濱特爾 (PNR) 2005 Q2 法說會逐字稿

At this time I'd like to welcome everyone to the Pentair second quarter earnings conference call. [OPERATOR INSTRUCTIONS] Thank you. Mr. Harrison, you may begin your conference.

Good morning, everyone. Thank you for joining us today to discuss Pentair's results for the second of 2005. With me today is Randy Hogan, our Chairman and Chief Executive Officer. Before we begin, as usual, 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 integration successfully and the risk that expected synergies may not be fully realized or may take longer to realize than expected. The seasonality of our business and cash flows as well as other economic and market risks. In addition, I would like to refer you to the risks outlined in our 10-K as of December 31, 2004 and our news releases. Forward-looking statements included herein are made as of today and the Company and 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.

Thinks Dave. Welcome to the conference call. The second quarter was a true test to the transformation of Pentair. And we passed with our margins up 70 basis points to 14.1%, our sales increasing by 49% to $789 million. 57% higher operating income at $111 million. And $0.63 of earnings per share, which is 50% higher than the same period last year. We're pleased with these results in what is now our seasonally highest order. It demonstrates that we are executing very well in our enclosures group and in our water businesses. And that we're getting solid bottom-line results from the integration of our new water businesses. Our organic growth initiatives are already showing strong results in enclosures and are beginning to gain traction in water.

Let's look at the headlines. Our performance during the second quarter of 2005 has set a new record for earnings per share. Up 15% over the previous high, which was the total as-reported EPS of the second quarter in 2004, which included our tools business. This means we have more than replaced the contribution of our formally largest business and less than one year. Our organic sales, removing the effects of acquisitions and excluding favorable foreign currency exchange, grew approximately 7% during the quarter. Price of over 3% and productivity continue to more than offset inflationary pressures.

Our supply management initiatives continued to deliver strong results achieving incremental growth savings of more than $10 million in the second quarter, compared to the same period last year. Our corporate goal continues to be a 5% reduction in year-over-year material costs. The integration of our new water businesses is going well and WICOR is meeting our 5 acquisition criteria. We're meeting our financial plans. It's right in our strategic sweet spot. It's proving to be a great fit with Pentair. Our integration plan is working and we've put in place sound leadership for the businesses.

Now, let's look at the groups in greater detail. In water, second quarter, 2005 sales were 66% higher than in the same period last year. Largely reflecting the impact of the WICOR acquisition. Removing the effects of the acquisitions and excluding foreign exchange, sales were up approximately 4% over the second quarter of 2004, when the group's organic growth rate was 15%. Sales and specialty pump markets, which includes municipal, agricultural, commercial and industrial pumps, we're up in the high single digits during the quarter. This was driven by demand for municipal standard pumps end parts, fire pumps, Hypro's agricultural products and several industrial high-pressure low-flow applications.

New products contributing to higher sales include Aurora's new end suction pump line for the commercial HVAS market. And Hypro's patented AccuMax foam injection system for the global petrochem industry fire production. Our global water systems pump sales were down however, as they continue to be hampered by a retailer's decision to add a second line, the impact of Franklin Electric's decision to sell direct and by weather delays in the professional well drilling season.

Water continued to see growth in food service markets driven by new products and customers. We experienced particularly strong demand from major beverage companies for our SHURflo Bag-In-Box pumps, which move beverages from both containers to dispensers. Coupled with continued penetration of Everpure filtration products in the restaurant market. Some of this strength was offset by a decline in the RV and marine markets resulting from a combination of unfavorable weather and high gasoline prices. Consumer filtration sales also were hurt by lower sales in the retail OMNIFILTER line, which we're moving to China in the second half to improve competitiveness.

Filtration sales, also are beginning to benefit from our improving ability to serve OEM's as a result of our new approach modeled on what we do at Pentair electronics packaging. This model specifically targets large branded OEM's that have broad global distribution. We've organized to meet the unique needs of these filtration OEM's by leveraging the technology and product design capabilities of our businesses and our India Research and design center, together with our low cost manufacturing facilities. This is part of our growth strategy for commercial and residential filtration and water treatment markets. We expect this OEM model to drive additional global growth as it gains traction in the marketplace.

Our sales of pool products increased nicely, despite the fact that there was generally cooler weather in the northern markets early in the quarter. In June, weather conditions reversed themselves driving record pool shipments for the quarter. New products include a redesigned heat pump featuring digital controls, the IntelliChlor salt chlorinator, a new diatomaceous earth filter for the above-ground pool market and the IntelliFlow pump with variable frequency drives.

In Europe our sales were down slightly due to adverse weather, tough growth comparisons and a slow economy. Our water treatment and filtration sales were relatively strong. However, water systems, pumps and pool sales were down. In response, we've crafted strong marketing programs to focus on building end market demand, while introducing new product offerings. Product line moves to low-cost manufacturing facilities and are expanding efforts in Eastern Europe will also help restore our growth in Europe.

The water group's second quarter operating income improved 58% over the same period last year and operating margins were 16% for the group. This strong profit performance benefited from our supply management efforts, productivity benefits resulting from ongoing application of our Pentair integrated management system are PIMS. And from our factor rationalization project. Higher selling prices also contributed to improving margins. The group showed significant progress in margin expansion with operating income margins of 16% in the second quarter, only 80 basis points below same period last year, prior to the WICOR acquisition. These margins are up 180 basis points over last year, with WICOR included. This is a great improvement, especially considering it was accomplished in less than a year. And it demonstrates the traction we're gaining from PIMS and supply management activity.

