overall our SG&A costs were down 70 basis points in the first quarter.

Selling was 30 basis points higher due to targeted selling expenses, which is laying the foundation for sales growth.

G&A was down 100 basis points, due to not having non-recurring expenses in the first quarter of 2005.

Such as we had in the first quarter of 2004 for integration planning and M&A activities in preparation for the WICOR acquisition.

From a reportable segment basis, other, including corporate, are $11.4 million which includes 1.4 million for amortization of tax strategy based investment.

We are accelerating this amortization in 2005 in preparation for new tax planning strategies.

Going forward, we expect other to be in the range of $11 million to $11.5 million.

Operating income margin for total Pentair improved from 10.3% on a continuing basis, in the first quarter of 2004, to 10.8% in the first quarter of this year.

The improvement of 50 basis points is even more impressive when you consider the margins are up 130 basis points from our as reported margin of 9.5% in the first quarter of 2004.

Our progress in improving our gross and operating margins reflects the higher quality of earnings we targeted from our recent transformation.

As Randy mentioned, with the inclusion of the new water businesses, our water operating income margins are lower on the combined businesses.

But we continued to close the gap on the margin differential between the new water group and Pentair's heritage water group.

Improving from a gap of 230 basis points in the fourth quarter of 2004 to a gap of only 110 basis points in the first quarter of 2005.

The enclosures group continues its quarter-over-quarter operating margin improvement with 13.1% ROS in the first quarter.

Up 200 basis points from the same period last year and 10 basis points better than the fourth quarter of 2004.

The group is now in its fourth year of sequential quarterly margin improvement.

Interest expense for the first quarter of 2005 increased $3.6 million compared to last year.

This is primarily due to the WICOR acquisition and the higher interest rates compared to the first quarter of 2004.

During the first quarter, we completed the refinancing of our revolving credit facility.

Increasing the total facility from $500 million to $800 million and lowering the interest rate on loans under this facility by 50 basis points.

The revolving credit facility matures in five years and includes multi-currency subfacilities to support investment outside the United States.

Also in the first quarter Standard and Poor's affirmed Pentair's BBB long term rating and changed the outlook from negative to stable.

The effective income tax rate for the first quarter of 2005 is 33.5% compared to 34.8% for the full year 2004.

This differs from the current estimated annual rate of 35.5% as a result of a favorable settlement of a routine IRS exam for prior years 1998 to 2001.

This resulted in a release of tax contingency reserves equal to about $0.01 of our $0.42 earnings per share.

Our estimated tax rate for the balance of this year is 35.5% Now, I'd like to turn the conference back to Randy.

Thanks, Dave.

We have good reason to be pleased with our performance in the first quarter of 2005.

We continue to more than offset material cost inflation with pricing and productivity.

The integration of the new water businesses is progressing smoothly and we continue to pursue acquisition opportunities in both our water and enclosure segments.

We're capturing solid organic growth in North America and we're getting excellent traction from our growth initiatives.

Going forward, we will work to replicate our successes in other markets, especially Europe.

We are committed to a goal of increasing international sales to 40% of our revenue from the current 23% level over a five-year period.

In the first quarter, we announced that Rick Cathcart was promoted to Vice Chairman and that he would assume primary responsibility for strategic growth initiatives, particularly international growth in addition to his focus on water.

Then, at the end of the first quarter we announced that Charlie Brown would rejoin Pentair as President and Chief Operating Officer overseeing our pump and pool operation.

You will recall that Charlie ran our tools group from August of 2003 until we successfully sold that business last year.

We also named Jack Dempsey, Senior Vice President of Operations and Technology.

A role in which he is leading our operations supply management, information technology and product management and overall technology initiatives.

Prior to joining Pentair, Jack was a Director at McKinsey and Company.

These leadership changes, together with the strong general management team we've built over the last several years, positions us well for the bright prospects that we have.

I believe we are now well positioned to continue our drive to operations excellence and systemic growth in both water and enclosures.

I think the first quarter performance is evidence of it.

Looking ahead to our second quarter, we reiterate our expectation of EPS between $0.61 and $0.65, which is a minimum 45% higher than the same period in 2004.

