濱特爾 (PNR) 2013 Q2 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 Q2 2013 earnings conference call.

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

(Operator Instructions) Thank you.

I'll now turn the call over to Mr. Jim Lucas, VP Investor Relations.

You may begin your conference.

Thanks, Tracy, and welcome to Pentair's second quarter 2013 earnings conference call.

We are glad you could join us.

I'm Jim Lucas, Vice President 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 the second quarter 2013 performance as well as our third quarter and full-year 2013 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 most recent 10-K and 10-Q and today's release.

Forward-looking statements contained herein are made as of today and the Company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances.

Actual results could differ materially from anticipated results.

Today's webcast is accompanied by a presentation which could be found in the investors section of Pentair's website.

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.

In recognition that there are other calls this morning, we will target to be done in an hour.

With that, I'd like to request you limit your questions to one and a follow-up, and get back in the queue for further questions so that everyone has an opportunity to ask their questions.

I will now turn the call over to Randy.

Thanks, Jim, and good morning everyone.

Let me begin with our second-quarter performance which is on slide three of the deck.

Pentair's second quarter was strong for many reasons.

We were very pleased with our 4% core growth in the quarter and saw two of our three segments grow, which highlights our narrowly diversified portfolio's balance.

All three segments drove operating margin expansion greater than 100 basis points, and Water & Fluid Solutions achieved a 15% operating margin, a record for that segment.

Our adjusted EPS came in at the high end of our guidance.

It has been nine months since we closed the Flow Control merger, and every day we see further support for the rationale of the deal.

We remain confident in our ability to deliver on the synergy targets we've outlined, given Pentair's proven track record of execution and the actions we continue to identify to drive our success.

This is important since many of our end markets around the globe are sending mixed signals ranging from sluggish and pessimistic to moderate optimism.

A continued North American residential recovery, strength in food and beverage, and steadiness in energy is helping counterbalance the ongoing headwinds in industrial, where many had anticipated a second-half acceleration that does not appear to be materializing.

Before I go through the second quarter results in detail, I want to note that we will be discussing our operating results on an adjusted basis to better address the core operating performance of our businesses, and referring to 2012 on a pro forma adjusted basis to provide a more accurate apples-to-apples comparison that includes Flow Control in the results.

With that, here are the numbers.

As I mentioned a moment ago, second-quarter revenue grew 4% on an organic basis with foreign exchange neutral in the quarter.

Adjusted operating income grew 13% while adjusted operating margins increased 120 basis points to 13.7% as price and productivity once again more than offset inflation.

Adjusted EPS grew 19% year-over-year to $0.92, which came in slightly higher than our expected range.

Free cash flow for the quarter was $331 million, which is greater than what we generated for all of 2012.

And we expect to deliver full-year free cash flow greater than 100% of net income once again.

We continue to build momentum on the elements within our control and we see opportunities to deliver double-digit EPS growth even as we wait for better economic conditions around the globe.

Now let's turn to slide 4 for a performance review of our largest segment, Water & Fluid Solutions.

Water & Fluid Solutions sales were up 8% on a core basis, made up of 7% volume growth and 1% of price.

Sales in the Residential and Commercial vertical, which represents roughly half of the segment, grew 8% in the quarter as the North American residential recovery continued.

We once again saw double-digit sales gains in our Aquatics business and our Filtration & Flow businesses also performed very well.

The European residential market remains sluggish, but the North American market is more than offsetting this continued weakness.

Our Food and Beverage vertical, which accounts for nearly one-fifth of Water & Fluid Solutions sales, grew revenue 25% in the quarter with agriculture, beverage and food service all delivering strong double-digit gains.

Our Infrastructure vertical, which accounts for nearly 20% of Water & Fluid Solutions sales, was up modestly as our North American break and fix business continued to ship from its backlog, and we're at long-last seeing signs of stabilization in our European business, particularly with desal customers in the Middle East.

The right half of the page shows second-quarter Water & Fluid Solutions operating profits and margins for the quarter.

Water & Fluid Solutions adjusted operating margins improved 120 basis points and hit a record 15% as the benefits of productivity and price drove the expansion.

With the North American residential recovery gaining momentum, we again saw a strong drop through to the bottom line as a result of the cost structure we built during the prolonged housing downturn.

In addition, we made good progress with our recent repositioning actions, which have begun to show benefit too.

In summary, Water & Fluid Solutions delivered its second consecutive strong quarter driven by our Residential and Food and Beverage verticals.

Now let's turn to slide 5 for review of our Valves & Controls segment performance.

The second-quarter performance in Valves & Controls is beginning to show the power of PIMS adoption.

Lean implementation continues to go better than we had anticipated and we saw further improvements in on-time delivery rates for the business.

We made good progress in Valves & Controls reorganization moves, and our clear focus on service has produced some nice wins.

In addition, we continue to be more disciplined in pursuing large projects, as evidenced by improving margin and backlog.

Also in the second quarter, we were encouraged that backlogs remain near record levels and orders grew.

We continue to expect to deliver low single-digit growth for the full-year based on our backlog and shipment schedules.

After a topline decline in the first quarter, Valves & Controls sales grew 4% in the second quarter, driven by volume, as FX and price were both flat.

Oil and gas and mining sales both increased at a low double-digit rate while power sales were flat and industrial process sales declined modestly.

We also saw strong growth in service across Valves & Controls with the top line up low double-digit and MRO growing at a mid single-digit rate.

We'll discuss orders and backlogs in further detail in just a moment.

The right half of the page shows second-quarter Valves & Controls operating profits and margins.

Operating margins were up 160 basis points to 13.5%, owing to productivity improvements.

We've seen broad adoption of PIMS, particularly in the lean enterprises, and synergies are also contributing to the margin expansion.

