濱特爾 (PNR) 2011 Q4 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Pentair Q4 2011 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer session.

(Operator Instructions) Thank you, and I will now introduce and turn the call over to Sara Zawoyski, Head of Investor Relations.

You may begin your conference.

Thanks, Tracy, and welcome to Pentair's full-year and Q4 2011 earnings conference call.

We're glad you can join us.

I'm Sara Zawoyski, Head of Investor Relations.

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 2011 performance as well as our Q1 2012 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-Q for the quarter ended October 1, 2011, 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 investor section of Pentair's website at www.pentair.com.

We will reference these slides throughout our prepared remarks.

All references today will be on an adjusted basis unless otherwise indicated for which the non-GAAP financials are reconciled in the appendix of the presentation.

We will be sure to reserve time for questions and answers after our prepared remarks, but in recognition that there are other calls going on this morning, we will target to be done in an hour.

With that, I'd like to request you to limit your questions to one and get back in the queue for further questions so we can try to make it through everyone's this morning.

With that, Randy?

Thanks, Sara.

Welcome, everybody.

Let me begin with our fourth-quarter performance on slide number 2.

As you saw in the press release, we recorded a non-cash goodwill impairment charge of roughly $200 million pretax and $1.82 per share related exclusively to our Residential Filtration business as a result of our annual impairment assessment process.

The recent declines we saw in residential water treatment component sales in the US and western Europe and the expected continued softness in these end markets no longer supported the level of goodwill carried in Residential Filtration.

Clearly, this is a difficult headline on which to end the year and one that I'm personally disappointed to have to report.

However, it does not change where we are as a company, the progress we've made in 2011, and the growth opportunities we have ahead.

Today, we sell roughly $1.2 billion into the global residential end markets.

Roughly one-third of that relates to pools which has already back to setting records with good secular trends in efficiency and automation.

Another third of that is flow with solid replacement event and a strong performance in 2011.

The remaining third is filtration which includes point of use filtration which has low penetration and solid global growth and the water treatment softener component business that mainly serves developed regions and tends to be more discretionary.

This business is the one that's been impacted by consumer sentiment and financing in the housing business.

We still, however, continue to see long-term value in the Residential Filtration business with growing scale and fast growth regions and industry changing innovation like the Hybrid DI coming to market this year.

We expect to continue to gain from our global expansion and innovation to drive top-line growth and will be relentless on our focus on operational excellence and improving operating performance in Residential Filtration.

To be sure, Pentair is well positioned to benefit from a meaningful residential recovery in this business when it comes.

The other item impacting Q4 reported earnings was an $11 million pretax restructuring charge as we reposition the Company to capture CPT cost synergies, address the realities in the developed markets that continue to reposition to support growth.

Let's turn now to the core operating performance in Q4 which came in generally in line with the revised growth expectations we shared in December.

The operating performance headlines were solid despite the headwinds in western Europe and Residential Filtration.

Overall, we grew sales 15%, expanded adjusted operating margins to drive operating profits up 18% and delivered adjusted EPS $0.56 which is up 14%.

Strength continued in many of the end markets we serve including industrial, beverage, agriculture and energy.

Momentum continued in the fast growth regions as well with sales up 23% in the quarter before including the CPT acquisition.

We continue to execute well on our growth initiatives with new products and expanding coverage adding to our growth.

Margins increased another 30 basis points in the fourth quarter, generally, as expected.

Volume, productivity, and pricing helped to offset resistant material inflation and sustained growth investments.

In Q4 we delivered adjusted EPS of $0.56 compared to the $0.49 in the prior year reflecting the solid sales in both water and technical products, excellent operating performance and benefit from CPT.

We finished strong in cash flow generating $61 million in the quarter.

This brings our full-year free cash flow to $248 million.

In sum, we delivered another quarter of solid operating performance with strong execution driving top-line results, good price cost dynamics enabling margin expansion, and sustained productivity funding continued growth investments which we believe it positions us well for growth in 2012 and beyond.

Now let's turn to slide 3 for a review of our water results.

Water sales grew 21% year over year in the quarter largely driven by the CPT acquisition which added $92 million in sales.

Excluding the 2010 GIWW project headwind in Engineered Flow, organic sales grew 6% in water with good price realization and broad-based growth across the businesses.

Residential flow sales were up 7% in the quarter, share capture with better delivery and quality, new products, and geographic expansion helped offset headwinds in western European pump sales which were down nearly 10% in the fourth quarter.

Agricultural equipment sales, including irrigation pumps and crop spray, grew an impressive 31% in the quarter, lapping a 30% growth of a year ago to finish the year of overall up 19%.

While still relatively modest today, we believe this business can meaningfully contribute to Pentair's future growth with innovation, geographic expansion, and channel improvements.

Residential Filtration sales grew 5% in the quarter.

Fast growth region sales continue to grow at a robust pace with India more than doubling.

We continue to expand distribution coverage and make great strides in our end region four region strategy.

In contrast, sales in developed regions were down 5% in the quarter reflecting channel and discretionary pressures in residential softener components as well as the sharp adjustment in year end pro channel inventory levels in the US.

While we have some upcoming product launches, including a new treatment valve in Q2, we expect continued weakness in residential softener component sales this year.

Pool sales were up 18% in the quarter reflecting share gains in solid after-market demand.

Early-Buy program sales were strong with good carryover while standard orders grew at an even faster rate, both of which are positive indicators for 2012.

Expanded distribution continues to be a key growth driver adding another 95 dealers in the quarter totaling over 400 additions for the year.

Our Eco-Select products well out paced the industry growing 25% in 2011 led by impressive IntelliFlo pump sales which were up over 50% this year.

Next in innovation is the IntelliChem which is an efficient auto dosing pool system that monitors pH and sanitizing levels to maintain safe, well-balanced water.

Even with no meaningful housing recovery, industry growth fundamentals remain strong with now over 30 utility funded rebate programs for energy efficient pool products and expected launch of an Energy Star program by the EPA with support from the DOE for pool pumps later in 2012.

Share gains combined with targeted international expansion and technology and innovation investments should position us well for sustained growth going forward.

