濱特爾 (PNR) 2014 Q3 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Pentair Q3 2014 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).

Jim Lucas, Vice President of Investor Relations, you may begin your conference.

Thanks, Keith.

And welcome to Pentair's third quarter 2014 earnings conference call.

We are glad you could join us.

I am Jim Lucas, Vice President of Investor Relations, and with me today are 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 2014 performance as well as our fourth quarter and full year 2014 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.

Any references to 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.

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 in order 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 third quarter performance, which is on slide 4.

We are very pleased with third quarter performance, as revenue met our forecast and we delivered strong margin expansion and EPS growth once again.

Sales grew 3% during the quarter, with technical solutions leading the way with 8% growth.

Our operating income grew 12% and operating margins expanded 130 basis points to 15.2%.

EPS grew 22% and exceeded the high end of our guidance for the quarter.

Free cash flow continued to be strong and was greater than 120% of net income in Q3.

We remain on track to generate free cash flow greater than 110% for the full year.

Now let's turn to slide 5 for a more detailed look at the third-quarter results.

After a slow start to the year, the 3% sales growth was an encouraging continuation of the top line acceleration experienced in the second quarter.

Volume grew 2% and we delivered a positive point of price in the third quarter.

Foreign-exchange was neutral, but we are closely watching the strengthening of the dollar against many currencies, and are anticipating FX headwinds to pick up in the fourth quarter.

We will discuss the geographical and vertical performance of the Company in more detail shortly, but it was particularly encouraging to see all five vertical markets grow in the quarter.

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

Our adjusted operating income increase of 12%, and adjusted operating margin expansion of 130 basis points to 15.2%, were driven by growth leverage and strong productivity and synergies.

Inflation remained consistent with the first half and price and productivity continued to more than offset inflation.

We continue to make great progress with our Lean and sourcing initiatives, particularly in our 16 focus factories.

Now let's turn to slide 6 for a review of our largest segment, Valves & Controls.

In the third quarter, Valves & Controls had flat sales with price mostly offsetting slightly weaker volume.

Orders were flat in the quarter and backlog was down 3%, excluding FX, to $1.3 billion.

During the quarter, oil and gas grew 3% and process sales saw 5% growth, while the smaller power and mining sales declined.

We continue to see quarter to quarter volatility in power, but the mining weakness is expected to continue.

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

We were very pleased with the operating performance of Valves & Controls in the third quarter, with adjusted operating margins expanding 260 basis points to 15.7%, even including $4 million in costs for the segment's operating model transformation, or OMT.

As a reminder, we expect the OMT investments in Valves & Controls to continue on an annual basis through 2016, with that investment expected to drive nearly $80 million of annual operating income savings once completed, and an overall tax benefit to Pentair of roughly 3 points due to the optimization of the global Valves & Controls structure.

We continue to see strong adoption of PIMS and momentum in Lean is accelerating, as seen by continuing improvements in on-time deliveries in Valves & Controls.

Now let's turn to slide 7 for a look at the orders and backlog in this segment.

As you can see on slide 7, Valves & Controls backlog is broken down in four key industries, three of which fall into our Energy vertical: oil & gas, power, and mining, and one in our Industrial vertical, which is the process business.

Overall, backlog ended the quarter down 3% excluding FX to $1.3 billion.

Energy remained mixed in Valves & Controls, with oil & gas delivering strong order growth, while power declined and mining was weak.

This is the second consecutive quarter of orders growth for oil & gas, and quoting remained healthy.

In particular, we continue to see strength in North America LNG.

With the sharp decline in oil prices the past month, we are monitoring quoting activity closely.

Overall, power orders were down in the quarter.

We did see some large power orders finally break in India and China during the quarter, while Europe remained soft.

Mining continued to be in a secular decline.

And, while we are seeing maintenance orders come through in mining, the overall outlook for this smallest piece of Valves & Controls remains guarded.

We saw the biggest backlog declines in process and power.

Although power is expected to remain volatile quarter to quarter, we expect improvements in process in 2015 as we continue to see positive signs of an acceleration in North American orders, based upon strong quoting activity.

Now let's move to slide 8 for another view of Valves & Controls orders.

Obviously, the fluctuations around orders and backlog are disquieting.

That is why we are building more rigor in our forecasting of Valves & Controls orders and sales.

This chart is an example of one way we are looking at the business.

The left side shows the quarterly volatility we have seen in Valves & Controls orders.

So, to see clearer trends, we look at running averages.

You can see on a trailing six-month basis, orders are showing that a positive trend may be emerging.

On a trailing 12-month basis, that potential trend is further evidenced.

It is likely that quarter to quarter volatility will continue with this business, given project timing and customer needs.

But our improved forecasting models are showing improvement in both the trailing six- and trailing 12-month orders for both industrial process, and oil & gas.

Given these two industries comprise nearly 75% of Valves & Controls business, we remain cautiously optimistic for the segment.

Now let's move to slide 9 for a look at our Process Technologies segment.

Process Technologies has reported solid topline growth of 4%, with volumes contributing 3% and a positive 1% from price.

Residential & Commercial remains strong with 7% growth.

Food & Beverage grew 5% and Infrastructure was up 2%.

Our beverage business experienced some customer delays in spending, but these projects are delays and not cancellations.

Our food service business delivered another strong quarter of double-digit growth, which was broad-based globally.

The right half of the page shows second quarter Process Technologies' operating profits and margins.

We are disappointed with the operating margins of Process Technologies during the quarter.

Mix was a primary factor in the income and margin decline, as we saw more growth from our lower-margin project businesses within Process Technologies, and our pool business began managing its early buy program more closely.

In our residential filtration business, we have seen a shift to more point of use than point of entry solutions, which also had a detrimental effect on margins.

