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Executives

Randall J. Hogan – Chairman and Chief Executive Officer

Analysts

Robert J. Venable – Robert W. Baird & Co.

Sara Zawoyski – Vice President, Investor Relations

Pentair, Inc. (PNR) Baird's 2011 Industrial Conference November 9, 2011 ET

Robert J. Venable – Robert W. Baird & Co.

Good afternoon. I’m Bob Venable, Head of Equities. I want to welcome you to the Pentair presentation.

Pentair is a diversified manufacturer of Water products and electrical enclosures. Its market leadership is driven in large part by one common element, the strength of its product brands. Pentair intends to drive above average GDP growth through targeting high-growth vertical markets such as desalination, Water reuse, hospitality and industrial filtration and introducing new products into these channels. Pentair is also actively expanding its global reach, especially in high growth regions such as the Middle East, China, India and Latin America.

Here this morning to tell you more about Pentair and its growth prospects are Randall Hogan, Chairman and CEO; and Sara Zawoyski, VP of Investor Relations. With that, Randy?

Randall J. Hogan

Thanks, Bob, and thanks to all of you for showing interest in Pentair. Look forward to tell you all about it. This is the forward-looking statement, you’ve all read them before. But the first thing I am going to do for you is not read it to you. So let me talk about Pentair.

Pentair is a $3.5 billion publicly-traded company, in two segments Water, and as Bob said I still kind of enclosures as I ran it 14 years ago, but we now call it Technical Products, and in that organize into six global business units as we report. This chart shows three different ways of looking at the business, and if you look at it by the global business unit, the six global business units, technical parts is both the segment and the business unit, and then we split up Water into Filtration Solutions and Engineered Flow Pool, Residential Filtration, and Residential Flow in order to get more granularity on the strategies going forward.

We have a very balanced portfolio. One of the ways we’re balancing it is by driving more geographic growth. The middle chart shows, we’re still U.S. dominated, and this is partly historical and we are correcting that by intent. Fast-growth markets in fact are now 19% of our sales. If you go back five years ago, it was less than 10%, because we're focusing a lot on driving our growth there and I got a lot more about that coming.

And then finally, by vertical market, again what we do is we take our strong brands and our solutions and we deliver them precisely how it should be in various different vertical markets and that's part of our strategy too.

Residential markets, which has made the last few years an interesting ride, at 35% of our sales, a little less than 25% of our sales are U.S. Residential. Despite that if you look at our performance, we have performed at or better than our peer averages which have no residential exposure and we feel good about that and that's something that can sustain. A big reason for that is, we have done well in the industry and agriculture; we have done well in infrastructure, and we continue to do well in commercial.

That is clear in this chart, which shows you from the nadir up to the financial crisis when we fell $3.4 billion to $2.7 billion and our margins fell just under 11%, return on sales and in EBIT margin. We grew to $3 billion and this year we'll be around $3.5 billion. Now that includes a recent completed acquisition called CPT or Clean Process Technologies. However, either you take that out, we’ve grown sequentially 10% a year, as we’ve snap back and in fact are above including CPT the sales level that we had in 2008 and more importantly we’re well beyond the profitability, the prior peak profitability in the company which I’ll come back to. We’ve done that because we’ve able to expand margin 240 basis points over this time period and still done a number of acquisitions as I mentioned not just CPT, that remain on track and are making a good impact for us right now.

One of this we focused on certainly over the last 11 years that I have been CEO is cash flow and our focus is to deliver more than a 100% conversion of net income into free cash flow. As a measure not only the right thing for shareholders, but it’s part of lean philosophy, a lean philosophy, lean enterprise, the total production system and the Danaher business system, we are big practitioners of that, and in some businesses we’ve already achieved world-class performance in that arena, and that delivers free cash flow. We expect free cash flow to be about $250 million this year.

Now, what do we do with that free cash flow? We keep our balance sheet strong, we have maintained it at investment grade, and then very close to the same level of priority is dividends. We believe philosophically that we should deliver something back to shareholders every year. We’re very proud of the fact that right including the financial crisis, we are now 35 years in a row that we have raised dividends every year, and our payout ratio now is about 30%, a little over 30%. While that’s not a policy, it’s really a philosophy and those who know lean is part of my standard work, is managing dividends.