Engineer Flow sales decreased 25% with the GIWW comparison driving 17 percentage points of that decline.

The remaining 8% decline reflects continued softness in the large US Municipal project sales partially offset by strong industrial sales.

While Muni backlog seems to be stabilizing, running at roughly $60 million consistent with 2010 end of year numbers but better than a 2011 low point of approximately $45 million, we continue to expect ongoing sluggish municipal sales in the US as reduced capital spending for water infrastructure continues.

The Filtration Solutions sales were up 3% ex-CPT and up 5% excluding foreign exchange.

We continue to see nice growth in desalination through the distribution channel along with some project work.

Food service steadily adds to sales each quarter growing 4% in Q4.

In energy, sales were down modestly year over year reflecting some project delays.

Backlog in energy projects, however, has never been stronger as we apply our existing technology and systems know how outside of the refinery to solve a broader set of customer needs in the oil and gas market.

CPT added $92 million in sales in Q4 and grew mid single digits in local currency when compared to pre-acquisition 2010 sales.

Growth moderated from Q3 reflecting market pressures, a tighter project focus, and currency headwinds.

From a market view, while backlog remains strong, we've seen some delays in project activity particularly on the municipal water side which we expect to continue into 2012.

Q4 also reflects a tighter focus on profitable growth muting the top line slightly near-term but expected to boost profitability longer term.

And, last, currency was more of a headwind than we expected coming into the quarter.

For 2012, I'm confident in our ability to generate 10% plus top-line growth in this business and grow profits at an even faster pace.

We've got some exciting innovations with both our Megablock and anaerobic MBR solutions now both in the market.

In dairy we just launched the first and currently only mix proof valve that does not require a full port leakage chamber which simply means greater efficiency, much more safety, and smarter operation in a new space-saving design for our customers.

We are also developing a new technology platform around hollow fiber nano filtration that improves performance, uses less energy, and reduces the footprint compared to a standard RO solution used today.

The first target application is the removal of silica from water using high purity applications like boiler water feed and steam generation in power plants with plans for broader applications in the future, including color and endocrine disruptor at removal in 2013 and beyond.

Cross-selling opportunities are also beginning to take hold.

Global sales training for CPT should be complete in Q1 unlocking pull-through potential for vessels, pumps, and the full water product line.

The cross-selling opportunities extends to food and beverage as well with our leading position in aseptic valves and dairy, for example, we've recently started quoting utility pumps, incoming water treatment, boiler feed water and wastewater treatment, providing meaningful upside potential.

I believe we've only just begun to see the benefits of our combined sales coverage, technology platforms, and product portfolios.

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

Water operating margins expanded 20 basis points to 11.2% in the quarter, a significant accomplishment given the mix pressures.

I'm pleased with pricing and productivity was constant in Q4 helping to offset inflation.

While CPT seasonality helped water margins in Q4, we expect to drive meaningful improvements in CPT margins going forward through a combination of volume leverage, lean-driven efficiencies as well as synergistic cost take-outs from the Q4 repositioning efforts.

Through the application of lean discipline, we've already made progress in multiple plants.

Examples include cutting machine set-up time in half, doubling output of [cells] with no additional headcount and rolling out our Safety First program.

All while reinvesting these savings to create lean leader roles at all CPT sites to ensure a compounding, sustaining impact as we move forward.

Overall, I'm pleased with the water performance this quarter and continue to be excited about its future with CPT in the fold and the global investments we've seeded over the last several years.

Now let's move to slide number 4 for review of technical products.

Technical product sales were up 2% in local currency and operating profits were up 12%.

The top line results reflected good price realization with no net volume contribution.

While the majority of end markets we serve continue to grow nicely, including industry, energy, commercial, and infrastructure which all grew double digits, communications, which accounts for nearly 20% of technical product sales, was down 19% in the quarter.

Consistent with what we said in Q3, roughly half of the decline reflects the lumpiness of the telecom program going end-of-life and the remainder is due to communications market softness overall.

Technical Products drove fast growth region sales higher by 25% in the quarter led by impressive growth in China and southeast Asia.

We continue to execute our end region, four region strategy including repositioning our Chengdu operation to more directly focus on serving the China market with branded products.

In Brazil, we've begun localizing thermal production to support our "Grow Global Cooling" initiative.

We continue to leverage our lower cost manufacturing capabilities and strong brands to build our position in key growth markets and expand distribution.

While there is still more work to be done, Technical Products increased fast growth region sales in excess of 28% for the year to over $135 million.

Technical Products operating profit grew 12% in the quarter with an impressive 80% drop through in sales.

Operating margins reached 16.4% in Q4, a significant accomplishment given our continued growth investments and mix headwinds for fast growth regions.

Bottom line in Technical Products is that like the market, we are growing.

We continue to see robust growth in US and global industrial as business is spending more on maintenance and capital.

We are also benefiting from some positive mix shift away from communications and our established lean disciplines continue to drive margins higher.

Please turn to slide 5 as I cover the full year.

2011 sales grew a strong 14% year-over-year to a record $3.5 billion which reflects 6% organic growth including roughly 1 point of foreign exchange benefit offset by the negative 2-point impact from GIWW.

For the year, US organic sales grew 5%, fast growth regions were up over 20% and Europe 3% in local currency.

Our clear focus and execution on growth initiatives are driving top line results.

At the operating margin line, solid pricing, productivity, and lean actions help offset inflation in the CPT acquisition impact of 20 basis points.

Pentair adjusted margins expanded 70 basis points in 2011 on top of prior-year 140 basis point improvement.

At the same time, we continue to invest in global capabilities and technology innovation and sales and marketing.

From a segment view, water revenues grew 16% for the full year with CPT innovation and distribution all playing key roles and margins expanded 60 basis points.

Technical Products grew revenue 10% for the full year and expanded margins by an impressive 190 basis points on top of last year's 230 basis point improvement.

The bottom line for 2011 was adjusted EPS of $2.41 which was an increase of 21%.

2011 marks a year of solid sales growth and margin advancement along with significant progress in strategy that we believe position us well for 2012.

