Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Sara Zawoyski - VP, IR

Randy Hogan - Chairman & CEO

John Stauch - EVP & CFO

Analysts

Hamzah Mazari - Credit Suisse

Jim Lucas - Janney Capital Markets

Robert Barry - UBS

Deane Dray - Citi Investment Research

Ajay Kejriwal - FBR Capital Markets

Christopher Glynn - Oppenheimer

Brian Drab - William Blair

Scott Graham - Jefferies & Company

David Rose - Wedbush Securities

Pentair, Inc. (PNR) Pentair Financial Outlook for 2012 Conference Call December 14, 2011 9:00 AM ET

Operator

Good morning. My name is Sarah and I will be your conference operator today. At this time I would like to welcome everyone to the Pentair 2012 outlook conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions). Thank you. Ms. Zawoyski, you may begin your conference.

Sara Zawoyski

Thank you Sarah and welcome to Pentair’s 2012 outlook conference call. We’re glad you could join us. I'm Sara Zawoyski, Head of Investor Relations. With me today is Randy Hogan, our Chairman and Chief Executive Officer; and John Stauch, our Chief Financial Officer. On today’s call, we’ll provide details on our 2012 outlook along with an updated outlook for the fourth quarter and full year 2011 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 risk outlined in Pentair’s 10-Q for the quarter ended October 1st, 2011 and today’s release.

Forward-looking statements included herein are made as of today and the company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances. Actual results could differ materially from anticipated results.

Today’s webcast is accompanied by a presentation which can be found in the investor section of Pentair’s website at www.pentair.com. We’ll reference these slides throughout our prepared remarks, any references to non-GAAP financials are reconciled to the appendix of the presentation. We’ll be sure to reserve for questions and answers after our prepared remarks this morning. In recognition that there are other calls this morning, we’ll target it to be done in an hour. With that, I kindly request that you limit your question to one and get back in the queue for further questions so that we can try to make it through everyone. With that, Randy?

Randy Hogan

Thanks Sara and welcome. Before turning to 2012, I’d like to address the fourth quarter of 2011 and what we’re seeing in our businesses. This is shown on slide number 2. As indicated in this morning’s release we lowered our sales and earnings expectations for the fourth quarter. Our updated Q4 guidance reflects sales growth of roughly 14% year-over-year versus the previous estimate of 18%. This revised near-term outlook largely reflects the impact of weaker Western European sales, both volume and some foreign exchange impact.

In addition, we’re experiencing a sharp reduction in residential water treatment components sale reflecting adjustments in yearend pro channel inventory levels. Both of these factors are negatively impacting profitability. The remaining businesses and geographies are generally performing in line with expectations.

We’re encouraged by a fairly fast start to December along with a better price cost and net productivity performance, but we don’t expect these fully to offset the impact in the lowered sales expectations related to a weaker quarter to date performance. While clearly disappointed in the lower expectations, we still expect top and bottom line growth along with margin expansion in the fourth quarter.

Importantly, we included this new market reality into our 2012 operating plans. In addition, we’re ramping up productivity initiatives, further prioritizing our investments and moving forward on repositioning the company after the CPT acquisition as we mentioned before. These should all yield additional savings.

Moving to slide three, you’ll see that the majority of our portfolio is still performing well with good execution of our strategic priorities in 2011 to position us positively as we move forward. Full year 2011 sales are expected to grow a strong 14% year-over-year or up 6% organic including a negative 2 percentage point impact from the Gulf Intracoastal Waterway project or GIWW which we shipped in 2010.

We anticipate margin expansion of nearly 70 basis points in 2011. On top of prior years, a 140 basis point improvement as pricing and productivity helped offset 4.5% material inflation in the CPT acquisition impact. In total, we expect adjusted EPS to grow approximately 20% to a range of $2.38 to $2.4o. Beyond the numbers, we made good progress on our strategic priorities setting the stage for future success and sustainable growth.

Fast growth regions are expected to grow over 20% organically in 2011. We meaningfully advanced our global water capabilities with the acquisition of Norit’s Clean Process Technologies business as well as Hidro Filtros in Brazil. We also remain committed to investing for growth increasing our overall R&D investments and doubling our product launches in fast growth regions in the last two years alone. So 2011 marks a year of solid sales growth and margin advancement along with significant progress and the strategy that we believe positions us well for 2012.

Now let’s turn to slide 4 to begin our 2012 discussion. Our 2012 plan framework reflects the balanced view of Pentair’s attractive growth opportunities, but also the realities and today’s uncertainties in slower growth environment. Our topline perspective, we expect sales to grow 7% to 10% which includes the impact from the CPT acquisition. The underlying 4% to 6% organic growth reflects a moderate volume contribution from both water and technical products, solid pricing and roughly one percentage point of foreign exchange headwind.

