濱特爾 (PNR) 2005 Q4 法說會逐字稿

Good afternoon. [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 fourth quarter and the full year 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 acquisitions successfully and the risks that expected synergies may not fully be realized or may take longer to realize than expected; the seasonality of our businesses 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.

I am sure you recall that on December the 19, 2005, we announced that we would early adopt FAS 123-R for share-based payment, an accounting change requiring companies to recognize an expense in the income statement for stock options instead of reflecting the pro forma impact in a footnote disclosure in the financial statements.

As a result, we have reported our fourth quarter and full year 2005 results and have restated the first three quarters of 2005 to reflect the impact of stock option expensing.

For comparison purposes, we have also included our fourth quarter and full year results without the impact of stock option expenses.

You can find the statements and a reconciliation of our results to exclude the impact of stock option expensing in our fourth-quarter earnings announcement.

The announcement is available on our website, at pentair.com.

For the purpose of our call today, we will use comparisons that do not reflect the impact of stock option expensing.

We believe this is a more clear and relevant way to look at our performance in the fourth quarter and full year, so as to have comparable -- comparability to 2004.

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

Thanks, Dave.

And welcome everyone to our conference call.

The goals we set when we embarked on the transformation of Pentair were to exit our least attractive business and focus on our more attractive businesses and to do both in a way that benefited our shareholders.

We've done that. 2005 was our first full year after this transformation of Pentair into a water-led business, and we're pleased that we not only met our strategic and financial goals of replacing our former Tools group and its earnings but also added 14% additional EPS on top of it.

In fact, our 2005 performance yielded EPS of $1.92, representing an increase of 42% on a continuing basis.

This performance compares very favorably to our double-digit EPS growth goal.

These earnings were achieved on a 29% sales growth, or 6% on a pro forma basis.

The 6% is within our 5 to 8% organic growth goal.

We also seek to expand our margins every year, and we did that in 2005, gaining about 60 basis points over the year earlier level, in spite of higher raw material costs and the investments we made for growth.

We once again exceeded our longstanding free cash flow goal of $200 million by generating $210 million.

That represents a 107% conversion of 2005 net income versus our goal of 100%.

And we delivered our highest return on invested capital in the last five years, reaching 15.3%.

Moreover, we made all of these accomplishments happen during a year of tremendous change for our organization.

While we're pleased with our progress in 2005, we aren't done.

We're now driving broader-based growth initiatives into higher profitability in 2006.

We've accelerated our investments to drive growth and instill operating excellence throughout the company.

These activities include developing new products and new customer relationships; reinforcing our international management, sales, engineering, sourcing and manufacturing talent; implementing a unified business system infrastructure in Europe; launching our Faradyne Motors joint venture with ITT Industries; and continuing to strengthen our sourcing and operating competencies

In addition, through our disciplined M&A process, we examined a number of opportunities and completed two acquisitions that are consistent with our growth strategies - Delta Environmental, a manufacturer of wastewater treatment products for the residential and commercial on-site treatment markets; and the Thermal Management Businesses, which provide thermal management solutions and electronic integration services to a wide array of vertical markets.

As mentioned on our conference call last quarter, we saw inflationary pressures intensify.

We didn't see any further inflation in the fourth quarter, but as expected, we lost a percentage point in price further narrowing the price over inflation gap.

The net result was that we still have a positive, but narrower, gap between price and inflation.

We expect to widen that gap positively again, as 2006 progresses.

Now, let's turn to the operating groups.

In the water group, fourth-quarter sales of $518 million were up 10% over the same period last year.

Excluding unfavorable currency translations, sales were up about 11%.

Sales in all markets grew by at least mid-single digits in local currency, highlighted by strong growth in pump and pool markets.

Pumps sales grew in the high single digits, spurred by new products, strong municipal and industrial pump demand, and favorable pricing actions.

Water systems sales grew in the mid-single digits.

Pool equipment sales benefited from favorable weather conditions and successful early buy programs.

Sales of filtration products grew in the mid-single digits.

Especially strong were Everpure and SHURflo sales in food and beverage markets, which together with sales of specialty filtration products, which include SHURflo Industrial and CodeLine, grew in the low teens.

Filtration continues to strengthen relationships with key players in food and beverage.

For example, Everpure recently extended its supply agreements with Starbucks in Asia.

Of particular note in industrial filtration is the fact that OEMs continue to purchase substantial quantities of CodeLine vessels for use in military systems.

We've also secured orders for thousands of [romination] systems to be installed on Navy vessels.

New Water products significantly contributed to fourth-quarter sales.

Some of the new pump products include bulk chemical transfer systems; a drainer pump; a gas engine-driven transfer pump; and new solids handling, centrifugal and split case pumps.

New pool products included new heat pumps, automation controls, lights, filters, chlorinators, pumps, and pool finishes.

Filtration sales benefited from a new modular filtration system and a number of new OEM products.

In Europe, the momentum of our third quarter carried into the fourth quarter.

Everpure and SHURflo filtration lines sold particularly well, and sales in the European pool market increased, benefiting from early buy programs.

Sales in Asian markets were up significantly as a result of the ramp up of production of our Suzhou, China manufacturing facility.

Globally, sales and orders of CodeLine pressure vessels used in desalination and filtration projects were strong.