Now let's turn to slide number 6.

Per our standard work, details of free cash flow are on the left of the slide and a summary of our debt levels are on the right.

We finished the year strong generating $61 million in free cash flow in the fourth quarter.

This brought our full-year free cash flow to $248 million representing a net income conversion of greater than 100% and above our goal once again.

We returned approximately $80 million to shareholders through dividends and recently raised our 2012 quarterly dividend 10% which equates to an annual dividend of $0.88 per share parking our 36th consecutive annual dividend increase.

In addition, we repurchased $13 million in shares under our share buyback authorization program to help offset dilution and have a similar program in place for 2012.

ROIC, which is shown on the bottom right section of this spot, continues to be a key priority for our execution.

We are exiting 2011 at 9% on ROIC up 80 basis points from the 8.2% at the end of last year.

Our goal continues to be to drive ROIC back in to the double-digit range.

Now let's turn to slide 7.

Beyond the numbers, we made good progress on our strategic priorities, setting the stage for future success and sustainable growth.

Organically, we increased fast growth region sales 22% in 2011, now totaling about $650 million with CPT.

We also meaningfully advanced our global water and fluid process capabilities through acquisitions through Clean Process Technologies and Hidro Filtros in Brazil.

Both acquisitions directly align with the biggest mega trend driving the world today and that is the population and wealth growth of what we call the new, New World.

This is putting incredible pressure and demand on food, water, energy, and industrial and transport infrastructure.

On the innovation front, we remain committed to investing for growth and serving these growing needs, sustaining higher R&D investments to deliver customers what they need including better efficiency, sustainability, automation, and safety.

We continue to be recognized by customers for our service and our innovation solutions.

We continue to grow beyond market rates by identifying new adjacent opportunities including expanding our global thermal platforms and Technical Products which is up 40% outside the US as we design, develop, and manufacture new products in China and India, for China and India.

In water we see exciting new market opportunities in high-growth areas like dairy and agriculture.

Another key growth driver is our Pentair integrated management system.

We continue to improve product quality, on-time delivery, work place safety as well as cost and cash as shown by our 80 basis point gross margin expansion in 2011.

We also have over a decade of generating strong cash flow and consistently converting greater than 100% of net income to free cash flow while investing for future growth.

We also recognize our "one-year anniversary" of the Rapid Growth Process, training over 500 global leaders in this new discipline growth process and adding another strong tool in our PIMS toolkit.

We believe the progress in 2011 to advance our strategy in technology and innovation, fast growth regions and PIMS positions us well for sustained profitable growth in 2012 and beyond.

In the Q4 repositioning actions are yet another catalyst as we better align to capture fast growth region opportunities, flow resources to the best opportunities, and lower cost structures in developed regions.

With that, let's turn to slide 8 for a snapshot of our realignment within Water.

Three years ago we implemented our global business unit organization structure enabling us to advance our global growth strategies and execution.

As we leveraged PIMS and incorporated our rapid growth process, we gained deeper insights in to their market, common processes, and growth platforms.

Now with CPT in the fold, our next step was to ensure we were aligned around how the customers want to do business while also recognizing today's market realities.

Our new Water and Fluid process alignment focuses on three key platforms, two of them -- Flow and Treatment and Process -- each represent roughly $1 billion in sales today.

Aquatic systems, which is the renamed Pool business, represents roughly $500 million in sales.

Within this framework we will prioritize technology platforms, leverage scale where we can, like in flow, and have a shared fast growth region strategy across businesses.

This will help ensure we are moving swiftly and efficiently on opportunities in key growth markets like China, India, and Brazil, maximizing growth, customer alignment, and scale while reducing channel and business conflict.

We believe this new water alignment will help us advance our mission towards being an increasingly global company while delivering superior returns to our shareholders.

With that, let's turn to slide 9 which is the same outlook we've provided in December.

We continue to expect organic revenue for 2012 to grow in the mid-single digits, margins to expand 40 to 80 basis points, and EPS of $2.60 to $2.75 a share.

We enter 2012 with good price cost momentum, additional price actions under way and a strong track record of productivity.

With additional savings expected from our recent repositioning actions and the improvement in CPT margins, we believe we can manage the continued mix pressures and current foreign currency headwinds.

We also expect to once again convert greater than 100% net income in to free cash flow and improve an additional 50 basis points in ROIC.

With that, let me turned to John to review in greater detail the 2011 financial performance and 2012 guidance.

John?

Thanks, Randy.

Please turn to slide 10 where I will discuss the adjustment items acting full-year reported EPS.

The acquisition related costs, including deal costs, customer backlog, inventory step up adjustments came in at $0.15 for the full year, in line with initial estimates with no carryover into 2012.

The restructuring charge totaled about $0.08 in the fourth quarter and $0.10 for the full year which reflects repositioning actions.

Randy discussed, recognizing today's market realities, we've reduced capacity and consolidated warehouses to lower cost in developed regions.

At the same time, we better aligned the channels between CPT and the base water businesses and taken a more market-backed look at key fast growth regions to ensure we are leveraging the broader Pentair portfolio and have the right prioritized investments in the right regions.

And, last, is the goodwill impairment charge for $1.82 in the fourth quarter resulting from our annual impairment analysis.

Under GAAP, goodwill impairment is determined using a two-step process.

In the first step we determine that the carrying value of the Residential Filtration business exceeded its fair value.

From there you move on to the second step which includes a rigorous and thorough evaluation analysis of the business and all the assets and reevaluation of goodwill.

The second step results in a $200.5 million pretax reduction in goodwill and our Residential Filtration GBU which was primarily triggered by performance in valves and tank products for water softeners in developed regions.

As Randy mentioned, we still feel that our technology in this business, especially the to-be-launched Hybrid DI, our Home Spring application, and all of our point-of-use technology for fast growth markets has significant value.

With the steady downturn of the US housing market combined with the shift from the pro channel to the retail channel which pressured profitability.

And the performance of this business in Q3 and Q4 of 2011 could no longer sustain, for accounting purposes, the value of the goodwill on the balance sheet.

