濱特爾 (PNR) 2008 Q3 法說會逐字稿

Good afternoon.

My name is Meg and I will be your conference operator today.

At this time I would like to welcome everyone to the Pentair third quarter 2008 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 call now.

Thanks, Meg and welcome to Pentair's third quarter earnings release conference call.

We're glad you could join us.

I'm Todd Gleason, Vice President of Investor Relations and Business Analysis Planning.

With me today is Randy Hogan, our Chairman and Chief Executive Officer, and John Stauch, our Chief Financial Officer.

On today's call, we will provide details on our third quarter results, as well as discuss our guidance for the fourth quarter and full year 2008.

We will also discuss how we are approaching our outlook for 2009.

Before we begin, let me remind that 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 Pentair's 10-Q as of December 31st, 2007 and Pentair's 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.

Today's webcast is accompanied by a presentation which could be found in the financial information section of Pentair's website at www.Pentair.com.

We will reference these slides throughout our prepared remarks.

Any references to non-GAAP financials are reconciled in the appendix of the presentation.

We would also like to point out that all financial results and references are year-over-year numbers in today's call and presentation and are on a continuing operations basis unless otherwise noted or highlighted.

As is our custom, we will reserve time for questions and answers after our prepared remarks.

I will now hand it over to Randy who will take you through Pentair's third quarter results and highlights then John will discuss our fourth quarter and full year guidance and finally Randy will wrap up by outlining our early view on 2009 and actions we are taking to drive results.

Randy?

Thanks, Todd, and thanks to all of you for joining us today.

Let's begin by reviewing our third quarter results shown on slide number two.

The headline is we had good performance in the third quarter.

In the quarter, we delivered reported earnings per share from continuing operations of $0.42, which includes non-recurring items predominantly associated with the restructuring actions we announced in July.

We will discuss these items later in more detail.

If we remove those items, which gets us to the basis of our guidance, we delivered $0.55 of EPS on an adjusted basis.

The $0.55 is up 2% versus the $0.54 in the third quarter of 2007.

The $0.55 also bested the high end of our $0.51 to $0.53 EPS guidance by $0.02 per share.

While the economic environment continued to be challenging, sales and operating margins in our Water group slightly exceeded the expectations we set in July which enabled us to deliver higher adjusted earnings per share.

It also reminds you that our adjusted earnings per share of $0.55 still includes approximately $6 million of expenses related to the integration of our Residential Water Filtration business with General Electric's Residential Water Filtration business.

Pentair third quarter sales of $864 million were 5% above the $821 million in sales we generated in Q3 2007.

Our organic growth was up 3% in the quarter, and up 1% in local currencies.

Third quarter sales in our Water segment were up 4% year-over-year.

We continue to overcome difficult residential and Pool related end markets with global growth, new products and new vertical market penetrations.

Our Technical Products business grew 8% in the third quarter versus Q3 2007, in line with the guidance we provided in July.

As the slide shows, margins contracted 100 basis points for the total company.

The positive 400 basis point benefit from price and productivity could not offset the negative 500 basis point impact from inflation, foreign exchange, and product mix.

The negative $6 million expense related to the Residential Water Filtration integration is netted in productivity.

Relative to our adjusted EPS, our third quarter effective tax rate was 33%, reflecting the investment we have made to position our global operations more optimally.

The 33% rate is the rate we expect for the full year.

In the quarter, we bought back shares worth approximately $15.7 million.

We have approximately $12 million remaining on our authorization, which we expect to fully utilize in the fourth quarter.

We continue to expect to deliver full year free cash flow above adjusted net income.

In the third quarter, we delivered $70 million of free cash flow, excluding the $23 million net settlement for the Horizon litigation.

Year-to-date we generated a positive $128 million.

So those are the Pentair level highlights for the third quarter.

Now let's turn to slide number three.

Thinking back to when we provided third quarter guidance, the world seems like a very different place.

Turmoil had yet to hit the stock market, and the credit markets will still actively humming along.

However, the end markets Pentair has been dealing with have been choppy for some time, especially in the residential and commercial markets.

While we did have to navigate some new negative forces in the market, and proactively manage more uncertainty we delivered a very solid quarter.

As this slide highlights, the guidance we suggested in July had sales between $845 and $855 million.

Adjusted operating income between $92 and $96 million, and adjusted EPS in the range of $0.51 to $0.53.

Actual sales exceeded the guidance range coming in at $864 million.

Adjusted operating income also surpassed the range at $99 million, which was nice OI conversion on the additional sales.

Adjusted EPS of $0.55 was $0.02 higher than the top end of our range, and is a reflection of the additional operating income we just mentioned.

Pretty straightforward.

The diversity of our portfolio has been an asset all year.

This quarter proved once again that global balance and end market diversity pays dividends when environments become less predictable.

We certainly look forward to residential markets improving, some day, but we have yet to see positive trends beyond some moderating declines in a few of the residential markets.

I think it's also a testament to our organization that we continue to proactively go after our cost structure and internal opportunities rather than just react after markets deteriorate.

I'd like to thank all our employees for that commitment.

Now please turn to slide number four and we'll review our third quarter performance in more detail.

