濱特爾 (PNR) 2005 Q3 法說會逐字稿

At this time I would like to welcome everyone to the Pentair, Inc. third-quarter conference earnings 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.

Good morning, everyone.

Thank you for joining us today to discuss Pentair's results for the third 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 risks that expected synergies may not be fully realized or may take longer to realize than expected, the ability to close and integrate the acquisition of APW's thermal management businesses, 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 undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances.

Actual results could differ materially from anticipated results.

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

Thanks, Dave, and welcome to our conference call.

As noted in our press release, we're pleased with the progress we made on several fronts in the third quarter.

These include the following.

We reported a 44% year-over-year increase in earnings per share on a sales gain of 18%.

On a pro forma basis, assuming we had acquired WICOR at the beginning of the third quarter of 2004 and excluding favorable currency exchange, sales growth was approximately 7%.

Also on a pro forma basis, sales growth in our Water Group was approximately 5% in the third quarter, up from the low single-digits we had in the first half.

As anticipated, the Water Group's operating income margins of 11.7% in the third quarter crossed over and are now 60 basis points higher than the margins the Group recorded in the same quarter a year ago.

Our net integration savings on a year-to-date basis are $26 million, with our current full-year estimate of $37 million versus the full-year goal of $30 million.

For total Pentair, price increases of about 3% and improved productivity combined to more than offset inflationary pressures.

Our supply management initiatives delivered incremental gross savings of about $14 million in the third quarter compared to the same period last year.

However, we realized a decline in our price to inflation spread from the first half of 2005.

We expect this to continue into the fourth quarter as raw material input costs continue to rise ahead of our catch-up price increases.

We achieved our 15th consecutive quarter of sequential margin improvements in the Enclosures Group, reaching 14.2% -- another record.

That is 140 basis points above the same period last year and 90 basis points above the second quarter of this year.

Now I'll turn to the individual operating groups.

In the Water Group, sales were up 21% over the same period last year, or about 5% on a pro forma basis.

This performance was led by pool equipment sales that grew in the high-teens because of favorable weather conditions, share gains, and successful Fall stocking programs.

Specialty pump sales grew in the high single-digits, spurred by strong municipal, industrial and agricultural equipment demand and by pricing actions.

This higher demand was met by products manufactured by the Fairbanks Morse, Hypro and Aurora operations.

Hypro for example was up across all industries that it serves -- agriculture, fire, industrial and even marine.

The upswing is a combination of good market conditions and market share gains from picking up several important new customers and sales of new products.

Fairbanks has seen a pickup in its core municipal market segment.

This growth is attributed to a combination of large projects that shipped in the quarter as well as day-to-day business that has grown through consistent execution and a number of new products.

These products include larger split-case pumps for clean water in municipal applications, as well as some support for hurricane-related recovery.

Aurora capitalized on its quick ship capabilities to record higher sales of rush orders for pumps and spare parts.

European water sales were stronger in the third quarter than at any other time in the year.

Growth in European filtration was supported by strong market penetration into the food and beverage markets, while strong pump sales were driven by new product introductions and channel penetration.

The European pool business benefited from late-season warm weather as well.

New products were significant in driving third-quarter sales across water, including new transfer, split-case and solid handling pumps, and new pool lighting products and control systems.

As I mentioned before, sales of residential filtration products were affected by share losses at a big retail customer throughout 2004.

We have accelerated the move of this product line to China to improve its competitive position in the market and have increased our efforts to secure new filtration business with OEMs and other customers.

As a result, our momentum continues to build, with new OEM wins for shower filters, pitcher filters and faucet filters scheduled to kick in during the fourth quarter.

Operating income in water was up 27% due as the result of pricing and synergy savings.

Margins expanded 60 basis points from the same period last year to 11.7%.

Inflationary pressures intensified during the third quarter with raw material input costs rising and pressuring the margin between price and inflation.

While still achieving good supply management savings, resident energy prices are rising while realized prices have moderated, yielding benefits about $4 million lower in the third quarter versus the first two quarters of 2004.

This is disappointing given our early success in inflation recovery.

So, we are renewing our focus, moving aggressively to counter these cost increases and raising our product prices, but this will still affect us in the fourth quarter.

You may recall that in the second quarter conference call we said that we would be hitting a peak in integration-related product moves during the third quarter.

In fact, we had three ongoing plant shutdowns in the quarter, two of which were completed and one of which is still in progress.

We also had two low-cost country plants ramping up to accommodate the product relocated because of the shutdowns.

The shutdown that is still underway was delayed to ensure our processes were stable at the new location where our water storage tanks will be manufactured.

We're gaining NSF approval for these tank products now and are on track to complete the move in February.

The other issue mentioned in the second quarter was related to the logistics of ramping up manufacturing for select pool products at our new location.

I'm pleased to say that this move is back on track to achieve targeted cost reductions and one related plant was closed in the third quarter.

The full move is expected to be complete in the fourth quarter of 2005.

These issues aside, our integration plan is proceeding well and the benefits remain on track to achieve the expected cost savings and efficiencies.

In the Enclosures Group, our growth initiatives delivered 11% over the same period last year, principally due to strong sales in North American industrial, commercial, medical and networking markets.