For example, we've received orders for CodeLine pressure vessels manufactured at our Goa, India, operation for installation in a number of signature desal plants being built around the world.

Fourth-quarter operating income for the water segment totaled $56.8 million.

That's up 16% over the same period last year, resulting from higher volumes, supply savings, and price increases, which more than offset the temporary operating inefficiencies related to the product moves and plant consolidations that we cited in the third quarter.

Also affecting margin in the quarter were higher customer incentives rebates, higher material inflation and investments for growth.

The integration of the water businesses continued on track in the fourth quarter with $9 million of savings realized net of integration costs for a 2005 total of $36 million against a goal of 30 million.

In the third quarter conference call, we mentioned that several plant closings were underway, two of which were delayed.

Of these two shutdowns, one was completed in the fourth quarter.

At the other facility, we have now completed all the NSF certifications and are in the process of completing the final product moves.

All production will be transferred to the new facility by the end of February, as expected.

Our investments for growth included low cost country engineering and sourcing, start up of a new Eastern European manufacturing plant, increased infrastructure in China and Europe to support local market opportunities, filtration R&D programs, and the Faradyne Motors joint venture.

I am pleased to be finally able to now elaborate on Faradyne Motor's, the joint venture we have with ITT industries.

We publicly announced the JV on December 15th and concurrently previewed its product range, including control boxes, six-inch motors, and four-inch high thrust motors at the National Ground Water Association show in December.

We're very pleased with the response from the customer base.

The show room floor was jammed from the time we made the announcement and we received many favorable comments about our motor design and features.

Subsequent communications with customers indicates that the North American motor market is ready for an infusion of this innovation in the competition.

That's just we intend to give it with the Faradyne Motor joint venture.

Before I move to enclosures, I'd like to address the impact of last year's hurricanes on our fourth quarter sales.

As expected, we continued to take orders in the fourth quarter for rebuilding efforts related to Hurricane Katrina.

Our water pumps, superior delivery and service capabilities help meet urgent demands from customers, who needed to replace damaged fire pumps.

Buyers captured orders for replacement grinder pumps in the Gulf Coast region and Fairbanks Morse realized rebuilding related sales of its large diesel driven pumps.

Our new Delta Environmental business secured the contract for wastewater treatment facilities at Louisiana State University shortly after the disaster occurred.

Filtration recreational vehicle OEM sales boosted at the end of the third quarter by FEMA orders, is now seeing higher than expected orders to replace depleted inventories caused by last year's hurricanes.

Looking forward, we expect our HVAC pump business to pick up soon as end-users replace end suction and split case pumps damaged in the flooding.

Enclosures also continues to get orders from rebuilding projects related to hurricane damage.

In the fourth quarter, our newly acquired operations in San Diego realized strong demand for chassis that house switching cards in wireless applications.

This demand is expected to continue into the second quarter of 2006 and is attributable to the replacement of base stations damaged by hurricane flooding.

Collectively, hurricane related activities represented about one percentage point of our fourth quarter 2005 sales growth.

Our enclosures group continued their strong performance in the fourth quarter, capping an outstanding year in which we set a number of financial records.

Enclosures group sales of $214 million in the quarter were up 18% from the same period last year with all markets, even Europe, showing growth in the quarter.

Fourth quarter organic sales, excluding the sales of the newly acquired thermal management businesses and the impact of unfavorable currency exchange, was about 13% compared to last year.

Sales of our electrical enclosures were significantly above the growth rate of the addressed markets.

Hoffman's commercial sales surged in the quarter and our vertical markets strategies drove growth in petrochemical, food and beverage, water and wastewater, and pharmaceutical.

Pentair Electronics Packaging sales growth was robust with a marked increase in business related to telecom projects and strong performance in Brazil.

We continued to win new Advanced Telecommunications Computing Architecture or ATCA programs with major OEM customers.

We're supplementing our product lines with new ATCA based systems to serve this growing market.

We've been in the forefront of this evolving standard and our December 1st acquisitions strengthen our position by giving us more technical expertise on the West Coast, where many of our ATCA customers are located.

Our European enclosures business generates a sale gain in local currency in the high single-digits, the strongest growth in the past five quarters.

However, a weaker Euro in the fourth quarter of 2005 versus a year ago masked this growth in US currency.

Europe's growth was aided by new program wins including new outdoor cabinets for Deutsche Telecom and growth related to our ATCA platform and new Varistar cabinet line.

Sales growth in Eastern Europe markets also contributed in the improved performance.

Enclosure sales in our Asian markets increased significantly in the quarter, albeit from a small base.

Our sales in Japan grew for the first time since the third quarter of 2004 and growth in China continued to accelerate.

China now accounts for almost 60% of our sales in Asia, up from less than 10% just a few years ago.

The Enclosures group's fourth quarter operating income totaled $30.7 million, 30% higher than in the same period last year, setting another Enclosures operating income record.

Even including the lower initial margins of the thermal business for one month, Enclosures margins reached 14.3% in the fourth quarter, up 130 basis points over a year ago level.

This represents Enclosures' 16th consecutive quarter of sequential margin improvement.

The group's profitability was driven by increased volume and improved productivity resulting from the ongoing application of lean enterprise.

Enclosures continues to be our proof of concept for our operating excellence programs.