While mix will be important to improving margins, we continue to have a lot of opportunities to drive productivity within the businesses.

This is an area of focus for Process Technologies.

Now let's move to slide 10 for a look at Flow Technologies.

Flow Tech reported a 2% revenue decline, as a point of positive price contribution was not enough to offset a 3% reduction in volume.

As we indicated last quarter, we have strategically been deemphasizing lower margin retail business and this did have a negative impact on the quarter's reported results.

This is the correct strategic and financial decision.

And, while we will have a few more quarters of topline headwind, we are more clearly focused on driving differentiated growth in the more profitable pro channel.

The retail shift was the contributing factor to the Residential & Commercial decline in the quarter, but we also saw the Industrial and Infrastructure businesses decline in this segment.

Industrial saw growth in its global fire offerings, but this was not enough to offset sluggish OEM demand.

Within Infrastructure, we saw some growth in the break and fix business, but project activity continued to be slow for our engineered flow business.

We saw growth in Food & Beverage as our applied water business once again delivered differentiated growth, which more than offset continued weakness in agriculture.

The right half of the page shows second quarter Flow Technologies operating profits and margins.

Operating income was flat, with operating margins expanding 30 basis points to 14.1%.

Flow Technologies delivered positive price and productivity that offset inflation during the quarter.

The weaker top line, including the retail shift we mentioned previously, hindered income growth.

But, operating margin expansion is expected to accelerate as mix slowly improves.

Let's now turn to slide 11 for a look at Technical Solutions results.

Technical Solutions had a great third quarter with 8% sales growth, with all verticals contributing in the quarter.

Volume grew 7%, and price was a positive contribution at 1%.

Industrial grew 5%, led by our North American equipment protection business.

Energy sales showed strong growth of 13% in the quarter with strength globally, particularly in Canada.

While it was encouraging to see Canada turned positive for the first time this year for Technical Solutions, it is far too early to call this a trend, and we are watching order rates in the Oil Sands very closely.

Infrastructure was up 12% on the strength of our European electronics business, where comparisons will begin to get tougher starting in the fourth quarter.

Finally, Residential & Commercial grew 9%, as last year's cold winter has led to early stocking in both North America and European channels.

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

Operating income grew 15% and operating margins expanded 140 basis points to 22%.

Price and productivity remained a hallmark of this segment.

What the strong topline demonstrates is leverage in this business, and how a little bit of growth can quickly flow through to the bottom line.

Again, we are very encouraged by the strength of Technical Solutions in the quarter.

And while the growth rate is expected to moderate in the fourth quarter, it does appear that the Industrial business has strengthened in the back half of the year, as we had expected.

Let's now turn to slide 12 for a closer look at the total Pentair growth profile.

Like the first half of the year, during the third quarter we saw solid growth in developed countries, while fast growth regions remain mixed.

US grew at a mid-single digit rate and Canada grew double digits.

But we saw Europe decline for the first time this year.

Overall, developed economies delivered solid growth.

Fast growth regions were down modestly for the quarter, but it truly was a mixed bag.

China, Southeast Asia, and Latin America all grew double digits, but we continue to see declines in the Middle East and softness in Eastern Europe and Africa.

While weakness in the Middle East is due mostly to a couple of large projects last year that did not repeat, we still see attractive growth prospects for the Middle East long-term.

Energy turned positive for the first time this year and remains down year to date.

Part of the decline is the previously mentioned large projects in the Middle East.

We have seen strength in the last two quarters in oil & gas, particularly in North America, but the declines occurring in the smaller power and mining industries are masking the oil & gas improvement.

Industrial grew modestly overall and is up year to date.

We are particularly encouraged to see the strength in our high margin North American equipment protection business.

While process orders have shown quarterly lumpiness, we believe that we are well-positioned for what we see as improving North American orders in 2015 and 2016.

Quoting activity remains strong as process companies make CapEx commitments to take advantage of lower energy and feedstock prices.

While we have seen Residential & Commercial growth rates moderate, growth remained healthy on the strength of a strong North American housing market.

We also saw continued signs of recovery in our smaller commercial businesses.

Food & Beverage has seen growth moderate, largely due to two factors.

First, as mentioned earlier, the slowing in agriculture is clearly having an impact on our ag-related businesses.

Second, delays in beverage projects has muted the growth in this vertical.

Infrastructure was a positive story once again this quarter, driven mostly by our electronics business within Technical Solutions.

While the costs begin to get tougher for electronics next quarter, we are seeing small signs of encouragement to make us believe our water-related Infrastructure businesses are slowly turning positive.

After a slow start to the year, we are seeing improvements in our two largest verticals, Energy and Industrial.

We continue to grow, albeit at a more moderate rate than was anticipated at this point of an economic recovery, and we are positive about the progress we are making around productivity and standardization.

While the global economic environment has its share of challenges, we remain cautiously optimistic.

Cash flow remains a very bright spot for us and we remain focused on disciplined capital allocation.

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

Thank you, Randy.

Please turn to slide number 13, entitled Q4 2014 Pentair outlook.

For the fourth quarter of 2014, we expect sales to be up approximately 1% to 2% to $1.85 billion, which includes about a point of anticipated FX headwinds.

Valves & Controls is forecasted to be flat, Process Technologies is expected to be up 5%, Flow Technologies is estimated to be down 4% with tougher comps in ag and further de-emphasis of lower margin retail business.

And Technical Solutions is expected to be up 4% on continued strength in Industrial.

We expect operating income to be up roughly 9% and operating margins to expand 90 basis points to 14.5%.

This includes ongoing OMT investments in Valves & Controls, and less of a negative mix issue in Process Technologies.

Our EPS forecast for the fourth quarter is a range of $1.02 to $1.04, for an increase of roughly 20%.

