濱特爾 (PNR) 2007 Q2 法說會逐字稿

Good afternoon. My name is Sandrel, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 2007 Pentair earnings 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. Gleason, you may begin your conference.

Thanks, Sandrel, and welcome to Pentair's second quarter earnings release conference call. We're glad you could join us.

I'm Todd Gleason, Vice President of Investor Relations. With me today is Randy Hogan, our Chairman and Chief Executive Officer, as well as John Stauch, our Chief Financial Officer. On today's call, we will provide details on our second quarter and first half 2007 results as well as update you on Pentair's outlook for the third quarter and full year 2007.

Before we begin, let me remind you that any statements made about the Company's anticipated financial results are forward-looking statements subject to future risks and uncertainties such as outlined in Pentair's 10-K as of December 31, 2006, and Pentair news releases. Forward-looking statements 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.

Today's webcast is accompanied by a presentation, which can be found on the financial information section of Pentair's website at www.pentair.com. We will reference these slides throughout our prepared remarks today. Any references to non-GAAP financials are reconciled in the appendix of this presentation.

As is our custom, we will reserve time for questions and answers after our prepared remarks. I will now hand the call over to Randy who will take you through Pentair's second quarter results and highlights, provide his perspective on the markets in which we operate, and describe the detailed productivity actions we're taking to help ensure we deliver the expected results this year. Then John Stauch will conclude our formal remarks with an overview of our third quarter, second half, and and full year forecast.

Randy?

Thanks, Todd, and thank you all for joining us today.

Let's begin by reviewing our second quarter results shown on slide two of the document that Todd just told you to find on our website. As we look at our second quarter performance, we're pleased to have delivered $0.62 per share of earnings from continuing operations on revenue growth of 7%. The $0.62 of EPS was down $0.05 versus last year on a reported basis. The year earlier second quarter EPS of $0.67, however, included $0.08 of one-time tax benefits. So we recognize a nice improvement in the second quarter on an operating basis. The $0.62 also compares favorably to the guidance we provided in April of $0.57 to $0.59 per share.

Let's review the highlights of how we got there. Overall, Pentair sales of $923 million were a record for the second quarter and 7% above the $862 million in sales we generated in the second quarter of 2006. Three percentage points of our growth was organic, or up 2% in local currencies despite the challenging declines we've seen in the North American residential, new construction market and the continued softness on electronics markets.

Acquisitions added another 4% to our top line versus last year. Our water business generated 10% sales growth with 5% organic. With the North American residential new construction market down approximately 25% to 30% and pool permits lagging normal levels, we were encouraged by these sales results.

Our technical products business had organic sales declines of 1% as sales growth in our Hoffman Enclosures division and solid growth in Asia and Latin America regions could not offset the declines associated with the global telecom market. In the quarter, we continued to face difficult year-over-year comparisons in the portion of our electronics business that serves the global datacom and telecom markets.

Overall return on sales or operating margins declined ten basis points. As you can see on the chart, positive volume and price coupled with solid productivity can not completely offset total inflation.

Free cash flow in the quarter was $145 million, an improvement of $16 million year-over-year, driven primarily by cash provided from working capital. This brings our year-to-date free cash flow to $69 million positive, an improvement of $42 million over the first half of 2006.

Let's turn now to slide number three and review our water business, which grew all sales almost $60 million to $665 million, up 10% versus last year's sales. Organic sales were up 5% and acquisitions added another five points of growth. You can see the composition of our total water sales walk on the top left section of the chart, and rather than go through that detail, let me provide information on our sales in pump, pool and spa, filtration, and international markets.

North American pump sales were up 9% as sales of our industrial, municipal and commercial pumps more than offset softness in the North American residential markets. As we mentioned in our press release this morning, our pump business benefited from the sale of $21 million worth of large pumps for a major project for New Orleans.

We originally forecast that seven of the 11 large pumps, which ship in the second quarter. The customer requested delivery of all the pumps in the quarter, however, and we were able to meet this demand. So approximately one-third of the project's revenue came in a little earlier, which benefited the second quarter in sales and income.

If you remove the entire impact of this large project, our North American pump revenue would have been about flat as municipal, commercial, and agricultural growth offset residential declines. When John outlines our EPS guidance, he'll revisit this topic to help you size the EPS benefit to Q2 and the modest impact to the second half of 2007.

Our Faradyne joint venture continues to meet commitments and the acceptance of our [motor] with Pentair customers reached the penetration rate of over 85% in the second quarter. The actions of our new competitor here will continue to be a drag as price pressures and high inventories impact the well pumped market niche.

Our North American pool and spa sales were flat with Q2 of last year. April and May were better than expected, but June fell short of expectations. In aggregate, pool and spa sales were slightly ahead of our original Q2 expectation and helped the quarter.

New products as expected sold very well in the quarter. The pool market continues to be unpredictable and choppy as new pool permits remain soft in Florida, Arizona, and California, and we saw it drop dramatically in Texas in the second quarter due to abnormal rainy weather.

While predictions remain difficult, we continue to anticipate soft customer buying patterns in the pool markets in the second half of 2007. North American filtration sales were up 7%, driven by the Porous Media acquisition. Organic sales were down 1% as increases in our commercial and industrial markets and continued momentum in food service did not offset declines in residential.

The filtration food service market remains good and we continue to grow in this attractive space. Our water sales in the European, Middle East, and Asia Pacific were up double digits. Sales in Asia Pacific grew 34% while Europe, Middle East, and Africa grew organic water sales 13%.