Raw material cost increases in the fourth quarter were offset by actions in both pricing and productivity.

Steel cost has stabilized, but we anticipate higher transportation and energy costs throughout 2006.

We completed the acquisition of the thermal management business on December 1st and immediately began applying our operating disciplines.

Integration activity has been extremely high, including employee orientations, rapid negotiations with the supply base, lean training, initial 5S and Kaizen events, implementation of our strategy deployment process, and tools to track synergy costs and savings, and training of course on Pentair's policies and procedures.

On a visit to the McLean operation here in Minnesota few weeks ago, I was very impressed with the enthusiasm and the drive of the McLean employees.

Several commented that they were pleased that Pentair finally acquired McLean and that cementing the relationship between Pentair and McLean was long overdue.

It was heartening to hear the positive comments from McLean employees and confirms my belief that our new employees are excited about Pentair's values and are embracing our processes.

I think that's a great starting point.

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

Dave?

Thank you, Randy.

As I stated earlier, all the numbers in our discussion are on the same basis as 2004, which excludes the impact of 123R stock option expensing.

We had a solid fourth quarter with very good results on many fronts in our businesses.

Sales for total Pentair came in at $732 million, up approximately 12% excluding the impact of recent Enclosures acquisition and foreign exchange.

For the full year, sales came in at $2.947 billion, up approximately 6%, assuming we had acquired the former WICOR business at the beginning of 2004 and excluding the impact of recent Enclosures acquisitions and foreign exchange.

Fourth quarter EPS was $0.41, up 24% from the $0.33 in the fourth quarter of last year.

Full year EPS came in at $1.92, up 42% over the continuing EPS from 2004.

As Randy mentioned, we are moving to the next phase in the development of our business.

If you compare our EPS of $1.92 in 2005 to the $0.99 continuing operation EPS in 2003, we have realized a 39% compounded annual growth rate.

Looking at the compounded annual growth rate including Tools, EPS grew from $1.42 in 2003 to $1.92 in 2005, representing a 16% compounded annual growth rate through our transition.

Gross margins were up 30 basis points in the fourth quarter, following a 10 basis point improvement in the third quarter.

Improvements late in the year resulting from higher volume, supply savings and price increases offset the reduced gross margins we were experiencing in the first half as a result of the WICOR acquisition, improving gross margins 10 basis points for the full year.

As a percentage of sales, selling, general and administration expense is down 20 basis points for the quarter and 80 basis points for the total year, reflecting the favorable cost leverage from the combined larger company, somewhat offset by the investments we made for growth.

From a reportable segment basis, the line item “other” including corporate is $16.7 million in the fourth quarter.

This is higher than our typical run rate due to amortization of tax strategy based investments, expenses for M&A activity on potential acquisitions, we decided not to meet -- we decided do not meet our strategic and financial criteria, and costs for evaluating the feasibility of the proposed unified business systems infrastructure in Europe, which may reduce our overall tax rate over the long-term.

R&D costs are up 30 basis points in the quarter and 20 basis points for the year due to increased investments in new products and new markets, especially in the water filtration arena.

As a result, operating income margins were up by 20 basis points in the quarter and 60 basis points for the year.

We have consolidated an $800 million company operating at about half of our ROS, challenged with the complexity of moving several product lines to new factories in the US, Mexico and China, absorbed associated integration costs, and still ended up with higher margins in the first full year of operations.

Interest expense was up $371,000 in the fourth quarter and $7.8 million for the year because of acquisitions and 13 interest rate increases over the last 18 months.

The effective tax rate was 410 basis points lower in the fourth quarter due primarily to R&D tax credits culminating from a lengthy special project to document our innovation spending and our ability to use foreign tax credits.

However, these were offset in the earlier quarters due to prior year settlements leaving the total year rate at 34.3% versus 34.8% in 2004.

Cash flow of $210 million for the total year of 2005, the details of which are set forth in this morning's news release, is in line with our original goals stated at the beginning of the year, and is stronger than our estimate at end of the third quarter.

Several customers took advantage of early payment discounts, which dramatically increased our collections in December.

Average working capital finished the year at 38 days, up 1 day from the end of last quarter and 5 days from the same period last year.

Higher inventory levels have been required as product moves and plant rationalizations continued throughout the year.

The higher working capital continues to reflect the embedded opportunity remaining from cash flow from the WICOR acquisition.

This should read out when the product moves are completed and lean enterprise takes root.

Our debt to total capital ratio was 32.6% at the end of the fourth quarter.

This compares to 33.7% at the same time last year.

We are particularly pleased that we were able to end 2005 with a lower debt ratio, even after a net cash outlay of $150 million for the purchase of the thermal management business and Delta Environmental, also paying out $53 million of dividends and buying back $25 million of stock.

The debt to total capital ratio continues to be well below our target level of 40%, giving us more than adequate financial resources to expand our water and enclosures business further.

One final note.

The finalization of the transaction selling our former Tools Group to Black & Decker is pending, as we await the arbitration outcome of our outstanding, relatively minor, purchase price dispute.

We believe we are adequately reserved for this matter.

If the arbitration decision is received prior to the filing of our Form 10-K, we will reflect the outcome in the fourth quarter results published in the 10-K and in other disclosures as required.

