濱特爾 (PNR) 2010 Q1 法說會逐字稿

Good morning.

My name is Lori and I will be your conference operator.

At this time I would like to welcome everyone to the Pentair first-quarter 2010 earnings conference call.

(Operator Instructions).

I will now turn the call over to Todd Gleason, Vice President of Strategic Planning and Investor Relations.

Please go ahead sir.

Thanks, Lori, and welcome to Pentair's first-quarter earnings release conference call.

We are glad you could join us.

I am Todd Gleason, head of Investor Relations, and 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 first-quarter results as well as update you on our outlook for 2010.

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 the risks outlined in Pentair's 10-K as of December 31, 2009, and Pentair 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 can 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 this presentation.

I would also like to point out that all financial results and references to year-over-year numbers in today's call and presentation 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 the call over to Randy, who will take you through Pentair's first-quarter 2010 results and provide his perspective on our markets and performance.

Then John will conclude our formal comments with additional information regarding first-quarter performance and provide more detail on our outlook.

Thanks, Todd.

And thank you all for joining us today.

The headline for the first quarter is that the tremendous efforts we applied to weather the economic downturn, while also positioning us for growth and recovery, are steadily yielding significant benefits.

Sales, margins, earnings and cash flow were all strong, and we look forward to carrying this momentum forward throughout 2010.

Sales of $707 million were up 12% year-over-year or up 9% in local currencies, all organic.

Sales in our Water Group were up 13% as major markets such as residential, industrial, and municipal all showed nice growth.

Technical Products sales increased 9%, led by strong double-digit growth in general electronics, industrial and infrastructure markets.

In Q1 we delivered earnings per share from continuing operations of $0.35, which was up 75% when compared to adjusted EPS in the first quarter of 2009.

The $0.35 of EPS met the high end of the guidance we provided in February.

Total Company operating margins of 9% expanded 270 basis points when compared to adjusted Q1 2009.

The positive benefit from volume and productivity more than offset the negative impact from modest selling price decreases and inflation.

In the quarter we reinstated a number of employee benefits, incentive programs, customer rebate accruals, and continue to make investments in sales, marketing and R&D to support exciting growth opportunities going forward.

So we did turn on some items that lead to higher costs.

One other note, I would highlight that we are not adjusting first-quarter 2010 for any restructuring costs in our operating margins or EPS, despite having had some expenses associated with final plant moves or pay-as-you-go costs.

We will discuss these items in more detail, but for 2010 we do not anticipate having separate reported and adjusted numbers as we did throughout our major restructuring campaign of 2008 and 2009.

Relative to our EPS our first-quarter effective tax rate was 33.5%, which is about 1.5 point higher than guidance, as our mix of sales skewed to higher tax jurisdictions.

We now expect our full-year tax rate will between 33% and 34%.

While the first quarter is always a period of cash usage, we had a nice start to the year with respect to free cash flow, ending the quarter at a negative $22 million, which is favorable by $11 million versus the first quarter of 2009.

As you know, receivables and inventories grow in our first quarter as we prepare for seasonal sales in the coming months.

We believe we are on track to deliver $225 million in free cash flow for the full year, well in excess of the 100% conversion of net income.

Now let's turn to slide number three, which provides an overview of our Q1 Water results.

Here are the details.

On the top of the slide we provide our standard sales and operating income (inaudible).

We will refer to these as we describe the performance of the Water Group.

Overall Water sales increased $54 million to $478 million, up 13% versus first quarter of 2009 sales or up 11% in local currencies.

Sales growth of several points above the expectation was provided in February.

As we will discuss, while we had good growth in each GBU, our overall sales performance was led by Pool and Residential Filtration, where new products in recovering markets drove strong results.

The additional sales versus our original forecasts were in large part because of demand for sump pumps in retail channels, as massive rains and flooding throughout much of the United States in Q1 drove higher demand.

These pumps typically have slightly lower margins, so our mix was modestly negative on these incremental sales.

Let's review our five Water global business units a little further.

Our Residential Flow GBU was up 12% year-over-year.

Growth was balanced as US sales benefited from that retail demand for sump pumps, while growth in emerging markets and our agricultural products were very strong.

We have launched a number of new products in our Residential Flow business.

And we continue to see great results from our energy efficient INTELLIDRIVE line, which reduces energy consumption while improving water pressure.

While we haven't talked about our Faradyne joint venture in a while, we have recently celebrated the shipment of Faradyne's 1 millionth motor.

Customers continue be very pleased with Faradyne's quality and performance, and we look forward to updating you on our new line of high horsepower motors very soon.

No doubt, more great milestones to share in the near future.

Residential Filtration was up 14% in the quarter, led by a steady market recovery in the US and strong international sales.

We have launched a number of exciting new point of view systems in our East Asia and Indian markets, and we continue to expand our penetration in both the Middle East and Latin American markets.

Our pool GBU was up 25% as we continue to see market recovery and distributor inventory replenishments from extremely low levels.

Eco Select, our sustainability line of pool equipment, continues to lead and enable us to attract new dealers and distributors.

We continue to penetrate and grow our share in the Middle East, Latin America and Asia.

While the first quarter is seasonably our smallest quarter, we like the trends we have seen and quarter-to-date order activity remains strong.

Engineered Flow grew 10% as strong municipal and good industrial sales growth more than offset double-digit declines in our commercial pump markets.

The municipal business continues to have record backlog and good order activity.

We remain on track with the large Gulf intracoastal waterway project, with the bulk of 2010 deliveries set to occur in the second half of this year.

Engineered Flow continues to make steady progress in international markets, as sales in Asia almost doubling year-over-year in this GBU.

So our investments in fast growth regions are really beginning to pay dividends.

Filtration Solutions was up 8% to strong double-digit growth, and Food Service more than offset weakness in other commercial markets.

In the quarter sales of desalination product, specifically our CodeLine vessels, were down as the timing of project wins negatively impacted sales in Q1.