We are expecting the tax rate to be around 23.5% and the share count to be around 187 million, reflecting recent stock buyback efforts.

Please turn to slide number 14, labeled balance sheet and cash flow.

Quarter end debt was approximately $3 billion, or $2.7 billion on a net debt basis, inclusive of global cash on hand.

In the third quarter, we returned over $450 million to shareholders in the form of dividends and share repurchases.

At the end of the third quarter, we have approximately $300 million remaining under our current $1 billion share repurchase authorization.

We plan to exhaust the remaining authorization levels in the fourth quarter.

Our ROIC ended the quarter above 10%.

We continue to have a lot of opportunities on the working capital front with the legacy flow control businesses and we expect to make further progress as the year continues.

Please turn to slide number 15, labeled full year 2014 Pentair outlook.

We are raising our 2014 adjusted EPS to a range of $3.72 to $3.74, from a range of $3.65 to $3.70, or greater than 20% growth, reflecting the third quarter results.

For the year, we are expecting the top line to grow 1% to 2%, inclusive of the impact of foreign exchange, to $7.1 billion.

We expect Valves & Controls to be down modestly for the full year.

Process Technologies is expected to grow 5% for the year on the strength of pool, beverage systems, and food service.

Flow Technologies is anticipated to be down 2% for the full year and Technical Solutions is forecasted to grow 4%, due largely to an improving Industrial business.

Adjusted operating income is expected to be up approximately 13% to just over $1.01 billion, and this includes roughly $20 million of OMT investments within Valves & Controls.

Adjusted operating margins are anticipated to expand 140 basis points to 14.3%.

For the full year, we expect the tax rate to be around 23.5% and the share count to be about 195 million.

Free cash flow remains on track to be north of 110% of net income.

Operator, can you please open the line for questions?

Thank you.

(Operator Instructions) Steve Tusa, JPMorgan.

When we think about the dynamics around the Valve orders and some of the stuff that is coming out of process, or -- which segment is it, the one that is down in the fourth quarter -- the Flow segment this year, along with some other incremental headwinds, how does all this kind of mix together and set up for the growth dynamics for next year?

You talked about the rolling Valve orders being good.

Does the fourth quarter look okay on that front?

Maybe you could just talk about those dynamics.

Yes.

I think, we'd never put too much emphasis on Q3, first of all.

I mean, with August being a pretty light order month, traditionally, and July, and we take a look at a couple of dynamics.

We look at our win rate in the quarters that we are quoting.

We look at how strong the front log is and that where the quote log is.

The actual quoted activity in Q3 was down.

So we feel like our win rate held in and we still see a bunch of projects heading into Q4.

So we expect in Q4 to be another strong orders growth, and we need it as we set up our expectations for next year.

But we are certainly in a wait-and-see mode on the pace of those orders and, obviously, mid-December we will be providing guidance, so we will give an update about how we feel about next year.

And so, can you still -- that $4.50 number is still kind of out there as a possibility?

Or is it too late now to book enough orders to have that at least as part of the range?

I wouldn't take it off the table at all, no.

I mean, we are not done until we are done.

Right.

As we mentioned, our hit rate is good.

There is lots of activity out there.

We track hit rate and things have slid.

We all know that.

Everyone in the industry has seen that.

But we haven't seen massive cancellations or share loss that we can calculate.

Steve, I think when you look at the dynamics, what we are trying to drive, and I think Q3 is indicative of this, we want to have things -- and most of the things in our control.

And one thing that is not in our control is the markets.

But we still have a lot of synergies remaining.

And we are building momentum in Lean.

We have got carryover restructuring that we are working on heading into next year, and the operational performance is encouraging, because we are building momentum there.

We want to grow more than anybody, and every time we see some markets go forward, a couple of markets go backwards.

And so, we have got to look at it as things we can control, and within the things we control we are exceeding our expectations.

And then we have to see where the market is going to shake out next year.

But I think, given our operational execution, we still feel confident we can deliver superior value as a Company.

What percentage of your oil & gas business is midstream, upstream, downstream?

How do we think about that?

Just under a third would be midstream.

And then upstream, is it a third, a third, a third?

A little more than a third and then downstream is a little less than a third.

Okay.

But the way we look at Valves & Controls, if you look -- we are particularly strong in mining and power.

They are not as big as oil & gas, obviously, or process.

So their being weak is not great news for us.

But, frankly, we are very strong in LNG and we are very strong in process.

And those two, the outlook for those two applications, LNG in particular with cryogenic applications, we are very strong in that.

And we see a number of projects there that are quite exciting.

In just North America, there is going to be five or six new plants every year for the next three years in the petrochemical space and probably five or six expansions.

It is early days for the valves to be let in that, because in the way it rolls out, they do plant level awards first.

And then they get to the valves.

But we are tracking them all and then all we feel good about those.

Okay.

Thanks a lot.

Steven Winoker, Bernstein Research.

Randy, maybe you could follow up a little bit on that.

In terms of, if oil prices were to stay similar to the current range for a little bit more of an extended time, and you look at the balance of your exposure that you just described upstream, midstream, downstream, to what extent do you see that as kind of a headwind versus tailwind for the Company?

Well, I am not an oil guru, but we are watching with great anticipation like everyone else what the impact will be if -- what oil prices, different activity change, but the end customers are not changing their CapEx plan based on movements week to week on oil prices.

They are waiting -- it takes a year to do a directionally drilled well in the tight shale formation.

So, it is not something that you turn on and off on a weekly or monthly basis, so -- when you look at overall CapEx plans.

But, in particular, if you take a look at the two businesses I just talked about, LNG, the thing that is driving LNG right now is the opportunity to export LNG from North America.

If you take a look at it, we have a vast amount of natural gas.

It is priced for the first time below its BTU value.

Since the deregulation in natural gas, for the first time natural gas is trading at a price lower than its BTU value.