Now, I'll turn the conference back to Randy.

Thanks Dave.

As we look forward to the continuing development of the company, we have several priorities.

First, with most of the heavy lifting done on the WICOR integration, we need to wrap up the last plant moves and drive productivity, both cost productivity and inventory productivity, to achieve our year-end targets.

Second, we'll continue to drive the three key elements of our strategy -- operating excellence, international expansion, and growth, both organic and acquired.

The Pentair Integrated Management System or PIMS is the key to driving this strategy.

PIMS has evolved to include three key elements.

These are, one, strategy deployment, which aligns our actions at the operating level with the business strategy to achieve breakthrough targets.

Strategy deployment is helping us establish common processes, actions, metrics and reporting across the company.

Two, lean enterprise, which eliminates waste and variability from every aspect of our business, with special focus on sourcing and supply management, cash management, and lean operations.

Lean is the real cultural lever for us to achieve operating excellence.

And third, ignite, which is our process to drive organic growth actions through data driven market understanding and effective marketing strategies.

These initiatives and the benefits that derive from them are already incorporated in our outlook and we're reaffirming our previous guidance for the full year 2006 of between $2.08 and $2.18 on mid-single digit organic growth.

In addition, we expect first quarter EPS in a range of $0.40 to $0.42.

Our guidance for the first quarter and full year 2006 includes the impact of stock option expensing.

Thanks for your attention.

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

Arnica?

[OPERATOR INSTRUCTIONS] Your first question comes from Curt Woodworth.

Hi.

Good morning.

Good morning, Curt.

Randy, you mentioned that you were evaluating a number of opportunities on the acquisition side this year and you made two acquisitions, can you talk a little bit about the pipeline for '06 and, obviously, the free cash flow is going to be going up?

What are you seeing there -- have multiples come down in the water space relative to last year?

Well, I think multiples are still up there.

Water properties are still pretty high.

But we do think if we can go through and see and build through our process of understanding does it fit our strategy, number one; number two, how could we afford the price required, how would we drive the synergies, we're still in the market.

And we're looking at a lot of small ones, and I'd say the pipeline looks pretty good on water.

In Enclosures, it's quite good.

You've seen some recent acquisitions by some other people in the space, which I think validates our strategy of what we've been doing in enclosures.

And there's a few things there, too.

And particularly, there was -- we really want to grow our international business faster than our domestic business.

So a lot of our efforts and the number of our investments have gone towards that.

So I would say our pipeline is full, and we certainly can use whatever cash flow we develop to support those acquisitions.

Great.

Thanks.

On enclosures, the margin rate continues to exceed, at least, my expectations.

And I know that you're going to have some dilution with the APW transaction --

Right.

-- but even with that, do you think that you can kind of maintain the margin levels that you were at in '05 or should we assume that the margins will go down a little in '06?

Well, in the first half it's going to be lower because of the -- I mean my view and our expectations -- it's going to be lower because of lower margins of McLean and the electronic solutions businesses that we bought from APW.

We expect though that those margins will gain.

We have such strong -- we've really achieved the cultural transformation we want in most of the enclosures in terms of driving lean, and as they apply those, I think we're going to see those margins improve by the second half.

So I think year-over-year -- year-over-year, I'd say margin's kind of flat for the -- as I think about enclosures year-over-year.

And a little bit lower growth.

I don't think the -- in fact, our plan for 2005 was high single digits growth for Enclosures, and they turned in a low-teens kind of growth, which is outstanding.

It reflects our share gain, but I think as we look out, we're a little more cautious about the organic growth rates.

Okay.

That's why we're using a mid single digits kind of growth rate and a flattish kind of margin.

But we do think we're in the right parts of enclosures.

We do think that the margin rates and our goal of 15% in enclosures is still quite achievable.

Okay.

And just one final question on filtration.

You talked about new products adding some growth this quarter, and modular filtration systems were mentioned as well as new OEM products.

Can you just give a little bit more color on what exactly those are, how important are they to '06 in terms of new product development relative to just overall market growth, just to get a sense for organically what you're thinking about for filtration for '06?

They're really important because a lot of the R&D spending we're spending is to develop those OEM products.

They don't typically like us to enumerate who they are, but one of the things we ramped up about a year ago and it's continued to build throughout the year is a focus on the residential and commercial end.

And we are working in R&D with these OEMs and it's that -- investments are still going to outweigh the benefits in the first half.

But we're expecting to see some sales from some of these programs in the second half.

As I mentioned that, it's the, what we call, specialty filtration and then the food and beverage, the SHURflo and the Everpure, that it had really strong growth in 2005, and our residential has -- was actually negative in the first part and is now flat in the second part.

So it's really in mid to last half of '06 where I think we're going to see some sales benefits from it.

Okay.

Great.

Thank you very much.

Okay.

Your next question comes from Deane Dray.

Thank you.

I had a question on the first quarter guidance.

And just kind of walk us through your expectations.

You're coming out of the fourth quarter very strong organic growth in water, you are sounding for the company as a whole, sort of, mid single digits.

What in particular, are you looking for in water on organic growth basis?

Our number of investments, both the R&D and in filtration, are the European infrastructure project and Faradyne JV are actually going to have higher expenses in the first half and in the first quarter in particular.

And not really any payoff.

