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Edited Transcript of PNR earnings conference call or presentation 17-Apr-19 1:00pm GMT

Q1 2019 Pentair PLC Earnings Call

Manchester Apr 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Pentair plc earnings conference call or presentation Wednesday, April 17, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James C. Lucas

Pentair plc - Senior VP of IR & Treasurer

* John L. Stauch

Pentair plc - President, CEO & Director

* Mark C. Borin

Pentair plc - Executive VP & CFO

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Conference Call Participants

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* Andrew Burris Obin

BofA Merrill Lynch, Research Division - MD

* Bradley James Vanino

KeyBanc Capital Markets Inc., Research Division - Associate

* Brian Paul Drab

William Blair & Company L.L.C., Research Division - Partner & Analyst

* Charles Stephen Tusa

JP Morgan Chase & Co, Research Division - MD

* Damian Karas

UBS Investment Bank, Research Division - Associate Director and Equity Research Associate of Electric Equipment & Multi-Industry

* Deane Michael Dray

RBC Capital Markets, LLC, Research Division - Analyst

* Joseph Craig Giordano

Cowen and Company, LLC, Research Division - MD and Senior Analyst

* Joshua Charles Pokrzywinski

Morgan Stanley, Research Division - Equity Analyst

* Julian C.H. Mitchell

Barclays Bank PLC, Research Division - Research Analyst

* Michael Patrick Halloran

Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research & Senior Research Analyst

* Nathan Hardie Jones

Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst

* Robert Scott Graham

BMO Capital Markets Equity Research - Analyst

* Tingjia Yuan

Goldman Sachs Group Inc., Research Division - Research Analyst

* Walter Scott Liptak

Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst

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Presentation

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Operator [1]

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Good morning. My name is a Zetania, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pentair 2019 First Quarter Earnings Conference Call. (Operator Instructions). I would now like to turn the call over to your host, Mr. Jim Lucas. Sir, you may begin your conference.

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James C. Lucas, Pentair plc - Senior VP of IR & Treasurer [2]

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Thanks, Zetania, and welcome to Pentair's First Quarter 2019 Earnings Conference Call. We're glad you could join us. I'm Jim Lucas, Senior Vice President of Investor Relations and Treasurer, and with me today is John Stauch, our President and Chief Executive Officer; and Mark Borin, our Chief Financial Officer. On today's call, we will provide details on our first quarter 2019 performance as well as our second quarter and full year 2019 outlook as outlined in this morning's press 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 Form 10-Q, Form 10-K and today's press 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 Relations 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. (Operator Instructions). I will now turn the call over to John.

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John L. Stauch, Pentair plc - President, CEO & Director [3]

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Thank you, Jim, and good morning, everyone. Please turn to Slide #4, titled Executive Summary. As we shared earlier this month, our first quarter of 2019 reflected cold, wet weather in many parts of the country and this had an adverse impact on our first quarter sales of our high-margin pool and specialty ag spray businesses. This weather pattern combined with distribution inventory that was created to avoid our heavier-than-usual price increases related to 2018 tariff impacts created a significant impact to the bottom line. The slower pull through of demand in Q1 related to weather and pool means that we expect inventory will now be worked out of the channel in Q2 and Q3 causing the further reduction to our full year guidance. While these 2 events create a unique impact on the business, we feel that this situation is isolated to 2019 and our overall thesis for our pool business remains healthy and intact.

On a more positive note, we completed 2 strategic acquisitions during the first quarter that further our strategic initiative to accelerate residential and commercial water treatment. Both acquisitions are performing well and the integrations are on track.

I will now turn the call over to Mark who'll provide more detail on Q1, Q2 and the full year forecast. Mark?

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Mark C. Borin, Pentair plc - Executive VP & CFO [4]

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Thank you, John. Please turn to Slide 5, labeled Q1 '19 Pentair Performance. For the first quarter, we saw core sales decline 4%. Segment income fall 16% and adjusted EPS was down 12%. We'll provide more color on the individual segment performance shortly. Below the line, we saw an adjusted tax rate of 18%, net interest other expense of $8.5 million and our average shares in the quarter were 172.5 million. Net interest other expense was a bit higher than planned due to the 2 acquisitions closing earlier than expected.

Please turn to Slide 6, labeled Q1 '19 Pentair Segment Performance. This slide lays out the first quarter performance of our 3 segments. Following robust growth in 2018, which we believe was somewhat elevated as distributors bought inventory ahead of price increases as we commented on our fourth quarter call, first quarter core sales in Aquatics declined 6%. Segment income in Aquatics declined 13% as the produced top line led to under-absorption in the quarter.

Core sales declined 6% in Filtration Solutions but segment income was flat due primarily to positive mix. Within the core residential and commercial business, we saw 2 areas of softness that we believe are short term in nature. First, we experienced lower component sales as Aquion is now represented as intercompany sales and is no longer reflected as external sales. Second, Europe saw ongoing weakness but the comps are easing. While this had an impact on our first quarter sales, mostly due to timing, we continue to see positive growth prospects for the key residential and commercial piece of Filtration. We note that the food and beverage and industrial businesses were on plan for the quarter.

Flow Technologies reported flat core sales but that does not capture the story of the 22% segment income decline. While price helped the residential piece of Flow, we saw our specialty business, which is exposed to agriculture crop spray, face significant top line pressure. Specialty is one of the most profitable product lines within Flow and the sales in this contributed to the income decline in the quarter. We are rightsizing the cost structure of specialty to the adjusted demand levels now expected for 2019.

Please turn to Slide 7, labeled Balance Sheet and Cash Flow. Our first quarter saw cash flow usage in line with seasonal trends as we tend to build working capital in advance of the important residential selling season, primarily in our Aquatics segment. In addition, we closed on 2 strategic acquisitions during the quarter and saw our debt level increase as a result. While our debt level increased from the end of 2018, we expect cash flow to turn positive in the second quarter, and we anticipate debt levels coming down as cash flow improves throughout the year. While we did not repurchase any shares during the first quarter, we remain committed to buying $150 million in 2019.