On margins, we are targeting another 40 to 80 basis points net improvement reflecting a strong organic margin performance and including the roughly 40 basis points of negative impact from CPT as we fold in the additional five months in 2012. This margin improvement reflects better pricing, solid productivity and a modest volume benefit. Like 2011 we expect to yield pricing in the one and half to two percentage point range reflecting our value added portfolio and channel strength and enough to offset trailing material inflation.

Net productivity is expected to drive roughly three quarters of the margin expansion supported by a large productivity program funnel and year-over-year improvements in CPT with the remainder driven by volume. These levers along with cost savings from cost containment and repositioning initiatives should help fund ongoing investments and geographic expansion in key growth platforms.

Cash flow and return on invested capital continue to be very important to the success of Pentair. We expect another year of cash flow in excess of net income enabling us to fund the company and return cash to shareholders. As you saw in the release this morning, we raised our quarterly dividend 10% which equates to $0.88 annually, making this our 36th consecutive annual increase.

Our acquisition focus remains on fast growth regions and technology as we take a more bolt-on acquisition approach into 2012. And last, we are targeting more than 50 basis points of improvement in ROIC to roughly 9%. We continue to make solid progress here, up from 6.2% in 2009. Our goal continues to be to drive ROIC to 15% by 2015.

So despite the more challenging environment, we believe we have a balanced approach to growth with solid pricing, moderate volume growth assumptions and accelerated productivity and cost savings programs.

Before we discuss the 2012 growth assumptions by business, I would like to provide a snapshot of our portfolio today as a baseline. This is shown in slide five. On the left of the slide, you will see our 2011 sales mix by geography. Notably, sales in fast growth regions are now nearly 20% of our overall sales, with solid contributions from Latin America, the Middle East and China.

On the right of the slide, you will see our two segments. Water, roughly 70% of our sales with the largest piece being filtration and process followed by pumps and then by pool and agriculture. Technical Products is roughly 30% of sales and there is a diversity of end markets globally. We believe both businesses provide attractive growth prospects and are well positioned for global growth in 2012 and beyond.

Now let's turn to slide six for a discussion of our top-line growth assumptions beginning with water. You will see in the left of the slide that our water segment is about $2.4 billion in sales today. We expect to exit 2011 with sales up 16% or seven points excluding the CPT acquisition and GIWW impact.

In 2012, we expect another 47% organic growth in water sales. This lower underlying growth rate reflects the Q4 weakness in residential water treatment components; a softer Western European outlook and the point of currency headwind probably offset by a larger mix of fast growth regions and impact from our growth platforms.

To the right of the slide, we provided our growth assumptions for our water segment. Let me begin with filtration and process; our largest and one of our highest growth platforms in water. Like in 2011, we expect strong high single-digit growth with leading technologies and expanding applications in beverage, energy, medical and water reuse.

We expect moderate growth in point of use filtration which includes food service and drinking water applications, but then a upside potential coming from an expanded global product portfolio in the fast growth region investments. In contrast, we expect continued weakness in residential treatment components in the developed markets of North America and Western Europe.

Our agriculture business including irrigation pumps and crops spray products is expected to grow high single digits on top of 15% growth in 2011. While still relatively small today, we believe this is a business with greater focus and meaningfully grow beyond approximately $150 million in sales for us today, with innovation, geographic expansion and channel improvements in the works.

In pool, we expect to grow sales in the mid to high single-digit range in 2012 through continued innovation, carryover dealer gain and pricing actions to offset inflation. This is on top of an expected sales growth of over 12% in 2011. Aftermarket sales are a big part of this growth.

Today, we estimate that more than 90% of our pool business is replacement and repair and as a significant install based to serve with an estimate of over 5 million in-ground pools in North America alone. We are also expanding geographically into adjacent markets including aquaculture where we can leverage much of our current technology and product set to serve this attractive industry. There will be more to come on this in the future.

In pumps, we expect low to mid single digit percentage growth. We expect ongoing sluggish large project municipal sales as reduced capital expending for water infrastructure continues. In residential pumps, we expect moderate growth based on a continued healthy replacement market supported by geographic and product portfolio expansion and innovation. Commercial and industrial sales should continue to see good growth particularly in the oil and gas sector. So again, our 2012 plans for water are not dependent on a strong market recovery. We believe we are in a great position for accelerated growth when the slowing markets rebound, including residential.

Turning to technical products on slide seven, we expect another 4% to 6% growth in 2012 on top of the 10% growth rate we expect to post in 2011. While this will still yield below 2008 peak sales, we’re already meaningfully exceeding prior peak operating profits and margins this year, demonstrating the brand and channel strength of this franchise.

On the right side of the slide, you’ll see the vertical growth assumptions for 2012. In industrial, our largest vertical, we expect solid demand in mid to high single digit sales growth reflecting continued capital and maintenance spending. In energy, we anticipate continued strength with up low double digits in 2012 compared to plus 20% in 2011. This reflects good growth prospects in oil and gas as well as alternative energy.

Global infrastructure and commercial are expected to be up high single digits in 2012 reflecting our focus and strong growth prospects in fast growth regions, with more muted volume expectations in developed regions. In electronics and other which includes security and defense and medical, we expect only modest growth in 2012 reflecting a softer flow in market.