So those investments are higher than in the fourth quarter.

We're more cautious, as I said about the growth rate.

The growth rate in the fourth quarter was helped, as we mentioned, by a point or a little more maybe from the hurricanes.

We don't know whether that -- that's really prudent to expect in the first quarter.

In fact, I don't think it is.

And the second was -- we -- which also helped our cash flow but hurt the pricing in water.

We had a more successful early buy program in pool than we thought we would have.

So those are both why we're looking at that mid single-digit organic growth.

We certainly -- we'd be - we'd welcome doing better, we just don't think it's prudent to plan on that.

So it's a higher investment level than in the fourth quarter.

And that's really the way we saw the year laying out.

It's the continued productivity ramp-up of our new facilities which we're getting good line of sight on and it's a higher level of investments.

We just -- we want to keep these investments going in international.

The joint venture obviously is very important and we're quite pleased with the progress of it so far.

And in the filtration arena, those OEM investments are also up a little bit higher.

So that's what underlies the first quarter forecast.

Thank you.

Those three items that you identified, of the hurricane and the early buy, I can see where that -- if it's not repeating or is not repeating as much would lower the organic growth rate, but certainly the Faradyne and growth investments does not -- they do not impact your organic growth rate.

No.

I'm sorry, if I wasn't clear.

That's what is impacting margins.

Understand.

The $0.41 to $0. 42 is a function of the build up - well, I don't need to tell you that.

But the -- if you will, those investment levels are higher in the first quarter and the second quarter than they were in the fourth quarter.

Sure.

And then just to follow-up, Dave, in the prepared remarks you gave the additional color as to what was going on in the other and corporate line, and out of those three items that you called out -- the tax planning, the M&A transactions or transactions that you did not complete, and then the feasibility study in Europe, could you size those?

And then in particular, could we get any more color regarding what was going on in the M&A transactions you were looking at?

Let me rank order them.

We're not going to put out exact numbers on it.

But in rank order, the M&A activity was the largest, followed by the activities in Europe.

And then the tax effect that we -- basically, the amortization write-off that we have of the tax issue would be the lower one.

I don't think I've heard you call out before some M&A expenses like that, especially if the transaction didn't go through.

Was that due diligence?

Any color as to -- was it the transaction was done away, was it too expensive or so forth?

Yes.

Let me -- I didn't like to comment on things we don't finish, but they were transactions that most of them went through, and we just chose not to pursue them and most of them were in water.

So let me leave it at that.

Okay.

Thank you.

Your next question comes from Michael Schneider.

Good morning, guys.

Good morning.

I guess, first, just on pool and spa sounds like you did have a great quarter there.

Can you put some -- just frame around the growth rates there, you mentioned pumps were high single-digits.

What was the pool and spa --?

Pools was double-digit.

Double digit.

Okay.

And I mentioned the other -- the early buy was a little more successful than we thought it, in our initial planning, and actually the number of people who took the cash discount was higher than we thought as well, which is why the cash flow finished higher than the high-end of our range that we said in last quarter's call.

Okay.

And the 11% organic growth in water, you mentioned hurricanes probably added a point, what do you think that successful pool and spa kind of pre-season selling added in points?

I'd -- it will just triangulate back and I don't want to get in the habit of breaking out growth underneath it.

Pool was up double-digits, so it was the highest single segment, so I'll leave it at that.

And was there -- I know you're trying to more level load the factories to account for the seasonality, was there something different about the program this year that motivated people to take advantage of it more so than in prior years?

We didn't think so, but I'd have to say, it might have had -- there were some competitive issues.

There were some competitive issues with Water Pik having been for sale and they were pretty active in the marketplace and we needed to be competitive.

So our program reflected that.

But the weather was also a lot better.

So it wasn't just the early buying.

We -- there was also year-over-year better weather in the Southwest and the South that makes a difference even in the fourth quarter.

Okay.

And then just taking a step back, just on the Water Group and its relocation efforts, the product moves, et cetera.

Can you put some numbers around what you expect the incremental expenses to be in '06, if indeed they are going to be higher in '05?

I'm trying to get a sense of what the headwind is as a result of a lot of these relocations and new facility costs.

Yes.

I don't -- it's not really incremental costs, it's more just getting to the level of productivity we expect.

So we -- it's -- if we're not operating at the level that we know we can operate at.

And, I can't add them all up, I look at it plant by plant by plant.

In the first half, I'd say it's, a couple of million a quarter, probably.

And is that just mainly inefficiencies?

It's inefficiencies.

I mean we have one more plant move that's per plan, it wasn't planned until this year, and we're all over that one.

And that one looks pretty good.

So that's not a difference from -- and there is some investment in that, but just in terms of inefficiencies, a couple million, 2 to 3 million in the early quarters and diminishing in later ones.

Okay.

And then you spent, I think, unusual amount of time on new products this quarter, which I think signals the shift in the focus from the integration now to growth again.

Do you have some numbers for us as to what new products contributed to as a percent of sales in '05 in water and then what you would expect the number of products you cited here to contribute in '06?

Let me just grab something.

In the quarter, when we look at growth - I’ve got to get to the right page.

When we look at growth - and I'll just talk about water.

Enclosure is little harder to cut between customers and products because a lot of products are actually customer specific.