In addition, we're raising the lower end of our previous 2005 EPS guidance from $1.95 to $2.00, while maintaining the high end of the range at $2.10.

Thanks for your attention.

I'd now like to ask the operator to come back on the line and please give the audience instructions for the Q&A portion of this call.

[ OPERATOR INSTRUCTIONS ] your first question comes from Jim Lucas with Janney Montgomery Scott.

Hi, guys.

A couple of questions first on just housekeeping.

Dave, could you give us an update of where you stand for the year budgetwise on CapEx and D&A?

Yes.

We're looking at CapEx of being in the range of 65 to 70.

And we're looking at a combination of depreciation and amortization of being roughly 85 million.

Okay.

And on the 5% core growth in the quarter, how much of that was pricing?

Pricing was approximately 2%.

Okay.

And could you give a little bit more color on Europe from a standpoint, one with it being weak, could you expand on some of the weakness you're seeing there?

But conversely, given your focus on growing internationally, could you talk about the acquisition environment in Europe as well?

I can't really give you a lot of insights into the acquisition environment on Europe but I would like to give you some insights into the European market.

I will say one thing about the acquisitions, which are they are out there in Europe.

But I'll just leave it at that.

But in terms of the overall economic environment, what we're seeing, and it is particularly true in enclosures, and enclosures serves a lot of export oriented markets and the strength of the euro isn't helping the customer base in Europe.

That has affected water somewhat.

Water is a little bit of a mix.

We have some segments that are doing fairly well like filtration and we have some others like pump that are not doing so well.

I think that's a combination of the markets we're in and the positions we have.

I think we need to work to strengthen our position in pump in Europe in water, and I think we can.

I think we have a very good operation over there.

And I think as we integrate the business across Europe, we should have opportunities to sell in more broadly.

And when you talk about the pump market, what specifically, what niche of the pump -- is it across across-the-board, or is there any specific niches?

Well, our business in Europe is really what I would call more of a residential product line than anything else.

There are some specialty pumps as well.

But it's more on the residential side of the products they use.

It's more similar to say what we sell to Lowe's or Home Depot than it is to what we sell - - it's not like our big pumps.

Your next question comes from Dan Whang with Lehman Brothers.

Good morning, Randy, Dave.

My first question was regarding WICOR, I think you commented that the integration process is going smoothly.

Could you just provide a little bit more detail what you've achieved to date and what's really left in completing that integration process going forward?

I'd start with, you know, we're -- as we've said, we're focusing on getting $30 million of synergies out of the costs in the first year.

I think we're on track.

As Dave mentioned, this is the first quarter where we have a net gain in the synergies.

So we feel really good about the progress there.

Despite the fact that material cost is a lot higher than we anticipated it would be when we set that plan.

Secondly, we are targeting $40 million to get out of working capital over the first 18 months or so.

As you can see in the first quarter there's not a lot of evidence of that yet.

But we are committed to get it.

So I think as we put in our disciplines we're on lean and get the focus on inventories broadly set in the Company, I think you'll see some improvements there.

Importantly -- so that's sort of the numeric look at it.

The things that I find really encouraging are; we have a lot of change going on.

We've mentioned the 15 plants.

And the 15 plants are well underway.

They have gone -- they haven't gone without a hitch because that's life but they've gone very, very well.

The way the new Pentair water employees and the heritage Pentair water employees work together is outstanding.

As you know we merged these teams we work hard to make it a merger as opposed to just a raw takeover.

I'm not sure it always felt that way for everybody that came from the WICOR side but we certainly had that intent and it has gone well.

I'm impressed with the way the people are working together.

The fact that we have 10 plants closed already is ahead of schedule.

The fact that we were able to get Mexico up -- and in fact, if I talk about the Mexico factory, I'd like to point out something that I think is special about the employees of Pentair.

That factory getting up at 84 days is way ahead of schedule.

And it was very helpful that we were in Reynosa because there were as many enclosures people involved in helping get that plant set up as water people.

It was a Pentair effort to get that plant up.

And the way those teams worked together is frankly inspiring.

So that's what's going very well.

