Pentair plc (PNR) — Q2 2016 Earnings Call Transcript

Thanks, Emily, and welcome to Pentair's second quarter 2016 earnings conference call. We're glad you can join us. I'm Jim Lucas, Vice President of Investor Relations and Strategic Planning. And with me today is Randy Hogan, our Chairman and Chief Executive Officer; and John Stauch, our Chief Financial Officer. On today's call, we will provide details on our second quarter 2016 performance, as well as our third quarter and full year 2016 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 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 to ensure everyone an opportunity to ask their questions. I will now turn the call over to Randy.

Thanks, Jim, and good morning, everyone. I’m starting on page 4. We are pleased with our second quarter results, which came in at the high end of our expectations. The top line was consistent with our forecast and income and margins were slightly better than our expectations driven by strong execution and continued benefit from our cost-out actions. Integration of ERICO is meeting our expectations; we remain on track to meet or exceed the $10 million in synergies we targeted. Free cash flow was once again a positive story and we’re very pleased with our performance here. For the first half of the year, we’ve generated $304 million in free cash, which is over $150 million better than what we delivered in the first half of last year. We’re updating our full year adjusted EPS outlook to a range of $4.05 to $4.20, which is bringing a nickel off the top end of the range. Valves & Controls have started to become more predictable; we’re seeing the negative impact of sales mix in both Flow & Filtration Solutions and Technical Solutions. Now I’ll turn to slide 5 for discussion of our Q2 2016 results. Second quarter core sales declined 1%, which is slightly better than our previously communicated expectations. Water Quality Systems delivered solid growth once again against a tough comparison; our Flow & Filtration Solutions felt the impact of continued difficult agriculture markets. The declined Valves & Controls sales moderated and Technical Solutions was flat compared to our expectation with a slight decline in the quarter. ERICO contributed positively with sales in line with our expectations. Segment income increased 7% and return on sales expanded 30 basis points to 16.8%. Water quality systems saw 200 basis point expansion and Valves & Controls slightly beat second quarter income and margin commitments, which were big steps up from the first quarter. Adjusted EPS grew 3% to $1.11 per share and was at the high end of our guidance of $1.00 to $1.11. As I mentioned previously, free cash flow was very strong in the quarter. Now let’s turn to slide 6 for more detail on Pentair’s Q2. Our sales performance was mixed by vertical with strong growth in residential, commercial, and infrastructure. We saw signs of stabilization industrial with a rate of decline continuing to moderate and energy did not get worse. Food & Beverage was down in the quarter due to ongoing declines in agriculture, which we believe our beverage business remains healthy. Our largest vertical residential and commercial saw 2% sales growth with strength in residential and water quality systems and ongoing strength in commercial in both Flow & Filtration Solutions and Technical Solutions. While ERICO’s performance is not captured in core results yet, we would point out that commercial markets remain solid for it, too. Infrastructure was positive once again led by continued growth in both North American Municipal Pumps and improved project activity in Process Filtration globally. We’ve been looking for Flow & Filtration Solutions to see infrastructure growth this year which has played out as expected and we’re encouraged that bidding activity remains healthy as well. The rate of decline within Industrial moderated further and we believe that this largest vertical appears to have found a bottom. Therefore, we’re not looking for a second half rebound comparisons even in the second half and should report results. Food & Beverage declined for the second consecutive quarter as Flow and Filtration Solutions continued to feel the impact of agriculture, which declined at a double-digit rate for us. Energy declined at a low double-digit rate for the second consecutive quarter, but we expect energy sales to find a bottom in the second half based on the bottoming and sequential orders we’ve experienced. As you can see on the right-hand side of the page, productivity remains strong and more than offset inflation. ERICO contributed strength to the bottom line and strong underlying performance in synergies. Now let’s turn to slide 7 for a look at water quality systems performance in Q2. Water quality systems delivered another strong quarter with 3% core sales growth. Although growth rate declined sequentially with the tough comparison as the second quarter last reflected slightly different timing in the North American cool season than what we’re experiencing this year. Although timing is different, we believe the North American cool season remains very healthy. Water filtration grew sales 1% as both our residential filtration business and our food service business faced tough comps. Segment income grew an impressive 11% and return on sales expanded 200 basis points to 24.7%. Robust operating leverage was the key contributor to margin expansion in the quarter. Timing of growth investments may mute the rate of margin expansion in the second half but we anticipate the prospects remain strong for water quality systems. Now let’s move to slide 8 for a look at Flow & Filtration Solutions. Flow & Filtration saw core sales decline 1%. We had anticipated the segment to return to growth in the second quarter and rather infrastructure growth came through as expected, but food and beverage performance was negatively impacted by very challenging agriculture sales. Water Technologies core sales declined 3% while strength in residential and commercial and infrastructure pump shipments were more than offset by double-digit declines in irrigation pump shipments. This is very similar to what we saw last quarter in this business. We expect both the residential and commercial