European sales were down in the quarter as economic conditions continued weak.

The outlook for Europe is mixed, but we expect to advance our leading position in ATCA.

Sales in China more than doubled compared to the same period in 2004, reflecting continued success in OEM markets and the successful transfer of a cabinet program from a domestic manufacturing location to our enclosures operations in Qingdao.

The Enclosures Group rolled out a number of new products targeting growth in specific end markets.

For example, new cable management products were introduced to drive growth in the networking market.

In addition, two new cabinets were targeted towards high thermal load applications and a newly-launched data interface for industrial applications is winning awards.

The Enclosures Group operating income was up 23% and set a new record.

This performance was driven by volume, supply management savings, productivity improvements and pricing.

Margins reached 14.2%, expanding by 140 basis points over the third quarter of last year and delivering the Enclosures Group's 15th consecutive quarter of sequential margin improvement.

Raw material costs increased about 6% in the quarter and were offset by actions in both pricing and productivity.

Steel costs are expected to moderate through the balance of the year, although higher transportation and energy costs are anticipated.

Just last week we announced our intent to acquire APW's thermal management and electronic solutions businesses.

These businesses, with fiscal year 2005 sales of about $140 million, have strong market positions, good brand recognition and a reputation for high-quality, innovative products.

It includes three U.S. facilities, the largest of which is located just a few miles south of our main Hoffman facility.

In fact Hoffman's current thermal products are manufactured by MacLean, the core of the businesses we are buying.

We expect this transaction to position Pentair Enclosures as a global leader in providing thermal management solutions and integration services to the telecommunication, data, medical, security and industrial markets.

In fact, some 60% of these new businesses' sales are now derived from industrial, medical, security and tested measurement customers already.

We believe the thermal management business presents significant upside in that it further enhances our capabilities and product offering and provides a new dynamic platform for growth.

The acquisition will also strengthen us in the emerging ATCA market, giving us technical expertise on the West Coast, where many potential customers are located.

Beyond the revenue opportunities, we also expect to realize synergies by applying our proven lean enterprise processes.

As a result, we expect the transaction to be accretive to earnings in the first full 12 months of ownership.

Pentair's disciplined integration process will be led by a team comprised of executives from Pentair and the acquired businesses.

Integration planning is already underway and we anticipate being ready to hit the ground running once the deals close.

Due to this acquisition, Pentair Enclosures will create a new thermal business unit and will integrate the electronics solutions business into our Pentair Electronics Packaging.

This signals the beginning of a transformation in the Enclosures Group into a broader technical products business, one that will better serve customers through expanded product and service offerings.

Now I'll ask Dave Harrison to address the financials in his comments.

Dave?

Thank you.

As Randy mentioned, we had a solid third quarter with very good results on many fronts.

With this strong performance, the year-to-date EPS now stands at $1.51, up 48% over the continuing EPS from the first nine months of 2004.

Cash flow of $76 million in the third quarter of 2005, the reconciliation of which is set forth in this morning's news release, brought free cash flow for the first nine months of 2005 to $95 million.

Average working capital finished the quarter at 37 days, up four days from the same period last year.

We are currently estimating that working capital throughout the remainder of the year will be higher than previously anticipated due primarily to increased sourcing out of Asia, with longer supply lines and higher levels of safety stock of certain materials, particularly resins and motors.

We expect to mitigate these conditions throughout 2006 as we optimize the supply chain.

We expect free cash flow for 2005 to be within the range of 170 to $190 million.

Our debt to total capital ratio was 31% at the end of the third quarter.

This compares to 54% at the same time last year and 34% at year-end.

Following the purchase of APW's thermal management business, our debt to total capital level will be approximately 32%, well below our target level of 40%.

Gross margins were up 10 basis points in the third quarter, with price and productivity offsetting the unfavorable product mix and inflation.

The integration costs from the water businesses' factory rationalization activity in the third quarter of this year were approximately equal to the expensing of fair market value inventory adjustments in the third quarter of last year that related to the water acquisitions.

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

Selling was 20 basis points lower due to sales growth starting to outpace the selling expenses as the targeted investment for sales growth begins to pay off.

G&A was down 50 basis points, primarily due to elimination of expenses we had in the third quarter of 2004 for integration planning and M&A activities related to the WICOR acquisition.

From a reportable-segment basis, the line item other, including corporate, is $8 million in the third quarter.

As I mentioned in earlier quarters, this 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.

We expect expenses of 12 million in this category in the fourth quarter.

Operating income margins for total Pentair improved from 10.5% on a continuing basis in the third quarter of 2004 to 11.3% in the third quarter of this year.

On a continuing operations basis, this is the highest third-quarter operating margin achieved since 2000.

Our progress in increasing our operating margins reflects Pentair's ability to acquire businesses with lower initial margins, and then, through programs such as PIMS, work quickly to improve their margins.

In regards to the WICOR acquisition, we have completely closed the gap on the margin differential between the new Water Group and Pentair's Water Group, and now crossed over in the third quarter of 2005 and improved margins by 60 basis points over the third quarter of 2004.

The 60 basis points improvement includes our strategic investments in global growth initiatives.