As I mentioned, the water group's integration plan is ongoing. At the end of the second quarter we had completed 11 plant closings or consolidations with another six announced and in progress. Collectively, these represent about 77% of the total square footage targeted for closure or consolidation in the plan. Naturally we incurred some productivity losses as we ramp up our new facilities and wind down old facilities do production and inventory redundancies. But these efforts will pay off. Product line moves to our New Mexico facility are continuing with the spa and bath line transfers nearly complete.

Second quarter production in our recently refurbished plant in Suzhou, China was up more than double over the prior year levels. With new injection molding capabilities and an additional carbon black extrusion line now in place. Utility and sump pump production is now underway at Suzhou. While costly and complex,l all of the global closings, consolidations and moves, together with other investments made in talent and our research and development are necessary to support our growth and profit objectives in water.

In the third quarter we had a peak in product moves. We expect these moves to put a drag on productivity to the tune of $4 to $5million. Sales at our enclosures group during the second quarter grew 15%, marking the tenth consecutive quarter of sequential sales growth and continuing the stronger than market growth in our enclosures business. North American sales remained strong in the quarter, driven by new products and deeper penetration of our vertical markets. Sales in the rest of the world were down slightly.

We continue to make great strides in our North American industrial markets. We have a very strong distribution network and have successfully leveraged our PIMS programs to improve cycle times and cost competitiveness. Allowing us to capture new business with major industrial OEM's. For example, in the second quarter we won a new program for aluminum power cabinets for cell phone sites from one of these major OEM's. We also received the first enclosure orders from other industrial customers including products for a mail automation program. And others for automation equipment in the semiconductor industry. Our industrial OEM business is growing strong and as more than doubled as a percentage of our total sales over the last 5 years.

Looking at the key vertical markets. In datacom, sales of our proprietary accessories for service continued strong. We're currently selling to three major datacom players and expanding our offerings to other key customers. We continue to win new, advanced telecommunications and computing architecture or ATCA programs with major datacom customers. And we're currently working on a variety of new ATCA based systems to serve this growing product platform. Major medical market opportunities with three top players include an expanded program with an existing customer, new programs requiring stainless steel enclosures and carts used for containment and transportation of biomedical material. And strong prospects for a new cabinet program for a next generation system. In telecom, we've received preliminary acceptance for a double bay cabinet with integration services. And our Brazilian operation will supply that same customer with the cabinets for a key development program. In addition, we will receive first production orders for a new Motorola chassis. And orders for the initial phase of a program providing advanced voice quality products designed for next generation wireless networks.

In the commercial vertical we continue to gain ground as a result of our improved availability and focused distribution. This has resulted in a 20% increase in commercial sales each year since 2001. This is even more significant when you consider that we've captured this growth in the market that is flat to down over the same period. Operating income for the group increased 25% as a result of our efforts to improve productivity through our PIMS activities and supply management initiatives, as well as improved pricing. Second quarter operating margins of 13.3% grew 110 basis points, compared to the same period last year. This was our 14th consecutive quarter of sequential ROS expansion for the group.

The enclosures group remains a pacesetter in applying our PIMS clean enterprise concepts. Which not only improves our operating performance but is a key driver for growth. In the second quarter, the group held a total of 120 tie-ins. Of which about one-third focused on building efficiencies in business processes. And the remainder focused on manufacturing processes. We've improved enclosures group margins each quarter for 3.5 years and now stand at an impressive 13.3%. We expect that there's still more to come, however. In fact we believe this group is capable of achieving 15% margins over the next two to three years. Now ask Dave to address the financials in his comments. Dave?

As Randy mentioned, we have a solid second quarter with very good results in many fronts. With this strong performance, the year-to-date EPS now stands at $1.05, up 50% over the continuing EPS from the first half of 2004. Cash flow of $117 million in the second quarter of 2005, the reconciliation of which is set forth in this morning's news release, brought free cash flow for the first half of 2005 to $19 million. Average working capital finished the quarter at 36 days, up three days from the end of the first half last year, which was before the acquisition of WICOR. We are targeting free cash flow of $200 million in 2005.

We continue to anticipate a significant reduction in working capital in the second half of this year. Our debt to total capital ratio was 33% at the end of the second quarter. This compares to 36% at the same time last year and 34% at year end. Which underscores the value of our positive cash flow initiatives. This is significantly below our target level of 40%. And it will be further reduced as cash flow increases in the remainder of the year. Gross margins corporate-wide were down 70 basis points in the second quarter on a continuing basis, which reflects the acquired water business. Gross margins continued to improve in both our enclosures and water businesses.

The lower initial margins of the former WICOR businesses are being somewhat offset by the excellent progress made by 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 again had a net synergy benefit in this quarter. It is also significant to note that compared to the as-reported numbers, including tools in the second quarter of 2004, we have improved our gross margin by 230 basis points.