and infrastructure businesses to see continued growth; however, irrigation headwinds will likely persist. Comparisons remain challenging given the drought conditions in the west that helped our sales last year. Core sales in Fluid Solutions declined 3%, while beverage returned to growth in the quarter and experienced strong orders growth as well. The precision spray presence was negatively impacted by the beleaguered agriculture markets. Process filtration saw core sales growth of 10% as we continue to see momentum build from our focus on industrial water reuse solutions and a return to growth in infrastructure with some desalination investments. This business has some lumpiness given the timing of projects, but we believe we continue to gain momentum from our focus on industrial water reuse. Segment income and return on sales contracted modestly due to a negative mix weight on the segments' results. We believe this is just a pause in the margin improvement journey in the Flow & Filtration Solutions and there is still a long runway ahead for further margin growth. Now let’s turn to slide 9 to discuss our Technical Solutions performance in the second quarter. Technical Solutions reported 32% sales growth for the quarter consisting of flat core sales growth and a 1% headwind from FX and a 34% positive contribution from ERICO. Core sales in Enclosures declined 5%, but we were encouraged by the stabilization in the daily order rate which reinforces our view to easier comparisons in the back half of the year. Thermal Management delivered core sales growth of 7%, helped in part by two projects in Canada that we previously discussed that are reaching completion. We’ve talked this year about our Industrial Heat Tracing business continuing to win small projects and unfortunately we’re seeing no sign of downstream MRO spending growth return yet. All the results of ERICO are captured as acquisition contribution, and the business performed in line with our expectations. As a reminder, over 75% of ERICO’s sales are into commercial end markets which remained very healthy in the quarter. We remain on track to deliver over $10 million in synergies for the year on top of the base business profitability, which is performing as expected. Segment income grew 30%, but return on sales contracted 60 basis points to 20.6%. The margin contraction was isolated to our Thermal Management business, as the growth we mentioned in projects versus higher margin MRO product sales negatively impacted mix. ERICO has performed as we had anticipated; Enclosures are seeing signs of stabilization. The performance of these two segments was not enough in the quarter to offset the impact of the negative mix experienced in Thermal Management on the return on sales. We’re not expecting downstream MRO spending to rebound in the second half, and we expect this will undoubtedly have an impact on third quarter margins for Technical Solutions. So with ERICO and Enclosures performing as expected, Technical Solutions remain well-positioned long term. Now let’s move to slide 10 to discuss the Valves & Controls performance in Q2. For the second consecutive quarter, Valves & Controls met or beat its forecast for both sales and margins. Even more, the heavy lifting we’ve done to right size the cost structure of the business read out in the nice gain and margin sequentially. Orders appear to have stabilized. Valves & Controls reported a 13% decline in revenue with core sales down 11% and a 2% headwind from FX. Backlog was down 7% sequentially, which includes negative FX translation. Core orders were down 27% year-over-year against the tough comparison, but as stated, we did see a flattening of orders sequentially. Core sales were down 6% in aftermarket and down 17% in projects. In line with our expectation, the aftermarket business remained weak as OpEx continues to be constrained along with CapEx at many customers. We believe the order funnel overall is beginning to strengthen, which reinforces our view that orders will bottom in the second quarter and will begin to expand at near double-digit rates sequentially starting in the third quarter. The right half of the page shows second quarter segment income and return on sales, which both met our forecast. Return on sales of 10.1% was slightly ahead of our forecast and up significantly from the first quarter as our cost-out benefit registered in line with our previously communicated expectations. The Valves & Controls team has done a courageous job in realigning the business to reflect the significant energy industry reset. It executed in the cost side while aligning the business with the opportunities that exist today and over the next several years. We continue to believe that Valves & Controls is well positioned for an eventual recovery in its end markets beginning in 2017 and will continue to enjoy rising margins sequentially even before that. Now, let's move to slide 11 for a look at Valves & Controls backlog. Much of the backlog decline we saw has come as a result of progress we're making in reducing our past dues. Last year, we booked roughly $100 million in orders from projects greater than $5 million. However, we have not booked even one order greater than $5 million during the first half of 2016. Yet orders are bottoming out sequentially and as our customers sort out the spending plans, we expect to see a return of some larger projects. We believe that the second quarter marks the bottom for orders and we're expecting orders to improve in the second half of the year from the depressed first half levels. For the past three quarters, the business has improved its forecasting capabilities and with aftermarket orders now approximating 55% of orders, that should improve the margin mix. We're encouraged with Valves & Controls meeting or beating its forecast on sales, orders, and income for the second consecutive quarter. There has been tremendous progress made on right sizing the cost structure of the business and better alignment between sales and operations has improved forecasting and execution ability of the segment. We believe the order funnel will continue to strengthen, and while the top line will not show it right away, orders bottoming and margins improving show brighter days ahead.