On the top right section of the chart you can see our year-over-year operating income walk for water. Overall water margins contracted 20 basis points with volume, price, foreign exchange, and acquisitions and aggregate contributing a positive 230 basis points. Productivity, that of key strategic investments primarily driven by investments in SAP, a new swift company structure, and Asian infrastructure added ten basis points. These improvements could not offset inflation of a negative 260 basis points.

So in total, water margins were 13.7% for the second quarter of 2007. Year-to-date margins in our water business are relatively flat versus last year at 12.4%. To remind you, the residential markets did not show significant signs of softening until the third quarter of last year when we took actions to right size the business.

These actions have played out as we expected in the first half of 2007 and we anticipate even more positive year-over-year benefits in the second half. These items will help produce significantly better margins in our water business in the second half year-over-year. We'll update you on our specific actions to achieve our targeted water margins of 12.5% for the full year in just a few slides.

Let's move over to slide number four now and review our technical products business. Similar to the water chart, we provide you with total business sales and operating income walks at the upper half of the chart. Technical product sales in the second quarter were basically flat as 6% growth in our Hoffman electrical business was negatively offset by electronic sales declines.

North American electronic sales were down 27% because of contraction and consolidation in the telecom market. Technical products, Europe was down slightly excluding favorable currency exchange. These declines mask the significant progress of our technical products Asia business, which recorded 60% year-over-year growth.

Shifting to technical products margins, we delivered overall margins of 14.1% in the second quarter, down 140 basis points versus the same period in 2006. Core operational improvements of 210 basis points via lean driven productivity actions were not enough to offset metals inflation and the impact of the sales decline in the North American electronics market. Despite being down year-over-year, the second quarter's 14.1% margin exceeded the guidance we provided in April of 13% to 13.4%.

Two key factors led to this higher than anticipated margins. First at Hoffman, which includes McLean and Aspen, sales and productivity performance were strong, and second, we closed the gap between our product price and our costs related to pressures from stainless steel. Both these items helped improve technical products margin and total company earnings in the second quarter.

As we move into the second half of the year, we expect modest sales improvements as we begin to lap the market declines in the telecom and datacom segments. We also expect continued mid-single digit level sales increases in our electrical business.

Turning now to slide number five, let's take a quick look at the total financial figures for Pentair in the second quarter. Starting with the highlighted bullets on the right side of the chart, we had sales growth of 7%, as I've already said and we expanded gross margins of 30 basis points to 30.7%.

Our EBITDA margin was flat year-over-year at 14.9% for the quarter. Net interest expense was up $6.3 million, as we added approximately $375 million of debt from last year primarily related to the Jung Pump and Porous Media acquisitions.

For the quarter, our effective tax rate was 35.4%, in line with our expectations. Last year our second quarter tax rate was 28.1%, as favorable benefits from the settlement of prior year IRS examinations in Q2 '06 reduced the effective tax rate by over 700 basis points.

Diluted shares were 100.4 million, a 2% reduction from last year's 102.4 million share count. We have approximately $30 million remaining in our current buyback authorization, which we expect to use in the second half of this year.

Consistent with Q1, we're putting our key metrics front and center. We believe this transparency provides important insights to our commitments and improves our ability to communicate our strategies with shareholders. Our leadership is committed to world class results and achieving those results starts with a comprehensive understanding of our current situation. So we had solid year-to-date results and we're well-positioned for the second half of the year.

Let's move now to slide number six and review our cash performance and related metrics. As mentioned earlier we had another strong cash conversion quarter and still have a lot of opportunity within working capital to improve it further.

We take a look at the components of return on invested capital to the right side of the slide, you'd see our four quarter trailing net operating profit after tax, or NOPAT was $218 million. Our average invested capital was $2.56 billion, which gives us a year-over-year ROIC decline of 140 basis points to 8.5%. Obviously, we're not satisfied with an after-tax ROIC of 8.5%, but we'd point out that as we move into the second half of 2007, we begin to distance ourselves from a few items.

First, we have easier comps year-over-year with regard to net income. So the numerator will immediately improve. Also, acquisitions that added to our investment denominator but haven't added to the numerator yet will begin to add to income, which will improve the ratio, as well. All that is to say we begin to move into better territory with regard to ROIC.

As we said in Q1, the path to a higher ROIC is straight forward. More NOPAT driven from a focussed effort on operations and a continuing progression on our demonstrated lien journey, which helps us better serve our customers, drive profitability and lower our investments.

Our ending working capital was $461 million, a reduction of $45 million versus Q1 of '07, and our 12 month moving average working capital was $431 million, which is 13.2% of our four quarters trailing sales. Return on equity was 12% and our total debt was just under $1.2 billion for a debt to total capital ratio of 40%. As a reminder, the non-GAAP to GAAP reconciliation of these calculations and numbers are included in the appendix to the presentation.

Similar to the first quarter, when we highlighted our pool and spa business, we'd like to do a quick review of our global $1 billion pump business. We'll start that on page--on slide number seven. The top left section of slide seven provides detail around the $30 billion global pump market.

As we highlight on the chart, Pentair's pump businesses and products participate in about half of the market. The global pump market is very balanced geographically with the markets split between the Americas, Europe and the Middle East and Asia Pacific. We estimate the market to have an annual growth rate of approximately 3% to 5% a year. This is a fragmented market with a modest number of large players, so no competitor has a dominant position.

