Good morning, and welcome to the Pentair’s Third Quarter 2022 Results Conference Call. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Jim Lucas, Senior Vice President, Treasurer and Investor Relations. Please go ahead.

Thanks, Andrea, and welcome to Pentair's Third Quarter 2022 Earnings Conference Call. We're glad you can join us. With me today is John Stauch, our President and Chief Executive Officer; and Bob Fishman, our Chief Financial Officer. On today's call, we will provide details on our third quarter performance as outlined in this morning's press release. Before we begin, let me remind you that during our presentation today, we will make forward-looking statements. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond the control of Pentair. These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to carefully review the risk factors in our most recent Form 10-Q and Form 10-K and today's release. We will also reference certain non-GAAP measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures can be found in the Investor Relations section of Pentair's Web site. We will be sure to reserve time for questions and answers after our prepared remarks. I would like to request that you please limit your questions to one and a follow up to ensure everyone an opportunity to ask their questions. I will now turn the call over to John.

Thank you, Jim, and good morning, everyone. Please turn to Slide number 4, titled Executive Summary. We are pleased to announce that our Q3 results were strong considering near-term challenges, and were in line with our expectations. Sales growth of 9% and segment income growth of 15% included a partial quarter of our recently-completed Manitowoc Ice acquisition. ROS expanded 110 basis points, demonstrating that price and productivity offset inflation, and our adjusted EPS grew 11% to $0.99 in Q3, which included incremental debt from our acquisitions and rising interest rates. We are very excited about the addition of Ice to our portfolio and the expansion of our commercial Water Solutions platform, and the team and the integration process is off to a fast start. Bob will give more detail on our updated full year 2022 guidance later in this call. While we have modestly reduced our full year expectations due primarily to increased FX headwinds and higher interest rates, the year is generally playing out the way we thought it would after our Q2 earnings call. We are seeing the previously communicated inventory correction in most of our residential channels, which we believe the industry is now addressing as supply chain challenges begin to abate. With our updated guidance, we now expect that we will have cleared nearly $200 million of channel inventory pool by the end of the year. We are encouraged that underlying demand is still up year-over-year as evidenced by dealer and distributor sell through despite the rising interest rates within the US residential industry. I will speak in a few slides about some preliminary thoughts on 2023. But the main takeaway is that we believe we are well positioned to grow sales, segment income, margins and adjusted EPS next year. Please turn to Slide number 5,…

Thank you, John. Please turn to Slide 14, labeled Q3 2022 Pentair Performance. We delivered second quarter sales growth of 9% with core sales increasing 4% as strong price contribution offset anticipated volume decline. Consumer Solutions core sales were down 2% as residential channels rebalanced inventory levels as our supply chain constraints lessened and as a result of our lead times beginning to return to more normal levels. Industrial & Flow Technologies reported strong 14% core sales growth with strength across the entire segment. Segment income increased 15% and return on sales increased 110 basis points year-over-year to 19.6%. Price once again offset inflation and productivity showed some sign of improvement as manufacturing inefficiencies improved modestly as supply chain constraints eased a little in the quarter. Below the line, net interest and other expense was $18.6 million with increased debt as we closed our Manitowoc Ice acquisition earlier in the quarter. Our adjusted tax rate was 13% during the quarter as we trued up our planning for the year, with the new full year rate now expected to be 15%. Our share count was $165.2 million and adjusted EPS grew 11% to $0.99 and exceeded our guidance for the quarter. Please turn to Slide 15, labeled Q3 2022 Consumer Solutions Performance. Consumer Solutions increased sales 8% with core sales declining 2% comprised of 16 points of price, offset by an 18% decline in volume. The volume decline was due to tough year-over-year comparisons and the anticipated inventory correction across many product lines in our residential channel. Segment income grew 10% and return on sales expanded 30 basis points to 23.8%. Our Pool business had a 4% decline in sales and many product lines such as heaters, cleaners and lighting experienced a delay in orders as inventory in the channel took…

We will now begin the question and answer question [Operator Instructions]. And our first question will come from Andy Kaplowitz of Citigroup.

John or Bob, can you give us a little more color into your volume expectations for Pool in Q4, and a little more color into how you're thinking about '23 in Pool? I know you said that you baked in channel destocking in Pool in the second half of the year. But has the destocking been higher than your expectations? And then it seems like you have confidence in break and fix, but you mentioned more uncertainty regarding renovation. Have you seen a drop off in that backlog at this point?