Thank you, Andy, please turn to slide number 12, titled balance sheet and cash flow. We ended the second quarter with $4.6 billion of net debt inclusive of cash on hand. This was an improvement from where we ended the year as we used our strong cash flows in the quarter to reduce our debt levels. As Randy mentioned earlier, free cash flow increased over $150 million during the first half of the year versus the comparable period last year. We continue to expect to deliver free cash flow greater than adjusted net income for the full year. Our ROIC ended the quarter at 9.6%. Our forecast for capital expenditures remains at $150 million as we continue to invest in businesses that have earned the right to grow and drive standardization and productivity across the enterprise. We remain focused on generating strong cash flow and further debt reduction. Please turn to slide 13, labeled Q3, 2016 Pentair outlook. For the third quarter, we expect core sales to be flat, and total sales to increase 7% inclusive of FX headwinds and a positive contribution from ERICO. As a reminder, we closed on the purchase of ERICO just before the end of Q3 last year. Starting in Q4, ERICO will be included in the core. On a core basis, we expect water quality systems to grow approximately 8%, while flow & filtration solutions are expected to see core sales decline approximately 1%. Technical solutions is expected to be flat on a core basis, while valves & controls are anticipated to see core sales decline 6%. We expect segment income to increase approximately 11% and return on sales to expand roughly 60 basis points to 16.7%. Below the operating line, we continue to expect the tax rate to remain around 20.5%, net interest and other to approximate $35 million, and shares outstanding to be around 183 million. We expect free cash flow to continue to be strong during the quarter. Please turn to slide 14, labeled full year 2016 Pentair outlook. As Randy mentioned at the beginning of the call, we have taken a nickel off of the top end of our range, and our full year adjusted EPS outlook is now $4.05 to $4.20. For the full year, we expect core sales to decline 1%, while water quality systems' full year core sales are anticipated to be up approximately 6%, which is slightly better than our prior forecast. We now expect flow & filtration solutions to see a core sales decline of 1% versus our prior forecast of modest growth for the full year. Technical solutions core sales are expected to be flat for the full year, which is slightly better than our prior forecast. Finally, valves & controls are expected to see core sales decline of approximately 9%. We expect segment income to grow roughly 8% and return on sales to expand approximately 70 basis points to 16.3%. Our revised forecast factors in slightly better operating performance from water quality systems and valves & controls, while technical solutions and flow & filtration solutions are expected to see margins impacted by negative mix related to unfavorable market conditions. We anticipate full year corporate cost to be just under $90 million, net interest and other to be roughly $140 million, and the share count to be roughly 183 million. Adjusted EPS is expected to grow approximately 5% at the midpoint of the range. Finally, we remain on track to generate free cash flow in excess of adjusted net income for the full year. Emily, can you please open the line for questions? Thank you.

Good morning, guys.

Good morning, Shannon.

Good morning.

So, I guess maybe just start with your current assessment of strategic views on valves & controls and given news items. Also does the fact that you're executing so much better impact your view of that? How do you think about that currently?

Well, I'm not going to comment about speculation. If we have anything to say, we would have said it. But I'm really pleased with the progress. There are a lot of doubters in many places about how well our actions would read out. And I think this was a proven quarter. To go from the margins we had in the first quarter to the second quarter and see the bottoming of orders, I'd say valves have a clearer future today than it had in the first quarter.

Yes, and I would add. This is a great business in the difficult market conditions. In 2014, we were nearly at 17% margins and roughly $400 million in segment income. In what we feel like is a trough year, we're still going to be at an 11.5% return on sales. We're slugging through it. I mean, obviously seeing some sequentially bottom of the orders is a good sign and seeing the order funnels start to become a more robust time in Q3 and Q4 gives us excitement that we feel like we can start contributing more and more as we go forward in valves & controls.

Okay. And then, maybe just within valves & controls but even technical and more broadly some things you're saying are bottoming. You talked about, I think within valves, essential double-digit order increases sequentially in Q3. But then there are other things like downstream; you said you're not expecting any recovery. I guess, where do you expect sequential recovery and where do you think the market is still going to remain depressed?

This is just a weird time. I mean, there's such a mix geographically and between verticals in terms of what's growing and not growing, and I think that reflects the greater uncertainty in the world. We feel really good about industrial and commercial; we feel like infrastructure is coming back with some momentum. As I mentioned, the orders not only a sales op but orders act; order activity has remained up. And while agriculture continues muted spending in agriculture, it mutes our Food & Beverage line. We feel really good about food service and beverage overall. So, we think a lot about what individuals are spending money on, which is good: residential, commercial, food and beverage, and even in industrial. The fact that we're getting to the point where we're seeing flattened daily order rates in industrial tells us why we're seeing the bottom there. We just don’t expect it to increase a lot in the second half yet.