The top right section shows how our pump sales are split between vertical markets and geography. Our largest segment is residential with about 50% of total sales, split relatively evenly between replacements or after market sales and residential new construction. The other 50% is divided equally between municipal, commercial and agricultural, and industrial.

A majority of our sales are in North America, but we are expanding internationally and the growth rates there are attractive. The bottom half of the chart provides you with perspective on our 2004 to 2007 organic growth rate, which was approximately 6%. We've already made progress on margins in pump with global margins of about 14% now, and we see tremendous opportunity to expand margins further as we roll out our lien initiatives and capture growth opportunities.

As our objectives state, we have been and will continue to invest in our growth strategies and lien initiatives. We can build upon our leadership position in the residential market and we can leverage our investments and technical capabilities for the international expansion.

Furthermore, we have attractive product offerings in agricultural, commercial, and municipal markets and are targeting those markets for higher than market average growth rates. So we have a strong position and a fragmented $30 billion global market with nice growth characteristics.

Turning to slide number eight, here's our current view of the markets and our growth in 2007. The pictures on the left side of the slide give you a sense of the breath of offering we have in the pump space. The products range from small, relatively simple pumps to very large, very complex industrial or municipal pump systems. We have a solid position across this broad product range, and we have the distribution and dealer networks we need to reach the end customers.

Our largest market is North American residential. There are a number of residential products--product lines or product families that we highlight on the chart. I'd point out that Faradyne joint venture supports our $100 million submersible well vertical market.

Obviously the North American residential market is soft as new construction is down significantly. We expect our $450 million residential related product lines will decline roughly 2% as new products and replacement demand will not overcome overall market contraction.

Looking at the North American commercial and industrial segments, those markets are currently very strong. When coupled with municipal and agricultural, we expect hat this market will grow at around 6%. We expect 2 times this growth rate as the large municipal pump projects in New Orleans provides five to seven points of growth on top of the inline market growth.

As you can see, our sales are very balanced in this area so we're able to take advantage of growth in commercial, industrial, municipal and agricultural markets, and finally, international markets remain healthy with mid-single digit growth rates. We continue to expect rapid growth in the Middle East, Asia and Latin America and anticipate mid-teen organic growth rates in 2007 for our international product sales.

Our Jung Pump acquisition added $70 million of sales to our European business and that integration, by the way is going very well. So to summarize, we have a diverse pump business with nice growth characteristics and a broad product offering. We expect around 5% global sales growth in '07 and we're well-positioned for continued growth in the future. Next quarter we plan to highlight our filtration business as we've received feedback that this is helpful to provide--it's helpful to provide this additional color on our businesses.

Turning now to slide 9, let me update you on something we introduced on the first quarter earnings conference call. As you may remember, we outlined specific actions to achieve full year 2007 operating margins of 12.5% in our water business. Specifically we detailed $35 million of cost actions that we believe allow us to meet that target.

Here's an update. The top left section of the chart bridges 2006 full year water margins of 9.9% to our stated goal of 12.5% for 2007. Immediately below that graph is supporting information that provides additional clarity. As you can see, the outlook includes a negative 280 basis point impact from inflation.

We continue to drive solid core productivity and will benefit from the absence of charges we took in 2006. The 160 basis point expansion we expect to receive from $35 million of cost actions is shown as the final piece to the year-over-year bridge.

On balance, we remain on track to achieve the $35 million in cost reductions. The forecast for each action is listed on the right side of the chart. The progress to date has been in line with our original expectation and we currently anticipate achieving these results by year end. So we're making nice progress in water and expect to hit our full year margin goal of 12.5%. This margin level is not the end goal, of course and we'll continue to outline long-term expectations as we deliver on these short-term targets.

Before I turn it over to John, let me summarize our full year outlook which is shown on slide number ten. We had a solid first half of 2007 and continue to drive the right actions. We're committed to operational improvement, investing in organic growth opportunities, generating robust free cash flow and improving our ROIC. John will walk through the anatomy of our second half guidance and expectations, but as you can see on the chart, we have a realistic view of our end markets and a focus on delivering on our commitments.

John?

Thanks, Randy.

Before we leave slide number 10, let me take a second to highlight the guidance on the top of the page. We now expect we'll earn between $2.00 and $2.05 of earnings per share for the full year 2007, up between 10% and 13% versus 2006. This new range is an update to the guidance we provided in April, which was $2.00 plus.

While our markets remain challenging, we are encouraged by our year-to-date results, the actions we have in place, and how our businesses are positioned for continued growth and productivity. Additionally, we remain committed to our full year free cash flow target of $205 million to $225 million, up over 15% using the middle of the range.

Let's review our earnings per share outlook by quarter for 2007. Please turn to chart number 11. As you can see on the top of the chart, the guidance we provided in April demonstrated our view that we were committed to achieving $2.00 of EPS for the full year.

Our second quarter guidance was $0.57 to $0.59 per share. If you combine the expectations we have for the market for the second and third quarter, you can see it was around $1.09 per share for the middle part of our year. Our second quarter performance resulted in earning per share of $0.62.

Part of the overdrive versus our guidance was a result of increased revenues associated with pump shipments to our New Orleans project in the quarter. The increased shipments were driven by a customer request. As the chart demonstrates, this brought an additional $0.02 of EPS into Q2, which we had originally expected in Q3.