Now let me talk about each of the segments in turn starting with Water. Water business today is about $2.5 billion; it makes us one of the leaders in water equipment in the world. And we are unique in terms of how we have that mix; I call it the little water cycle. We play a role across the water cycle in a number of meaningful ways. Our largest single segment now is Filtration and Treatment, which is about $900 million, we have Pumps at about $850 million. We have Pool, which we breakout as a vertical market because it is actually controls and pumps and filters and everything that has unique distribution characteristics and unique end-market characteristics; that's about $500 million. And then agriculture is now large enough for us to break that out and we have a strategic focus in them and that's about $150 million.

You can see the growth rates on the right and the ROS. Our biggest opportunity as a company is to get the return on sales up to 15% in Water. And I'm pleased to say that we made progress, we've got 100 basis points improvement in each of the last two years as we've been able to recover some of the sales growth and this is despite the fact that the residential market has not recovered meaningfully at all in the United States or in Western Europe where we’re also active in the residential market.

So I'm quite pleased with the progress. Still yielding an ROIC that is not acceptable, but heading in the right direction to earn the proper return on capital that we know we can get here. We serve about a $70 billion market here. Market, as I’ll come back to with some great growth fundamentals. I mentioned earlier we have made a couple of acquisitions CPT is one, Clean Process Technologies. We have also done another called Hidro Filtros in Brazil and then Nocchi, which was in China. We just want to checkmark here how it fit our overall strategy, because every acquisition we have done in the past 10 years has been very meaningfully tied to the strategy that we have shared with investors throughout.

The key elements of our strategy is driving innovation and technology, building our application expertise, favoring everything that helps us in fast-growth markets and then building a market leadership position. And you can see, CPT checked all those boxes. The Clean Process Technologies acquisition is the most 100% fit of an acquisition I've ever done in my life, I've done a few. Hidro Filtros, which is a Portuguese water filter spigot brand out in Brazil, is about a $10 million business and it checks those things you can see. And then Nocchi is a large pump manufacturing company, already was building pumps for us under our brand and we took it over so that we could grow it more rapidly to help us serve infrastructure opportunities in China. So three good acquisitions.

Let me talk about Technical Products for a minute. It’s about $1 billion today; it's the business that some people in your industry believe we are spending play to achieve the performance, because it's making about 17%. And people say, how do you make 17% in a business that’s just metal boxes. I think the most profound thing you need to understand about this business is we make metal boxes, but that’s not what we sell. What we sell is safety and security for critical, mission critical electronics. How you need it? When you need it? And where you need it? And that's why we can sustain the profitability we have. We have the highest quality; we have the most reliable delivery; we have comprehensive coverage; and we have very few competitors that can do that globally against us.

As a result you can see as this business recovered from $800 million to about $1.1 billion today, our margins bottomed out at 13%, which is pretty attractive for some businesses and back up at 17% already. Through every cycle in this business, the margins have gone up. And the nice thing is as I will touch on in a minute is that we’ve got some great drivers. The reason this business is attractive, again, we are housing and protecting the electronics, the electronics which are more and more ubiquitous in our world, whether it’s to help you with your cellphone or whether it’s to help improve productivity in a factory, electronics are vital, and we house and protect that electronics.

A little more about 2011, and where we are, I am not going to go through it, but the third quarter is on the left of this chart, and it came in as exactly as we thought; a little bit better because of some floods in the North East, but not as strong in a couple of other areas. So we came in at the high end of our range. In that, if you take a look at the Q4 assumptions, a little bit more softness in Europe than we’ve seen early in the year, moderating growth in industrial. But again kind like we thought we would be and with those fourth quarter assumptions and expectations for the year we will get to $3.5 billion, which is 15% growth.

13.5% return on sales and another 100 basis points approval to the year and then $2.44 and $2.47 record earnings per share for the company by far, which is 22% to 24% growth. So despite everything that’s going on we’re consistently delivering right along what we said we would, and actually a little better that we said we would a year ago.

Now, let me back up and tell you why we like these two segments. As we think about strategy and we think about how you build the company, we define ourselves as a narrowly diversified company, industrial company. And our strategy is always been governed by two things, we want to be in market that have good growth fundamentals. As Bob mentioned earlier, businesses that we believe can grow 1.5 to 2 times G&P, good growth fundamentals.

And then take all the other strategy questions and bullets onto this one, and that is can we control our destiny in that business and how? The reason I say it that way is because if you can control your destiny, you can innovate, you can manage your channels effectively, you can raise prices, you can drive productivity, you can earn a good cost of capital, so good growth, good opportunities to earn in the end, high cost of capital. And both of our segments qualify.

And the thing I’m most excited about is the fact that the global mega trends that are driving the world today, and there are the most important things driving the world today, not Greece, not Italy, not residential and housing, and that was a fact that we got another 2 billion people who have been unleashed to achieve their potential and I call that a new-new world. That population and more important than the population, the wealth growth in those countries is changing a lot and you all know this.