Starting with Water.

Since we're going to cover a fair amount of information today, and this is one of our standard slides, I'll just hit some of the highlights.

On the top of the slide you can see we we provide our standard sales and operating income walk.

We will refer to these as we described the performance of the Water group.

Overall Water sales were up $20 million to $566 million, up 4% versus last year's sales, and flat organically.

As you know, approximately 40 to 45% of our Water group is exposed to residential markets.

Those businesses continue to be down double digits as softness in the US and European residential markets continue to impact our sales.

However, most of our other major markets continue to grow nicely, as we have invested to grow in emerging regions and non-residential vertical markets.

Our global flow technologies business grew 7% as commercial, municipal and agriculture each had nice growth.

We continue to expand into new International markets, which have enabled our commercial slow segment to drive strong double digit growth In spite of the US slowdown.

And new products for our agricultural pump markets around spraying and crop protection have positioned this business for sustainable growth.

Global Filtration was up 10% in the third quarter versus last year as the group benefited from the newly created Pentair Residential Water Filtration business venture with GE.

Excluding the sales related to this combination, Filtration sales were basically flat year-over-year.

Several key vertical markets such as food service and industrial continue to grow nicely, But those verticals could not overcome declines related to residential Filtration markets.

Global Pool and Spa was down 10% in the quarter, as residential Pool permits in the US continue to be down over 30%, led by declines in major markets such as Florida, California, Arizona and Nevada.

While we remain cautious regarding the Pool segment, our sales decline improved from down 22% in the second quarter, to the aforementioned down 10% in the third quarter.

More importantly, we're beginning to get a sense for the early buy program, which occurs each fourth quarter.

While it's too early to say definitively how the program will finish, so far we're on track with our expectations.

Internationally, sales in Europe, the Middle East and Africa or EMEA were essentially flat when you remove foreign exchange.

We've seen a slowdown in Western European markets, which negatively impacted our sales in the region.

Sales to the Middle East and Eastern Europe continue to expand at double-digit growth rates.

In Asia, Water sales were up over 20% as we continue to see strong system sales in China, which were up over 40%.

Let's shift gears and discuss operating profits and margins for Water group.

On the top right you can see our year-over-year operating income walk for Water.

Adjusted margins were 10.8%, down 130 basis points year-over-year.

Inflation impacted Water margins by over 440 basis points and could not be overcome by productivity, price and product mix.

Our third quarter adjusted margins include the $6 million associated with the pay as you go expenses for our restructuring actions, and the integration costs associated with the GE combination.

Those are some additional expenses that will no longer be with us as we enter 2009.

The adjusted margins of 10.8% are towards the high end of the guidance we provided in July.

We continue to drive solid productivity in the face of ongoing softness in residential construction and residential Pool markets.

We're taking significant actions to rationalize our global footprint, reduce structure, and drive growth opportunities.

We expect these to reverse the margin declines once the actions are all complete.

So we continue to take the right steps in a challenging environment.

Now turn to slide number five and we'll review Technical Products.

Technical Products results in the third quarter remained solid as we grew sales 8% and delivered adjusted margins of 16.2%, which were down slightly versus the third quarter last year.

In last year's third quarter, it was extremely strong as the division produced record sales and margin levels for the period.

So we're essentially matching some pretty good comps.

As we look at our sales results for the third quarter this year, our Global Electrical business grew 9% versus last year.

We continue to benefit from a very diverse set of vertical markets.

On last quarter's earnings call, we provided detail on the diversity of our Technical Products vertical markets.

And we reinforced that at our September 10th Analyst Day, which is available on our website, so I won't repeat that detail here.

Clearly, some key verticals have exhibited weakness, such as automotive and machine tools, which remains one of our largest verticals.

But others such as networking, energy and continuous flow remained strong, helping maintain nice sales momentum.

Our Global Electronics business grew 7%, led by strong growth Internationally.

Europe grew single digits excluding exchange and Asia grew in the mid-teens in local currencies.

In the US, electronic sales were down in the high single digits.

Looking at Technical Products margins, growth and productivity together contributed 380 basis points of margin expansion.

This could not quite offset the impact of a negative 410 basis points from total inflation, which was impacted by higher steel prices.

In the quarter, we paid approximately $200 more per ton of steel than we were paying earlier in the year, an increase of about 25%, so while steel prices have begun to pull back recently, we will still pay higher steel prices for a few more periods on a year-over-year basis.

We executed well on the 2007 restructuring actions, which included the shutdown of facilities outside of Chicago and one in the UK.

By reducing our technical products footprint, we believe we will get even better operating leverage, even if markets contract.

Given increases in metal prices, we initiated several price increases this year, which has enabled us to largely offset commodities.

So in sum, Technical Products delivered a good top line, helped by price increases, and had great execution to deliver solid bottom line results in Q3.

Now I'm going to hand it over to John Stauch, who will provide additional detail on the quarter, as well as discuss our outlook for the remainder of 2008.

John?

Thanks, Randy.

I'm going to start on slide number six.

As we typically do each quarter, we would like to highlight cash and ROIC, which is shown on the chart with the red box around the figures.