The remaining EPS overdrive was not timing related so that lives through for the full year, therefore, if you look at our third quarter EPS of $0.48 to $0.51 and combine that with our second quarter EPS of $0.62 you see we are delivering more earnings for the two periods combined than we expected in April. This provides additional support to our full year outlook.

Now let's review our outlook for the third quarter. Please turn to chart number 12. While we remain cautious in regard to our major markets, we expect third quarter sales growth of approximately 8% with about 3% coming organically.

Technical products begins to lap the decline seen in third and fourth quarters of 2006. We believe we may experience some modest relief in the telecom, datacom markets based on current order rates and continued growth in electrical in Asia, therefore, we anticipate technical products will have organic growth in the range of 7%.

In our water segment, we expect the unpredictable North American housing market to remain challenging, and we continue to face some competitive pressures in the well pump segment, however, overall we continue to see strong sales opportunities in our international markets and commercial, municipal and agricultural markets also remain very healthy. We anticipate organic sales of approximately 2% in the third quarter for water net of a nearly 30% decline in our largest market North American residential, new construction.

We anticipate overall margins for Pentair in the range of 11.1% to 11.7%, a significant increase over the third quarter 2006 as we benefit from improving sales, additional productivity, and the absence of charges in our water business in 2006. We continue to work on the right things in both water and technical products to reduce cost, implement lien, and leverage our investments.

As we previously indicated, our third quarter 2007 earnings per share guidance is $0.48 to $0.51, up over 50% versus the same period of 2006. We are assuming a tax rate of around 35% as we continue to work on items to lower our long-term effective tax rate. Interest expense is expected to be down slightly from the second quarter or approximately $18 million to $18.5 million as we begin to use our cash generation to pay down debt.

Finally, in line with our full year free cash flow goals, we expect the third quarter free cash flow to be up versus last year. We currently estimate third quarter free cash flow of between $75 million and $100 million versus $66 million in the third quarter of 2006.

We'll go to wrap up with slide number 13, our full year outlook. As we said back in April, we are committed to exceeding $2.00 of earnings per share for the full year, and today we update guidance to $2.00 to $2.05. We are committed to improving ROIC and continue to work on actions, deliver sales growth and productivity despite fractious head wind.

For the full year, we expect sales to be up in the range of 7% with about 3% organic growth. Our organic growth in water is estimated to be around 3% to 5% and technical products organic growth is expected to be around 3% for the full year. Based on our year-to-date results and our expectations for the second half of 2007, we expect full year margins to expand approximately 180 basis points in 2007 for the total company.

We expect operating income will be up around 25% to approximately $385 million plus and operating margins will expand about 180 basis points to approximately 11.5%. Water margins would then be approximately 12.5% and technical products margins are estimated to be around 14%. Favorable tax items for 2006 will not be repeated in 2007 and therefore and favorably impact EPS by about $0.20 per share on a year-over-year basis.

Also, we expect interest expense to increase almost $18 million for the full year, which negatively impacts EPS by around $0.12 per share on a year-over-year basis. Despite the unfavorable tax and interest comparisons year-over-year, our outlook for full year reported EPS is up 10% to 13%. We expect a full year cash flow range of $205 million to $225 million, which would exceed 100% of net income. We also anticipate year-end debt to be about $1.1 billion and a debt to total capital ratio of approximately 37% for year end.

That concludes our review. Operator, we'll now open it up to questions.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of Curt Woodworth with JPMorgan.

Hi, good morning.

Hi, Kurt.

Thanks for the transparency on the quarter and outlook. I have a question on the water margin segment. In the slide you showed, you had about 280 basis points of a negative hit this year from inflation. I'm wondering, is that mainly commodity inflation, I assume, is that a net number?

It's commodity, it's total inflations, commodity and labor. So it's not just materials inflation. We added all the inflation up to come to that number, but the biggest impact is materials.

And would that be net of price?

No, the price is shown in the growth and productivity.

So if you would kind of isolate a net number in terms of the commodity head wind this year, would it be kind of the variance there negative 30?

That's probably fair.

Well it does affect growth (inaudible) product share.

Well, no, no, but I think if he said the commodity head wind that we're experiencing over what we would call normalized, probably 30 to 50 basis points.

Okay, and you commented that the pump business on the organic growth was essentially flat this quarter if you take out the big New Orleans project. Can you just break out what the volume or growth was on the residential side of the business versus the commercial and industrial side?

Yes, residential was down, commercial was strong, ag was strong, municipal was strong, and I just for comparisons purposes I took out that $21 million, but municipal remains strong. We still have a--even after shipping that, we still have a big increase in backlog year-over-year. Residential was down--what would you say?

Well, it's down what we kind of showed in the chart because we kind of used updated numbers in that 2007 guidance, Curt.

Yes.

So we're showing 2% to 3% in residential net, which nets out our installed base growth, which we get both price and growth on. Pump just for perspective we were down 1% in Q1, flat in Q2 means that our year-over-year comparables are just slightly better, but still a rough market.

Kind of giving the 50/50 split, you would say that ex the project, the residential business is off sort of two and then the others were up two to net you out at flat ex the project this quarter?

I would say 2 to 3 and then the others are just slightly up 2 to 3 in agriculture.

Interesting, and then just one last question on the telecom side of the business, you commented in the press release you expect a recovery there in the back half of the year, is that--are you seeing improving order patterns or is that simply a function of the comparable get a lot easier?

I would say it's 80% comps easier.

Yes.

But we actually think sequentially in North America and in Europe that we'll see sequentially higher sales in the second half than the first.

Great.