Now I will discuss operating profits and margins for our Water Group.

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

Operating origins were 8.8%, up 210 basis points year-over-year.

Margins benefited from solid growth and productivity included the 100 basis point impact from our final plant moves, which as you know, has been a significant effort for the past 18 to 24 months.

As I mentioned earlier, for 2010 we do not anticipate separating out these final restructuring costs in our financial results.

But we will continue to provide some color as to the impact for your edification.

So in sum, water had a solid start with good sales growth and margin expansion.

Please turn to slide number four and let's discuss how our Q1 Water results and market trends inform our view of the year.

On the left side of the slide we provide an overview of our Water Group sales split by market and geography.

Additionally, we provide expected growth rates in these geographies.

In all, we believe we will see strong growth in fast growth regions and developed Asia, while the US and Western Europe will grow, but a slightly slower pace.

On the right we review our major markets and how the start of the year is influencing our view on growth in Water.

In global residential the order trends in Residential Flow, Filtration and Pool are all encouraging.

Certainly the most influential quarter is the second quarter, since most of our sales are in the Northern Hemisphere.

So we will have a better view of the year by July.

We currently expect full-year sales growth in the low teens for this market.

Global commercial is a bit of a mixed bag for us.

On the positive side we expect Food Service to maintain the double-digit sales growth we are now enjoying.

We continue to do very well with our global sales efforts, which are delivering great returns.

On the negative side commercial construction is down over 20%, and we expect the full year to be at those levels.

So in aggregate we expect our sales in the global commercial market will be down around 10% for the year.

Global industrial is up double digits in Water, and we expect that trend to continue.

Currently this is our smallest market for Water, but overall it is a large market.

So we are investing in global penetration, particularly in energy and industrial systems, and expect our investments to yield double-digit sales growth for the year.

Global municipal continues to be a strong market for us.

In the quarter municipal sales related to the large DIWW project I just talked about were minimal, less than a few million dollars.

We expect major shipments to begin in Q2, and really ramp up in the second half of 2010.

Sales from this project alone give our municipal market a solid double-digit lift, and we expect to grow in municipal outside this project.

So we are currently forecasting 20% sales growth for the year in this space.

These are our views of the markets and our sales.

In all, they support about 10% growth in Water for the full year, which is very encouraging.

Please turn to slide number five and now let's review Technical Products.

Year-over-year first-quarter sales in Technical Products were up 9% or 7% in local currencies.

Sales are strongest in general electronics, which was up 26%.

Industrial and infrastructure sales each grew mid to high teens and continued their sequential improvement trend.

Sales were lowest in energy, communications and commercial, with the latter two showing a decline year-over-year.

Throughout 2009 Technical Products showed solid sequential margin expansion.

As we start 2010, Technical Products again delivered strong operating margin improvement, and we believe it remains well-positioned to benefit from productivity actions and growth from recovering markets.

Operating margins for Technical Products were 14.5%, an increase of 440 basis points when compared to first-quarter 2009 adjusted operating margins.

Similar to Water, the 14.5% margins include the impact of final plant moves, which will be completed in mid-Q2.

Technical Products is introducing a number of exciting new platforms and growth initiatives.

One example is Energy Parking, currently a European-based modular charging station that combines electric automobile recharging with parking meters.

The product was launched at the Intertraffic Trade Show in Amsterdam this March.

The city of Frankfurt, Germany will be the first to pilot the program.

We believe this could be a $25 million program in total for Technical Products if it is successful.

We look forward to updating you on this product and other growth initiatives throughout the year.

Please turn to slide number six and let's discuss how our Q1 Technical Products results and market trends informs our view for the year in that GBU.

Similar to the Water market analysis slide, we provide our sales split for Technical Products in both served markets and geography on the left-hand side.

For Datacom and telecom we are off to a solid start for the year.

Furthermore, some large projects in this market influence year-over-year sales, given the timing of certain programs.

Our current expectation is for about that 5% growth for the year.

General electronics is up nicely, and we accept expect low double-digit sales growth for the year.

This includes test and measurement, medical and our traditional [Troff] product.

This market showed the highest sequential improvement, so trends here are solid.

Key industrial market segments such as automotive, machine tool and packaged goods are also gaining momentum.

We expect these markets to be up low double-digits for the year as rising demand in these markets is leading to higher capital expenditures.

Energy markets and markets related to infrastructure are each expected to drive high single to low double-digit sales increases for the year.

As I highlighted previously, our new Energy Parking program is an exciting initiative.

We also successfully launched Fusion, our new global industrial productline.

Feedback on Fusion has been excellent, and we are encouraged by initial orders at international customers.

Additionally, Technical Products has a number of key international wins, such as a large wind turbine producer in China, that also helped fuel our growth outlook.

In our infrastructure market we recently launched our new rail transport platform, which has been well received.

So on balance, a very good growth trajectory for Technical Products for 2010.

Now please turn to slide number seven and let's look at our balance sheet and cash flow metrics.

This is one of our standard metrics slides, so I won't spend a lot of time here.

We provide this detail so you have easy access to our free cash flow walk, which is found on the left-hand side of the slide.

We also provide a summary of our debt levels and maturity dates on the top right section of the slide.

As you can see, we have a comfortable debt level and rate and no maturities for a couple of years.

Our key ratios of ROIC, return on equity, and debt to total capital are listed on the bottom right section.

We expect steady improvement to our ROIC metric as our sales and earnings growth in 2010 and beyond.

Our near-term goal is to get after-tax ROIC back into double-digits and ultimately to 15%.

Now please turn to slide number eight, and I will wrap up my discussion on the first quarter.

We outlined our growth in key markets in detail.

Starting the year with double-digit sales growth feels great I must say.

We had shared throughout 2009 many of the key actions we were taking to position Pentair for growth, so it is nice to demonstrate the results.

And while much of our growth was the result of investment in innovation and resources, no doubt our key markets are beginning to recover.

