濱特爾 (PNR) 2006 Q3 法說會逐字稿

Good morning. My name is Angela and I will be you conference operator today. At this time, I would like to welcome everyone to the Pentair Inc. third quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. (Operator Instructions). Thank you. Mr. Harrison, you may begin your conference.

Thank you, Angela, and thank you all for joining us today to discuss Pentair's results for the third quarter of 2006. I'm Dave Harrison, Chief Financial Officer, and with me today 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 the risks outlined in our 10-K as of December 31, 2005, and our news releases. Forward-looking statements included herein are made as of today and the Company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances. Actual results could differ materially from anticipated results.

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

Thanks, Dave. You saw in this morning's announcement that our third quarter results came in at $0.33 per share on sales of $778 million. That puts sales up 9% from the same period a year ago. These results reflect strong performance in our Technical Products, Pump and Filtration businesses.

Accelerating growth in the Asian and European markets also played an important role in our performance, but the quarter also showed weakness in pool and spa, a reflection of the downturn in housing and slowing in pool starts.

As we forecasted in our September announcement, the majority of our businesses performed well. Sales in commercial and industrial markets have remained robust and investments are beginning to pay off in international sales growth. For example, Technical Products' total sales for the quarter increased nearly $46 million compared to the same period last year, and operating income rose over $9 million, or 33%. Return on sales for both the quarter and the year-to-date are at our 15% target. The Thermal Management businesses acquired last December continue to produce results ahead of expectations. In fact, through September, this acquisition has already surpassed its operating income goal for the full-year 2006.

In our Water Group, pump performance continued to lead the way with good sales in North America in commercial, industrial and wastewater markets, combining with international to drive growth. In addition, our Filtration businesses achieved the strongest sales growth we've seen in two years as the investments we've been making to offset prior sales losses and leverage our product breadth and expertise are beginning to pay off.

Also as announced last month, this performance was offset by the effects of the softening pool, equipment market on the performance of our Pool and Spa business. Excluding the Pool and Spa business, the Water Group's sales grew by nearly 5% in the quarter. You'll recall that on September 26, 2006, we revised our earnings guidance for the third and fourth quarters of this year in recognition of the weaker pool markets and a third-quarter charge of $17 million, or $0.11 a share. The charge related to increased reserves for accounts receivable, inventory and warranty in the Company's Pool and Spa business, and some severance costs in the Water Group and at corporate. The majority of these costs have been spent to reposition the pool business to deal with the near-term declines and the lower growth expected next year in their markets. The balance of the cost was to streamline our corporate leadership structure and processes. As a result of these changes, we're moving our talent closer to the point of impact to support growth and operating improvement.

We built our talent base in order to institutionalize or ignite growth process and operations practices, particularly lean enterprise and supply management. These processes are now well-established. We are now moving some of these additions to our team into our operating units to directly drive these initiatives to get results.

And of course, I'm pleased to have promoted Mike Schrock to COO of all of Pentair operations. Mike has done an outstanding job leading Technical Products to record levels of performance, utilizing the key elements of our Pentair Integrated Management Systems, or PIMS, to do so.

In our Water Group, it is now evident that we will not exit this year at the 15% operating margin run rate that we were targeting. This is due to the unfavorable impact on our growth from the U.S. housing downturn, and also the need to accelerate progress on operating performance improvements across that group. In his new role, Mike will help us drive PIMs faster and harder in our Water business in order to achieve our goal of returning Water to 15% return on sales, which we still believe is a reasonable goal.

Returning to the businesses, while the downturn in our Pool and Spa market is challenging in the near-term, we have taken actions that we expect to drive improved performance in the uncertain environments, including actions to reduce cost and accelerate growth in our other water markets, particularly municipal, foodservice, commercial and international markets. We expect these actions, together with our ongoing initiatives to increase productivity while delivering quality products and customer service, to generate $35 million in incremental operating profit improvements in 2007. Further, we anticipate that with low-single-digit sales growth, we will be able to reestablish double-digit earnings growth next year as a result of the cost actions we're taking now in combination with the margin expansion initiatives we already have underway.

In the Water Group, third quarter sales of $532 million were up 3% over third quarter 2005 sales. The impact of foreign currency exchange was negligible. Pump sales were up in the third quarter, driven by strong double-digit commercial and export sales and mid-single-digit applied wastewater and residential sales. Much of the growth in Pump was driven by new products, including our new Pentek electronic pump controls, fire pumps, low-cost end suction pumps for HVAC applications, booster pump systems, packaged fired protection systems and several new pumps in the residential market.

As I have indicated, Pool and Spa sales declined 2% in the quarter due to inventory adjustments and the distribution channel, coupled with overall market declines. Looking within those markets, we estimate that the pool equipment market was flat in the quarter, the spa and bath market was down 20% with the spa portion of that market down 30%, and the bath portion down 12%. Spa and bath is directly tied to new housing and consumer spending. The pool equipment market is about 50% replacement and 50% new pool construction. New pool starts declined in the third quarter from the second quarter with continued weakness in California, further weakening in Florida and declines in the Southwest as well.