And with the abundance of natural gas, you can see us having a real opportunity to export that gas to other countries, but -- basically, Asia and Europe.

And there's four or five projects underway right now, then there are 17 being planned.

And then, on the process -- on the petrochemical side, same thing.

A lot of the investments left over time as natural gas, which is the feedstock of petrochemical -- the natural gas liquids.

As they went up in price, that capacity left the country and now it is coming back, and all for the same reason.

Natural gas prices look pretty low.

And so, those two in particular benefit from the longer-term ore cost of natural gas.

And so that is why I am encouraged and I am worried less about what oil prices do to those two things than I am to what it would do to E&P.

Okay.

And then, John, page 5, which is really helpful, the operating income walk that talks about growth inflation and productivity versus price, the inflation you cite as sort of a 1.5% for the whole Company, I'm going to make the assumption that that is including wage and material, total inflation.

And then, mix is somewhere baked in here.

Maybe you could describe where you put it.

And then, your basic business model, then, is kind of 1.5% inflation offset by 1% of price and 2% of productivity.

Is that the way -- that just happened to obviously be this quarter, but as you think about the business model for the Company, in the absence of growth, how should we think about this?

And then, how do you think about it sort of in a little bit longer term?

Yes.

So you are right.

Our inflation numbers include both labor inflation and material inflation.

So you are right.

And then, mix is netted in the productivity and price column, so that is inclusive of any negative mix we have.

I think, as we think about where we are right now, I think inflation is going to get a little higher.

And that is not a bad thing.

We are actually hoping for it to go up a little bit.

And then, overall, we do strive to get about a point of price.

I mean, we are -- 70 to 80 basis points of price is a full yield for us, given the fact that half of the revenue or about 40% of our global revenue is more projects and systems now, so less price opportunity there.

And our productivity is two points and that is what we try to achieve.

And, right now, we have got a lot of tailwinds there.

We will start to see benefits of OMT next year.

As I mentioned, we have got some carryover restructuring, and we are really building that momentum around Lean and sourcing in the new flow control additions.

So I don't think it is time to pull back on productivity anytime soon.

As a matter of fact, we want to push the pedal harder on that, Steve.

And those -- I said it earlier; those are in our control.

Mike Halloran, Baird.

Just on the thermal side of the business, maybe you could just talk a little bit about how backlogs are trending there, project acceptance, some of the Canadian activity, but then also what the quoting activity looks like and how that is tracking relative to expectations.

Yes, so a couple of elements there.

I will start with Canada first.

I mean, Canada, we are at levels now on an annual basis that we feel really reflect hopefully a floor, but we have been tracking at those levels and starting to see an uptick.

And we did see an uptick in both orders and shipments in Canada in Q3 that we think that will continue into Q4.

As far as the order rates, certainly getting a strong pickup in the order rates on the Industrial side -- industrial heat tracing, starting to see the benefits of some of those petrochemical, particularly sulfur orders that Randy mentioned earlier.

And we are starting to see some fairly strong encouraging news on what is happening in Energy in that space.

And so we feel pretty optimistic heading into Q4 that we are starting to see those orders tick up in a way that could be helpful in the future.

Yes.

And I would add, one of the things, as we have talked before, we have gone underneath the segments.

We have gone to 19 focused platforms to drive growth.

And in the thermal areas, what that did was we broke out the commercial thermal business, commercial thermal solutions.

And that focus has led to higher growth.

I mentioned in the script that we have seen some nice stocking orders in preparation for -- as a result of the cold winter last year.

We actually had stock out last winter with the heat tracing for snow melt and rail protection, et cetera.

And so our business, with the focus we have, we have been able to get out in front, make sure the stock is in place for what might be needed for this upcoming winter.

And that whole focus has led to some more innovations in terms of other applications in the commercial space for install on hot water and some other interesting applications.

So thermal is looking pretty good.

Thanks for that.

And then, at a higher level, obviously, you guys took down revenue expectations last quarter.

There is still talk of push-outs and there is a few moving pieces within the portfolio.

I guess what I'm asking is, if you take out the FX swings with the strengthening dollar here, relative to your expectations, how much on the revenue line on a forward basis has really changed?

And maybe you could just talk about a couple of the puts and takes as you see, versus where you guys laid out expectations last quarter.

The way we do FX is we take the ending rate, and the ending rate at the end of September is about $1.28 on the euro.

And there is other currencies of course, but that one had the biggest impact.

And so, if you would take that into next year and assume that we are tracking right around where the euro to dollar is today, that is roughly a 1% headwind next year, and that is current views.

We can't forecast where the currency is going to go.

The way I would tell you is that every penny of euro to dollar movement is worth about $10 million to Pentair on an annual basis.

On the revenue line.

On revenue line.

And when it gets to the operating income line, there are some natural transactional benefits that also occurs, so it is not a big substantial headwind.

Other than that, I think we will be watching, as we head into next year, where the Valves & Controls backlog is and how that impacts next year.

Then we have had a couple of headwinds.

We have had this retail issues at Flow, which is about a point of revenue to Pentair, and that continues next year.

So there is puts and takes.

At the same time, the Industrial and the thermal is performing at higher level.

But I would say, with the exception of FX, we kind of see the world the way we did when we talked last quarter.

FX is different, but, other than that --.

Yes.

That makes sense and that is what I thought you were driving to, so appreciate the time.

Joe Ritchie, Goldman Sachs.

My first question is really just not to delve too much into this -- into the oil & gas pressures that we have seen of late, but perhaps maybe you can talk a little bit about the quoting activity that you mentioned.

It was lower this quarter.

Is that a seasonal factor?

How much of that related to what you are hearing from your oil & gas customers?