We are well-positioned to these markets to benefit and are winning good programs.

Some examples include the rail transport win in Technical Products, global initiatives in Food Service, the municipal pump orders in the Middle East, and our dealer expansion success in Pool.

There will be more to come, and we look forward to sharing achievements throughout 2010.

Margin expansion in Q1 was strong.

And now that our plant moves are behind us, we expect even better leverage in the second quarter and second half of 2010.

As John will share in a few minutes, we remain committed to 30% to 40% conversion on incremental sales.

We have also maintained our investments for growth and also reinstated key employee benefits and compensation programs.

Morale is good and our organization is focused on growth.

We have a number of new products that are fueling excitement, and our global sales and marketing organization continue to gain strength and capabilities.

With expected strong free cash flow for the year, we look forward to putting that cash to use for debt reductions or to fuel growth.

I will now hand it over to John, who will walk you through additional details on our performance and our outlook for Q2 and the full year.

Thanks, Randy.

Please turn to slide number nine.

Last year we introduced various cost structure summary.

During 2009 we were in the midst of the largest restructuring in Pentair history, with the closure of 18 facilities in 18 months.

We had accelerated the original plan, which called for a 36 month horizon, but felt the global recession called for us to hasten our efforts.

Based on determination and commitment of our employees, we successfully completed the announced closures in our Water businesses, and will be completely done with the one remaining Technical Products facility closure in mid-Q2.

Given that effort is substantially complete, we now shift our focus from restructuring to improving our already solid customer service, on-time delivery, and lean processes within each of our locations.

While we are proud of our accomplishments and metrics, significant productivity opportunities remain with respect to lean savings and best-landed sourcing savings.

Additionally, a bulk of the production from the facilities we closed moved to our best-cost plants in Mexico and China.

Over the past few years we nearly doubled our output in these plans.

Currently China and Mexico account for approximately 25% to 30% of our production, which will yield strong productivity on future revenue.

With the production transfer nearly complete, we can focus on lean process improvements, which we expect will drive savings going forward.

With that as a lead-in, let's review the data on the slides.

For 2010 we are forecasting 7% to 9% revenue growth year-over-year, or about $200 million of sales versus 2009 levels.

We continue to expect these incremental sales to deliver 30% to 40% income conversion, a very solid number for the year.

Moving to materials.

We reiterate the commentary in our February earnings call that we enter 2010 with approximately $30 million of carryover material productivity.

We are already seeing those savings read out, and we expect the full-year material as a percentage of sales to be around 40%, better than 2009 by around 100 basis points.

While the we expect raw material costs to rise slightly starting in Q2 and continuing through the balance of the year, we have stolid material purchase contracts in place, and our commodity programs have been active.

Furthermore, we expect recently announced sales price increases will offset the eventual material inflation, as our favorable contracts and hedge protection (inaudible).

So we remain comfortable with the 40% material sales relationship for 2010.

Through our lean efforts and plant closings we believe we reduced hourly labor as a percentage of sales by 50 to 80 basis points.

This will provide about $20 million in savings for 2010.

Currently we are just north of 10% of sales, but expect to end the year closer to 9%.

These numbers include the reinstatement of merit raises and 401(k) contributions to our employees.

Please turn to slide 10.

We expect 2010 gross margins to improve sequentially.

Our first quarter is traditionally our weakest quarter of the year, and going forward our expected incremental volume growth should leverage off our cost structure to provide solid sequential improvement.

You can see the components of this productivity leverage in the far right of the slide under the column labeled, Full-Year Expectations.

Operating expenses met our expectations for the first quarter and were up $20 million year-over-year.

Given the dramatic sales declines early last year, Q1 2009 operating expense levels benefited from the reduction or absence of sales and employee incentive accruals, as well as the reduction in certain employee benefits.

Comparing operating expenses sequentially versus Q4 2009, costs were higher by $8 million.

The sequential increase was driven by higher sales accruals, the reinstatement of employee benefit programs, and more investment in selling, marketing and R&D to drive growth programs.

Longer term we expect to maintain operating expense at 20% of sales.

We plan to migrate more of the OpEx spend towards growth-related components such as sales and marketing and R&D, while reducing our G&A costs through efficiencies.

For 2010 we expect to spend 20.5% on operating expenses, as we expect to accelerate investment to drive international growth and new product introductions throughout 2010.

So to summarize these slides, our current revenue forecast, combined with our productivity actions and focused investment, should deliver solid operating margins in 2010.

We expect Op margins of about 11%, which put us on track to achieve our goal of 15% operating margins by 2014.

Please turn to slide number 11.

We, and the entire industry, are anxious to recover the sales drop that occurred during the global recession of 2008 to 2009.

By driving the right growth opportunities and delivering solid productivity, we expect to deliver very good incremental EPS and ROIC.

To help track and monitor our own progress we are holding ourselves to an operating income to sales conversion metric.

We believe that the appropriate conversion on incremental organic sales growth, that is sales which remove the impact from foreign exchange or any acquisitions and divestitures, should be above 30%.

Let's review how we get there.

Our walk starts with revenue at 100%, but of course, sales do not drop through at 100%, as revenue is impacted by material, labor, variable overhead and oftentimes sales commissions, rebates and incentives.

So the expected impact to our incremental organic sales growth is shown here at about 35%.

There are opportunities to improve this conversion, but also times it will be negative.

We list the major variable items in the text box, And we are constantly working to drive improvements in each.

These items include sales prices, lean productivity savings, mix of products, and mix of where our products are made.

Additionally we control the pace and scale of growth investments.

We would anticipate that these factors would influence the 35% conversion by plus or minus 5% on average.

Going forward, we will discuss this metric and how we are delivering against it.

Please turn to slide number 12 and let's discuss our Q2 2010 outlook.

For the second quarter 2010 we expect total Company organic sales to be between $780 million and $795 million, an increase of over 10%.

This includes sales increases in both Water and Technical Products of 10% to 13%.

