濱特爾 (PNR) 2013 Q3 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the Pentair Q3 2013 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) I would now like to turn the call over to Mr. Jim Lucas.

Please go ahead, sir.

Thanks, Michelle, and welcome to Pentair's third quarter 2013 earnings conference call.

We are glad you could join us.

I am 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 our third quarter 2013 performance as well as our fourth-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 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.

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 would like to request that 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.

It was on this call one year ago that we talked about a successful day one following our merger with Tyco's Flow Control business.

Today we can look back at a very successful year one.

The integration is ahead of schedule and we again have seen our synergies exceed our plan in the quarter and for the full year.

Culturally, the two organizations are coming together as one Pentair.

While there is still more to be done, we are pleased with our progress in this first year.

We have clearly demonstrated the power of the Pentair Integrated Management System in delivering on the integration.

Now we look forward to delivering year two of the new Pentair.

Let me turn to our third-quarter performance on slide 3. Before I go through the results in detail, as has been our practice since the Flow Control merger, I want to note that we again 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.

The third quarter met our expectations on the bottom line as margins expanded 210 basis points to 13.6%.

Price and productivity more than offset inflation, mix was positive and synergies read out better than expected.

Our adjusted EPS grew 25% even though sales declined 1% organically.

For the quarter, sales were $50 million below our expectations due primarily to weak results in Australia that were not only related to the local economy, but also suffered a significant FX headwind.

While we are not pleased with the top-line performance, we continue to see growth in many of our more profitable businesses, including stabilization in the North American electrical distribution channel.

Residential continues to be a bright spot for us.

Food and Beverage remains very strong and, encouragingly, we saw modest growth in Western Europe for the second consecutive quarter.

We continue to build momentum on the elements within our control, and because of our strong PIMS execution, we are targeting double-digit EPS growth for the year.

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

Water and Fluid Solutions sales were up 1% but improved 9% excluding the negative impact of the sharp decline that our Australian water business experienced in the quarter.

Sales in the Residential and Commercial vertical, which represents roughly 45% of the segment, grew 12% in the quarter as the North American Residential recovery continued and we saw growth in commercial channels.

We again had double-digit sales gains in our Aquatic Systems business while our Filtration and Process and Flow Technologies businesses also grew well.

Europe showed a modest improvement in the quarter, and while we are not expecting a rapid rebound, we are at least seeing signs of stabilization at last.

Our Infrastructure vertical, which accounts for nearly 20% of Water and Fluid Solutions sales, showed a sharp overall decline as Australian projects paused in 2013.

In North America, we saw strong double-digit growth as the break-and-fix pump business continues to improve.

We also saw strong global infrastructure pump sales as a result of gross synergies generated by our global sales force selling the full range of Pentair products.

While the global municipal markets remained challenged, we believe our sales growth is proof that our sales efforts and scale are yielding results.

Global desalination opportunities are at a low level not seen in over a decade, and while project activity remains very low, our win rate remains high as we secured two more significant orders in the quarter.

Our Food and Beverage vertical, which accounts for roughly 1/5 of Water and Fluid Solutions' sales, grew revenue 20% in the quarter.

We saw double-digit sales gains in both beverage and food service while agriculture sales continued to grow at a high-single-digit rate, showing some moderation after strong growth last couple of years.

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

Water and Fluid Solutions' adjusted operating margins improved 280 basis points to 13.4% as the benefits of productivity and price drove the expansion.

Although our Australian water businesses saw a sharp top-line decline, the team there responded aggressively by right-sizing the cost structure and achieving margins that were flat.

In addition, we made good progress with our recent repositioning actions.

In summary, Water and Fluid Solutions delivered another strong quarter driven by our Residential and Food and Beverage verticals, masked somewhat by the tough market in Australia.

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

The third quarter performance in Valves and Controls again demonstrated the power of PIMS adoption.

Lean implementation continues to go better than we planned, driving productivity and improvements in on-time delivery rates for the business.

We made good progress in Valves and Controls' reorganization efforts and our clear focus on service has produced some early wins.

In addition, we continue to be more disciplined in large projects as the margin and backlog continues to improve.

Valves and Controls sales declined 1% in the quarter but would have been up 1% if Australia were excluded.

Oil and gas sales were flat in the quarter as we have seen many downstream customers defer annual maintenance shutdowns due to high activity.

Mining sales were up 2% in the quarter as we continue to ship on our project in the Middle East.

Power sales declined 10% as Europe remains weak and projects in China and India continue to be pushed out.

Industrial grew 5% driven by MRO activities increasing and growing investment by North American chemical customers.

Many companies are taking advantage of lower input prices and adding US capacity for the first time in quite a while.

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

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

Operating margins were up 190 basis points to 13.1%, owing to productivity improvements.

We saw accelerated adoption of Lean enterprise and synergies also contributed to the margin expansion.

Additionally, more disciplined pricing helped margin expansion.

Our focus on service and MRO has also helped drive margin improvements with mild single-digit growth across all key verticals.

In summary, Valves and Controls faced a tough year-over-year comparison but still delivered robust margin expansion.

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

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

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

Process saw a modest decline in its backlog and orders remained weak due to tougher comps in Asia.

We continue to see North American chemical activity as many manufacturers take advantage of lower natural gas prices.

Within oil and gas, backlog remains strong globally and orders were down year-over-year as large project activity continued to be delayed.

We believe this is seems to be more of a timing issue as quoting activity remains healthy.

In addition, we have seen many refining customers defer annual maintenance, as they are not shutting down and continue to run near full capacity.

The power business saw a slight increase in order as activity in China picked up.

Third-quarter orders in mining decreased as expected, and we expect this small piece of our Valves and Controls business to continue to be weak.

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

Sales for Technical Solutions declined 8% as our Thermal Management business not only faced a tough comparison due to a large project a year ago, but continued delays in Canadian project awards and slower European Industrial sales accounted for the majority of the decline in this segment.