As we discussed last quarter, we've deployed eight senior operating leaders to help accelerate the deployment of Lean, and over 10,000 PIMS e-learning modules have been completed by over 4000 Valves & Controls employees.

In addition, over 1000 Valves & Controls employees have participated in PIMS growth training already.

In summary, Valves & Controls growth in the second quarter followed a modest contraction last quarter, highlighting that there may be some quarter to quarter variability around the timing of shipments.

But our long-term outlook in this segment remains quite positive.

Now let's move to slide 6 for a look at the orders and backlog for Valves & Controls.

As you can see on slide 6, the Valves & Controls backlog is broken down in four key industries, three of which fall into our Energy vertical -- oil and gas, power and then mining, and one in our Industrial vertical, which is the process business.

Backlog was essentially flat overall and remains at a near-record level of $1.4 billion.

Process saw a small decline in its backlog while orders grew.

There continues to be some slowness in the Asia-Pacific region, but North American quoting activities picked up as a result of projects aimed to take advantage of inexpensive North American natural gas.

Within oil and gas, backlog remains strong globally and orders grew 10% after declining in the first quarter.

The power business saw a decline in orders against a tough comparison, but backlog remains strong and we still expect the second half to show some growth in power shipments.

Second-quarter orders in mining increased as a large project was booked, but the near-term outlook on the overall industry remains challenged.

Mining backlog remains at a record level with many projects scheduled to ship through the remainder of the year.

Now let's move to slide 7 for the review of Technical Solutions.

Sales for this segment declined 4% for the quarter, led by another double-digit decrease in Infrastructure consisting largely of datacom, telecom and networking, which remains weak, particularly in Europe.

Industrial sales declined 2%, as many customers continue to delay capital spending.

After seeing daily Industrial order rates improve in April and May, we saw a decline in June.

It's too early to tell if this is a further destocking or customers further lowering their capital spend, but the outlook for Industrial remains less than favorable.

Energy sales were down 9% as our Thermal Management business saw continued delays with megaprojects, mostly in Canada.

The right half of the page shows second-quarter Technical Solutions operating profits and margins.

Technical Solutions operating margin increased 200 basis points to 17.6% owing to positive contributions from price, productivity and mix, which offset inflation the quarter.

As we've seen in the past few quarters, Technical Solutions profitable business grew, while the lower margin Infrastructure business declined.

We expect the topline to remain pressured in Technical Solutions, as an anticipated acceleration in second half Industrial activity does not appear to be materializing.

However, we anticipate further margin improvement as mix remains favorable and standardization efforts continue to gain momentum.

Let's now turn to slide 8 for a closer look at Pentair's growth in the first half.

Given the topline challenges that persist, and continued mixed economic signs, we thought it would be helpful to provide an update on the trends in our key geographies and our five key verticals.

The US has been a bright spot in the first half as the long-awaited North American residential recovery gains momentum.

We've also seen improvements in our Infrastructure break and fix business, where backlogs have remained steady for over four quarters.

Canada has been slower, with a number of delayed projects in Energy, but we've not seen many cancellations.

Western Europe continues to send mixed signals, but we saw modest growth in the second quarter after several quarters of declines.

While the European Residential and Commercial business remains weak, we've seen strength in Food and Beverage, and are starting to see signs of stabilization in Infrastructure, or, at least, tougher comps flattening out.

Fast growth regions have also been mixed with China declining, Southeast Asia and Latin America growing at a double-digit rate and the Middle East showing nice gains.

Looking within our five verticals, we still expect Energy sales to grow at a low single-digit rate for the full year.

Based on our backlogs, we see second half growth in oil and gas, power and mining.

As we alluded to earlier in our Valves & Controls discussion, Energy will be the vertical with the most lumpiness due to project shipment timing.

Industrial has been a wildcard all year, and the anticipated second half acceleration does not appear to be materializing.

The process business in Valves & Controls backlog has shipped, but the shorter cycle Technical Solutions business continues to see customers pull their purse strings tight.

Residential and Commercial is finally a bright spot, which we don't get tired of saying after a six-year downturn that we suffered in North American residential.

While there is some second-half seasonality that should contribute to the growth rate moderating, we still expect mid single-digit growth in Residential and Commercial for the full year.

We have yet to see much in the way of a recovery in commercial construction, so we expect sales to residential customers to continue to drive the topline in this vertical.

Infrastructure sales have been tracking as expected for the year, with the rate of decline moderating.

While sales and communications customers within Technical Solutions remains weak, we've seen Water & Fluid Solutions sales in North America post respectable growth, and European sales appear to be stabilizing after an 18-month contraction.

Finally, Food and Beverage remains a great story.

We're seeing strong gains in all three of our focus areas in the space.

Agriculture continues to post near double-digit gains driven by demand in both irrigation and crop-spraying.

Beverage is seeing strong demand, particularly within the beer industry.

And Food Service is having a good year, as the business is well positioned with key customers that are expanding globally.

Now let's turn to slide 9 for an update on our guidance.

We're tightening our 2013 EPS guidance to a range of $3.15 to $3.25 from a range of $3.10 to $3.30.

We've seen positives in the first half, such as better productivity and synergies, but the outlook for the topline remains murky.

In particular, the lack of second-half acceleration in Industrial, as well as FX becoming a headwind, has led us to bring down the top end of our range by $0.05.

At the same time, the elements within our control give us the confidence to raise the lower end of the range by $0.05.

Now, let's turn to slide 10 for a first-half recap and full-year outlook.

We delivered on our first half expectations as our proven operating disciplines helped to offset the ongoing external challenges on the topline.

As we enter the second half, we've seen signs that Europe is finally stabilizing, but don't see that as a signal that it is returning to growth.

We expect price to continue to offset inflation, synergies continue to move ahead of our initial expectations and our record backlog to contribute to growth in the second half.