As you may recall, this was an initial unfavorable margin gap of 230 basis points in the fourth quarter of 2004, narrowing to a gap of 110 basis points in the first quarter of 2005, then 80 basis points in the second quarter.

As predicted, we did cross over this third quarter with Water Group margins that are higher than in the prior-year quarter.

We are on track with our post-acquisition integration activities in water, achieving a net synergy benefit of approximately $11 million in this quarter.

The Enclosures Group continued its quarter-over-quarter operating margin improvement with 14.2% ROS in the third quarter, up 140 basis points from the same period last year and 90 basis points better than the second quarter of 2005.

The Group has recorded over 3.5 years of sequential quarterly margin improvement.

Interest expense for the third quarter decreased $400,000 compared to last year.

This was primarily a result of a bridge financing and the allocation of debt costs in 2004 to discontinued operations for Tools.

This contrasts with all the interest in 2005 being charged to continuing operations.

Lower interest expense resulted despite higher rates.

Third-quarter 2005 EPS includes a $1 million favorable tax accrual adjustment related to the recently filed 2004 federal tax return.

The overall effective tax rate of 32.3% in the third quarter of 2005 was due to this onetime item and taking the year-to-date tax run rate from 35.5% to 35%.

This resulted from proactive efforts to reduce the tax expense through international tax management.

Our estimated tax return rate for the balance of the year is 35%.

We will be adopting FAS No. 123-R which requires the expensing of stock options in the first quarter of 2006.

The exact impact on the EPS and cash flow cannot be quantified at this time.

We are also evaluating the impact of an early adoption in the fourth quarter of 2005.

We do not expect the adoption to result in amounts that are materially different from the current pro forma disclosures under FAS 123.

Now I would like to turn the conference back to Randy.

Thanks, Dave.

Our third quarter was notable for a solid EPS gain, improving sales growth and excellent progress in advancing the integration of our new water businesses.

As we looked at the fourth quarter and 2006, we saw a number of factors affecting us.

In the fourth quarter, the following factors affected our current outlook of $0.40 to $0.42 per share.

These include slightly lower volume and less profitable mix in water than in our prior outlook, continued pressure on prices over-inflation, closing the APW transaction, which will be dilutive in the fourth quarter due to the write-up of inventories, and higher investments for the future in support of growth and building our global business, particularly in Asia.

On this last point, we have expanded our engineering resources for new product development in Asia, creating an engineering design center in China and expanding our center for development research in India, in which we now have more than 80 engineers.

We have also added bench strength to our Asian management team to execute our strategy to expand international sales and operations.

As we set guidance for 2006, we expect to continue to increase margins in water, continue to invest in our global expansion, and given the uncertainty in the economy, are using a mid single-digit growth outlook.

As a result, we are initiating guidance for 2006 EPS in a range between $2.20 and $2.30, excluding the pending adoption of FAS 123-R requiring the expensing of stock options.

This will result in an expected EPS increase over 2005 of between 15 and 20%.

Thanks for your attention.

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

(OPERATOR INSTRUCTIONS).

John Quealy with Adams, Harkness.

Just a couple of quick questions here.

First of all, Randy, you just gave us it looks like four reasons about your Q4 outlook in terms of what's driving that.

Can you talk about what was most surprising to you this quarter?

Was it the volume in the mix or the inflationary cost?

Can you just give us a bit more detail on what was most surprising to you on that side this quarter?

One of them was a new item, which was the APW acquisition.

Closing it is going to cost us $0.01 to $0.02 in the quarter because of the accounting for the acquisition.

So, I would not call it a surprise, but it's certainly a difference from the last guidance.

I wouldn't call it a surprise either, but I would call it disappointing that -- we did such a good job of getting out in front of inflation on pricing, and it was a real good help and driver of our performance over the last 18 months.

As we looked at the third quarter and saw that $4 million decline, if you will, from price -- in price recovery over inflation in the third quarter, and we project that in the fourth quarter, that was I would say the biggest concern as we looked at the fourth quarter.

Now, I see that as temporary because we are hitting the price pedal again.

I think maybe we declared victory a little too soon.

And certainly the jump up in resin prices and energy, which hits water the most and also hits our freight costs, obviously, the energy costs -- I would say that jumped up faster than we could respond.

So, now we're in a position of not being proactive on pricing but being reactive.

And that's not where we want to be.

So, I would say that is probably number one.

The investments are what they are.

They are a little higher in Asia this quarter because our costs are running higher in Asia.

But I'm pretty pleased with the investments we are making in Asia.

So, I wouldn't say that's a surprise.

I would say that it's getting a little bit ahead of our sales in order to pay for some of those.

So, that's also, I would say, the second of the four in terms of differences.

My next question.

In terms of the working capital use in the next quarter here for (indiscernible) hitting the leadtimes in safety stocks, can you talk a little bit about what particular materials -- it looks like resin and some motors.

Does this so to speak solve the motor issue from Franklin that we had a couple of quarters ago?

Let me -- the Franklin motor situation continues.

They took the direct sales motors that we were selling a year ago.

In fact, it hit a peak in the third quarter in terms of the year-over-year impact on our sales.

So, let me first talk about resins.

I was pretty pleased with -- after Hurricane Katrina took out all of the capacity in the Gulf Coast, within 48 hours our supply management team was actually securing new resin supplies because we were concerned about shortages.