So, we wrote it down to what was more in line with the business outlook reflecting the realities of today's market.

Because the majority of our goodwill is not tax deductible, we have only a small tax benefit associated with the impairment, $19.4 million, resulting in an after-tax charge of $181 million or $1.82 per share.

With that as a review of the adjustment, let's turn to slide 11 for a view on the ongoing operating performance.

Over the past two years we've expanded margins by 210 basis points with another 40 to 80 basis points of expansion expected this year.

Lean discipline and productivity enhancements along with repositioning savings will positively impact 2012 all while continuing to invest more in R&D, technology, and selling and marketing growth initiatives primarily in fast growth regions.

In 2012 we expect to build upon the product quality, on-time delivery, and workplace safety improvements of a year ago enabling us to serve our global customers better and more efficiently.

We are anticipating our repositioning effort to drive over $20 million in savings in 2012 equating to approximately one-third of the top end of the net productivity range we provided in December.

This gives us a higher level of confidence in our 2012 operating targets while helping us fuel future growth.

Another key enabler to our margin expansion is improving CPT margins with roughly 15% EBITDA margins for the Pentair ownership period in line with our expectations.

Full-year CPT EBITDA margins for 2011 were about 12%.

Along with volume leverage, we are driving material sourcing savings, lean transformation, and a tighter profit focus to increase profitability.

Net pricing and productivity should yield even better results for us in 2012.

We expect pricing to yield 150 to 250 basis points for the full year with most pricing actions rolling in during Q1 and early Q2.

We expect material inflation to moderate a bit in 2012 compared to the persistent inflation of plus 4.8% last year providing a better price material cost dynamic.

In 2012, we will continue to prioritize and allocate our resources to the best opportunities available.

We will continue to fund our growth initiatives with R&D and sales and marketing investments critical to driving share gains and delivering long-term sustainable growth.

Corporate costs should increase by about $5 million versus 2011 due to higher pension and medical costs and global investments in business development, brand marketing, and fast growth market infrastructure.

Please turn to slide number 12 labeled Q1 2012 Outlook.

For Q1, we expect Water revenue to be up approximately 20% over the first quarter of last year with Technical Products up low single digits.

This puts total Pentair revenue of 13% to 15%, including the contribution from CPT of approximately 10 points or roughly $80 million in sales.

We expect operating income to grow 7% to 12% which equates to operating margins between 10.5% and 11%, slightly below the Q1 2011 margin of 11.1%.

Because of the seasonality of CPT and the softer geographic mix, we expect water margins to be down 50 to 100 basis points.

We expect technical product margins to expand 30 to 50 basis points, reflecting some carryover pricing actions.

Below the line, we expect interest expense to be about $8 million higher in Q1 of this year versus Q1 2011 and a tax rate between 29% and 30% consistent with full year 2011 results.

Overall, we expect earnings per share in the quarter to be between $0.53 and $0.57 which equals growth of 2% to 10% over last year.

Also, we want to remind you that like previous years, our cash flow typically runs negative in Q1 due to the seasonality of our revenue.

Please turn to my next slide, slide number 13 labeled Q1 and Full-Year 2012 Outlook.

As we said in our December call, we anticipate generating roughly half of our EPS in the first half of 2012 which implies a modestly lower first-half growth rate to specifically Q1 as shown here on the slide.

We expect Western European headwinds to carry over into the first quarter impacting both sales and profitability.

Further on, sales year-over-year growth in technical products is negatively impacted by the choppy telecom projects by roughly 3 points in Q1 and into Q2.

While the CPT acquisition adds to Q1 sales, we expect CPT margins in the low single digits in Q1 typical of their normal seasonality that we are working hard to improve through focus on higher margin projects and a transition to improved operating structure.

In addition, we have an incremental $8 million of acquisition headwinds related to deal which we did not have in Q1 of 2011.

Pricing and reposition savings should ramp in the first half before reaching the full run rate in Q3 thus being the lightest benefit in Q1.

All in, we are expecting good start in Q1 and have a clear path forward for growth and margin expansion in 2012.

Please turn to my next slide, slide number 14 labeled Full Year 2012 Outlook.

For the full year 2012, we are reaffirming our previous guidance initiated in December.

We expect revenues to be up 7% to 10% to about $3.75 billion at the midpoint and we anticipate $445 million to $470 million of operating income which would yield operating margin expansion between 40 and 80 basis points.

We continue to expect another solid year of EPS growth with earnings per share of $2.60 to $2.75.

We expect free cash flow in 2012 to be roughly $270 million or at least 100% of net income.

We are targeting a 75 basis point increase in ROIC by the end of 2012.

Please turn to my last slide, slide number 15, for the summary.

Our record sales and strong operating performance in 2011 demonstrates our excellent execution of growth and productivity initiatives by both our water and technical products teams.

Our presence in fast growth markets has never been stronger and will continue to leverage the investments in new product development and selling and marketing that we have seeded over the past few years.

We continue to convert income to cash at very healthy rates and deploy disciplined capital allocation strategy through a balance of dividend and buybacks, high return capital expenditures, and acquisitions with strong strategic fits.

In 2012, we are committed to our growth agenda through discipline investments, focused resource allocation, and prioritized initiatives.

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

With that, we will open it up for questions.

Tracy?

( Operator Instructions) Your first question comes from the line of Robert Barry with UBS.

Your line is open.

Hi, guys.

Good morning.

Good morning.

Based on how you calculate the return on invested capital, how much of the improvement, if any, was related to the goodwill impairment charge?

Very small, 10, 15 basis points.

What we do is we basically take a five quarter average of the ROIC so we blend it in, so we don't have the full investment base of CPT in yet either, but there isn't a full benefit from the goodwill reduction within the Residential Filtration business either.

Okay.

Thanks.

I will stick to one question and get back in the queue.

Thank you.

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

Your line is now open.

Good morning, guys.

This is Mike (inaudible) sitting in for Jim.

Not that we would expect 80% incremental margins in tech to continue, but what was the main reason for that?

Will it return to normal like 35%, 40% in 1Q?