Okay, great. Thanks, guys.

Thanks, Shannon.

Thank you. Good morning, everyone.

Good morning.

Hey Randy, I was hoping you could expand on a comment you made in your opening remarks regarding the negative sales mix. I think you addressed it pretty clearly in your Valves & Controls business. But I'd be interested in hearing where else you're seeing a negative mix as it relates to customers in this environment instead of buying such and such; they're opting for either a cheaper replacement. How does it translate into your customer behavior into a negative mix this quarter?

Yes. Thanks, Deane for asking that so I can clarify. It's not the mix; the mix we're seeing is not between a customer saying buying a lower margin, lower performing product for the same application. It's specifically in Flow and Filtration; our Ag business has higher margins than our residential and commercial business. And so when Ag goes down and residential goes up, we get a negative mix. So, it isn’t product substitution in application, it's just a mix of what's growing and what isn’t. And in the Thermal business and Technical Solutions, again products MRO have high margins, while projects don't. So, we actually expected MRO to come back; maybe that was Pollyannaish, probably was, but it didn’t, and therefore all the projects that we were happy about winning kind of overwhelmed margins for Thermal.

And just to clarify, when you say in your reference Ag, this is irrigation pumps that you're primarily exposed?

There are two pieces in there, both in Flow and Filtration that we're talking about that have seen big negatives. One is irrigation, and year-over-year it held up pretty well last year because we had pretty high share, where there were droughts. There was a lot of activity drilling new wells because of the drought. We don’t have that impact this year. And the second is in crop spray, where we've actually been listening to the graveyard a little bit because we've been not declining the shaft as the market, and this is largely OEMs and distribution where we sell these precision spray systems that are used in agriculture as well. And that market remains depressed.

Thank you. And then on an unrelated topic, we had the opportunity last month to see Pentair as an attractive new business in China for residential water treatment. So, this is a brand new market for us to see. And estimates reported like 20% to 30% growth annually and you all have been recognized as one of the leaders in this business, basically mini RO systems for home appliances that are being bought by the rising middle class who just can't drink the water without boiling it. So, I haven’t seen you talk about this opportunity before but we saw everyone's talking about it. Maybe you can talk about what the opportunity is, how it fits, what the ramp is and what kind of contribution you should expect?

Yes, I probably should talk about it more, stop fighting fires. What's really interesting is there is much more awareness about the importance of safe, clean water among the middle class and the developing world than there is in the US and Europe. Now, for sad reasons, there is increasing awareness in the US. We saw a bump in the US because of the concern about drinking water in cities and schools, and we could see that in our orders. And we are the largest provider of equipment for residential water treatment and filtration in the world. That business has been growing nicely. The little bit in China, we do have a nice exposure there; it has been lumpy because a lot of ours goes through distribution and it's been as credit has been harder to get there. Some of our distributors have had to slow down. But if you take a look at it over the last few years, it has been growing very substantially. And I moved that business to Karl Frykman and his WQS team a couple of years ago because we were the largest player in that business, but we weren’t the best performing. We made huge progress under Karl's leadership in taking that order filtration, that part. It did water filtration; water filtration is made up of that residential and commercial and the foodservice piece, the Everpure brand, if you will. And a lot of the margin expansion you saw in WQS is actually because of the momentum we're gaining there. And we'll talk more about it.

Thank you.

Thanks and good morning, folks.

Good morning.

Could you maybe talk a little bit through the progress that Bess is making in flow & filtration and kind of, I mean, it's still early days in many ways. But just talk about where you are in that task and how the quarter as you sort of look forward where you think this could head at least over the next four quarters?

Yes. I think Bess' progress is good. I mean, no one was more disciplined than she was about getting growth in the second quarter. I think we need to get more traction, and she believes we need to get more traction on the things we're investing in to grow. We shouldn’t be surprised by what happened in irrigation. We need to be more intimate and close with the customer. And we need to keep driving on the areas that are working, like the shift to industrial water and capturing as much of the infrastructure and rest as soon as possible. We still believe that there is probably more growth opportunities in the offerings that she leads and the markets that she serves than in any other business we have. There's no reason FFS shouldn’t be able to grow and perform just like WQS.

And what are the biggest ones that jump out of you in that, besides sort of the Chinese water, when we all saw over the last year?

Yes. Well, I mean, the infrastructure globally, there's a return to investments particularly in the municipalities and other water filtration on the municipal and commercial scale. We have leading positions in advanced technologies for water reuse, methane capture, CO2 capture for food & beverage, and we're having promising early results. We need to flood this own and get more advanced in those businesses. And also, just in terms of our membrane technology. I think there is too narrow of a focus on where we're applying our technologies and we need to be planful about it, but the opportunities for us to be if you well Pentair inside, on membranes in a lot of applications which we are a component supplier to high-value applications.