And we decided to lay in safety stocks of resins not only for ourselves, but have our -- we buy a lot of parts that are already molded.

So, we have our molders laying in safety stock as well.

So, that is one element.

Motors is an element of it as well, because we -- number one, we have incentives to buy certain amounts of motors, so we like to make those because we get rebates.

So, we want to hit those targets.

We also are sourcing from other people, which is moving us from a consignment situation to one where we have long leadtimes because they are not domestic-based suppliers.

It's part of our motor solution.

My last question.

It looks like Europe was a little softer for enclosures but was better for water.

Can you just give us a little bit more background on that geography for your business?

Yes, I would be glad to.

I was really particularly pleased with the performance of our water Europe business.

They had an incredibly good '04, much better than market.

The first half was tough.

But what we saw kick in, in particular in the third quarter -- because they were up actually -- in Europe water was actually up low double-digits.

And it was not because of the market, it was because a number of programs in the foodservice filtration area, where we had really good growth year-over-year.

And secondly, our pump business, which actually came with the WICOR acquisition in Italy, is a small player outside of Italy.

And they did also a number of new products over the last seven months and new penetration strategies, particularly in the professional channel.

And they're having good success with that.

I was particularly pleased to see those two things.

At the same time, enclosures continues to face a very tough market situation and we haven't really cracked a lot of new customers over there.

We continue to secure good business, but the electronics world in Europe is not a good one.

Robert McCarthy, CIBC World Markets.

I wanted to talk just about your core organic growth rates, perhaps breaking out for pool and spa pumps and filtration.

Can you give that kind of detail?

We usually don't give it in detail, but I will give you a rough order of magnitude.

Pool continues to be our high performer in the water group.

And if you take a look at our largest customer, you can see their kind of growth rates.

And we kind of parallel that.

I think we're both gaining share.

We have a business that is very adept at new product innovation.

And I think it's the best sales force in the world.

So, that combined with what I think is very good general management there.

One of the things we look at, and we have looked at through the whole WICOR integration is that studies show that when you have an integration the size we have gone through, 91% of the time you lose sales.

And when I take a look at our pool business, where we had pretty substantial stay right from WICOR and pretty substantial Pentair, and I see that we are actually gaining sales in both sides, I think our team has done a heck of a job on the growth side there.

So, pool is number one.

Pump was in a hole in the first half because of the loss of the Franklin motor business, and loss -- we have talked about this before -- of placement at one of the large retailers who decided to add a second supplier, which was their -- it wasn't an issue with our supply.

It was one that water was getting to be a big enough category where they did not want to have all their eggs in one basket.

So, they brought in a second supplier.

So, we have been fighting that.

And that caused pump to be down in the first half.

In the third quarter we actually saw pump increase in sales.

Despite those two headwinds, they actually got growth -- admittedly low growth -- in the third quarter, but a step-up in growth, whereas they were down in the first half.

I mentioned Europe already.

So, I mean, if you sort of ranked order of the growth, I would say it was -- well, it was pool Europe, pool Asia Europe, pump, and then filtration was flat.

And filtration was flat because of some of the challenges they have.

And they have also -- they lost a number of retail products earlier.

We have talked about that in prior quarters.

In fact, we have been busy moving that to low-cost country sourcing -- I think I mentioned that -- to get back into that market.

And that has been a major focus of us.

In filtration we have got a lot of very interesting programs underway, particularly on the OEM front, that we are pretty bullish on looking at next year.

We'll get some of that in the fourth quarter.

So, that is sort of the rank order in terms of the organic growth.

Okay, thank you.

In terms of the raw material input costs, I mean, now obviously that's a concern, particularly on the water side.

And I think you alluded to a $4 million sequential drag versus the first half of the year.

Is that correct?

Right.

Is there any way you could -- I know it's tough, and it may not be the right way to think about it -- but to apportion how much of it was the actual raw materials itself, just energy cost, logistics cost?

What should we think is the main driver?

And perhaps if you had any kind of quantification of the kind of resins and what kind of price inflation or cost inflation you were seeing there?

I mean, I will just talk generally.

I mean, basically what we buy -- we buy a lot of polyethylene, polypropylene and ABS.

And when you take a look at the total resin plus parts, plastic parts we buy, that is well in excess of $100 million worth of annual purchases.

And we are seeing -- and all of that stuff comes from natural gas or oil -- natural gas liquids or oil.

And so, they're seeing all this pressure on energy from the energy prices.

So, we are fighting to keep those increases down in the 10 to 15 to 20% range.

But it's a fight to keep it there.

And then, I mentioned earlier about there's supply -- we're concerned about shortages.

We want to make sure that we can make the products and serve customers.

So, I mean that's the kind of inflation we are fighting there.

When I look at the third quarter, I will tell you that 4 million is about half lower price and half higher inflation.

Now, in enclosures, they don't buy that much plastic.

But they do have pretty high freight costs and they do have high natural gas usage.

Freight plus energy is probably in the $150 million range for us to buy, 125 to $150 million.

So, that's the other area.

And we are looking at our freight minimums.