The China factory, as you know, we bought the Suzhou factory back from Black & Decker when we closed that deal, and the factory needed to be obviously reconfigured for a whole different set of manufacturing processes and that has been done.

So it's on the manufacturing side.

Then as I mentioned if you take a look at how the pool businesses have gone together, our teams are just doing a great job.

I think it's a testament to the integration planning that was done.

I think it's a testament to the people involved.

And also, you know, I think in the enclosures business you talked about potential cross selling opportunity with the water business.

Could you talk a little bit more about that?

I think --.

Sure, if you go to any water show and you go through, you see enclosures everywhere.

Enclosures are ubiquitous.

We said that before.

They are used everywhere.

What our enclosures people have developed is a capability to focus more on end markets and actually develop what to one person may be a box.

To another person, it's a solution.

And our enclosures people find the right solution.

The watership product we developed for the food and beverage industry and the pharmaceutical industry is a good example of that.

And it's doing very well.

We think the same opportunity exists in water.

Hoffman already had a very good share in water by the way.

But it never really focused on it as an end market.

So by focusing on talking to end customers and their needs, as we get a broader footprint in water, we see more of those customers.

It's just a logical market for Hoffman in particular to be focusing on now.

And finally, I think you're making good progress on offsetting these commodity price increases through pricing and productivity.

What are you seeing right now in terms of some of the commodities that you're exposed to?

I think now it's primarily resin and steel.

Overall, I always look at material inflation overall as a percent of sales and that number is less than 3% overall.

But if you look inside that number for instance steel, which is a very big component of -- it's the big biggest component that enclosures deals we're facing a 35% Q1 to Q1 increase in steel.

That said, they got 6% material cost productivity on the rest of what they were buying in enclosures.

So even though they are fighting that headwind, if you will, in steel, they are doing a good job with their disciplines on the other areas where they buy.

In terms of motors and resins, which are the two big areas we're seeing, and by the way, these percentages are costs.

They are not percent of sales, right?

The 35% is how much we saw increased in steel.

But in resins, it's probably 10% to 15%.

In motors it's probably high single digits percent kind of increases we're seeing.

And we are expecting resins is going to continue because it tracks with oil.

We think motors and steel -– steel certainly we think will moderate.

Your next question comes from John Quealy with Adams Harkness.

Hi, good afternoon.

A couple of questions here.

Randy, you gave a couple of examples of what seems to be some nice momentum in the pool business with a potential $20 million of incremental sales moving forward.

Also on the Ecolab, it sounds like your initial reaction there is favorable.

Can you comment a little bit about if this is more of market share gains or are those niches actually performing well in this economic environment?

I think it's both.

Talking about the pool, the cross selling opportunities, we are maintaining both the Pentair and the StaRite brands in the pool business.

And StaRite had a narrower product line than we had on the Pentair side.

So there's some real natural line extensions if you will in the StaRite sales and channel for filling out with Pentair products.

And there's also some nice StaRite products that are going to be helpful in the Pentair line.

So if you will it's helping us improve our coverage and penetration of the pool business.

And the pool business is very nice.

If you look at STP they reported a nice growth in the first quarter.

We kind of look at water over a multi-quarter period because orders and sales move around between the channel and us.

And we think despite the fact that the first quarter had some pretty bad weather in some of our key markets like southern California, we think it's going to set up nicely for a good year on pool.

And then the -- what was the second area you asked about?

On the EcoLab.

We just think the food service business is a great, great business and while we agree with EcoLab, we're not going to talk about specific numbers.

They have 2500 people and we're in 40% of all the food outlets in North America every week.

And so that gives us another channel to market.

It gives them a broader set of solutions to sell.

And so I think we're both excited about it.

Maybe we might be a little more excited about it than them.

I don't know.

But we have a pretty good relationships all the way to the top there.

So, food service just is a great business.

There's nothing more fundamental -- the feed stock of food is water.

You've got to have good water.

Not only just for the feed stock but also for the cleaning of the plates and glasses.

So it's just a really exciting opportunity for us.

Randy, moving to the M&A side, you've talked a little bit about geography earlier in the call.

Can you comment a little bit about by product line in water and enclosures?