Overall, our SG&A costs were down 150 basis points in the second quarter. Selling was 20 basis points higher than targeted selling expenses, which is laying the foundation for sales growth. G&A was down 170 basis points, due to elimination of expenses we had in the second quarter of 2004 for integration, planning and M&A activities in preparation for the WICOR acquisition.

From a reportable segment basis, the line item other, including corporate, is $9.1 million compared to 9.9 million last year. Lower costs reflected lower spending in the quarter. We expect expenses of $10 to $11 million in this category going forward per quarter. Operating income margin for total Pentair improved from 13.4% on a continuing basis in the second quarter of 2004, to 14.1% in the second quarter of this year. The improvement of 70 basis points is even more impressive if you consider that margins were up 220 basis points from our as-reported margin of 11.9% in the second quarter of 2004.

Our progress is improving, our operating margins reflect the higher quality of earnings we targeted from our recent transformation. We continue to a close the gap on the margin differential between the new water group and Pentair's pre-WICOR water group. Improving from a gap of 230 basis points in the the fourth quarter of 2004 to a gap of 110 basis points in the first quarter 2005. And finally to just 80 basis points in the second quarter. That's better than we anticipated at the end of 2004 when we said the gap would be about 100 basis points in this quarter. We will cross over in the third quarter with water group margins that are higher than in the higher prior year quarter.

The enclosures group continues its quarter over quarter operating margin improvement, with 13.3% ROS in the second quarter. Up 110 basis points from the same period last year and 20 basis points better than the first quarter of 2005. The group has reported 3.5 years of sequential quarterly margin improvement. Interest expense for the second quarter increased $4.2 million compared to last year. This was primarily due to the allocation of debt costs in 2004 through discontinued operations for tools. This contrasts with all the interest in 2005 being charged to continuing operations. In addition interest rates are higher in 2005.

Second quarter 2005 EPS includes two offsetting, one-time items. A $5.2 million pre-tax gain or a net gain of $3.3 million after-tax from the sale of our investment in the stock of LN Holdings Corporation. This gain was offset by a $3.2 million charge to tax expense, related to an anticipated settlement of a routine German tax exam for prior years that is likely to be unfavorable. The overall effective tax rate of 38.5% in the second quarter of 2005 was higher than our normal 2005 tax run rate of 35.5% due to the additional $3.2 million tax expense. Our estimated tax rate for the balance of the year is 35.5%. Now I'd like to turn the conference back to Randy.

Thanks Dave. Looking ahead, we're initiating third quarter EPS guidance in a range of between $0.43 and $0.47, which is at minimum 34% higher than the same period in 2004. In addition, we're tightening the range of our previous 2005 EPS guidance up from $2 to $2.10 to $2 to $2.05, or at least 48% higher than 2004 continuing EPS. While we trim the top of our guidance, we're still in our original EPS performance range we set a year ago. Looking ahead, there are two key items in our business that we're particularly focusing on. Number one, raising organic growth from the mid to high single digits. And number two, the productivity impact of simultaneous multi-plant moves.

On the second point, we've already demonstrated that the integration is going fairly well. We just have some redundant plant costs that are hitting a peak. Along with acceleration of one of the plant closings in the third quarter. On the first point, the headwind we've been facing in water systems, consumer filtration, and in Europe accounted for about 3 points of growth in the second quarter. We believe that this is a timing related too. And we still anticipate that we water can and will grow 6% to 9% organically in the longer term.

Our approach to growth in water echoed the approach that has been proven in enclosures. It includes clear metrics that we analyze on our growth strategies, defined vertical markets, not just product markets that we focus on. And specific growth initiatives that we're driving. Many of which we referenced earlier. We have every confidence that this approach to driving growth will generate equally good results in water. So we expect organic growth to improve. And of course, we expect to remain on track with our integration activities.

A quick look back at Pentair's second quarter margins over the last four years shows steady improvement from 10.2%, in 2002 to 11.6 in 2003 to 13.4 in 2004 and now to 14.1% ROS in 2005. This progressive improvement reflects the high quality of the businesses we have today and demonstrates the positive impact of our strategic initiatives on performance. Both of which will continue to build value for shareholders. Thanks for your attention. I now ask the operator to come online and please provide our audience with instructions for the Q&A portion of the call.

[OPERATOR INSTRUCTIONS] Your first question comes from John Quealy.

Good morning Randy and Dave.

Good morning.

Quick question on Europe. Obviously, we've heard rumblings out of weakness in Europe for some time. Can you talk a little bit about if any of that weakness surprised you in the quarter? And looking forward into Q3, can you give us a little more context there?

Well, if I look at enclosures, I would - - I'll talk about each business in turn it. In enclosures we're disappointed that we're having more success similar to the Pentair electronics packaging business, which has been driving enormous growth through their focus on OEM's. And we're getting a lot of growth in ATCA with the help of our European team but the sales seem to be coming in America and China more than they are in Europe. So, I think we need to redouble our efforts to gain new OEM business in Europe, in enclosures. In water, I would have to say that we were disappointed in the second quarter with the growth in both water systems pumps, which is what we call the residential water business - - water pump business. And in the pool business, which got off to a very very good start in the first quarter and really slowed greatly in the second quarter. Which of course we're examining now. We do have a lot of good programs going on the filtration side and the water treatment side. And I think our - - moving more to low cost sourcing is going to help the business grew as well, in water.