In communications, which accounts for roughly 20% of technical product sales, we anticipate sales to be down year-over-year. This largely reflects an end-of-life telecom program we’ve been serving and will carry into the first half of 2012 along with some underlying end markets office in both datacom and telecom.

Fast growth regions now 13% of technical product sales continue to provide attractive growth prospects for the business. As we leverage our manufacturing capabilities and strong product lines. Despite some of the headwinds in communications and electronics, we continue to expect nice growth across the majority of our end markets served in technical products. Expanding global product offerings, channel development and pricing should help further support the overall 4% to 6% growth expectations in 2012.

Despite today’s economic challenges and uncertainties, growth opportunities for Pentair are plentiful and priorities are clear. For the year ahead, four things stand above all others as outlined on slide number eight.

First is the continued expansion in fast growth regions to better serve the growing needs of the new world. Today our combined sales in fast growth regions are approximately $700 million with the 2015 target of $1.3 billion. We’ve invested over $60 million over the past three years in localized manufacturing, engineering and lean enterprise capabilities supporting our relentless pursuit of our in region, full region product strategy. Now we’re turning our focus to drive added distribution, coverage and penetration in key regions including Latin America, China and the Middle East.

Second is our commitment to innovation and delivering our customers what they need, including better efficiency, greater sustainability, more automation and safety. Just recently, we were honored on Aquatech Amsterdam, the world’s top trade exhibition for process drinking and waste water. We have won several awards here for innovation including a specialty engineered fish-friendly pump and a not-yet-to-market Hollow Fiber Nano Filtration product that’s capable of removing contaminants which current technologies can't.

We also gave the world a peek at our Hybrid Deionization System, the first electronic water purification system is not going to require (inaudible), and our electric car charging station. We also see good opportunities to take new technologies and apply them to new markets like gas recovery systems and anaerobic membrane bioreactors.

Third, we need to drive greater productivity, contain costs and reposition the company and continue to drive sustainable profitable growth. In 2012, we expect to build on a strong track record of productivity and cost management, implementing a broad range of initiatives designed to fully exploit the CPG cost synergies and address the realities in this market.

And finally, we are positioning Pentair for long term success and strong future growth. This begins with our Pentair Integrated Management System or PIMS, where we continue to serve our global customers better everyday by improving product quality, on time delivery, workplace safety and delivering cost and cash too.

We continue to move to a more advanced level of lean deployment across the company, extending lean by moving beyond the four factory walls into the front office and into our supply base more broadly. You've seen the results of PIMS in the top and bottom line, but there's still plenty more to go. Now we've added the rapid growth process to the PIMS tool kit and we are using it to establishing on organic growth process that can power our strategic initiatives. As we head into 2012, our growth accelerators include a more robust brand strategy and greater alignment in our go-to market approaches in fast growth regions.

In sum, we believe we’re well-positioned for continued future success with an aligned strategy and clear priorities. Now, I’d like to turn the call over to John.

John Stauch

Thanks, Randy. Please turn to my first slide, slide number 9, labeled Full-year 2012 Outlook. Overall for 2012, we expect to grow revenue by seven to 10 points, inclusive of the 5 basis carry over month CPT, which adds about 3.5 points of growth to our 2012 expectations. Organic growth, excluding the impact of CPT is expected to be 3.5 to 6.5 points year-over-year or up mid-single digits, inclusive of about 150 to 200 basis points of price, about 100 basis points of FX headwinds, and therefore about three to five points of core value growth.

Our volume growth assumptions assume that the impact of Western Europe will remain at headwind with roughly 14% of our revenue experiencing a 5% year-over-year decline. We expect the US economy to grow at about one to two points of volume, and Best growth markets to be up around 15% year-over-year. This three to five points of volume growth is comparable to the roughly six points of volume growth experienced in 2011, excluding the impact of the year-over-year GIWW project shift in 2010. It’s about one to three points softer in volume. This is reflected in West European headwind as well as continued sluggish demand for water treatment components and a little softer volume within technical products.

Turning to slide 10, we have a similar outlook for operating income. In 2012, we expect to grow operating income by roughly 13% at the midpoint or up to approximately $445 million to $470 million. We’re targeting operating margin expansion of 40 to 80 basis points or up roughly 100 basis points excluding the impact of CPT to the five-month comparison period. Solid pricing should help mitigate the impact of material plus labor inflation. We expect to ensure that operating expenses stay relatively flat as a percentage of sales as we direct investment to fast-growth regions and across the prioritize set of platform technology.

We are anticipating conversion on volume of roughly 20%, inclusive of mix as we expect revenue in fast-growth regions to produce less contribution than we experience in developed region growth, although improved. As Randy mentioned earlier, we are anticipating repositioning savings related to anticipated fourth quarter actions, the yield savings that equate to approximately one-third of the top end of the net productivity range, giving us a higher level of confidence in a year-over-year projections or helping to fuel future growth.