Our sales into the North American Filtration market increased in the mid-single digits. This is the highest quarterly growth rate for filtration since the WICOR acquisition. Sales growth in foodservice, commercial, industrial and residential filtration markets more than offset declines in RV and marine markets and a flat residential water treatment market. In fact, sales of Everpure products to commercial foodservice markets increased in the teens from year-ago levels, and strong residential filtration growth was attributable to orders from OEM customers, like GE and Brita.

In Europe, double-digit sales growth was driven in part by demand for pumps and filtration. Sales gains in Asia resulted in part from improved performance in Australia and New Zealand and in large pressure vessels and pumps. In fact, sales of our Codeline pressure vessels use in desalination and other large filtration projects continue to be very strong and particularly benefited the Asian business. Total Codeline shipments increased to more than 50% year-over-year, generating record operating income. Codeline's quote pipeline has steadily increased from the beginning of this year to a record high in the third quarter. This quotation activity suggests continued strength in the fourth quarter and into next year.

Operating income for the Water Group totaled $36 million, down 39% over the same period last year. Return on sales was 6.8%, down 460 basis points, compared to the same period last year. The decline was attributed to onetime costs for reserve adjustments and severance totaling $15 million in Water, lower unit volume in Pool and Spa and ongoing investment spending. Excluding the $15 million in charges that are attributable to the Water, however, the Water Group's return on sales was 9.6%, down 180 basis points from the prior year.

Continued strong margins at the Pump operations benefited from supply management savings, low-cost country sourcing activities and volume. And as described earlier, not only did Asia grow, but the business improved return on sales year-over-year, driven by that growth.

The Faradyne pump motor joint venture continues to progress well. Shipments to Pentair began in mid-September and 4-inch Faradyne motor equipped submersible pumps were shipped to key Pentair distributors in the month. Units shipped to date have been installed in key accounts and we received good feedback about the quality of the products.

For Water, the gap between price and inflation improved as a recent price actions more than offset inflationary pressures for key commodities, such as resin, copper and brass.

Total sales in our Technical Products Group grew by nearly $46 million, or 23%, compared to the same period last year. Organic growth of 5% moderated in the quarter compared to the first half of the year. Foreign currency translation accounted for a percentage point of that 5, but had minimal impact year-to-date. Lower organic growth was driven entirely by slower sales in North American data and telecom markets, primarily due to OEM projects that reach end of life or transition to our Asian operations. Without the end-of-life programs, organic growth would have been in-line with the second quarter, about 6% to 7%. This is because Tech Products enjoyed continued strong growth in North American and industrial and commercial markets, and in Asia, and European sales growth increased from the first half. In fact, Technical Products Europe grew sales in the low-teens amid markets that remained relatively robust, with test and measurement and telecom markets being particularly strong. Excluding currency, growth was 8%, driven by strong results in Germany and Scandinavia, partially offset by weaker performance in the UK.

We continue to win new customers in Europe, like Dallmeier, a German manufacturer of digital surveillance systems; Eltech, a Norwegian manufacturer of power solutions for the telecom industry; and Airspan, a UK provider of the fixed and wireless voice and data systems. Technical Products sales in Asia increased dramatically in the quarter. Two large OEM programs, both of which were won by Pentair Electronics Packaging in the U.S. for manufacture in China drove very strong growth in China, while Japan continued to benefit from ATCA sales into telecom markets, as well as strong sales of Schroff components into the semiconductor market.

Volume leverage and supply savings, combined with cost reductions and improved productivity to propel Technical Products to a second consecutive quarter of 15% ROS, our overall operating goal for Pentair. Although this means that the string of quarter-over-quarter sequential margin expansion is over after 18 quarters, the group has produced 16 straight quarters of year-over-year margin improvement, and we would like to keep that going.

As I mentioned earlier, our recently acquired Thermal Management business continued to produce excellent results, exceeding our expectations in both sales and operating income. Higher sales volume and our ongoing implementation of lean and supply management practices have driven significant expansion in ROS compared to their prior-year results. Strong material inflation is expected to continue going into the fourth quarter. Stainless steel prices, which have retreated slightly from their all-time highs, will continue to be a challenge. Carbon steel prices have started to drop and we don't believe the benefit will be significant in the quarter.

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

Thank you, Randy. I would like to remind you that Pentair adopted FAS 123(R) for stock option expensing in the fourth quarter of 2005 on a modified retrospective basis. Therefore, our third quarter 2006 numbers are directly comparable to our third quarter 2005 results.

Also, I should mention that we're using some non-GAAP financial measures in our discussion of the results today. A reconciliation of these non-GAAP measures to GAAP measures has been posted on our web site. This reconciliation can be found adjacent to the conference call webcasting link, which can be accessed from the overview page in the financial information section of our web site at Pentair.com.

As you recall on September 26th, we revised our third quarter EPS guidance to $0.30 to $0.32 from continuing operations. The revised guidance reflected the soft pool equipment market and resolving distributor inventory adjustments on our Pool and Spa business. Our actual third quarter continuing operations EPS came in at $0.33. This includes a $0.03 benefit in the third quarter from the resolution of prior-year tax-related items. The 29.5% blended tax rate for the quarter is lower than the 34% guidance I gave you last quarter. That tax rate differential contributed an additional $0.02 of EPS relative to our previous guidance.