My second question in terms of Q3, on the bottom line, I think you mentioned, Randy 4 to 5 million in productivity losses has mean your factoring lines get switched around. My math is about $0.03 of a negative impact that quarter. What else is the moving pieces for EPS to face that headwind in Q3 if productivity I assume is number one?

Well, as we looked at in the old range, things have to go perfectly in integration and they had to grow at the top end of our growth range. Compared to where the analysts had us in growth, which I think the analysts on average has us at an organic growth rate of about 11% in the third quarter. And we don't see that, we see more of a continuing run rate of organic growth like we're seeing. A little bit stronger in water. Enclosures has been running, I think I said on TV at the outset of the year, I though I had enclosures at a 9% kind of a clip. 8% to 10% kind of a clip for the year would be very good. As you know, enclosures has grown well over 10% in the first half of the year. They're going to start covering some pretty strong quarters, so we expect them to still grow. We don't expect them to keep a clip of 15%. So, the way we look at it is it's about a 2/3, 1/3. 2/3 cost and 1/3 volume kind of the difference from our original expectations.

And my final two questions, looking into the Q4 period, can you comment on the bookings outlook? How it shapes up to you to get comfort on that Q4 number.

Yes, most of our business is really short cycle. We enter a quarter and pur backlog might be 25 to 30% of the sales we expect in the quarter. And not all that backlog ships in the quarter because there's only two or three businesses that have a long term backlog. Much of our business in water and enclosures is really short cycle. Even when we're on long programs with a datacom or telecom, we can be on platform but we don't necessarily get releases off of that without - - much much more than a week's notice. So, I don't think it's particularly helpful to tell you today how much of the backlog in the fourth quarter we have booked. We look at it more from an initiative standpoint. And I talked about the headwind, we think the headwind gets a little lower in the fourth quarter. And we expect more traction on the initiatives that we have going. So, that's the way I look at it.

And lastly, Randy, in terms of co-sourcing some pump motors, can you talk any developments you've made for plans moving forward?

We've got nothing - - no comment on the right now. Thanks.

Thank you

Your next question comes from Jim Lucas.

Thanks, afternoon guys. Couple of questions. First, Dave, could you walk us through on the cash flow side? We're getting a sense of the new seasonality of the earnings with the - - now that the transformation is complete. But can you give us a little bit of flavor on the cash flow of where that strength is going to come in the second half? Is it inventories, is it receivables or a combination?

Well, if you look at the cash report that we put out this morning, you will see that it is pretty seasonable when you look at some of the working capital items. And the second quarter actually we had a very very good question. We had terms basically in the pool business, which put a lot of the collections for that seasonality into the second quarter and give us $117 million of free cash flow in the quarter. As we look throughout the rest of the year, we'll continue to see some reduction in receivables. We'll also continue to see reductions in the inventory arena We built inventory toward the end of last year to support the customer in terms of some of our plant movement. And also, we expect to see additional working capital both from - - primarily from inventory coming from WICOR - - from the WICOR acquisition. So as we go through the last half of the year, we expect to see a significant reduction in our inventories. As well as continued impact to cash flow from our income.

Okay. And two unrelated questions. First on the enclosures, it's been impressive what happened with the margins. Could you talk a little bit - - the gap has always been there on North America versus Europe and what is driving you to that 15% goal that you alluded to? And then secondly with the balance sheet being where it is and cash flow improving in the second half, can you talk about some potential uses of that balance sheet and what's the environment out there, especially from an M&A standpoint is looking like?

Sure. On the enclosures business, we've talked for some years about our goal is to have the through distribution business, the Hoffman light to be around 20% profitability. And have the OEM business about a 10% profitability and sort of blends at 15. A lot more of our growth in EPS has come from the distribution standard business like Hoffman and from the OEM business in North America. Europe margins are struggling right now and a lot of it is because of volume. So, were looking at both the cost side and driving the volume type to get those European margins back up. Which were north of 10% back in the 2000 time period. So, that's the mix of margins as see it. And so our model hasn't changed. And we're thinking if we Europe fixed that's when we start getting the 15%. It's getting harder for Mike and his team to keep putting up those sequential numbers but we certainly know he's got the focus on that in terms of the improvement.

And the second in terms of the cash flow, we're sticking with our disciplines. We are looking at acquisitions. We're focused in both water and enclosures now. I've said before in enclosures our focused isn't - - it isn't capacity because we can build plants to make enclosures. And it's not for customer contact because we've been able to basically secure customers because of our technical capability and our cost position. So our real focus in enclosures is if you will, expanding beyond the enclosures business. We're interested in a number of what I would ancillary products that go into the - - as I like to call it in the technology business. We like to path of stuff, we like to make if you will, in the dumb stuff. We like the margins in the dumb stull.

And what's in the - - on the water side just from what you're seeing in the overall environment particularly on a valuation side?

Well, certainly valuations are higher because water has gotten hot. And certainly filtration they're very high. So we're looking at smaller businesses and we're looking at international, we're focused on international. We still like the pool business a lot and there may be segments of the pump and water systems business. Similar to like what we just got into with Delta Environmental, which is we think it's very intriguing growth play for us albeit small right now. In the water re-use in the local area. Gray water re-use.

