濱特爾 (PNR) 2010 Q4 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Pentair Q4, 2010 earnings conference call.

(Operator Instructions).

Thank you, Ms.

Zawoyski, you may begin your conference.

Thank you, Felicia, and welcome to Pentair's full-year and Q4 2010 earnings conference call.We're glad you could join us.

I'm Sara Zawoyski, 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 Q4 and full-year 2010 performance, as well as our Q1 2011 outlook as outlined in this morning's release.

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 today's release.

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, and any references to non-GAAP financials are reconciled in the appendix of the presentation.

I will now hand the call over to Randy, who will take you through Pentair's financial performance for 2010, and provide further perspective on our anticipated performance in 2011, which we outlined for you in December.

Then John will provide additional information regarding the Q4 operating performance, and key assumptions for Q1 and full-year 2011.

And we will be sure to reserve ample time for questions and answers, after our prepared remarks.

Randy?

Thanks, Sara, and welcome, everyone.

Let me begin with slide two.

Our fourth quarter performance, which as you probably saw came in a bit better than we expected.

Top line strength continued, with daily sales up sequentially from Q3, and solid demand in most key end markets.

We continue to execute well on our growth initiatives with new products, expanding distribution, and a growing presence in fast growth regions adding to our growth.

The sales growth was broad based, with the US up 10%, western Europe up higher by 8% excluding foreign exchange, and fast growth regions up 16%.Margins came in generally as expected, with volume, productivity and pricing helping to partially offset higher material inflation, along with reinstated employee benefits and growth investments.Specific to Q4, material inflation was at it's highest level with limited pricing benefits, and four fewer selling days negatively impacted fixed cost absorption.

This a the fourth quarter phenomenon, as we expect margin expansion to return in both Water and Technical Products in 2011.

In Q4, we delivered EPS of $0.49, compared to the adjusted $0.47 in the prior year.

Better sales performance in both Water and Technical Products, along with a lower tax rate, drove EPS $0.02 above the high end of the guidance we provided in October.

We generated $30 million in free cash flow in the quarter, before a $25 million accelerated pension contribution at the end of the year.

This brings our year-to-date free cash flow to $236 million, or $211 million including the extra pension contribution.

In sum, fourth quarter was another solid performance with good execution, driving strong top line results, and productivity funding continued growth investments positioning us well for more growth in 2011 and beyond.

Now let's turn to slide three for a review of our Water results.

We're pleased with Water's top line results, with sales up 5%.

Residential Flow sales were up 1% in the quarter, or up 2% excluding FX, reflecting modest growth in US residential pump sales.

We continue to gain share in the pro channel, and the recent roll-out of our Flotech Professional Series should help to improve performance in the retail channel as we enter 2011.

Agricultural equipment sales continue to post robust growth rates, up 30% in the quarter, helping to offset some softness in specialty pump sales.

Residential Filtration sales grew 1% in the quarter, or up 3% excluding FX.

While US sales were essentially flat and western Europe business soft in the quarter, fast growth regions continued to grow at a robust pace, up over 20%.

We're adding OEM partners, expanding distribution, and building on our global water softener system business.

In the quarter, the world's greenest water softener system was installed in a California community, using our advanced technology providing up to 90% salt efficiency, and a brine-less discharge.

Pool sales were up 4%, reflecting solid demand and continued share gain.

Standard orders grew at an even faster pace, indicating good sell-through, and early buy was a bit ahead of last year.

Both of those things are positive indicators for 2011.

We added another 50 distributors and dealers in the quarter, totaling nearly 350 additions for the year, resulting in a 3 to 4 point gain in market share.

The number of utilities funding rebate programs for energy-efficient Pool products grew to 25, with the recent addition of Pittsburgh, helping to drive more IntelliFlow pump and control sales.

And there is plenty of runway for growth, with variable speed pumps applied in less than 5% of the installed base, of over five million in-ground Pools in the US.

Engineered Flow sales increased over 20%, driven by the $16 million related to GIWW, which is now substantially complete.

Underlying sales were essentially flat in the quarter, as strong commercial and industrial sales helped offset a decline in large municipal project sales.

We continue to drive growth through an expanded product portfolio, including the recent launch of our own ANSI pump line in the quarter.

Filtration Solution sales were up 9%, led by increases in the energy market, as well as higher CodeLine sales.

We're encouraged by the positive movements in the desalinization market, and resulting demand for our products.

Notably in Q4, we received our largest CodeLine order ever, for approximately $7 million, that should ship in 2011 to the Middle East.

And importantly, we continue to make significant progress in building our Systems business into a scalable growth platform, adding 17 more standardized designs that allow for short lead times and cost efficient profitable production.

Fast growth market sales in Water grew 16% in the quarter with a stand-out performance in China, up 42% along with good growth in southeast Asia, India and Latin America.

The right half of the page shows Q4 Water profits and margins.

Water operating margins of 11% were a bit better than we expected, as net material and price improved from Q3, along with productivity.

Still, we saw a modest decline in margins year-over-year, as material inflation was at it's highest for the year, while the pricing actions taken won't yield benefit in 2011, resulting in a modest decline in margin year-over-year.

Now let's move to slide three for a review of Technical Products.

Technical Product sales were up 13% in local currency, with average daily sales up sequentially from the third quarter.

Again, growth was broad-based across geographies in most end markets.

Our largest end market industrial posted an 18% year-over-year increase, as we continue to see businesses increase spending on maintenance and capital.

General electronics and energy also posted strong double digit growth, with communications down for us due to some timing on some -- a couple of specific programs.

We continue to focus on high growth vertical markets, including datacom and energy, along with expanding global product offerings and further channel development.

In fast growth regions, China grew an impressive 57% in the quarter, and over 45% for the full-year.

The breadth and depth of our product portfolio, brand strength, and global manufacturing footprint is enabling us to capture more growth opportunities, as the market recovery continues.

Technical Products operating profits grew 9%, and 15% operating margins were in line with expectations.

Growth in productivity partially offset material inflation and reinstated employee benefits, as well as higher year-over-year channel partner rebates, much of which we expect not to repeat at these levels in the future.

Please turn to slide five to cover the year.

For the full-year 2010, Pentair drew strong top line growth and margin expansion.