Please turn to Slide 8, labeled Q2 2019 Pentair Outlook. We anticipate second quarter core sales to be flat to up 1%. We expect Aquatic Systems to be flat to down 1%, Filtration Solutions to be flat to down 2% and Flow Technologies to grow 2% to 4%. We anticipate segment income to be down approximately 5% to 7% as some of our more profitable businesses continue to see short-term top line pressure. We expect adjusted EPS to be in a range of $0.63 to $0.66 per share. Below the line, we expect corporate expense to be approximately $14 million to $16 million. We expect our second quarter tax rate to be 22% as we anticipate a true-up during the quarter. We also expect net interest other expense of roughly $11 million and shares to be approximately 171 million.

Please turn to Slide 9, labeled Full Year 2019 Pentair Outlook. Slide 9 looks at the different components of our updated 2019 outlook. For the full year, we expect core sales to be flat to up 1%. We continue to expect price of roughly 3% for the full year. We expect total sales growth of roughly 1% to 2% with roughly 3% contribution from the recently announced acquisitions offset by a 2% headwind from FX. We anticipate segment income to be flat to up 2%. Our full year adjusted EPS range is $2.30 to $2.35 per share. Other items embedded in our guidance include corporate expense of $60 million to $65 million, a tax rate of 20.5%, net interest other expense of $38 million and an average share count for the year of 171 million shares.

I would like to turn the call back to John.

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John L. Stauch, Pentair plc - President, CEO & Director [5]

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Thank you, Mark. Please turn to Slide #10, labeled Full Year Guidance Update. Before I discuss our longer-term outlook, this slide is meant to be a helpful look at what has changed since we provided our initial 2019 guidance. While we do not like to use weather as a reason for sales miss, the reality is that cold, wet weather had a pronounced impact on 2 of our businesses, pool and agricultural precision spray. The main change from original forecast is our very profitable Aquatics business.

In 2018, Aquatics delivered higher-than-average growth of 11%. We anticipated that some inventory was pulled ahead of price increases but it is worth talking about what was -- what has happened to the start of the year. Wet and cold weather delayed pool construction activity in several key markets such as California, Texas and Arizona. The inclement weather also impacted pool openings in other parts of the country primarily the Sun Belt. As a result, sell-through in our distribution channels was impacted and therefore inventories were not reduced at the levels we would have expected if the pattern would had been more consistent with historical trends when weather was not a factor. Of importance is that we have not seen any significant changes in demand trends within the key Aquatics markets. Our dealers continue to report strong backlog and while weather created delays, we expect inventory levels in the channel to come down as activity resumes in the second and third quarters.

Within Flow Technologies, we saw our higher-margin agricultural precision spray impacted as many parts of the country were under water to start the planting season. Given these delays and the limited number of months in the season, we are not anticipating a rebound in activity and are adjusting the cost structure of this business accordingly.

With Aquatics and the specialty business in Flow experiencing slower top line growth rates in 2019, this has led to reduced expectations for segment income and adjusted EPS growth. We do believe this is a short-term issue but unfortunately, the weather-related delays were compounded by the higher inventory levels in the distribution channels.

Please turn to Slide 11, titled Segment Positioning. We wanted to take a moment to speak to our 3 segments and why we believe we are well positioned for the longer term. Aquatic Systems is a leading franchise where we believe long-term demand trends remain in place. We expect to continue to invest in dealer engagement and consumer pull. We have been expanding aftermarket products, including in the faster-growing automation space. We have built a strong business, and while the growth rate in 2019 is not up to historical standards, we believe that averaging 2018 and 2019 is more reflective of the longer-term growth rate of this attractive business.

As we mentioned earlier in the call, we strengthened our residential and commercial water treatment business with 2 strategic acquisitions. Aquion, brought water treatment systems capabilities and an affiliated dealer network, while Pelican brought a water conditioning systems capability and an established e-commerce platform. In 2019, we will experience some modest impact to the top line as former component sales to Aquion are now recognized as intercompany sales. We continue to focus on digital marketing and engaging consumers to build our brand.

Flow Technologies continues to be a business where we are focusing on leveraging our core PIMS competencies and improving margins. While parts of the Flow portfolio have been impacted by inventory and weather issues, we are accelerating operations, sourcing and structural changes to improve our overall cost structure to create a solid foundation for 2020.

Please turn to Slide 12, titled Long-Term Value Creation Goals. This is an updated version of a chart we have referenced in the past but an important slide as it highlights our longer-term goals. With last year's separation and our emergence as a pure play-focused residential and commercial water treatment company, we remain committed to delivering more consistent performance.

We continue to believe that we have a portfolio capable of delivering low to mid-single-digit core sales growth over this cycle. With a portfolio capable of delivering positive price coupled with the relentless focus on productivity, we expect segment income to grow mid- to high single digits. We generate strong free cash flow and have committed to repurchasing 150 million of our shares annually. We believe that this should result in top quartile EPS growth and disciplined capital allocation would add upside to a strong base performance. We recognize that consistency is the key to being recognized as a top-quartile performer, and we remain committed to achieving these long-term goals.

I would now like to turn the call over to Zetania for Q&A after which I will have a few closing remarks. Zetania, please open the line for questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Steve Tusa with JPMorgan.

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Charles Stephen Tusa, JP Morgan Chase & Co, Research Division - MD [2]

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So just curious as to what really kind of changed from when you gave guidance in, I guess, late January or early February to today. I mean I missed it as well. But POOL was very clear that they were not going to have the greatest first quarter on the planet and with the destocking impact, you guys actually had guidance like above what they said they were going to guide. I don't know what that is. That's either a disconnect -- there's a disconnect somewhere. What happened there? Why didn't you guys just come out in January and say, hey, first quarter was going to be -- is going to be weak given these dynamics?