We're looking at everything you'd expect us to look at in terms of dealing with those issues, and then also just in terms of running more energy-efficient operations, which our folks -- our manufacturing folks are all over.

In coming up with your guidance for '06, obviously, you've moderated kind of your core organic growth to kind of a mid single-digit range.

But in terms of your price cost recapture, in that assumption is that the fact that you'll be able to get -- at least have some success in getting price?

Yes.

We are assuming this issue (indiscernible) on the third quarter we are seeing the fourth quarter -- we're going to get it back on track.

I believe that we will because we had it on track for 18 months.

And we are in businesses where we have more pricing flexibility.

There are some lines which are tough.

The retail filtration business, as I mentioned, is a tough place to get price.

That's why we're moving that.

We have moved it already to low-cost and sourcing and shut the plant down.

So, we won't get it everywhere, but we will get it in most places.

Jim Lucas, Janney Montgomery Scott.

First question, Dave.

CapEx and D&A looking out to the next year -- do you have any preliminary numbers there?

Yes.

We are looking -- obviously, it's going to go down a little bit.

Our 65 to $70 million spending that we're looking at this year includes building factories in Mexico, in China.

And next year we probably won't have that same cost.

We will be doing some of it probably in lower-cost arenas in Europe.

And we're looking at something in the range of -- versus the 65 to 70 that we have this year, something in the range of probably 55 to 60 next year.

And then on the amortization and depreciation together, we are looking -- this year it is about -- looking like about 82, $83 million.

And next year we're looking at about 85.

Okay.

Thanks for that.

Just a clarification on the outlook.

With that 2.20 to 2.30, you mentioned you don't have the option expensing.

Once that is evaluated, does that imply that the guidance for next year could go a little bit lower?

It does not include the option expensing, nor does this year.

So, the comparisons would be similar in terms of the increase year-over-year, because you would also have --

You're going to pro forma it.

I think whether it is pro forma in early adoption (multiple speakers)

It's apples and oranges (multiple speakers).

We are looking at -- either way we are looking at a 15 to 20% earnings growth year-over-year, which is the goal that the Board and I have for the Company.

And we believe we can do it and we will.

Just wanted a clarification on that.

And then, on the pricing side, not to beat a dead horse here, but can you talk a little bit on the water side about is there something -- you touched on a few of the product lines where it is tougher to get pricing.

You've got this six-month lag.

You had done a good job early on.

What has happened over the last one or two quarters where the pricing has become such a disconnect from what was happening on the inflation side?

Part of it is the inflation is hitting the businesses that hadn't been more aggressive on price.

You know, in particular filtration.

That probably is a place where we are suffering the greatest because that's the highest usage of plastic, is there.

We also have pretty high usage of the plastics in pools, but pool I would say is -- has been in control of their destiny on the pricing side.

So, that is one element of it.

Part of it is our (indiscernible).

I think we were more aggressive out of the box on pricing.

So, you look at it in the third quarter; pricing is about 3%.

It was actually higher than that in the first half.

So, it's really a bit of both.

And you know, we are still achieving price plus productivity in excess of inflation.

So, that was the goal we set.

And in fact, what we did when we set the plan on the integration of WICOR, what we said was -- we set some supply plans and some productivity plans and some rationalization integration, which is where we came up with the $30 million.

And we stayed true to that and measured that.

And when we started to see inflation which really came after the planning cycle, what we said is okay, we're going to look at price and inflation together.

And we got out of the box fast on that on the pricing.

And you know, I'd hate to say we took our eye off the ball on the pricing side.

What I would say is we need to put our foot to the pedal more in pricing.

And that's why I said earlier it's about half and half, price versus inflation, in terms of that $4 million that I saw in the third quarter.

Finally, on enclosures you had alluded to it a little bit earlier.

When you look at Hoffman versus Schroff, clearly North America continues to carry the torch here.

Can you expand a little bit more on what you are seeing in the enclosures business in Europe?

You alluded to the fact that the outlook there is mixed.

Can you talk about the pluses and minuses of what you are seeing there?

Well, you know, our European business is a highly technical business.

We have some of our deepest technical capability, particularly in the advanced telecommunication architecture, the ATCA business.

And we are doing well on that.

But a lot of the programs they are supporting are actually programs in North America.

They face a tough situation in that a lot of their customers have moved their production out of Europe.

We don't have our plant up in Poland, so they are facing some tough competitiveness issues now.

We have low-cost production up and running in China and in Mexico, so we are utilizing that as best we can.

And we don't really play in the industrial business in Europe, which we do in North America.

So, I think that we do have some strategic issues there that we are dealing with.

Deane Dray, Goldman Sachs.

The first question relates to, Randy, when you identified the four components of the shortfall in the fourth-quarter outlook.

The first was mix.

Could you give us the next layer of detail between water and enclosures, how mix is considered to be lower or working against you in the fourth quarter?

Let me talk about enclosures.

There is an element of enclosures mix.

The industrial business is a lot more profitable than the electronics business.

And we have fewer days in the fourth quarter in our industrial business.

So, the impact there is slightly worse mix.

But the bigger issue is in water where we have a higher mix of Asia where we don't make much money yet.

And we have a lower mix of some of the businesses where we make the highest amount of money.

For instance, the water treatment area.

So, that is the mix I'm talking about.