As the slide suggest, we are anticipating a headwind from pension about 7 million to 8 million or about $0.05 per share. As a reminder, we have curtailed our defined benefit pension plan starting 2017, and therefore, expect the ongoing headwind to soften as we move forward in 2012 into 2013 and beyond.

Please turn to the next slide label 2012 Calendarization.

Looking at the Calendarization of 2012 EPS expectation, we anticipate generating roughly 50% of our EPS in the first half of 2012, and the balance in the second half. This implies lower year-over-year growth rates in the first half, reflecting the seasonally low CPT business and higher acquisition related interest, along with the choppy telecom project that we should begin in the latter Q3 and tougher Western Europe volume comparisons that’ll be compounded by expected FX headwinds.

As we move through 2012, we are expecting easier year-over-year comparisons, have a fully integrated CPT business, get a sustainable full pricing run rate and have the benefit of all of the previously mentioned repositioning action.

Please turn to slide number 12, labeled Key Operating Metrics. Like we’ve done in the past years, we wanted to highlight key operating metrics that are important to achieving our long term profitable growth goals for Pentair. The first goal is to continue driving strong organic revenue growth. We expect Water to be up 9% to 12% or roughly 4% to 7% under organic basis. This is slightly less than our 5% to 8% long term growth expectations, was also reflective of a more substantial headwind in 2012 related to Western Europe.

Embedded in this growth rate are the exciting opportunities at Water Reuse, Fluid Processing, Waste-to-Value Systems and beverage, Point of Use Filtration opportunities globally, and sustainable Pool business driven by replacement markets as focused on products that yield energy efficiency, allow for automation of existing platforms. Balance against these higher growth opportunities are the realities of the global municipal market are still struggling and that the consumer who needs financing is having a tough time finding some. This is reflected in our municipal systems platforms and our expectations for water treatment components into the residential water softener market.

The technical products, we are expecting organic growth in the 4% to 6% range for the year, reflecting a more normalized year-over-year performance.

Energy and industrial growth market are expected to continue this solid growth, offset in parts by an expected decline in year-over-year on the communications vertical market segment.

In 2012 for Pentair, we will continue to target more profitable mix of growth and execute on an even more productivity initiatives, as a result anticipate expanding gross margins by approximately 50 to 80 basis points. While material inflation should ease from this level in 2011, we still expect commodities to be up in the 2.5% and 3% range, and have reflected this type of inflation into our guidance model.

Overall, we expect Pentair operating margins to improve by 40 to 80 basis points, largely through more productivity as volume leverage and price help offset mix pressure, and the CPT acquisition.

Finally, we are targeting free cash flow of approximately $270 million and anticipate CapEx to be about 2% of sales for the year, forecasted just slightly above depreciation.

Please turn to slide number 13 labeled cash summary. Cash flow remains a key focus for us and we continually strive to improve all aspects of the cash cycle. In 2012 we look to generate approximately $270 million of free cash flow or more than 100% of net income. On the right hand portion of the slide, you can see our capital allocation priorities for cash. These priorities remain consistent. It is our goal to return cash to our shareholders through dividends and improve our ROIC through the funding of organic opportunities.

We are committed to retaining our investment grade rating on our debt and expect to return to a more consistent bolt-on acquisition strategy focused on broadening technology platforms, geographical expansion opportunities in the fast growth markets and potential new channels to market. Our board just authorized a 10% increase in the dividend reflecting our confidence and our continued cash growth and also approved the reintroduction of our $25 million per year stock buyback program.

Please turn to my final slide labeled full year 2012 outlook. Within 2012, we expect to achieve mid-single digit organic sales growth, operating income of roughly $460 million with operating margins in excess of 12% for the year. As we look below the line, we are expecting interest to be approximately $10 million higher in 2012 reflecting the acquisition-related debt related to CPT.

Our effective tax rate should be around 29% to 30% which should be in line with 2011 and reflective of our penetration outside in the United States. As mentioned previously, earnings per share is expected in the range of $2.60 to $2.75 or up approximately 9% to 15% that is revised to 2011 expectations.

Overall we feel we have the portfolio and strategic vision for driving profitable growth in 2012 and in the long term. While we are prepared to continue delivering short term expectations, we are also maintaining our focus on creating differentiated topline and EPS growth business model that can be high performing, predictable and consistently growing above market expectation. We’ll now take your questions. Sara, please open the line for questions. Operator? Sara?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Hamzah Mazari from Credit Suisse.

Hamzah Mazari - Credit Suisse

May be if you could, Randy and John, add some color on the cost actions you’re taking in terms of how much your structural cost takeout versus temporary at this stage with the macro uncertainty you’re facing and as your mix goes to more fast growth markets, how do you adapt your sales channel to that and do you need to shut down facilities in Europe and move them over to some of these regions, how dynamic is your sales channel and manufacturing footprint as fast growth markets become a bigger part of the mix?