Okay, and Randy if I could just come back at that Valves & Controls answer you gave earlier, I guess something come out a little bit differently which is considering how you are thinking about Valves & Controls from kind of day one in terms of the strategic fit with the rest of the portfolio and the opportunity, I mean to what extent is for getting price and everything else here, to what extent is the strategic fit of that segment important to how Pentair grows going forward in your mind and then the importance to the other segments or from some other perspective that would suggest that it's really still going to be worth more to you than somebody else?

Well, I see a good runway ahead for performance improvement there and what we're good at. We are good at performance improvement. So I think we have really turned the corner in the business. I am not going to speculate on strategy right here, but it gives us great scale, and it has great scale. I mean it's a large player in a large fragmented business and we speculated before on what needs to happen in the industry; we are not going to speculate anymore right now.

Alright, that's helpful. I got it. Thanks very much. I will pass it on.

Hi guys.

Hi Steve.

Thanks for the color on the Chinese water business, I appreciate that. The tech product segment, the margins were cut there and you talked about mix; is there any how do you look at kind of price cost dynamics there and how much deal do you guys buy on an annual basis?

How many deals we buy in? A lot, I mean there are a couple hundred million dollars Steve, but I think we take a look at the technical solutions margins. It's really simply that there was an expectation that we would see the MRO in the aftermarket product side, which is a very high margin product line, kind of basically not gravitating towards where they were planning on being flat to up. It’s down double-digits in Q2, and so we are seeing a margin squeeze between that product’s fall off and it was an expectation that that would rally in the second half, and we have taken away that expectation to the second half now with the anticipation that we are not going to see any recovery in the aftermarket side. We deferred that aftermarket; we covered it to 2017. Therefore, that the product decline of double-digit is really impacting the squeeze in the margins for technical solutions.

Okay, I understand. It's mainly the thermal aspects. What are you observing in the technical chain? Wesco reported weak volume numbers today, and many distributors are experiencing similar issues. Rockwell mentioned delays in their business. What is your perspective on the stabilization you mentioned for the core Enclosures business?

Yes, for the core Enclosures we have seen stabilization in our daily order rate, and it's interesting; there is quite a mix of what we are learning from what distributors are saying. Clearly, ones that are deeply industrial facing are facing more challenges than the ones more balanced are skewed towards commercial, and we do serve multiple markets. So maybe that's why we are seeing the flat.

Okay, and then one last question about Valves; I know things tend to bottom out sequentially, but historically, Q2 is usually better than the first quarter for an average business. I'm not sure what that indicates. I believe you mentioned a double-digit increase sequentially in the third quarter; is that in comparison to year-to-date orders? Sorry.

Double-digit.

Yes, double-digit. Okay. So that brings the year-to-date probably still down double-digit; does that change the complexion of how you're feeling about 2017? Or does this sequence to the sequential dynamics now kind of like really make feel may be a little worse in 2Q but better in 3Q make you feel like you are still on track for that kind of flat EBITDA type of hope for 2Q for 2017?

Yes Steve, I think what we feel is that we have got a fairly high past two backlogs that we are still working on from the standpoint of on-time delivery, roughly 70%. Not great by any standard, I mean not horrible in the industry but not great by Pentair standard. So we are working at past two backlogs that's helping revenue. When you take a look at the orders and what Randy mentioned, not getting any large orders means that our conversion ratio is going to be higher. So we feel like as we head into 2017, even ending the year with lower orders in 2016, we think our conversion ratio is going to get back to historical norms, which is around 51% of orders that are booked in the year and shipped in that year. That trough last year was around 43%. So I think we feel like we're starting to get that mix up, as we mentioned with more aftermarket standards, and so we feel like right now 2017 is an up year versus 2016 from the income side for sure. And orders will continue to rally in 2017 from this point the way we are looking at.

Exactly and the other thing I would add is that we have really fixed funnel; we are looking at has been cleansed, high quality.

Pretty attractive for any buyer out there. Thanks a lot, guys.

Thank you, Steve.

Hi, thanks. Good morning, guys. I am going to ask Steve's questions slightly differently. And so, if you look at your expectation for double-digit sequential order growth that would imply that your orders for the second half of the year were down call it like roughly mid single-digits. Comps would kind of get you to down mid tens, and so there is underlying improvement embedded in that number and I am just wondering, did the things get much better, is the quarter progress, and what’s given you the confidence in the underlying improvement in the order number in the second half of the year?

Yes, I hit on this in Analyst Day last year, and then we have had several sessions with the business since. But we have a fairly sizable project contribution as we worked our way through the 2014 and 2015 timeframe. As Randy mentioned, not having a single order greater than $5 million over the last several quarters means that we have got a rich backlog or rich funnel of shorter cycle orders, higher margins. So, I think where we are is that we do believe we are going to start to see some projects and we are working on those on the funnel; those will be contributions, but if you look at the order rates and the order levels absent of those large project orders, it’s actually a pretty good contribution. So, when you think about that as a base and that base moving fairly stable, any orders on top of that gives you great excitement that we are going to start to see a ramp from here.