I mean, as a reminder, we did start the year saying that we expected that the supply chain constraints that were there throughout 2020 and '21 would likely, as they start to abate, identify that there's probably excess inventory in the channel. As the year played out in Q2 and after our Q2 conference call, I mean, what was happening and you can see it happening in other industries like retail, we expected that we would see a pullback again in demand and therefore, have to burn through inventory in the channel. So I would say it's playing out generally as expected, maybe a little bit higher in Q4, with a little bit higher being that the overall demand in the industry has slowed modestly. So we're not at the high to mid single digit sell through numbers that we were historically, and we're starting to see some pullback actually in the overall demand and therefore, that needs to add to the inventory correction.

And then, John, maybe backing up, could you give us a little more color into the buckets you cited that can help you provide the '23 growth that you seem confident of. I think in the past, you've talked about the Manitowoc Ice accretion being around $0.10. Maybe any sort of color on pricing carryover, or transformation and related tailwind would help, and then how much manufacturing efficiencies impacted you this year?

I mean, it's really early for guide and obviously, you understand these interests. I mean, I think where our confidence level comes by growing on an absolute basis on revenue EPS is that Manitowoc is going to -- should be well over $200 million as it brings the full year performance to Pentair. And that's a fairly high margin business, so we really feel good about the income contribution. And their backlog substantiate everything we saw in the business model and we're off to a strong start in integration, so I'll start there. I don't keep low worried about Pool but we're nowhere near what we saw in '08, '09, when we saw the correction. And so when you think about how Pool Corp on their call, it's a major distributor of ours, characterized as the industry dynamics. and we look at it as 20% of the industry is new, 20% is remodeled, and we have the overall break and fix in the service to our pool business. Usually, the way those dynamics work, since our dealers are capacity constrained on labor, they'll shift their work to either building new pool or remodeling, not doing both at the same time and/or servicing the pools on a break and fix basis. So we think that that's going to -- even if you project downward trends in the industry, we think that's going to be a modest impact to Pentair. And then ultimately, we believe that we have carryover pricing as a company, and then we like the diversity of our portfolio. And we're trying to remind everybody that we're not 100% exposed to Residential. As a matter of fact, we're less than 50% exposed to Residential, and the rest of our cycles are still in growth mode. They're building orders and pipelines and backlog, and we're going to see those contributions in the next year. So that's on the revenue side. On the income side, our manufacturing inefficiencies are really more about we received product late in the quarter from our suppliers, and we have to rally and push it out to our customers. And so those inefficiencies come in the form of premium break in and less than in full truckloads on the way out, as well as a lot of overtime and extra people required to get that product out the door. So I had to quantify it, I'd say it's around $50 million. And so we're going to address all that and bring our cost in line, and we feel fairly confident that we're going to see the ROS expand next year because we're going to get back to our standard productivity levels that we were at prior to the whole COVID impact.

The next question comes from Mike Halloran of Baird.

So John, just a clarification on something you're saying in there. You referenced Pool Corp's commentary in the prepared remarks, talked about the splits there. Was that for Pentair specific, or was that an industry sellout thought process or the sell through versus what you're expecting for your revenue base, if that makes sense?

The statistics I give on a sell through basis, we've been using for a very long period of time, and they're generally in line with what I said, like they don't change very much. It's hard to get as specific because our dealers serve all three of the channels. And as they buy product, we make assumptions based on pool permits and/or what was bought in the pool [full] pad versus maybe just a couple of products that feel more like replacement. But our dealers serve all three forms of the industry, and most of what we've been selling lately feels more pool pad oriented. And so therefore, we're convinced that there's more to go on the break and fix. And when we talk about break and fix, we're talking about putting our dealers out there to help that individual try to automate their pool. And it's hard to push that if you don't have the electronics that produce that product. And we feel like we're catching up on that and we feel like we got runway in '23 and '24 to really change that penetration rate.

So just to clarify, I just want to make sure I understand. So the sell through piece is the 20%, that's the news was where you're going to get industry headwinds, repair, replace up a little bit, maybe flattish as per your commentary. And then the flex is in the remodel side, where we used to play out the visibility yet. And then the inventory piece would be Pentair specific as you get to the correction, so a little bit worse than those sell through numbers is what the thought process is? Correct?