Sales exceeded $3 billion in 2010, with organic revenue up 13%, and all businesses and geographies contributing.

For the year, US sales grew 15%, fast growth regions were up 15%, and western Europe was up 11% excluding foreign exchange.

The investments we maintained through the recession in innovation, sales distribution and fast-growth regions helped fuel top-line growth, along with a strengthening global economy and a return in business spending.

At the operating margin line, productivity and lean actions along with a lower cost structure helped offset growth investments and the higher cost related to reinstated employee benefits.

As a result, operating income grew 30%, with operating margins expanding over 140 basis points.

So turning to slide six, you see the bottom line for 2010.

We delivered $2.00 a share, an increase of 36% from the adjusted 2009 EPS of $1.47, despite the fact that one of our major end markets, US residential, hasn't yet had any meaningful recovery.

And from a segment view, Water revenues grew 10% for the full-year with innovation and distribution playing a key role.

We made significant progress in building our Systems capabilities, are well-positioned for the position -- the positive turn in desalination, have expanded our portfolio in the industrial market, continued to innovate around energy efficiency and automation, and added new distribution particularly in Pool and in fast growth regions, to name a few of the growth drivers for Water.

Our clear focus and execution on our growth initiatives are driving top-line results, and our leaner cost structure along with lean disciplines, enabled margin expansion of 100 basis points for the year.

Technical Products grew revenue 17% for the full-year, and expanded margins an outstanding 230 basis points.

We made meaningful progress in leveraging our product strength and global capabilities to grow our presence in fast growth regions.

We've more than doubled the number of China's distributors in 2010 versus 2009.

For example, made solid inroads with distributor gains in the Middle East, Turkey and Russia.

We've also embraced the in-country for-country strategy in Technical Products, leveraging our strengthening global engineering and manufacturing capabilities, to drive locally relevant innovation and low-cost product -- production.

Overall, it was a year of tremendous progress for Pentair, thanks to the efforts of all of our employees around the globe.

Now let's turn to slide seven.

Per our standard practice, details of free cash flow are on the left of the slide, and the summary of our debt levels and maturity dates are on the top right section of the slide.

Pentair has over a decade of generating strong free cash flow, consistently converting greater than 100% of net income to free cash flow, while investing for future growth.

2010 was no different.

We finished the year strong, generating $30 million in free cash flow in the fourth quarter, excluding the accelerated $25 million pension contribution, and bringing our year-to-date free cash flow to $236 million, as I mentioned before.

This represents a net income conversion of approximately 120%.

Cash flow continues to be a top priority for us, and we demonstrated good working capital management, even as sales ramp back up this year.

In addition, we returned approximately $75 million to shareholders through dividends, and recently raised our 2011 annual dividend 5% to $0.80 per share, marking our 35th consecutive annual dividend increase.

We also re-initiated our share buyback program to offset dilution, with $25 million of shares repurchased in 2010, and a similar program in place in 2011.

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

I'd like to highlight ROIC, which is shown on the bottom right section of the slide.

We're exiting 2010 at 8.2% on return -- for return on invested capital, up 200 basis points from the 6.2% at the end of last year.

Our goal continues to be -- to be to drive ROIC back into double digits, and ultimately 15% by 2014.

It's great to be back above $3 billion and $2.00 of EPS, but we're fully aware that the 2010 sales, margins, and EPS are still not at 2008's record levels.

As a result, we're rapidly moving forward in 2011, finding ways to improve in everything that we do, driving pricing actions and greater productivity with urgency, and aggressively pursuing our growth initiatives with speed and focus.

With that, let's turn to slide eight, which is the same outlook we provided in December.

We continue to expect organic revenue to grow in the mid-single digits, with pricing, productivity and operating leverage expected to deliver greater than 100 basis points of operating margin expansion, and EPS of $2.20 to $2.35 for the year.

We also expect to once again convert greater than 100% of our net income to free cash flow, and improve an additional 150 basis points or so in ROIC.

To the right of the slide is our segments view.

In the , we expect our recurring organic revenue growth, which excludes the impact of GIWW, to accelerate in 2011, up 7% to 9%.

This reflects anticipated broad-based growth across our global business units, with the exception of Engineered Flow, which we expect to be flat to down slightly, excluding GIWW.

In Technical Products, we exited 2010 with sales up 17%, and expect another 7% to 8% growth in 2011 and continued margin expansion.

Now let's turn to slide nine to discuss the key enablers to our continued top line growth and margin expansion.

Growth begins with globalization.

In the past few years, we've invested over $40 million in building capability, and expanded presence in key growth markets, China, Latin America and India.

We've doubled our manufacturing capacity in Suzhou, China, added localized innovation labs and design teams, and increased distribution and availability through Pentair Water show rooms, additional retail outlets, and increased selling resources.

We're beginning to see the returns, with China up 26%, and Latin America up 18% in 2010, and fast growth region sales now totaling over $425 million for Pentair.

We believe the best is yet to come, as we leverage the investments and strengthen global capabilities to capture more growth opportunities.

We also look to augment our organic growth strategy with acquisitions that fit our geography and technology streams.

A good example of this, is the recent acquisition of Hidro Filtros, a $10 million water filtration provider in Brazil in the southern cone.

It's more than doubled our share of the Residential Filtration market in Brazil, and importantly, provides a platform for future growth, through an expanded product portfolio, local manufacturing capabilities, and an established sales and distribution network.

2010 was a breakthrough year in innovation, nearly doubling the new product launches compared to 2009.

We also made significant strides in expanding our points of distribution, for example, adding new distributors in Pool and the roll-out of retail outlets for Residential Filtration, and the doubling of distributors for tech products in China.

So we enter 2011 with significant momentum from innovation and distribution, and we have a robust launch calendar for 2011, including expanding our agriculture product portfolio with two new pump lines.

We're also adding more standard designs to grow our Systems business and Filtration solutions, and more green solutions in Pool and Residential Filtration, just to name a few of the upcoming innovative new products.

We've improved our innovation processes, driven by the voice of the customer to build this momentum.

We also expect to see continued improvement in end markets, particularly in industrial where we expect expanding demand for our products, as capital and maintenance spending continues to rise.

Like we said on our December outlook call, the US residential market recovery is slow, but positive.