The biggest drivers of that are one -- I mean, they really are our lean champions, they had good price and they had real positive mix.

The decline in communications, communications is the lowest margin business line, so they had a positive mix shift.

That helps, too.

So, yes, you can expect it to drop more to a normal rate.

I still think high end of that normal rate.

They are a solid, solid business.

Okay.

Thanks a lot, guys.

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

Your line is now open.

Thank you.

Randy, hoping you could touch a little more on the realignment of the water global business units and maybe how this helps you in terms of a better sales channel, go-to-market strategy, and then also operationally, in terms of driving productivity.

How do the benefits specifically play out in your mind over the next couple of years?

And does this change your thinking in terms of M&A amongst those various buckets or that's not really relevant?

Well, let me start with that.

Our M&A focus continues to be in the areas of technology.

We are learning that there is some of the most attractive businesses like dairy, like industry.

Those have the highest margins and they have really good growth fundamentals.

We are looking at applying anaerobic MBRs in to a broad array of industries and we have market-leading capability there, CO2 recovery the same thing.

The realignment is really to do a couple things.

Number one, it's to allow us to get some cost synergies from the CPT acquisition.

The Nijhuis business that we bought which is really a pump business, we get more synergies by aligning it with our pump businesses.

As we looked at that, we looked at our high-performing Residential Flow business and our struggling Engineered Flow business, we saw an opportunity to take costs out by putting them all back together.

It was particularly relevant as we looked at globalizing because we have a lot of brands in the US, for instance.

The channels are well established, but as we go overseas, we had gaps in coverage and we have conflict in brands that we could make more coherent by managing it as one unified piece, so that is the answer in Flow.

In terms of filtration, we still have two GBUs in filtration; one the Residential Filtration and, two, the more technical end of process solutions.

It is primarily there are similar technologies but the applications and go to market are very different.

One is an implied capability and the other one is more through distribution.

Again, what we see is as we go to these new countries we want to go as Pentair, we don't want to go as individual GBUs, so that's the other big change we are making here.

In China we are Pentair.

We are not Pentair Residential Filtration.

We are not CPT.

We are Pentair.

We see big leverage there.

For instance, I was recently in Qingdao, 32 million people.

We only had three sales people and they were all Residential Filtration.

It's an industrial capital of the city, huge opportunity for us.

So we need to be there as Pentair, for Pentair.

That is a big part of the realignment.

Finally, the focus on Pool.

Pool is leading our efforts in aquaculture because we already sell $20 million to $25 million worth of equipment in to the -- the segment of aquaculture.

What they use is pool equipment and actually our advanced pool equipment helps raise the yields in those applications, so we are quite excited about that.

We felt that name change better captured where we are investing in our platform.

So we are seeing the benefits both in terms of cost and in terms of prioritized investments in being Pentair, not individual GBUs in new markets.

That's very helpful.

Thank you.

Thank you.

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

Your line is open.

Hi, good morning.

It is Chip Moore for John.

Good morning.

I was hoping you guys could talk about what you are seeing in January in a little more detail, particularly in the muni market, and if you are still looking for that to be down sort of in the single-digit range for the year.

A couple things.

If you kind of take a look at Q4, we did, as we shared in December, see a pretty steep decline in November.

We did have a nice recovery in December.

So while Western Europe is still challenged for us in the first part of 2012, we did see a distributor reaction based upon the economic outlook in Europe that we think impacted us primarily, as Randy mentioned, in Residential Filtration.

As we look out to 2012, the muni market we still think is down mid single digits globally.

Clearly, a customer base that doesn't have a lot of money.

Break and fix will probably still get done, but large projects that have been anticipated continue to get delayed.

So, we are still anticipating a tough outlook for the municipal market for 2012.

Great.

Thanks, guys.

Thank you.

Your next question comes from the line of Josh Pokryzwinski with MKM Partners.

Your line is now open.

Hi.

Good morning, guys.

Hi, Josh.

Just maybe to dig in on China for a moment given some of the more macro sensitivity there.

Are you guys able to calibrate kind of same-store or same-city sales?

I would imagine that you are kind of moving west and penetrating more cities as you go.

Some of the more established cities on the East Coast, has growth flattened there or gone negative?

Maybe help us calibrate kind of within country.

Is the growth coming from additional regions or more growth within already established regions?

Gosh, it's a combination.

First of all, we do about $130 million to $140 million in China.

So, our growth rate is still strong in the 20s from a volume basis.

We think obviously we come in from a little lower base than some more established organizations, but it is continuing to add distributors, adding new customers.

And, as Randy mentioned in his comments, we've got more localized content with more localized production with more localized marketing application.

And then I think there's a lot to this one Pentair aspect in serving the customer the way the customer wants to be served.

So, all of those things factoring in and we still see a pretty strong outlook for our products in technologies for 2012.

If I could add one other texture.

All of those things are really more than offsetting.

What we have seen, which is some of our more established distributors, having it more difficult as no surprise here, getting financing to put in inventory.

That is the impact of the government being more strict about where money is going.

We have seen that, too, but as John aptly described, the new initiatives and the new coverage is what will sway.

All right.

Thanks, guys.

Thank you, Josh.

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

Your line is now open.

Hi.

Good morning, guys.

Can you just run through within the mid single-digit organic growth how you are thinking about fast growth regions versus Europe versus North America and maybe just touch on how you are thinking about FX relative to your previous guidance?

Yes, if you take a look at full year 2012, Jeff, we've got FX at about 100 to 150 basis points of a headwind.

You are going to see a predominant amount of that in Q2.

I'm not assuming we are going to get back to the FX levels or euro levels that we had last year.

So, let's call it 100 to 150 basis points.

Acquisitions, as you know, will still carry over and give us about 5 points.

If you look at core volume growth, it's closer to 4 points.

In that context, we are thinking 15-ish for fast growth regions which, for us, is around 20%.

So, that kind of gives you what developed is looking like.

Within that, we have a context of Europe being down about 5%, and we still see some growth in the US domestic market.

Okay.

And you're not really changing your revenue guidance, so what is the offset to the FX headwind?