We expect second-quarter total Company operating income of between $90 million and $95 million, an increase of about 40% year-over-year.

This would produce operating margins of around 12% for the Company.

We expect second-quarter operating margins in Water to be around 13%, or up about 420 basis points sequentially when compared to the just completed first quarter.

We expect Technical Products to deliver operating margins of over 15%.

We expect that the Q1 2000 (sic - see press release) tax rate will between 33% and 34%, and that interest expense will be approximately $9.5 million.

The share count is expected to be approximately 100 million shares.

So our expectation and guidance for Q2 2010 EPS is $0.52 to $0.55 per share, a year-over-year increase of over 35%.

Finally, we expect to continue to deliver solid free cash flow, and are targeting over $100 million in the second quarter, which would be a net income conversion of almost 200%.

Please turn to slide number 13 and let's discuss our full-year 2010 outlook.

The main headline for the full year is we are maintaining our guidance of $1.75 to $1.90.

As you know, the second quarter is the most critical quarter for Pentair.

It is the season for several of our businesses, and really informs our ability to deliver on our financial commitments.

Thus it is important we validate the trends we experience in the first quarter before we modify full-year guidance.

Our full-year guidance includes total Company sales expectations of around $2.9 billion and full-year free cash flow of $225 million, a conversion of net income of well over 100%.

Let's wrap up our prepared remarks.

Please turn to slide number 14.

Overall we had a solid start to 2010.

First-quarter sales were up 12% year-over-year.

We expect sales for the full year will be up greater than 7% when compared to 2009.

Material productivity was on track in Q1, and our selling price performance was as we expected.

We recently announced price increases in several of our businesses, and are confident we will offset expected material inflation.

For the year we expect to achieve 100 basis points of improvement in our materials as a percentage of sales versus 2009.

Our manufacturing conversion performance in Q1 provided good evidence that our manufacturing rationalization effort is already paying off.

With these closures completed we have reinvigorated our core lean program to focus on four-wall accountability and deliver productivity benefits from our existing organization.

This will, we expect, lower our hourly labor costs as a percentage of sales by around 50 to 80 basis points.

Our operating expenses met our expectations in the first quarter.

While up sequentially, we provided the appropriate level of funding to fuel growth and reinstate benefit and compensation programs, which will reward our employees for sales growth, customer service, productivity, income conversion and free cash flow.

Our employees continue to demonstrate their commitment to Pentair and our shareholders, and we know they are proud of the accomplishments we have achieved to date, and eager to deliver outstanding results in 2010.

And while our operating income conversion was at the lower end of our range in Q1, we expect our growth investments and revenue mix to level off and improve going forward.

Thus our comparisons will ease throughout 2010, and we expect to demonstrate even better conversion in Q2.

Finally, we know that delivering cash is most important.

Free cash flow enables us to control our destiny, make the appropriate growth investments, and grow our Company and our dividend, which we have done for 34 consecutive years.

We are off to a great start, and we are confident in our ability to generate $225 million of free cash flow for the year.

That concludes our prepared remarks.

We will now open up the call for questions.

(Operator Instructions).

Mike Cox, Piper Jaffray.

This is Alex for Mike.

I guess starting with revenue guidance for the full year, clearly this was a good quarter for revenue, and I guess 2Q looks like it's going to be another good quarter for revenue.

It implied in the relative no change in the full-year guidance.

It seems like you are implying a deceleration of growth in the back half.

Is this just a function of the fact that you want to, as you were saying, validate recent trends hold through the high season?

Does that basically explain that?

That explains it.

Then also with regard to the conversion, you had mentioned that you were at the low end of the range here for the first quarter.

Why is that?

Is that because of the restructuring costs coming in, in addition to the lower gross margin that you're getting on some of those sump pumps?

What was driving that?

It was a better-than-expected revenue quarter, but I guess it didn't translate into EPS.

(technical difficulty) clearly year-over-year operating expenses were up $20 million.

As I mentioned, last year we set plan as a Company equal to 2008 levels.

So incentives were based upon a flat income growth, and therefore a lot of incentives weren't incurred, or being able to be distributed to our employees.

And revenue to our distributors and our sales commissions were based on those levels at all.

So that would be the largest year-over-year delta.

Then we get into the move costs.

As you know, when you finish the factory closings and moves, you tend to find things related to having to shut down the factories, clean them up to put back the leases or put the businesses up for sale.

You have inventory that you built that needs to be adjusted.

So we had a substantial amount of those costs in the quarter.

And those two things moved us to the lower end of the conversion metric.

If we go forward, all of those issues start to level off.

Our run rate of operating expenses is about appropriate for the year.

So sequentially we won't see much movement there.

Our pay-as-you-go costs are not expected to continue into Q2.

Okay, very good.

Then I was just wondering also with regard to Pool and I guess pretty much for any of your Residential Water segments, how much of the growth would you say is related to sell-through versus restocking?

That is really what we want to see the second quarter for.

We are very encouraged versus the year-ago first quarter for Residential was horrible.

We are pleased with how it came in, but we are still not back to the levels that first quarter was at in 2008, when you add all three of those businesses up.

So a lot of it was stock.

Right now as we mentioned earlier in the call, some of those orders have held up pretty well into April, which is pretty encouraging.

But as the National Weather Service pointed out, spring broke two weeks early, so sell-through may have started two weeks early too.

Those are all pretty encouraging signs, but we really will know at the end of the second quarter how much is sell-through versus restocking.

Clearly, and you can see it in the industrial markets as well, big restocking.

And there has been articles written about companies that didn't have inventory and missed sales as a result.

So I think that is generally known that there is a broad-based restocking across industries.

And it will be the sell-through that tells the story long-term, or in the intermediate term.

But right now I am encouraged by what I see.

Okay, very good.

Thanks a lot guys.

Hamzah Mazari, Credit Suisse.

Just a question on your Water segment.