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John L. Stauch, Pentair plc - President, CEO & Director [3]

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Yes. I think it's a fair question, a good question, Steve. I think the different dynamics are it's easy to sit here now and look backwards at what inventory is in the channel. But as we raised prices last year, primarily related to the tariffs, we knew there was a little bit of inventory in the channel being built. But that's all based upon what the expected sell-through is through our dealers into the markets that they serve. And so we had anticipated that the inventory would be dealt with in Q1. But the significant drop in the sell-through produced more inventory in the channel and therefore it didn't make sense to continue to sell into the channel. And that was really what happened later in the quarter, Steve.

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Charles Stephen Tusa, JP Morgan Chase & Co, Research Division - MD [4]

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No. I understand that. And I'm just saying like is there something in the FP&A function here that you guys aren't kind of picking up what the channel is saying? Because again, like, it was a public company telling you what the growth rate was going to be. And if there was destocking in the first quarter, then you guys would have been below that growth rate instead of guiding to something like 4% to 6%. And then going around to conferences and kind of not really insinuating it all that things were weak over the course of the quarter. Because I think visibility here is a question that I'm getting from investors all the time. And I think there's just a bit of a confidence issue that people have that you guys aren't picking up the right tea leaves in the channel.

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John L. Stauch, Pentair plc - President, CEO & Director [5]

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Yes. Again, I wish it was that easy, Steve. I think we're looking at 4 days of inventory on hand, and there's a lot of inputs in there. And I do want to remind everyone there's more than a distributor, right? I mean the pool market and also part of this is distributors in Flow as well, it's not just all pool. And there's lots and lots of distributors and lots of estimates that go into a 4 days of inventory on hand. And I think we didn't know till late in the quarter that we were in the situation we were. And as soon as we knew, we went out and told people and we dealt with it accordingly. And we're taking out the cost, and we're taking all the actions we can to position ourselves the best we can for next year. I don't want to damage a great business like pool, and I think we're off doing all the right things to grow share and pull demand in that particular business. And I think it's demonstrated that success consistently over a series of years. And I do want to remind you that the tariff changes and the significant price increases was part of this issue as well and those don't happen often.

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Charles Stephen Tusa, JP Morgan Chase & Co, Research Division - MD [6]

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Sure. On Filtration, what was the -- why was that weak? Because I mean, I think, we were expecting some weaker sales in Flow given the flooding and all that kind of stuff, which is complete legitimate issue. Everybody is kind of seeing the weather and the flooding out there, that's definitely not specific to you guys. But filtration was definitely weak. Can you maybe just talk a little bit more about what happened there? And you guys cut guidance there as well on revenue.

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John L. Stauch, Pentair plc - President, CEO & Director [7]

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Yes. It definitely was slightly weaker than we expected, Steve. I think weather impacted it as well primarily on the service and the installs. The timing of the acquisition was positive as far as the reported acquisition but it also changed the way the intercompany sales moved from us to those 2 acquisitions because we sell to both of them. And then we did experience slightly weaker European demand, which we have adjusted our full year guide to reflect.

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Charles Stephen Tusa, JP Morgan Chase & Co, Research Division - MD [8]

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That also would have been helpful to know that you're going to kind of, like, have a little bit less of an organic impact from these deals that could have been communicated better probably at the time of the deal, just some feedback.

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Operator [9]

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Your next question comes from the line of Nathan Jones with Stifel.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [10]

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I'm going to follow-up on the pool business here. I understand it's seasonal. I would have thought that customers would have been making these decisions -- spending decisions on an annual basis. And if we had poor weather in the first quarter that might defer revenue out of the first quarter into the second quarter or third quarter. Can you guys talk maybe a little bit more about the dynamics there and why you're not just going to catch that revenue up? I mean I can understand why the sprayer business doesn't catch up. But I'm just a little confused on why that pool revenue wouldn't just shift from 1 quarter to the other rather than disappear altogether.

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John L. Stauch, Pentair plc - President, CEO & Director [11]

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Yes. It does. I think clearly, if we didn't have the inventory situation in the channel that we have, part of the Q1 miss would be made up in likely Q2 and Q3, Nathan. I mean there is limited labor. So people don't go out and necessarily hire more. They're going to slide jobs a week or 2 or so in the schedule. And so they tend to do as best they can to make them up in the season. What we're really reflecting in the outward quarters is the fact that we still have to deal with the inventory in the channel. So I do think the dealers will make up the demand. I do think that our channel partners will see that demand come through, and it's more muted on us because of the inventory build that occurred from the Q1 sell-through.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [12]

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So does that mean there was more inventory in the channel than you guys had predicted when you reported 4Q? I mean I know you said you thought there was $30 million of pre-buy in 4Q '18 ahead of the price increases. Did that end up being higher than you expected, which is part of what contributes to this 2018 was higher than it should be and 2019 is lower than it should be?

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John L. Stauch, Pentair plc - President, CEO & Director [13]

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Yes. What we anticipated to be about a point of headwind for overall Pentair is now a couple points of headwind. Now again, I'm reminding you that it's not just pool. There's a little bit in the Flow Technologies distribution channel as well related to the weather. But yes, as I was mentioning, rearward-looking, as you looked at days of inventory on hand forward-looking in Q4, it felt like 30. Because of the lack of sell-through that happened in Q1, that number expanded and it's got to be dealt with in Q2.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [14]

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Okay. I just want to follow up on Steve's question about maybe looking inwardly at your own forecasting tools. Have you run a root cause analysis on this thing kind of looked at the FP&A processes to see if there's things that you guys can do to improve the predictability results here?

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Mark C. Borin, Pentair plc - Executive VP & CFO [15]

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Nathan, yes. As you'd expect, we have our PIMS toolkit and that doesn't just apply to how we run the operations, it applies to how we run our back-office functions as well. So we are using our root cause countermeasure tools to try to understand what are the things that we could have had better visibility to and gotten more out in front of. But as John said, sometimes it's a little bit easier to do that when you're -- when you've got hindsight information to look at. But that's the information that we need to think about, and how do we put that more at the front end rather than seeing it at the back end. So absolutely, we're working on that and looking for improvements across the board.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [16]

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Is there anything that you found that you could share that could change -- could improve those kind of processes? Are you still in progress?