And we expect to grow sales in the mid to high single digit range in 2011, based upon new products and distribution gains, along with serving the significant installed base, as over 80% of our business is now in replacement, repair, and consumables for residential.

Another growth accelerator is our Pentair Integrated Management System.

In 2010, we continue to improve product quality, on-time delivery, workplace safety, as well as costs and cash, or SQDCC, the hallmark of the Pentair Integrated Management System.

This enabled us to serve our global customers better.

In addition, we have the facility moves behind us, along with the learning curve and production cost inefficiencies that came with relocating lines, training the new employees, and retuning our supply chain.

This enabled us to realign our resources now, to support more growth initiatives and value engineering.

Net pricing and productivity should yield even better results for us, beginning with price.

As we've said in 2010, we were very cautious on price increases, even though we expected some material inflation pressures.

We simply did not want to risk volume in the recovery.

Today we have already implemented over 80% of our planned price increases for the first quarter, and expect the full impact in Q2, yielding 150 to 200 basis points of price for the full-year.

Reinstating employee benefits that were curtailed during the recession was a $50 million headwind in 2010.

In 2011, that headwind abates, and with higher price realization, we will see a better readout on margin drop through from the operating leverage we'll see from growth.

With that as a review for -- of our growth and margin accelerators for 2011, let's turn to slide ten for a view of how this fits with our long-term goals.

Here we have charted our 2010 performance and expectations for 2011, compared to our 2014 goals that we shared with you at our Investor Day in September.

As shown here, we made tremendous progress towards our long-term goals, and 2011 should keep us on track to reach over $4 billion in sales, operating margins of 15%, and EPS of greater than $3.50 in 2014.

As you can see from the chart, the performance improvements we need to deliver to achieve those goals is at or below the average of 2010 and 2011.

Not easy, but achievable.

With that, let me turn it over to John, to review in greater detail the 2010 financial performance, and 2011 guidance.

Thank you, Randy.

Let me begin on slide 11, titled full-year 2011 margin expectations, starting with our expectations for Water.

Our expected recurring organic revenue growth, excluding GIWW, is expected to grow between 7% to 9% in 2011, helped by fast growth markets, new innovation launches and distribution and share wins.

GIWW 2010 revenue is about $56 million, and this will impact reported growth for Water by about 3 points.

We expanded margins by 100 basis points from 2010 versus 2009, and expect to increase margins by at least 100 basis points from 2010 to 2011.

The expansion will be driven by volume leverage, pricing actions that should offset material inflation, and continued productivity within our existing factories.

In Technical Products, we expect organic revenue growth to remain in the high single digits, as industrial spending and funding of global productivity projects continue to fuel growth.

We expect operating margins to expand at least 125 basis points in 2011 from 2010 levels, driven by price increases that should more than offset the general inflation, productivity improvements in the factories enabled by lean, and volume leverage on moderating operating expenses.

Overall, Pentair's revenues should expand high single digits on a recurring organic basis, with the GIWW revenue impacting us by about 2 points, at the overall Pentair level.

We expect operating margins to be greater than 12%, or up at least 100 basis points versus 2010.

The rate of operating expense increases will slow dramatically due to employee reinstatement costs behind us.

Many of our global growth initiatives are already funded, and the level of customer and channel rebates set at higher levels, which we hope pay out in excess of target, however, unlikely to max out, as so many of them did in 2010.

Corporate costs should increase by about $10 million versus 2010, due to higher pension costs, slightly higher medical costs, global investments in business development, brand marketing and fast growth markets.

Please turn to slide number 12, labeled Q1 2011 Pentair forecast.

For Q1, we are expecting that overall business trends experienced in Q3 and Q4 of 2010 continue.

As mentioned, we actually saw average daily sales rates accelerate in Q4 versus Q3, and we think that creates solid momentum, as we head into our first quarter.

We expect Water revenue to grow mid-single digits, and Technical Product sales to grow double digits, which for Pentair means we expect revenue between $750 million and $765 million in Q1, or up high single digits versus Q1 of 2010.

We expect operating margins of greater than 10%.

We would like to remind you that our Q1 Water revenue is comprised of a softer mix of products, primarily due to inventory stocking levels of retail pumps, which carried a lower margin than many of our other product lines.

We expect operating margin expansion of more than 100 basis points year-over-year, as pricing actions begin to be realized, mitigating some of the material inflation impact we experienced in Q3 and Q4 of 2010.

In Technical Products, pricing actions were announced and initiated, but we will only experience about half of the run rate, as the implementation of most of the programs is February and March.

Q2 should benefit from full implementation of pricing in both segments, and that is when we expect to be back to our more normal level of selling price to raw material relationship.

Overall, we expect operating income to expand 14% to 22% to around $73 million to $78 million, and EPS should expand around 20% to 29% year-over-year, resulting in $0.42 to $0.45 per share.

We want to remind you that cash flow typically runs negative in Q1, due to our normal seasonality of revenue.

Please turn to my last slide, slide number 13, labeled full-year 2011 outlook.

For the full-year 2011, we are confirming our previous guidance view of around $3.2 billion in revenue, around $380 million in operating income at the midpoint, return on sales of greater than 12%, and EPS of $2.20 to $2.35 per share.

We continue to expect free cash flow in 2011 to exceed $240 million, or at least 100% of net income.

I will now hand it back over to Randy, to summarize our 2010 performance and 2011 outlook.

Randy?

Thanks, John.

Our strong 2010 sales performance of up 13%, demonstrates our ability to drive strong balanced growth across our portfolio, with excellent execution of growth initiatives, by both our Water and Technical Products teams.

Volume growth, plus productivity and a leaner cost structure, yielded positive results, with over 140 basis points in margin expansion, even as we invested $40 million more in R&D, and selling and marketing to expand into new geographies, and increase our vertical market focus.

We continue to convert income to cash at very healthy rates, returning about $100 million to shareholders through dividends and buybacks, and we still have balance sheet flexibility.

The tremendous progress we made in 2010 positions us for another strong year.

We continue to expand our presence in fast-growth markets, and leverage the investments in new product development, and selling and marketing that we have seeded over the past few years.

We have a strong track record of passing along price increases to offset inflation.

With most pricing actions taken, coupled with our well-rooted lean culture and productivity initiatives, I'm confident we will see margin expansion again in 2011.