As mentioned previously, the topline will also be negatively impacted by FX translation in the second half, which, in addition to a small divestiture that occurred at the end of the first quarter, has led us to trim our revenue forecast by one point.

In the meantime, we continue to execute on the elements within our control and we expect operating margins to expand in excess of 150 basis points, putting us on track to deliver strong double-digit adjusted EPS growth.

We've completed $825 million of our $1.2 billion authorized share repurchase program, and we expect our free cash flow to be greater than 100% net income conversion for the year once again.

With that, I'll turn the call over to John.

Thank you, Randy.

Please turn to slide number 11 titled Q3 2013 Pentair outlook.

For Q3, we are introducing guidance of $1.9 billion in revenue; around $245 million of operating income, or about 13% ROS; and adjusted EPS of $0.83 to $0.87.

There are a couple of meaningful assumptions built into this estimate.

The first assumption is that we do not see any sizable acceleration in global Industrial shipments and that the current sluggish trends continue.

The second assumption takes into account that we are expecting some shift in revenue from Q3 into Q4 from the legacy Flow Control businesses as we change their fiscal year-end from September to December to align with the Pentair fiscal year-end.

Inclusive of these two events, we expect Q3 revenue will increase 1% to 2% for Pentair, with Water & Fluid up around 3% to 4% inclusive of a couple of points of year-over-year project headwinds in the Australian pipe services business.

We expect Valves & Controls revenue to increase around 1%, inclusive of an estimated 2 to 3 points of shifted revenue from Q3 to Q4 due to the change in fiscal year-end.

And finally we are forecasting Technical Solutions revenue down about 1% as we continue to experience a more subdued Industrial recovery than previously anticipated, and delays in larger projects within the oil sands of Canada.

We expect to begin to see a more pronounced expansion of operating margins across all segments as synergies accelerate, especially with contributions from sourcing and Lean, and easier year-over-year comparisons.

Overall, we expect adjusted EPS to be up greater than 20%, with the tax rate still hovering around 25%, in line with original guidance; and interest of around $16 million and share count of around 202 million.

Please turn to slide number 12 labeled Quarterly Linearity of Earnings, where I will describe briefly our view of the back half EPS estimates.

On the top part of the page, we have laid out the 2011 and 2012 pro forma Q2 to Q3 operating income change, and the 2013 forecasted Q2 to Q3 expectation.

As you can see, Q3 of 2013 is expected to follow the same pattern as 2012.

On the bottom we have laid out some of the assumptions, and shared with you our most seasonally affected businesses in their typical best to worst quarters.

We hope you find this information helpful.

Please turn to slide 13 where I will spend a few moments on our expectations for synergies and the internal funnels that helped fuel our confidence.

On the top left-hand side of page 13, you could see our expected sourcing savings.

Our 2015 goal is $20 million.

By the end of 2013 we will have realized 50% of our goal and have a growing funnel of projects.

We have shared with you that we have been conservative in our sourcing expectations due to the fact that there is both expected base performance and expected synergies that are required.

We feel we have a solid sourcing foundation and global commodity teams that have been expanded to our new businesses, and we're seeing great success in many global commodities.

A few that we have listed for you, and across all major processes.

We are very confident that we will exceed expectations, and are muting our external goals only because we are not able to predict the inflation headwinds that may be ahead of us and the impact that it could have on our results.

On the lower left we have shared with you are goals for Lean savings.

We're targeting $45 million by 2015 and are forecasting that we will be around $10 million by the end of 2013.

Again, fairly conservative expectations given our track record, our internal talent, and our processes that are now embedded in the new businesses.

Our internal goal is $115 million, which would yield $1 million in savings per plant over a three-year horizon, well below our experience.

Again, these savings are needed for both base performance and synergies.

So we are guarding against double counting and false victory by keeping our expectations lower.

On the top of page 14, we have shared our external expectations for back-office standardization and repositioning.

Our repositioning actions have already yielded an expected $85 million in savings in 2013, but we are just beginning the journey of simplifying the businesses to reduce waste and improve the customer experience.

We are targeting internally a 2%-plus reduction in overall G&A driven by efficiency of reduced complexity and standard work and processes in the areas of ERP systems, data centers, legal entities, IT applications, and accounting and payroll centers.

A few of our businesses are well down the path on this journey and the others will catch up.

Doing this correctly and swiftly will allow us to make acquisitions in the future in our best growth platforms that should be immediately accretive due to these efforts.

The last bucket we have listed is our operating income expectations from expected revenue synergies.

We are forecasting no net contribution in 2013, as most of our significant progress has gone to the funding the next wave of initiatives and investments in fast growth regions.

Our current funnel of opportunities and recent wins are a sample of the enthusiasm that is growing within our businesses for collaborating and sharing opportunities to enhance overall revenue, but more importantly, to satisfy our key customer needs.

A few examples include recent wins in Brazil, where Thermal Management used a local Equipment Protection facility to secure a $5 million order where local content was required; an example of the systems business in Australia specifying Pentair membranes in all of their latest wins around water treatment, and the Valves & Controls business partnering with our Energy business and Filtration and Process around oil filtration capabilities; and finally, continued success with over $10 million of orders so far this year secured in Food and Beverage by expanding the breadth of products sold to existing customers.

Overall, we're on track to deliver our 2013 synergy targets and have 60% of the 2015 synergies secured, and are accelerating the pipeline every day with new ideas.

Please turn to slide 15, where I will briefly touch on the synergies by quarter.

This slide has become standard, and it briefly brings you up to speed on our synergies by quarter realized and our forecasted synergies for Q3, Q4 and the full year.

We delivered $29 million in synergies in Q2 versus a forecast of $25 million.

The upside was from more cost take-out and we are pleased it helped drive results to the upside of our Q2 guidance.

As we head into the back half of the year, we will begin to see the sourcing and Lean savings accelerate as it begins to work through inventory and into the P&L.