As expected, we incurred approximately $17 million, or $0.11 EPS, for charges primarily related to the impact of the declining housing market on our Pool and Spa business. The charge related to increased reserves for our accounts receivable inventory and warranty in the Pool and Spa business and some severance cost in the Water Group and at corporate. Excluding these adjustments, EPS was $0.44.

Year-to-date earnings-per-share on a continuing operations basis now stands at $1.42, equal to the first nine months of 2005.

Now let's walk down through the individual line items on the income statement. Sales for total Pentair in the third quarter came in at $778 million. Consistent with the first half of 2006, sales for the third quarter and the first nine months continued to run about 9% higher than the prior year and organic growth remained in the mid-single digits. We are particularly pleased with the strong growth we realize in our Asian and European markets.

A moment ago, I mentioned that we incurred $17 million in charges in response to the impact that the softer housing market is having on our pool business. Of the $17 million in adjustments, $15 million went to the Water segment with $9 million in cost of goods sold and $6 million in SG&A. The remaining $2 million was also in SG&A, but as part of corporate, which is included in the line item other from a reportable business segment basis. Pentair's third quarter gross margin decreased year-over-year by 70 basis points. However, excluding the $9 million impact of the market-driven charges to cost of goods sold, our gross margin was up 50 basis points. Water Segment gross margins were about even with the prior year excluding these charges, while Technical Products continued to drive margin expansion through growth and productivity generating a 130-basis-point improvement. For the first nine months of 2006, Pentair's gross margins were the same as the prior year, despite a 40-basis-point adverse impact of the market-driven adjustment taken in the third quarter. As a percent of sales, third quarter SG&A expense was up 200 basis points from the prior year. 100 basis points of the increase came from the $8 million of adjustments that were charged to SG&A in the third quarter. The balance of the year-over-year SG&A spending increase was due to continued investment spending to drive future growth and to develop our I infrastructure in Europe. Year-to-date SG&A expense came in at 110 basis points over the prior year, primarily as a result of these investments in our third quarter adjustments.

From a reportable business segment basis, the line item other, which includes corporate, was $13 million in the third quarter, up $3 million from last year. This increase was the result of the $2 million of third-quarter charges related to corporate severance and the investment in resources focused on growth and low-cost supply initiatives. Going forward, these resources are being deployed out to the point of impact in our businesses. These higher costs were partially offset by a reduction in the corporate bonus expense accrual, consistent with our current business outlook. Our corporate spend is down sequentially in this quarter from the second and I'm pleased with our progress in reducing corporate spending. I expect our quarterly run rate to be more in line with the third quarter rate than the high rate experienced in the first half of 2006.

R&D costs were up 30 basis points in the quarter and through the first nine months. This increase was due to investments in new products and proportionately higher R&D spending in the newly acquired Thermal businesses where we continue to see great results. Pentair's operating margin for the third quarter was 7.7%, down 300 basis points from the prior year. Excluding the $17 million in charges we took in response to changing market conditions in our pool business, the operating margin was 9.9%, down 80 basis points from 2005. This decrease is primarily the result of lower Water margins being offset by higher Technical group margins.

As reported, the operating margin in the Water segment was 6.8%, down 460 basis points from the prior year operating margin of 11.4%. Excluding the $15 million in charges that are attributed to Water, however, Water's return on sales was 9.6%, down 180 basis points from the prior year and resulted from weaker market conditions in our Pool and Spa business and ongoing investment spending. Technical Products operating margin was up 110 basis points to 15%. Higher margins in Technical Products continue to be generated from growth and cost productivity improvements as well as the successful integration of the new Thermal businesses.

For the first nine months of the year, Pentair's operating margin was 10.2%, down 140 basis points from the prior year. Investments for growth, plant consolidation-related inefficiencies and a $17 million charge taken in the third quarter were the key contributors to our lower operating margin. Interest expense was up $2.3 million in the third quarter, primarily due to higher interest rates on our floating-rate debt and higher debt levels as a result of the Thermal acquisition in December of '05. The higher rates were attributable to the fixed interest rate increases by the Federal Reserve over the last 12 months. The effective tax rate of 29.5% was down 320 basis points in the third quarter versus a 2005 tax rate of 32.7%. As mentioned, favorable prior-year tax settlements resulted in $0.03 of EPS in our third quarter versus $0.01 of EPS from favorable tax settlements in the same quarter last year.

Our year-to-date tax rate is 30.3% versus 35.8% in the first nine months of 2005. The lower rate in 2006 was driven by favorable prior-year onetime tax adjustments compared to net unfavorable prior year tax adjustments in 2005. We are continually working on additional tax reduction opportunities and we expect our full-year blended tax rate to be between 28% and 30%. It should be noted that the tax rate in any quarter can be affected positively or negatively by adjustments from prior-year tax years that are required to be reported in a specific quarter of resolution. Year-to-date free cash flow for the first nine months was $93 million versus $87 million last year. While this is an improvement of $6 million compared to 2005, we're still experiencing high levels of inventory due to the purchase of submersible pump motors from both current and strategic suppliers, coupled with inventory put in place to support several plants and product line moves. With the current levels of inventory on the balance sheet, there is ample opportunity to reduce working capital and generate free cash flow in 2007.