Current business trends remain favorable, with the solid global economic recovery continuing.

And when the US residential market rebounds, well, we believe we're in a pretty good position to benefit from that as well.

We're committed to our growth agenda through disciplined investments, focused resource allocation, and prioritized initiatives.

We have the will to win, and a great win right culture.

We look forward to updating you on our progress throughout the year.

With that, we'll open it up for questions.

Operator?

(Operator Instructions).

Your first question comes from the line of Jim Lucas with Janney Capital Markets.

Thanks.

Good morning, all.

Good morning, Jim.

How are you?

All right, thanks.

A couple of questions here.First, could we talk a little bit about working capital, in particular receivables showed a little bit of jump here at year's end.

And it seems like there's still a lot of opportunity on the working capital front, which wasn't addressed too much in the prepared remarks.

Could you give a little color about what drove the receivable jump here at the end of the year?

Yes, Jim.

Two things.

One, is we do have some large projects in Flow that shipped in Q4, and the collection of those receivables is scheduled for Q1.

So I think we'll see a pretty nice uptick there, in the collection of those large projects.

And the we've become more global.

As we've become more global, there's definitely more stress on the days sales outstanding on receivables.

And we just have to offset that with a little bit better inventory, and make sure that our days in those regions are matched in fact, to the receivable terms we are giving our customers.

So both are significant opportunities for both 2011 and 2012.

Okay.

Thanks on that.

On pricing, could you talk a little about what you're seeing, in terms of a market response, in particular when you think about some of the fragmented markets you serve, were you guys out as leaders, in terms of the price increase?

And if you could just expand and give a little more color of what you're seeing, from both a competitive as well as customer response?

I'll start with -- I'd say that we were the leader in some areas, and not the leader in others, consistent with our position.

We were number one, we're pretty much the leaders on the way up.

We benefit from having over, as you know Jim, over 80% of our sales go through distribution.

And the structure for raising price on distribution is well established.

So I would say -- I wouldn't say people are welcoming them, but they are understanding them, given the way material prices are.

And if anything, I think that the fact that inflation now looks a little bit stronger than -- a little bit higher than we might have thought two or three months ago.

It's going to help us realize a higher percent of the price increases we implement, which is typical.

You implement some pricing, and you assume a realization from that.

So I think it's going pretty well.

Okay.

Finally in terms of GIWW, with that winding down, could you talk a little bit about what you're seeing, in terms of the larger project business, and municipal market in particular?

Well -- we -- it's a lumpy business for us.

We're -- the reason we expect the business to be flat or down this year, is because we don't have any large projects in the backlog now.

So I mean, I think it is softer than we would have thought six months ago.

The large -- the follow-on project, which maybe were spending a little too much time focused on, is not -- is going to be let in the second quarter, and it's not going to ship until 2012.It's going to be brutally price competitive.

So we want to be able to make money.

So I think that's the one area, where we expect some softness this year.

We are seeing the bids more accelerate, Jim.

I mean, we're starting to see some of the things that we talked about last year, at least being quoted.

So we'll see how we do in Q1 and Q2.

Those tend to be $5 million-ish jobs, and those can be booked and shipped in the current year.

So we're starting to see activity, but nothing's been let yet.

Okay.

Thanks.

Your next question comes from the line of Christopher Glynn with Oppenheimer.

Thanks, good morning.

Good morning, Chris.

Just fleshing out the organic -- the growth outlook for Water, excluding the GIWW.

Tracking below that now, and comparisons get a little bit tougher.

So just looking to flesh out the dynamic and the bridge there, certainly price is part of it, but with the filtration standardized designs, are you anticipating a nice acceleration for Filtration Solutions for example?

We expect filtration solutions to be one of the stronger growers next year, both globally.

But also in the US, as energy picks up, and through our food service businesses and food services, such a solid business for us.

So we -- I'd expect that to be at the higher end of the range for Water, GBUs.

And then, as we said earlier, Engineered flow at the bottom.

So that -- and then the residential, as we mentioned, mid hopefully high single digits.

It's our largest market.

As you saw in the fourth quarter, both residential GBUs only grew 1%.

So I'm expecting that -- we're expecting them to be at the lower end of that range, if you will, the Water range we gave.

Okay.

Then on the price, I think you mentioned 150 to 200 basis points.

What's the plus or minus by segment or roughly equivalent?

Yes.

I think we feel very confident that Technical Products will achieve, let's say, the higher end of that range.

And then across the Water components, we will probably be at least at the bottom of that range in all businesses, with a couple of the businesses being north of that range.

So I think -- to Randy's point, we're in distribution, we've already known what those price increases are, and we're very confident that those will go through.

The only variable right now would be in the OEM components of our business, but those are bid throughout the year.

And retail.

And retail.

Okay.

And then just the $40 million higher R&D in sales and marketing, does that -- that you had in investment for 2010 -- does that exclude any reinstated costs?

Is that a totally separate bucket?

Yes.

I mean, I think if you are looking at total operating expenses in general, we ended the year, let's call it, roughly around $600 million.

I mean, we think if you think about, maybe a 5% increase in the year.

That gives us roughly $30 million of incremental R&D, and selling and marketing.

As we mentioned, last year, some of the costs we're talking about, sales incentives, distributor incentives, generally maxed out, so that should give us more than enough room to do all of the investments we want.

That's why we mentioned that they're moderating now.

Got it.

Okay.

Thanks.

Thank you.

Your next question comes from the line of Ajay Kejriwal with FBR Capital Markets.

Thank you.

Good morning.

Good morning

Just following up on that previous question, so the $40 million in expense this year moderates next year.

I mean, does moderate, mean you're down next year?

Does the number go down?

When we say that, just doesn't -- if you will, those were investments that we had to cover this year, that aren't going to reoccur, but they're not going to reverse.

Okay.

So that $40 million remains flattish?

Is that the translation?

Well, let me say it differently.

We went up about $60 million or $65 million of operating expenses from 2009 to 2010.

We're expecting to go up another $30 million from 2010 to 2011.

So the rate of change moderates substantially, as it relates to the growth that we're planning.

That's all.

That's all --

That's all SG&A, and R&D, yes.

The majority of the increase will be in R&D and selling and marketing, as we fuel our global growth investments.