Equipment Protection posted modest sales growth in the quarter as North American Industrial stabilized and we experienced growth in European electronics sales.

Although Thermal experienced a sharp top-line decline in the quarter, orders and backlog grew, reflecting our entering the seasonally strongest period for the business.

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

Technical Solutions operating margins increased 240 basis points to 20.6% on positive combinations from price, productivity and mix.

In addition, the adoption of PIMS within Thermal has continued to gain momentum and Equipment Protection experienced strong contribution margins with the improvements seen in Europe during the quarter as well as strong productivity overall.

Let's now turn to slide 8 for a closer look at growth year to date.

Given the top-line challenges that persist and slow economic recovery, we thought it would be helpful to provide an update on the trends we see in our key geographies and our five key verticals.

In North America, the US has benefited from the continued improvement in Residential, and we have also seen improvements in our Infrastructure break-and-fix business.

Canada has been slower with a number of delayed projects in Energy.

We have not seen many cancellations.

Western Europe is finally showing signs of stabilizing as many of our businesses that experienced a downturn early in the cycle are starting to see some volume growth.

The last business to see the downturn, Thermal, is starting to see activity pick up as tougher comparisons begin to anniversary.

Residential in Europe seems to be stabilizing and we saw growth in Commercial during the quarter.

In addition, the European Equipment Protection business has returned to modest growth.

Fast growth regions remain mixed, but China declines appear to be slowing and we continue to see growth in Africa, Southeast Asia and the Middle East.

We've talked in the past about opportunities that we see in the Middle East and we wanted to highlight a recent growth synergy.

Earlier this year, we invested to localize our commercial pump line in the Middle East, utilizing the Valves and Controls plants in Sharjah.

After only a few months, we are already booking orders and delivering pumps to serve buildings and other commercial applications there.

We think these new regional product lines could at $25 billion to $50 million in incremental sales over the next five years, so it is encouraging that we are off and running.

Looking at our five verticals, we now expect Energy to be flat for the year compared to our prior forecast of modest growth.

When looking at our backlog and timing of shipments for the fourth quarter, we expect to see growth sequentially.

We continue to expect Industrial to be down modestly for the year, but the stabilization we began to see later in the second quarter has continued in line with our expectations.

Further, the process backlog in Valves and Controls is expected to continue to improve based on the strong quoting activity we are seeing in North America.

Residential and Commercial has been a bright spot all year, led by North American Residential.

While Commercial is a smaller contribution for us, we are seeing signs of improvement in both North America and Europe.

European Residential has also stabilized at long last, which means it is at least no longer getting worse as we wait for signs of further improvement.

Our outlook for Infrastructure is now lower, given the ongoing headwinds we expect in Australia.

We continue to expect a solid performance in North America.

While the outlook for global desalination opportunities remain weak, we have won a couple of jobs recently and our shift in investment from municipal to Industrial are starting to pay dividends.

Finally, Food and Beverage remains a great story.

We are seeing strong gains in all three of our focus areas in this space.

Beverage has been a great story all year, driven by our beer membrane filtration growth, and our backlog remains strong.

Food service is well positioned with key customers that are expanding globally.

Agriculture again posted near double-digit gains, driven by demand in both irrigation and crop spraying.

We expect the growth rate to moderate, but for growth to continue in the fourth quarter.

Let's now turn to slide 9 for a year-to-date assessment and full-year outlook.

Our results through the first nine months of 2013 met expectations as we have been able to over-deliver on synergies, productivity and price, which have offset some of the top-line challenges we faced.

We expect Australia to remain a headwind, but we continue to see solid backlogs in our longer-cycle businesses elsewhere.

Europe is no longer a negative and we are experiencing growth in our more profitable businesses while driving standardization across the Company GBUs.

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 have completed $875 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.

With that, I will turn the call over to John.

Thank you, Randy.

Please turn to slide number 10, entitled Q4 2013 Pentair outlook.

As we close out the year, we are anticipating revenue and operating income for overall Pentair to be about the same in Q4 as it was in Q3.

We are forecasting overall revenue to be about $1.8 billion, down slightly from Q3 and up 3% to 4% from Q4 of 2012.

Water and Fluid Solutions revenue is expected to be up 2% to 4%, reflecting continued Australian headwinds in our water transmission business, no improvement in the Australian dollar and continued strong performance in our Residential and Food and Beverage verticals.

The shift in the fiscal year end had a negative impact in Q3 for Valves & Controls, but we believe it will help Q4 with expected sales growth of greater than 6% versus Q4 of 2012.

Overall for Valves and Controls, we expect the seasonality of the quarterly revenue and income that we have delivered and our forecasting in 2013 to be the new pattern for their performance.

Finally, we expect that Technical Solutions will deliver their first year-over-year growth quarter of 2013 as Industrial headwinds are now lapped and year-over-year large project comparisons in our Thermal Management business are behind us.

We are expecting strong adjusted operating income performance of around $242 million, down slightly from Q3 and up sharply from Q4 of 2012.

We do want to remind you that last year's results included $20 million of transition cost associated with the merger with Flow Control.

We believe operating income will expand over 45% and operating margins are expected to be 13.4%, up 390 basis points with strong contribution from all three reporting segments.

You may have noticed in Q3 and in Q4 corporate costs are lower.

This reflects our final knowledge of incremental costs that, as of Q3, are now being allocated into the appropriate reporting segment.

The reported corp.

cost of approximately $25 million now reflects the appropriate ongoing corporate expectation.

Finally, cash is important and we expect to close out the year on a strong note and deliver the expected roughly $650 million of free cash flow for the year.

Please turn to slide number 11, labeled integration and standardization update.

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

Of particular note is that we are now anticipating realized synergies in 2013 to be about $120 million, reflecting the overdrive in Q3 and the expected uptick in Q4.

The increase over previous estimates is being driven by sourcing and Lean savings in Flow Control and is the result of building momentum around our proven PIMS operating system.