Even within pool, we have a number of backyard product lines which we actually source and just pass through.

And those have grown faster than some of the products we make.

So, we make lower margins in some of the sourced products.

That is a factor as well.

And if you size it, you said the APW acquisition might put you $0.01 to $0.02.

How much would mix contribute to that?

I put growth and mix together, and I saw that -- versus the former consensus of 51.

I saw that in the $0.02 to $0.03 range.

And there is also a volume piece there.

I talked about it in terms of our -- I think water is going to grow organically, but my expectation in the former look was a seven-ish kind of number, not a five-ish kind of number.

And now it is five?

Yes.

Same as the third quarter.

I understand.

In WICOR, the synergy number had been 30 million and now it's 37.

It sounded from the prepared remarks that the seven is coming from additional cost takeout.

Is that right?

Well, it's really right on the same time.

We did accelerate one plant closure from next year into this year, which was in our cost here in the third quarter.

It was related to that filtration business I talked about.

It is higher rationalization savings and higher supply savings in areas that are not getting affected by the inflation.

So, I think our supply -- we measure our supply (technical difficulty) on a net basis.

On a gross basis they're overachieving.

And that is all for the fourth quarter?

Well, the different -- what we had was we had $26 million through the first three quarters.

And so, we are projecting in the fourth quarter the number 11 to get to the 37 million.

If I look at your goodwill, it looks like you have had an increase of 22 million and change sequentially since the second quarter.

What does that relate to?

We actually.

If you go back and look at the acquisitions that we had last year, you have 12 months to true up the opening balance sheet.

So, it's primarily coming from truing up that balance sheet.

Is that a write-up of inventory?

Is it accounting adjustments?

What is it?

It's across the board just about in all of the accounts.

Including WICOR?

That's correct.

Last question.

It looked like corporate expense was lighter in the third quarter.

What were the circumstances there?

If you look at it compared to the prior year, we were up about $1.5 million over the prior year.

It fluctuates from quarter to quarter depending upon the expenses, the various different kinds of variable expenses that we have in the quarter.

So, it is running about the same as it was last year with the additional $1.5 million of amortization that we have on the tax side.

And, Dave, that additional amortization, that's for tax planning for next year?

No, that was tax planning that took place back in the late '90s that was being written off over a long period of time and now it's being accelerated because we're doing some more tax planning for the international arena that's going to be put in place at the end of next year.

It was done in 1997.

What is the outlook for tax in '06?

We are currently working on a rate that is 35, about 35%

Is that from higher contribution from lower tax jurisdictions?

That's right.

Michael Schneider, Robert W. Baird.

I'm wondering if you could first just address, Randy, your comment of reducing your growth expectations, say, from seven to five.

I understand the mix is working against you.

But what has actually slowed down, I guess, in your mind?

Especially since as we get through the fourth quarter, you start to lapse some of the retail pump losses, some of the residential filter losses.

So, it seems to me comparisons are getting easier and you're going to put through more price.

So, what causes the reduction in the growth outlook?

Just more uncertainty in the market.

We serve residential and commercial markets, so I'm just being cautious.

Is there any sign, in your eyes at least, from you guys on the ground that the consumer is indeed slowing down?

Not really.

When I look at the specifics, I feel pretty good about specific programs.

I mentioned the filtration OEMs.

I feel good about a number of the pump programs.

In fact, all of our specialty pump businesses, but not (ph) the municipal and industrial and agriculture, are looking very good.

We have been down in our water systems business in pumps, which is the primary business that serves residential.

But there's a number of factors for that and I saw some improvement in the third quarter versus the first half.

So, I just think I don't want to be overly optimistic.

I want to actually execute and perform my growth before I start counting on it.

And then also in '06, the margin comment you made is you expect margins to be up in water during 2006 over 2005.

And I'm trying to get my model to reconcile to that.

Because if I model mid single-digit growth for both businesses, it actually implies that margins in water will either be down 40 or up 30.

Well, first of all, enclosures will go down because the APW businesses have lower margins than our current enclosures business.

So, enclosures margins will be down.

And then they will increase again.

We expect to get it up back above 14%.

Our goal is to get all of our businesses to 15% EBIT ROS.

You know, we're still committed to having water at an exit rate of 15% at the end of next year.

Our plans add up to doing that.

What we're looking at is in terms of you have got to -- we see Asia growing faster, which is lower margins.

We see continued investment in growth, and particularly in the global side.

I don't know the details of your model, but the details of my model says that we're going to have water exit at 15%; we're going to have enclosures go down but get back up.

We will see improvements even within the year.

So, you must have a pretty steep ramp of margins in water through the year?

No, I think it's continuous.

Our view is that we should be able to see that 15 to 20% growth every quarter.

Our second quarter, obviously, is our best quarter in terms of margins.

It goes way up above the 15%.

So, there is no ramp that you would look at.

Okay.

So if your second quarter is well above 15 and your fourth quarter is presumably at or near 15, that means you're going to average the year somewhere in (multiple speakers)

No, no, no.

When I say exit rate 15, I mean the average of the year.

We'll be able to do 15 going into '07.

That was the goal we set 18 months ago for water.

So, it's not 15% in the fourth quarter.