Got it.

And then, on the temporary costs that came back, I thought that was the $50 million number mentioned.

And you said that goes away.

Does it go completely away, or is there some of that hitting you in 2011?

Well, what we're back is -- to the more normal raises.

If you go back to 2009, we froze salaries, we rolled some salaries back.

We eliminated our 401K match.

We eliminated our ESOP.

So all of those were reinstated.

So we had one year where we didn't have that at all, which was positive, why we had productivity.

And then we put that back in.

And according to one study we saw, less than 50% of the companies put it back in last year.

So that would be a headwind for other companies going forward, but it's behind us.

So we're glad we did, what we did.

It's the right thing to do for our employees.

So we're back to sort of more standard raises, you know?

So we're back to more normal practices on that.

Got it.

That's why it doesn't repeat.

Good, and maybe just one more on pull.

Clearly one of the drivers has been what you have done on dealer expansion in the last few quarters.

So maybe talk about the [runway] opportunity.

How much do you think adding dealers could contribute, over and above the end market growth?

Well, we added dealers.

One reason we're adding dealers is we have the most compelling product set.

So it's a combination.

The reason we're able to win the new dealers is because we have our Eco Select product line, which is basically superior, and the best way to get at that rebate money.

So we didn't get the full benefit of market share from those 350 this year, this past year, because they sort of came in as the year went.

So I would expect that we can gain share this year as well.

How many more distributors we'll add this year?

I don't know off the top of my head.

So --

Well, you are looking to add more distributors, right?

We will, to the extent that they help us gain share.

And so we start with the product innovations, and then they come to us, so --.

Got it.

Thank you.

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

Good morning, guys.

Good morning.

How are you?

Good.

My first question is on the growth in 2011.

I was wondering if you would slice it a little different way, and look at it by geography, as opposed to by GBU.

Is it fair to say the fast growth regions will continue to be double digit growers?

And then if that's the case, how would North America and Europe kind of stand in terms of low, mid type, single digit growth trajectory?

Well, I will start with the fast growth markets.

And let me start like -- what we put in our fast growth markets, just to let you know our definition.

It's obviously China, southeast Asia, and the Asian subcontinent, India.

We put the Middle East in there.

We put Latin America in there.

And we put Eastern Europe in there.

So when you look at all those, and we had the 15% growth this year, we'd expect higher than that in 2011.

Because we won't -- we don't think we'll have the decline we had in construction in the Middle East.

We're not that big in Egypt.

So we're planning to get bigger.

And we actually think that Eastern Europe is seeing some signs of life right now, so that's very positive.

So I'd say that's closer to 20 plus, I would like to see, in the fast growth markets this year.

Yes, and the US and Europe will be in the low single digit range.

We think US will probably be closer to around 7%, and we're between 3% and 5% in Europe.

It's kind of our current outlook.

So okay, that's very helpful.

In terms of the pricing action that was taken in the fourth quarter, could you maybe talk about what level of inflation that intends to cover?

If we continue to see inflation throughout course of 2011, or what level hedging you can do, so that you're not caught backwards, in the sense that we were in 2010?

If you recall on December 17th outlook call, we were expect material inflation to be around 2.5% of sales.

Our view right now, with what visibility we see, that would be more like 3% to 3.2%.

We've actually gone out, and told our GBUs could expect closer to 3.5% to 3.6% of inflation.

And then we priced accordingly to that number, which is why we're now talking about a higher price realization expectation.

So let's just say we're hopeful our price offsets our material inflation in mix, and we've got a little room in there for further inflation.

The number that means is most meaningful to us right now is copper.

And that number as you know, is bouncing around.

But if you think about last year's average being around 310 for us, that number today is around 440.

And that copper goes into valves for us, and it also goes into motors.

So that's where we see the pricing pressure, on the inflation side.

So what do we do to lock?

I mean, things like steel, where we buy a lot of steel with the Technical Products, we have good locking programs.

As it gets into the motors, and the types of purchases we're making it on the copper side, we tend to have volume-based contracts with our suppliers.

And we negotiate those, and then they do have inflation clauses in them.

Okay.

Thank you very much.

Thank you.

Your next question comes from the line of Hamzah Mazari with Credit Suisse.

Thank you.

Just two questions.

Most of my stuff has been answered.

In your 2011 guidance, given your heavy exposure to residential markets in North America, just curious, could you remind us what you're baking in there?

I know you flagged it to be stable.

Are we looking for a pickup in the second half?

Or how are you thinking about that exposure?

We're really not counting on any kind of market lift.

We're counting on a steady stabilization of the market.

And then, as I've said over 80% of our business is replacement at this point.

So in areas that where new product innovation helps, where energy efficiency helps, then we can expect higher growth.

We're not expecting any kind of lift from the general housing market.

Okay.

And then just very quickly, are you at the point right now where you can, Randy, sit down and just flag -- that hey, here are one or two growth initiatives that are going to move the needle?

Or are you still in the process of looking at a bunch of them?

Well, I mean, number one is the whole array of standard systems.

I mean, we've really moved beyond being a component player, into being a systems solutions player and filtration solutions.

So I think that is going to be increasingly meaningful for us.

And then, energy efficiency and the green initiatives.

But those are buckets of products.

So, no silver bullet, nor do I expect one in the kind of business that we're in.

Okay.

Thank you.

Very helpful.

Okay.

Your next question comes from the line of Brian Konigsberg with Vertical Research.

Good morning.

Good morning.

Hi, just first back on municipal.

You were talking about the follow-on project with GIWW, getting a bit price competitive.

Is it getting near a point where you would consider stop bidding for it, becomes uneconomical for you, or dilutive to margins?

Well, we're still involved, but we're not a not-for-profit.

So yes, I guess I could imagine a point where we would withdraw, but we haven't.

And on -- I'm just kind of referring back to you 2011outlook that you provided in December.

You're talking about $50 million of price increases.

You are expecting to offset costs, so I am assuming that's about $50 million assumption.

That might be a little bit higher now.

But you also talked about negative mix and productivity netting out to about a $35 million positive incremental on the operating profit line.

But if you just do the math, you're backing up productivity at around $40 million, $45 million, just using basic assumptions.

Can you just talk about what's driving that aggressive productivity target?