As mentioned earlier, we generated $70 million of free cash flow in the third quarter, excluding a $23 million net payment related to settling the Horizon litigation.

We continue to make progress in regard to working capital, but in a period it was a use of cash as we have built inventory in advance of several important customer programs that are currently in our Water and Technical Products backlog, and we have more working capital from the GE transaction.

If we take a look at the components of return on invested capital, ROIC, to the right of the slide, you see our fourth quarter trailing adjusted net operating profit after tax, or NOPAT, was $277 million, our average invested capital was $2.98 billion, which gives us an after tax ROIC of 9.3%.

This is up 60 basis points versus the same period a year ago.

We continue to focus on improving this metric.

Our total debt was just over $1 billion, for debt to total capital ratio of 33.6%.

As a reminder, the non-GAAP to GAAP reconciliation of these calculations and numbers are included in appendix to this presentation.

Since we just discussed our debt position, let me take a few minutes to discuss our balance sheet and debt in more detail.

Please turn to slide number seven.

Given the uncertainty in the credit markets, we felt it was important to highlight Pentair's debt and credit position which is a very good position.

Our debt levels are healthy and we expect to reduce debt to about $930 million by the end of the year.

A majority of our debt is fixed, with rates of approximately 6%.

The only notes we have maturing in the near term is our $134 million October of 2009 bonds.

As the slide demonstrates, we have ample coverage in our borrowing capacity, and strong banking partners in Banc of America, JP Morgan, Wells Fargo, US Bank and Bank of Tokyo Mitsubishi supporting our credit facilities.

So, Pentair's balance sheet and credit facilities are in great shape, which allows us to focus on operations, growth and our markets, rather than securing debt or other concerns.

Please turn to slide number eight, which reconciles reported to adjusted EPS.

Let me try to summarize a few of the moving pieces.

This slide is divided into three sections.

The top section provides you with our reported GAAP EPS earnings to the third quarter and year-to-date as well as our outlook for the balance of 2008.

We then walk across the adjustments to our year-to-date results, As well as expected adjustments in the fourth quarter of the year.

This middle section reconciles the GAAP to adjusted EPS so you can better understand our operating performance.

The third section, toward the bottom, summarizes the same periods in 2007 for GAAP EPS and adjusted EPS results for comparison.

Starting at the top, our third quarter reported GAAP EPS was $0.42.

Walking down to adjusted earnings, you would add back the unfavorable restructuring charges, which cost Pentair $0.13 per share in the period.

We forecasted we would take significant restructuring actions in the second half of 2008, and this represents a portion of those actions.

Thus, after adjusting for these items, third quarter EPS is $0.55, up 2%.

The next column proceeds down the same path, but with notable other items, which we described in great detail last quarter.

Our year-to-date reported EPS is $2.34.

Excluding the $0.86 gain from GE transactions, along with the legal settlement for Horizon, and restructuring charges we took in the first nine months of 2008, our year-to-date earnings on adjusted basis is $1.76, which is up about 12% versus last year's year-to-date EPS.

For the fourth quarter, we are forecasting reported results of $0.17 to $0.20 per share, which includes an expectation that the negative charges for restructuring other items in the fourth quarter will be about $0.35 per share.

We forecasted we would take significant action in the second half of 2008 on the July earnings call.

Given the slower economy, we are prepared to move proactively to address our global structure, which is what we're doing.

We have a number of headcount and facility actions under way, and more being considered and the expected fourth quarter charge represents those items.

So, by summing up all the quarters, full year reported EPS would be between $2.51 and $2.54.

By adjusting the full year impact of these restructuring items, we now expect our adjusted full year EPS to be between $2.28 and $2.31, up about 10% versus 2007.

As we stated last quarter, this adjusted EPS does include the incremental pay as you go costs related to the GE transaction and restructuring actions in Water and Technical Products.

Let's review the fourth quarter and full year earnings outlook in more detail on the next two slides.

Please go to slide number nine.

Let's review our outlook for Q4.

Overall we expect sales to be up 3% to 4%, to 840 to $850 million.

Adjusted operating income of $96 million to $100 million, and adjusted EPS of $0.52 to $0.55.

We expect Water sales to be up slightly, Technical Products sales growth is expected to be similar to the third quarter, or up about 8%.

Overall, we expect Pentair adjusted margins to be about 11.5%.

Our margin expectations include the pay as you go restructuring related impacts.

We expect our tax rate to be approximately 32 to 33%, and interest expense to be lower than Q4 2007 by about $2 million.

Our share count is expected to be close to 99 million shares, down over 1% year-over-year, and we expect to generate over $120 million in free cash flow.

So we maintained steady growth in margins despite heavy investment for restructuring and also increased investments in our global business unit structure and key growth initiatives.

We expect these investments will have nice payback in 2009 and beyond.

Please turn to slide number 10 as we will update you on our outlook for the full year.

To summarize, we are essentially maintaining the view we had had previously communicated but we are tweaking our adjusted EPS guidance range slightly.

Previously we had a range of $2.28 to $2.33.

We are updating the range to $2.28 to $2.31 as we increase our restructuring investments and also recognize the markets have softened.