Okay, thanks a lot.

Next question comes from Deane Dray.

Question on internal growth. If I heard you correctly, you said for the overall Company it was 7% and that was represented by 3 percentage points of price. Is that correct?

Yes, 3 plus.

And then how does that breakout between - - roughly between the contribution from price with water and enclosures?

They both did fairly well. I would say they're both - - I wouldn't really say there was really much difference between the two.

When you do an OEM business with enclosures and it's a new contract, does that enter into the pricing equation? Or is that just a same sort sales type of comparison?

Well, it's typically - - it's difficult to do because of it's a new kind of contract, we try to split what's price because a lot of times we're giving price up actually. But if it's a new - - it's a redesigned platform, the price goes down, we would typically called that a cost reduction as well as, and we wouldn't debit price. But we don't get a lot of price from OEM's today. We have gotten price, where it's common and materials cost is on us. We have gotten price. But we're constantly looking at cost reduction programs with OEM's. So less comes on that side.

And then on the cost-reduction program, where you stand today in the raw material price cost increases versus price increases?

Well we have them split between price and productivity. If you add price and productivity together it's higher than materials. We're ahead of the game on that map. We've seen some - - we've seen the pressure come off of steel but we're a big buyer of resins and moldings - - molded components - - injection molded components. And so we're getting all the freight surcharges due to oil. And most of the motor guys are still holding strong to 5% to 15% on a price increase. So, we're still fighting over that.

Thank you. And the last question, just to make sure I understand correctly, with regard to the change in guidance for '05, the nickel that comes out of the high-end of the range, if you just calibrate in terms of order of magnitude what the factors are to change your assumption changes for the back end of the year?

Well, as we look at the back end of the year, it's about 2/3 cost, 1/3 volume as we - - off of our performer. Probably a little more actually, if you're stroking off the tie-end of the range it would probably be 50/50 volume and cost. But versus what our last look was, it's about a 1/3 volume, 2/3. And we aspire to get to 2, 10 was going to be perfect execution on integration and high growth.

And when you say 50/50, that's all from the water side?

Versus the second half, from our expectations, yes.

Okay, and 30 million still on the goal for synergies for WICOR?

Right, right. And we're on track for that. We're - - we were actually ahead of the game for that. And this 5 million or so in the third quarter is going to take a chink but we still think we can get to 30 for the year.

Okay, thank you.

Your next question comes from the line of Brian Langenberg.

Good morning. A couple of things. Number one, just realizing that in the first full year it'ss a little tough but as I look at your gross margins in the quarter ,granted you didn't own WICOR last year but with pool and spa I would still that this is your strongest margin quarter for the year? And I was surprised that sequentially the gross margins were a little bit lower. Just maybe to put a number on what kind of unusual things may have taken place in the second quarter that went into the gross margins? And then let's just go a little but further down into the SG&A. I'm a little surprised that - - if the G&A was down 170 basis points on lower integration planning was that spend flowing through the segments last year as opposed to corporate?

We had some spending going through the segments and we have some segments going through corporate. It was split.

Okay so it was a mix. And just in terms of the gross margins, just talk to us a little bit about the sequentials. Because I was just surprised that that number didn't go up sequentially, even at a lower pace.

I always hate this answer Brian, but I have to tell you what it was mix. Even in our pool business we had the strongest growth in the lowest margin products within pool. And we still don't have - - and we had strong sales so - - the seasonal sales of the WICOR products, which aren't up to standard on the margin yet. So those are the two key drivers on the mix. We had a lot of focus on that. On the gross margins, our goal is certainly to get that back. And that's where we think going forward a lot of it as well, not in the third quarter but after the third quarter we'll impacts on the gross margin from - - that's where most of the integration kind of read out.

Okay and then just a last question on the 200 - - by the way nice performance on the cash flow in the quarter. Looking at the 200 million per year, is that a number you look at as thinking about right, stretchy, lay-up? I noticed the inventory hasn't come down yet. It seems to me like there is a good amount of juice you could get out of that in the second half..

It would be hard for me to say anything is lay-up today.

I'm sorry, that's easier for me to say then you to do. And I understand that.

Brain, we're targeting the 200 and I think that's probably enough said, really.

Your next question comes from the line of Dan Whang.

First question was regarding your current manufacturing footprint layout for water. Obviously you're making some shifts there. And what you expect that longer term, in terms of a percentage of manufacturing facilities in low cost countries? Do you think there's more to go?

Yes, there is more to go. We set goals but we have not said what they are externally. So, I'll leave it at that. For my business I'd rather talk to fold inside than out about that. But we have specific goals and we have plans on building our own factories. Right now we source in Eastern Europe but we of plans for both enclosures and water for Eastern Europe manufacturing. We - - as you know, have a lot of the capital we've spend has gone to building the capability in China and building the factories for water in Mexico. And we view ourselves long term. We believe we need to have manufacturing production in the countries where we serve timeliness. And a key driver of our PIMS activity is to keep those plants globally competitive. Because where we've done it, where we've really gotten the farthest in our PIMS activity, those plants are competitive even though they're in the United States or in Europe. So we have specific goals for low cost and China and Mexico are big polls right now. And ultimately, I think in Latin America, as well because we do have operations in Brazil. But we're a long way from there. We're today, we source about 15%-ish of our materials in low cost countries. And that shows you how much opportunity we have. And we have a lot more opportunity.