John Stauch

Okay, I’ll take the first part and I’ll let Randy talk about the dynamic nature of the global footprint. We’re taking a look at the repositioning actions we’re mentioning and we’re in the process of concluding what those are. We’re looking at high impact ROI and it’s all structural. So right now, we’re not anticipating any factory consolidations in the view, but we are taking a look at making sure that we’ve got the right investment in fast growth regions and looking at, making sure that the channels between CPT and the base water business are aligned properly and there’s a lot of synergy opportunities there as Randy mentioned and there is also the opportunity to get things right for the future state of how we want to go to market with these particular platforms and that’s really where the focus area will be and we expect a pretty good return on these investments.

Randy Hogan

And consistent with that, as we look at the investments, we both, we have investments and a good foot print in CPT and ones we’ve made, some of them are overlapping, some of them are complimentary. Frequently we have two sales offices in the city, we don’t need to, you know we’ll be collapsing those down and actually we’ll be able to -- it has low overhead and have more people on the street. And selling a broader product line for instance CPT has very strong sales folks who are selling highend applications and we are much stronger on the distribution side and setting up the distribution.

So we can give the application side, a bigger set of products to sell and a bigger set of applications to go after. And take some of the lower end component products of CPT mix and put them through our distribution channels. So that, a lot of the focus that’s going on in terms of combining the sales channel. The other thing is to leverage the factories that we built already in India and in China and in Brazil to actually build the systems that CPT is building in Europe today.

And you know that really improves the cost structure of those projects. So there is a structural cost improvements that John was talking about. There is a overhead for a reduction we can get in the fast growth markets and importantly, there is opportunities to lower our product cost, both through sourcing of the CPT business, both through sourcing and in terms of localizing the manufacturing of the systems. Those are the big pieces.

Operator

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

Jim Lucas - Janney Capital Markets

First CPT equation, any changes to your expectations of what you were thinking in 2012 and if you could also expand a little bit more on what you are seeing on the residential water treatment. It sounded like it was more inventory correction with your dealers in the 4th quarter, but what is the outlook there going forward?

John Stauch

From a business perspective, not expecting any dramatic change or any change in CPT for that matter. I think I can’t tell you where the FX rate is going to be, I mean if it keeps around here at 129, it will go south to 129, there will be a slight translation impact, but for the most part, everything is intact. You know we will see a slight (inaudible) headwind on the CPT side of the business, but we have got substantial opportunities on the industrial side to penetrate and continue the double digit growth rates in the business. So all things intact for CPT, maybe a small translation impact as we head into 2012.

Randy Hogan

Yeah and water treatment. We think we are seeing, we will know better as the quarter plays up. We think we are seeing some we say inventory adjustment, but as we look at particularly the impact in western Europe, there has been a deceleration over the last two quarters. It’s much sharper, it was much sharper and particularly in November and I don’t know whether that was inventory draw down, pretty sure there was an impact in the US inventory draw down. I think in Western Europe, Western Europe was doing really well, I mean the first quarter actually grew really 10% and in this quarter it is going to be down at least that much in residential; in residential treatment components. So we think that particularly in Europe in Europe which is a very attractive market for us in that space, we think we are seeing more than inventory adjustments particularly there.

Jim Lucas - Janney Capital Markets

And John, just a point of clarification on CPT, the EPS accretion of what you had been expecting in ’12, any changes on there?

John Stauch

No, I mean I was saying Tim that we expected a 10% uplift from 2011 to 2012; $0.10, I am sorry; it will be somewhere between $0.09 to $0.10 depending on the impact of FX.

Operator

You next question comes from the line of Robert Barry from UBS.

Robert Barry - UBS

I was just curious if you could expand a little bit on the weakness you are seeing in Europe. You touched on it vis-à-vis the resi piece in the last question, but more broadly in the other businesses what you are seeing? And then just a quick follow-up, I just wanted to clarify a few things, the US municipal business, it was supposed to be an engineered flow, its actually going to be down in 2012 versus ’11 is that a part of your planning assumption?

John Stauch

Yeah, let me take them in a couple of categories. I think you know for the full year Western Europe volumes, just to give you some context, we think the full year 2011 will be closer to 5% up which is made up of a strong Q1 as Randy mentioned, so double digit volume growth in Q1 and in contrast even with the strong recovery in December that we are seeing, we are expecting volume in Western Europe to be down 15%, which is 10 points higher than the 5% we are predicting in our outlook; that when we gave the Q4 outlook.

When we take a look at municipal next year in the United States and globally, we are anticipating it will be down in the single digits globally and that is anticipated in our 2012 guidance. And then in contrast for 2011, that market was down globally as well, so we’re not expecting any recovery and then we’re continuing to see headwinds in that space.

Robert Barry - UBS

And just to be clear, it sounds like then the European weakness is pretty broad-based, is that fair?

Randy Hogan

Yes, in water and in tech products it’s okay.

John Stauch

Well, it was generally broad-based and just to be clear a very strong downturn in October and November; so late October and November. We are seeing an uptick in December, the first two weeks of December globally for all of our business is very strong and a recovery in Europe, but it won't be strong enough to recover what the downturn in November was.