We have trimmed about 1% off of our sales growth outlook for the full year as a result.

For the year, we expect sales to be up 3 to 4%, to approximately $3.5 billion.

Adjusted operating income is expected to be at least $410 million, and as we just highlighted, adjusted EPS of $2.28 to $2.31.

We expect sales in Water to be up slightly for the year, and we continue to forecast Technical Products revenue growth of low double digits.

Overall, Pentair margins are expected to be up modestly, as we continue to overcome difficult residential markets and high commodity costs.

Also, in this margin assumption, are the expenses associated with integration of the Residential Water Filtration business and the pay as you go expenses for restructuring actions.

We expect our tax rate to be 33% as previously mentioned, and interest to be about $60 million.

Our diluted share count is expected to be close to $99.4 million, down 1% year-over-year.

And we expect free cash flow to be greater than adjusted net income, excluding the negative impact of the Horizon settlement.

Our debt position at the end of the year is expected to be approximately $930 million, providing a debt to total capital of about 32% and we fully intend to conclude our purchase of 50 million of our shares under our authorization.

As the take-away highlights, 2008 has been and will continue to be a year in which we are proactively navigating challenges.

I would like to add that we have been navigating these challenges for about 24 months and getting adept at doing so.

We expect our markets will not recover in the near term, which Randy will articulate next, so we are taking prudent actions to ensure we are positioned to endure the challenges that lay ahead.

With that, Randy?

Thanks, John.

Please turn to slide number 11.

Before we review Pentair's early view of 2009 and how we're approaching our plan, let me provide an update on our current environment and year-to-date results.

From a financial results perspective, our execution has been pretty solid.

Third quarter results exceeded guidance in a high quality way.

We continue to invest in growth, and also are aggressively cutting our cost structure.

John showed our balance sheet is in great shape.

So we're committed to execution, and delivering on our commitments.

As we think about some key accomplishments, I'd like to highlight a few of the major actions our company has driven.

We're successfully integrating our Residential Water Filtration business with GE and that remains on track and on budget.

Over the past few years, we've consistently been reducing our factory footprint and moving to best cost regions.

These actions are important to drive our profitability in the face of challenging end markets.

Also, on September 10th, we had a well attended investor and Analyst Day, which highlighted a number of our key growth and productivity initiatives.

It was great to see many of you there, and the feedback we received was positive, so we thank you for your participation The presentation material is available on our website, and I encourage everyone to take a look at it.

Finally, we continue to launch a number of exciting new products, many of which were highlighted at that Analyst Day.

Our new energy and environmentally efficient Enviro Reverse Osmosis Filtration product, the LC Dry Industrial Filtration product designed to dramatically improve hydraulic performance, like the loop system in windmills, we also highlighted our AquaLine Pre-filtration solution, that will reduce capital requirements as well as improve the life expectancy for pre-filtration systems in a number of applications including desalination.

There were many other new products displayed, and we will keep you updated on the progress of these leading applications.

Our perspective on the current environment, which is highlighted in the upper right quadrant, is that globally many markets such as residential and pool remain soft while many other markets, such as commercial and industrial, are generally weakening.

Clearly we expect markets to slow, and we're prepared for it.

So going forward, let me clearly state we're ramping up our cost take-out measures and monitoring our markets through our daily order reports and quotation and bid rates.

We've been navigating through very difficult end markets for over two years.

Residential and Pool construction market problems are well-known and in 2007 we had difficult electronic end markets.

So we've grown accustomed to operating in difficult environments.

With that as a backdrop, let's discuss how we're approaching our 2009 planning process.

Please turn now to slide number 12.

We, like many companies initiate our next year planning process in the late summer and early fall.

Since kicking off the planning sessions, the global economy and credit markets have experienced a high level of turbulence.

As the slide indicates, credit markets have tightened, recessionary environments are more real for the US and Western Europe, and many items such as commodities and foreign exchange have been bouncing around in terms of valuations.

These elements introduce a tremendous amount of uncertainty and challenges in the planning cycle.

So while our typical process is to introduce next year's guidance on our third quarter earnings call, we're going to hold off until we have completed our final business reviews and allow for some uncertainty to become clearer.

We would say however that the focused actions that we had always planned to take in 2009 remain the same.

We have consistently viewed 2009 as another difficult year in many end markets, which is why we initiated the aggressive restructuring actions in July of this year.

At the same time, many of our growth investments, such as desalination, food service, industrial filtration, water reuse and others remain attractive and will continue to receive the investments they deserve.

So not much needs to change inside Pentair from a big picture perspective, and we remain committed to delivering shareholder value during these times.

Please turn to slide number 13 which outlines many of the cost actions and related planning assumptions we're taking for 2009.

The top half of the slide summarizes many of the cost actions we have already announced and are implementing that will have a meaningful impact to 2009.

We anticipate the 11 plants we're closing in 2008 and 9, coupled with additional headcount reductions and the formation of our global business units should deliver about $0.15 of earnings per share in 2009.

Additionally we expect the actions we're initiating in the fourth quarter to reduce our G&A structure to yield another $0.10 per share next year.

So in the aggregate, we're taking actions in 2008 that we believe will have a $0.25 positive impact to earnings next year.