Meaning what, Jeff?

I guess is FX materially worse from your December outlook call?

No, it's not.

Actually, ironically, the euro ended 2011 starting in January about where it was last year.

I think the difference is that we just don't see it spiking in Q2 the way it ran up last year.

Okay.

Thanks, guys.

Thank you.

Your next question comes from the line of Scott Graham with Jefferies.

Your line is open.

Hi.

Good morning.

Hi, Scott.

Just wondering how Water versus Technical Products order rates were as the quarter progressed?

Meaning, are you talking about Q4?

Well, yes.

You indicated one business, the muni business, kind of weakened and then improved a little bit, but I was just wondering if you could maybe look at that more holistically by segment.

As the quarter progressed, October, November, December, how did these businesses do?

I was just trying to identify the trend?

Within water -- I mean, Tech Products we knew it was going to be low growth because we knew what communications impact was.

It really came in the way we thought it would with the low single-digit growth in the fourth quarter techno price.

In terms of water, what caused us to trim our guidance in December was the fact that Western Europe was a lot weaker.

We saw it weaken in November and in December it was still weaker, but not as weak as it was in November.

So it was really -- muni came in the way we thought it was going to be.

It was weak and we expected it to be weak.

The surprise for us in the quarter was how much weaker Western Europe got in the residential businesses in November and December.

Just to add to that, we usually expect and see some restocking in Q3 due to the season within residential and Residential Filtration working its way out more in the summer months.

You don't usually see a November sort of correction.

That's what caught us off guard in the Q4 was the November correction primarily in the Residential Filtration distributor base and, as we mentioned, there were tanks and valves specifically.

Got it.

Thank you.

Thank you.

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

Your line is now open.

Good morning.

Just wanted to ask about the Residential Filtration business again and make sure that I didn't miss something.

The outlook for that business in terms of organic growth 2012, what are your expectations there?

And then how is the JV with GE incorporated into that thinking and how is that business doing?

And I apologize for not -- I think you mentioned the spring business.

I'm not sure what we are talking about there.

Sure.

Let me start with the JV.

The Residential Filtration is the JV.

And we set that up in mid-2008 with the expectation that housing was going to strengthen and we would have the clear market leading position, particularly in the developed world and we have that.

We have that position.

We have actually made great progress in terms of new products and innovation and going global, particularly with the point of use product.

The problem was that the US market didn't come back for that business and the Western European market got worse.

It's that simple.

So strategically, and if you will, on terms of the initiatives we are investing in, that business has done everything we expected it to do and has been very aggressive on taking cost out too.

It really singularly is driven by the housing downturn going longer and having a greater impact, particularly on water softeners.

Basically, the water softener is something that if you lose your well pump or you lose an injector pump or you lose a trash pump -- well, trash pump you can do without, but if you have a grinder, you are going to replace it.

You are going to replace it.

If your water softener goes out, you can buy a bottle of water.

It's a more discretionary purchase.

That's really the whole impact there.

In terms of growth, John, you want to --?

If you take a look at the point of entry products which we call the valves and tanks, they were flattish for the year.

They were up slightly in Q1 and Q2 and a big correction in Q3 and Q4.

When we take a look at the outlook for next year, we still think we will be flattish on that side of the business and we've got strong double-digit growth on the fast growth markets on the point of use.

So this business is still expected to grow mid single digits.

The challenge is we make a lot of money on the piece that's flattish.

We are starting to make good money on the piece that's growing internationally or in the fast grow space.

In the Home Spring application, you asked, Randy.

Yes, we moved Home Spring now.

We make that in China.

We've improved margins dramatically.

It's an exciting product.

It's still at a price point where -- and it is a discretionary purchase, so it's where I think now with our lower costs we can be more aggressive in terms of pushing it and we are also very excited about the Hybrid DI which we showed at the Aquatech show.

This is basically -- we call it a Hybrid DI because it not only replaces the softener, it does some of the same characteristics as an RO system.

It basically makes, for the first time we will have or introduce this year a solution for those communities that don't want to have salt discharge anymore and we think that the opportunity that presents is enormous.

Again, we will be going commercial in that mid year this year.

So there are some exciting things going on in that business.

Great.

Thank you.

Thank you.

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

Your line is now open.

Great.

Good morning, guys.

Good morning, Brian.

Just referring to the balance sheet, from my calculations I calculate that you guys are kind of bumping up against your 3.5 times debt to EBITDA covenant in Q4.

I'm just curious, how do the charges in the quarter kind of play into those calculations and, also, is there an equity or capital-based covenant associated with your debt as well, it's just not highlighted?

We are no where near the covenant levels.

If you take a look at the debt levels versus the 500 plus of EBITDA, we are no where near the numbers that you are referring to.

And well within those bank limits, and most of those bank limits allow for non-cash adjustments anyway.

Right, and our banks have no problem with this one.

Okay.

I just have to recalculate that.

Okay.

Thank you.

We'll walk you through it.

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

Your line is now open.

Thank you.

Good morning, everyone.

Hi, Deane.

I jumped on a bit late just as you were going through the realignment of the water business unit.

I missed what you said regarding CPT.

I trust it's in that process technologies.

Is that correct?

Yes.

If you take a look at that, it's sort of the dotted line, you have what we call purification on the one side which is basically the Residential Filtration and the rest.

What we have really done is taken Nijhuis out of that and put it up in Flow so we have a strong technically focused group that includes the higher tech side of CPT.

So the initial plan when CPT was acquired is you were going to run it as a stand-alone business.

Does this reflect to some integration of the business further within Pentair?

If we characterized it that way, that was certainly not intended.

Our intent was to get to know the business before we made decisions about how to run it.

So what we wanted to do was run it through the year and get to know the business intimately so that when we did make changes they were smart changes, not some kind of top-down, corporate America slam down changes, which many of us have seen before.

So the intent always was, once we understood Nijhuis and the dynamics of Nijhuis how the pump business worked with the water side of CPT was to say, how can we get synergies?

As you know, we ended up selling some Nijhuis pumps through our Engineered Flow sales force.