Operator

Your next question comes from the line of Deane Dray from Citi Investment Research.

Deane Dray - Citi Investment Research

I just want to follow-up on Rob’s question regarding the Europe slowdown you’ve seen in the fourth quarter and how might that and it sounds like it has prong upon you a little bit more recently, but how might this have changed your thinking about 2012 and your expectations of what the downside might be across your European businesses and within the context, if I am not mistaken, it’s a big chunk of your business may be it’s 80% goes to your distribution and if you’ve got the destocking phenomena and this can run a couple of quarters, so how did this to run to your thinking and planning for 2012?

John Stauch

Well, Deane, let me break those into two other categories. First in Western Europe; I think we anticipated that Western Europe would be down next year, we didn’t anticipate Q4 for us would be down as much. So I think you know just to kind of set the context at the way we’re looking at 2012, you can think about a nickel being related to pension next year and about a nickel being related to the staring point of where we are finishing 2011;

Randy Hogan

Which we do I think is going carryover in the first quarter.

John Stauch

Right. The rest of the context is you know if you take the organic growth and the productivity and the price cost actions are generally aligned and probably throughout Q4, we’re going to reach a little deep to repositioning buckets to put ourselves in good position to get the productivity for next year.

When we take a look at the water softener components piece and I don’t know -- you know there is a couple of things going on in the industry you know related to where the financing is primarily North America and those product contents and there has been a shift in mix if you will away from the pro-channel into some of the retail at a much lower price point which does not necessarily favor all of our components all that wealth.

So when we think that our channel is getting healthier; as we take a look at the outlook for 2012 and it’s really into earlier we still think this is a down market as we look out in the 2012 unless we see some bounce in residential which would give us the pro-channel lift.

Deane Dray - Citi Investment Research

And then I just a follow upon CPT; one of the new products that you talked about at Aquatech was this nano-hollow fiber that allows you to screen out [interconnect] inhibitors and this is kind of been the Holy Grail of membrane technology. How soon does this get launched; what sort of ramp do you expect over the next couple of years?

Randy Hogan

We’re testing that now. I’ll give you more color on that when we actually do the earnings call. I haven’t had an update on it in the last three to four weeks, so I would rather not do that until I get the most recent update. We are excited about it; I think you are right this is kind of Holy Grail and hopefully we’ll find it you know this in the coming.

Operator

Your next question comes from the line of Ajay Kejriwal from FBR Capital Markets.

Ajay Kejriwal - FBR Capital Markets

May be give us a better sense of Europe in November; so how much was the business down and then it sounded like things came back a little bit in December. So what changed, I mean and macro still looks to be pretty weak so, but it sounds like you are seeing a rebound in December; any sense what’s driving that and is that sustainable?

John Stauch

I think that – you know we don’t have all the specifics on it, but obviously just to give you some color I mean as we mentioned earlier we expected volume and take the foreign exchange component out for Q4 to be down about 5%. That contrasted with what would have been more like breakeven volume in Q3 and as I mentioned up double digit in Q1. So we are seeing the trend throughout the Europe and the volume piece; November volumes for us were down you know north of 20% and as I mentioned earlier, we have seen this slight snap back in the volumes nearly we call them high single digit levels in December.

Randy Hogan

Well, it’s the best comment right John about all of Pentair stronger and this particular product line isn’t particularly…..

John Stauch

Right. And I was talking about Europe in whole Randy we have seen an uptick in Europe as well.

Randy Hogan

But it’s not a specific comment about residential well above (inaudible)

John Stauch

Correct. And so, when you take a look at it Ajay, we’re still thinking that we’re going to be double digit volume down in Q4 and I think if we take a look at our outlook for 2012, we think it will be -- continue to be deeper headwinds in Q1, but overall we’ve got about 5% down outlook in Europe. You know then Euro is more colored, you know, sitting right round of on a $1.30 is going to create some translation risk for everyone. If the Euro continues to weaken more, we do expect that we will see export sales pick up and increase as we saw in the first half of 2010 when we petered around the $1.15, $1.20 levels. So I think there's a lot to play out in Europe. I think for us, our distributors don't have a lot of access to cash and they become very uncertain about their future and adjust their inventory positions in lieu of, you know, what they think is going to happen to the economy and I think that has a steeper impact to us within the distribution community. That's the only color I can provide beyond what the date is. We will obviously know more as we close the quarter and get all the details behind the financials.

Randy Hogan

And one of the effects we always see at the end of the year is distributors trying to make next rebate level, sales people trying to make their commissions and so we tend not to be equate sort of factor those out, which will have a much better analog as we close.

Ajay Kejriwal - FBR Capital Markets

Thank you. That’s helpful. And then maybe just clarify on that CPT, I talked when acquisition was announced, we are expecting $0.15 to $0.20 accretion in ’12.

John Stauch

That's correct.