I will discuss our outlook for growth on the next slide.

But it's good for you to know we're taking actions in '08 that will make a meaningful impact to '09.

The lower half of the slide introduces some additional actions we're taking as we formalize our 2009 plans.

First, we're having each of our businesses create two six-month plans so we can adjust quickly as we feel it is necessary.

This approach will allow us to be more flexible in uncertain economic times and also provides an incentive model to ensure all of our businesses remain active and in the game, delivering the best results throughout the year.

As we will discuss in more detail over the next few slides, we're planning for slow to no global growth markets.

Thus, the facility rationalization and other cost take-out measures we're driving are imperative to ensure we deliver the highest levels of earnings.

We also have an opportunity to improve our net sourcing savings, with potentially a period of key material deflation.

So we're being proactive and assuming a challenging environment which we believe is realistic.

Now please go to slide number 14.

We're not giving official guidance we felt it would be helpful to indicate how we are viewing our end markets at this point.

I'm not going to read all the detail but each one of our major end markets is listed along with their expected market growth or declines.

Depending on how they materialize, the swing in global markets could be considerable.

This could drive Pentair to have slightly negative growth on the low end to modestly positive sales growth on the high end.

The detail on the right side of the slide is similar in nature to the previous slide.

In that, there are a number of growth items we have already accomplished in 2008 that we expect to provide benefit in 2009.

For example, we anticipate the Residential Water Filtration deal with GE will add $40 million of sales to 2009, representing the other half of the year we didn't have that business in 2008.

Additionally, 2008 price increases will recognize a full year of sales benefits.

And while US residential will likely be negative again in 2009, we may not see the same 30% decline in new home starts so moderating decline will be less of a headwind in 2009.

With more new products and opportunities in global desal, global municipal and other vertical markets, we have areas of growth that we expect to be beneficial to 2009 as well.

However, it is much more difficult than normal to predict how the consumer-led recession will impact global markets.

As the dollar continues to increase in value versus the Euro, we may see a negative value to exports we which we expect would hurt our Technical Products business and commercial and industrial water businesses.

These important factors reduce our ability to forecast 2009 sales growth at this time.

But again, we're being realistic.

Now let's talk about the cost side of the 2009 equation.

Please turn to slide number 15.

Each planning cycle includes a determination on cost inputs as well.

Some key inputs are listed on the slide towards the top.

You can see we have listed some preliminary assumptions that certain items like wages, benefits, and investments for growth are likely to be higher.

There are a few other items such as commodities, and other material inputs that are uncertain at this time.

Our view is that given lower oil prices, resins, and distribution logistics costs may be deflationary items next year.

The lower half of the slide puts it all together in several scenarios.

When we do provide 2009 guidance later this year, we will refine our full year assumption on what type of environment we most likely expect.

Regardless of the environment, we remain confident we can deliver on the cost take-out actions we outlined earlier, which we expect to offset areas of negative earnings or add to earnings growth with the right breaks.

Depending on the market environment, we will take different actions and plan accordingly.

For example, in a recessionary environment, we would clearly anticipate declining volumes, a more difficult pricing environment, we will also see the benefit of material deflation.

In an environment like we've been dealing with over the past 18 to 24 months, about the mid-case shown here, we would expect a mixed environment with some markets up and some markets struggling.

In this case, volumes would be down slightly but not to the same extent as a full recession.

Since Pentair's been dealing with some difficult markets already for the past few years, we have a lot of practice.

Finally, we list a high case where global economies somehow escape recession and instead see slightly below average growth.

While the expected impact to our planned EPS is shown under each set of assumptions, it's far too early to be comfortable with what outcome is most likely yet.

We hope these past few slides have been helpful in understanding how we see our company developing in 2009, under various conditions.

Now let's wrap up with slide number 16.

To summarize, we had a solid third quarter driven by our business diversity and global mix.

While end markets are becoming more unpredictable, we have a lot of experience navigating these kind of environments, and we have been very proactive regarding cost takeouts.

We have a great balance sheet so you don't have to spend time worrying about Pentair during this credit crisis.

While some markets are clearly turning for the worse, some markets are stabilizing or improving, and some cost inputs will also be beneficial in 2009.

While it's too early to forecast 2009, it's not too early to take action and ensure we are proactively positioning the company to maximize performance under possible market conditions.

Thanks for your attention.

Now we'll turn it over to the operator to open it up for questions.

Meg?

Okay.

(OPERATOR INSTRUCTIONS).

The first question comes from the line of Deane Dray with Goldman Sachs.

Your line is open.

Thank you.

Good day, gentlemen.

Hi, Deane.

Just -- I don't know if this is for Randy or for John, just to clarify the whole steel dynamic within Technical Products, you suggested that the steel prices benefit might not come through for the next couple of quarters.

Is that because you've locked in supplier agreements or you're less open to spot pricing?

No, we've been -- we haven't really locked in.

We've been expecting a decline.

It just takes a while to work through the books with FIFO.

We use a capitalized variance system, Deane, as our accounting methodology.

A quarter lag.

So we sometimes have a month to two lag on the favorable pricing, working its way through the system.