This is obviously great news as we are now exiting the year on a $168 million annual run rate, or nearly 73% of our $230 million synergy target.

What makes this performance even more impressive is that it does not yet take into consideration the significant synergies we still anticipate from Lean enterprise and our goal of reducing overall G&A from the current 8% of sales to the expected 6% of sales by 2015.

All of those programs are still in investment mode and we believe we will start to realize savings in 2014 and 2015.

Please turn to slide 12, labeled balance sheet and cash flow.

We had a very nice quarter as free cash flow was $206 million for the quarter, driven by over $173 million in net income and more disciplined working capital and capital spending policies.

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

Ending debt was under $2.6 billion, while we delivered over $100 million of cash in the quarter back to share owners in the form of dividends and share purchases.

We have completed $875 million of our approved $1.2 billion in buybacks through the third quarter.

Please turn to my final slide, slide number 13, labeled full-year 2013 Pentair outlook.

For the full year, we are expecting $7.4 billion in revenue, up 1% to 2% organically year-over-year, reflecting near-record bottom levels of projects in Australia, Canadian oil sands and EMEA as well as the absorption of a global Industrial slowdown in slow large greenfield sites globally, thus giving us confidence in the prospects for accelerating organic growth into our 2014 and 2015 planning horizon.

Overall operating income is expected to improve by nearly 20% versus 2012 and overall adjusted EPS at the $3.20 midpoint range will be up over 25% versus 2012.

So, one year into our merger with Flow Control, we feel like we have learned many things about the new businesses, introduced with speed our PIMS way of doing things and have seen two companies come together as a seamless one Pentair culture.

We have a clear and achievable path to achieve our $5 of EPS target by 2015.

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

Thanks, John.

Please turn to slide 14, labeled summary.

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

The top line has been a challenge this year with delays in large projects and a greater than anticipated headwind from Australia.

But on the brighter side, mix remains favorable and we continue to see growth in residential and food and beverage, where we do control our destiny.

Our integration and standardization efforts continue to build momentum and we now expect $120 million in synergies in 2013 versus our original target of $90 million for the year.

We are pleased with the success of the integration so far.

We 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 expectation and we are adopting one Pentair culture.

Finally, I would like to thank Mike Schrock for being a great partner the past 15 years.

Mike and I started at Pentair a week apart.

He has been a great contributor to building our operating agenda and our transformation from a holding company to an operating company.

With that, I will ask the operator to open it up for questions.

(Operator instructions) Steve Tusa, JPMorgan.

So I just wanted to talk about these projects.

You guys have said several times that you are contemplating limited large project activity.

How much visibility do you have on these things quarter to quarter?

Clearly, Australia has been weak for a lot of companies, and maybe that was something that could have been contemplated on the second quarter guide.

Then I guess for the fourth quarter, some of the stuff you are accelerating on your core for the fourth quarter -- maybe you could just comment on why your visibility is any different.

Are there projects that slipped into October that have already been booked?

Maybe just give us a little bit more comfort around why we don't repeat this issue in the fourth quarter that we did in the third on the revenue from.

And then I have one other follow-up.

Thanks.

Good question, and we will tag-team here, Randy and I. I think when you take a look at Q3 versus forecast, in summary, we missed about $50 million in Australia.

Half of that was actually currency, which we did not see coming, and half of that was roughly book-and-ship business that was expected in the quarter and now we don't expect that even in Q4.

We are anticipating that Australia becomes flat to the current levels in Q3 well into 2014, given the conditions there in mining and given overall state of the economy.

In Thermal, you notice the miss.

On a year-over-year basis, it was large projects.

We shipped a big Voyager contract last year.

We were not anticipating large projects in the quarter.

It was actually Europe, where they were the last to head into the decline mode.

We have record backlogs on Europe and the ship dates on those book-and-ship businesses started to slip throughout Q3 into Q4.

We have only put part of that into our forecasts for Q4, and the rest of the uptick reflects what we think is the new normal seasonality coming out of Q3, which was the old fiscal year end for Tyco/Flow and now reflecting the new year-end fiscal year end.

So a lot of these projects that would have been rushed to completion, if you will, in September on the order side we now think have their normal completion in the Q4 time frame.

Randy, I don't know if you want to add more?

Yes.

The only thing, Steve, I'm much more focused on the bottom line than the top line, but we always focus, we obviously want to get better at forecasting the top line.

John has it right.

One of the things that we didn't know going into the third quarter was how much the shift from the third quarter closeout of the year to the fourth quarter closeout of the year would affect the behavior in the Flow Control businesses.

I think we saw some I would call it less aggressive closing of orders.

John talked about sales, but in terms of orders I think there was less aggressive closing out of orders in the quarter that we are, in fact, seeing close in the fourth quarter now.

So I think it was a learning quarter.

Okay.

So ex-forex, you guys think you have the chance of us sitting here in January and you guys talking about another revenue slip; you are highly confident in that?

Well, Steve, yes.

Two things -- first of all, you know and Randy and I have both worked around large-project backlog businesses.

You should not miss large-project forecasts.

So I wanted to clarify; that's not where we missed it because you have your backlog, you have your shippable backlog.

Even if you expect a little bit of slippage, you put that into your estimates.

This is knowledge about, I think, the fiscal year end, the seasonality of these businesses.

Overall, I think we were able to manage through it effectively.

If you look at the year forecast, as a matter of fact, what we have done -- we have had some strong quarters of growth and we've had lesser quarters of growth.

I think that reflects more of the choppy seasonality last year within the Flow Control business than it does a normalized seasonal pattern that you are seeing start to form here throughout 2013.

Right.

Okay, that's totally fair.

Just one last question -- on the productivity side, if I take your synergies and then I add up all the productivity and synergies that you reported for the quarters, productivity looked pretty strong at like $25 million.

It was a pretty good quarter there.