Yes.

But in the fourth quarter and the year, when we think about in water, we think about product -- new products.

The [off mic] let me look it up and come back to you on that.

Okay.

That's fair.

And then just final question, Dave, the tax rate?

What should we be assuming for '06 on our models?

We are looking at a going forward run rate of about 35.5% plus.

When you add on to it the impact from the 123R, it's 36%.

Okay.

So, 36.

Okay.

Thanks again, guys.

Back to your question, just in the fourth quarter, because that's what I have handy.

Yes.

The way we measure our growth on our growth trees, we've talked about that before is we look at prices and new customers and new products and we look at share and economics.

I would say about a little less than half of the growth, we can track back to products that we've upgraded or launched in the last year-over-year.

So versus that 10 a little bit less than half --

Okay.

-- was new product related and that's why -- and a lot of our investments and back to your first question, in terms of the water margins, the investments are a bigger deal in, if you will, in dampening down margins right now than any inefficiencies.

And I want to be clear about that because we are investing a lot, particularly in the international infrastructure in this European project that is ramping up.

And in new products.

Not just in filtration, which I cited, but we also have a lot being spent in pool and we've also -- we're approaching 100 engineers in India and we've doubled the size of our engineering force in China.

So that -- we all count that towards new products.

In fact, you can see in the quarter we're up about $3 million year-over-year, which is a comparable run rate from the fourth quarter of last year in our R&D spending.

So, and that's all new product related.

So to be clear, the 10% or 11% organic growth in water, you're saying call it 4 to 5 points of that was due to new products just introduced in the past year?

Introduced or upgraded in the last year.

So that's -- I mean that's -- it's been a key part of our strategy, and that sort of growth, it's a little less than the half.

Okay.

That's impressive.

Thanks again.

Okay.

Your next question comes from Dan Whang.

Actually, this is [Stephen Weiss] with [Lexor Group].

A couple of questions regarding raw materials that you mentioned in the call, what are some of the risks you're seeing moving forward in 2006 for some of your major raw materials?

And what are some of the supply side initiatives you're putting in place to offset those risks?

Supply on -- supply is one of our best developed functions across the Company.

So I'll start with that.

The big issue right now are those that are petrochemical related, so it's resins.

And then transportation fuel cost.

We see steel as moderated and so we don't see further pressure on the metal side.

But resins, we expect to continue high.

And what we're doing there is we're qualifying additional suppliers aggressively.

We already started that and we've already converted a number of them.

We're looking at substitutions of materials.

For example, we have a range of tanks that are - pressure tanks that are fiber wound with either polyethylene or AVS liners.

And we are looking at substitution on the products from AVS to PE on, if you will, the applications where AVS isn't really required.

And we're also using price to differentiate if we in fact have to use a higher price material, we have pricing that reflects it.

So those are some of the examples of what our people jumped on early.

In fact, I'm pretty pleased that resin inflation wasn't even higher in the fourth quarter because our supply group was so fast; within 48 hours after Katrina; they had secured as much raw material as they could at the prices before they went up.

So that's the kind of aggressiveness we have in our supply group.

Yes.

You talked about on the call that low cost country sourcing was a big part of your company, will that continue?

Are you going to expand that even more?

Absolutely.

We have targets in each one of our business groups in terms of low-cost sourcing, the percent of their costs they have to get from low cost sourcing.

It's why we've invested in the plants in Reynosa, China and the new one in Eastern Europe that we're -- that we're building this year.

So, it's a key part.

We don't believe that one, we can be the global player we want to be without the low-cost country sourcing, and it's also critical to remaining, keeping our margins where we want them to.

So it's a part of our strategy.

What's been your supply feedback?

Do they feel like they're getting squeezed or are they pretty willing to work with you on these ventures?

It's a mixed bag.

I mean, there are those who think they're being squeezed.

But in lot of cases that we are just opening up and getting more competition by bringing new suppliers to the table.

And I don't want to dismiss the work that our suppliers are doing with us.

We have a number of suppliers who are working with us on the substitutions, working with us on the new qualifications.

So a lot of our suppliers are in the boat with us, as we are with a lot our customers as well.

Great.

Thank you very much.

Continued success down the road.

Thanks.

Your next question comes from Brian Langenberg.

Thank you guys.

Excellent quarter and year.

Just a couple of follow-ups yet.

Number one, with the acceleration from first quarter into fourth quarter, that's all about pool and spa that was nothing about Hurricanes.

Two very different things, I would assume.

Could you ask the question again?

Yes.

I'm not sure I said it right.

I mean we heard that there was some -- there was some good programs in pool and spa that accelerated some revenues into the fourth quarter from the first quarter of '06 it sounds like, unless I'm misinterpreting.

Well, I mean the early buy program was stronger than we thought it would be.

I mean that as long as it gets pulled through it does not really affect the first quarter, it was just stronger than we expected it to be.

Are we talking another 5, 10, 15 million kind of thing?

And the weather was stronger as well.

Yes.

The weather was stronger as well.

The -- a percent of growth we can identify would be $7, $8 million from the hurricane.

Okay.

So they're two unrelated things.

Okay.

Similar size, though?

No, I didn't say that.

Okay.

I won't put words in your mouth, then.