The operating margins there seem like they came in below your expectations, as well as ours, even if you adjust for pay-as-you-go.

Could you add more color there?

Is that just a timing thing?

Is there something structural?

And is it fair to say that the Water segment is where you have to do most of the work to get to your long-term ROIC target?

Let me start with your last question.

Yes.

That is where we made a lot of the acquisitions, and to get our ROIC to where we know we can a lot of that will be due to volume and margin expansion in Water.

I wouldn't say Water is troubled though in terms of margin.

As John talked about earlier, a lot of the cost we have turned back on in terms of incentives and sales commissions and the like were in the Water space.

As you saw, their growth was actually stronger than in Tech Product.

The other thing that -- and pay-as-you-go, if you add that back in, conversion is a little bit better.

But the other thing is mix.

Frankly, we are down in sales of very nice commercial construction-related pumps, and we are up in sales in terms of retail sump pumps.

That is not a great margin change.

So there is a little bit of mix in there.

Actually when you put the 100 basis points back in we are right at our expectations.

And we expect to be --.

100 basis points in the pay-as-you-go.

Yes, 100 basis points in pay-as-you-go.

We expect to be 12% for the year.

I think the 13% in Q2 reflects the improvement.

And I think you'll see focus on the second half and closing out to 12% for the year.

Then just -- a question on your R&D (inaudible) growth.

Could you comment a little more on what kind of a run rate you expect there?

Is R&D going to go to 3% of sales, above that -- or above that?

How much are you spending on growth right now?

And how should investors be thinking about all these various growth initiatives?

And what is the expected time frame of those moving the needle for you guys?

I will take the numbers, and then I will let Randy give you the flavor of the R&D investments.

But in the Q1 we spent about 2.5% of sales, which is up about 50 basis points versus last year.

We would expect that that starts to trend closer to 3% this year.

And, yes, over the next three, four years we would like to get it to 4% to 5%.

We have a model that allows for that.

And we are paying for that with the reduction in G&A and the efficiencies in our G&A structure.

Randy, you want to --?

In terms of the businesses that showed the greatest growth in the first quarter, which were Pool and Residential Filtration, those two GBUs, they have an impact -- direct impact -- their growth is directly impacted by the investments we made in both product and channel.

Specifically if you take a look at the Eco Select productline that we have launched over the last 18 months in Pool, those sales were up 45%, 47% in the first quarter versus a 25% for the business overall.

So clearly something is driving growth.

As well as those products are allowing us to expand distribution.

We are winning distributors that we didn't have because they need to have those products.

Similarly in Residential Filtration we have a number of new products that are giving us wins in channel.

So they are getting some right now.

The other growth I think is differential.

I think one -- you know, I have done a quick screen in terms of our growth versus other indicators.

And I think -- I feel like we may be gaining share in virtually all six GBUs.

Most of the rest is because of the investments we maintained in sales and marketing coverage.

The new products I expect will make a bigger difference in 2011 for those other GBUs.

But I think in those first two -- and Technical Products, because the Transport productline, which is going to help our infrastructure is going to help it.

I think Fusion will help as well on the new product side this year.

But most of the other investments are going forward.

In terms of R&D, we will continue to invest.

And we are investing with others.

We work with others, similar to what we did, not necessarily on the R&D site, but with ITT with Faradyne.

We see partnerships as a good way to go forward to innovate.

Just last question.

Are you guys looking at acquisitions right now?

What is your thought process there, if you can update us?

Thank you.

Well, we have taken the shackles off.

We are looking at acquisitions.

And our acquisition strategy hasn't changed from the one that we were pursuing before, which is we are going to invest organically for reach in markets that we are in.

We are going to invest in products.

But to the extent we can extend into new technology areas or into new geographies where we don't have reach now, those would be the main interest for us.

And more bolt-ons and smaller ones as opposed to large (inaudible) at this point.

Jeff Hammond, KeyBanc Capital Markets.

Just as I compare your fourth quarter, I guess your '10 guidance that you laid out in your fourth-quarter release versus first-quarter, it looks like you're raising the revenue in a range maybe 3 to 4 points.

Is that fair?

I got caught in the rounding.

I think we rounded down to 2.8 last time.

We are rounding up to 2.9.

The only adjustment we intended to give is an increase this year on the full year was the $20 million of (inaudible).

We haven't adjusted the revenue in the back half of the year yet at all.

So I guess maybe just walk me through the order trends through the quarter, how they built, and then maybe how April is shaping up as you get into the seasonally more important time?

And does that give you more or less confidence in the growth rates, because it just seems like they're coming in a lot better?

I am encouraged about what I see.

We mentioned in the script that through April the Pool business has maintained.

That is the one we really like to see, although it helps Residential Filtration and Flow as well in terms of how the season breaks.

So the trends had been encouraging.

The weather helped in the first quarter.

So I hate to say it, but we did say it, the flooding, particularly in the Northeast, was beneficial to the sump pump business, and jet pumps for that matter.

Weather doesn't sustain, but it does help improve the bottom line to the distributors who are improving their stock.

At the same time it is detrimental to Pool.

(multiple speakers)

Yes, it was.

Actually it gave -- it reduced the pool starts up there.

So I would say we are encouraged.

And we said it couple of times, I will say it again, I really want to see how the second quarter goes.

And it is really easy to be excited about what we are seeing.

I certainly am.

But I think we have to understand the fundamentals of this and listen to all the data points.

You take a look out there is still caution in terms of how sustainable the overall drivers are in the economy.

Certainly if you do the math, given the current market trends and our expectations, we recognize the low end of our guidance looks very conservative.

With that said, and as we stated this morning, as Randy just said, we need to validate the trends.

Q2 is our season.

And it will allow us to validate what is market demand versus restocking.

And the bottom line is we left guidance unchanged until we had enough information to adjust it in a more appropriate range.

That is really what we want to see Q2 through, and then we'll adjust the year in the appropriate way.

Okay, that's helpful.