Anything unusual in, I guess, the bridge?

I would characterize it as kind of like productivity and cost saves ex-synergies.

Anything unusual this quarter?

Or is -- you guys seem like you are getting really good base productivity out of the business.

Nothing unusual.

One of our goals when we closed the merger was to make sure we are focusing on margin and backlog, especially in the Valves and Controls business.

We have been very disciplined on the types of orders and types of jobs we are winning, and I think that is starting to show in the margin expansion in that business.

So I think it's not just about growing, it's about growing profitably, and I think you are seeing the effect of that.

Okay, great, thanks; thanks for the detail.

Deane Dray, Citi Research.

On the fast-growth markets being down 8%, this is now the second quarter, and likely some of this is still related to China.

But if you could just separate out what the pressure is in terms of -- is it Food and Beverage, is it Infrastructure?

How would you characterize you have the pressures there?

Yes.

Just a clarification -- overall fast growth was up around 2% in the quarter.

It's still not a great number, but overall for Pentair it was plus 2%.

In Water and Fluid, we were down 8%, and most of that really was India.

So I think overall, we are seeing -- it's still strength in China, in our product platform there.

We were up 23% on the quarter in China, and where we were down in Water and Fluid was primarily India and a little bit of Middle East.

As Randy mentioned, there hasn't been a lot of de-sal programs going on in that region.

Yes, and it really is -- it's what we call the advance of water.

It's the de-sal projects, it's the big wastewater projects that have been the net drag on fast-growth markets.

Actually, Food and Beverage has done very well.

Then on the increase in synergies, I might have missed this, but what was driving that additional $15 million in savings?

Then is there more in the tank on this?

Are there additional projects you can be doing?

Is the $120 million to be a stretch, and do you have line of sight on all those projects?

Yes, Dean, I think the upside was clearly sourcing and Lean, which I mentioned in my comments.

I think we always knew we were going to get that.

We have a great Lean and sourcing culture here.

I think the upside coming forward will be the Lean enterprise, which is all the back-office structures that we think we can get more synergies through.

We have been planning for that all this year.

We didn't expect any of that to hit in 2013, and we are set up nicely now for 2014 and 2015 savings related to those projects.

So we feel really good about where we are in the synergy roadmap.

Yes, I would just echo that and mention that the Lean is off to a great start.

It's really helping delivery right now, but it takes a little while for Lean to hit productivity and the sourcing.

The sourcing productivity has been really outstanding, and we think the funnel still looks good there for more.

Great.

Just last question for me is the -- we are all trying to gauge and calibrate the seasonality in the new combined business.

It looks like it will be a little bit challenging here for the fourth quarter, just in terms of identifying what is a seasonal trend versus some one-offs, so like making the adjustments for Australia here.

Tech Solutions has got a little bit easier comps.

But how would you frame the seasonal impact that is something that we would now be seeing on a go-forward basis?

Deane, I think no one is working harder on that then us, and I think we feel more knowledgeable today than we did a year ago.

Clearly, as I mentioned, if you look at Flow Control's results last year, they were bouncing around a little bit.

I think we feel very good about the seasonality being delivered in 2013 and the normal execution.

To your point, Thermal, which is -- likes cold-weather, is going to have a stronger Q4 in -- and that's its normal shipping pattern because of shipping ahead of the cold weather and the anticipated cold weather.

So that's the only real seasonal business, other than Australia, which will have a stronger Q2 historically.

Great, thanks.

And then congratulations to Mike.

He's had a great run.

Yes, absolutely.

Mike Halloran, Robert W. Baird.

So on the Valves side of the business, when you think about the order activity, backlog has been stable, tough order quarter here.

But it sounds like the quoting side for the Energy projects, in particular, still remains strong, so a couple of things there.

One, maybe you could just talk about what the customers are saying today.

What is driving some of the delays in getting the quoting through beyond just timing of the calendar?

Then, what do you think the catalyst here is to start seeing a little bit more consistent order strength?

Because not only you, but all of your peer group has been talking about strong order environment, or at least quoting environment for a few quarters here, but just haven't really got them to the finish line.

So any color there would be great.

I would just say, when we look and we talk to customers about their capital plans, which are obviously the things that drive the large projects, even the medium-sized projects for the oil and gas industry, the capital plans remain solid; and I would say not down, not up, maybe slightly up, but not greatly up.

What they are doing is they are looking to save cost.

For us, we are of a valve supplier to large projects.

So the valves are not a big part of those projects, and there seems to be more intense conversations between the end customer and the E&P players who control the projects overall.

So the activities are about trying to be more cost effective on the implementation of these projects.

That's my read of it; that's our read of it, not just mine, but our team's read of it.

But these projects are going to go forward.

So a number of projects we saw in the Middle East, a number of projects we've seen in the power industry -- they are just sort of slipping to the right, which is a term I hate, but it's what we're seeing right now, but not outright canceling -- with the exception of a couple of really large projects that everyone knows have been canceled up in Canada, have been canceled before.

We haven't seen any other cancellations.

That makes sense.

Then on the Residential side of the business, obviously very strong trends this quarter, healthy expectations for the fourth quarter.

Any signs of cracks there, or at least incremental slowing in the residential end markets you deal with in North America?

I would just say, Mike, and I will have Randy put in some comment, we like the trend there.

This high-single-digit type of growth pace that we are on is a good place for us to do well in and make money in.

I think we would have been more concerned if we would have seen the huge spikes and the over-buying of the houses or the over-delivery of the housing permits.

So I think we still feel we are in a healthy environment.

Obviously, six years of decline now coming back relatively strong, and our pace of activity is flowing through as we would expect it, pool with the high-end consumer.

There we have had strength because of our energy content.

Also, we haven't seen a huge impact in Residential Flow.

As you know, that's more weather-dependent, not new housing starts.

But we are starting to see in the quarter, finally, the water filtration plays and the growth in that space.

Right, and particularly in Europe, where it has lagged.