Yes. Mike, we feel like we're pretty good at that between what we've already done in Q3 and Q4. But as Bob alluded to in his comments, I still think there's more in Q1.

So then on the commercial side of things, maybe just talk about the trends through the quarter here, backlog levels and what the customer base is saying? Essentially kind of getting to the confidence level and the sustainability of the solid underlying trends you're seeing on the commercial side.

I mean, I think where we have the best visibility would be on the Manitowoc side. We recently acquired them but they've got a good visibility because they make a machine, and that machine takes a little longer time to make than our Everpure filtration would. And so we still see growth both in volume basis and in the backlog and order build. And then as we get to IFT, Mike, we're actually seeing accelerating orders and also building backlog, and those businesses giving us confidence that we're going to see further growth next year than the [IT] side.

The next question comes from Joe Giordano of Cowen.

As you mentioned, Pool Corp, but when they talked on their last quarter, their commentary on ending inventories for the fourth quarter had an enormous range, and it implied for their inventory purchases for fourth quarter like anywhere from almost minus 30% to minus 8%, so like a pretty big range. And they talked about like pre buy as well. So can you kind of talk about what you're guiding in the fourth quarter somewhat like in the context of that huge framework that they're laying out?

I can't speak to theirs at all, Joe. Between Bob and I, we'll try to answer this as we can. We're only a third probably of our key distributors’ businesses because they produce a lot of other product for customers. And obviously, Pool Corp is an important customer of ours, but they're not our only customer. So when we look at inventory, we look at it broadly across the entire channel for pool equipment that we produce. If we think about pool directionally being about 30% down in volume for Q4, which is a pretty big number and therefore, pretty big dent in any inventories in the channel if volume were to be relatively flat absent that. But we're being honest in the sense that when we look at it, we see early buy needs in Q4 that our customers are going to take advantage of. And we believe that in Q1, we're going to start to have a better understanding product by product where the excess inventory is in the channel, and those also need to be looked at branch by branch and state by state. And therefore, we still think there will be a little bit further impact in Q1 as people ready themselves for the 2023 pool season, which generally ramps up in Q2.

I would just say that our goal is to work down as much of the channel inventory this year. John talked about a $200 million number, there will be a little bit to go in Q1. But I think we're going to end this year much better positioned for 2023 by working down that channel inventory in pool. That's really our goal.

Just to clarify, you said -- broke up a little. Did you say, John, you're talking volumes in pool of minus [30] or so in 4Q? I just didn't catch the number…

Correct.

The next question comes from Nathan Jones of Stifel.

It's very helpful, the commentary around where the pool inventory is likely to be at the end of the year. I think if you put the pieces together on your outlook for the different parts of Pool, your sell through expectations for the Pool business in '23 look like they're maybe up a little bit, maybe down a bit, and the inventory comes out mostly in 2022. Is that a fair way to characterize it? And if the pool sell through happened to be lower next year, how much longer do you think it would take to work through this channel inventory?

Well, Bob, I don't know you want try this. I'm not going to comment, you've got a lot in there. I think we've already said that we do believe overall industry dynamics are down next year from a volume perspective for Pool. We just don't know how much. We do believe that builds are going to moderate on the new side. We don't know what [buyouts] are going to do on their 25 year old pools, we'll see where that steps up. And we overall think aftermarket grows, and then we got carryover pricing that helps mitigate it. So the forecast we have or the thoughts we have as we head in next year is the understanding we'll probably see down sell through for our particular product, and our inventory corrections are based upon those assumptions. And as Bob said, we're trying to clear as much as possible in Q4 but we do believe that it's not going to be a perfect solution, and we'll see a little bit of runoff in Q1. That's all I can give you right now.

The commentary today has been pretty bullish on the improvement around supply chain. Maybe you can talk a little bit more about where you are on supply chain, what disruptions remain and what your expectation is for how those play out in '23?

Yes, I would point to pumps as an example. While we're still catching up on pumps, our supply chain there is getting marginally better. When we look at inflation, we expect inflation to still be a headwind in Q4 but to improve from Q3. So we are seeing some supply chain improvements, we're encouraged by that. John talked about some of the inefficiencies within the manufacturing process, those should lessen as we go into 2023 and be a tailwind for us. So I would say we are seeing that piece of the business improving.