Then just on the -- I think you had originally talked about $30 million of inflation or temporary costs coming back.

Are you bringing those back faster or is that still the right number to think about?

We are not bringing them back faster.

What I told our team inside Pentair, and I think I mentioned outside, if not in these calls certainly in some -- in our Investor Relations.

We took out a number of employee benefits as the last act.

And I said as soon as we were stable, as soon as we had confidence that we had weathered this storm, it would be the first thing we would put back.

And we are good to our word.

That is what we did.

Then just final question.

John, on this 35% conversion, and you add these pluses and minuses, how should we think about carryover restructuring savings?

What I did there, and you can see, I actually used the -- what I would say is the new run rate for hours of labor and the new run rate for material.

So I would say those numbers I am giving you are inclusive of the carryover restructuring.

Okay, thanks guys.

You can take a look at all the other components and make your own view of what the conversion should be, but that is what I did in that chart.

Garik Shmois, Longbow Research.

The first question is with respect to your topline forecast for both the second quarter and the full year, certainly it is a little too early to say with respect to volumes, but could you give us just a rough sense of what you're seeing or what you expect as far as the mix breakdown between volumes and pricing in your topline forecast?

I will give it to you for Q1.

Pricing was modestly down about 50 basis points of contraction in the first quarter.

We expect it to be flattish to slightly up in Q2.

Call it 50 basis points up.

Then we expect that trend to be flattish to 50 basis points in Q3 and Q4, but not a lot of help to price.

Foreign exchange was a help in Q1.

It is about 2 to 3 points of a help in Q2.

Then that number on a year-over-year basis is generally flat.

And then the rest would be organic value.

In some of those end markets in which you saw pricing pressure in the first quarter, has that abated as we move into the second quarter?

Yes.

You talked about the negative mix on the residential to commercial pump sales in the quarter.

Is it possible to quantify how much of a margin hit that was?

If I quantified it, it would be about 50 basis points from Q1 for our residential.

And I think we will see a slight mix impact in the back half of the year as we shift the New Orleans pumps, which have lower gross margin, but don't take a lot of operating expense cost to get out.

So nice operating margin for us, but I think you'll see a mix impact on that $45 million of revenue in the back half of the year as well.

But overall, everything else has a pretty nice drop through.

We are expecting good conversion on the shipments in all of our businesses.

Just lastly, just talk about --.

Can I add one thing there, just in terms of the mix.

One of the issues with the sump pump, the retail, was we were scrambling.

We were going to all efforts to ship everything we could to serve our distribution partners, and we served them well.

And that cost us.

That is one reason why the mix was -- that is one reason why the mix was less favorable.

In a steadier environment that mix shift wouldn't be -- that change in margin wouldn't be as substantial.

Okay, got it.

I guess my last question would be on the stimulus program, at least in the acceleration of projects being released and other infrastructure arenas, particularly over the last one to two months.

Are you seeing anything meaningful in your end markets as (multiple speakers)?

We have tracked this a couple of ways.

One was top down by tracking all the money that was supposed to be spent in water.

We are tracking and we are winning.

We are about 65% of the orders, but they are still in the $10 million to $20 million range in total.

However, the municipal bidding activity has remained strong and our win rate is strong.

One of the reasons we feel good about municipal is because of that.

I believe that has got to be stimulus related, because where else would they have gotten the money?

So my belief is that it is helping.

Great, thank you very much.

John Quealy, Canaccord Adams.

This is actually Chip for John.

Just back to new products for a minute.

It sounds like you are seeing some excellent traction with the new energy-efficient products.

Can you maybe help quantifiy where they stand as a percentage of revenues now?

And then as you look out where do you see that going as the legacy products in the field start to wear out?

I would say -- it is easier GBU by GBU.

The full business is probably about 25% to 30% already, which is pretty extraordinary.

Some of those products cost 2 to 3 times as much as the other ones.

But they save so much money, and they're getting support from, I think, about 25 different utilities now that are doing rebate programs, and we have the best.

I think in total -- certainly -- it is certainly a thrust.

Sustainability is a key part of our strategy and it is impacting both Technical Products and Water.

I think what I look across all of the businesses I would say it is about 10%.

Our goal would be 20% in say three years.

So it is an important focus of ours.

When you take a look at our focus on supporting the wind energy business with control cabinets, lubrication -- control cabinets on Technical Products and lubrication systems on the Water side, you know, dewatering the lubricating oil to the gearboxes.

That is a focus, improving the efficiency of motors and pumps in everything.

The INTELLIDRIVE, if you will, you know, we have the IntelliTouch line in Tech Products.

We have the INTELLIDRIVE line in the rest of pumps is a major opportunity.

As well is improving the efficiency infiltration in filtration systems.

So whether that is Food Service or whether that is in the home, we think it is a good opportunity.

Great.

Back to the boost in the sump pump business from the weather.

Just in terms of scrambling to meet demand, is it safe to say there was a depletion of inventory there and some potential for restocking?

Yes.

I think -- I was going to say certainly our inventory.

But we still have some if you need one.

Yes, maybe.

Then just lastly, you mentioned some project timing issues for CodeLine.

Can you just maybe provide a little more detail.

One of the things that we saw in the financial crisis was a lot of the large desalination projects in the -- around the world were delayed for financial reasons, during the financial crisis.

So there was a hole in the bidding activity.

As well as our hit rate fell.

You know we were starting up a new plant in China, so we were not bidding on it there yet.

So that the line in China is starting up, and we have a number of nice quotes.

We have a lot of good quote activity right now, and it looks pretty encouraging.

So I view it as a hole that was caused primarily by the deferral of some big projects.

Would you expect that to tick up back half of the year, next quarter?

Backhalf, contingent on our winning.

My team is probably listening, so we are expecting them to win, right?

Thanks a lot guys.

Christopher Glynn, Oppenheimer.

I guess new products is a pretty big theme on this call.