For the full year, we're updating our synergy expectation to $105 million from $100 million, reflecting the Q2 beat.

This should provide an exit rate of $140 million-plus in annualized savings for 2014, or 60% of the 2015 target of $230 million.

Please turn to slide 16 labeled Balance Sheet and Cash Flow.

We had a very nice quarter as free cash flow was $331 million for the quarter, driven by over $80 million in working capital improvement.

We still have substantial room for further improvement in our cash metrics in the legacy Flow Control businesses, and we're rolling out our receivable and payable policies and processes to them, as well as directing many Lean projects towards targeted inventory reduction.

On the debt side, we ended at $2.7 billion outstanding debt as we accelerated $343 million of share buybacks into the quarter.

We have now completed $875 million of our targeted $1.2 billion of authorized share purchases.

We're expecting $650 million of free cash flow for the full year.

When we complete the final balance sheet adjustments in Q3, we'll bring back the measurement of ROIC into our cash metrics page, as we are keenly aware of the importance of that key measurement.

Please turn to my final slide, slide number 17 labeled Full-year 2013 Pentair Outlook.

For the full year, we're expecting $7.5 billion in revenue.

As Randy mentioned earlier, this is on track excluding the impacts of the Aspen Motors divestiture and an anticipated headwind from FX in the second half.

This will drive organic sales growth for the year of greater than 3%, with a 5% to 6% growth in Water & Fluid Solutions inclusive of pipe and services project headwinds; 1% to 2% organic growth in Valves & Controls; and flat to 1% growth in Technical Solutions.

Overall, operating margins are expected to be 160 basis points to 12.5% and overall EPS is expected to be up greater than 25% at the midpoint of the range.

With that, I will turn it back over to Randy, who will summarize, and then we'll open it up for questions.

Randy.

Thanks, John.

My summary is on slide 18.

In closing, we delivered on our first half commitments and we remain well-positioned to meet our 2013 full-year goals.

While the anticipated second half acceleration in Industrial and a growing FX headwind have dampened our topline expectations, we continue to see strength in North American residential and Food and Beverage, in addition to backlog in Energy that remains strong.

Our integration and standardization efforts continue to build momentum and we now expect $105 million in synergies in 2013 versus our original target of $90 million.

We're pleased with the success of the integration so far and realize that there is still a lot of work to be done.

But the adoption of PIMS within the Flow Control businesses continues to exceed our expectations as we evolve into one Pentair.

Thank you and operator, can we please take our first question?

Michael Halloran, Robert W. Baird.

So, could you just dig in a little bit to the Food and Beverage strength, and specifically what areas you are seeing it in?

And also if there's any tie-in to some of the things you're doing with Tyco on the food and beverage side and any of the revenue synergies there that might be developing?

Sure.

In what we call Food and Beverage, we have three focused areas.

One is agriculture where we have two positions, which is basically irrigation, largely North American related, and then crop spray, which is on tractor, on equipment, spray technologies.

That is actually a global business.

We have what we call our beverage business, which is supporting the manufacturers, if you will, of food and beverage.

And then we have the food service business, predominantly our Everpure brand that supports the restaurants and other food service players.

All three of those businesses grew double-digits.

Irrigation and crop spray has been a strong focus of ours, and that growth is coming in North America.

And it's the strength of the farm community essentially that's driving those, as well as nice global initiatives with some of the winning OEMs.

If you recall last year, on the beverage side -- basically dairy and soda and beer, last year was a tougher year where we were working on a lot of projects but they were not shipping.

This year we won a lot of those and they are doing very, very well.

Dairy in North America is very strong as well as beer, not so much in the developed markets but in the developing markets.

Particularly Africa and Southeast Asia the beer industry is growing very rapidly.

And we have leading technologies in that arena.

Also in that arena is where we are getting the synergies.

John mentioned $10 million of orders to date because of the synergistic offerings we have between our membrane technologies, our hygienic valves and the broad valve line that came from Tyco, and that's where the $10 million win is.

So the synergies are helping there.

And then finally food service, we are the strategic partner for the leaders and we have a lot of very state-of-the-art systems that they are adopting as standards, and as they grow globally we are winning with them.

So that's been a focus of ours for a long time, as you know, since 2003 actually, when we bought Everpure.

Right.

And it's nice to see it all working.

And then the follow-up on the order side for the Valves business, could you maybe just talk a little bit about the underlying momentum you're seeing there on the quoting and bidding side, and what your team is saying for how they expect some of that to materialize as you get to the back half of the year, and specifically in the Energy and power oriented end markets?

I'll provide some texture for you and then John can add in.

One of the things we've seen is fewer larger projects and a lot more smaller projects.

That's reading out in service volume.

It's reading out in MRO.

As we said, we have seen more process bidding in the US as capital, particularly for the chemical industry, cap spending in North America versus other areas has been rising.

So we're seeing bidding activity there.

I mentioned oil and gas is strong, but it's lumpy quarter to quarter and it's mostly upstream activity that we are involved in.

There's a lot of midstream activity, but that's an area I think where we need to grow share.

And then power where we are the leader, we have a decent backlog.

There is lots of activity in the developing world.

We'd like some of that to break free to ship.

John, would add anything?

No, I think you covered it.

I would just add to Randy's point that I think it's not as predictable as certainly our business and we would like.

But we're still seeing nice orders and we're still experiencing right now record backlog.

Yes.

One thing I'd say is that the new organization has been put in place has really clarified and simplified some of the decision-making there.

So I mentioned in the script that we are seeing an improvement in the margin in backlog.

We still have to ship some of what I would call ugly projects that were taken with more revenue in mind than margin.

That's a process that's been fixed but we still have to mind some of that through the backlog into sales over the rest of the balance of the year.

Well, I appreciate the time, thanks.