The seasonality gets you.

But if you take a look at what we'll be able to perform at -- and I can't tell you right now what the equivalent fourth quarter number is.

One other comment on the growth side.

The reason that I'm cautious is I'm reading the same things you are about what's going on with consumer confidence, what's the impact of energy going to be on spending.

And I just don't think it's prudent to assume that we are going to have steady-as-you-go growth plus our growth initiatives on top of that.

I just don't think that's the prudent way to set guidance.

Step back again on the margin question.

So to be clear then, you are saying that your goal is to have an average water margin of 15% for the entire year of '06?

No, '07.

It will be 15% in '07, but we'll have the cost structure in place by the end of '06 to secure that.

Okay.

Along the issue of the integration savings, you mentioned by year-end you expect to be at this 37 million run rate.

Do you have any sense of what you'll have realized this year (multiple speakers)

37 is what we will realize in the year.

What do you think -- and if you (multiple speakers)

Our run rate will be in excess of -- I mean, you can see if I was 26 million and I'm doing 11 million more in the fourth quarter, then our run rate is 11.

So, we will be -- our jump-off point, which is the way we measure it -- our jump-off point will be 44 million for the year.

Okay.

Final question, just again circling back to growth.

Randy, you mentioned that studies show 91% of acquisitions this big generally lose revenue in the combination.

And you held up pools as the example of the one that has done best in that challenge.

Where have you seen the most leakage?

In pump because of the Franklin actions and the loss of the retail.

But water in general -- that comment -- we expect to finish the year with organic growth, even ex price.

It may only be 1%, but we're going to finish it there.

Brian Langenberg, Foresight Research.

A couple of things.

Let's just talk about pumps for a little bit.

I'm not going to ask you to go down every product line, but it's a big enough part of your company.

Just take us through each of the pieces of the water segment.

And when we say the sales were up in pumps on a year-on-year basis, kind of give us a little bit -- maybe a little bit more of a handle on that.

Because with our channel checks, everybody is saying the market is up across the board, understanding the Franklin issue and what have you.

Are we thinking up low single-digits here in the quarter?

Was that about right?

The second thing.

If we could kind of dive down a little bit.

Just talk to us about year-on-year change of profitability for the three big areas of water between pump, pool and filtration.

I'm not looking for the absolute dollar amount but some kind of percentage change year-on-year.

First of all, on pumps in general, low single-digit.

Pump was -- as I mentioned, pump was down in the first half.

It was actually up.

And it was driven by high single-digit -- I said this in the script -- high single-digits in the what we call specialty pumps, which is our Aurora and our Fairbanks Morse, which is where we do the municipal business, and Hypro, which is a nugget of the business that came in the WICOR.

So, the whole pie, if we thought up one to three, that would be about right?

I said low single-digits, so (multiple speakers).

In terms of margins, we have made improvements across the board in all segments.

There's the one place where if you looked at it year-over-year on a pro forma -- well, what we did is we established our pro forma.

It was such a big change.

We took WICOR as was.

We added it to Pentair as was, established a pro forma, and then measured everything versus that pro forma.

And on that pro forma basis, every single operation with the exception of Asia-Pacific was better year-over-year.

Profits up year-on-year pro forma.

Not just profits, but ROS was up year-over-year.

And the reason Asia wasn't up was twofold.

One, they had an Australian business that isn't doing that well.

But secondly, we put a ton of investment in, because Asia is way to small for us.

We have a new president.

We have the investments we made in engineering there.

We have the investments we made in plants there.

And I don't regret any of those; in fact, I'm quite excited about those investments.

When you say new president, you are not talking about Rick, obviously.

He's the Vice Chairman.

You're talking about in China (multiple speakers)

We have a new President of APAC, of Asia-Pacific.

And in fact, not only is he in charge of water, he's also in charge of enclosures with the recent realignment that I did.

And how long ago did that happen?

Just remind us.

The new president.

Four months ago, five months ago.

It was June.

Last thing on filtration.

In terms of pockets of softness, it sounds like most of this is on the tanks and the pressure vessels, which is probably the cost of metal bending part of the sexy (ph) thing called filtration.

Is that fair?

That's by and large where you're getting some cost and margin pressure?

Well, there are two areas.

One is the residential filtration, which is the old -- it's not even all of tanks.

It's really -- I would say the weakest performing pieces of WICOR when we bought WICOR were in the filtration arena.

It was in the Park tank business and it was in the Omnifilter business.

And those are both places where -- one, we're getting a lot of inflation, and where we had very aggressive plans to move to low-cost sourcing.

And then on the tanks, the issue on tanks was we care a lot about quality.

We will not ship anything that isn't quality.

And we've started up those lines, but we want to make sure -- when I talk about having the lines stable, we need to have repeatability in our quality.

We're not just going to pass the NSF certification once and then assume it's right.

We've got to be able to pass every single unit.

So, we are committed to that.

And that's taken us longer than we intended.

And that's -- I referenced that.

I didn't reference it specifically, I don't think, in the second-quarter call.

But I just did -- I did just do it in this call.

So, it is those two areas.

It's tanks and it's -- you look at Everpure is doing well.

You look at SHURflo is doing well.

You look at our water conditioning valves; it's solid.