I would like to look into a couple of specific areas that you talked about in the past, initiatives around the pump side of desal, And commercial Pool, how is that business plan developing?

We have had -- the most success we've had in the pump side has actually been in Asia for the desalination plants.

We don't have any placements in the US yet.

Which I would like to get and get some reference sites.

So we have work to do there.

But our hit rate has been very good in China.

We have introduced them in Asia -- excuse me, in the Middle East.

And we have had some wins there.

So it is in the $5 million range.

It is not in the $50 million range yet.

When it gets to $50 million, and it could, then I will get real excited.

But it has been a key part.

I mentioned earlier that our pump business had doubled, our large pump -- our Engineered Flow pump business had doubled in Asia, and it is largely because of that.

In terms of commercial tool, we were up about 5%.

So not as much as Residential, but you have two things going on in commercial.

You've got one, the commercial construction cycle is still going down versus residential, which is clearly going up.

But we are growing despite that because I think we are gaining share, and doing better, particularly in markets outside the US.

Then looking back at Pool, I think you obviously had some nice distributor wins there.

Can you allocate your growth in the quarter to expanded footprint versus other, so to speak?

Let me look at something real quick.

Obviously, Q1 was a low quarter last year.

So if you take the percentage we are up -- if we estimated just because of the data that we get, we would say we are taking share.

And that share take could be in the 4% to 5% range.

Right.

I think in terms of product it is probably about 30%.

New product, yes.

New product.

70% I would say share in distribution and share from distribution gain.

And end market would be in the [70 rule of thumb].

Got it.

Any view into mix shift back towards the newbuilds versus the aftermarket, which kind of floated you last year?

That is one of the data points we need to see.

Pool is independent of financing, and we will see how the financing does in Q2.

I think -- and the thing is that their goods -- they are at the point where it is 92% replacement anyway.

What we know is, as everyone went into fetal position and didn't spend anything on anything, they were deferring maintenance on residential and commercial.

And that is being released.

You can see it in a number of different ways where people are beginning to adjust to the new norm here and spend money.

We saw it in particular, because if you have a pool, if your pump breaks or your filter breaks, you fix it.

But you don't have to fix lights, controls and heaters, and we talked about that before.

So we saw a real mix shift to, if you will, the heart and the lungs of the pool, the filter and the pump.

So we are beginning to see some of those things come back.

That could be new pool build, but it is certainly maintenance.

To me, I look at newbuilds as gravy on top of what should be a growth trend anyway.

It makes sense.

Thanks everybody.

Scott Graham, Ladenburg Thalmann.

The discretionary expense number that I think was part of your $300 million plus of costs, which I think that number, as previously said, was a little bit north of $70 million.

Is it fair to say that the $15 million year-over-year employee cost increase, is that part of it, part of that add back?

Yes.

Yes, absolutely.

The add back still is not expected to exceed $40 million, right?

Correct.

Great.

Next question is on pricing.

With raw materials up really for the balance of the second half of the year and on into the first quarter of this year, I guess I'm a little bit surprised at there weren't more definitive pricing actions taken before now.

Is it just a matter of timing or what -- maybe give me a little color there if you would.

If you take a look at a fair amount of our businesses material on a year-over-year basis is pretty positive for us, meaning a huge benefit.

It is hard to go out and ask for price increases when you're benefiting from raw material benefits.

I think as people are concerned about the potential increase in raw materials that are coming, I think it is a lot different environment to try to pass through the cost to your customer base.

I also think value helps.

From a standpoint of when you've got low demand, it is hard to expect that much more price when you go out into the market.

So I think all those trends suggest that we are going to see a different environment.

And we know, we are seeing it in the commercial supply base as well.

Okay, that's very fair actually.

Last question goes this way.

If I look at the Army Corps of Engineers with several different companies reporting that they still seem to be pretty bottlenecked.

I know that there is some skim that they are going to administer, but for the most part their core Army Corps of Engineers business still remains this big balance in their books to do a lot of projects along the Gulf Coast, California, what have you.

What are you seeing with the Army Corps?

You have this big New Orleans project that is a real good calling card for you.

What is your assessment of what the Army Corps' release plan looks like for 2010?

On this -- this is (inaudible), we have other business.

This one got pushed back a little bit, but not a lot.

We would have thought there would have been some more shipments in the first half year here.

But that is really, I would call it more site delays once they got under construction than it is any kind of a policy delay.

What we are seeing is there is another big project, and it has been pushed out.

We thought it would be let this year, and I don't think it will be let until next year.

And that is the other big -- it is bigger than actually this one.

And I would be guessing if I told you why it got delayed.

I don't really know.

But it is still a project that will get done.

We are just looking at less this year.

To Randy's point, our ability to come in and help out a couple of years ago and get the pumps installed in New Orleans was a big calling card to get this job.

And we would think that this is another good calling card to have opportunities in the future.

Okay, so they are allowing you to bid on things, but they are not -- they are just not releasing some things?

Right.

Well actually they are restructuring -- they are restructuring how they want to do the bids on the next round.

I got it.

Thanks very much.

Brian Drab, William Blair.

I just have a couple questions at this point.

Just to be clear, when I look at your guidance that you gave for the first quarter, $0.32 to $0.35, was the pay-as-you-go restructuring of 100 basis points in Water and 50 basis points in Technical Products contemplated or not contemplated when giving that guidance?

It was not contemplated.

It was not contemplated.

We just touched in the last question on the New Orleans order, could you just update us on the status of that order and where we are there?

It is 11 pumps now instead of 13.

And it is about $5 million or so in the second quarter of shipments.

And then it has been some millions of dollars, but not a lot that we -- that have been in our billing.

So the balance of the 50 or so in the second half.

(multiple speakers).

It is about $5 million in Q2.

We would expect somewhere around $25 million in Q3, about $15 million in Q4.

And then there is a carryover on the remaining piece that will ship in Q1 of 2011.

Great, thanks.

And then just lastly.