Jeff Hammond, KeyBanc Capital Markets.

So, I just to be clear on Valves & Controls, is the shift that you're seeing Q3 to Q4 more because of the organizational change or because of projects moving around?

They had a Q3 fiscal year-end, and as you know, there's always a push for incentives and to ship anything you can and book as many orders as you can by the end of whatever your fiscal year-end is.

The natural year-end in this business, because it's a capital spending across an annual cycle, would normally be Q4.

It would be the calendar Q4 like all the customers.

So what we are anticipating is that we will see likely revenues that might have been accelerating into Q3 follow their natural course of action and likely land in Q4.

Okay, and then in Water, it looks like you're calling for core growth kind of in line with the first half or maybe a little bit lower, yet the comps are a lot easier in the second half versus what you went against in the first half.

So is that again timing of shipments and some of this food and beverage stuff?

Or are you seeing some deceleration in some of those businesses into the second half?

No, we are seeing strength across all of what would be the legacy Pentair water businesses.

The only area that we have a little bit of headwind, Jeff, is we picked up a water business in Australia, which is part of the Flow Control businesses.

And there is a lack of projects in the backlog right now, primarily because most of the mining projects are being pushed into next year.

We had a year-over-year headwind, as I mentioned in my prepared remarks relative to that item.

Everything else is continued strength.

Okay, thanks guys.

Josh Pokrzywinski, MKM Partners.

Just to dig in again on the food and beverage and the visibility there, I mean, it seems like that was a bit of maybe an unexpected tailwind this quarter, or at least versus what you had in the first quarter 2013.

You're kind of doubling the growth rate through the balance of the year.

And I think for such a small business in the grand scheme of things to add, I think, on the consolidated basis a point of full-year growth, I'm just try to understand.

Does visibility take you through the end of the year?

Are there -- is there a chance you could get more project push and pull their quarter by quarter?

Obviously, people are still grappling with the seasonality and I think so much volatility in a small business.

Any color there would be helpful.

Because of the range of different areas we are in, some of them are fairly short cycle.

The irrigation business is sold through distribution.

And it's a shorter cycle business in North America versus the brewery business which we've got scheduled out a number of quarters.

We've got good visibility on that.

So it's really kind of a mix.

When I think about the strategy that's informed everything we've done, the focus, our Company, on going after that billions of new middle-class people on the demands they're going to drive, this has been a big focus.

And I wouldn't say that they -- and certainly 25% growth in this segment was a little higher than we would have forecasted.

I'd like to get used to forecasting that, but I don't think we forecasted that for the second half, have we John?

No.

Same rate.

Mid-teens.

Yes.

Got you, that's helpful.

And then just on the synergies, I think I asked last quarter as well and it's probably a little too early.

But any more color you can provide on what the bridge may look like between the $105 million in synergies this year and the $230 million in 2015, and how we should think about 2014 as a bridge between the two?

Yes, I think I mentioned in my remarks we are at $105 million, and we're exiting at $140 million-plus.

The plus would mean that we expect to realize $140 million of synergies from the exit rate in Q4 there, Josh.

Plus, if you take a look into the financials, we also took some incremental restructuring this quarter which will not likely benefit us until 2014.

Obviously, we want to get as much as quickly as possible for two reasons.

One is we want to make sure that tailwind for us.

And the second reason is we're driving the standardization across the GBUs for if and when we can do acquisitions again, that they can become synergistic and quickly accretive.

So there's a push to get that sooner rather than later as far as the total synergies.

There's no governor on what the total synergies can be.

As we tried to hint, we have a clear pipeline that should take us higher than the $230 million that we're driving to.

Understood, helpful, thanks guys.

Steven Winoker, Sanford Bernstein.

Hey, good morning, guys.

First question on page 20 of the reconciliation, you do mention the restructuring.

It looks like you're saying it is complete for the year.

Why is it zero for Q3 and Q4?

We don't have anything quantified at the moment, Steve.

It doesn't mean we wouldn't continue to look at opportunities.

I mean I think every time we meet and learn more about these businesses, we see more opportunity around the corner.

If we are going to see a flatter Industrial cycle over the horizon, we'll likely go back for more.

But right now we don't have anything quantified and we don't have any specific projects in the pipeline.

Even in getting to that full $230 million number?

Yes, our goal would be, if we look at 2014 and certainly in 2015, we have set aside what we call this integration standardization team budget.

We should be able to handle annual restructuring within that context as we drive to the 2014 and 2015 numbers.

Okay, and then second question on your margin breakout.

You had 20 points on volume leverage, 260 price productivity mix and 160 offset on inflation.

You know, with 4% growth and even looking at minus 4% in Technical Solutions, I would have thought my math on a higher fixed cost base would've gotten me a slightly -- a more significant margin on the volume side.

And then just maybe give us a sense for productivity within that price productivity mix, just a little bit of breakout there to get a sense for what's really happening is a result of operations as opposed to sort of pricing or mix.

Yes, I think all of your math is accurate.

The only two items that I would bring some color to, which were negative mix impacts or negative productivity is we were down double-digit in our Residential Commercial EMEA business, and that's a highly profitable business for us.

So that's inclusive in that negative productivity or negative volume impact, Steve.

The second one is some of these beverage projects, these large systems that we are putting into the new breweries do bring through a little bit lower margin than when we get the replacement membranes through those systems.

Those would be the only two things that I would add in addition to the math that you went through.

Okay.

Great, thanks, let me hand it off.

Scott Graham, Jefferies.

One question and one follow-up as requested (laughter).

What is your confidence, Randy, in being able to sustain positive price for the rest of the year?

You know, one of the measures we always do when we talk about being in businesses where we control our own destinies, one of the proof positives of that is your ability to get some price.

In our businesses that go through distribution, which are a lot of the ones that are growing right now -- you know, the food service business, the Residential business, the irrigation business, the Aquatics business -- through distribution, it's good structure.