Randy Hogan

It is the delta. It is $0.05 in 2011 and what John was talking about was an additional $0.10. So next year, so that's $0.15 is the total.

Operator

Your next question comes from the line of Christopher Glynn from Oppenheimer.

Christopher Glynn - Oppenheimer

Thanks, good morning. I have a question on the water portfolio in general. With CPT now enhancing the breadth of your growth portfolio, I was wondering where you are in the strategic thought processes segregating parts of the portfolio more as cost driven businesses, how you think about the opportunity there? And what’s the competitive dynamic on some of the more non-growing parts of the water portfolio?

Randy Hogan

Well, we’re particularly – let me talk about the sort of pieces of CPT. You know, we’re particularly excited about beverage on a large scale, not just on the filtration side or a broader system side, the CO2 recovery side, the energy recovery side. There’s some very, very exciting growth opportunities for us and that’s one of the areas we can use that it and enroll with membrane bio-reactors section, create energy from the waste streams and the beverage arena. So we see, we’re quite excited about and that’s what John was saying earlier about the industrial applications that would include these kinds of beverage in the area of application.

Pretty exciting, and we like the position it gives us in the water space. You know, we do expect a little bit of headwinds in the water space going forward. On the pump area, we think there’s opportunities to grow our pump business and improve our cost position in our pump business with the addition and the analysis we think about that product line. So most of the areas, the CPT, they really give us more growth prospects with, if you would back off the cost opportunities, you know like.

John Stauch

And Chris to your point, you know, we clearly have what we say in water, close to 10, 11 growth platforms and Randy mentioned a couple. And yes we will take a look at the growth opportunities of all those entire type and especially has we connect them to the fast-growth regions. Each of them have a different vertical markets driving there particular growth opportunities and as Randy mentioned in his remarks, clearly as we take a look at operating expenses next year in the wake of the economy, we will reprioritize in the higher impact platforms more than we will be prioritizing those that are more in a cash generation position.

Randy Hogan

And there in CPT is really, you know, rank order than we’ll talk more about that. They’re really kind of in a top three.

Christopher Glynn - Oppenheimer

Okay. And is there a fundamental opportunity it takes, you know, ex percent of your portfolio and run it differently as a real kind of cost constrained type of model compared to where you’ve been previously?

John Stauch

Well, when we talk about putting more discipline into our prioritization, that is code for us basically, making sure we’re investing in the investible and focusing on productivity in the less attractive segment, exactly right now, maybe product line basis or maybe in region basis or country basis, where we are best exactly what we are working on right now. You know we’re also looking at the business, particularly in water, and thinking more clearly about the catalog distribution business versus the applied value add business and making sure that we are honing our go-to-market strategies as best we can to make the most of both of those, and while that still could be use for distribution, it still can be used to help that application side. We really need, we really need opportunities to get closer to some key customers, drive specifications into a boarder set of product, and so that’s a big focus we have now on our growth side and our rapid growth process has helped us see that more clearly and see these opportunities more quickly.

Christopher Glynn - Oppenheimer

And can we may be anticipate next Labor Day when you tend to do your deeper dive call, you know more segregation or pie chart them what you look at as kind of cost driven versus more investable?

Randy Hogan

Sure

Christopher Glynn - Oppenheimer

Okay, and just last one on the Fish Farm opportunity, how you look at that opportunity going forward? Where is it now and how have you and what’s the history there?

Randy Hogan

You know, we do probably, you know, somewhere north of $25 million right now without trying. The, you know, there are kinds of fish farms, there is in the ocean, there is not that much of equivalent in that. There is the land based in-ponds, there is opportunity in filtration in farms and that. But there are really exciting opportunities in the, what I would call, the mechanized agriculture, which is going to be more like a factory-type of farm. We think it has got a growth rate that’s going to be north of 10% and we are focused. We have a pretty unique portfolio of products, the pool equipments, particularly the larger pool equipments, is ideal. We have number of programs working with thought leaders in that industry to basically take in our (inaudible) program and applying it to raise the yields, and yields both in terms of raising them fast but keeping the fish and as we talk about before, you know, we can’t seize the world sustainably, unless agriculture is playing a bigger, bigger role. You know we have so many contacts, here in Minnesota, who are sort of in the ag space, that we share.

Christopher Glynn - Oppenheimer

And is it fair to say that activism or whatever is driving a big mix shift towards agriculture from environmentally mix settings?

Randy Hogan

Well, I think it’s one of those well aligned things. It’s you know literally the yield of approaching from grain is higher with this. So if you are going to feed all this, it’s part of the new, new world thinking right. I mean if you are going to feed all these people, they move up Maslow’s Hierarchy of Needs. They want protein, they only want to do it such so. And it does help to stop over fishing in the oceans (inaudible) which is good.

Operator

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

Brian Drab - William Blair

On CPT, is there any way that you could help quantify the growth and performance in CPT before acquisition, post acquisition or understand obviously the economic environment difference post acquisition, but what was that business growing to your mind maybe in the first half of 2011 and what do you expect to grow in the second half of 2011 and what do you, putting the forecast for CPT growth for 2012.