So I guess obviously that's from a cost standpoint it would also just your longer-term growth outlook is more based on aggressive - - relatively more aggressive growth from outside of North America?

We really - - for us to be - - to reach our ambition, which is to have at least 40% of our sales outside of North America, we need to be growing a lot faster. And certainly haven't demonstrated that in the first half yet. But we need to be growing a lot faster outside North America than in. And we have particularly strong objectives for India and China and the rest of Asia. In fact we built a new team in Asia in water to drive that. And I'm quite excited about what they'll - - what they're planning to do.

Second question regarding what you're seeing in terms of the competitive landscape out there. At water and enclosures, are you seeing anything unusual with respect pricing are any of the practices out there?

I would have to say no. I think our competitive position has improved in enclosures. We - - our win rates are quite good and we're quite disciplined on our pricing. So, I would say that we're winning on our capability versus price. As I mentioned earlier, we've actually achieved price increases. We look hard to see whether those price increases have dampened our growth. We don't see strong evidence of it. So, the things that are dampening growth are the things that I mentioned earlier. So competitively I mentioned earlier, Franklin us certainly going direct with motors, was a direct loss in sales for us. And now they're entering the pump business to compete with us. That's not new news but that's certainly significant news. And then 3M buying CUNO is - - in filtration is an interesting change. Don't know exactly how that's going to impact CUNO. They were a pretty effective competitor before. So I would - - those are sort of the, if you will, the big items that I'm looking at.

Okay, and finally, could you update us on how things are progressing along in your sort of joint venture with Ecolab?

We've got the product line filled out. The training is done and it's ramping up in the sales. I would say it's not meaningful yet, in terms of its impact on the growth, but I think it's a good prospect.

Okay, great, thank you.

Your next question comes from Robert McCarthy.

Could you comment a little bit just in terms of the tenor of the sales trends and order trends for April, May and June? In terms of what you saw for the complexion of the quarter?

Well as I mentioned in the script, in pool but also in some of the other water businesses, the coolness in the early part of the quarter dampened demand. And then it's been up in the latter part, particularly in June. We're on our 4/4/5. So, four weeks, four weeks and five weeks. So, the last month is always important to us in a quarter but in particular, June was a pretty good month all around. Enclosures was pretty steady throughout the quarter.

And I guess just thinking about July, obviously there's been a lot of press about how July has actually been relatively record heat nationwide. You may dispute that but just - - shouldn't we be thinking as that - - ?

It feels hot here. I'll tell you.

That might have something different form of temperature. But nevertheless if you'd think about it in terms of that and this short cycle nature of your business, July and August, wouldn't you - -you'd have to at least think about your guidance for third quarter. The main driver is the $5 million, right?

About 1/3 of volume. 2/3 costs, 1/3 volume, from where we saw it before.

Right. Even though some other industrial companies have seen a clear acceleration in June into July. So you wouldn't feel maybe organic growth here could accelerate? Or is there something idiosyncratic to your businesses that we should think about when modeling for the third quarter?

Well we - - the third quarter always has a drop-off from the second quarter in about a 1/3of the water business. So we have to untangle - - we still haven't lapped ourselves on WICOR. This is the first July. We still haven't lapped ourselves WICOR. And there was some pricing actions last year. So, there's lots that goes in and it goes out. And we try to take all of that into account when we set the third quarter guidance.

Okay. And then if you look at the implied fourth quarter guidance. Fourth quarter actually probably is in the range of $0.50 to $0.55, assuming your year guidance is intact. And is there something going on there in terms of just improved organic growth trends? The costs and productivity actions have already taken in the third quarter? Is there any kind of issue we have to think about in terms of the walk with the divestiture of the tools business in the fourth quarter of last year that will give you a bit of a headwind? Excuse me, I mean a tailwind rather.

Well, that would all be discontinued operations anyway.

That would be in discontinued ops. So that wouldn't be an issue at all?

Yes, it isn't an issue. But it's really those same two things that we expect to have less of that productivity problem. That $5 million productivity problem in the fourth quarter and in the third. Now, that's higher than planned, that $5 million.

So that's the key driver.

And we expect more traction on the growth as well as some of the headwind on the losses goes - - starts to go away in the fourth quarter.

Okay. And I guess, change in the margin too is that you're targeting enclosures, I guess in the next couple of years, to hit the 15%?

Our goal is to get both businesses to 15%. And our guidance all along on water was to exit 2006 with a run rate of the 15%. And then enclosures, and is '06 or '07, to be for 15%. We really need to address the Europe growth in margin issues to get there.

And nothing's changed with respect to water business for exiting '06 with respect to that?

No. I think we're not - - what we're saying with our guidance is we no longer see the ability to get to the high end of that range. But we targeted $2 with the Board 18 months ago and we're still going at it. This has been a big integration. We sold 40% of the Company and we bought 30% back. And I have to give all our people, because I know a lot of them listen, I give them high marks. I thank we have a solid B in terms of our performance. It's not an A+ but it's a solid B. And I think we've got a good team in place. And we're going to make it happen.