For example, is the municipal/industrial solution interesting to you?

Can you talk a little bit about what you'd like to see in enclosures as well?

Sure.

As we look -- with the transformation, we like all the business we're in.

And so I wouldn't put a priority on one segment over another within water.

We clearly are interested in growing faster outside North America than inside North America in order to achieve our objective of 40% sales.

That said, we're looking for acquisitions which basically fit our strategic intent.

So it fits with one of our gross strategies in the markets we're in.

Secondly, there has to be a good reason why we're the right buyer, which means we need to bring some unique talent to it.

I think as you saw in what I was talking about in Hoffman and what we're doing with WICOR, we are proving up our process capabilities that we've been working on over the last four or five years.

And I think it's real evident in our numbers today that we're delivering in that regard.

And so we're looking for that to be a differentiator in our ability to bring shareholder value to any acquisition.

We have to have a detailed integration plan and we have to have a clear sense of how we run it.

And so we're sticking to those disciplines.

I think that things might be a little cheaper outside North America than in.

And when we do buy things outside North America we don't use dollars.

So, we try to use local currency, so we don't get disadvantaged by the weak dollar.

In terms of enclosures, we are very interested in building around the strength -- the awesome strength of our Hoffman brand and the Hoffman position.

And we're looking for, if you will, augmenting what we do.

We don't need capacity.

We don't need customer contact.

But building around that enclosures core for capability, whether it be related to wire handling or conditioning or any one of those areas, would be of interest to us.

So -- in enclosures.

And then as I said we're interested in the pool business.

We're interested in the filtration business, and we're interested in the pump business in water.

Okay.

Great.

One last question maybe for Dave.

In terms of the SG&A run rate as a percentage of revenue, should we expect that to dip down a little bit as we get into the summer months of June and September?

If you could provide a bit of an outlook there for us?

I don't believe that it's going to dip down.

I think we are in a mode right now where we are pushing very, very hard for growth.

Did you ask a percent of sales basis or a dollar basis?

It was actually percent of sales.

Yes, so I would expect that it's probably going to be flat to up a little bit.

Your next question comes from Ned Armstrong with FBR.

Good afternoon.

In the past you've set goals for where you think margins are going to and you've certainly been successful in raising the margins and integrating acquisitions.

Do you think that you'll be able to surpass those goals that you've laid out, and if so, is there a timeframe you can put out there?

I'm pleased with the progress we're making.

We're not resetting our goals.

Our objective is to exit this year with water margins at the rate that they were before WICOR.

And we're driving to get there.

And overall we're -- we think both our enclosures business and our water business has a 15% potential in the next two to three years, so I think we're on track.

I think we're -- we can get there.

Your next question comes from Mike Schneider with Robert W. Baird.

I wonder if we could drill down just into at least one of the areas that had challenges last quarter and that was the Ashland plant.

You had talked about some of the disruptions there.

Can you give us an update given that is a key plant on what on-time deliveries are looking like, what returns or defect ratios look like, anything like that?

Well, I'll give you a little more high level information than that.

Ashland did suffer from some delivery issues as we consolidated two plants into one plant there and we consolidated the teams.

By the end of the first quarter, we were back to standard.

In fact, when you look at our pump group overall, our pump business within the water group, they had an incredibly good quarter.

It is the area where we have more integration going on between WICOR and the older Pentair businesses than any other.

And they were also thrown more curve balls with motor prices increases and Franklin strategy changes and some customer setbacks that we knew were coming and weren't related to the acquisition.

They took those.

They put them behind them, and got Ashland done and got some very nice growth in a lot of the other segments.

So I think our learning from that was you can't be over -- you can't overplan a shutdown at two factories that are even that close together.

We thought it would be easier because they are close together, and what we learned is nothing is easy when it comes to shutting down a plant, but we're back on track.

In fact, I know as part of Pentair you guys measure everything.

How do you measure quality or what metric do you watch most closely in that regard?

We don't have one measure across our plants.

Although that's one of the things that -- when we added Jack Dempsey, one of the things he's driving is to a common set of measures.

When we look at quality in some businesses, we look at first pass yields, in some businesses we look at returns, in some businesses we look at warranties.