John, I think you said about $50 million of inefficiencies this year. Do you think you can get rid of all of that in '23, or there will still be some of that lingering around?

I think that's a target that we believe we're after, and we believe between transformation and catching up on the supply chain that that's what we're after.

I would add a third component to that. So we are adjusting our manufacturing cost for the volumes that we're seeing. So being rightsized going into 2023 from a manufacturing perspective is the third lever that we have.

And next question comes from Bryan Blair of Oppenheimer.

You had mentioned resi water treatment down low double digits, channel dynamics somewhat similar to Pool. Just curious what your team is contemplating in terms of fourth quarter sales from resi treatments? And given current visibility, how long you expect channel normalization to take?

We're taking advantage of strength in other places and what we're doing there is refocusing the business. We were putting products probably closer to the consumer, taking advantage of some of the themes and the trends that were happening during COVID, and we now reposition that business to be 100% focused on the trade channel and/or going through our direct market, which is our RainSoft affiliated dealers. So what you're seeing there is really business exits or us doing some 80/20 and walking away from product line revenue, and then reposition the business for success in 2023. So I think you're going to see a similar trend in Q4 than you're seeing and then we think we put all that behind us.

And just to confirm, is $0.10 still the guide for Manitowoc Ice accretion next year? And I guess, to level set a bit more if we were to exclude that, is the expectation -- just given current visibility that you grow core earnings, given all the levers that you've walked through on today's call?

$0.10 is still the EPS accretion target for '23. And we're really not in a position to give guidance for 2023 other than to say we have the five levers for earnings growth next year, whether it's price carryover, Manitowoc manufacturing inefficiencies, adjusting for volume or transformation, we feel good about income, EPS growth and ROS expansion next year.

The next question comes from Brian Lee of Goldman Sachs.

This is Miguel on for Brian Lee. Just to maybe piggyback off of that last question, I appreciate the early thoughts you gave on 2023. Can you maybe give a bit more color on maybe the mix of the contribution on revenue of price and volume, and on Manitowoc Ice for 2023?

No. I mean, the reason we introduced the 2023 early thoughts chart is really to remind people that we're more than just a pool company. We believe we have a strong diversity of our portfolio that goes well beyond residential. It seems like, and you can tell by the questions we're being asked, we don't get a lot of questions on the other half of the business. And we want to remind people that we just cleared an acquisition that is a really healthy contributor to our commercial water pipeline and portfolio. We're way too early to be able to give the exact science behind all of the different revenue streams as we haven't finished our planning process internally, and we haven't seen where some of the global economics are going to land. So we're not in a position to do that other than tell you given those five levers that Bob mentioned, we feel really strong about our ability on an absolute basis to grow revenue and EPS next year.

And then switching gears, and it's my last question. Recognizing that new pool is relatively small part of the business, but I wanted to make sure I heard correct. Are you able to provide an early view on new pool construction in '23? I thought I heard double digit decline next year from the prepared remarks, did I hear that correctly? And if not, I guess, how are you thinking about new pool in '23?

Yes, I think that's fair. What we -- the only indication we have is that pool permits uphold, we generally get a look at what those pool permits are in the main states that we serve. And they would suggest that there's likely to be a double digit decline in actual new pool builds next year. And so that's how we're formulating our thought process.

The next question comes from Jeff Hammond of KeyBanc Capital Markets.

Maybe just if you can speak to price carryover into 2023 just based on what you've already announced? And then just you mentioned the transformation savings. I know I think early next year, you're ready to talk more about that. But just any kind of early thoughts on how you're thinking about those savings into next year?

I mean, I think the best way I can characterize it, Jeff, and you're familiar with the industry. I mean, 75% of our revenue goes through the professional trade channel through [distributors]. So in most normalized [seasons], which we think we’ll be heading into one in 2023, when we put price through, we normally are able to maintain those price levels throughout the process. And so we feel there's a stickiness to announce price increases and implemented price increases that we feel we're going to benefit from. So I would say that we are moving into next year and in most cases, we we are experiencing labor inflation. And we did further our price increases here in Q4 for the 2023 season. So between the incremental price increases we announced and the ones that we implemented previously in the year, we believe we're starting from a fairly healthy carryover position heading into 2023.

In transformation?