With respect to the enclosures, could you just comment? You - - it sounds like you're really starting to think about investing in this business again pretty significantly. One alternative would be perhaps to monetize this business. And I've heard from some of your competitors that that would be a highly priced business. Is that something you explore least in the abstract?

Not in the abstract or in the concrete. Right now we like our mix of businesses. We're creating a lot of shareholder value with enclosures. Enclosures also has been, if you will, the laboratory where we're developing a lot of the initiatives. Developing our practices and a lot of the initiative. First with PIMS - - actually first with supply management. And then with Pentair integrated management system. We're exporting people from enclosures to help us with water. We couldn't have done the WICOR acquisition without enclosures because a lot of the folks that were able to put on the project and actually move over to water came out of enclosures. And then finally growth. The vertical market focus and what we call our go program, grow organic, is really been pioneered during enclosures. And of those practices of the disciplines we're now launching in water to help us grow at faster then market. And enclosures has grown faster than all - - we do a peer check and we think enclosures has been growing at about 1.5 to 2 times the market rate for about two years. And we think it's because they're creating their future. So, we view enclosures as more than a laboratory . As really our beta test for a lot of things that we believe can create shareholder long term.

Thanks for your time.

Your next question comes from Curt Woodworth.

Hi, good morning. I was wondering if you touch a little bit more specifically on the competitive environment in filtration? It seems like for - - filtration is perceived to be kind of the higher growth market here. And is it right to assume that your filtration business is actually down this quarter this quarter will the loss of OMNI and - - ?

No, and filtration was actually up a little bit. We did lose some - - OMNI is our retail, as I mentioned. And it is down. But our filtration group, which includes our water treatment and our food service filtration at and our industrial filtration, it is not down for the quarter. I wouldn't say it has real strong growth either. Because we have the RV business and the marine business, which didn't do too well in the quarter, in there as well. From a competitive standpoint, we are largely focused in water on residential and commercial. So, the people that we see there and compete with there, depending on the product line, are people like CUNO. And some segments sometimes, it's a Culligan or smaller OEM's. So, I don't see that environment changing much. I think it's still pretty solid. So it's really more end market that's driving us in filtration, like the RV and light fixing this retail. And that's a cost position. It's a good - - we have some good placement on the OMNIFILTER, we're just not making any money. So we need to get to the lower cost position.

Okay. And then in terms of thinking about the earnings distribution of this quarter, given the seasonality in pool and spa, which annually is about 30% of business, would it be fair to assume that that would be 40% to 45% of earnings for this quarter?

We don't split the earnings by product line segment. We don't give that out.

For sales for the quarter? Just to get a sense for how important it is.

Well, it's important in the quarter. It is the most seasonal of our businesses. But actually part of pump os seasonal as well. The water systems business, which is the one I mentioned was down, year over year. Still, second quarter is very important quarter for them.

And how big is the water systems business as a percent of your pump business and what was it down this quarter?

We don't want to split that out either.

Okay. And then finally, just make sure I heard this correctly, on price, the price benefit was about 3% in both water and enclosures this quarter?

3 plus is what I said.

3 plus okay. Thank you.

Your next question comes from the line of Mike Schneider.

On the inefficiencies, just so I'm clear, $4 to $5 million inefficiencies and productivity losses I guess in 3Q is what you're saying. What was the comparable number in the second quarter?

That was number versus planned, it wasn't that big versus planned in the second quarter. That's why we're hesitating. We're looking at it versus - - plan is the wrong word - - versus forecast. Versus our last forecast we got - - it got $5 million worse. So, it's kind of hard to say. We had some good news on integration also against plan.

And why would the number actually grew sequentially?

We've got about 4 or 5 plants that are in play right now it. We've got the China and the Mexico factories ramping up in production. And they're not yet at the productivity level that we had forecast. Secondly, we've got what I call the exit plants. The plants that are exiting the product line. Some of them are actually being closed. Some of them are not being closed but the costs have to come out of the plants they're coming out of. And the costs aren't coming out of there fast enough either. And the final thing is, related to actually the OMNIFILTER business, we decided to - - the right thing to do was to accelerate that plant consolidation and move it to China. And so we've pulled those costs in to the third quarter, which our - - originally forecast to be in the fourth.

Okay, so this is money simply being spent on added work force facilities and presumably moving expenses?

Well, it's a reduction in force on people. Things that hit the P&L. A lot of the stuff we had in the first quarter and second quarter related to things that we could charge to the balance sheet, transition reserves under acquisition accounting. And a lot of these things are ongoing costs and they just don't get charged there. So, it's less the move costs than it is the, if you will, the redundant costs in the exit plants and the lack of getting the standard cost in the new plants fast enough.

And then looking at the integration in a different way, can you qualitatively comment on the lead times and on-time delivery, etc.? Are those showing signs of stress, as well?

We've had some. I think people can remember around the beginning of the year, issues in our Ashland pump business where we had some delivery. We've got caught up. A lot of inventory that we have, the excess inventory that we have in the system right now is to help protect service levels. We watch them very closely. And we'll flex some of the activity to make sure that we minimize any hurt to the customer. So that's something we watch pretty carefully.

Okay. And then just switching to the water organic growth rate, you expect it to accelerate to this 6% to 9% range in the second half? And is that driven primarily just the - -?