There's been no changes in competitive dynamics that would indicate to me that we shouldn't be able to sustain price there.

The area that's always difficult to calculate price is in the project area.

In the project area of Food and Beverage, and the larger bids in Valves & Controls and Thermal, that's where we're tracking margin in backlog.

It's hard to say whether it's price, but the important thing is to get margin.

So I feel good about our disciplines around price, and I feel confident in our focus on price, so.

Great, thank you.

The follow-up question is probably more for John.

John, the productivity target, forgetting about the synergies, but over and above that the productivity target of 100 basis points per year in each side -- the Pentair side and the Tyco side -- has that changed at all?

Are you tracking along the 100 basis points of your core block and tackle type of productivity in each business?

Yes, Scott, we're looking at about 160 basis points a year.

We went public saying about 80 basis points a year from core and 80 basis points from the synergies and standardization.

And against that 80, I'd say absolutely.

We feel like there is more in the core, too.

If we get more revenue growth or see more quarters at 4% and above, we should be inching that base higher than what we are targeting because volume leverage is a very powerful thing.

Yes.

Fair enough, you always did say roughly 100.

I think you were probably rounding up, so 80.

So it's on track, nothing is changed.

No.

Very good, thanks.

Thank you.

Deane Dray, Citi Research.

On North American water, maybe you can give us some color regarding some of the dynamics and product lines.

This was one of the wettest periods that the Northeast certainly has seen in years.

Was there an impact?

I know it's a lower margin on the sump pump side.

And maybe comment how the spring selling season in pool went.

Yes, you know, the wet Northeast in particular slowed Aquatics a little bit, but not much.

And it certainly was a benefit in our Flow Technologies business.

They had good double-digit mid-teens kind of growth largely driven by flood related residential and commercial spending.

An interesting aside, right now globally we have about 50 projects that we're working on, on flood protection.

It is -- these are large projects, obviously, more along the lines with what we've done in New Orleans and other places like that, in the Netherlands.

So, flood continues to be a good focus of ours.

But Aquatics, you know, our market share position and because of our leadership in technology and innovation in Aquatics, we do really well where there are a lot of pools.

And that's the South.

So they were less impacted.

They actually had a slow start, too, weather-wise in the South.

But it wasn't quite as impactful as if we had just been focused in the Northeast.

And what was Aquatics year over year?

In the quarter?

Yes.

They were up high teens.

Yes.

I mean, just add to Randy's point, and I think this was in his remarks, the North American residential segment grew as a whole low double digits.

So we saw that strength.

Clearly we had some easier comparisons on retail in Flow and so those were up very, very strong.

Even Filtration and Processes, water softener market was up nearly 5%, that's the second quarter in a row now that we've seen that growth.

And that's a later cycle.

Yes.

It's a later cycle recovery kind of product line.

I mentioned in the script that Residential and Commercial was up 8%.

That this with Europe down.

So, North America resi itself was up 12% to 14% in the quarter.

Great, and then a follow-up.

On page 13 when you go through the key internal funnel, the $115 million, there's a line in there with a checkmark, says Pentair experience has been on a factory greater than $2 million in savings.

And you made a reference to the $1 million assumption.

And I remember that was from the initial Tyco facilities.

Are you just showing that -- I'm trying to reconcile the $2 million.

The $2 million is what you had gotten previously in sort of the PIMS initiatives and showing that the $1 million assumption is conservative?

Is that the point?

Yes, it's obviously an average, but you could read into it that that is below our experience level and we would be disappointed if we only achieved that result.

All right, that's helpful.

And just lastly, the buybacks in the quarter at that pace, do you expect to be able to continue that pace carried into next year?

I don't think it will be that pace.

We haven't figured out what we're going to do yet.

But we felt that it made sense to accelerate the buybacks given what we were looking at in the acquisition funnel.

And the good cash flow.

And the good cash flow that we had.

Obviously, we'll take a look at what Q2 and Q3 and the remainder of the segments look like at the appropriate time.

But you have the authorization and the cash flow to support that level if you wanted, though?

Yes.

To the $1.2 billion, yes.

Great, thank you.

Hamzah Mazari, Credit Suisse.

Randy, I was hoping you could give some more color on the second half Industrial re-acceleration not materializing.

I assume that's broad-based.

Any particular regions where it is worse than expectation, and also any views on further destocking and what you are seeing in July?

Sure, let me parse it between the different segments.

In the process area of Valves & Controls, we actually see some decent order activity.

And it's largely in the chemical arena, and largely because of the low energy costs we talked about.

Our second half assumptions around our Hoffman brand, you know, the profitable juggernaut, if you will, of our Technical Products business was that we would see the same kind of continuation in order rates.

As we mentioned, June went down.

I wish we had better visibility you know that's all sold through distribution.

Right now we just don't see the capital spending breaking out.

So what we had was we had a very profitable segment, a very profitable product line in Hoffman where we didn't feel comfortable that we had the visibility on the base to continue with that base assumption that we would see Industrial up 3% to 5% in the second half.

So that's really what it is.

I don't think that there's been a major drawdown.

We don't think there has been a major draw down in inventory.

We have really good visibility on our inventory in the channel.

The thing that I've asked our business to do is find out, we can see publicly which distributors are performing.

And we have a few peers left that we can track in terms of their growth, and seeing if we have been active enough in managing our distribution coverage to make sure that we are getting the add back where markets are growing.

And that's an area where I'm not yet comfortable we have adequate coverage I'd say in the Balkan or some other areas that should be growing.

Great, that's very helpful.

And just the follow-up would be on the Valves business, could you give some color on what you're seeing on the aftermarket side for the Valves business?

You know some of your peer group is seeing some deferred maintenance still amongst customers.

Are you seeing that?