Got it. Okay, but is there like any specific end markets that are driving these improvements?

Yes, we are starting to see the downstream investment again. The OpEx has been turned off for some period of time. We are starting to see a fair amount of aftermarket consolidation. So, our customer spending with the scale providers gives us great excitement as being the largest valves supplier in our space that we are going to see a lot more aftermarket consolidation and that's a big growth opportunity for us. And then, we also are back in the game in the Middle East and we are starting to see orders contribute in the Middle East where we have been out of that game for some time.

Okay, alright. Maybe one follow-up and it looks done a really nice job on the tech solution side. I guess the question I have is you saw a little bit margin degradation this quarter on flat growth. Your expectation for the back half of the year is for growth to be down from margins to flatten and actually improve versus 2Q. So maybe just kind of talk through some of the puts and takes there on the tech solutions margin from the second half?

Yes, we are finishing a job in Q2 that was a six-bit job in thermal, and we had some overrun on the labor side on that project. So that job is ending early Q3, and so with that behind us, we are back to more of a normal project margins and normal product margins. So it was one large job that we worked through last year, and we have the final labor runs going through Q2 and early Q3, and then it's behind us.

And what was that impact, John?

It was a project order, and it was fixed hourly or fixed fee. We overran the labor to install it and complete the job. And so it ended in Q2 and Q3, so it's finishing up here in July, and then we are going to see that margin get better from here.

Okay, I have a follow-up on that impact later. Thank you, guys.

Hey, good morning, everyone. So, a couple of Flow & Filtration questions. First on the water reuse side; obviously, you got some lumpiness in your process filtration piece in general. Maybe you could just talk about the underlying momentum there, what the core trends from the industry look like, and how your positioning is and how are you doing on a relative basis?

Just the process filtration piece?

Yes, and I have a second one on the hag side.

Yes, I think that we have a lot of capability and we have not fully achieved ignition in the marketplace. Infrastructure, we have pretty good reach globally to basically the components that go in the large projects and we do pretty well there. Our hit rate when we compete for industrial is pretty good. We need to get more FX on that. Similarly, there is a vast opportunity for us to sell membrane bundles and not just modules and systems. So I think we are early days in terms of all the growth opportunities of process filtration.

And then, on the hag side; obviously some challenging comps year-over-year, some challenging trend industry-wise; talk about the sequential trends. Are you seeing any signs of stability in the industry relative to what a normal sequential would look like, and what’s the thought process going forward?

You are talking about Flow & Filtration in total? Well, given the lack of good predictability that we have going into the second quarter, I will be less confident in answering we expect to see some improvements in crop spray coming, but irrigation I think is going to be this is irrigation season. So the fact that it wasn't up now means it won’t be up in the third quarter. It tracks pretty closely with farm income unless you have an issue like we have with the drought.

Right, but I guess I am more asking stability emerging on that side for you guys with all the headwinds there or do you think that there is still more swing ahead?

Not worsening, not bettering, no. I would say.

Great. Thanks, guys.

Thank you.

Thanks. Good morning, gents. Hey, so $20 million of steel purchases you called out; is that just for TSO, or was that Pentair wide?

Pentair wide.

Okay, that's what I thought. I just wanted to clarify on that point. So, on BNC margins, can you maybe just help just from 2Q to 15%? Do we still have FIFO tailwinds into the second half of the year, or is the gap between low doubles to mid tens? Is that primarily cost saves at this point?

This is small little tailwind from the variances associated with last year productivity working its way through Q1 and Q2; but most of it is the momentum of the incremental cost saves on the operational side and also some momentum around material savings working its way through the shipments.

Okay, and I guess the fact is that there is no price and degradation in the margin bridge? It's borderline shocking; I think we were all expecting that to be price and headwind this year. Is that because the price in the markets is, we just haven't seen price cuts because the end market conditions are so awful? Or is it just primarily a function of Pentair walking away from low price projects, maybe a bit of a mix issue as well? Maybe any kind of color on pricing would be helpful?

Yes, Nigel, just to be clear and thank you for asking the question. Our price that shows up in the Valves & Controls chart is a like product to like product. Sub-standard product and it's an aftermarket usually, and it's a like for like. We are seeing, as we have talked about over the last several quarters, the project margin headwind that works its way into the growth and the FX bar on the right as far as segment income, so we are seeing that project mix and project pricing work its way through that, and that is stabilized, but it's still on the year-over-year basis pretty large as you can see there.

Okay, just to clarify, regarding the three-point delta you mentioned for the full year, is that due to minor issues or is there something more significant involved?