This was much more natural in terms of what we've done here and we took some cost structure out while we did it.

This is perfectly to plan.

That makes sense.

How about some color regarding what is the seasonality impact in the first quarter of CPT?

What is it about the nature of their sales that would be softer in the first quarter?

Part of it is I would call it the cultural organizational training.

There was a business that always focused on the year, so the fourth quarter was the crescendo and then they kind of paused in the first quarter.

A lot of the first-quarter business, at least as we look at it traditionally for that business, was pump business in countries that we no longer do business in.

We exited those business -- those countries.

We are not getting that business which would typically be in the first quarter.

It's a seasonally weak quarter.

We will see over time whether that will continue or whether we'll end up flattening things out as they go, but that will come with the knowledge work.

Deane, Randy is right on.

It's just a private equity model that has a shift to a public company model.

That Q4 was very meaningful.

I think over time Q4 would be a little less contribution and will get to more normalized activity in Q1 and Q2 as we flatten that project in that booking cycle.

Particularly, as we drive our lean disciplines.

It's interesting, one of the factors I went to, the first thing that hit me was the capital expenditure request because they were out of capacity.

We have already run three lean events and we've created about 20% capacity in a factory with no capital.

As we get to more of a lean kind of pulse in the business, I would hope we could flatten things out and create capacity and use it earlier in the year.

That's helpful.

And then just last question for me regarding CPT.

What are you expecting for contributions from new products in 2012?

On a percent basis, I don't have that right off the top of my head.

About 20-ish.

Is that the roll out of some of those new membranes or is that more of a 2013 event?

No.

The new membranes are -- we are going to see the first rollout of the nano filtration about midyear.

We think that application is going to be an exciting one.

As you recall a few years ago, we built an RO system in Vietnam to basically remove silica for feed water for new power plant in Vietnam.

RO is a sledgehammer, as we've talked about before.

This first application is aimed at more technical removal like silica.

That plant would cost less than half of what it would applying a nano filtration solution.

So we think that there is a whole range of solutions for that are going to be very exciting.

We are also very excited about the anaerobic MBR.

The anaerobic MBR and the CO2 removal in beverage and other food process is a huge opportunity to improve the efficiency as well as the environmental footprint of all of these plants.

We've talked before about the Yogurt plant in the US with the anaerobic MBR that's very exciting.

We've already sold two more.

So, that's something we are very excited about.

Great.

Thank you.

Thank you.

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

Your line is now open.

Thank you.

Just wondering how much if any of the dry and warm weather in North America played into the strong results in pool in the corner and, if so, is it possible to quantify how much of a demand was put forward away from the first half of 2012?

We don't think in the fourth quarter that we saw a lot of pull ahead.

In fact, the carryover of orders into the first quarter were stronger than they were a year ago.

We had a lot of -- in the fourth quarter we had stronger regular orders as opposed to early buy which means that's selling through and that could be because of the drier weather, but it also could be just that we returned to a more normal application.

30 utilities driving rebates to drive energy is pretty compelling.

The 400 additional dealers that we've got in place to drive because of our superior solutions is really why we think we are out growing the market.

Okay.

Thank you.

Your next question comes from the line of Terry Darling with Goldman Sachs.

Your line is now open.

Thanks, and good morning.

Hi, Terry.

Just wanted to get a little more color on end market expectations within water in 2012.

So, John, if I follow the discussion correctly and I will qualify that I got on the call late as well given some overlap, but Water up 9 to 12 for the year, call it 6 to 9 ex-CPT, call it 7 to 10 adjusting for the currency head wind, roughly.

I think I heard you say you are expecting municipal down mid single digit.

Can you take us through the other segments just broad brush what you are expecting on organic?

Yes.

As we mentioned, it will look just north of 20% in water is fast growth that we think is going to grow at least 15%.

I'm sorry, just talking about like resi flow, Engineer Flow, pool --

Yes, take the Engineered Flow business, I think you are down mid single digits to flat with exports around commercial being a little stronger than they were in 2011, and then you've got what we think is a continued muni headwind of around 5 points of decline.

Residential Flow grew mid-single digits last year.

We still think it's growing mid-single digits this year helped by agriculture, which we think continues to grow double digit.

When we take a look at Residential Filtration we mentioned mid-single digits with a lot of its fast growth penetration offsetting which is likely to be flattish developed market shipments and pool we still think will be high single digits based upon trends in the market, all the factors around the dealers, certainly the energy efficiency plays that Randy mentioned.

We don't see significant slow down in what would be the high single-digits growth rate in our pool business.

And we also got the Aquaculture penetration in there that Randy mentioned.

All in all, I think we grew overall volume in water last year at roughly 5% all in for water absent price in the foreign exchange and acquisition and we think it is about a point lower around 4% this year.

So is the way to connect the dots between those comments which kind of mapped to mid singles, you are not including price in all of those segment indications?

That's correct.

Price for water we expect to be around 175 to 200 basis points.

Okay, and what was it again for all of 2011?

It was just north of 100.

Okay.

Do you need to take additional price increase actions in the channel to get to that number or are we talking about a run rate or January price increases that gets you there?

We are talking about everything that's either in or planned at the moment, meaning it's anticipated and it's lined up.

Okay.

And then are there any other acquisition revenues other than CPT in the mix for 2012?

Not at the moment.

Okay.

So did the CPT revenue expectation for 2012 come down because of the weakness in Europe?

It might come down slightly, but it's still strong double-digit growth.

We still expect double-digit growth.

There is a euro impact on it, Terry.

When we were $1.24 ...

CPT and we are now $1.30-ish.

So there is that impact, but other than that, core volume roughly the same.

Okay.

Thanks very much, guys.

Thank you.

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

Your line is open.

Good morning.

I have a follow-up on the CPT revenue expectations for next year, as well as the breakdown in residential, just to be clear on Residential Filtration.

On CPT you are guiding for mid single-digit growth in the first quarter.

Why are we seeing an acceleration for the rest of the year to get to strong double-digit growth?

Yes, it's really --

I'm sorry, and particularly when you said you are de-emphasizing sales and focusing more on margin.