But in particular as we look at it, that wealth growth is driving new demands for food, new demands on energy, and new demands on infrastructure. And both our Water and Technical Products businesses serve those in meaningful and profitable ways. And we do that because – in particular water scarcity, water scarcity is not just a problem, it’s an economic issue in these fast-growth markets. You cannot develop industry, you cannot provide people what they need if you don’t have enough water.

We’re going to get there and solve all of these problems with some new, very interesting innovation. In fact last week, at last week’s Aquatech show, we as Pentair received three innovation awards including the Overall Most Innovative Company award from Aquatech, which is the biggest water show in the world, every two years.

Efficiency and sustainability, we all want to be sustainable, but sustainability matters when it’s economically compelling. And that’s the way we focus on sustainability. And then finally the health and safety, whether it’s water, whether it’s electronics, we play into these fundamental drivers.

So a little more depth on that, that led us to the vertical focuses we have in each business. So if you take a look at Water, Technical Products and you take a look at the Infrastructure, we do about $300 million in Infrastructure. And there is two pieces of it. Kind of slow growth in municipal break and fix business in the U.S., but then there is the very exciting infrastructure development going outside of the U.S. in the new-new world.

Agriculture, I mentioned food earlier. The way technology is being delivered in the mechanization of farming in the rest of the world is a huge opportunity for us. And that’s already grown from about $100 million to $115 million over the last two years for us alone. Industrial, we have meaningful position serving some important industries like food and beverage in Water or basically the broad industrial manufacturing front in Technical Products, and then, food service, which we are a global leader. And then on the Tech Products side, energy, walk through any factory, walk through any refinery, walk through any development site, and you'll see largely our favorite stainless steel explosion proof, weatherproof enclosures. That's a good business.

Infrastructure, all the trains being built, we have equipment on trains running throughout China, and then industrial and communication. So that's how we think about how we focus from those megatrends into vertical markets. I mentioned earlier the emerging global middle class. You take a look at the demand that that emerging middle class is putting on energy and water, just take a look at water, there is no more water. And in fact, when you look at the U.S. and the fact that population moves south, which has less water or you take a look at where the wealth is growing, it's in very water-constrained areas.

I will submit to you that they will adopt newer technologies in Chongqing, China before they will in Los Angeles, California, maybe a bad example, New York, because they care a lot more about water in those places. So what's our strategy, how we're prosecuting the company? It's been fairly consistent over time and it's one where still we believe it's been validated by the success we've had and it's how we're going forward. First is to invest in innovative technology, both organically and through our acquisitions. Innovate around sustainability. And again, it's not just good to do, it's economically compelling to do, and that's how we're focusing our efforts.

We have made a major push into the fast-growth regions. Most of our major investments have all been about the fast-growth markets. And then taking PIMS, I mentioned lean enterprise, we have something we call Pentair Integrated Management System. It includes lean enterprise and the practice of lean enterprise. but it also includes talent management that’s world class and includes rapid growth process so we can add the same kind of compelling growth that we’ve had in terms of productivity from lean. And then finally a new process that we’re driving to drive innovations, so that’s our Pentair Integrated Management System.

We are investing more in growth, we have a better process, we are also investing more in growth and I am not going to go through all those products, but those are the some of the products that we’ve introduced over the past, we’re single stated company we don’t have any moon launches. And I am okay with that. But what we have is a lot of those products there are products that are in country, for country, so there are products in made in India, designed in India, being delivered in India through our new partnership with Eureka Forbes. Or it’s in China, for China or as in food service, for food service. That’s the way we’re targeting our developments and we expect that percent of sales to continue to grow up to 4% in 2015.

We’re also moving up the S curve in technology. If you take a look at the part that’s shaded blue or grey depending on how you see it, we’re leaders in top of curve there in Filtration (inaudible) our own exchange. But where we’ve been investing is down the curve, I mean the ultrafiltration and one of the awards we won last week was for U.S. nano-filter that has some real excitement among our customers, and then in membrane bioreactors for water reuse and in disinfection and high efficiency system. So we’re very meaningfully moving down the curve and basically lower on the curve means lower is early in its infancy and the technology that will drive growth going forward. So very planful about where we’re putting our money.