John Stauch

Yeah, I mean a good question Brian. I mean I think just to give some insight, the CPT business topline 2010 and certainly throughout 2011 even for our months of ownership is growing north of 20% of the topline. Our goal is to look at that as a 10% plus topline growth heading into 2012 and repositioning the operating income fees to expand margins more significantly. The operating income in both 2010 in and pre our ownership wasn’t a primary focus and that will be a primary focus under the Pentair ownership and making sure that we’ve got good returns and higher margins for the type of technological advantage that they actually offer into the market space. So I think you can expect a little bit more margin discipline and a may be slightly slower growth rate, but still one more to 10%.

Brian Drab - William Blair

Okay, great and the slightly slower growth rate to expand fiscal comparisons in the economic environment offset and quantify the synergies that what we’re talking about, is that fair enough? Think about it that way?

Randy Hogan

We always thought we’d have a lower growth rate as we put a stronger focus on profitable growth versus growth. So that means what John just said is consistent with sort of the philosophy that we put into this strategy when we originally bought it. It looks like actually the fact that the water in municipal is down, that is the lower profitable stuff, so, right. It’s kind of consistent with the right thing to do.

John Stauch

But it is inclusive of our double-digit growth outlook forward, so we still think we’re going to grow double-digit inclusive of those market headwinds.

Operator

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

Scott Graham - Jefferies & Company

My really only question centers around the margin. A couple of months back at the analyst meeting you indicated that you’re trying to march your way toward a 36% gross margin and I know that these things are not linear, but we’re kind of coming off of a pretty weak 2009 and then a good recovery in 2010 and 2011, but I guess my question here is that at a gross margin guidance of 50 to 80 basis points up, what would kind of be the delta versus let’s say 100% -- 100 basis point annual type of number; what changed since then?

John Stauch

One simple answer Scott, little less volume absorption; little less volume benefit that’s it versus those assumptions.

Scott Graham - Jefferies & Company

But Europe is only 15% of sales and it looks to me like the rest of the businesses are performing the same way that they were a couple of months back?

John Stauch

Its fair, but as we talked about in the comments, in my comments and Randy’s comments, our growth expectations for 2012 which include our 50 basis point of gross expansion which is what you just pointed out is going to be a slightly less volume contribution in that outlook.

When you take a look at both the gross margin and the operating margin, as we mentioned in the slide and also in the comments, if you take a look at the negative impact of CPT was 40 basis points and look at the headwind, we’re growing a 100 basis points margin expansion excluding the negative headwind of CPT. So we’re still on-track; all of our productivity actions and lean initiatives still yielding what we expect; its 100 basis points without CPT and roughly 60 basis points in the midpoint with CPT.

Scott Graham - Jefferies & Company

Operator

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

David Rose - Wedbush Securities

I have a couple of follow up questions. On Europe, and trying to get back to some of the previous questions on leveraging operating margin. If Europe does stabilize, what sort of incremental leverage can we expect and where is that relative to the top-end and the bottom end of the guidance; one? And two is, on the initiatives for new product introductions, are you including the launch of saltless water softener, water treatment products or not? And then lastly are you assuming or can we assume any potential acquisitions of distributors as you want to get closer to the customers?

John Stauch

I think just to give you some context; our Western European revenue which is roughly 14% to 15% of revenue generates about 13% to 15% of operating margins, so it is profitable healthy piece of the overall Pentair portfolio. And as I mentioned earlier David, we are anticipating about 5% volume downward draft on that next year, so it kind of gives you the color to be able to do your own view is the markets not down as much or its down more, what’s the incremental impact that we would expect in that piece of the business. I’ll let Randy handle the launch of the.

Randy Hogan

We called it the Hybrid DI for Deionization which we showed at Aquatech. As we said then, we’re still on track for mid year launch in 2012, so there will be some volume in second half. We don’t expect it to be – its going to be a more technical sale; we got to work with the channel in order to bring it on so we see sort of map as opposed to huge overhead kind of (inaudible) launch mush as I like that and we see it being slower. So not assuming a huge bottom line impact or top line impact in the guidance that’s given here and it is more an impact in 2013.

And in terms of distribution, we work closely with distribution. There has been a number of things that have been for say and you know I would say right now our focus is in that direction. We’re focused more on investing in innovation and to footprint outside of Europe and the US.

Operator

There are no further questions at this time.

Randy Hogan

Okay, thank you very much, and thank you all for letting us finish in time for you to all participate in the next call. So, Sarah could you give out the replay information.

Operator

Absolutely. Thank you for participating in today's 2012 Outlook Conference Call. This call will be available for replay beginning today approximately two hours from now. The conference ID number for the replay is 312-411-04. Again the conference ID number for the replay is 312-411-04. The number to dial for the replay is 1855-859-2056 or 404-537-3406. Thank you again for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Pentair's CEO Discusses 2012 Outlook - Conference Call Transcript
This Transcript
All Transcripts