But with Residential, we're turning to a more stable environment in Europe.

That bodes well for us further because that's an important market for us in the Residential Filtration business.

Great, I appreciate the time.

Steven Winoker, Sanford Bernstein.

Just first one to check my math.

On the price versus productivity side, I count $78 million listed for productivity/price and op income, and roughly about $14 million on price on the sales side, most of which drops through.

So is your productivity-only numbers closer to $60 million or $65 million?

I'm sorry?

Say that again, Steve?

Just what is your productivity-only operating income number net of price?

It's about $55 million excluding -- well, $57 million excluding inflation.

Okay, but including -- just that productivity/price in op income that you've got --

It's about $70 million.

$70 million?

Okay, thanks.

And then on the Water and Fluid walk, you talk about $20 million of volume on sales but zero impact on the op income side from growth.

What is going on there?

It's net impact of volume and foreign exchange.

We drop that through in op margin, in that walk, and then the leverage of that, or the lack of leverage, comes in the productivity side of the equation.

Okay, great.

Then finally, just on the top-line integration impact, you talked about the Middle East commercial pump line and getting the $25 million to $50 million in sales over five years and all that.

But how do you know -- to what extent are you confident that all of these massive integration activities happening across the portfolio did not have a negative impact on your sales for this quarter?

Well, that's certainly something we talk to all our presidents about and the businesses.

There is a lot of focus on cost structure, but we have been very selective in terms of hitting cost structure on the go-to-market side.

Most of the structure has been on what I would call the G&A side in manufacturing side, but we certainly are aware of that risk.

I do think that our focus on profitable growth probably has kept us from having as high a top line as we might have.

But frankly, I don't want any more projects that don't make money.

So if that's all we are losing, I'm okay with that.

Well, the word project selectivity is used by some of your colleagues in the former -- in the other Tyco.

Are you going through a pretty significant change in comp and other things for the sales force on -- to impact those more profitable projects?

Well, we have.

We have got clearer focus on that margin.

The Valves and Controls business was reorganized from an end market focus, which was really focused on market share and there were measures on market share and growing in each of the verticals.

Now we're focused on product line profitability and functional excellence.

So I do believe that that change has been beneficial in terms of making sure that we are taking profitable projects.

So I can't comment on what the rest of Tyco is doing.

We can measure the margin in backlog, though, Steve, and that's the measure of it.

Is that backlog a more profitable backlog?

And it is today.

Okay; thanks, John; thanks, Randy.

Jeff Hammond, KeyBanc Capital Markets.

Just to close the loop on Valves and Controls orders, can you give us the blended order rate and what the comp was for 3Q?

Meaning the -- you mean the total orders?

Yes.

We've got it by those four segments.

Yes, and while you are looking for that, I kind of, blended, come up with down high singles/low doubles.

But I'm just trying to understand better because it seems like there's some fiscal year timing changes, some focus on profitability.

What's really just timing here in the order or maybe a tough comp versus real fundamental weakness, weakening in the business?

Let me talk about -- while John is looking that up, let me talk about just in general.

The Flow Control businesses used to close out their fiscal year at the end of September.

If you recall, then we moved to fourth quarter after taking over a year ago.

If you recall, all those businesses had weak fourth quarters, and they had spectacularly strong third-quarters.

So this is our first time through that change.

We will see, but we expect that there was some orders that would have been booked maybe with a different fiscal year in the third quarter that will get booked in the fourth quarter.

Yes.

The actual -- if you add it all up, you should be somewhere around $562 million to $565 million, Jeff, in total orders.

What was it last year?

Last year, it would have been, on the same basis, $636 million.

Okay.

But as Randy reflected, they sequentially from Q3 to Q4 dropped significantly, well below $575 million in orders in Q4, reflecting a peak in Q3 and then a big drop in Q4.

We are now expecting a more normalized pattern between Q3 and Q4 with a little uptick in Q4 versus Q3.

So I think this is about the seasonality of the year end more than it is about an indication of what is going on and industry trends.

Okay, and then just shifting gears to Aquatics and Food and Beverage, you guys have had just great growth there.

It sounds like quoting is pretty good at Food and Beverage.

But to what extent do we start to worry about tough compares there?

Well, we haven't given 2014 guidance yet.

But when we look at Aquatics and Food and Beverage, in particular, with the exception of agriculture, which has had some benefits in the US with some tax treatments that are going to expire at the end of the year, which I think is going to slow down irrigation and maybe crop spraying.

With the food service -- in food service right now, we have a lot of momentum.

Globally, we have a lot of momentum.

Then Food and Beverage, we have a great backlog in the beverage and dairy business.

So I feel good about that.

In terms of Aquatics, Aquatics, as you know, has controlled their own destiny for some time.

Now on top of that, they've got growth in the end markets.

They were growing for three years while the market was declining, and now on top of that the market is going up and they continue to innovate.

So I have great confidence in Aquatics' growth.

Just to follow, I think as we take a look forward on the Food and Beverage side, I would think about half of the year growth rate this year is what we would be anticipating next year with, as Randy said, ag being the tougher comps next year and the Food and Beverage and food service side continuing to go forward.

Clearly, in Aquatic, we are not going to continue that rate of growth as well.

But high-single digits is certainly something that we feel is achievable in the next several years.

Okay, thanks, guys.

Brian Konigsberg, Vertical Research.

I just wanted to touch a bit on the funnel.

So you mentioned again you are finding more opportunities in all the different buckets that you are attacking.

If you aggregated the last quarter, you are talking about $390 million.

I'm sure you don't want to get in the habit of quantifying this.

But has that increased meaningfully versus where you were at Q2?

If you could give a little color there and maybe where it's coming from.

I think the way I would describe it is we are clearly, as a Company, sitting around 8% G&A.

That's well higher than historically Pentair has ever been.

6% is our targeted G&A for 2015.