We'll give a number when we produce the guide, but we've been working very, very hard on these individual streams. And we'll give directional views of what we think we're going to achieve across each of those streams when we give our guidance for next year on the Q4 earnings announcement.

And then just on Manitowoc Ice, maybe just level set us on -- I think that's a fairly stable business, but how -- and you've got pretty good visibility. But just how it's acted in maybe past recessions around cyclicality?

It's a -- think of Manitowoc Ice has been roughly a 5% grower. When we look back historically, that's typically what the business does. There's seasonality associated with it, so about 60% of its revenue comes in Q2 and Q3 with 40% in Q1 and Q4. But overall, when we looked at the business, it's a pretty solid 5% grower. We talked about revenue synergies that could accelerate that to 10% when you add on the Everpure business, the KBI and the cross selling across some of the customers that each of us have. So again, when we look out over the next couple of years, we're encouraged by the revenue growth of that business.

And Jeff, it's highly -- I mean, like our [Technical Difficulty] business, we benefit a lot towards the restaurants and they generally do relatively better in downturns and recessions. And they're very focused on cold drink dispense and that market tends to do best with inside those restaurants and stores.

The next question comes from Scott Graham of Loop Capital Markets.

Really two questions. Could you -- the Pool side has been beaten to death, so I'm going to stay away from resi altogether. Could you tell us a little bit more about Commercial and Industrial sort of order or sales cadence as the quarter progresses? I don't mean dollars because everything is seasonal, of course. And the year-over-years, did you see any kind of fall off at all on into October?

No, I think in our non-residential businesses, we feel like we continue to see order trends and funnels as growing as we're working through those particular cycles. The only place that we've seen the year-over-year headwinds has really been on the residential channel so far, so that's where we sit today.

I would say because we started disclosing backlog in our Q, what you'll see when we file our Q is backlogs are very healthy in the IFT business. So that's an encouraging data point as well.

And so both of your comments also are about particularly your -- year-over-year growth in the commercial side of Consumer Solutions. Is that fair?

As we sit here today, yes.

And then the longer term goal talked about in the Analyst Investor Day last year of getting to, I think it was 21% margin in 2025. You got residential that's going to be a little weaker for a couple of quarters coming with Pool a big chunk of that being higher margin. Does that enable us to keep to the 20 -- I mean, netting off against some of the other things you said about supply chain and internal inefficiencies, what have you. Can you still get to that number in 2025?

I mean, we would be very disappointed if we did not. We talked at the Investor Day about transformation being our lever to expand 100 basis points a year, that excludes Manitowoc Ice. So when you add Manitowoc Ice to the mix, we would be disappointed if we just got to 21%. And I would say that we will get there much sooner than what we had described at our Analyst Day. Our focus is very much on ROS expansion.

The next question comes from Julian Mitchell of Barclays.

This is Matthew Shaffer on for Julian Mitchell. I was wondering how management is thinking about balancing inventory liquidation with the potential EPS headwind from underproducing to normalized inventory here over the next few quarters?

Well, I mean, I think our inventory situation, as I said today, is mainly a result of us doing the best we can to get the raw inventory in around the core aspects have been hard to get, and we would expect to work that down pretty aggressively here over the next couple of quarters. And as Bob mentioned earlier, we'd be in a position to benefit from the cash generation of that inventory. It serves two purposes, it's moving down faster. If you think we can buy it cheaper in the future, obviously, we don't want to be sitting on higher cost inventory so we're aggressively moving to that reason. And the second one is the cash mobilization and getting the cash benefit from that inventory.

And then on IFT, I was just curious like how management is thinking about the price volume dynamics here in Q4 and into 2023 after a pretty strong quarter here in Q3?

We want to continue the momentum that we've built over the last couple of quarters, and it's not -- I mean, we'd like to accelerate it is what we'd like to do.

And we're very focused on the complexity reduction, and the transformation will help that segment significantly.

Okay. I'd like to thank everybody for joining us today. At Pentair, we are focused on creating a better world for people and the planet through smart, sustainable water solutions. We appreciate your interest today and as we continue to focus on helping the world sustainably move, improve enjoy water, life's most essential resource, we remain committed to driving superior shareholder value that we maybe the world's most valued sustainable water solutions company for employees, customers and shareholders. Andrea, you can conclude the call.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.