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Mark C. Borin, Pentair plc - Executive VP & CFO [17]

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Nathan, that would be such an easy answer if that was it. I mean there's no way we could predict the Q1 weather patterns.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [18]

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No, that's fair.

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Mark C. Borin, Pentair plc - Executive VP & CFO [19]

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I mean California, Arizona and Texas I mentioned are such significant markets to the pool business. And what happened there was so unusual as far as the wet, cold weather and that stops production or stops pool builds for a period of time because they can't move machines in. So I don't know what we could do. I mean we always run sensitivity analysis on our forward-looking analysis but that's not one we would've predicted.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [20]

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I should have qualified that question to be outside of weather effects and things that were -- would be obviously unpredictable.

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Mark C. Borin, Pentair plc - Executive VP & CFO [21]

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The answer is no. Because I mean we found out afterwards as we shared in our Q4 call that we felt there was inventory in the channel and that inventory would've normally burned off in Q1. The specialty ag business was also uniquely impacted and that all happened throughout the process in Q1 as well. So those 2 things led to the Q1 challenges and we've not sensed -- not put in a forecast of the recovery in pool, and we've not put any recovery of the specialty ag in the outlook, and then we've adjusted demand to be what we think are on the lower ends of our forecast models and then we're working the cost actions to go build the foundation for 2020. And that's the only way I could think of reacting to the situation.

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Operator [22]

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Your next question comes from Joe Giordano with Cowen.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [23]

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So I don't want to keep asking the same question but one thing that's confusing to me a little bit. I -- heading into the quarter when you had your look at inventory and pool, I totally understand that, that changes because of weather on a day's basis because the demand side of it changes. But like on a gross level of inventory, that number is a fixed number. And so if we're saying that this is largely going to like shift quarters on the revenue side, that's where I don't get why the overhang doesn't like kind of fix itself sooner. Because yes, we could change, like, what we thought was 40 days is really 50 or something like that because the denominator changes but the top -- the actual amount of inventory was a fixed number of units. So that's kind of where I struggle with. I don't understand that.

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John L. Stauch, Pentair plc - President, CEO & Director [24]

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That's fair. I mean, I think the one thing I'll remind you is that if it was just a product sale, it was not dependent on labor required to install it, I do think you'd see a quicker recovery. But the labor is not excessive, right? I mean, it's not going to -- like you're going to go out and add more labor to build more pools in the short term. So it will come through the channel clearly. And we do think that, that will spread itself over Q2 and Q3. But the Q1 hit to us is going to be reflected as an inventory reduction in Q2 and Q3. It won't affect the channel that same way.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [25]

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How much of that -- like, is that actual construction element weighing down? Because I always -- we talk about this business being like that's not really a big piece of it at all. So I'm just curious as to how that...

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John L. Stauch, Pentair plc - President, CEO & Director [26]

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Well, every dealer is out there either installing a new pool or they're also out there doing the aftermarket aspects or scheduling the aftermarket pool product install. So they're -- they generally are the same people, and they're going to do their best to get those pools in place. And so there will be a delay on both ends, the aftermarket and the new pools.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [27]

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Okay. And then on the forward guide for that business, so 2Q implies, like, more of a seasonal sequential ramp than normal, which I guess maybe some of that is a snap -- a little bit of a shift in that demand. But the second half guide is essentially flat year-on-year versus last year, and we keep talking about how much pull-forward there was and that was a plus 12 comp. So how comfortable are you with the back half being flat year-on-year? And what kind of visibility do you have into that?

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Mark C. Borin, Pentair plc - Executive VP & CFO [28]

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Yes, Q2 and Q3, as we talked, will be impacted by the inventory coming down and then Q4, we expect kind of as you look at it sequentially, it will pick up and get better, and we'll see some of that recovery coming through. And we -- when we look at it for the full year, we're confident that the full year expectation is appropriate. And as John said, we factored in everything that we know to date as we look at the out quarters.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [29]

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Okay. And then if I could just shift quick to last one on Filtration, just to follow a little bit on what Steve asked initially. To me, that was like the biggest surprise was the magnitude of the miss there. It's not pool, it's not Flow, and it was a pretty sizable miss versus the initial guide. So the -- your comment on lower component sales like not being intercompany makes sense but that -- those I assume were kind of factored in because you announced those deals before you gave the initial guide. So can you maybe talk through what -- some of a little bit more detail there?

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John L. Stauch, Pentair plc - President, CEO & Director [30]

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Yes. Let me just frame that. I mean the intercompany sales are roughly about a point overall total Filtration Solutions for the year, okay? Which will give you an impact on kind of what it is per quarter. Keep in mind, we did not have the acquisition as a contribution in Q1. We had it closing after Q1. So these 2 things, you're seeing the benefit of the acquisitions. But we had not forecasted in the quarter the impact of the intercompany sales. But the real impact that we saw was a little bit slowing in Q1 where the weather impact us. We do expect to catch that up in Q2. And then the European trends are not where we'd want them to be. And that's really the reflection that we added to the full year forecast. I don't think we know that. I think we're anticipating it, and we're planning for it.

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Operator [31]

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Your next question comes from Mike Halloran with Baird.

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Michael Patrick Halloran, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research & Senior Research Analyst [32]

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So question on the margins on the Flow side. So talk a little bit about the inefficiencies in the mix side, please? And then also, when do you think that can normalize back to what your previous run rate suggestions were? And how long does some of these headwinds [render]?