As you saw the first quarter was going to come in better than expected on the top line, do you take advantage of that and reinvest in the business and reinvest in organic growth more than you had expected to originally?

And if so, what was the part primary area of focus?

I think the primary area of focus will be maintaining the sales and marketing and R&D spend related to the core programs that Randy mentioned.

This is Todd Gleason.

I just want to -- we of course want to get to everybody in the queue, but since we're almost to the end of our hour, we just thought we would check to see how many people are in queue.

You have two remaining.

Okay, let's go ahead and try to tackle those two quickly.

Jim Lucas, Janney Montgomery Scott.

I was just wondering on the pool dealer expansion, you said that it has expanded.

Is it because there is new dealers that are opening up or you're getting penetration in existing dealers?

It is not new dealers opening up, there is actually more dealers failing then there are opening.

It is two things.

One is we are gaining share at some of the bigger ones that we -- most of the big distributors carry the big three (inaudible) and our two big competitors.

And we are winning share there because of our Eco Select.

And then other distributors who hadn't carried us are signing us up because they need the Eco Select.

As I mentioned, we get 22 or so utilities who are rebating installation of an Eco Select product, and -- to save the energy.

If the distributor doesn't have the Eco Select product, they can't leverage the rebate.

So that is (inaudible).

Then on the global commercial forecast you said that you are expecting it to be down just 10%.

I'm just wondering with commercial construction continuing to fall, that actually seems like it is not that bad.

Is it all because of Food Service, or can you explain a little bit more about that?

Exactly.

The Food Service is definitely helping the commercial numbers.

That is where it is included in our outlook.

If you took Food Service out it is a more dismal view.

It is down around 20, as Randy mentioned.

So the Food Service acceleration and the new products and just kind of our global penetration there are helping to offset that down swing.

Okay.

Thanks for your help.

That's all I have.

David Rose, Wedbush Securities.

I had a couple of questions.

I will try to be brief.

I am trying to get a little bit more clarity on your expectations for the top line.

I think everybody else is challenged as well to understand.

If you have new dealers coming onboard and your backlog is up, can you give us some guidance in terms of maybe the percentage year-over-year of backlog, the increase in backlog?

And to understand what sort of expectations you have on the downside in the second half?

If you -- clearly there seems to be some upside, but if you have the downside in the second half does that get you to the numbers?

And what sort of downside are you anticipating so (multiple speakers)?

We carry backlog, just to be clear, in our municipal and some of our commercial businesses, where we go out longer than what we call a 90 day shipment window.

The more relevant number we would look at is book to bill.

And book to bill is very encouraging, as Randy mentioned.

Certainly for the season we are running book to bills right now somewhere around 1.2 or 1.15 on the low end, 1.2, 1.25 on the high end in some of our businesses, and that is encouraging.

Now these are firm orders, like a backlog would be.

And seeing what the season is and seeing how much is docking and how much is sell-through is imperative for us to change our view for the full year.

What was your book to bill last year at the same period?

We were running about 1 to a 1, slightly below 1.

Then with respect to dealers, are there more dealers or distributors outside of the pool network that you have added?

(multiple speakers) the last part of the question.

Did you add more distributors outside of the pool segment?

Yes.

We have strengthened our position in the Other segments of retail.

That is one of our focuses is to fill in, if you will, we call it the [light] space to make sure we have coverage.

So if I look at the fact that your book to bill is up, you have added more dealers, is this a (inaudible) expectation based on your concerns about perhaps the Gulf -- orders for the Gulf project being delayed?

Let's not try to be too mathematical.

The thing we want to see is we are very pleased about our progress in terms of penetration.

We are very pleased in terms of our progress on new products, and the resultant growth that you see.

At the end of the second quarter we will decide how much of that was sell-through and how much was -- how much sold through distribution.

85% of what we sell goes through distribution.

I think it is really -- I think it is great for the country.

I think it is great for the world.

It is great for the economy that things are coming back.

But I think that we should all decide how much is just getting back to the -- getting back to normal stocking levels or is this how much is really selling through into end markets.

That is all.

It is that simple.

We haven't ground to 5 decimal places on this, and therefore we haven't updated guidance.

So we are not making assumptions about downturns or anything.

We just think we will be in --

Better shape to give it at the end of Q2.

Okay, that's fair.

Then two last questions.

You hadn't mentioned much about water reuse, your water reuse projects.

Are there any update for that, new interesting projects that are onboard?

The rain water recycling system is up and running at the Minnesota Twins ballpark.

We think water reuse is -- we are investing a lot to go after it.

We think that Asia actually will be a hotter market for water reuse than the US for now, because their need is more urgent.

And so we have introduced a number of our products into India.

And again, small numbers, but promising.

We think it has opportunity in Southeast Asia as well.

It is an area we continue to invest in.

We are not throwing huge money at it, because it is going to be a business that we have to build.

And it is a project business.

So we like the demonstration project that we have built at the stadium is getting a lot of keen interest from other commercial developers, particularly ones that have a real interest in being green.

Which is, I would submit five years from now will be every commercial project in the world.

Last question is on the receivables.

Do you expect to have any more benefits on your DSOs going forward or is this where we are at?

I think there is two things.

One is, as we mentioned last year, we didn't discount the Pool receivables.

We [made an] early buy.

So we will collect those.

So that will be a nice little tailwind for us in Q2.

We will receive pressure as we become more international on the DSO side.

But we have a lot of opportunity on the payable side, and we think that those two things more than offset.

If that is our last question in the queue, I think we would wrap up here and say thank you for everyone's participation.

And if you could remind everyone the replay information, that would be helpful.

Thank you for participating in today's Pentair conference call.

This call will be available for replay beginning at 12 PM Eastern standard time today through 11.59 PM Eastern standard time on May 25, 2010.

The conference ID number for the replay is 54420296.

Again, the conference ID number for the replay is 54420296.

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

This concludes today's conference call.

You may now disconnect.