Or -- it seems like your business is doing better on share gain; any color there?

I don't know if it's that we're in different segments than our peers.

Right now, as I mentioned, our service business is up; MRO is up.

Now, we have a strong focus on it.

One of the beauties of the new organization is the clarity of focus we're getting on different areas and the teams rallying together really nicely.

They really are running it as one Valves team.

Actually we see the opposite in mining.

We see a lot of the activity, particularly in Australia, moving -- since capital is down, we're seeing maintenance up, which makes sense, right?

If you're not replacing equipment you have got to maintain the equipment you got.

So I think it really depends on where your exposure is, as to what you're seeing.

We've had a lot of focus on where we are losing, where were not seeing large projects, focusing a lot on smaller projects.

I think that's helped us in MRO.

And I hope it's share gain, but I don't know enough about the business yet to be confident in saying it is or not.

Got you.

Thanks a lot (multiple speakers) -- sorry, go ahead.

Just to follow up on Randy's point real quickly, I mean, I think where we are seeing deferrals is in larger projects.

Right.

And we continue to see those larger projects, as many of our peers have said, being pushed out now.

Randy and I were also talking that in the Industrial space, capital is at an all-time borrowing rates low.

IRRs are really high on putting capital to work, and with the threat of increasing interest rates and what particular point in time are we going to see that breakthrough.

That's not in our forecast right now, but that's what we're monitoring and keeping an eye on.

Great, thanks a lot.

Brian Konigsberg, Vertical Research.

Hey, John, I think you had mentioned -- there was a question previously, I do believe it was Steve talking about the conversion of the core business.

And you highlighted the Water and Fluid component.

But actually the Valves & Controls piece it looks like the core conversion was fairly modest as well.

Maybe can you address that?

Was there something unusual in the quarter?

And maybe how do we think about normalized conversion rates in that, excluding productivity and price and others?

Yes, I think Randy mentioned this earlier.

We do have a few larger projects that are in the backlog that are working their way through.

They will probably be working their way through Q2, Q3, and Q4.

Those were won previously.

As Randy also mentioned earlier, we changed our focus to be more of making sure that we've got a better insight into what the margin backlog is.

And quite frankly our margin backlog is higher now, so that bodes well for the future.

But what we've got is a little bit of shipments that we still have to get through.

It's like heartburn.

Yes.

Okay, I got it.

Have to work it through the system.

I see.

And then actually you mentioned FX, a headwind in the second half of the year; that just seems kind of contrary to what we see with the euro for sure.

Why is that a headwind?

Are there other significant exposures we should be thinking about for Pentair's business?

Yes, two particular currencies -- one is the Australian dollar, which is a big piece of this on the billion dollars or so of Australian business we have in both Valves & Controls, the legacy Pentair businesses, and also the Flow or the pipe and systems business with inside of legacy Flow.

The second currency would be the euro.

We did do this forecast at about $1.29.

I do recognize that that's slightly below where the current euro/dollar is.

This was factored on $1.29.

Can I slip in one more quick one in?

You mentioned process.

Actually it's good in North America because of natural gas.

But in Asia, I think second quarter in a row you said it was weak.

Maybe you could just touch on the trends there and I'll pass it along.

Well, it's really China.

I mean, China Valves & Controls and processes is down, and it's the slower capital spending that's going on there.

We have a pretty substantial business there in Valves & Controls.

And the rest, Southeast Asia is good.

So, it's really specific to China that's slowing.

I mean I think everyone is talking about that.

Right, do you think China is actually pulling back because of the build in North America?

Or is it just an issue with the internal funding mechanisms?

I think it has more to do with just the general slowing of Industrial activity there and them getting overshot.

You know, most -- I think every industry always puts in too much -- when the growth rate changes, you really have a bunch of capacity that gets put online that you don't need to soon as you thought.

I mean it was true in the power industry in the US and basically every -- happens in the pulp and paper industry all the time, but I digress.

Right.

Thank you very much.

Garik Shmois, Longbow Research.

Actually a follow-up to the last question on China and fast growth markets in the back half of the year.

It was up 2% year to date for fast growth overall.

Just wondering what your expectations are for the second half of the year in those regions?

Yes, and I'd say we've got it close to the high single digits in Q3 and Q4.

I think the main reason for that, as Randy mentioned earlier, some of our fast growth region volume is more project-oriented or related to where the orders in the backlog and the timing of that backlog is.

So we do have a forecasted higher single digits for fast growth regions in total for the second half of the year.

Okay.

And those would be non-China markets, I understood; is that correct?

Well, China would be a part of that as well.

I mean, one of the markets in China that is big for us is power.

Power.

We've been building the backlog throughout the last three or four quarters.

We do expect those projects to ship in the second half.

Okay and then just lastly, just on the full-year guidance, first half of the year you had exceeded your midpoint both quarters.

And you maintained the midpoint for the full-year guidance, albeit narrowing the range.

I can appreciate that you have a more conservative revenue outlook that you cited because of the divestiture plus FX.

It seems like Industrial is slowing a little bit.

But Water does appear to be accelerating.

Just wondering if you could walk us through your thinking on maintaining the guidance despite the strong first half of the year.

Yes, I would say it's less conservatism and it's more experientially-based.

You know, we always know it can go well but we always know that stuff goes wrong.

And since we don't know what's going to go wrong, we're twice bitten, once shy.

Okay, fair enough, thanks.

Once bitten, twice shy?

(laughter)

Brian Drab, William Blair.

I think it was mentioned that some of the projects in backlog, some of your businesses are of lower margin than average.

And some are at higher margin, I think John just mentioned.

Can you give us a sense for what the average margin of orders and backlog is relative to the 13.7% that you did this quarter?

I can tell you that the standard margin in backlog is about a point higher in the outlook.

If I take a look at 2014 and beyond, it's about a point higher than what we'll finish shipping in 2013.