I mentioned more global today. In 2009, we were 14% fast growth market and if you go back two more years and we were 8% fast growth markets, today we’re 19%, we intend to double, we’ve doubled the $700 million, and we intend to double again. In fact we want to double to about $1.3 billion by 2015. And that’s important because that’s where the growth is, but as I said it’s not just the growth, I think they will be the early adaptors of the advanced technology that we are talking about, because particularly in the waterside, their need is more compelling and their urgency is profound.

So we’re quite excited about what’s going on there. And frankly it’s a lot of our words, we’re focused here on in the west, whether it’s Europe or in the United States, we’re focused on the debt, and we’re clouded by doubt. There, even when we worry about China, if you talk to people in China today, they’re still seeing opportunity and they’re still optimistic about it, and we are tapping into that excitement.

I mentioned PIMS earlier; these are the four elements of PIMS that I mentioned. I don't need to cover it again, but it is being implemented across the 15,000 employees of Pentair and they get it. And we even launched it our new acquisitions of CPT and Nocchi and Hidro Filtros. Now, all that we believe is going to add long-term shareholder value. We're driving differentiated organic growth because of the investments we're making in innovation and the investments we're making to be where the growth is, which is the fast growth markets.

Our track record on productivity is good and it's getting better. Our price-material mix, in fact if you followed us recently has gotten better; we're getting price, inflation's moderating and our productivity is holding out. So our yield should be even higher on that.

Now our new acquisitions, we got another opportunity to exercise our global logistics and supply management capability, which is maybe not world class yet, but it’s pretty good, it’s pretty good. And I mentioned earlier we are designing in country, for country and we are much more sophisticated about localizing and tuning where we make what, moving products between China and Mexico, between Mexico and Poland, so that we can balance our best cost country more closely with the markets that they are serving.

And then finally capital allocation, I mentioned earlier that we’re maintaining a solid balance sheet. We’re committed to dividend and paying that. And we can still do some self-funded bolt-ons and certainly organic investments on top of that. So we’re very disciplined in our capital allocation, it hasn’t changed in the 11 years and we’re sticking to it.

So as we look from the ‘09 to ‘11 period, this shows on the left what we achieved in terms of growth on revenue, margin, EPS and free cash flow and what we expect between now and 2015. We expect to clock about a 7% organic growth rate. That includes another one point that will get from the CPT acquisition that will get next year as we lap first half. We expect to continue to drive a 100 basis points improvement in profitability. Doing that, we will achieve a good ROIC, that’s key. Growth plus the ROS advancement will deliver the ROIC as we have more piles of EBIT.

So we’ll be able to grow earnings per share on top of that, over 15% and continue our conversion of net income into cash at 100% level. So we believe in some that our portfolio reflects better technology, better innovation, better opportunities in fast growth markets. The mega trends are in our favor. Our execution on growth as well as productivity is first grade. The Pentair Integrated Management System, we’re proving and we’re beginning to validate that by others observing, that it is well on its way to being a meaningful competitive advantage and all of that means we’re well positioned to deliver shareholder value.

So with that, do we have time for questions? I think we do. Any questions? Quiet crowd, I know, lunch is outside.

Question-and-Answer Session

Robert J. Venable – Robert W. Baird & Co.

Maybe I’ll maybe lead off and just, in terms of acquisitions maybe talk about the pipeline and areas that would be most attractive and then just related to that, any chance that you’d consider a third leg or would the focus be within the two current areas.

Randall J. Hogan

Just in terms of the pipeline, I’ll take those in order. In terms of the pipeline, we’re methodical. I mean, the people in the industry that are involved, they know what our strategy is. Our strategy in terms of acquisitions are things that advance our innovation or advance our position in channel, largely in fast growth markets and you can see the acquisitions we made is consistent with that.

That doesn’t mean we haven’t ruled out taking a look at other opportunities and there are not quite a few. There is number of things bubbling out there right now and we are certainly aware of those. But we are fairly staying in our lanes in terms of what we are looking at and we are looking. But I’m thinking more bolt-ons at this point as opposed to anything large. An interesting game now with cycle spinning off low control and certainly with Xylem now as an independent company, it makes the playing field more fun I think.

Now, in terms of a third leg, I think we have enough growth opportunities within those two, to not take on a third. I mean, there is some other businesses where the grass is always greener, right, it looks better sometimes in some other industries. And I think we’re to the point right now where we can actually count on our Pentair Integrated M System to let us add value in areas. But I think we have enough opportunities within those two spaces to stick with that. That’s it?

Robert J. Venable – Robert W. Baird & Co.

Given that lunch await, we’re going to do a breakout session immediately outside, but please join me in thanking Randy for the presentation.

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Source: Pentair at Baird's 2011 Industrial Conference Call Transcript
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