That's pretty much just the Ag issues.

Okay, great. That's good. Thanks a lot.

Good morning, everyone.

Morning, Nathan.

Just a follow-up on Nigel’s question there; we have heard companies talking about demand being so lousy. Some of those oil and gas markets that there is no point in cutting price. Would you expect that there could be any increased pricing competition as orders do rebound as folks compete for that volume?

Yes, I mean, I don't know if it gets worse from here, Nathan, but I don't think we are planning on getting too much better from here on those projects. I think I personally believe that a lot of that reset in pricing was the foreign exchange resets since a lot of these valve producers are outside the United States and the euro going down makes major products more affordable. I think the big EPCs are taking advantage of that, and so I think it's stabilizing now as most people have taken up the capacity, but I don't think it's going to recover to the levels that it used to be at either.

So, you wouldn't expect to see in the back half of the year order rates improve any additional pricing pressure as people compete for that volume?

We don't think so, no.

Okay. Then, my other question on water quality solutions; you talked about growth investments in the second half. Can you give us some more color on what those growth investments are and maybe what the impact on margins is in the back half of the year? And if there is continuing investments or discreet investments?

Yes. Before I get into the specifics of the investment, what we meant was that we had such a nice increase in margins; I just don't think people should expect it to be that good, and we gave you some insights on what we expect the margins to be. The investments are basically in two areas: one is product innovation, and the other one is in channel geography investments and sales coverage. So, maybe it's 50 basis points a quarter in investment increase, and one is it's a business that as the conversation about China and the conversation we talked about earlier on the pool business, it really is a business that is yielding innovation so product innovation pays. As I mentioned, we are applying some of the pool playbook to water purification to get more eminent and closer to the customer, and those are the geography and channel investments we are making.

So, it sounds like continuing investment that you expect the rewards on the top line?

Right, right.

Thank you.

Hey, good morning, guys.

Good morning.

Not to beat this too hard, but I am just trying to get a better sense of where you are seeing this sequential improvement visibility that 10% improvement, what sub-verticals, and is it your customers telling you or actually in order rates?

You are talking about valves?

Yes.

Yes, okay. Great. Yes, listen, we have had a fairly sizable frontline for a period of time, and I think as Randy mentioned, we scrubbed it. We have discounted the larger projects from the expectations that those were closed this year, but what we did when we reorganized the sales force is put a lot more energy and effort into the aftermarket side. One of the things we bring to the table to a lot of the larger customers is the ability to service a vast majority of valves. The way that we are servicing those right now is on an aggregated buy basis from those customers and then also working inside their factory to their plants to be able to benefit from that. So that's the big piece of it. The second one is that there has been some Pentair demand on the downstream side, especially the MRO downstream, and as we always said we don't think that that could be deferred forever, and we’re starting to see that start to come in. So, we are not declaring victory yet; I think we are saying is that we believe the Q2 represents the bottom of the orders and we are starting to see the increase from here. A double-digit increase of the Q2 is still a modest level of orders that we - versus what we are used to, but at least the sign that we are going to see that downstream investments start to come back.

Okay, helpful. And then just free cash flow came in a lot better; how are you thinking about upside to free cash flow for the year?

Right now we are committed to the 100% of that income, and we are tracking, as we said, $150 million better than last year. But we are focused on this, and obviously getting our debt paid down.

We are not only $150 million ahead of last year; we are ahead of where we thought we would be this.

Yes, but Jeff I think we got to see another quarter too before we obviously - we will too have it, but anyway we need to see another quarter before we are going to declare that there is upside to that number.

Okay, thanks, guys.

Thank you.

Hey, good morning. I have a question on water quality system first, not Valves & Controls. You are looking for a nice bump up in organic in the third quarter, and we are just hoping you can give us a little color around that?

Yes, there are a couple of factors. One is the Europe comp in water purification in the second quarter was tough, so we didn't show growth there. We think that it gets better, and then we talked about the pool timing. As you can look at comp, there are few comps you can look at. The pool market is really quite strong, and we think that more that will read out too. You will see that more because of the timing comp; the timing won’t mess up the comp.

Yes, the weather can have an impact on the timing of the pool season, Scott, and last year, there was a very, very strong Q2, and we are now back to more of a normal trend on a year-over-year basis in Q3. As we shared, our product and environmental system business has been growing yearly double digits now for four or five years in a row, so we feel really good about the visibility to the summer and feel very good about the growth rate for Q3.

Yes, makes sense. Thank you. The other question I had was simply on the shrinkage of the footprint; in the past, you have given us some metrics of improvement, whether it was facility or people or otherwise; anything you are willing to share this quarter?

No. I mean we have few more factories in the works to reduce. So we are just under 100 total factories to Pentair, and we expect to have reduced it by around five or six by the beginning of the year to the end of the year. So we are modestly addressing it where we feel we have excess capacity due to the end markets that we are serving, but we are not aggressively reducing the factory at this time.