But maybe I just misheard Randy.

I thought he said a couple of quarters.

Did you mean a couple of months or quarters.

I think I said a couple of periods.

I probably should have said a couple months.

That's helpful.

What about the -- how sticky will the prices be, the price increases that you were able to get over the past year?

What have you seen in the past about being able to hold price?

Well, one of the things we do is our prices go into our base.

We don't do surcharges and the like.

So it goes into our base pricing and 80% of what we sell we sell through distribution and prices tend to be pretty sticky through distribution.

I think it's evidenced in the fact that we were able to get as much price as we did if you compare that to other businesses that weren't quite as capable of getting as much price to offset commodities.

I don't think that was so much execution differences as it was industry structure differences.

So our planning would be that a lot of that price will stick.

It won't stick everywhere.

But a lot of it will stick and so we'll get some good readout material on productivity next year, which, frankly, we haven't this year because of the inflation.

That's helpful.

And then we fully appreciate the fact that it's going to be hard to nail down a specific guidance range for '09 at this stage, so you've actually provided some good level of detail here in terms of some of the end markets.

If there was one that kind of stuck out, that might be a little in need of explanation, is in the Water markets, municipal/desal being up 5%, my guess is it's more of the desal dynamic than the municipal, but if you split those two, what would the dynamics be?

It's really global.

Our municipal business, call it $100 million, most of those sales are in the US today on the flow side.

We've got $100 million of quotes outside of the United States this year.

We're so small, we believe we can grow with a decent hit rate in those and our backlog and code line, the vessels for desal mostly outside the US is really quite strong.

So when we see municipal, we're thinking more US but you're talking Water treatment overall?

We've been investing enormously and the team has done a great job of getting focused outside and taking the capability we have outside.

Now, we've had the advantage of fairly favorable dollar and that's why I referenced in my prepared talk that the dollar strengthening could be a headwind for those businesses.

But I just feel really good to have that quote backlog going from zero to $100 million in pumps, municipal pumps outside the US.

On the early buy program, I know that's always hard to gauge at this stage of the year because it can be -- surprise you on the up side or the down side.

What are your expectations and where do distributor inventories sit today?

If you take a look at -- you know, we were down, as I said, the Pool equipment business was down to 22% in the second quarter, it was -- the group, was only down 10% in the third quarter which we think reflects more of the market now.

So we don't think that the inventory came down much.

At least as the way we set our -- we set our expectations for the fourth quarter that John just went through, assuming that we would see it kind of a market level decline in the early buy and everything we see is consistent with that.

Great.

Thank you.

Next question comes from the line of Michael Cox with Piper Jaffray.

Your line is open.

Good morning.

Thank you very much for taking my question and thanks for all the detail provided this morning.

You're welcome.

My first question is on municipal spending and domestically, I'm just curious what you're seeing on that front given what we're seeing in terms of state level budgets and just local budget process as well.

I'll give you a couple data points.

On the flow side, we still have a good backlog.

We haven't seen any cancellations and the order rate has remained pretty good.

On tech products, which also serves the public sector.

we have seen a slower growth.

It went from being double digits to single digits.

So we're seeing it there on the tech products side.

Okay.

That's helpful.

And on the Water side, with the margins down in the quarter, I understand largely from the GE transaction, but as you look out to 2009 from the crystal ball you're looking into, do you see the Water segment margins being relatively flat?

Is that a realistic expectation?

And how much the drag in water margins is coming off the Pool segment right now?

That's a good question.

We really think we have the ability next year, even in a down market, to expand our Water margins.

We've taken a lot of structure out.

We continue to migrate the factories and so we would expect to increase the margins.

Pool equipment, which is a part of the Pool and Spa business, is roughly around a 10% margin business today, and we would like to say that we're near the bottom of the trough.

Right?

So I think it's reflective of the hard work that that team's done and we've seen those margins continually tick up at the volumes come back so we kind of like our core cost position.

So we would say that we're bullish on the Water margins because we got aggressive with the actions early in 2008 and we continue to address our cost structure.

After two years, flat will feel like up to them.

Yes.

Sounds good.

Thank you very much.

Next question comes from the line of Mike Schneider with Robert W.

Baird.

Your line is open.

Good morning, guys.

Hey, Mike.

Maybe we can focus on Technical Products for a minute and just look back.

I lived through the '01 and '02 challenges and I'm just curious if you could at least compare the business today to what we saw then and just as a refresher, I think Technical Products' revenue was down 29% peak to trough earlier this decade and margins basically got cut in half from 12 to 6.

As you look at the business now with the acquisitions with the pricing contribution, et cetera, what's kind of -- what's your recession expectation for that business and compare it to what's gone on in the past cycle.

Yeah, I don't want to jump the gun and tell you I think it's going to be that bad.

Let me tell you what's the same.

The same is that we will not be immune in tech products of this downturn that we're all expecting to need to plan in.

Let me tell you what's different.

We actually have a much more variable cost structure.

We had a lot more structure.

We had about six more plants than we have now and that cost structure was a heavy load, as you recall.

We had to shut down a lot.