As a result of our lean efforts, the need for expansion capital has been lower than expected. For this reason, we're targeting a lower level of capital expenditures for the total year 2006 in the range of $60 to $65 million. For the full year 2006, we're targeting free cash flow of $170 to $180 million and remain committed to our free cash flow goal of 100% conversion of net income. Our debt to total capital ratio was 32.6% at the end of the third quarter, down 50 basis points from the second quarter and equal to year-end 2005. We continue to maintain our low debt to total capital ratio despite funding acquisitions of $163 million, dividend payments of $56 million and stock buybacks of $75 million, all totaling $294 million over the last 12 months.

Finally, I would like to conclude my remarks with an update on the Horizon litigation. As you might recall on June 29, we announced that we have received an adverse jury verdict of $193 million in this litigation. That verdict was exclusive of prejudgment interest and attorney fees. Post-trial motions have been filed and we anticipate that they will be heard and decided in the fourth quarter. Therefore, no adjustments have been made to our previously established reserve, except for accruals of additional quarters' interest expense and legal fees related to the matter. As stated in our initial release on this topic, we believe that this verdict is not consistent with the law, nor the evidence offered at the trial, and we are committed to pursuing all available means to achieve reversal of the verdict. Pentair's EPS guidance does not reflect any potential impact of this litigation. In the meantime, this litigation matter has not distracted our intention or focus on our plans or operations.

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

Thanks, Dave. Looking ahead to the fourth quarter, we expect sales in Pool and Spa to be down significantly due to adjustments in channel inventories when compared to the strong fourth quarter 2005 sales resulting from last year's robust early buy program. However, we believe the inventory drawdown will be largely complete by the end of the fourth quarter. Thereafter, we should attract more closely to end market demand.

In the interim, we have taken action to reduce costs and accelerate growth in all of our Water businesses. With more nimble decision-making and additional resources focused on growth and productivity in the field and lower overhead, we believe Pentair is better positioned to face whenever challenges 2007 may bring while reinforcing our commitment to serve customers well.

We are reiterating our full-year 2006 EPS guidance from continuing operations of between $1.72 and $1.76. In addition, we're initiating EPS guidance full-year 2007 in a range between $2.00 and $2.15, indicating an increase of between 14% and 25% over 2006 EPS. The low end of the 2007 guidance assumes a sustained weakness in housing markets that would affect both our Pump and Pool businesses, while the high end of the range represents some moderation of these impacts on housing and continued strength in our other markets.

Thank you for your attention. I would now ask the operator to come on the line and provide our audience with instructions for the Q&A portion of this call.

(Operator Instructions). Curt Woodworth, JP Morgan.

A question on the Water margin this quarter. Even if you adjust for the onetime charges, they were still down 180 basis points year-on-year, despite much improved growth in some of your higher margin businesses and in Filtration and Commercial Pumps. And I'm just wondering -- and the margins are even lower than two years ago when you first put together the WICOR transaction. So I'm wondering, can you talk about, are you seeing any structural changes in the margins of these businesses among the three product lines and talk about -- you said you still feel the 15% goal is reasonable. Can you kind of maybe give us a sense for how you're going to get there and a time line?

Mike and I have spent a lot of time on that. It's going to take us another 12 to 18 months I think to get to the 15%. The way to think about that 180 basis points, which is the same decline as it was in the second quarter, we were expecting before the Pool business fell off like it did, we were expecting the third quarter in Water to be down, but not down as much as the second quarter. We thought it would be down more like 100 basis points. And in fact, if you take that 180 basis points and you just factor out the decline in the Pool and Spa business, that's about 110 basis points. So, if you subtract that out, the business was -- Water was down about 70 basis points. So it was more in line with our expectations. And the reason that the fundamentals underneath that are -- Asia's better in margins, Pump is a lot better in margins. Filtration has made a nice step up sequentially in margins but isn't yet lapping itself. We expect that to happen very soon. In other words, Filtration margins are going to be an improvement in our margin base going forward, but Pool and Spa and Europe are down. Europe is down because of the investment in our systems and the fact that we need to get better productivity in Europe. And then, the Pool business is down because of the volume.

We also in the quarter, these investments we've been having every quarter, which were running about $7 to $8 million in the first two quarters, did decline, but they were still about $6 million or so in the third quarter and we expect them to drop off in the fourth quarter. So that's the way to think about it, but that's why we still think and that's why, as I said, Mike and I have spent lot of time to revalidate the 15% is still a good goal. So we don't think there are structural changes, and we're going to keep driving back to that 15%.

One question on the '07 guidance. In terms of the 15% EPS range, can you walk us through how this math works, in terms of how negative are you assuming the housing market gets at the low end? And, what kind of incremental margin are you applying to that potential weakness on those parts of your business that are impacted so we can kind of --?

While Dave figures out the second part of that question, I'll answer the first part. Basically, about 50% of our total Water business serves the North American residential market. About half of that is tied to new construction, either new pools or new housing. So it's about 25%, the exposure is about 25% of our total Water business. We expect the growth in commercial and industrial and municipal and international to continue like it has, and we're expecting housing in the low case to affect that 25%, it's probably some 5% to 8%. So if you do all of that math, in our low case, the $2.00 case, we have a growth rate of -- for all of the Water that's 0 to 1, basically call it a flat case overall. So the [other] businesses is offsetting the downturn in (inaudible).