I know you're doing some material productivity, but what are the other issues?

Yes, if you think about where we ended the year, to where the mid-point is next year.

Let's say we need around $45 million of operating income.

Let's come back to the material and price, because right now, I'd like to you think about that being relatively flat, which is price offsetting material inflation and mix.

And as I mentioned earlier, I think we've got some contingency in there, but we don't know where inflation's going head between now and the end of the year.

We would expect to get about 50 basis points, from labor productivity in our factories.

And we'd expect to get about 50 basis points from our overhead and variable manufacturing for about 100%, a 100 basis points of growth margin expansion.

That is really, if you think about it, that gets us home.

It allows us to spend a little bit in operating expenses to continue to grow.

I don't want to oversimplify it, but I mean, it's really about making sure that we get the growth, and that we convert the growth at least greater than 30% ratio.

And let me add a couple of specific examples that might help.

Last year we had 13% organic growth.

We didn't plan on that.

So we had a lot of businesses that were -- you can plus or minus, the 5% to 7%, you can be really productive.

When you get stressed, like our Technical Products did in a couple of our plants, when actually in our Residential Flo business, which as you recall last year and last spring, with the massive flooding, we delighted our customers by being able to serve them well with product.

We didn't like the results, because we were expediting, and overtiming, and not driving great productivity.

Our businesses are much better prepared for that eventuality this year in Residential Flow.

Our Technical Products business, frankly, owes us, owes us -- owes themselves much better, and more normal productivity from the kind of growth they had.

So those are two areas where I expect to see nice steps forward.

Those two businesses alone, should deliver nice productivity this coming year.

Got you.

And lastly, acquisitions haven't seemed to materialized in any large degree as of yet.

At what point do you start get more aggressive with other capital deployment options, like buybacks?

Our priority is first, we have a 35 year history of raising dividends every year.

And that's the first thing that we look at, and it's a track record that we're proud of.

And after the financial crisis, it's not a big club anymore.

So we look to dividends first to return value to shareholders.

We want to manage our balance sheet to a debt level, that keeps us in investment grade.

And then invest in acquisitions, and then we'd look at share buyback.

We do the share buyback to manage dilution today.

I would never rule out a larger share buyback, but it's down at the bottom of our capital allocation list I just gave you.

I would not assume there won't be acquisitions.

We've staffed back up in M&A.We made the small acquisition.

We continue to be interested in acquisitions that would improve our reach geographically, and our scope, technologically.

So -- and I think Hidro Filtros is a great example, but there could be bigger ones, too.

I wouldn't rule out M&A as -- at this point yet.

Thank you very much.

Thank you.

Your next question comes from the line of Jeff Hammond with KeyBanc Capital Market.

Hi, good morning, guys.

Good morning.

Hi, Jeff.

Can you just say where, you saw particular acceleration in the daily (inaudible) rates, either from an end market or geographic basis, and if that's continuing into the first quarter?

Yes.

I mean, Jeff, just as we took everybody through, we had four less selling days, year-over-year.

So when you take a look at the GBU rates, you can kind of start to do the math on what the daily average sales rates were, but in fact, we saw an acceleration in all businesses, except for Residential Flow, which is a seasonal downtick that they always experience as they head into Q4.

So we feel pretty confident that all of our businesses are seeing an acceleration.

We didn't see destocking levels and those trends continue here into Q1.

Okay.

And then just back to the price initiative.

You said you're going back to your GBUs to -- push for more price realization.

Can you just walk through, how easy that is to kind of go back to the customers with your list price increase, and kind of ask for more?

Jeff, just to clarify on that.

I mean we always have list price increases, and those are out there.

What we encourage the businesses to do now, is not to look at rebates or discounts to those, in wake of concerns about competitive pressures.

I think we're going to have to wait those out, and realize that all of our competition, and everybody in the market is experiencing the same inflation we are, and hold firm closer to the list prices that we have.

That's really what we refer to when we say, about realized prices closer to 175 to 200 basis points, Jeff.

And if you look back to 2004, last time we really saw some major inflation, we actually raised prices three times in Tech Products, and they all stuck.

Because -- and we typically don't do surcharges n materials, we typically adjust list price.

And then as John said, basically then -- there's list price flows.

And then for larger programs, distributors come back, and ask us for pricing help sometimes.

And that's where you firm it up -- is at that point -- where you -- where you don't make those adjustments.

So that is how it will work.

Okay.

Helpful, guys.

Thanks.

Thank you ,

Your next question comes from the line of Garik Shmois with Longbow Research.

Hi, thanks Good morning.

Good morning.

I just have a question to clarify something in the prepared remarks.

You said that inflation peaked in the fourth quarter at 2.6%.

Was that referring to 2011?

Because obviously --

Yes, it's 2010 versus 2009.

And so what we look at, is year-over-year change.

We had a low point in 2009 on inflation, particularly in our Tech Products business, and so the gap was high there.

I mean, in other words, we had the high inflation for the year 2010.

And we had the low -- we had the high material costs in the fourth quarter for 2010, and the low material costs in 2009.

So the gap, year-over-year.

That doesn't mean that we're not assuming material costs is going up, but the year-over-year, if you will, gap between the two material costs is not going up.

Okay.

Make sense?

Yes, I know.

Thanks for that.

And just one more question in the press release, you indicated softness in Europe in Res Filtration.

Just wondered if you could just expand upon that, if that's continuing?

Well, we saw it in the fourth quarter.

We saw softer Europe in the fourth quarter than we had in Residential Filtration, than we'd seen earlier in the year.

We're not expecting that to get worse.

We're hoping and expecting that it might get a little bit better.

Okay.

In line with the projected European growth --?

In line, in line with our guidance

Yes, in October and November, we were a little softer than we would like, and December accelerated versus our expectation.

And as we head into this year, we're more in line with where we were in December.

Okay.

Great.

Thank you very much.

Your next question comes from the line of Deane Dray with Citi Investment Research.

Thank you.

Good morning, everyone.

Hi, Deane.

Hi, we've covered a lot of ground here this morning, and you've given a lot of good color and detail on the first quarter and 2011.

I really appreciate that.

And I thought maybe I'd through out more of a strategic question.

And just given the move by ITT to break up, it really -- and the read across there as a market, is very positive on the prospects for a Water pure play.