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Mark C. Borin, Pentair plc - Executive VP & CFO [33]

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Sure. The biggest contributor to the margins in Flow is the mix impact from the decline on the specialty ag spray business at a higher profit component of that overall portfolio. So that's the -- the biggest driver. And then the other driver is just the timing in how price works its way in throughout the year as all their price actions take hold. We had talked last quarter about the couple of factories. Those are stabilizing, and we see those not having a negative impact to margins during the year and improving as we get through the balance of the year.

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Michael Patrick Halloran, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research & Senior Research Analyst [34]

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Sounds good. And then when we think about the second half of the year here, just frame what's changed now versus your previous guidance. Obviously, the -- so on the Aquatic side, the assumptions on the top line have come in a little bit. Obviously, we're adjusting a little bit through some of the costs on the Filtration side that are no longer external sales. Anything else you would point to that's changed in the back half of the year versus the previous guidance?

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Mark C. Borin, Pentair plc - Executive VP & CFO [35]

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Sure. I mean, I think the -- overall, when you think about it, not a lot has changed. So that'd be how I'd characterize kind of the headline. We talked before about just the timing of inventory and how that works off. But -- and then specialty that the business that we referenced, right, the softness there. We have not projected that, that is going to improve as we work through the balance of the year. And so those are probably the 2 biggest factors when we think about what's different. But overall, really the back half of the year is not significantly different than what we had previously been thinking.

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John L. Stauch, Pentair plc - President, CEO & Director [36]

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We have also not assumed, like, any benefit from tariff relief in this outlook. So that's consistent with the previous outlook. And we've also most of the operations and sourcing and the targeted actions this year are not expected to have 2019 benefits. But they generally are expected to offer contributions in 2020. Meaning we're driving the activities this year and assuming it's going to take a longer term to -- longer time to realize it and therefore are really driving them as a 2020 foundational benefit.

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Michael Patrick Halloran, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research & Senior Research Analyst [37]

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So in other words, if you hit your plan, your expectation is that the run rate exiting 2019 is slightly lower than what you were originally expecting but not meaningfully lower like the front half trajectory would imply?

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Mark C. Borin, Pentair plc - Executive VP & CFO [38]

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Yes, that's correct.

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Operator [39]

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Your next question comes from Deane Dray with RBC Capital Markets.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [40]

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I might have missed this, but are you able to separate and quantify the impact of weather this quarter from the inventory dynamics?

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Mark C. Borin, Pentair plc - Executive VP & CFO [41]

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We didn't specifically quantify it earlier, Dean. But think of it as $30 million to $40 million. So if you think about the majority of the Q1 impact is really driven by weather, which as John said, delays the bleed off of that excess inventory that then happens in Q2 and Q3.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [42]

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Got it. I just wanted to make sure that part had been quantified. And then just is there any ripple effect on pricing? I know you called out the 3% pricing assumption. But with an incentive to work inventory down, is there going to be any compromise on pricing? And what might the dynamics be there?

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Mark C. Borin, Pentair plc - Executive VP & CFO [43]

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No. No. The overall pricing profile stays the same as you referenced, we talked about 3% for the year. And so nothing changing from a price perspective.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [44]

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Got it. And just last one for me is it's more of a business model question and maybe it's just an observation. But as Pentair has refocused the portfolio to a water pure play, you've lost that benefit of earnings diversification that you had when nVent was part of the company. So now we're -- we see this vulnerability to weather that really maybe just as magnified versus what the company structure was before. Is this variability or vulnerability just something that comes with the more focused portfolio? And had that been part of the framework that you're looking at for the company, Pentair, as it is today?

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John L. Stauch, Pentair plc - President, CEO & Director [45]

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Dean, I think it's a great observation. The answer is -- to the first question is yes. I mean that has definitely exposed more vulnerability on weather impacts. Now what we got to do is build more diversification into our portfolio to account for that. I mean we did see spots of it. I mean we did have a good China quarter. I think things in China have improved. We had that little bit of softness in Europe. Normally, that wouldn't have happened. But I think the diversification of portfolio is something we will focus on and ensure that we do not subject ourselves to these types of weather patterns and the variability that they can cause.

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Operator [46]

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Your next question comes from Scott Graham with BMO Capital Markets.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [47]

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So kind of a follow-on to that question. Would it be fair to say that even though Aquatics is really the flagship, the best business, the highest margin and all of that, that the business will be built more going forward through organic means aftermarket consumables and that kind of thing and then your acquisitions would be more focused on the other 2 segments?

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John L. Stauch, Pentair plc - President, CEO & Director [48]

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Yes. I mean, I think the pool business is well positioned, and I think we have a lot of organic growth runway remaining. And I think we continue to innovate there from a new product perspective, and we continue to have good intimacy with our channels and our consumers and understand what they have. So I think that's going to be more of our organic strategy as we go forward. As evidenced by the 2 acquisitions that we just did, our goals in Filtration Solutions is to build out a closer-to-customer model and also make sure that we're doing our part to drive demand in the channel. The overall penetration rate of Filtration systems in homes is relatively low. And although it's better in the commercial office space and/or commercial restaurant space, it's still not where we think it should be or can be. And so most of our acquisition activity will be focused about how do we drive that demand and how do we get closer to the customer to drive that demand in Filtration.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [49]

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Okay, John, that helps. My follow-up is really not to beat the horse even deader here, but would you be able to maybe answer this question because you indicated that there doesn't seem to be much of a change in demand on the pool side. I'm not quite sure what you meant by that. And maybe the question specifically would be what was sell-through by your dealers in the quarter?

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Mark C. Borin, Pentair plc - Executive VP & CFO [50]

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Yes. What -- when we see -- when we talk to our dealers and we hear from our -- from the builders and understand sort of what's going on out in the market, backlogs remain high, business remains solid. So when we talk about we're not hearing anything from an underlying perspective that the market is slowing, it's based on those discussions and that insight. And that's really what -- kind of what informs the way we're thinking about that. I mean sell-through from the information that we have access to remains strong. I think we would expect an impact in Q1 from weather, but as we said that starts to turn around and as we move into the heavy season here in Q2 and Q3. So again, underlying trends in demand, we're not seeing anything that would indicate softness there.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [51]

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So your -- from what I think, I'm gleaning from this is that your distribution channel is kind of normalizing right now?