And then if in fact the pool business is as other people predict it to be, and that we see housing flatten out, and we could see as much as, in the high case, the high case, the assumption is that Water could be in the 3% to 5% growth range, which would be better success with our global growth, continued strength in commercial and then housing not being down 5% to 8%, but maybe down 0% to 5%. So that's kind of the rough math that we use top-down.

In terms of how to think about the incremental margin on those sales that are exposed to the housing market, it seems like the Pool and Spa is much higher incremental than maybe we anticipated.

To me, the problem with Pool and Spa in the short-term is, we can't adjust cost (indiscernible). Our drop-through is -- it's really dropping through at contribution margins and it has been very seasonal. And frankly, I think we have been too promotional in that business, plus the seasonality has not let us drive that business in an operations excellence way. So we are really focused now on level loading those factories in Pool and driving to attack time that [sits] the seasonality, but is going to let us drive higher productivity in that business. So it was our most profitable business, Pool and Spa last year, and so it naturally would have a pretty high drop-through. But, this acute issue we have in the fourth quarter on their margins is not something that we're going to live with in that business. We're going to get it so that we can handle the seasonality and try to keep margins more steady.

So, I would think, Curt, that as we move forward next year, even in the low-growth scenario, we should be looking at Water getting back to closer to what it was in the '05 time period, even with the low growth, and that would be coming from the productivity improvements, not having the inefficiencies that we had this year. But, I would think that we should be getting back closer to those levels. And then obviously if we get the growth, then we should be able to move ahead of where we were in 2005.

Great. Thank you.

Mike Schneider, Robert W. Baird.

Hi, guys. Randy, maybe you could just address some macro on the residential market. Obviously, the Pool and Spa impact has been discussed. But, have you seen anything as of late that would lead you to believe it's beginning to impact either the tanks business or the residential filtration or any of the other businesses? And I particularly call it out just because Franklin Electric last night specifically called out that their submersible pump business had fallen off in September because of housing.

In terms of the well market, we actually think the well market, the well sales, pump sales, were down maybe 1% in the third quarter. Our overall pump business was up mid-single-digits though because commercial was strong, other elements, our residential business, was strong. So we're Fairly diverse in terms of our exposure into just that segment. And well pumps is one of the areas where you would expect housing to have more of an impact. Most of our pump business in residential is actually replacement. It's driven more by weather. Probably in pump overall, it's probably -- residential is probably -- it's probably two-thirds, or 70% is replacement, as opposed to related to new housing as we look at our mix of businesses. We're fairly big in the retail channel, and the retail channel is really not that tied to new housing. It's really tied more to weather and droughts and floods. So we do think it will impact pump, but we think pump has a fairly diverse end market. The other piece that will impact pump going forward is the competition that's going on with the motors and the pumps and all. And I think that will cause a great deal of uncertainty month to month to month, because I think that's going to be an 18-month battle.

But it doesn't sound as though you've felt or seen any early impact on some of the other businesses, be it tanks or filtration?

I did mention in Filtration that residential water softening was flat. Overall, our business in residential was up because of the investments we have made to penetrate more deeply residential filtration, which is really more of a replacement business. That's 60%, 70% replacement. So that more than offset the weakness we saw in RV and marine.

The other think, in water softening, we didn't see a huge bump up in water softening because of the housing, because a lot of where housing was growing strong, they don't use water softeners, and so we don't expect to see a big drop-off in water softeners either, particularly in the pro channel, where big chunk of that business is being replacement anyway.

Okay. And then going back to the earnings announcement last month, you mentioned in there that you expected $35 million of profit improvement from a lot of the initiatives you have been discussing. Given the passage of a month and I guess better clarity, have you revised that estimate? And maybe you could just spend some time specifically talking about what productivity initiatives truly delivered these savings, or is it more a lack of --.

In general, that $35 million is consistent with the middle of our range. The range we have set is a top-down number. The key drivers on the $35 million is for us to sustain the pump margins by -- right now, I would say they are in the second inning of their lean journey. They've done a great job and they're operating at the highest margins they've ever achieved in pump. But, we still have a lot of benefit to come in lean. And not only will that help in terms of margins, but that's when you'll begin to see the reductions in inventories that we expect to get in the future, which need to come from the pump business and the pool business in particular.

The second big source is -- our Filtration business is now building momentum with their lean initiatives and their supply chain management initiatives, and also actually an improvement in mix that's going to drive their margins to be a nice step up next year. So a big piece of the $35 million is Filtration. Another big piece of it is for us to get the investments behind us in Europe and get a nice step up in margins. Europe had been our most profitable region in Water, and right now, it's our least profitable region. So it's getting the investments behind us and getting the productivity from those investments to deliver while maintaining the growth rates that we're enjoying in Europe right now.