And there's no question Pentair could be in a similar position in our view.

S I'd be interested, Randy, in sharing with us, has this been a topic for the Board?

Has it come up more regularly?

Is there -- and I say this with respect to the fact that Pentair has had a long, long history of reinventing itself at various times between paper and tools.

But it just begs the question of, yes, where is this, in a potential discussion topic?

Sure.

No, I appreciate it.

First, I'd compliment Steve and the ITT team on taking the courageous action to do what they're doing.

And you are right.

We do have a history.

You go back to 2004, when we decided, the Board and I decided we would sell our largest business, which is 45% of the Company, power tools.

And actually, I would compare ITT to the situation we were in, when we were -- our largest business was power tools.

I would say that they are the analogous situation.

We had an attractive, what we call enclosures business, now we call it Technical Products, and we had an attractive Water business, were both smaller than power tools.

Power tools traded at a lower multiple, because we didn't control our destiny there, right?

Home Depot and Lowes controlled our destiny.

So we crafted a strategy to actually double Water and exit power tools at the same time.

But I would say that the strategic motive for that was the same ITT sees.

They have a defense business which is dragging down the multiples of the other two businesses.

So they're unlocking value that way, versus the way we did it.

And you're right, Pentair's history, we've transformed four times.

Not many companies do it twice, and in our history we've done it four times.When I look at the two businesses, and the Board looks at the two businesses we're in, if you take a look at them independently, the valuations aren't that much different.

And both of them are large enough for us to control our strategic destiny, and create shareholder value with them.

We don't just talk about those things at the Board level, because ITT does something.

We talk about that all of the time.

And so, we like the two businesses we're in.

We share resources across them.

We apply the standard practices of Lean enterprise across them.

And we -- we're about shareholder value.

So we're --we're always looking at those things.

Again, I think the analogy is really what we did in power tools, versus what ITT's doing today.

And I look forward to them freeing up their Water business to continue to play in the Water business.

It's a good business.

That's real helpful.

And I'll just -- from our perspective, we run some of the parts analysis regularly, and you can see that there's not as much upside to be on lock, if you were to separate the two companies.

It's good to hear that's a healthy prospect that you look at.

What I've heard you just say -- is that neither business is being sacrificed in their growth opportunities by being together.

And so that's also one of the other reasons that you could say that they belong together.

It's a great point, Deane.

We do not believe we're starving tech products.

Yes.

That's real important.

And then just, on the implications, on Faradyne regarding the breakup, is there any ramifications?

No.

We've been assured by ITT that that continues to be a strategic asset for them.

It will go, obviously, with the Water spin.

But no change in the structure of the partnership?

No, no no.

How about the willingness to take on outside customers?

Shouldn't be any change.

It's an independent Board -- actually, Gretchen who I -- is targeted to be the CEO, is on that Board.

John's on that board.

Taking outside customers is the right thing to do, to help us make that more profitable.

So I imagine that won't change.

And what was the expected contribution from Faradyne in 2011?

That's a good question.

Well, we're looking probably around the $1 million to $2 million contribution.

There was a particular price decrease passed from Faradyne to each of the partners.

So we won't see as much below the line, and we will see a little bit of benefit above the line.

It's real helpful.

Thank you.

Thanks, Deane.

Your next question comes from the line of John Quealy with Canaccord.

Thanks, it's Chip Moore for John.

Hi, Chip.

For tech products, was wondering if you could drill down on where you are seeing the biggest demand out of the fast growth geographies, whether that's energy, infrastructure, cooling, et cetera?

In the fast growth markets, a lot of it's been communications related data com, but we also see straight industrial and energy as big opportunities as well.

So one of the other areas we're excited about is rail.

And we talked about, we've shown those in our website and in our other presentations.

Our European business is very tight with the major rail players.

So as they go after rail opportunities in the fast growth markets, we go along with them.

So I would throw that into the infrastructure bucket.

Sure.

And on US residential, you're not really seeing any signs of meaningful recovery yet.

Can you just talk a little bit about what your outlook takes into account, and maybe where you see some potential areas for out performance?

yes.

I think we're looking at the same housing start builds that you're looking at.

And those are modest at best.

And where we will really see th benefit is when those particular housing starts turn into occupancy.

And we can get in there, and offer our Water treatment systems.

So I think, we're looking at this to be a modest increase year for us.

It's still not declining.

It's growing modestly.

And we think we're still participating with newer products and innovation on the aftermarket side.

So that's why we mentioned in our remarks, it's still to come.

And we still believe housing in North America will reach a million units at one point again, and close to 1.5 million.

It has to.

That's what the -- it's a micro economics thing.

Never should have been at 2.3 for five years either, but it's true.

Okay?

Thanks.

Thank you.

Felicia, just given the time, can we get a quick check, in terms of who else is in the queue?

I'm currently showing that we have four more participants in queue.

Let's try to do that fast.

Your next question comes from the line of Wendy Caplan with SunTrust.

Thanks.

Morning, and thanks for taking my call.

Hi, Wendy.

Hi, new products were a very important part of the growth this year.

Can you talk about your -- you mentioned the $600 million -- plus 5% -- million for 2011 in terms of operating expenses.

Specifically, how much did you spend in R&D, and what's your expectation for 2011 there?

Is that also a 5% increase?

We spent roughly call it around 2.2%, 2.3% in R&D in 2010, and we're expecting to spend a little north of 2.5% in 2011.

So we're starting to change the rate of that investment as a percentage of sales, Wendy.

Is there a goal on that?

I mean, do you think -- what's the -- is 0.5 the right amount?

Our longer term goal in the 2014 number is 4%, R&D is 4% of sales.

But we're not, I mean, our engineers get real excited about that, because they want to go spend it right now.

We really need to build it up, from the opportunities up.

But that's our ambition in terms of the cost structure we'd like to have, out longer term.

Okay.

And just to clarify the pricing cost equation one more time.

As we look into the first quarter, assuming that costs, material costs remain the same as they are today, are we going have an issue in Q1 when you report it?

Will we hear about that, or assuming that they stay where they are today or are we covering all of our costs?

We expect to expand margin in Q1 as we said, but our material as a percentage of sales will be up year-over-year from Q1 in 2010 to Q1 in 2011.