If you take that 2 points time sales and you start adding that to the current synergies, and assume that we will continue to get sourcing and continue to get Lean rollout, we feel very good about our potential ability to continue to expand margins.

We are cautious about providing the funnels because, as we said, this is about productivity and synergies, and we need both.

So we are really driving a rate of margin expansion through ensuring that we are getting from both sides, the Flow Control and legacy Pentair, the right amount of margin expansion in gross margin and the operating expense leverage.

So we are working both simultaneously and the only way we win is the bottom line.

So we feel good about what pipeline we have.

Okay, fair enough.

Just back to Valves and Controls orders, you had been talking about selectivity.

I think last quarter, you talked about maybe a 100-basis-point improvement in margin and what is in your backlog versus what you are reporting.

Can you give us an update on where that stands today?

That's still about accurate.

Okay.

Finally, also just on the process side of the business, so it sounds like US still fairly solid with MRO work, China or Asia a bit weak.

But just more focusing on the US the side -- so we've heard a couple of ethane crackers get announced by some of the major companies.

I'm just curious; I'm sure you're going to be competing for those.

When should we anticipate that order profile starts to inflect higher for Pentair?

I guess the question more is, where do you sit in the construction cycle, and when do you start to see the benefits of these large projects getting off the ground?

Well, as you know, we have frame agreements with a lot of those customers already.

So we have -- if you will, we have a preferred or at least a right to bid on those.

So we will work those with the customer if it gets spec'd in, immediately, even before they announce them, usually.

So you can bet we are working on them.

They will award then typically after the EPC awards.

Right.

So a couple of EPCs have been awarded.

Are you talking about a couple quarters out there, or is it a year later?

How do you intend on actually recognizing the revenue?

Is that going to be a percentage of completion, or would that be just --

Generally, on Valves, we'd recognize it when we ship them.

But there's multiple valves, so they ship in multiple orders.

Right now we feel good about the process industry in general and chemicals in general in North America, because of those kind of large, but also a lot of smaller projects that are going in there.

I can't comment specifically on when I expect those would ship if we win them.

Is it safe to say orders from these couple of projects that have recently been announced would be a 2014 event, or is it later than that?

If I tell you it's 2014, it will probably be 2015.

If I tell you it's 2015, it would probably be 2014.

So I'm not going to give you a date.

Okay, thank you very much.

Brian, a large order for us is going to be in the $10 million to $20 million of valves range, and that is a large, large order.

So we are talking about a series of $2 million to $5 million orders here, and those are all the types of things that continue to add confidence to the growing industrial process side.

It is right to focus on it, though, and we are focused on it, because when they are putting in ethylene crackers, they are making long-term bets on an industry and the market for those monomer streams.

So they are there and there will be other investments that go along with it.

I actually think it's a new day for chemicals in America.

Great, thank you.

Josh Pokrzywinski, MKM Partners.

Just a question on Valves and Controls, and I know that some of the comments you made at your analyst day last year, we don't get a sense of the shape of the growth you outline.

But to pick on that specifically, you had the 5% CAGR over the planning horizon, leaving kind of an 8% CAGR over the next two years.

Do you think some of these project deferrals can lead to that acceleration in the growth?

If that fails to happen, do you feel like you have the synergy pipeline to overdrive on that?

I guess the way my math works, if it ends up being more like that 5% for the next two years, you are going to need another, call it $30 million in EBIT.

Clearly, you guys are finding upside there.

Just help us calibrate the growth versus synergy offset here with 2013 coming in wider on the top line.

Let me talk about it within the whole arc of this merger.

Originally, when we first looked at the forecast of the Flow Control outlook, it was pretty high.

We took it down.

What you are asking under the 5% and then -- you're asking is, if the 5% isn't there, what can we do?

I would tell you that, clearly, the orders and sales have not been consistent with what we would have anticipated 15 months ago.

But having spent a year with the business, the opportunities for productivity are even better than I thought.

So my answer would be, and then we will see what John says -- my answer would be, if the volume isn't there I am still committed to get to 5%, and I think we know the way.

I obviously agree with Randy because he's a brilliant man.

I would say, when you look at slide 6 and you look at our percentage of our overall revenue backlog, and it feels, as we were talking about earlier, that Industrial process is starting to pick up.

Industrial has been flat throughout most of the year, and you look at other peoples order rates there and it has been improving.

That's really the one we need to move forward into mid-single digits to be able to contribute that higher single-digit growth rate.

We are feeling good about the activity there and we are feeling good how that is starting to unfold.

As you can see, there's a lot of focus on mining.

But for our mining business, it's less than 10% of our overall sales.

So the downturn there or the upturn doesn't move the needle the way Industrial process does.

Right.

But you could see mid- to high-single-digit growth in that process business with that turning?

That's, order of magnitude, consistent with what they are able to do historically.

Correct.

Okay.

Then just one follow-up on the growth -- is it that these businesses need more investment?

Just stripping out the project timing things, and these things happen, especially in this macro environment.

But do you feel like it's just more investment that is needed to get the growth?

Is it a lack of opportunities for investment, so you guys are funding everything but there aren't enough ideas?

Or, are these businesses just more like grind it out than you originally anticipated?

How do you help them among those?

One thing is we are not overreacting to the vagaries of the up and down.

The standard deviation around orders is 10%, plus or minus, every quarter.

So we are trying not to overreact to just the vagaries quarter to quarter.

That said, we believe that we can do a better job of priority focus on growing in the markets that are most attractive.

That may require us to fill in some product line gaps.

We are not the strongest, for instance, upstream.

We are not as strong upstream as we think we would like to be, for example.

But it's also to make sure that we are investing in the markets that are growing.

We mentioned India was down.

We need to be bigger in some of the markets.

We want to be bigger in the Middle East; we want to be bigger in Africa.

So it's both a geography focus and it's a product line priority.

That's what we are doing in the planning cycle now to make sure that we are putting our best resources against those priority focuses.