I expect it to - - I said longer term, I didn't say the second half. What I said about the second half on TV this morning, and I think I said earlier today, was is that we expect more of a - - the kind of run rate on growth that we saw in the second court in the second half with a little bit of improvement in water and maybe a little bit of decline in enclosures to - - from 14% level they're at now.

Okay, okay. And then finally, just the water pump group, is there anything about that market other than just unfavorable weather during the quarter that might explain why it's down?

Well, that's where we got hit by the loss of the retail business. And it's also where got hit by the Franklin. Wed use to sell a lot of Franklin motors as parts. And we're not selling to them anymore.

And is that conversion rate, that is Franklin going direct, is that happening faster than you expected that might explain why there's a discrepancy in volume? Or is there something else?

No, it actually, if you looked at our volume where it came out, versus I think where analysts had us in the second quarter, it's within 1%. On enclosures a little higher, water is a little lower. I would say it is about what was expected. What we thought is we'd have more success with some of our growth initiatives that were going to offset that, than we've seen.

And what are some of those initiatives?

Well, we're looking at adding distribution. We're doing cross selling. We have new products, I mentioned a couple of them. And the water systems. The gray water market, which actually we got some growth in. But it's just such a small business it's hard to offset it. So, it's new products and it's new channels and cross-selling are the keys.

And how much of that though, is baked into the forecast for the second half? Success in those areas?

Well, we expect to get more traction on those but not fully offset the headwind.

Okay, thank you.

Okay, your last question comes from the line of the David Smith.

Hi guys. On the water business, would you characterize - - the sort of the single digit growth, would you characterize that as the industry pace right now or would you say that X the industry you guys seem to be suffering a little bit do some internal problems, like Franklin and being one?

I wouldn't call those internal problems. What I - - when we look at Europe, we think we're growing with the market. When I look at filtration I think we're growing with the market. When I look at pool, and I've got some pretty good metric, I know we were growing with the market. So I would say it's limited to the - - the difference is limited to the water systems part of pump. Because we actually grew in the - - what we call the specialty pump groups. So it was really the water systems business where we're struggling with. And that's where Franklin hits us and that where the loss of that retail business hit us. And those were not small hits.

Did you have double digit kind of down year-over-year?

In water systems?

Yes.

In the first half, maybe. Maybe. On water systems, not just pumps.

One other thing. On the one-time costs side, where there any restructuring charges within the quarter that would have impacted margins? Or would you say it was a fairly clean quarter from the perspective?

In the second quarter?

Yes.

It was pretty clean. It was - - a lot of these ramp costs were ones we weren't planning to see in the second quarter because since it's seasonally high, we weren't planning - - we wanted to get past the second quarter before a lot of these plant moves hit. So, we're kind of - - everything is real active in the kitchen right now.

Is there any net benefit you can give us of where WICOR stood out in the quarter, dollar wise?

Well, the way we looked at it; and we looked at the year over year change and we said how much was - - how much of the earnings per share improvement was WICOR and how much was performance improvement in the rest of Pentair? And we kind of looked at as 50/50.

So it's a good add?

Yes. It's a good add. That's why I'd say we're - - I'd give us a B. It's not an A+, which is what it would have had to be to be at the high end of the range and that's why we trimmed the range..

Okay. And the last thing on Europe, can you just give us a sense of what turns this business around for you , both on the enclosures and water side? Or is that something that is going to take a bit of time to get through?

It's different things between water and enclosures. If you look at water, our margins are still very good. It's still a very attractive business. And we need to get more traction on some of these initiatives. Low-cost sourcing is going to help us a lot in the water systems business there, where we make our pumps in Italy. And then in the pool business, we were off to a great start. I think we might have got a little overheated in terms of getting stuff in the the distribution channel and it's not selling through fast enough. So - - I think in Europe, we've got some pretty good plans in water and I think we'll see that turn. And in enclosures there's some more fundamental issues. There's - - we need to get the same kind of, if you will, creative sales and marketing effort going. And getting some more new customers in Europe to drive volumes. And we need to leverage more low-cost. Which is one of the benefits we have in the U.S. is we have this will world class in Mexico that can deliver to the U.S. very fast. And we don't have that some local low cost capability yet. We will. That's our plan. So enclosures is a little tougher.

Okay, so I guess on both sides, to some degree, it sounds like an organic growth issue more than anything else.

It is. And the market's soft. And the European economies not to break up.

What about the competition of there? Is it pretty strong? I know Retall(ph) on the enclosures side.

Retall is strong but we've been competing with them. That's no real change in terms of their competitive position. I think a lot of it is - - the competitive situation is very stable in Europe. Operator, if you could come on. And thank you all for your attention. And Operator, if you could give directions on how to call in and get a replay.

Thank you for participating in today's Pentair second quarter earnings conference call. This call will be available for replay beginning at 3:00 p.m. Eastern Standard Time today through 11:59 p.m. Eastern Standard Time on July 30, 2005. The conference ID number for the replay is 7442561. Again the conference again for the replay is 7442561. The number to dial for the replay is 1-800-642-1687 or 706-645-9291. Again the number is 1-800-642-1687 or 706-645-9291. This concludes today's conference call. You may now disconnect.