Just two other things, the easy one is can you just give us the currency impact for each of the two segments on a fourth quarter basis?

Yes.

Overall for the total business in the fourth quarter, it was negative by about 1%.

1% overall.

And the majority of that was in water.

Mostly water.

Okay.

And then the last one, could you just maybe at least touch on without telling us the internal spreadsheet, North American filtration in the fourth quarter?

Brian, just to clarify on the last one, that was sales you were asking for, right?

Yes, sir.

Impact from sales, yes.

Yes, sales.

And just touch on at least briefly North American filtration, kind of the pricing ongoing dynamics, so the issues are moderating?

Clearly you're able to make up for some things in other areas of your business, but just touch on that, please.

Well, I think our filtration business has been facing number one, a number of our plant moves have been in the filtration arena to the business that we're bringing in from WICOR and at SHURflo, which is really good and at OMNIFILTER, which was somewhat challenged from a margin standpoint.

And sales have been impacted in particular on the material cost side.

Right.

What about share issues?

We think, when we look at food service, we think share is quite -- we actually think share is up.

When we look at some of the other specialty applications we have, we think share is up or at least flat.

On the residential retail for the year, share was down, but we think in the fourth quarter that was reversed and that was -- we talked about that earlier in the year there were a number of placements at retail that were lost.

Okay.

We started lapping ourselves a little bit on that in the third and fourth quarter.

Okay.

So, we can't bug you about it for five more years or anything?

Okay.

Excuse me?

We can't bother you about it for another five years or anything.

Okay, good.

Thank you very much.

Great quarter.

Your next question comes from Ian Fleischer.

Hi, good morning.

Good morning.

Could you just touch on how you feel that the Ecolab alliance you announced last year is doing with respect to driving business in that segment?

Sure.

The Ecolab alliance that we have is a critical strategic alliance for us.

It did not achieve the volume we thought it would in the first year, bluntly.

But it -- we have the placement.

The training has gone in.

I think we both see it as a successful program, and we expect it will grow next year.

We have some additional products that are being added to the program next year, and I think water is certainly a key part of their offering.

And as we learn to work better together, I expect it will grow.

But from our standpoint, it was lower sales than we had initially anticipated we'd get in '05.

In your press release, you mentioned in the water segment two headwinds to margins.

One was materials and the other were investments in a bunch of different things.

Can you give us a sense as to the magnitude of both?

On a percent basis or a dollar basis?

Yes, whatever you've got.

Whatever.

I think, probably, if you look at the materials, basically, is being -- we had a pretty good movement of price.

So the real impact really comes from the investment and the growth aspect, trying to grow the business.

I'd answer, really -- in the fourth quarter, the narrowing of the gap of price over materials from the third to the fourth quarter was probably worth the full point.

And there's probably a couple of points in water that would have been related to the investments.

Going forward, that investment is actually a little bit higher, but we think the price over materials gap shouldn't be as bad as the decline from third to fourth quarter.

And when do you think the investments start to decelerate a bit?

In the second half.

That's when they start paying for themselves.

The investments will stay high.

But for instance, the JV is more cost than revenue in the first half as well as the R&D on new products.

And the European infrastructure projects will be the same all year in terms of expense.

Okay.

And just one final question.

Where are WICOR's margins relative to the group?

Well, we can't tell any more, because we've merged -- we've shuttered 17 facilities, and we've merged them into other facilities.

So we can't really unwind it now.

The way we look at it is we took them -- they were a little bit -- we were 13% to 14% in our water group, and they were 7 to 8% in their water group.

So we look at it that way.

We start there, and then we put them together.

And we've made a good step-up in terms of bringing the overall business back up to that 13%.

That's right.

So that's the way we look at it now, because it's just -- it's not worth the effort and we wouldn't be right if we tried to look at WICOR separately, now

All right.

Thanks very much.

Your next question comes from Robert McCarthy.

Good afternoon, gentlemen.

Could you amplify your comments about Emerson's Knurr acquisition?

You obviously see this as the validation of your strategy, but is there any competitive issues or should we think that changed the market?

Does it change the market and the opportunity of the multiples being paid for some of the properties in that space?

I think, first of all, the multiple paid for that business is a reflection of how much money that business was making.

So -- and let me leave that at that.

It does not reflect the value of our business, because we make a lot more money than they do.

But even in Europe, I mean, Knurr is a company we know well.

The guy running it used to work for us.

And they compete with us.

I would say we complement each other 60%, and we compete 40% between our Schroff business and our Knurr business.

They're more, if you will -- and the overall Emerson strategy is more data room down to cabinet, and we're more cabinet down to card.

And so we -- Emerson is a customer of ours, and we're a -- they're a -- we're a customer of theirs.

So I think that's their strategy, and buying Knurr fits their strategy well based on Knurr's outside cabinets and their overall cabinets and what we call technical furniture, which goes in the data room.

But Emerson has been in the business for a while, and Knurr has been a supplier to them.

So I mean it's not a surprising acquisition.

Okay.

And then I guess, then what you're saying is that back half of the year is relatively easy comps then and you expect a lot of these initiatives you've been doing and spending on in the first part of the year to really bear some fruit.

So that would be why your guidance would be ostensibly back-end loaded.

Yes, it will.

Our margins, our year-over-year improvement is back-end loaded.