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John L. Stauch, Pentair plc - President, CEO & Director [52]

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I mean, I can't speak to that. But I can tell you what Mark is saying is the sell-through is accelerating, right? The March sell-through was definitely towards the end high from the dealer channel and then we also know the dealer channel is going to make up. As we mentioned most of that weather loss in Q1, they're going to do their best to make that up in Q2. Why that's muted to Pentair is because there is that inventory in the channel that needs to be worked out before we're going to see the benefit of that recovery of the channel shift.

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Operator [53]

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Your next question comes from Josh Pokrzywinski with Morgan Stanley.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [54]

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Just a follow-up, just a finer point on pool that I think Mark raised earlier, I want to not miss it in passing that the business should normalize by the fourth quarter. I guess just given everything we've seen from tariff pre-buy and even your callouts about the inventory position exiting the year. I guess mathematically looking at guidance, you do have to pick up the growth rate by the fourth quarter. Is that explicitly something that you're calling for? And I guess why not take a more conservative track just given some of the surprises this quarter?

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John L. Stauch, Pentair plc - President, CEO & Director [55]

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I think we have, Josh. I mean, I think if -- when we take a look at what our new estimates are in that sell-through demand throughout the year, we are assuming taking inventory down to at or below normalized historic levels, right? It is still a growing market and is still a growing industry. And so you'd expect inventory to actually be accelerating through this period. I think what we wanted to do is make sure we forecast it on the downward end. And I know it looks like Q4 is out of the norm but we would expect our normalized patterns to continue and Q4 is usually a pretty good quarter for Pentair.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [56]

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Got it. And then, I guess, just following up a little bit on Deane's question on pricing. Looking holistically at price-cost productivity, I know you kind of think about that -- those 3 different legs of the stool. I would imagine there was some drag there from all the disruption this quarter. But thinking about that total bucket the rest of the year, how should we think about that gap closing, improving or getting worse? I would imagine something happens in the world as it pertains to rebates or pricing power given volume. But just thinking about it holistically, should that get better or worse from here?

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Mark C. Borin, Pentair plc - Executive VP & CFO [57]

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Yes, you hit on it. It does get better as we move through the year, which is in line with, sort of, how we expected it to move. Just with the timing of when price is impacted with rebates and other things. But as we said on our earlier guidance, we continue to believe that effectively price and inflation will offset each other. So we continue to view that as the overall way to look at the guidance, and that's a full year statement. So we see that, and we sort of see that starting to turn as you get into Q2, 3 and 4.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [58]

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Got it. And if I can just sneak one more here. More of a question philosophically on how you guys get impacted from a weather perspective. If I think back to 1Q of '18, I think some other folks in the broader construction ecosystem called out weather then in January. Was there anything in the comp that would have said, 1Q of last year wasn't particularly smooth sailing on the weather front?

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John L. Stauch, Pentair plc - President, CEO & Director [59]

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No, Josh. Last year's Q1 actually was one of our stronger organic growth quarters of the year. I think we benefited from some of the tax changes that occurred and demand was strong out of the gate. So I'd say, we don't think that weather had a significant impact on Q1 of '18 at all. And usually if it happens earlier in the quarter, it's not as big of a deal because those things can get made up. I mean, really what we're talking about is the end of January and February was 6 significant weeks in a row of a consistent pattern in the states where it matters to us.

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Operator [60]

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Your next question comes from Jeff Hammond with KeyBanc Capital Markets.

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Bradley James Vanino, KeyBanc Capital Markets Inc., Research Division - Associate [61]

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This is Brad, on for Jeff. Just to clarify something. In the first quarter, it seems like cash flows is particularly weak. I understand some of the abnormalities going on there. But just on a full year basis, what's your confidence on hitting the target?

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Mark C. Borin, Pentair plc - Executive VP & CFO [62]

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Yes, I mean, Q1 cash flow as you referenced is traditionally our weakest quarter. As a reminder, Q1 of last year was when we were going through this separation. So we were -- there was noise in '18 and sort of the visibility to what a run rate level of Q1 cash flow for this separate water business would look like. So this, I think, is the -- in many respects is sort of the new view of what Q1 looks like and we'll start to turn that in Q2 and turn positive in Q2 and then continue that through the balance of the year. So remain confident in our ability as we target cash flow to equal adjusted net income.

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Bradley James Vanino, KeyBanc Capital Markets Inc., Research Division - Associate [63]

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Okay. That makes sense. And then just on the strategic initiatives and investments you have going on. You talked about, on the last call, some flexibility to kind of throttle those back should demand kind of weaken a little bit. Just given what happened in the first quarter, have your strategic investments changed and plans for those for this year? And kind of -- does that have any kind of trickle-down impact over the longer term?

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John L. Stauch, Pentair plc - President, CEO & Director [64]

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No. I think we're focused on still building out a portfolio that we think has a lot of runway around organic growth. Couple of small additions that we're looking to do again on the tuck-in side on the residential and commercial Filtration side to continue to build out our portfolio. And then from an organic standpoint, continuing to make the consumer aware of what Pentair can bring to the table. And then how we bring that through our channel partners and how we give the consumer what they want. That's what the strategic investments are, and we're going to continue to invest in high-priority areas throughout 2019.

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Operator [65]

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Your next question comes from the line of Brian Lee with Goldman Sachs.

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Tingjia Yuan, Goldman Sachs Group Inc., Research Division - Research Analyst [66]

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This is Rebecca Yuan, on for Brian. So aside from the weaker demand in Europe that you point out, have you seen any slowdown in your end markets? And can you maybe speak to the growth trends you're seeing or any broader macro comments?