In most businesses we look at all of something like that and quality is back up to standard in Ashland

And how about across the pump group though given that there are a lot of moving parts.

Are on-time deliveries back to standard overall and is quality as measured by whatever metric back on standard?

Right.

I'm not concerned about either.

Okay.

And then switching gears just to the enclosures group.

The margins now have been on obviously a multi-year tear here but the pace of growth on a subsequential basis is definitely slowing against the tougher comparisons.

What drives margins higher from here in the enclosures group given the pricing has probably flowed through?

And should we expect maybe subsequentially margins actually top out here for a while?

Well, our goal is 15% and we're at 13.1% now.

And I would never bet against Mike Schrock to keep his sequence of 13 going.

That's not a promise.

I just tell you where I'd put my money.

It will -- obviously the rate of growth getting 200 basis point improvements, it's going to be asymptotic at 15%.

Now, the source is what's going to happen?

I think we still are going to grow.

We still have a lot of opportunity to grow.

I think that 12% without FX, 13% with FX growth is amazingly good, and it's better than we had planned.

It would be nice to do 20% every year but frankly I'd rather have this kind of growth than the fake growth we had back in the telecom days.

In terms of margins, we continue, I mentioned that we're expanding our plant in Mexico so we continue to leverage our low cost operations.

That will be up in May.

That will help costs.

Our China factory we actually just moved from a smaller China factory to our larger factory in our Qingdao facility in China.

And we're working with a lot of new customers in China, which will help drive growth, we think.

So we're not giving up on our productivity.

And one thing we'll see a lot higher productivity with steel prices.

Imagine -- think about this business, the major commodity they buy is steel.

And you never saw any impact from steel prices going up some 52% over an extended period in their performance.

So in a more stable environment, I think we're going to see a lot more productivity fall to the bottom end.

A lot less damage control being done, if you will, and a lot more proactive supply management.

We have a dynamite supply management team in our enclosures business.

Okay.

And final question just on Europe, we've heard from you and a wealth of other players about the weakness in that region really across almost all sectors, it seems, industrial consumer, et cetera.

What are you doing in that region to prepare for a recession?

Because the data certainly seems to indicate that could be coming.

We are keenly interested in eastern Europe right now in terms of both growth opportunity but also as a local source -- a local low cost source.

We're also looking for low cost sources around.

Thankfully we are pretty lean.

As you know, the enclosures business went through a downturn.

And even though enclosures sales were down in Europe, their profitability we think was greater.

And so I think we do continue to do industry planning in most areas of our business.

In Europe the most important thing is for us to find ways to grow.

We're not so big in any of our markets that we shouldn't find ways to grow.

Even if the enclosures market is down, for example, they should have the same opportunities to grow as we have in our Pentair electronics packaging business in North America.

And we don't have a Hoffman business in Europe, but we continue to wonder how we might tap into some of the industrial area there.

So it's a combination of finding new growth and watching our costs tightly.

And was -- the pumps business was down year-over-year as well in Europe.

Was profitability up there as well?

No.

Your next question comes from David Smith with Smith Barney.

Just on -- you talked a bit about Ecolab in North America.

Is there any benefit coming out of Europe on Ecolab?

Well, the agreement is on around North America.

There is opportunity beyond that, but it's not structured yet.

Okay.

As far as integration costs go for WICOR in the quarter, can you quantify what they were in the net positive benefit?

Generally we have not laid that out specifically.

But it's safe to say that the improvement quarter-over-quarter was pretty significant to be able to get to the point where we now have a net benefit.

We're on track based upon the $30 million that Randy talked about to achieve throughout this year.

We are on track, and it will continue.

You'll see that build as we go throughout the year in improving margin.

Okay.

One thing on the pools business, the pool & spa, heading into the seasonally stronger second quarter, can you give us any color on the orderbook heading into the second quarter?

Is it kind of trending what you saw last year, or is it higher looking numbers?

Well, if you look at our overall -- where we stand today in terms of our backlogs in order and book to bill and so on and so forth, we have a strong backlog as we basically left the quarter.