Not a lot higher.

Right.

Q3, up $4 million to $6 million sequentially versus Q2. This isn't a big step up, and we do have--the order pattern has increased, and we have had increasing order pattern. It's just the year-over-year comps are significantly easier as Randy pointed out.

Okay, and then you haven't seen any real change in demand trends on the electrical side which is obviously the big incremental margin business?

We continue to see real solid demand from industrial, commercial, and in particular, one of the growth areas that Hoffman has been focusing on, it's in our electrical (inaudible)--it's a distribution business, but it's networking, which is somewhat tied to commercial, but it's been a small business for us, and we continue to gain share in that business as we focused on it through the Hoffman channel it's gone very well, and then as I mentioned, Mclean and Aspen, the two businesses that came in the Thermal acquisition had very solid quarters.

Great. Thank you very much.

Thank you, Curt.

Your next question comes from the line of Deane Dray with Goldman Sachs.

Thank you, just a follow-up on the questions regarding price and volume in water, and first of all, those slides are very helpful, got to make sure that I didn't miss it. Did you break out the contribution of price and water for the quarter?

Sure. For the quarter, price is roughly for water about $6 million--I'm sorry $19 million, Deane.

19 million?

19 million in price.

So was that meant that basically volume was flat?

Volume was roughly about $6 million.

Okay. And so--?

I think price is the best kind of volume, Deane.

Absolutely, and is there any sort of push back in terms of your ability to get price in this environment, probably on the residential side, but what about commercial and muni, and specifically on the New Orleans business?

The only place we really, really struggle with price in water is retail.

Well, and residential's been tough in a couple of the segments beyond retail.

But as we go through the distributor channels, Deane, which is the more than half of the water business, that is usually receptive to price increases, usually.

Understood, and for the third quarter guidance when you talk about a 2% organic growth expectation in water, how much of that is price, and is there any FX in there?

FX will be about $5 million to $6 million in Q3, roughly, and price on a year-over-year basis is slightly less in Q3 and Q4 than we experienced in Q1 and Q2. Because we start lapping some increases that we've put in at the tail end of last year as the residential softened.

Okay, and then on slide seven, and this is pardon the water pun, either glass half full or glass half empty. When we look at the global water market split between Americas, Europe, and Asia, roughly a third, a third, a third, you are dramatically skewed still to North America.

Right.

All right. So I know you're going to take the glass half full view of this, but how do you go about lagging into this and taking advantage? Because there's so much growth going on in Asia and you're just not participating. Is this is a build versus buy opportunity?

Well, we--that's one of the reasons we bought Jung Pump. We view Europe as a pretty well-established market. So Jung Pump gave us an entree into the very attractive product set in an attractive market and into the 50 cycle world that we can leverage into the Latin America and into Asia, but I wouldn't rule out acquisitions ultimately in Asia.

The big opportunity in Asia is the move from all the local players and their quality level and their performance level to world class, and we do make pumps. We are actively moving production of some pumps from North America over to China right now. We have activity in our design center in India on pumps, so I would say that Asia for us, there's a bigger organic opportunity than we had in Europe, and now we have Jung Pump, we now have organic opportunities there, as well.

I definitely view it as glass half full, I view it as an opportunity, and the point I was making about you can look at, we're $1 billion, that's nothing to sniff at. We're smaller than a couple of other players globally, but we're not smaller in terms of resources available or passion or ambition.

And then just last question, did you provide goals yet for return on invested capital and return on equity?

Goals for '07?

Yes, either end of '07 end of '08, however you want to calibrate it

I think we're going to get roughly around 10% after tax ROIC by the end of the year, Deane, and then we've got to quickly get to 15%. We got to figure out how long it takes us to get there, but we can't wait, and as Randy said, each $25 million of notepad equals a point of ROIC. So it's about our water businesses contributing and it's about fixing and turning around the electronics piece of technical products and both of those will significantly contribute if we can do them.

So we've got to get to 10% first, that's our goal for 2007. And then as we head into '08 and '09, we'll decide how much we can chew off in each of the subsequent years.

Okay. Thank you.

Your next question comes from the line of Michael Schneider with Robert W. Baird and Company.

I'll add, as well, thank you very much for the transparency, extremely helpful.

Starting just on slide three, you note that acquisitions contributed $4 million in Op Income on $29 million in sales. Can you just address two things? Can you address what level of inventory step-up or unusual charges are in that quarterly number, and then what you believe the hit to 2007 would be just so we can start looking forward to '08 and understand what the relief will be from those initial expenses?

For the total, both for Jung Pump--

It's about $2 million a step-up, Mike, plus obviously the ongoing amortization, but both acquisitions ironically are about the same and each will have about a 20% EBIT after amortization going forward. So you could do the math and take the $29 million times 20%, that would give you roughly what it would be excluding the step-up.

Okay, and then just in terms of where those businesses were and where they are today, has anything structurally changed? Because it's at least my understanding from prior contacts with these companies that they were running nearly 25% to 30% EBIT. Is it just the amortization hitting that or is something--?

It's just the amortization. It's a pretty big step up and Jung, obviously because of the customer list and the intellectual property. So it's just about 9 to 10 points of D&A that we have to absorb on that, and then same thing with Porous, there was about 30% EBIT and about 10 points of hit for D&A.

Okay.

Both are right now being run primarily stand alone entities and the opportunity for both is the sales synergies we can get through using our channels.