So, you have got it right.

Curt Woodworth, JP Morgan.

A question on the filtration business.

You mentioned some new OEM programs and the new low-cost countries.

Can you just provide a little bit more color on that, what exactly are those programs and the timing of some of this in terms of when you will see the benefits?

By agreement with the customers we don't talk about the specific names.

But what I am excited about is we're using the disciplines.

And this is an export, if you will, of our OEM process disciplines that we developed in enclosures that we have exported to our filtration business.

We're one of the largest providers of filtration equipment and components to the residential and commercial world.

And what we said was is that there's a lot of people out there who have brand names and they're in the business and they want to be in the business, but they need partners to help them develop new products and make the products in cost-effective places.

So, it was a strategy we launched a year ago.

It takes a long time to get an OEM business up and going.

But those are the references.

They're the kind of products that you would see in residential application, and they will be ramping up starting in this quarter but into the next year, which is why I am pretty confident we have got a good strategy in filtration.

One last question.

In terms of the debt to cap currently at 32% pro forma APW below the 40% target -- so, you still have some room, obviously, on the acquisition front.

Can you talk about the strategy going forward?

Have you seen multiples for water assets come down?

Do you expect to focus -- you can continue to grow out the enclosures business and just help us think of maybe activity there going forward.

We, obviously, have room in terms of acquisitions.

And basically what -- we are constantly looking for the right acquisitions to bring into Pentair, where we can use our PIMS activities to basically bring value to the acquisition.

So, we are constantly screening and reviewing potential acquisitions.

And at this point in time we do have the opportunity.

I would just add, as Dave said, we continue to look.

I don't know whether prices -- the reality -- if perception -- the reality lags perception or if perception lags the reality.

In the case of valuations in some water businesses, I would say perception lags the reality of what the multiple should be.

So, things are still hot.

Ned Armstrong with Friedman, Billings, Ramsey.

You had alluded earlier to some management changes at levels below what you had publicly announced, and you specifically alluded to Asia.

Were there any other such type changes in other geographic areas, the Americas and/or Europe?

We are always looking to upgrade talent and reassign people to get better fits.

There were some changes in pump in the first half this year.

And those are the only ones I would say.

For us to reach the goals that the Board and I have set for Pentair, we need to continue to invest in talent.

So, you can expect us to keep doing that.

That's why we did that in Asia.

I think we have talked before about the investments we made over the last 18 months to two years, really, in our water Europe leadership.

And I think that's paying dividends for us.

That's why we're seeing the kind of growth we're seeing, because I really feel good about the team we have on the ground in Europe in water.

And you put -- that was really put into place, though, 18 months or so ago.

It was really put in place starting two years ago.

A lot of the changes have been made within the last 12 months I would say.

For instance, the head of operations there just had his first anniversary with that there.

For the benefit of the folks on the call that probably have other things to do, we probably should limit it to maybe one more question.

Okay.

Just one more question.

Dan Whang, Lehman Brothers.

(inaudible) regarding commodity purchasing practice.

Could you describe how much of resin and steel price purchasing you do through contract?

And as much as you can share it with us, how far out do those contracts extend?

We typically buy steel on contract.

We actually have been short on steel because we didn't want to lock in the contracts at high-end.

So we make -- it's not a rule.

It's based on what our commodity experts think we should be doing.

In the case of resins, the reason our people jumped out and tried to secure other sources is because we were concerned about some of the force majeure issues being taken in some of our contracts where suppliers couldn't guarantee that they could supply to the contract because they lost capacity.

So, resins have been kind of a brouhaha.

Our goal would be to lock in longer-term.

We don't want to be commodity speculators.

Our goal is to basically have our costs locked in and then run to that cost.

But I fully agreed with our folks in steel not to go long and buy long-term, you know, (indiscernible) contracts when prices were so high.

I think that that's been good, because prices have eased a little bit.

Although the outlook is with energy prices being where it is, probably is for it not to decline much more from here.

So, that's how we think about it.

Supply is an area -- to the earlier question, supply is an area where over the last three or four years we have built, I think, a world-class team.

We have got great leadership and the folks are really proactive.

So, that force majeure kicked in after the hurricanes?

So, I guess at that point out you had to go out and secure additional volume.

Right.

And that doesn't mean they're not supplying.

They're just giving us notice that if they miss their contract they're not legally bound.

We're still getting supplies from some of those, but we've also been busy securing other supplies, which is why we laid in some of the extra resin inventory.

Any pricing surcharge as a result of that capacity loss?

Oh yes.

Price pressures are pretty significant.

I may have missed this point about '06 guidance.

You talk about mid single-digit growth.

So, you are assuming mid single-digit organic growth in the water enclosure side, plus the contributions from APW over that on the enclosures?

Right.

On top of that.

Thank you very much.

If the operator can come back on and give directions on the call-in number of the replay?

We'll be done after that.

Thank you for participating in today's Pentair, Inc. third-quarter earnings conference call.

This call will be available for replay beginning at 3:00 PM Eastern today through 11:59 PM Eastern on Saturday October 29, 2005.

The conference ID number for the replay is 7444493.

Again, the conference ID number for the replay is a 7444493.

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

Thank you.

Thank you and see you out there.