And when you look at the sales in the first quarter and the billings, pretty much we're very similar in terms of the percentage increase, and that's basically leaving us with a book to bill of around 1 to 1.

I must say, though, May and June is always an interesting period in this business.

I've had he never been in a business this seasonal before.

And our ability now, as I mentioned, to ship reliably to 96% is an extraordinary improvement in our capability.

And I'm looking forward to seeing that get leveraged.

Do you have any sense of where the inventories are in the channel right now in the pool & spa side?

Our sense is that as I said the first quarter was soft in a lot of areas of the country because of weather.

That's not uncommon.

But our view is that the inventories are probably not -- they are not too deep in the channel right now.

Which also I think favors our ability to deliver.

Okay.

Just last thing.

I just want to maybe if you could put a little more color on the organic growth in the water business overall.

Was it -- overall was the water business up like low single digits?

Yes.

And Europe would it be down lower or higher single digits?

Well, you know, it depends on local currency or dollars.

In dollars they would be down local currencies.

But overall we're up.

The way I look at it is I always factor in the things I know are changing and then I look at the things I know we're changing.

In other words, we know for instance, when we get a customer.

We know when we lose a customer.

We know -- and we factor those things in.

And I think the business is really running at a good clip organically.

Most times when you put a business together of the scale we've just done here, the internal focus usually leads to you're losing sales.

So I'm pleased to see we're not.

I am pleased to see we're growing organically.

And I think if you will the capability we have is to grow in that 6% to 10% range, which is our goal in water.

And once we get a few losses behind us of -- customer losses that we knew were coming and they weren't necessarily related to WICOR but they there were good reasons for them; that we'll be able to grow in that mid single digit range on a sustained basis at minimum.

Okay.

One other thing I just saw on this page.

You talked briefly about Asia, you haven't touched on that really in the conversation.

Is there anything we should be aware of around China or India?

Both grew well in water.

Our enclosures business has some very exciting stuff going on in China.

We have a fairly decent sized Japanese business in enclosures, which was negative in the quarter.

In other words, down year-over-year.

But in China we're working with [Faway].

We've got new business.

We're working with Alcatel.

We're really deepening our customer base in China in very exciting ways and building enclosures teams to go after that.

And then both -- in water both India and China were up nice double digit numbers.

Your next question comes from Debra Coy with Stanford Washington Research Group.

Good morning, guys.

Randy, just to try and understand this organic growth outlook a little better, I do know that you're going through a transition here and it's hard to sort it all out.

But looking at a quarter ago where you had 10% organic growth and 3% price this quarter it's 5% organic growth, 2% of that was price presumably pretty much to cover the cost of higher raw materials.

I think you just mentioned that -- I think that you just mentioned that enclosures was up about 12%, 14% X on local currency?

12% in constant currency.

So I'm trying to figure out how we get to then as you said low single digits in water.

I mean, it feels like water must have been about flat.

No it was up low single digits a couple points, a couple percentages.

And the other thing is when I look at water, is what I was trying to say, it's particularly true in pool.

I don't get all that hung up on one quarter.

I look over multiple quarters.

If you look at our pool business in the fourth quarter, it was huge.

It was up over 20%.

In the first quarter it wasn't up that much.

But --.

And didn't you have a fairly tough comp versus last year?

Exactly we had a huge first quarter last year because -- actually we weren't shipping very well last year.

And we weren't shipping in the fourth quarter before that.

So we were basically getting the pig through the python.

Now our ability to ship faster has actually allowed our customers to order closer to their real need.

And so when we look across water, we kind of look at it across the pool year, which begins -- it's really fourth quarter, first quarter, so the first half.

When we look at that, we --.

Average it out.

Exactly.

We think we're just fine there.

So I wouldn't get hung up on the 2% of water.

And actually my other question was to try and get a sense then if we can, since each one of the pieces is quite large.

So if pool was really just more we're seeing seasonal bouncing around, what do you see as kind of the trendline organic growth in the filtration and the pumps businesses?

And I do understand you've been saying you've had some moving parts within those two with Europe weaker for instance.

But what would you say is sort of the trendline organic growth in those two pieces?