Okay, and then Jung Pump and can you just give us kind of an update and review of that acquisition? Presumably the European market is benefiting you, but competitively, has it opened doors in this European design that you didn't have before? Any color would be helpful.

It's early for a big impact there. We've got our [Noki] pump business and our Italian, which is in Italy, and the Jung Pump people sharing leave and there's been some modest pickups from that. Right now the big opportunity is in this--right now is the work being done between our larger North American pump business and Jung Pump in terms of integrating the product lines, and there's some interesting things going on there.

In general, they are ahead of plan a little bit on sales and right where we think they'd be right where they should be on margins. In fact, we just had a board meeting over there at Jung Pump a couple of weeks ago, and we think there's more opportunity to grow in Europe based on some of the early work that we've done than we even thought.

Okay, and then final question, just on Asia, up 34% within the water segment. Is that an apples-to-apples number, and by that, I mean, have you transferred--I know you've been transferring production to Asia, is that distorting the number, or is that truly an organic growth number considering what products had been there a year ago and what they're selling today?

It's a good question, Mike, it is the way we run our regional businesses, there is what we call sales volume production back to the states, but ironically, the numbers are the same. So we've got an action to try to increase the amount of production that we're placing in China, and we have increased that, although a long way to go from our goal of 40% plus, but the organic growth rate to the sales locally in Asia are 34%, 35% roughly, as well. So it's the same number, just kind of works out that way, and we are focussed as you brought up as to what is the organic growth in the region opportunity, and also separately how much production we can ship to Asia to get the benefit of the China manufacturer.

Okay, thank you again.

Your next question comes from the line of Dan Whang with Lehman Brothers.

Yes, good afternoon.

Hi, Dan.

Hi. First question was regarding the $35 million in specific actions that you're taking that would bring about those benefits this year. How much of that do you think has been achieved so far in the first half?

When I take a look at it at what--I bucket the $35 million together with productivity overall, and then net against that some of the bad news ex-inflation to pull that out for separate, and the calculation we ran is about halfway through the year we've got about 35% of the results in. So we knew it would be back end loaded, so it's about two-thirds in the second half, and we booked about a third of it already.

So it's coming in at about where we thought. We broke out--we changed the forecast on that page nine as you saw, we said spa and bath we were targeting 5, it looks like it's going to be more like 4, and that's not because the actions aren't working, the market's a little bit worse because of the North American bath business, but we think filtration and pump are going to be higher, and we expect the rest of pool will be higher from the plan consolidation and cost reductions that we have there. So about, as I said, 35% of the way there in the total bucket of $35 million plus the productivity in the water.

Right, so obviously this is resulting from the actions and planning efforts that you've rolled out and have been implementing through this year so far. So in terms of going forward, how much additional sort of effort is there at the operational level to capture that remaining 65%, or is it--it sounds like you're pretty confident in being able to capture that, but--?

Yes, it's basically, it's managing--it's managing the down drafts. For instance, in the residential market with the downturn, we have in the residential market, we have more aggressive returns coming from distribution, and we got to make sure that that is well-managed and that doesn't--that's one of those things that eats away productivity, and in fact, you saw a little bit of it in the number in the second quarter versus the first quarter. So it's really managing some of, if you will, the down sides not so much finishing the execution on the upsides. Does that make sense?

Yes, sure does, and just next, I guess kind of a next part of that question now would be I think longer term, you had talked about that 15% target for water, could you just update us on sort of a time frame to getting there, and sort of the additional actions that would be--that would need to be taken to get to that 15% from the 12.5% that you strive to achieve by the end of this year?

Let me try this one, Dan, I think two things, we believe we're going to hit the 12.5% this year, and that's why we're articulating that particular path, I think as you look at '08 and '09, 15%'s not our goal, clearly want to be closer to 20% so it's a matter of how we get to that. I think the water businesses continue to have our best organic growth opportunities and so we want to invest a little there, but at the same time, the big opportunities for improving water margins are global sourcing and factory consolidations, and if we want to--and growth, obviously.

If we get the organic growth and the two cost actions would be reducing some of the excess capacity in North America and then taking a look at what we can accomplish from global sourcing. We'll roll up our 2008 plans with an aggressive view internally and then we'll figure out what we'll share externally to how we're going to get towards that end point.

Okay. Great. I'll--

Significant room for opportunity is what I would say.

Right. Right.

It's the matter of the timing of it.

Okay. I'll let someone else have a chance. Thank you very much.

Thank you, Dan.

And your next question comes from the line of Jim Lucas with Janney Montgomery Scott.

Good afternoon.

Hey, Jim.

A few questions here. Number one, you've given a little bit of color, but can you give some updates on both the Porous and the Jung integrations, specifically, with these acquisitions are you doing anything differently today as you approach acquisition integration that can be applied going forward just trying to gain a better understanding of how you're approaching the acquisition integration now?

Well, yes, the thing that we learned from White Corp. was we really did too much too fast. We set about closing 22 factories and distribution centers, and we did well on 70% of them and fell on our face on enough to cause some problems. In neither of these cases do we have plan consolidation as part of the strategy, and therefore, I think we're taking a much more planful cautious approach.

We're focusing on material cost savings, where we know that we can help, and that's going well, and then we're doing a lot on the technical side in the engineering side, and identifying opportunities to work on together, and then resourcing the opportunities that they have making sure that we're not constraining them to go after their growth whether that growth be in Germany or in Porous Media's case in the energy markets right now.