Just to be clear, we've got a plethora of opportunities in CPT.

What we are doing is prioritizing those that have repetitive sales after them, so things that we can do and solve and then have a repetitive sell through into the industrial cycle.

The second one is backing away from some of the lower margin aspects and a lot of those happen to be in muni where you are solving a water issue once and you don't have that repetitive sale.

What you're seeing in Europe -- what you are seeing in Q1 is just a little more FX headwind on the business and a little less Western Europe volume.

We are starting to ramp the backlog in the business and we feel pretty good about the second half of opportunity there.

So you are talking about consumables.

This is one of the calls that you haven't talked a lot about, UltraPure Water, aside from boiler feed, but you've talked about life sciences, some microelectronics opportunities, similar markets that Pall serves.

Is there still expectation that we will see more on the UltraPure side?

Yes.

We think the nano -- I just used a couple of samples but basically the nano filter we are launching mid year is going to be a superior product to put into UltraPure applications.

I just used some of the simpler ones, if you would, as examples because they are real time and we are already selling in to them but, no, we still see opportunities there and we are still excited about them.

Okay.

And you've been talking about anaerobic MBR for almost a year.

You have two products.

I think you said you've made two product sales.

Two projects.

It's not a product.

These are big --.

I was thinking system sales.

I'm sorry, how much are the system sales each?

They are millions.

We don't have a number.

Okay.

So we will expect that to ramp up.

Yes.

Okay.

And then last question.

When we look at the Residential Filtration market and break it down between point of use and point of entry, I'm trying to better understand the dynamics.

From what I understand, you've got a lot of growth in the point of use mostly from emerging markets.

You've identified a weak US and European residential market that has hurt point of entry.

With that said, what do we expect for the Hybrid DI given that macro?

We expect the Hybrid DI is going to have high margins and it's going to enter the high end and ultimately as rules get changed some places where you will need to put them in that it will have a ramp.

As I said before on another call, it's not going to have an iPad kind of ramp, but it's going to have a very profound impact over time on how people solve treatment problems, particularly in areas where salt discharge is an issue which basically means any place that is arid and you have water shortage problems.

Just to give you numbers, think of point of entry which is the valves and tanks in the water softener being about 60% of the business and the other 40% being what we call point of use.

The rest of the world solves their drinking water issue at the point of use.

The one particular area they are going to drink from because of cost and also footprint issues.

So that part of the market and the technology there is doing exceptionally well and I still think we feel that the rest of the business will recover, there is a need for it.

It's about 10% to 15% penetrated in the North American market.

It is right now struggling to get financing.

That's challenging both the price point and the penetration rate.

Okay.

Thank you.

Thank you.

At this time there are currently four participants remaining in the Q&A queue.

Would you like to continue with questions?

Yes, let's do those four quickly and hopefully one question each.

Okay.

The next person comes from the line of Robert Berry with UBS.

Your line is now open.

Hi, Rob.

He might have moved on.

Rob?

Your next question comes from the line of Mike Halloran with Robert Baird.

Your line is open.

Hi, everyone.

I promise to stick to the one question.

Could you talk a little bit about the water margin side of things.

Sequentially comparable revenue in water 4Q to 1Q but down margins, but then as we work through the year here, obviously a nice sharp recovery and expecting year-over-year growth.

Is it really just the seasonality component particularly related to the CPT business and a little of the resi softness, or could you bucket those out a little bit?

I would say 80% CPT margin headwind and the rest would be a little bit of the Western Europe headwind would make pretty good margins.

That's it.

Don't want to over complicate it.

We are anniversarying and putting CPT for the first time in the first half of the year.

It's not where they make the majority of their income.

As we mentioned, we will be improving that as we go forward, but it is going to have a margin headwind, hopefully one last time in Q1 and early Q2.

Makes sense.

Thanks.

Your next question comes from the line of Scott Graham with Jefferies.

Your line is now open.

Hi, just on the goodwill impairment.

Could you tell us the sales size of the business that this affected?

Yes, about mid 400s.

And if I may, John, I know that you know you are not thinking this way at all on CPT, but clearly you saw a couple things in the quarter that you didn't like and needed to fix.

I guess how do we avoid this on CPT three, four years from now?

Well, I think we are looking at two different things.

We had a series of business we combined in the residential period where the residential housing market in North America was at 2.0 million some.

There were certain expectations and valuations of the things we put on the balance sheet that reflected that.

I think where we are with CPT is obviously looking out into industrial process and some things that I think are a little bit more predictable as far as what their revenue contribution could be.

I mean, hindsight is 20/20, right, but it's hard to think back to 2 million housing starts going all the way down to mid 400s.

When we got to 2008 and we re-valued and put the GE business in our fold, we had what we felt was a realistic view of the residential market but it's significantly higher than where we were today.

We still feel that we are long-term going to get the value of the business, but it's getting harder and harder and, therefore, why we took the charge to get the accounting perspective to agree with our particular views of where residential is going to go.

So, I think we are in good shape with CPT.

Clearly, it's going to be about executing on all of the things that we shared with you internally to our strategic plan.

Very good.

Thanks.

Your next question comes from the line of Stewart Scharf with S&P Capital IQ.

Your line is now open.

Good morning.

Good morning.

Just wondering how you plan to prioritize your cash use with a debt to capital at 40% regarding reductions, share buybacks, acquisitions?

Well, our first goal has always been to raise dividends every year, pay dividends and raise them every year, support CapEx inside the business.

We always have a share buyback that is to manage dilution.

And then the rest would be to support our strategic initiatives.

Okay.

Regarding long-term growth targets for revenues and EPS you had about 7% CAGR and 15% respectively, that still holds true through 2015?

The best way I would answer it is we are looking at roughly 5% to 7%-ish this year.

I think every year around that is going to reflect a different type of economic outlook, but we still believe that we are sitting there with our growth outlook this year and we continue to throw off cash and ability to augment that in the strategic initiatives that Randy mentioned.

Okay.

Thank you.

Thank you.

At this time there are no further questions in the queue.

I will turn the call back over to the presenters.

All right.

Thank you very much.

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