And then we have reduced headcount. We reduced headcount about 125 million people with the 17 -- 125 people, (inaudible) -- 125 people, that's the $17 million, and most of which are in the pool business, but we also did some cutting in other segments of Water and at corporate as well. So those are the big blocks. Dave, did I leave any of those big blocks out, or.

Pretty well covered, I think.

Well, also higher margins in Asia as we get more growth in Asia.

That's a good segue to my last question, which is Asian growth. You mentioned in the press release, it was up 25%. Can you talk, how much of that is just being driven by product being relocated from U.S. to European plants to Asia, and truly how much is what I'll call organic growth of that business?

That is our third-party number. So the intercompany gets canceled out, and so it's mostly sales outside. Some of it, though, is transferred from -- and particularly in Tech Products where it's either transferred or it's actually sold in one region and developed in the other. But I would say that the majority of that growth is -- the majority of the 25% is not that, maybe 5%. Dave, what do you think of that split between transfers and -- it's probably 5 points out of the 25?

Yes, that's probably right.

Yes, 5 points out of 25. Actually in the quarter, we saw great Tech Products growth, but not as great as the second quarter. So -- and that was largely because of the transfers. So 25% is -- and I'd say 5% is the transfer.

Okay, thank you guys.

Jim Lucas, Janney Montgomery Scott.

Thanks, good afternoon. Two questions unrelated. One, on the financial side, Dave, could to give us an update of how much stock you bought back in the quarter, average price and how much you have left under the authorization? And secondly on the Filtration side, Randy, could you give us a little bit more color of, now that you have had new leadership in place there, what were the problems, what have you done to make the necessary changes and kind of coincidentally and with that, give us an update on the [eco lab].

Let me start out, Jim. First of all, we had -- we started out with a $25 million authorization and then kicked that up to $50 million in the quarter. So during -- for the first -- through the end of the quarter, for the year, we had purchased 1,650,000 shares at $30.30, for a total of $50 million. So we -- at the last Board meeting, that has been kicked up now to an authorization for the year of $100 million. So, we will be spending the other $50 million as we go through the quarter, through the fourth quarter.

So you're actively going to be in the fourth quarter (multiple speakers) million?

That's correct. On Filtration, the Filtration business proved to be the area where we had the biggest challenges in terms of the WICOR integration, because they had some businesses, particularly the retail business and their tank business, which were struggling operations. So that was one challenge that we have overcome. The second one was that, a number of our growth initiatives, we were overly skewed to the OEM side and had not taken advantage of what is frankly an extraordinarily strong position in what I call the pro channel side. And so I think we had underinvested in the pro channel and overinvested in OEM. And as you know, we moved Filtration over to Mike about a year ago and then made a change about five months ago. And we have gotten that fixed. We have more of a focus on the pro channel, and we have -- I would call it a balanced, successful focus on OEMs, and we continue to drive nice partnerships with people like Ecolab.

Ecolab is progressing well. It's a business and it's a channel that requires a lot of training and the product lines we have introduced there are fairly diverse. So we are actively training and driving growth. We are up for the year. Not up per the plan that Ecloab and we had, but we do have some nice growth and we're committed to it and we think it's going to be a long-term winner for us. We have introduced a new line of what we call FresH2O filtration systems that are exclusive to Ecolab which we think is going to be a nice step up from the product that they used to have which we did not make. And then in terms of the cartridge change-out and water softener, which they are now selling, we think that it's a channel that's really going to pay off over the next couple of years.

Okay, thank you.

Christopher Glynn, CIBC World Markets.

A question -- on the last quarter, you called out Pump margins going through 15%, and I didn't see it specifically called out. But, did you reference a couple minutes ago that it again hit a record?

Well it didn't hit -- Pump is a seasonal business. The second quarter is always their -- the third quarter is usually, it's a lower sales quarter and it's a lower margin quarter, so there's some seasonality in Pump. It was certainly a record for the third quarter, but it wasn't as high as the second quarter. And it's within the range of our 15% goal, so it was a nice step up year-over-year.

On the Technical Products margins, it is down a little sequentially. Could you just break that down a little in terms of how much it might have been deleveraged sequentially or maybe some mix issues?

Let me just take a quick look. Part of it is the Thermal business also was stronger in the second quarter. When it gets hot, that's when a lot of the installed base breaks and you get to replace it. So the Thermal business sequentially was a little bit smaller. And then our electronic -- I mentioned our Electronics business was down year-over-year, which caused our North American business to be a flat because of some end-of-life programs, and so their margins fell off second quarter to third quarter. But all of the other businesses, Europe was good, (indiscernible) was good, Asia was good (indiscernible).

And last question. With Emerson now having [Kinur] in there, does that change the landscape? It seems like a pretty notable sort of new entrant that will be trying to establish itself in North America. I just wondered if you could comment on that.

Yes, Kinur was never very successful in North America and Kinur's strongest business is what we would call computer room furniture. It's electronic furniture used in computer rooms, which I think fits Emerson's levered room-based strategy. And so I guess we kind of converge with our Thermal acquisition, which is cabinet-level and they are sort of -- they are room-level thermal management. There is some convergence, but right now, I view Emerson more as customer than a competitor.

Okay. Can you just lever it a tiny bit more on the viewing them as a customer? What do they buy from you?