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John L. Stauch, Pentair plc - President, CEO & Director [67]

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No, we haven't. We did, as evidenced by our particular outlooks for the year, adjusted to what we've called the lower end of the ranges for some of our revenue forecasts that we could get ahead of the cost curve and work on the foundational aspects. But as I mentioned, I think we're starting to see a stronger China as we move forward here in 2019, and we think we got maybe 1 more quarter of headwinds in Europe. Some of the slowdown started in Q3 and Q4 last year for us in our particular markets. And overall, we think that our end markets continue to be solid, and I think our position in those end markets is solid.

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Tingjia Yuan, Goldman Sachs Group Inc., Research Division - Research Analyst [68]

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Okay. And then just as a follow-up for some of long-term goals that you highlighted, can you maybe give us an idea of the timeframes, whether like 3 years or 5 years?

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John L. Stauch, Pentair plc - President, CEO & Director [69]

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Well, we'll continue to move rapidly to build out the portfolio in those strategic growth areas. I mean, yes, this is a 3- to 5-year vision, and we want to move aggressively and fast as we can to achieve that vision. But it's a combination of organic growth efforts that we're doing with marketing and sales and new product development organically as well as a series of tuck-in acquisitions that we would do over time. Can never time those and obviously, we continue to try to grow the funnel but executing them is not always within our control.

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Operator [70]

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Your next question comes from the line of Walter Liptak with Seaport Global.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [71]

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I wanted to ask a capital allocation question. The share repurchase, it looks like there was no share repurchase done in the first quarter and with the shares that you guys talked about, it looks like 80 million in the second, have you started on the share repurchase yet this quarter?

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Mark C. Borin, Pentair plc - Executive VP & CFO [72]

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We can't really comment on the timing of when we're in the market doing share repurchases. But as I said in my comments, we're committed to the 150 million for this year and would expect to execute that in the -- from now to the balance of the year. And you're correct, we did not do any purchases in the first quarter. And generally that's because as we talked about cash flow, we utilize cash in the first quarter and so we think it's most prudent to manage the planned buybacks in Q2, 3 and 4.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [73]

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Okay. And with the share repurchase, can you be opportunistic with it? Could you do a bigger amount in the first -- in the second quarter? Or do you have to spread it through the rest of the year?

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John L. Stauch, Pentair plc - President, CEO & Director [74]

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Short answer is yes.

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Operator [75]

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Your next question comes from the line of Julian Mitchell with Barclays.

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Julian C.H. Mitchell, Barclays Bank PLC, Research Division - Research Analyst [76]

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Maybe just a question on something below the top line for a change. You talked on Slide 13 about optimizing the cost structure in the operational footprint, and it was notable that your SG&A to sales rose quite a bit year-on-year in Q1. Is there any way that you could quantify the scale of the savings program when we're thinking about the sort of base number for 2020? And then also looking at the sort of operating profit in Q1, the GAAP profit was about 30% lower than the adjusted segment profit. It looks like there was an asset impairment charge in there. So maybe just give us some background on that charge?

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John L. Stauch, Pentair plc - President, CEO & Director [77]

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Sure. I'll handle the first one and I'll let Mark handle the second. I think when we talk about going forward what our actions are, I mean the first and foremost, I think making sure that our sourcing activities are connected to our business units and quite frankly, the product lines is the number one priority. Because we have to have the anticipation of what's happening in the commodities that we're buying and be able to make the determination of either cost out on the sourcing side or value-added -- value engineering on the cost side or be able to price appropriately and give our distributor partners enough heads-up that those pricings would come.

The second one is the operational footprint. Some of our businesses have way more capacity than they need, and that capacity might not be in the right regions. And so getting after the operational footprint is the second largest priority. The third one on the operating structure is making sure that we're adjusting our cost investments to the priorities of the company and not what we feel is the priorities of the individual product lines of the businesses. And that is a huge opportunity for us. And as Mark mentioned, we're going to rightsize the areas that are affected by what we call more cyclical trends where they're not going to recover any time shortly. That's really the cost efforts. I don't want to quantify it yet because they're fairly sizable targets internally that we expect to go after and get as a foundation for 2020. And at the appropriate time, we'll share what those benefits are. Mark, you want to handle the second part?

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Mark C. Borin, Pentair plc - Executive VP & CFO [78]

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Sure. The asset impairment items, think of those as relating to the optimization and some of the actions and activities that we talked about in 2018. Part of that was exiting certain businesses. In this case, these are a couple of cost-based investment businesses. So they're not businesses that are part of what we're running as Pentair but small investments. And we wrote those down in Q1 based on an updated view of what we would be able to sell those assets for. But it's -- so it's not something new. It's really just the continuation of some of that work that we talked about last year. And as we finalize that and get those things behind us, that was an adjustment that we had to record.

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Julian C.H. Mitchell, Barclays Bank PLC, Research Division - Research Analyst [79]

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And just my follow-up would be around the top line in Flow Technologies. The core sales were sort of flattish in Q1, guided to grow 2% to 4% in Q2. It sounds like ag is still going to be weak. So maybe just talk a little bit about how much of a reacceleration in the resi parts of Flow you expect? And what types of products were really affected by the excess channel inventories in Flow?

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Mark C. Borin, Pentair plc - Executive VP & CFO [80]

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Sure. So maybe a couple of things. So in Flow, there's really 3 parts to that business, the residential irrigation and commercial infrastructure and the specialty business. So as you said, specialty is -- pulls numbers down. But then we do expect to see the residential irrigation and commercial infrastructure parts of the business start to pick up as we move through the balance of the year. Some of that comes from price. So we -- a lot of the price impact that we're projecting for the year is coming from the Flow business and particularly in the residential side, and that starts to read out as we move into Q2, 3 and 4. And so those are the -- those would be the biggest drivers of that. The residential irrigation business would have been impacted in Q1 somewhat by the channel inventory and weather, and that starts to correct itself as we get into Q2, 3 and 4.

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Operator [81]

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

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [82]

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Just a point of clarification. I'm not sure that it was clear, what exactly was the weather impact on the Filtration business? And which markets were you seeing that in the most?