Alright, very good, thank you.

Thank you.

Hi, good morning, guys.

Good morning, Joshua Pokrzywinski.

Yes, just to come back to the tech product side, I understand there are some mix issues that you're talking about in thermal, but we've heard a lot of companies call out particularly price cost. Obviously, it's a steel-intensive business. I would have imagined a bit more support from price cost in this quarter particularly on the Enclosure side, and maybe a bit more turnaround headwind in the second half. And I guess all the questions or responses around tech product seem to be focusing more on thermal than on Enclosures or ERICO. So, just trying to dimension out within, I guess Hoffman or maybe ERICO specifically how you see mix evolving there, how you see some of the margin read out particularly retain price cost?

Yes, we have done really well on the price costs on both ERICO and Enclosure, so we did single out the thermal business, Josh, primarily because that is not really steel related. It's more of the heat tracing cable versus the labor and the integration cost to bring that project there. So when we take on the projects, we are doing the design, the engineering, and the installation, and we’re bringing the cable along; we are going to have a compression of margins when the product side is down. As we mentioned, the aftermarket MRO sometimes goes to distribution or goes direct to the end site and again installed, and that's the part that's been down double-digit. So we are up significantly in the project side. We are down in the product side and we’re experiencing an overall mix issue even though we are up in the revenue.

But just to be clear on Enclosures and ERICO, no change in the margins versus 1Q for the full year outlook?

No change; we have probably experienced a little bit modest headwind on Q3 and Q4, and I save a couple million dollars in the rising cost of steel, but not anything significant.

Got you, and then just shifting gears to water quality. I think I know you mentioned the easy comp in Europe. Is that a low mix dynamic where you wouldn't see a lot of pool through profitability on that, I guess having just said, there is a late start to the pool season. Maybe that's still over in the third quarter; you got the strong volume quarter coming. I would imagine that margin would look a little bit better than what you're showing or what you're showing in guidance?

Well, water purification in Europe pool isn't that big in Europe; but the water purification side is, and margins there are bad. There is little mix...

I think there is, Randy mentioned, there is the desire to do significant growth investment, and this is a business that absolutely deserves to do these growth investments. We factor them in at the business, spending them; the likelihood that they would actually spend them would be low.

Got you, but there is no blue bird in the second quarter apart from just good mix - okay.

No, not at all.

Got you; alright, thanks guys.

Thanks, good morning. Hey, so the tech solutions trends overall showed a little revenue upside but some negative mix on the thermal side. With the intuition being for 2017 to have some favorable mix versions on margin and a little bit of net organic pressure, or you kind of see thermal more likely to compound the growth?

Early to call that, but I think your intuition about right.

Yes, I would certainly start with that. William started that.

I think your intuition we are doing now is correct.

Okay, and then just comment on how to size the corporate line in the second half?

Yes, I think you should look at around $43ish million divided equally between Q3 and Q4.

Great, that's all I got. Thanks.

Thank you.

Hey guys, good morning. So I wanted to clarify in valves, the improvement you expect in the second half, is that on the aftermarket?

Yes, we've got a little bit more short cycle product shipments and also getting up with past two backlogs, so we see that we're expecting to get a slightly higher standard margins we move that through the shipments, and we also, as we mentioned, that we took in a fair amount of deferred variances from last year, which I think we spent more than we should have on the labor side and we had a belief that that off in the first couple of quarters this year; so we have a little tailwind associated with that.

Got you, and I think in an answer to an earlier question you alluded to some of the deferred maintenance starting to show up. Is that refinery maintenance you're seeing come through it?

I don't think refinery; we're seeing more of the petrochem spending come through, which has been actively being bid. One thing that seems pretty clear is that now that the rapid decline in capital spending has happened, our customers are really sorting out normally who is working on it, who has stored and formed it, which projects are going to go forward with and we execute little projects. We talk a lot of our big projects as the thing is that they move a needle a lot, but our average project size is $100 million, so those are small outage turnarounds just maintenance-related activities. I think we’re going to get into a more normalized albeit lower level of how they’re deployed.

That’s good to hear. Just lastly, you’ve been making a lot of changes to the sales organization in Valves; at this point, are all of these changes kind of net, net helping or hurting the order growth?

I think the structure itself is the right structure. I think when you make this level of change where you have project-oriented salespeople trying to call into the aftermarket, you’re going to find areas where that’s the wrong skill set. I think that’s where we’re going to have to continue to migrate the sales force to the right skill set over time. To say we’re optimized to the moment, I would say, is not accurate, and I think we think the structure is right and what we now need to do is get the processes, the support for the structure operating fully, and then we think we can benefit going forward. Has that hurt us? Probably here and there, but not dramatically.

Great, thank you.