I think in terms of filtration -- when you look across filtration we’ve have got a range, we've got specialty filtration, we've got food and beverage, they are doing very well.

Residential isn't so hot.

The residential filtration business isn't so hot.

I guess when I integrate all those, I'm looking at mid single digits, but I think pump could be even a little better than that at mid single digits.

You had an unusually good quarter you said in pumps for a variety of reasons.

Well, we had a good quarter.

From a growth standpoint we didn't have an unusually good quarter.

More on the margin side.

Given all they had to do and the integration of the team and if you will all the headwind they had to fly against, they had a good quarter.

They had some growth.

But I wouldn't say they had a good growth quarter.

Okay.

So to the higher end of mid single digits.

No.

Not for pump.

Okay.

I think I can get some sense of how that works.

And my last question in terms of trying to sort all this out then is you clearly had very nice margin improvement in the water segment in the quarter.

Can you speak on a relative basis as to which one of those three groups did the best on margin improvement?

I would probably say pump.

Pool did well too.

I'd rank order them.

And Europe did well too.

Even despite sales being way down?

Despite sales being down, yes.

So do you expect given that you're going to have obviously a seasonally much bigger quarter in pool next quarter, would you expect a continuing narrowing of this gap or would you expect it will widen again because of seasonal impacts?

No.

We expect that it's going to narrow every quarter.

It was 230 basis points in the fourth quarter.

It was 110 basis points in the first quarter.

I expect it to be lower in the second quarter.

And I expect it to cross over because we have two months of WICOR.

Because your water margin a year ago was over 16%.

So would you expect it to be over 15% in 2Q?

I --.

In other words, less than 110 basis points?

Yes, I would hope so.

Mr. Harrison, I am showing it's three minutes to the hour and you do have four participants left in queue.

Okay.

Let's see if we can get all four in quickly.

Your next question comes from David Petiwicz with Neuberger Berman.

Hi, good afternoon.

Thanks for a very fine quarter.

Just a couple of quick questions.

One new level of granularity on organic sales.

Could you talk a little bit about how the WICOR businesses are performing relative to the other water businesses?

Yes.

We've put the businesses in a way -- we've merged them and we don't think that's meaningful.

When we talk about organic growth now, we're talking about if you will we know what they did in the first quarter and we know what we did in the first quarter last year.

We add them together and then we figure out organic growth from that.

Which we think is a better way to look at it.

Because we've actually moved product lines from one plant to another and it's just it's not meaningful anymore.

So we mentioned in the fourth quarter that was the last time we were going to do that.

Okay.

Understood.

I must be thinking completely wrong about the enclosures business because I've always thought about it as an economically sensitive cyclical business.

And it almost seems like we're talking about it as a growth business.

Are we really suggesting that the margins in this business can reach 15% and stay there?

Or are we thinking that this is going to be a cyclical to a certain extent business where we see peak and trough margins through a cycle?

Our objective is to get to 15% plus and minus around the economic cycles.

Why do we say that?

We think our industrial business can be a 20% business and we think we can get our telecom and datacom segments to being a 10% business and they will be about half and half.

Why do we believe that?

We believe that, number one, I believe that what happened with the dotcom fantasy and the telecom and datacom boom and bust, I think that was an anomaly.

I don't think that should have happened and it won't happen again in terms of driving the demand and therefore driving the supply so out of scale that it drives our margins down.

Secondly, we have the lowest cost structure in the industry and we are the most intimate with customers.

So we should have the highest margins in the industry.

That's how I think about it.

That's why my expectations are what we are.

And is there a long-term cyclical growth target you want to give us for that or secular growth target?

Our goal for enclosures is 5% to 8%, which we think is a 1.5 times GNP kind of a growth market.

We are not really active in South America yet.

We're just getting to Asia.

There's lots of markets.

We are in Brazil.

I should say that, less I hear from our enclosures guys later.

Anyway, next.

I want to see it we if we can get the last three in because I'm supposed to be out of here.

Your next question comes from Deane Dray with Goldman Sachs.

Thanks, Randy and Dave.

You mentioned some customer losses in water but said that it was not related to the WICOR integration.

What was it related to and could you size it for us?