So that's our approach. It's much--it's much more I would say cautious and focussed on the growth side, which is the nature of these deals too. If we did one where we needed to close the plant, we've learned a lot about that too, we've got much better disciplines around plant closings.

And that segs into my next--

So Jim, let me just add to that, the other thing is Mike Schrock, myself, and Randy are also reviewing them on a 30 day basis, as well, and in the past some of these were done a level below, and so we're getting both the good news and the bad news and we're getting to decision-making that's required a lot faster.

And we have greater clarity on their performance too.

Okay, that part's helpful, and segging into the next part with regards to acquisitions going forward in terms of how you're looking at the deals, again there any color you could share on the thought process of how you're looking at the M&A market whether growth versus turnarounds, international versus domestic, any holes in the portfolio? Any color you can provide there?

First I would tell you that we are--our main focus is on execution both on the organic growth side and on the cost side. So we don't--we aren't working on anything right now that is as large as Jung Pump and Porous Media. I think that's the first, most important point. That doesn't mean we won't get back there, but we're not there for the foreseeable couple of quarters.

We are staying in the market in terms of tracking things that we're interested in, and we're using the same five screens if you will that I've shared before. Number one, how does this fit our strategy? Number two, why are we the best buyer? Number three, how can we justify the premium given that everything goes for a premium? And number four, what's our and that gets into the integration plan, and then number four, who are the people we're going to put on it? And finally five, of course, what are the financials? So that hasn't changed, and it wasn't there that we dropped the ball, it wasn't on any of those things.

That said, we have raised pump up in terms of our interest, and international continues to be our prime interest. In other words, we were focussed on filtration, we did some things in pool, we weren't that focussed on pump. Pump has really earned the right if you look at their ROIC, they have really earned the right to be investable, so we're more actively looking at pump opportunities.

Okay, and then two final questions.

Number one, with regards to Europe, you've done a lot of infrastructure spending there. You talked about the new Swiss structure you put in place. Can you just give us an update in terms of your European infrastructure, and finally with regards to the management team, are there any holes left to fill there?

I'll start with the management. No, the European team has really come together nicely. We made a number of changes as you know because of some of the execution issues we had there. The performance in Europe has stepped nicely.

Most, if you look at that $35 million, most of the benefit of $35 million, their $10 million share was actually expected in Europe and we're right on track for that. So the team is in place, we're pleased with what they're doing, they've really come together, and they've had some nice growth opportunities to go after lately, so that's good.

In terms of infrastructure, we still have some IT spending. John, do you want to--

Yes, we're towards the tail end of the IT spending. It should conclude here at the end of the year. We've got a couple more, very, very small ones. We finished our two biggest ones, which is [BOOT] which is our valve business in France, and we also did Belgium. Those are the large sizable ones went pretty smoothly, or you would have heard about it, right? And we're now on track to start realizing some of these tax benefits, which was one of the things we sought out to do here, and that should be pretty substantial benefit almost a point to the tax rate in 2008 and we're now getting comfortable that we're going to realize that.

Okay. Great. Thank you very much.

Thank you.

And your next question comes from the line of Mark Siegel with Canaccord Adams.

Good afternoon. In the press release, you made reference to softness in the residential water treatment market in Europe. I was just wondering if you could elaborate on the dynamics that are driving this?

The big issue there is I think more--we're very--we're large in France and we're large in Belgium, we're not that big in Germany, and I think it may be as much of a channel issue as opposed to an end market issue right now. That's one of the things we're trying to understand more fully.

In other words, I think the channel's a little fuller than--and we're not seeing the end market directly. We've also seen a pickup on orders here as we start Q3 here, as well, so while although a small Q2 issue, we're starting to see recovery here in Q3, but there's also some softness on the OEM side in which we participate globally on the tanks.

Okay, that helps, and then--

It's not so much our valve issue.

Okay, and then on the technical products side, given the weakness in the telecom market here in North America, just wondering if there's any further room for future cost reductions and/or pricing adjustments?

Well, I think when you take a look at the impact we've had on margins, based on what's happened, we are definitely focussed on cost, and we've got to get the margins--it isn't enough to just get the growth back in electronics. I would say globally, not just in North America, the growth in Europe hasn't been very good either, and the margins, even though we have growth in Asia, the margins aren't where they should be, so we look at electronics globally, and we've got to get the cost structure in place so that we have an attractive ROIC in that business, which we don't have right now.

Right now, the technical products business is definitely a tale of two cities, we have an incredibly strong, what we call the electrical business, it was Hoffman (inaudible), and the electronics business is none of the three operations, Asia, North America, or Europe are satisfactory.

All right. Great. Thanks. That helps.

Thank you.

Sandrel, we probably have time for maybe one more question set of questions or a few more questions. If we know how many more are in the queue.

There are three.

Okay. We'll try to go through it as quickly as we can see what we can do.

Okay, your next question comes from the line of Mike Hamilton with RBC/Dain.

Morning.

Hey, Mike.

Could you just take a look at the North American water business and give a view from high level as to what you're seeing in competitive pricing?

It really varies, Mike, by segment. As we mentioned there are some--most segments we're able to get price. The ones where we can't are some of the residential related OEMs and a couple of the niches in residential where the competition's out of whack and the industry has too much inventory in the channel, I'm sorry you mentioned retail, not OEM, retail. Otherwise we're able to get prices as the numbers show.

Thanks.

Thank you.

Your next question comes from the line of Christopher Glynn with CIBC World Markets.