The fact they're gone and we've been able through lean to be able to grow the business, we have a more variable cost structure so I think that's important and will help us manage margins.

The second thing is we're a lot more global than we were.

We really weren't active in Asia and I think with the amount of growth that we have in sight in Asia, even if Asia softens a little bit or grows at a slower rate, we've still got a lot of market penetration there that will help, albeit that is lower margin that our US business.

Last is that we have a much more diverse vertical market set.

We've talked a lot about how we've broadened the business, for instance, we're much more involved with continuous flow.

We're much more involved with deeper and more engaged in energy and I think energy spending will stay up and we're already -- we've already suffered some pretty big slowdowns in automotive in there.

So I think the more diverse market set will help a lot.

So the other thing is, I think, we have, look at the performance we've delivered with the kind of commodity inflation that we've had, and that's going to go away.

I mean, if we have a recession, there's no place that commodities will go but down and our tech products business has proven that they manage really well, in their material costs, I expect.

I will tell you this.

I don't think that the best days are behind tech products.

I think our team will manage it well.

We've had a lot of discussions about getting prepared for it and they are.

So while we'll have a little bit of headwinds, I think we won't see a repeat of 2001.

And can you just, based on your experience in this channel, can you discuss if the price inflation that's occurred over the last three, four years, does that create more risk to margins over the next two years if indeed we go through a recession, or is it less of a risk?

Let me jump in and I'll let Randy.

This is John Stauch.

I think there's two halves.

We've got to remember in electronics, we've been challenged by going out and bidding and winning jobs on pricing and we've lost on the material inflation on those fixed price jobs.

We've been able to price in the distribution side on the electrical side and capture most of the commodity increases that we've seen.

So it actually will reverse, right?

I mean, if we take a look at the distribution side, we may or may not see price decreases but we'll have the ability to realize the commodity inflation.

On the electronics side, we won't be caught the way we've been squeezed through this.

Should carry some relief in productivity.

We have to figure that all, Mike.

We're clearly going through our planning cycle and running a series of scenarios around what that looks like and we're trying to balance that with the fact that we haven't seen these markets drop significantly yet.

So we're challenging our teams to assume that they will.

Okay.

Thank you again, guys.

Thanks, Mike.

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

Your line is open.

Hi, good afternoon.

Hey, there.

Just want to talk a little bit more about some of the cost actions that you outlined in the presentation.

For your fourth quarter slide deck, regarding new actions you're talking about $50 million of annualized take-out which is about $0.34 a share and then on your other slide deck, you talked about about $0.25 of total cost benefits to be realized in '09, partly from what you're planning to do in 4Q, which you said was $0.10 and partly from the 1Q to 3Q actions of 15.

Is the annualized number that you're throwing out in the fourth quarter slide, is that really kind of the run rate you expect to get to by the end of '09 or how do I think about reconciling some of these numbers?

We've been -- just to hit it head on, we've been dealing with what we're going to do with spa bath all year.

In Q4, some type of action related to spa bath.

Don't know exactly what that action is yet but we're forecasting either a major restructuring or some type of adjustment and that's why you're not seeing the same payback that you're seeing from the Q1 to Q3 actions.

Okay.

But that would be embedded in the $0.10 benefit?

Versus the --

That you outlined for 4Q.

Versus the $0.35 cost that you're referring to, correct.

We wouldn't see that benefit until 2009.

Okay.

And then in terms of the price raw material conversation, if you look at this quarter in Water, it looked like that hurt you by at least $0.05 a share.

So I'm wondering, would you expect to get some relief on that metric, at least in the short run, as commodity prices go down and maybe you can get to more of a neutral or even positive position?

Yes.

Clearly, we're looking at those commodities.

As Randy mentioned in his remarks, they're bouncing around, right.

But we're waiting for them to settle and we would expect that we would see more deflationary environment in Water.

Curt, when I look at Water, I look at the details, we have some pretty good cost reduction actions and supply, just they didn't read out because inflation was that much worse.

I think that process will deliver in spades next year, without in fact inflation and then be turbo charged by some deflation for Water.

Okay.

And then I guess a follow-up to Mike's question on the Technical Products.

If you look at -- I think, Randy, you commented on the call that you think you could see better operating leverage even in a down market.

So what would the sensitivity be?

I know there's a lot of moving pieces, but can you help frame maybe what the margins would look like under a flat unit volume growth scenario or down, say, 5% or down 10%?

You just in terms of thinking about how bad margins could theoretically get next year if volume was to go down 5 to 10.

I think we'll give when we do give guidance later this year, I think we'll go into a little more detail how we're thinking about that.

In a flat environment, I think margins could stay right where they are because between productivity and particularly material productivity, I think there's still a lot that can go better in tech products, particularly on the electronics side.

So I think in a flat environment, they could do better.

I think in a down environment, we can build a plan to be flat.

But I don't want to jump the gun.

We've got meetings scheduled with the team over the next week to work through the scenarios.

Mike said it well.

In the last downturn, we went from a 12 peak to a six and now actually our peak's 17.

So we're up five points from that peak.

And I think -- I don't think we necessarily -- there's no way we'll drop 50%.

I would hope we wouldn't even drop the six points.