And right now, that's the only quarter that we're anticipating a continued negative headwind in our actual material percentage of sales.

And sequentially versus Q4?

Slightly better, given the fact that the pricing comes into Q1, and what's called halfway through Q1 or half realization.

So we expect it to be down slightly versus our Q4 levels.

Okay.

And one of the relatively new products is a variable speed Pool pump.

Can you tell us what has to happen to see that Pool substitution gain traction?

You mentioned that 5% of the pumps out there are at variable speed.

Well, the thing that we're investing to help make that happen, too, is to work with utilities, and want to put in place the rebate programs.

And then probably even more importantly, because these pumps fail in the four to seven-year period anyway, is to get all of the installers educated on how to sell the benefits of putting in the more expensive, but much more energy efficient pump.

So we run programs all across the country, training installers.

And so, that's the other key.

Okay.

And finally, just from a strategic standpoint, can you get to 2014 goals without residential recovery?

We need it to continue at the pace it's continuing at.

As we said in that Analyst Day, our 2014 numbers were based upon a million housing starts.

At that time, the published number for 2014 was close to 1.5 million housing starts.

And I'll give you, Wendy, the over under on whether residential gets back to normal level by 2014, I'll take that bet.

Okay.

Thank you.

I'm not a betting man, but I did live through the crisis in Texas in the 80s.

So I've seen this movie before.

Yes.

Thank you.

Your next question comes from the line of Brian Drab with William Blair.

Morning Just two quick questions.

Looking at the Water segment in the fourth quarter, your guidance going into the quarter was for up to low single digits.

You did 5% .

Which was the business or a couple businesses that generated that modest upside

It was primarily Filtration Solutions, and Pool were slightly better, yes.

And Pool, okay.

And then tax rate in the quarter, I'm not sure it was mentioned on the call yet, but was a little bit lower than expected.

What was the main driver there?

Well, we had a 31.7% full-year tax rate for our adjusted business in 2009.

And we ended up 2010 or 32.4%.

So it drives the tax rate in Q4, as the year-to-date true-ups on the foreign tax credits, and everything to get back to your full-year rate.

And we're expecting that same rate to continue in 2011, right around 32.5%

Was there anything in the fourth quarter that different than what you expect, given the guidance was for 32 to 33 for the quarter, came in at 30?

Yes, I was telling this to Randy, we should have expected the lower tax rates from -- our year due to true-ups and our foreign tax locations, the R&D tax credit, et cetera.

Okay.

For those things, we're booked.

Okay.

Thank you.

Your next question comes from the line of David Rose with Wedbush Securities.

Good morning.

Excuse me, on two points, On the -- one you haven't really discussed Water reuse to a great degree on the call.

Can you give us a little bit more detail on progress on Water reuse?

And then secondly if you can discuss, a little bit more on the discontinued operations number?

What business was discontinued, and why the magnitude?

And then lastly, if you can give us a little bit more color on the leverage you have in China?

I think the last time you did discuss a little bit about percentage utilization and factory utilization rates in China.

If you can give us a little bit more color there?

That would be helpful.

Real quick, we doubled our factory size in our Water business in China, so we still have lots of room.

I'd say, we're still less than 60% utilized in the facilities there.

Some might say only 50, because we just doubled it, and we're still moving products into there.

In terms of Water reuse, we continue to make progress, new bids.

We have some partnerships, in terms of media suppliers that are working pretty well.

We are very aggressively bidding outside the US, and taking -- in taking, in fact, we have one system going into Egypt right now.

I don't know where that stands right now.

It's not meaningful to our forecast.

We continue to make progress, and it's in that Systems business we talked about.

It's one of our key areas for growth.

And then --

Discontinued ops, we basically sold our -- if you recall our tools business that's an discontinued ops.

And we still retain some of the liabilities.

And there was a product recall on a particular item, which we did the analysis on accrued appropriately, for what we think the outstanding amount of the claims could be.

So it wasn't a new business.

It was a legacy business, and it was the accrual associated with the product recall claims.

Okay, perfect.

That helps.

Thank you very much.

Thank you.

Your last question comes from a line of Michael Coleman with Sterne Agee.

Good morning.

Good morning.

Just a quick question on -- you mentioned desalinization in your prepared remarks.And I was wondering if you could provide some kind of framework, or characterize the kind of tendering activity on a global basis relative to six months ago?

And if you're successful in some of this bids and tendering, when that might come into play in 2011?

Well, it -- I mentioned the large project, $7 million, that was a deferred project.

It was one of those projects that have been delayed for over 18 months.

And finally, the project has been let, and we won it.

And we feel good about that.

We see a lot more of these breaking loose now.

So more to the third and fourth quarter, in terms of shipping as they go.

But our CodeLine business, which is our largest business is the vessels for deferred Desal.

That quotation activity has been picking up all through the fourth quarter, and our win rate has.

And we've just opened -- very excited about the fact that we are producing that product now in China.

China had a 20% duty, made us uncompetitive in China.

And our win rate in China has tripled, and so we're very excited about what we're getting.

And those are smaller, a lot of industrial based RO projects.

But it's an important step forward for us, in our CodeLine business.

We expect not a quantum leap, but a nice step up it in Desal 2010 to 2011.

Just a quick follow up on that, the -- when you think about the back half of the year in terms of incremental margin, is the Desalp pump, is in line a little better?

Or how did that shake out in, terms of kind of thinking about it on the incremental contribution?

In terms of the challenge for us with our new high efficiency high pressure feed pump, which is the one you're asking about, I believe, is basically getting experience.

We have agreement from several OEMs, who are putting them in, so we can prove up our efficiency.

Cost competitiveness, we feel, is good.

It's the higher efficiency, that we need to -- prove it -- in their installation.

So this is the year of prove it for, that product.

It's not one, which is going yield a heck of a lot of sales for us.

Okay.

Thank you.

Thank you.

All right.

That's it.

Felicia, I think we're ready for the replay then.

Thanks, all.

Thank you for participating in today's Pentair Q4 2010 earnings conference call.

This call will be available for replay, beginning at 11.00 AM Eastern Standard Time today through 11.59 PM Eastern Standard Time on March 4, 2011.

The conference number for the replay is 37005356.

Again, the conference ID number is 37005356.

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.