I want to drill down into technical products a little bit. You've talked about quite a head wind from telecom, maybe $0.04, sounds like that's coming back a little bit. A stilted 14.1% margin seems like the telecom head wind a lot more than 100 basis points. Could you just talk about the outlook for telecom to come back further in '08? Everything we track says that's a pretty good outlook, and then why you couldn't target a 16% margin? It seems like they are now ex-ing out some of these factors.

Well, we're there on one half of the business.

No, we're way over that.

Way over that on one half of the business in the electrical side in technical products.

Right, but blended, you're 14.

And the piece of the business that's struggling is electronics, and sequentially we do see the improvement, and we are seeing small margin improvements.

But not enough even on the volume.

But not enough, and I don't think we're chasing right now the large significant orders as we have in the past, and we've got to take some particular cost actions to push the margins to the 16% number that you're referring to, and Randy, myself, and Mike have to make sure that there's a committed pay back to those investments if we're willing to make them.

What I don't want to do is go take some large actions or consolidate the cost structure, and give it away in price to win a job, and we've got to make sure that this business is executed. We like what they did in Q2, collectively, so it's a step forward from Q1. Another step forward in the forecast in Q3, and as we head into '08, we'll figure out where we are, but we are seeing a recovery, but modest.

Okay. So the cost structure that you would have on some of the larger projects, that's why you're not chasing those right now?

Correct.

We lost a large order, which we're finally going to lap in the second half here from Dell. We just wouldn't meet the price, and I'm not sure it was cost or whether it was price expectations for the customer, as long as someone else is willing to take something at a price. And we're just--that's never been our strategy on electronics.

Our strategy has always been to be in the higher application, higher margin opportunity. The whole strategy was having electronics business that we can grow in excess of 10% a year and have 10% margins. We're a long way from 10% margins right now, and that business has got to prove to me that they have a strategy to get back there. So right now we're going quarter to quarter, and we'll tell you what we think this business can be in '08 after we drill that strategy.

And Chris, what I'm referring to is some of the volumes on those large OEM contracts don't always materialize, so you price and you're focussed on trying to deliver it, and then the volumes are sometimes half or three quarters what you expected and you lost all your margins. That's what we've learned and we're taking those learnings forward as we quote the higher value jobs which are primarily in test and measurement, certainly medical, aerospace, etc.

Defense. That looks like a nice segment. We've been working to try to skew our efforts, to skew our marketing efforts to grow in those markets and have more balance, and we need to see more results from that.

Okay. It seems like if you get the operations right there that the telecom can be a really nice opportunity through the next few years.

Yes, one thing I'd point out, though, is if you take a look at the telecom market and you take a look through the cycle, right? Go back to 1997 or something, watch the cycles, it cycles, and every time it cycles, the margin peak is lower. The margin peak we had in electronics was lower than the one we had in 2000. I think that's a structural--

But this wasn't a cyclical thing. This was more the consolidation-driven, right?

I would basically say that is cyclical. It's certainly of the industry, right? It's being--why is the industry consolidating? Because demand has been contracting and costs are collapsing, and that's why consolidation happens. I don't want anyone to think that all we need is volume to make this electronics business meet my goals. It's more than volume. That's the only point I'm trying to make.

Great, thanks. I'll take the rest offline.

All right, thank you.

Was there one more?

Yes, sir, your next question comes from the line of Francesca McCann with Stanford Group Company.

Hello, there.

Hi.

I'll be quite quick with this one. Several of my questions have been answered and the rest I can take offline, but just a quick question on Asia. Certainly very attractive market size, phenomenal growth potential, and push to expand there, but to what level are you comfortable, actually, growing that business? So what level would you be comfortable with having it comprise certain portion of revenues?

I would like Asia--you take a look at pump, I mean 10 years from now if Asia was 33% of our sales, I'd be delighted.

Okay.

Right now, I think our goal would be get it up to 10% of our total sales.

Okay.

In a more intermediate term. It's interesting, our filtration businesses already achieved 40% of sales outside of North America, so we've made some nice progress there, largely because of our industrial filtration and our food service initiatives.

It's like anything Francesca, we obviously want the low-cost position and to play in the scale in China is necessary, period. Right? Because that gives you the value to bring products and services back to the other markets.

But we definitely want to grow more, where we have technological advantage and we have a unique product offering that's not going to compete long-term on price, and right now we have a good lineup around that primarily in filtration, and also in pump, and that's kind of where our focus is. So I don't think it's a distinct size as much as it's size and the profit and the ROIC returns.

Right, no, and balancing that with--I just feel like there hasn't been much talk of risk there so I'm assuming that that's factored in. That's fine. That's all for now. Thank you.

It is, by the way, it is if you take a look at our margins in water, it is a net detractor from our margins in water. So from a risk standpoint it's balancing the investments there and driving it as hard as we can while also advancing our margins in the business overall. That's how I view the risk management there.

Okay.

All right. Thank you much.

Thank you. Good quarter.

Thank you. Todd?

Okay, well, thanks again for participating on today's call, and we will be around all day to answer any questions you have offline.

Thank you.

Okay, the operator?

Thank you for participating in today's 2007 Pentair Q2 earnings conference call. This call will be available for replay beginning at 3 p.m. eastern standard time today through 11:59 p.m. eastern standard time on Saturday, July 28, 2007. The conference ID number for the replay is 1362274, again the conference ID number for the replay is 1362274. The number to dial for the replay is 1-800-642-1687 or 706-645-9291.