It's not the comps, what it is is it's the productivity improvements in the factories and it's the investments, if you will, being lower in the second half than the first half.

All right.

Thank you for your time.

I think we have time for two or three more questions, operator.

Your next question comes from David Smith.

Good afternoon, guys.

Hi.

Just quickly on FARADYNE, when do you see that ramping up and starting to ship product?

Well, I mean, we haven't given out all the details, but the investments are heavy now.

We expect to be shipping in the second half.

Okay.

So no shipments before the second half?

No.

Okay.

What about a quick update on APW?

You know, you talked briefly, but as far as the margins in the quarter in the enclosures segment, obviously, coming in very strong that includes the month of APW and also includes options.

What were the margins in enclosures ex those two items?

I did not know that of the top of my head.

It would be a little bit higher.

Okay.

We generally don't break that out, but obviously it did have impression of the margins in the fourth quarter.

But it did pretty well.

Yes.

All right.

Is it fair to say that APW's margins were maybe closer to 10% -- 10 -- 12%?

Lower.

Lower.

Lower than that.

They had a pretty good December, which is always nice to see in a new business.

But we only have one month of them so they didn't have that big an impact.

And actually European margins came in strong - strongest of the year -- for the quarter, and our Hoffman business continues to be just a juggernaut.

One thing following up on Dan's question on the corporate expense, should we -- are we assuming then if we go back to where it was in the past few quarters going forward, are these all one-time type of items?

Going forward, we're looking at a number something in the range of 13 million run rate per quarter.

Okay.

Any Franklin impact that you can discuss in the quarter?

No, not really.

I mean we lost the motor business to them starting in the fourth quarter last year.

So we started lapping because we don't have that headwind anymore.

So that certainly is why the water system's part of pump's growth rate was much better than it was--

Okay.

I thought that was in the first quarter.

Okay.

That's good.

Well, we began in the fourth quarter.

Okay.

It wasn't fully effective until the first quarter.

But for'06 it should be a pretty clean comp year-over-year?

Yes.

And last thing, Randy, on filtration, I just kind of caught what you said a minute ago, but are you negative in filtration right now as far as price cost on the rising materials?

We're neutral.

You're neutral.

Whereas we're positive in other places.

Okay.

Actually one last thing on buyback, is this something new that was in the quarter?

No, we have a standing -- the stock buyback -- we have a standing program.

Authorization.

Authorization right.

Thank you.

That's the right word -- to basically offset dilution.

And we did it all in the quarter when the stock went down a lot after the last announcement.

We seized that opportunity.

Just to give you the statistics on that, we bought back 755,000 shares at an average rate of 33.08 and all that was over a period of about a week.

Okay.

And how much is left from the authorization?

Well, that was last year's authorization, and the standing authorization is for $25 million a year.

Okay, great.

Okay.

Thanks guys.

We have time for one more question.

Your next question comes from Debra Coy.

Hi, Debra.

Good morning, Randy.

Just to follow-up a little bit more on the filtration side, and that was certainly a pleasant surprise in the quarter to see the organic growth back in the mid-single digits after a couple of weak quarters.

Can you say whether there were any sort of buyback or special programs that impacted filtration?

It sounded like CodeLine was particularly -- unusually strong, and kind of what's going on?

There's been a lot of moving parts in filtration, what are you seeing now in terms of the mix of business and the organic growth going forward, particularly in one half?

The filtration business -- it really was food and service, food and beverage continue to be very, very strong.

And these specialty applications like the CodeLine applications we mentioned, which are used in portable units that the military uses and are also used in emergency applications, the shipboard applications.

We're investing more marketing and sales activity into some of these special applications and we saw some results from that in the quarter.

Food and beverage has been strong all year.

We're pleased with Everpure and SHURflo.

What really helped was we were negative in the residential arena.

That was the biggest change.

It wasn't any real -- it wasn't any buyback or anything that affected the number so much.

So you don't think you've borrowed anything from 1Q into 4Q in filtration?

I don't think so.

Okay.

And then on food and beverage, would you say that you're partly benefiting from perhaps some transition stuff going on over that [Cuono] they've been acquired, would that be part of it?

It's in the same areas that we were continuing to have traction even before the announcement.

There may be some -- I think some of our people may cite some specific wins versus Cuono.

I do think we've entered a number of programs with some large food and beverage players that are ramping up nicely.

And we did get some growth from Ecolab too.

So I mean it -- I wouldn't attribute it to that.

So bottom line --

I hope it's happening.

I wouldn't cite that.

And if you add all that up together, it sounds like you think that you can maintain this mid-single digit organic growth in filtration.

That's our target.

Okay.

All right.

Thanks very much.

Okay.

Thank you very much.

And operator, if you could give replay instructions.

Arnica?

Yes.

I'm here.

One moment --

Okay.

If you could give the replay instructions.

One moment.

Thank you for participating in today's conference call.

This will be available today, February 2nd, at 2 o'clock PM, Eastern Time.

And the numbers?

The phone -- call-in numbers?

I tell you what, the call-in number is 800-642-1687, and the conference ID number is 3613028.

I hope you all heard that.

Thank you very much.

We'll post those call-in numbers on our website in case anyone missed it.

This concludes today's Pentair conference call.

You may now disconnect.