And, specifically, going back to a question that was asked earlier on your exposure, when you talk about your upstream exposure, what percentage of your business is linked to longer-term projects versus shorter-term projects?

On that one, I can't give you that split sitting here right now.

I don't know, John, if you get (multiple speakers).

Yes.

So yes, Q3 is seasonal.

We inherited some businesses that used to have a fiscal year in September.

So, just to remind everyone, it used to be a big push for them because it was a fiscal year end.

But, naturally, Q3 would be a lighter quoting activity, given shutdowns in August and in Europe and that kind of leaking over into the United States lifestyle.

When it comes to projects, large projects do make up about 70% of our overall quote activity, still today.

And so we are looking for large projects.

And I want to define large projects as anything over $1 million to $5 million.

These are not megaprojects at all.

They are just larger valve order rates.

So those continue to be the trends that we are looking to.

And, like Randy said, the quarters have been very volatile.

And what we have been looking to is the six-month and trailing month order rates to try to get some sense of normality as to where these markets are going.

Is it fair to say you didn't sense, necessarily, from the conversations you were having with your customers that -- like the project push-outs you have been talking about first for quite some time now, but there wasn't really -- was there much of a change in the quarter in the tone relating to the projects that you are looking at?

We would have expected to be up modestly in orders entering into the quarter.

And we came out around flat.

So there were a couple of projects that we could point to that have felt like they have slipped, primarily around EPC actions and activities that have pushed those out.

And so, that is consistent with what I think you are hearing from others.

And we don't feel like there is any share loss in there.

And, therefore, we feel like as the market comes back, we are going to participate in that.

Okay, and just one follow-up question on the margins, because the margins in your Valves & Controls business was -- were really strong this quarter.

The expectation, as you head into 4Q, is another really strong quarter.

So, two follow-ups there.

One, can you tell me the OMT headwind that you are expecting in 4Q versus 3Q?

And then, secondly, you are basically expecting to see about 280 basis points in margin expansion in 4Q.

Just help me understand the confidence in that number from where we sit today.

Yes.

So we are expecting $5 million of OMT in Q4, which is about $1 million higher than it was in Q3, but tracking to the $20 million on the annual basis.

That is fairly consistent.

The margins last year, just to remind you, we had a little challenge in a couple of our factories in a couple of --

Well, we have one big project, too, that shifted.

One big project that was a very low margin project.

So when you take a look at it sequentially, it looks more normal.

And we feel like Q3 performance is indicative of how we are performing in our factories and the sourcing benefits we are receiving, and the mix of projects that we are shipping.

So we feel comfortable heading into Q4 with that same margin look.

Okay great.

Thanks guys.

Nathan Jones, Stifel Nicolaus.

If we go back to the Valves & Controls business, you said you were looking at order rates pretty closely with the decline in oil & gas.

If you looked more at the short cycle side of that business, have you seen any meaningful change there over the last couple of months with the price decline in oil?

Well, we were softer in short cycle orders than we would have liked to have been in the third quarter.

That is largely due to lower mining activity and lower power than it is oil & gas.

When we take a look at what the change rate was, not so big a difference in oil and gas.

Okay.

You also called out a softer Middle East relative to some tough comps from projects last year.

It is pretty typical of the Middle East to build a lot, digest for a while; build a lot, digest for a while.

Sounds like we are in that digestion period.

Can you talk about the outlook there and where you think we are in those cycles, maybe when you expect to when you expect to pick up in Middle East?

Well, I would say second half next year would be when we would expect to see it.

I mean, there is some activity in terms of quotations now, but it wouldn't hit sales until the second half of next year.

So you would expect orders to start hitting maybe six months before that?

Yes.

That's very helpful, thanks.

Scott Graham, Jefferies.

When we look at the fourth quarter sales guidance and we adjust for the FX, it doesn't really look a lot different than what we saw in the third quarter.

Yet, we have had a bunch of negative headlines in press from second quarter till now.

Is this essentially a function of your saying, or are you essentially saying to us that your customers have really not -- there orders have not been impacted?

And, again, the Company as a whole I am talking about here.

Yes.

You know, I think there was some fear of that out there, heading into the quarter, and you guys are in a lot of different markets.

So, just as a general statement, are you not seeing your customers pull back off of some of these negative headlines?

Well, let me start with your last point.

We do serve a diverse set of end markets and they are not all moving together.

And they don't all move with oil and gas, even though with the oil and gas, as I mentioned, the lower prices are actually good for some applications.

But, we think food and beverage is still strong.

We think our residential position in the US is going to continue to give us growth, albeit maybe at a little bit more moderate rate.

And, so we think particularly those two businesses are quite, good.

Europe is the thing that is weaker now that we thought it would be.

So we are cautious on our oil and gas, but again, oil and gas is just part of our energy exposure, and energy is only 28% of our sales.

So, oil and gas is less than 15% or so.

I could give you an exact number.

So we look at all of those end markets as important to us.

In particular, the industrial North American growth in capital spending is a huge driver for us.

And we saw that in the fourth quarter and you can see what it does that we get some growth there.

We don't expect to book another 8% in the fourth quarter, but (multiple speakers).

It sounds like there was nothing knee-jerk from what you saw in the quarter, essentially.

Right.

Right.

That's correct.

Thank you.

The second question is more about the intended uses of cash next year.

With the reset to the guidance and the divestiture of that business, kind of looking at that [450] maybe a little bit differently, is there a chance that we could see some M&A mixed into your cash usage next year on top of share repurchases?

Yes.

There is a chance, yes.

A chance.

Okay.

So anything sizable?

Are you no longer looking at small things?

Are you looking at things that are maybe a little bit more of size since the Company's larger?

We are always actively looking and we have been actively looking hard.

We think that we have proven that we can integrate.

And there are several of our platforms and businesses that certainly have an appetite to do deals and have the capacity to do deals.