It's in the tens of millions.

And it's a number of different customers.

Some retail customers who were just going -- they were changing strategy where they're putting in some second sources.

Nothing against us.

They just wanted to have a second source and they didn't.

And some Franklin business.

Is that Franklin because they are going to do it themselves?

Right.

Okay.

I understand that.

And then for the second quarter guidance it's not as though the margin improvement is really driving the EPS, but do you have a sense of what the core growth assumptions are in your second quarter guidance?

The growth assumptions in the second quarter guidance?

Yes.

Core growth.

In the core growth?

It's organic.

Mid digits.

Yes.

Mid single digits in -- pretty much across-the-board.

And how about for the year?

I would say that we're -- our expectations are getting to within the long-term growth aspects that we have talked about in the past.

Our long-term goals are 6% to 8%.

And I hope for the year we can be at least in the low end of that range.

Okay.

And then on the cash flow side, was there anything in particular that surprised you in the first quarter?

I know this is the new seasonality of Pentair.

But with regard to the use of cash, was that a surprise?

Well, I wouldn't call it so much as a surprise but a little disappointed we didn't make more progress on inventory, frankly.

The CapEx we knew because we - when we realized we could go fast and we were going to get benefit from going fast, we said go ahead.

We knew that CapEx was coming out.

We certainly knew the difference between the tools business and the pool business.

But I think inventories is not so much a surprise -- because we see the numbers on a regular basis, so it wasn't a surprise.

But it's a disappointment we haven't made more progress.

I think our people really erred on the side of trying to make sure that they had enough inventory as we're making the changes in our plants.

And we're pleased that they basically were looking out for the customer.

But what it provides us is the opportunity as we go through the next few quarters to work that down.

Okay.

This is the last question.

It looks like you've lowered your tax rate assumption for the balance of the year by 50 basis points.

Is that all related to an acceleration of this amortization?

It's pretty close.

Yes.

We have some items that we're basically working on.

But there is a correlation with that.

What would be the sustainable rate for '06?

For '06?

We would hope to be able to get it down to the 35 level.

Your last question comes from Curt Woodworth with J.P. Morgan.

Hi, good afternoon.

I'll make it quick.

What is -- in terms of the water segment what is your exposure to Europe in terms of percentage of sales?

It's -- we'll give you a number that's fairly precise.

It's -- I'd say between 10% and 15%.

Okay.

And then in terms of your pump business, your forecasts looking out over the next few quarters; can you, number one, give us a sense, what is the size of the commercial and industrial exposure there versus residential?

We put commercial and residential together.

There's a lot of overlapping pumps between -- in our applications.

And we're 80% commercial and industrial.

We only do about 10% of our business -- correction 80% commercial and residential, sorry.

We're only about 10% industrial and 10% municipal.

And what's the split between commercial residential?

I'd probably say it's 60/40 residential to commercial.

Okay.

And then in terms of the filtration end markets, can you talk a little bit about what your exposure is residential/commercial versus food service and industrial?

Just to give us a sense of the key drivers.

You know, I don't have that right off the top of my head.

It's a good thing I don't because I don't know right now.

Do you have any sense of what the residential exposure is?

It's, you know, I would guess 30%.

Okay.

And then just in terms of your comments of residential not being so hot this quarter, what's driving that?

We lost one of our OEMs.

We do a lot of private label.

We make the product for other people, other names.

One of our -- one of the OEM's lost a placement in our retail account.

All right.

Thanks, all for your questions and interest.

Operator, if you could come on and give the call-in number?

This call will be available for replay beginning at 2:00 p.m.

Eastern Standard Time today through 11:59 p.m.

Eastern Standard Time on Saturday, April 30, 2005.

The conference ID number for the replay is 5013429.

Again, the conference ID number for the replay is 5013429.

The number to dial for the replay is 1-800-642-1687 or 706-645-9291.

Again, the number to dial for the replay is 1-800-642-1687 or 706-645-9291.

Are there any closing remarks?

No.

I just thank you all for your interest and support.

And we'll see you out there.

Bye.

This concludes today's Pentair's first quarter conference call.

You may now disconnect.