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John L. Stauch, Pentair plc - President, CEO & Director [83]

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It's just as you think about the installs of water treatment and water conditioning systems. They were affected by some of the weather patterns and those are like days, right? So we pushed -- we didn't get to do it in a day. So they pushed out their installs weeks or so. And that's why we feel that, that all will recover in Q2.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [84]

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Okay. So it just made it harder, even though these are -- and this is all primarily inside jobs, right, where you're installing food and beverage filtration system, you're installing something -- it's in a factory it's in a facility? You're just saying that the weather in general just kind of dampened -- sorry about the pun, just kind of dampened that activity, is that what you're saying?

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John L. Stauch, Pentair plc - President, CEO & Director [85]

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Yes, it was minor in Filtration. But yes.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [86]

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Okay. Okay. And then can you quantify at all what growth or decline overall you reported in Europe and in China for the first quarter?

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John L. Stauch, Pentair plc - President, CEO & Director [87]

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Yes. I mean China had a recovery and was up double digit. And in Europe, we're talking about modestly down.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [88]

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Okay. You broke up a little bit on my end on China. You said it was -- what'd you say on China?

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John L. Stauch, Pentair plc - President, CEO & Director [89]

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Double digits, and then we were modestly down in Europe.

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Operator [90]

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Your next question comes from the line of Andrew Obin with Bank of America.

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Andrew Burris Obin, BofA Merrill Lynch, Research Division - MD [91]

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Just a simple math question. So if I look at the guidance on Aquatic Systems before for the year and where you ended up, it seems there is 8 percentage point difference, which is I think for the year is a little bit over $80 million. And if I look at the delta for first quarter versus what you were guiding versus what you reported, so it seems $30 million. So if I think that $30 million is a combination of a little bit too much inventory and weather, that sort of implies that non-weather-related stuff is $60 million for the remainder of the year. Is that how I should think about it?

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John L. Stauch, Pentair plc - President, CEO & Director [92]

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On the outer end, yes, you got it right. Meaning the inventory did not get worked down in Q1 as we've said. And that inventory will be worked down in Q2 and Q3. And so yes, you've got it right. So the weather impact for us, you've got it quantified correctly. The rest of it is the inventory burn that we're expecting Q2 to Q3. And using the outer end or the lower end of the projections as you do that math. So yes, you got it right.

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Andrew Burris Obin, BofA Merrill Lynch, Research Division - MD [93]

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And I'm just struggling with a concept. So you said if you can't do pools in Q1, so you can hire people to dig pools in Q2 and Q3. Because it seems that you say there are labor constraints. And I'm just struggling to understand the concept, I apologize.

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John L. Stauch, Pentair plc - President, CEO & Director [94]

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Yes. So again, we're talking about a couple of things. Certainly, they will do their best to work as fast as possible to build those pools in Q2 and Q3. But as I've said, we're not going to benefit from that because we have to work our inventory down through our distributors and dealer channels. And so that will recover in the industry but because Q1 demand was so soft and the inventory did not get reduced in Q1, we are planning on reducing our inventory in Q2 and Q3 as all of that activities that you mentioned gets happening in the outer end of the market.

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Operator [95]

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And your final question comes from the line of Damian Karas with UBS.

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Damian Karas, UBS Investment Bank, Research Division - Associate Director and Equity Research Associate of Electric Equipment & Multi-Industry [96]

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So a follow-up on Aquatics. You highlighted some of the areas in the U.S. that were most impacted by the colder weather and the inventory destocking. Just thinking about your expectations for the further destocking over the next 1 to 2 quarters here and then what ensues, could you give us a sense on whether you're really expecting a similar level of activity across all these regions? Or could there be some dispersion or any unique regional circumstances that you're perhaps factoring in?

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John L. Stauch, Pentair plc - President, CEO & Director [97]

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We're not factoring any unique dispersion or circumstances. What we're doing is trying to get below this and get to the bottom of the range. And so we're assuming that the inventory gets worked out. Obviously, it's not perfect. The inventory is not ideal or perfectly balanced by region or all those other things. But we feel like we need to work to get this inventory out of the channel. We have a great business. It's a business that has performed historically at the upper single-digit growth range, and we believe it's going to perform again to mid- to upper single-digit growth range. And so what we want to do is get it rightsized from the inventory perspective, work on the demand pull to the consumer, our new product development and all our great marketing and sales activities and make this business the right business -- the great business it used to be in 2020 and beyond. That's what we're doing.

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Damian Karas, UBS Investment Bank, Research Division - Associate Director and Equity Research Associate of Electric Equipment & Multi-Industry [98]

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Okay. Sounds good. Makes sense. And just on CapEx. So you've guided that $10 million higher. Just wonder if you can give any additional color on what led you to up the budget there and just any color on where you're planning to spend this?

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John L. Stauch, Pentair plc - President, CEO & Director [99]

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Yes, I think we've gone out and made sure that our businesses understand that capital is an important factor in driving productivity. It doesn't matter if it's not on -- it's on the software or the front-end marketing and sales-related activities as well as automation in the factories and capital investment in the factories to drive productivity. So just a philosophy of Mark and myself that we need to use capital to help drive productivity, and we wanted to make sure that the businesses have the capital they need to do that.

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Operator [100]

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I would now like to turn the call over to Pentair for any closing remarks.

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John L. Stauch, Pentair plc - President, CEO & Director [101]

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Thank you for joining us today. We continue to invest in our prioritized growth initiatives around advancing pool growth and accelerating residential and commercial water treatment. We're driving operations, sourcing and cost-out actions where appropriate, particularly in our Flow Technologies segment. We have a strong capital structure, solid free cash flow generation, and we will continue to invest in our strategy to be the leading residential and commercial water treatment company. Thank you for your continued interest. Zetania, you can conclude the call.

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Operator [102]

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This concludes today's conference call. You may now disconnect.