So, we are constantly looking and we have got to have the right price between the seller and the buyer, and those things have to line up.

So it is hard to predict.

Right.

Fair enough.

In the absence of M&A, though, we should, I think, realistically then expect more share repurchases in 2015, kind of maybe not along the lines of a year and a half ago, but maybe something along the lines of maybe the last couple of quarters that we have seen?

Clearly, we are a new Company.

We used to be, before our merger, if we had $250 million in cash flow, that was a big deal.

We are going to do over $800 million and as we get bigger, it is going to be in the billion-dollar range.

Since the merger, which was just two years ago, we closed two years ago, we have almost done $2 billion in share buybacks already.

So we see the benefit of doing that and, at that level and at that rate, would be pretty dramatic.

But, we do believe in returning -- giving shareholders a return.

We have done it with about 38 years in a row -- or is it 39?

38 years in a row with our dividend increases.

And our belief is that capital should be used, not wasted.

Jeff Hammond, KeyBanc Capital Markets.

John, just back to your comment about, we expect strong orders in the fourth quarter, can you just clarify that?

I mean, is that just translating some of this quoting activity into orders?

Yes.

I mean, what I am saying is that, obviously, we are going to put the pedal to the metal on trying to get as much orders as possible.

And there still is activity out there.

And as Randy mentioned, we can't just be wed to the price of oil.

And there is a lot of other markets in which we serve that we are focused on.

So we got to keep going after it, and there is still a good solid quote log heading into Q4 and we want to continue to take advantage of that.

And then, just on this $4.50 number, clearly, you are doing a lot more buyback here than certainly I would have thought.

And that helps.

And you seem to be pushing pretty hard, still, on productivity and you should get some OMT benefit.

But, can you maybe frame how you think about -- what you mean in terms of topline growth to kind of approach that $4.50 number?

Yes.

I mean, just to remind everybody, the $4.50 was in response to the $5 target, with about a quarter of that related to losing water transport contribution, the other quarter due to macro environments.

And that is all at a point in time.

So as we talked about earlier, mid-December we will be giving guidance heading into next year, which will frame kind of how we feel about the overall contribution, based upon what we see in December.

That will include our Q4 order rates and it will include current foreign-exchange views.

It will include where we think the balance sheet participates in that and we will have a better insight to what to provide.

Right now, there is really nothing to update against that number.

Yes.

Where we are in our process right now, over the next month and a half, we will be doing the heavy lifting and doing the disciplined planning.

And productivity will always be part of our strategy.

We plan our work and then we execute that.

And then I think you can see in our integration, and you can see in our consistent productivity over time, we know how to do that.

What we will be doing is building that detailed growth plan.

That will roll up into our budget.

Those budgets will inform the guidance that we give in December.

So we will tell you then.

Brian Konigsberg, Vertical Research.

Can you actually just give an update on where you stand with the synergy number?

I know you have been kind of moving away from it, but you talked about $200 million completed as of the end of Q2.

Where do you stand at the end of Q3?

And to the extent you can, maybe what the bridge will be between 2014 and 2015.

Yes.

I think the $200 million was -- might be the same number, but it was also the repositioning or cost take-out that we were actually driving to, so permanent cost structure reduction.

I mean, as we gave the update, we were looking to get over $275 million of synergies by the end of next year, which was the new number exclusive of the water transport contribution.

And, given where we ended Q3, it is fair to say we are tracking stronger than that number.

And if you were going to push me for a number, I would say we are $10 million to $15 million, maybe $20 million better than that expectation.

We have been blending this in.

What we are really looking at is what we are doing at gross margin and how much that gross margin is coming into Lean and sourcing.

And then, what are we doing at our cost structure, primarily G&A and what is that as a percentage of sales and the reductions there?

That is really where we are driving it.

It falls under a standardization category, so reductions in ERPs, reductions in accounting centers, and then where are we as far as Lean evolution in all factories, including the legacy Pentair side as well.

We feel really good about what we have achieved so far.

Yes.

It has been good.

Another question, just coming back to -- you talked about your strong positioning in LNG and chemical.

When you are bidding for these projects, are you being -- are you really appointed as a sole-source supplier as valves and heat tracing equipment on these projects or are they breaking it up amongst multiple suppliers?

Well, it really depends on what the specific quotes are.

Sometimes there will be a multiple package.

And the range of technologies and then performance characteristics of valves, they are pretty broad.

So for instance, we are a leader in triple offset valves.

We are a leader in pressure relief valves.

And all of those get specified and you bid those.

Sometimes you bid them as a package.

The EPC and the end customer will -- a large project will decide how they will split up the packages.

They will let that DCS go and then they will do the pumps, and when they get to the pipe piping and the valves, each of those come in packages.

So it is really -- it is not a one-size-fits-all in how it gets bid.

And then, depends on -- I mentioned LNG -- LNG has a lot of cryogenic applications.

We are a leader in that in terms of our valves, particularly our triple offset valves and our pressure relief valves.

So we tend to have higher share in those kind of applications.

Other applications, maybe not so -- maybe not so high a share.

So it is kind of hard to generalize.

Got it.

Can I just sneak one last quick one in?

I see you changed your CapEx modestly to the downside, same with D&A.

Can you just address what the thought behind that was?

Yes.

I mean, it really is as simple as, every year the GBUs -- our businesses and segments start out with a plan and we approve capital as it goes along, and we make those capital decisions based upon the returns.

And, usually, they overestimate in the beginning what they we are going to spend, and usually by the end of the year we get to the correct number.

So we are just kind of getting to the correct number, is the way I would describe it.

That, in my 14 years, is probably -- 12 out of 14 years where that has been the case.

Christopher Glynn, Oppenheimer.

John, I just wanted to go back to the Valves & Controls margin.