It's related to three or four larger projects that were won about 18 months ago, Randy?

Right, right.

Those projects are at a very, very low margin.

And as Randy mentioned, we changed that behavior to be more margin focused.

And so I think we have a richer, more favorable backlog as we go forward.

Okay, great.

And then the legacy type of Thermal Controls business is about 10% of your sales after the merger, I believe.

You mentioned some delays in that business.

But are you seeing cancellations?

Is the oil sands business slowing?

What does the pipeline look like there?

Yes, we referenced Canada.

It is the oil sands that have slowed down.

In fact in the quarter year-over-year there was a really large shipment in the oil sands a year ago that wasn't in the numbers this year.

That was the big Energy down, if you will, in that business.

That business has done a nice job growing the smaller businesses, though, so -- and nice improvements in profitability in that.

So we think most of those projects will go.

And when they go, we'll do fine.

In the meantime, we'll grow elsewhere.

So growth in that business, though, over the next 18 months or -- how is the pipeline?

Just to remind everybody what we did was we did go in and pro forma the financials for the Thermal business, excluding megaprojects or large projects.

So our forecast in the way we're looking at it is primarily base projects and product shipments.

And as Randy mentioned, we believe we can grow mid-single digits in that business.

And then these particular large projects that we're talking about, they would be phenomenal to have , but we don't have to have them is the way to describe it.

Got it, thank you.

David Rose, Wedbush.

Just a follow-up to -- a couple of follow-ups; but to the last question, just to be a little bit clearer on the Canadian business in the expectation for Thermal, did that imply we don't have any major projects coming in through the third quarter on a year-over-year basis?

That's correct, yes.

There's no major projects in our Q3 or Q4 outlook.

Okay.

In fact one of the things that -- and this is actually kind of fun.

One of the things that we are doing as we come to become one Pentair is really to establish a set of principles around how we build the business and forecast it.

Anything that we really don't control our own destiny on or have really high visibility, let's put those above the forecast.

That's where the philosophy on these megaprojects that John just talked about came from.

We love them when they happen, but we're going to build a business where that's more than gravy on top.

I can appreciate there's a lot of legacy business that you did not have.

And if we look at the Australian business, what was the drag on that business and what -- was the pipe business profitable in the quarter?

Yes, it's actually a very profitable piece of the overall business.

It's just that there is not a lot of large projects in the backlog and/or in the shipments now.

And as you know, the business can cycle up and down from call it 10%-ish margins to 20%, 25% at the peak.

So the assumption is that (multiple speakers)

Right now we're heading towards the bottom of that assumption (laughter).

We think there's a political situation that has got to unwind itself as far as the tax on the mining groups.

And as that unwinds, we're hopeful that the future is a lot better than the current environment that we are participating in.

And to be clear, that's a component of why you expect Water & Fluid Solutions to step down in terms of year-over-year growth?

That's correct.

Okay, great.

Thank you very much.

Jeff Hammond, KeyBanc Capital Markets.

Hey guys, just a follow-up on the synergy and funnel comment.

Would you -- as you identify those additional funnel opportunity, is that something you think of as upside in 2014 and 2015 or upside beyond 2015?

Well, Jeff, not to confuse you, but here's the way to look at it.

When we look into sourcing and Lean, there's both a base and a synergy.

As we said before it's hard to track what's truly a synergy sometimes versus what's the base expectation.

So we have productivity funnels; we need those productivity funnels and we're driving gross margin and making sure that volumes leveraged appropriately.

Clearly when we look at the operating margin of Pentair and we look at the operating margin of our businesses, there is a substantial amount of opportunity between where we are and where our benchmark peer groups would be at.

We're not going to lose sight of that opportunity and what we're really trying to do.

Randy and I were talking yesterday; we have to drive the business models.

And that business model creates that opportunity.

These are rich pipelines, but I think they are going to continue to get richer as we go forward.

Okay but the $230 million number is what's in your $5 number or (multiple speakers) and so the $160 million over is upside opportunity?

It would be if all realized, correct.

All realized above the base.

The point, Jeff, is -- and you can even think about the $105 million versus the $90 million as higher yield of either productivity or synergies.

Frankly, I'm indifferent because what we want to do is build business plans in each of the segments that incorporate both, right, and that's victory.

That's only victory if it reads out at the bottom line.

So we can't have higher synergies and lower productivity or vice versa.

So, that's the way we think about it and that's what John was describing.

Okay, thanks guys.

Your next question --

How many questions left?

How many people?

This is the last one.

Last one, okay.

Steven Winoker, Sanford Bernstein.

Hey, thanks for taking this last question.

Randy, we had spoken over the last six months about you getting to the point in June or July where you'd expect to arrive at some conclusions with regard to several of the businesses that might fit that are with other owners.

How has that thinking progressed in the current environment?

How should we think about that going forward?

Well, we never don't think about that.

And you're right; I always put things out in six months.

That's probably what I did when I said that.

But we are always looking at how things fit.

Right now we're going through a process in our strategy where we are looking at dozens and dozens of platforms and looking at the priorities.

And at the end of that process, we'll decide where we are.

But in particular a lot of people ask about Australia.

As we have gotten into Australia, we look at it, we are sort of at the bottom of a cycle in terms of mining and domestic water spending.

But we're finding some nice synergies and we are finding some people who are really buying into what we're doing.

In Pentair, we've taken some cost structure out.

So, you know I think it's a better business than I might have thought going in.

Okay, we'll keep following it.

Thanks.

Thank you.

All right, thank you all.

And operator could you give the call back number?

Thanks.

Thank you for joining today.

Ladies and gentlemen, this concludes today's conference call.

And for a replay the number that you would need to dial is in the press release.

It's in the press release.

Thank you all.

Thank you.

Okay, thank you very much.

This concludes today's conference call.

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