They buy a range of products from us in Tech Products, including some air handling units, air conditioners, cabinets, even on the industrial side from [Hoffman], they have been a long-standing customer.

And Kinur doesn't change that at all?

Kinur doesn't make any of those things. They don't make the thermal -- they don't make cabinet-level thermal management. They do make cabinets, but they don't make the kind of cabinets they buy from us and Hoffman. So we know Kinur well. The guy who was running it used to work for us.

Great, thanks a lot.

Dan Whang, Lehman Brothers.

My first question was regarding the perhaps an update on the pool pre-buy program. I think you had provided some expectations for the fourth quarter, perhaps year-over-year decrease in the $30, $60 million. And could you provide an update on that?

Well, it's not complete. We won't really have it all in until the end of the month. But I would say that it is going to be down. Certainly, the inventory adjustment is going on. You can see it in the results of the third quarter from the channel. And even if it's stronger, we think that it probably won't shift. What we're refocusing was the shipments in the fourth quarter. Last year, as you know, we had a blowout quarter on the early buy. We think it was too big and we didn't manage it well. This year, it's going to be smaller and we're going to manage it better. What Mike and I are working on is making sure we level load and we can execute and deliver the higher customer service level as opposed to how it was done last year.

So we do think it's going to be lower. We do still think it's going to be -- it's certainly going to be worse than the market, and that is why we really think that the inventory adjustment is going to be over by the end of this quarter.

Okay. And just jumping over to the Filtration business, you stated the strength in that business, strongest in [three] years. It sounds like maybe that was up mid-single digits or better. What would you say is driving that? Is it new products? I think previously, you had talked about maybe the Brita opportunity -- is that --?

That's going to help. Actually, the OEM business, particularly with GE and Brita, were both up. Filtration -- our Everpure business and the foodservice piece of Everpure, it was really outstanding. It is such a great franchise. And so that was a big driver. We also had some nice industrial business. We have a number of niche opportunities that we serve in the industrial space. We have more focus with the current management team on driving some of those niche opportunities, because we think there's nice margins in them. And then, let's see, Dave what was the other? There's really commercial, and then Codeline. Codeline in North America goes through that business, so I would call it infrastructure or industrial business.

Okay. You talked about the rate of investment spend, I think you talked about $8 million or say $9 million the first, second quarter, and then it sounds like it was $6 million. How should we model that in in the fourth quarter? And then, looking out into '06, I think the previous guidance was that it may be essentially half of the amount that would be in for '06 in total. Does that still stand?

Yes that still stands, although right now, the biggest change in our look forward is really the volumes, and the case we have going forward is, as the lower volumes from Pool, it also has low volumes for Pump because of what I talked about earlier, that we do expect -- we do see a little bit of an impact from residential and we think it's right to continue that, and that's what I said was the $2 -- was the low end of our '07 range, was really more volume related (inaudible) than it is that investment.

Last question is regarding the Technical Products. You did talk about the impact on the end of life cycle of some of the telecom OEM project. So going forward, should we expect that level maybe mid-single-digit, maybe 4% or 5% type of organic growth until those projects get anniversaried, or maybe just some thoughts on that.

Yes, that's right, that's a good number, the mid-single digits. Our plan was to do better than that because we're doing really with some new products, particularly our ATCA, and we thought that ATCA would fill in the hole that we saw coming from those two programs, which are Dell and Intel. And ATC has not ramped up quite -- it's up, but it hasn't ramped up quite as fast because or [ROJAS] environmental compliance, and just the adoption rate. I think we were a little optimistic about the adoption. The industry was a little optimistic about the adoption rate. But our market share is holding in ATC and we have some other nice wins, so we still feel good about the growth fundamentals around the leadership position we've built on ATC (inaudible).

Okay, thank you.

David Smith, Citigroup Investment Research.

As far as they pre-buy goes, I'm just not understanding in the fourth quarter, what should we be thinking the first half in terms of Pool and Spa? Because last year, there were very easy comps in the first half because so much was pulled forward into the fourth quarter, and that's what seemed to drive a lot of the organic weakness in the first half in the Pool and Spa business. What should we be thinking? Should we be thinking definitely down from those easier comps?

I think there is a lot of uncertainty on how it's going to unfold. Right now, I'm trying to take a balanced view of Pool, which I think most people will probably say would be down. I think that's just a safer bet.

Even off of those easier numbers?

Yes, because -- well, it was easy numbers, the market was still good. We were actually flattish, but the market was stronger. The market -- in the case we were on the market maybe down as much as on a blended basis 5% in the first quarter. And so if the inventory adjustment is over and we see that 5%, then that's what we have to factor in. Now, we also have new products that will help, and we also have price that will help. We have some things that will offset that market decline. But we don't think it's prudent to plan on nor drive programmatics that would shape demand differently.

Maybe phrase it this way. How much below market were you last year in the first half in the Pool and Spa business?

We were actually -- if you take out the Spa piece of it, we were actually up on the Pool side in the first half of the year, something in the range of 2% or 3%.

And the market was?

Probably 5.

I see -- you were trailing the market with the pre-buy?

Yes.

In the enclosures business, you're at your 15% target. Where do we go from here? Does it get any better than this, or does it depend on mix?