It sort of showed some pretty significant upside versus the margins.

The plant issues were last year known, and so a pretty sudden sharp uptick.

I am wondering, is that just all sustainable structural step-up?

I think that we crossed into the upper 15s.

We are forecasting to slightly above 14.5% to 15% for Q4.

The only difference is that we get a stronger level of manufacturing in the September, and in December we sort of have those last couple of weeks where we start to tail off, which creates some absorption issues in some of the factories.

So we think that we are now at this type of run rate.

We feel very good about the progress being made around sourcing, as I mentioned.

And we can see margin in backlog, and we have got a better handle on a lot of the intercompany shipments between each other, so feeling good about the Q3 performance and feeling good about our ability to sustain it.

Great.

And then, you mentioned being aggressive to get the orders in place in the fourth quarter.

Just to kind of beat a dead horse on the Valves & Controls margins sustainability, do the second half run rates here -- do they reflect a level of quoting discipline that you have room to back off of a little bit?

Yes.

And I wouldn't say that we are necessarily backing off, but one of the things that the Valves & Controls team has done a nice job of is using Lean across the quoting activity.

And we are spending quality time on the right quotes and the right engineering jobs, and when we are doing that, we feel good about our ability to go on with a quote that we think meets our margin needs and meets the customers' value proposition.

So I think we feel good about the progress we are making and using the Lean tools outside the factory, and I think you are seeing that in our quoting activity.

Josh Pokrzywinski, Buckingham Research.

I think it is me, based on the announcement.

Just to circle up on Valves & Controls, you mentioned some of the other areas that you are participating in or focusing on outside of oil & gas, and maybe why we shouldn't be focused on the correction in oil prices.

And I get all that, but I guess, thinking about the comment you made earlier, John, on 70% of the business being project-related in some way, even if those projects are smaller, how much of this business that you are going after in pockets of strength is a legacy position for flow control or for Valves & Controls, where you are calling on customers where you have relationships versus trying to start things from scratch, in maybe an environment where projects are getting pushed around.

And it is a little tougher to kind of call on a customer for the first time.

Our brands are well-known and they are known pretty much to all the EPCs and all of the oil & gas or any other customer set, for that matter.

But we are -- for instance, in subsea, we are not really strong in subsea.

So there is a lot of subsea activity we are not going to get.

We do better on land in that category, I mentioned.

We do better in liquefaction stations, in natural gas than we do in pipeline.

And it is really more of a product mix.

So we look at all that.

And we look at our hit rates.

And what I would like to do is I would like to see a higher hit rate on where we are strong, and I would like to see us figure out how to get better in some of the places where our hit rate isn't.

And that's -- there isn't a general answer I can give you on that.

I guess what drives the better hit rate, though, is my question, that -- I mean, clearly, it is not price.

I know you guys have been very forthright with that.

Is it lead time?

Is it capability?

Is it just (multiple speakers)

We believe configure to order can help us on smaller projects, in particular.

Having product in stock and being able to configure to order in our 80 locations is something that we think we can do better at.

That is an idea yet.

It's not a plan.

We are doing some alpha tests on that.

That will be helpful for the smaller projects.

The rest is a lot of specification work.

And we would rather be specified and take our chances than just compete on price, as you said.

And we have been more disciplined, we believe, on price than maybe before.

Got you.

And then, John, just two follow ups, little housekeeping items.

If spot rates stay where they are at on FX, and you mentioned that point of topline headwind in the next year, what does that work out to on an EPS basis with some of the transactional benefits you get that you mentioned?

And then, on the share count, if you do what you plan in the fourth quarter, what is the starting share count for 2015?

So, a couple of different answers there.

I mean, on the transactional and translational FX basis, if we saw somewhere around a $0.10 movement in the currency, we would -- that would be the impact on the revenue line.

It is $0.10 times what I said before, $100 million on the top line.

We would be within sight of a nickel, is what the impact would be on EPS.

That is a model that we run quarterly and annually.

And there is, as I mentioned, benefits to currency going down that offsets some of the impacts of currency going down.

When we take a look at where we are in share count, heading into next year, we are anticipating what purchasers would be made.

And, as of today, there is $70 million remaining on the authorization.

And that would drive somewhere around 185 million of the share count next year.

Got you, all right.

Thank you.

Brian Drab, William Blair.

I guess, at this point on the call, I need to drive in some finer detail on a high level that hasn't been touched on.

One comment you made today is that you are seeing the shift, I think, the point of entry water filtration system (multiple speakers).

Yes.

I said that backwards.

I'm glad you asked that.

It is point of use, not point of entry.

I said it backwards.

And I have read that script three times and I didn't (multiple speakers).

Basically, a lot more under sink, a lot more point of use versus point of entry.

Point of entry has a bigger content for us, and frankly, a better mix of margins on the products.

So I'm glad you asked so I could clarify.

All right.

Thanks for the clarification.

The related question was just going to be around that hybrid DI system.

I think it was last year with your Milwaukee team, they said that they were working hard on that product.

But it didn't seem to be at the point yet where the price was going to result in an inflection point where you would see a significant uptick in adoption of that product.

But how is that going with that hybrid DI product?

We are still in development.

We have actually done some redesign work to take some of the cost out and improve the efficiency of what is called the sack -- membrane sack, and improve the control of it, so that it doesn't have to cycle as often.

And so, we have got that on beta test now and looking at it and we don't have a new launch date yet to go public with.

But we still have positive thoughts about what that can do in the marketplace to eliminate -- to basically provide the softness.

Okay.

Thanks.

I guess you have touched on this, but I just want to ask it may be a little bit different way.

For the fourth quarter forecast for valves and controls, I'm just trying to get a better -- a higher level of confidence in the forecast.