All right, thanks a lot, see you guys in Houston.

Scott Graham, Jefferies.

Good morning, and congrats to Mike Schrock; I just really only have one question.

You guys have done a great job in increasing the synergies for 2013 all year.

You are now expecting a nice little ramp in sales growth for each of the three segments in the fourth quarter.

I was just wondering, are any of the synergies actually going back into the Company, being reinvested to try to drive and make sure of that top-line growth acceleration?

Are you spending any of that toward sales?

Yes, Scott.

I think, as Randy mentioned, it was a key focus of ours not to attack or go after the sales and marketing and the growth-related resource and percentage of sales.

We have held the percentage of sales and then, in most cases, increased them.

So the focus has been on Lean, the operations, and also the back office, driving the synergies and making sure that we are continuing to invest it.

But as Randy mentioned earlier, now we're spending a lot of time making sure the money is being spent in the appropriate areas that can actually drive the most profitable growth.

That's a big part of the 2014 planning activity.

And we've talked about some examples.

I mentioned the investment we made to localize commercial pumps in the Middle East, leveraging the Sharjah factory.

We have invested even more than that in the Middle East.

We've talked before about the investments we made to cross-sell Valves in the Food and Beverage business.

So some of the wins we have invested in MRO, and that is up 6%, 7% in the quarter.

So we are seeing results from the investments we've made, and we've talked about them.

So essentially what I think I hear is that the combination of the spending and easier comps, some of these timing issues we've talked about in a couple of the businesses -- you feel good about those fourth-quarter sales expectations by segment?

You know, I learned under a master to never be comfortable with the forecast.

(laughter)

We are committed to the forecast.

That's a good answer.

I actually have a second question that I just thought of, and it's kind of a piggyback off the last question.

If I recall correctly, at the end of the analyst meeting last year, one of the things that I think you said very clearly, John, was that, hey, we don't have a crystal ball.

We don't know what the top line looks like.

It is our goal -- we are committed to 5% growth, but if it doesn't happen we are still confident in making the $5 number.

I know you just kind of said the same thing, but it's just really a combination not just of the synergies to get there, but you could also pull the share buyback lever to get there as well if you come a little short of that 5%.

Right?

Absolutely.

Scott, I think what you are hearing from Randy and I today is we've had a year now to look at these businesses and understand what was in the core, what was in the base.

You look at some of the projects that have come out in Australia, and you look at some of the megas that were there in Thermal that are no longer there, primarily the Voyager project.

We take a look at where we are in the base, and the core growth rate in the base, and it more than reflects what we want to do on an ongoing basis.

So we feel that coming off of this base, knowing what is in there and the ability to grow organically, we feel very good with that and the cost structure to achieve our commitments.

Thanks.

A lot of moving parts; I get that.

Thanks for your time.

David Rose, Wedbush Securities.

A couple of follow-up questions -- in the guidance, you had some divestitures in the first half of the year.

Are we thinking about potentially more rationalization of businesses?

I imagine they are small, but how should we think about that in terms of the guidance?

Generally, that's not reflected in the guidance, but it should impact your top line, nevertheless -- is that fair?

Yes.

We are not reflecting any of that at the moment, and we would feel it would be our problem to absorb and deal with that as well.

Okay.

So we can assume that if there are any divestitures, that won't be really an excuse for lower top line unless they are sizable.

Correct.

Okay.

Within the guidance, I think this has been addressed before by others here, but you have the headwind from Sandy.

It's not a meaningful headwind for you, but it's factored in your business.

Are there any other headwinds that we should think about in the fourth quarter that may not have been highlighted?

I think we feel like we learned a little about the Australian dollar in the quarter.

I think we've got that forecasted to not recover.

At some point, if a currency goes even much weaker, it should help its ability to export out.

So right now, as of this date, there's nothing that we can factor in.

But we are not weather forecasters, either.

Yes, I just want to make sure that we are clear on everything.

Okay, great.

Thank you very much.

Christopher Glynn, Oppenheimer.

Randy, you mentioned some of the areas of opportunity where you have product line gaps.

With the Tyco integration pulling forward quite a bit and going really well, I just wondered if you could update us on the time line of your appetite for getting back to funding some bolt-ons in that area.

Well, we are active in the marketplace looking at the different opportunities.

We want to be as disciplined as we have always been, which is we start with what fits our strategy.

So the product line gaps are -- I'm not going to comment on specific ones -- but the product line gaps are a key starting point for that.

We've got to make sure that we're disciplined in the terms of financials and that we continue to hew to the promises we made to shareholders in terms of our stock buyback program and the agencies and our overall capital plan.

So I wouldn't predict as to when we might announce any kind of bolt-on.

Okay, but it sounds like you are ready to go.

Yes, if the right thing came along.

Okay, and then just looking at next year, I think we have $85 million cost benefits from the 2Q restructuring this year, maybe $60 million to $80 million incremental synergies.

Is that drop-through completely independent of growth, if that should remain elusive?

That should be completely dropped through, correct.

Obviously, we have to manage inflation and those types of things, but that's why we are showing that chart the way we are showing it is that run rate should be incremental, even on flat growth.

Got it, thanks.

Brian Drab, William Blair.

First question just on the order outlook.

If we look at slide 6 and you are thinking about the fourth quarter, taking into account everything that we've talked about so far on this call with the fiscal year end situation, can you give us a sense for these for end market outlooks in terms of order growth?

What is this going to look like in the fourth quarter?

Will we be up in orders in each of these end markets?

I think I mentioned, we don't expect mining to go up.

Power -- we are seeing activity in power, but that has been sliding sideways.

I think, overall, we expect orders will be up from the third quarter.

That's correct.

I think Industrial process and oil and gas is where we would expect them to go up.

As Randy mentioned, mining is likely to be down and power is likely to be flattish.

Now, you are asking us to split hairs on a $2.5 billion business.

So it's not something we usually do is provide perspective orders by vertical market.