So that sort of frames my expectations.

Great.

Okay.

Thank you.

Next question comes from the line of John Quealy with Canaccord Adams.

Your line is open.

Thanks.

This is actually Chip Moore for John.

You talked about slowing conditions in Western Europe, wondering if you could go through what you're seeing from the commercial industrial residential markets, et cetera, kind of how that -- what you saw versus your expectations and what you see going forward.

Well, we actually expected it to decline when we set the third quarter.

One reason we beat Water revenue was we actually were expecting a decline.

We could see it coming.

We're skewed residential in Water, Europe, so residential is down, Spain, Italy, France, UK, all those residential markets are down.

But we're seeing slowing in commercial and industrial as well, which is before -- because the residential decline started earlier but the commercial and industrial we saw that decline.

That said, the European team has done a great job on margins and we implemented an SAP system there that they leveraged nicely.

They've been supporting a lot of growth the Middle East and in Eastern Europe, so I think we still have a lot of opportunity.

Great.

Thank you.

Glad you agree.

The next question comes from the line of Chris Chen with Oppenheimer.

Your line is open.

Thank you.

On the restructuring front, the $0.25, is that all Water?

In which period, Chris?

For next year?

Yeah, just the benefits you're looking for in '09 from the restructuring actions.

We took more aggressive actions in the first part of the year in Water but we're certainly looking to do some things in Technical Products as well and the Technical Products business is reviewing those actions and they'll be presenting us some ideas here in Q4.

Okay.

And just in terms of restructuring beyond what you've laid out, would you expect a couple factories a year type of thing or prospects for another significant sort of action strategy.

And then specifically with respect to your China or Eastern European footprint, are those appropriate comfort level with the ground expertise in those areas?

Yeah, I think we've presented some thoughts on that at the analyst meeting, as you recall.

We continue to see the need.

We have a lot of plans.

We need to continue to have a more productive footprint and particularly get to what we're calling best cost countries, which isn't just purely chasing low labor, it's having the best cost plants to serve the markets we're serving.

So while we like our position in China, we like the position we're building in India, our Poland factory in tech products is finally profitable and helping us in Europe.

So in fact, actually, in Europe, we were up in tech products in the third quarter.

So we haven't seen the market decline there yet.

And I think one of the reasons is that the Polish factory is giving us a more competitive cost position to grow with.

So we like the position.

We have a nice position in Brazil as well with our tech products business there that we are leveraging in the Water.

And the teams there are solid, Chris and I think what we plan to do is take this tranche of savings and continue to invest annually and constantly getting after the cost basis on a more continuing basis.

Okay.

And then just lastly, at Pool, what's the mix of new builds versus after-market shaking out these days?

It's getting close to 100.

Not quite.

We'd estimate 75 to 80% right now is after market.

Okay, thanks a lot.

You have another question coming from the line of Mike Schneider with Robert W.

Baird.

Your line is open.

On the ballot this fall the California legislature is going to take up this issue of banning Water softeners.

Could you give us an update just on your market analysis around this and what your exposure is if indeed this becomes one of the Green phenomenons?

They already took it up and Governor Schwarzenegger vetoed it.

That said, Water softeners is a fairly small part of the commodity problems in the water in California.

The big problem in California is not having enough Water.

So you'll see right now the State of Washington is looking at banning personal car washes and last I checked it rains there a lot so I mean, I don't think they lack Water in Washington.

I think there's a long-term trend toward more restrictions on water use and that's a long-term trend that is favorable for us for water reuse.

It's favorable for us for Filtration and it's favorable for us for actually flow.

So we are I think the largest provider of products into Water conditioning and Water softening so we pay a lot of attention to things like what's going on in California and we view long-term there will probably be a saltless way to deionize Water.

One of the things that we're working on with GE is that technology, so that's how we're thinking about it.

As far as the GE deal goes, given that the world has changed just even in the last three weeks, four weeks, have you gone back to your GE modeling assumptions for the joint venture and made any material adjustments to that?

No.

You know, when we formed that venture it was really a shared view that we had with GE that the residential markets would be viable and exciting in the future and why not build now during this weak time a world beating company to win in it.

So that's really what we're on.

We had the review yesterday, actually, our monthly review and status is quite good from a plant restructuring standpoint.

The thing I'm most excited about is the growth strategy that they're building.

So we don't see any need with recent events to change the assumptions around that venture, if anything I'm more confident that we'll be -- when residential comes back and I'm not picking a date or a time, but I will tell you I'm bullish on our prospects when it comes back.

Meg, this is Todd Gleason.

I want to make sure we are able to get to everybody in the queue.

And I know we have about five minutes left on the scheduled time.

We're willing to go over.

How many people do we have in the queue?

Actually, Mr.

Schneider's call, question was the last question.

Okay.

Well, Mike did you have anything else, Mike?

That's it, thanks, guys.

Great.

Thanks.

Okay.

Well, sounds like we have no one else left in the queue.

If that's the case, we'll go ahead and wrap up today's conference call.

Thank you very much for joining us.

If you have any questions let us know.

Our presentation material is on our website and hopefully you have access to that.

Thank you very much.

Thanks.

Thank you.

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