Because your forecasting flat revenue for the segment suggests that 5% sequential increase, but backlog was down sequentially in the third quarter.

Is this just the typical end of your push, seasonality dynamic or is there a particular vertical you have more confidence in or better than average visibility in?

Thanks.

Yes.

Part of that backlog decline was foreign exchange.

And that is already reflected.

But that rolls through over the next 12 months.

So there is a small impact to Q4 related to that.

It is a combination of how we feel about the shippable backlog.

And then, just as a reminder, we had about $35 million to $40 million of one project last year that went out at zero margin, which was in the Q4 number last year.

So if you pull that out, you're going to see a little bit more revenue growth, excluding that project.

And you are going to see --

Year-over-year.

Yes.

Year-over-year and you should see the benefit of that drop through as it pertains to the operating income and where the margin is.

Does that help?

Yes.

Definitely.

Thanks a lot.

Andrew Obin, Bank of America Merrill Lynch.

Just a question on your bridge, just going back to slide 5 as I'm thinking to the fourth quarter, and I'm thinking about your productivity price in fourth quarter, should we see it roughly in line with the third quarter?

Because if you sort of do the math, it implies a slight deceleration.

Yes.

As I mentioned earlier, we don't tend to get the same December contribution that we get out of June and September on an end-of-quarter basis, primarily because of the way the holidays impact the last couple weeks of shipping in the year.

But all other components, inflation roughly there, little bit of headwind for foreign-exchange -- not a lot, and then also we expect to see a good productivity price push as well.

Got you, really appreciate it.

And, just to clarify, no restructuring this quarter and what is the thinking?

And does that mean that we reaccelerate in the fourth quarter?

We have not taken any incremental restructuring in Q3, as you indicated.

And as Randy mentioned earlier, in the context of rolling up plans and taking a look at where we think we are going to be next year, and what contribution that we have in productivity and growth, I mean, any further decisions on that would be taken as necessary.

So, are we waiting for the Board meeting or right now the plan for no restructuring in the fourth quarter and it is just a placeholder?

No.

We are evaluating where the markets are going.

We are evaluating the confidence in the growth plans.

We are evaluating the confidence in the current productivity views and how all of those things work their way into any further actions we need.

Terrific.

Thank you very much.

Jonathan Wright, Nomura Securities.

Just on SG&A, down at 18.7% as a percent of sales this quarter, I think in the past you have talked about kind of a long-term target of 20% of that.

Is there anything going on specifically in the quarter that was weighing on bringing down SG&A or is that longer-term target now sort of sliding down a little bit?

Can you get more cost out of that than you originally thought?

Well, it is a combination of a couple of things.

One is, we do think we can get more G&A out.

No doubt about it.

But, certainly feel, even on current levels of G&A, we don't need to add any, so growth helps leverage that down.

And then, we are certainly -- we cover up the difference by adding more in R&D line over time, and adding to selling and marketing as necessary.

And right now, we are evaluating these 19 growth platforms that Randy mentioned and we are certainly giving them all the money they need at the moment.

And, as they earn the right to be invested in more, we will add more to the growth buckets.

So looking forward, you think SG&A as going to sales can be more like 18% to 19% sustainable?

Yes.

I think so.

I mean, the quarters fluctuate.

So take a look at where your full-year is coming in and right now we think around 20% is achievable, and then also drifting down to 19% would not be -- there is no magic formula in there.

But we are disciples of the Lean enterprise.

And G&A -- no offense anybody on my team, but G&A is considered muda in the Lean concepts.

Muda is waste, so I mean we want G&A to be as productive -- in a perfect world there need be no G&A, in a perfectly Lean world.

Any other questions?

Hearing none.

No one else.

Operator?

Anymore questions in the queue?

David Rose.

I don't want to beat this to death, either, but just to get a little bit more clarity around the comfort in the orders for Q4.

If I look at Q4 last year, it you really had an exceptional period.

And you have got some very tough comp comps.

Mining, as you mentioned, is not doing that great.

That is probably your easiest comparison.

Help me get more comfortable on the specific projects that you are looking at.

And how do we frame the risk at Q4 orders on the upside and the downside, given where they were last year?

Can I just say, comfort is a word that I am not familiar with, when you are projecting the future.

But, I mean, in terms of the model, when we think about it, we would look at our backlog that we have, and we look at what is shippable.

And we look at the quotation activities and that is what we used to drive our forecast for (multiple speakers).

And this is all front log, right?

Yes.

And I just -- what we are doing is we are trying to build the backlog up to get the next 9 to 12 months of shippable backlog.

And there is also a book and ship element in the order take as well.

So I agree with Randy.

I would not use the word comfortable.

But the level of execution around consistently getting robust orders growth is where we are trying to drive to, and we are not yet ready to say that it is not where we need it to be.

But also want to remind you, it relates to 1/3 of our business.

And we also are looking at all the order and the book and ship business in the other 2/3 of the business.

And, as Randy mentioned, when you see some oil & gas move in a particular direction, that is not necessarily bad for some of the Industrial segments that we serve, either.

So, all of it has got to weigh into what we think we can achieve for next year.

Okay.

That's helpful.

And, maybe, a last one is, last time we had a big disruption in Europe, or at least concerns over Europe, there was a lot of destocking in the channel.

Has October shaped up to be that way at all?

I would say too soon to tell in terms of Europe, specifically.

Europe was a surprise -- the weakness in Europe was -- we had growth in Europe in the first half, and then it went -- declined in the third quarter.

So that is a note of caution in terms of what we are looking at.

It was one of the bigger pullbacks in September with the Europe performance in September.

It was really soft.

And, for Europe, because July and August are vacation months, it is all about September in Europe, so making sense of what it means when you have a weak September in Europe takes a little while.

Thank you.

That is it, then we either -- you can give the call-in information, please, operator.

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