But right now, that's indicative of what markets we think will continue to expand.

Okay, yes; I'm just trying to make sure I understand the pieces that get to the aggregate order growth, because we are looking at -- I'm just trying to reconcile a few things that were said this morning.

It looked like on what is slide 8 that you are expecting the fourth quarter to be better in the Energy and Industrial verticals in terms of revenue growth, and you are expecting Valves and Controls -- and that obviously has a lot of bearing on Valves and Controls.

You are expecting Valves and Controls to be up 6% in the fourth quarter.

You have had these order headwinds lately, but then you made the comment, John, about 2014 returning to an acceleration in organic revenue growth.

So that would require, it seems to me, a fourth-quarter recovery in orders.

Just remember, Brian, the backlog page there just applies to Valves & Controls.

Most of our Industrial is book-and-ship.

It doesn't run, really, through a backlog number.

That's where the Equipment Protection business is.

That's where, frankly, a lot of the Valves and Controls and Thermal is, too.

I said in my comments, in 2012 and Energy and Thermal, there was a Voyager project in which we anticipated in the beginning of the year having that Voyager project continuing within 2013.

That project, as Randy mentioned, was canceled.

So the last year-over-year headwind in Thermal Energy related to projects was in Q3.

That's a big piece of the turnaround as you look at Q4 and full year.

Okay, great, and that's kind of a segue to my last question here.

Of course, we are aware that Voyager was canceled.

But we, of course, knew that coming into this period.

It looks like the guidance for Technical Solutions was flat to down slightly, the legacy Pentair business did well.

Thermal, you saw some projects delayed.

Can you give any more granularity there in terms of -- was that several projects, one larger project?

(multiple speakers) it wasn't projects, it was book-and-ship Industrial in Europe.

Record backlogs, and the shipment and timing was delayed from Q3 into Q4.

Well, you mentioned oil sands here for -- within Thermal.

Voyager was oil sands, right?

Oil sands has nothing to do with Europe.

I just want to be clear, then.

When you say oil sands you are talking only about the Voyager project, nothing incremental to what we already knew going into the quarter.

That's correct, that's correct.

Okay, no, that's, helpful.

And MRO in the oil sands was solid?

Yes.

All right, thanks very much.

Garik Shmois, Longbow Research.

I have a question on mix.

You called out some favorable mix benefit on the op income line, particularly in Water and Tech Solutions in the quarter.

Just wondering, as you are looking the 4Q guide, you have got very good incremental margin expansion.

I recognize part of that is seasonality, part of that is continued productivity.

But how much of a mix benefit do you continue to expect into the fourth quarter, maybe how sustainable is that as you look out to 2014?

We think it's sustainable because what turned down substantially was a lower-margin Australian business, which is on the lower end of the margin within Water and Fluid.

So our results in Q3 reflect that.

In Q4 and beyond, we don't have any recovery in that product line anticipated due to the economy there.

In Thermal, as we mentioned, it was the impact of larger projects, which are still nicely profitable, but nowhere near the drop-through of the pure product shipments.

Again, not planning any large project activity in the near-term as well.

Okay, thanks.

Then just as a quick follow-up, can you remind us how much of the percent of sales Australia represents for you?

Yes, Australia on a full-year basis for 2012 was about $1 billion, just under $1 billion of total revenue within the overall Pentair.

In Q3, it represented just under $200 million.

So we are down about $50 million, as I mentioned, year-over-year, so that kind of gives you the rate of change.

That's helpful, thanks.

Hamzah Mazari, Credit Suisse.

Good morning, thank you.

Just a question on the aftermarket business in Tyco valves.

You spoke about an increased focus on service.

Maybe if you could give us a sense of how that business is running.

Is it up mid-single digit?

What does the growth look like there?

Then how much of that business is aftermarket now?

Is it still around 35%-40%?

First, for everybody, it's no longer Tyco valves.

It's Pentair Valves.

Sorry, Pentair Valves.

Anyhow, the parts and service business, which is a focus for us, a greater focus, and it was up between 5% and 7% pretty much across all verticals, because we look at that as service and parts, MRO.

So interestingly, on the service side, a lot of the service is done on other people's valves.

We think that's a nice growth area with this keener focus on the service side.

So I would expect it to continue at that kind of a rate.

I think, you know, it has an effect on MRO, and you will hear this from others as well.

I think when the refineries run full out, as they did in the quarter, it does delay some of the MRO spending.

But overall, you are right to think about 55%-ish is the installed base for us, and that continues to do nicely.

Great.

Just to follow up, on the Technical Solutions side of the business, it seems like margins there are close to peak.

But in fact, it seems like mix is potentially negative to you right now.

I know there has been some re-segmentation post the Tyco transaction, but could you talk about how you feel about margins going forward in that business?

I know you have done a lot historically on the channel and operationally and on the cost side to get margins up in that business.

Well, mix was actually positive in the Technical Solutions segment because there was more product sales and less big projects, right?

The big projects have lower margin, so that was a positive mix in the quarter.

I never believed from margin is at peak.

I think the fact that we booked it -- it's over 20% this quarter, proves that.

I think other people in the past have said it was an 18% peak or is a 19% peak, and now we are over 20%.

So I would say there is no peak.

To follow on to Randy, I think we are still as optimistic.

I believe, and Randy has this experience too, great businesses get even greater and they see more.

This is our business that has been after Lean for the longest period of time and we continue to think that the margins will expand from here.

Great, thank you for the time.

All right, thank you all.

Operator, if you could give the replay, please?

Thank you all for your attention.

Thank you, everyone.

As said, there will be a replay of this call and it will be available today, October 22, 2013, at 12.30 PM and will run until November 22, 2013.

The numbers to call in are 800-585-8367, and 855-859-2056; or, internationally at 404-537-3406.

At that time, please enter your conference code to enter.

Thank you, everyone.

This concludes today's conference call.

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