It can get better, because while we're at 15% overall, which is our goal, the goal that Mike and the team have had for Tech Products was to run our electrical side of that business at a 5% growth rate and a 20% margin, and run the electronic side, which is Europe, Asia and (indiscernible) North America at a 10%-plus growth rate and make 10% ROI. And we really at are 15% because we've overperformed in electrical. We still have not achieved the margins in electronics that we think we should be able to get to. So moving it in that direction, moving margins up on the electronics side, could help the business do even better.

Kind of pricing that down a little bit, what are you seeing in terms of regional margins? Is North America like a flattish kind of market, is that where you're seeing some erosion?

Not really, because North America is where the industrial and electrical business is, and that's the highest-performing part of Pentair, period. So on the electronics side, it is where we [see it]. And it's not really erosion, they just haven't gotten to the level, they haven't gotten to the 10%. Back when I ran enclosures, electronics was above 10% at the peak. So we've gotten electronics -- we've gotten electrical back well above where it ever was, setting huge new records. Europe is close and we need to get the North American electronics business, which is the laggard of all of the pieces in terms of margins. We need to get those margins up.

Okay. And as far as pricing in the Pool and Spa business, are you guys seeing a more competitive environment these days with the decline obviously in the pre-buy?

Pricing is -- it is tougher, particularly -- it's a transaction by transaction level. It's not so tough in the distribution channel. But as you work with the larger customers, it certainly has that. But it's generally still rational.

More like direct OEM kind of business?

Not OEM, but direct to builder.

Last thing. As far as, you have obviously some great cost savings in the Water business over the past year, two years, but I guess I'm a little surprised to see not a little bit more optimism on the guidance front. Where do you see incremental operating profit in the Water business in '07? It has been obviously very good in the enclosures business, but as far as Water goes, where do you see that kind of unfolding over the next year to two years?

Filtration number one, Europe number two, and then finally when we can get Pool stabilized, getting Pool back to where it already was. It was already above our 15% and we believe it can get there again. And to get there, it's fixing this Spa and Bath business, which has been a real drag in the numbers on the top line, but an even bigger drag on the bottom line. And those are the priority -- and keeping Pump where it is. That's how we think about the margins in Water.

Great, thanks

We probably have time for just a couple more questions.

Mike Hamilton, RBC Dain.

Good morning. Just a couple of detailed questions first. '07, could you hit on what you're building into CapEx at this stage?

We're looking at a number that's probably going to be very similar to what we had or what we were expecting earlier this year. Something probably in the range of 70 is what I would use for modeling.

And we're at 60 current year, right?

We're looking at 60 to 65 current year, yes.

What is rolling in in fourth quarter? That implies a pretty big build here.

We are building the Tech Products plant in Poland. It's a new plant that we expect we'll -- we started building it in May with the high capitals now.

Thanks. How about tax rate on '07?

We're looking at a number right now in terms of effective tax rate of around 35%.

One bigger picture. Assuming, Randy, the kind of middle range on housing that you're looking at, what do you anticipate blended across your lines, in terms of pricing?

The way we're planning is, we want to be able to offset inflation with pricing. We actually did a little better than that in Water in the third quarter. So, we still are looking at offsetting inflation and we (indiscernible) we kind of zero out the two in our planning top-down. We'll get more precise as we get closer.

Not seeing any real aggressive signs of competitive pricing in here in the weakening market?

No. Actually, our price realization in Water in particular was as good as it has been all year in the third quarter.

Thank you very much, that's it for me.

Kevin McVeigh, Goldman Sachs.

One quick clarification on the third quarter if I could. I think the guidance was 30 to 32. Did that exclude the $0.03 tax benefit?

We had in our guidance for the 30 to 32, we knew that there was going to be some, so we picked up probably another $0.01 versus what we had originally expected.

Okay, so Dave, if you adjust for that, you came in at $0.30, which would have been the lower end of the range? Correct?

No, we had $0.02 -- we were looking at about $0.02 in that 30 to 32.

$0.02 of tax was in that number?

Yes, so we looked at it as 30 (multiple speakers) versus what we thought, we came in $0.01 better, so $0.32.

Okay, $0.32, because I wasn't sure about that. And as you think about the fall-off in Pool and Spa, Randy, could you calibrate what the difference is between inventory adjustments at the distributor level versus fall-off in end market demand in terms of severity? I know we were down low-single digits in the quarter. How much of that again was related to inventory adjustments versus end market demand?

We think the end market in the Pool business was flat and we were down 2%, so that's the difference. And we think it will be even bigger in the fourth quarter. We think the market probably flat to maybe down a point, and we will be down quite a bit.

Okay, thank you.

(indiscernible). Thanks a lot for your questions. Operator, if you could come on and give them directions on the callback and the 800 number.

Thank you for participating in today's Pentair Inc. third quarter conference call. This call will be available for replay beginning at 3:00 PM Eastern standard time today through 11:59 PM Eastern standard time on Saturday, October 28, 2006. The conference ID number for the replay is 361-3416. (Operator Instructions). The number to dial for the replay is 1-800-642-1687, or 706-645-9291. Mr. Harrison?

Thank you very much. Bye now.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.