Pentair PLC

Welcome to the Pentair second quarter 2022 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please send a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star and then one on your telephone keypad. To withdraw your questions, you may press star and two. Please also note that today's event is being recorded. At this time, I'd like to turn the conference call over to Jim Lucas, SVP, Treasurer, FP&A, and Investor Relations. Please go ahead.

Thanks, Jamie, and welcome to Pentair's second quarter 2022 earnings conference call. We're glad you can join us. With me today is John Stauk, our President and Chief Executive Officer, and Bob Fishman, our Chief Financial Officer. On today's call, we will provide details on our second quarter performance as outlined in this morning's press release. Before we begin, let me remind you that during our presentation today, we'll 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 PINTAIR. 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 Pinter's website. We will be sure to reserve time for questions and answers after our prepared remarks. I would like to request that you limit your questions to one and a follow-up 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 four titled Executive Summary. Pentair delivered another strong quarter with sales, segment income, and adjusted EPS all up double digits. We were particularly encouraged with our margin expansion, both sequentially and year over year, as price more that got offset continued inflationary headwinds. We're also excited to have received all of the necessary regulatory approvals related to our acquisition of Manitowoc Ice, and we expect to close the acquisition later this week. With the significant growth of pools since 2019 and a water solutions business expected to exceed $1 billion in sales on a pro forma basis, including Manitowoc ice, and to be predominantly a commercial platform, we'll be moving to three segment reporting segments starting January 1st, 2023. The three segments will be pool, water solutions, industrial flow technologies. I'll provide more details on the new segment structure shortly. We're also introducing Q3 guidance of $0.93 to $0.95 and tightening our full year guidance to a range of $3.70 to $3.75. Bob will give more details on guidance later in the call, but we're seeing headwinds from FX translation, as well as higher interest expense with the rise in rates over the past several months. We continue to believe we are well positioned in attractive markets. Transformation is helping strengthen our performance and the addition of Manitowoc ice and our new segment structure positions us to continue delivering for all of our stakeholders. Please turn to slide number five, labeled Building a Stronger Commercial Water Solutions Platform. We introduced this slide in March when we announced our plans to acquire Manitowoc Ice. Manitowoc Ice is an iconic brand and a great business that we expect to help our commercial water solutions business to deliver scaled, end-to-end water filtration and ice solutions for food service customers, along with predictive services that identify and address customer issues before they arise. This combination will transform our current water treatment business, which historically has been roughly two-thirds residential and one-third commercial focused. With Mantua Ice, we expect water treatment to be $1 billion on a pro forma basis, with commercial representing nearly two-thirds of the business, and improved profitability in addition to even greater growth prospects. Please turn to slide six, labeled Aligning Organization for accelerated success. To further expand on our announced segmentation move, the addition of Mantua Ice will provide us with an expanded and scaled end-to-end commercial water solutions platform for important global customers. It will also reshape our water treatment business to be more commercial, focused by both revenue and contribution of income than our residential business. In addition, our pool business has nearly doubled in revenue and income since 2018, which further supports a change in our consumer solution segment structure. As a result, pool and water solutions will each become individual segments, and each will be focused on the respective growth and transformation plans in line with our expectations. Our existing industrial flow technology segment will remain the same. As a result of this new structure, we have also announced a number of management changes effective January 1, 2023, when the new structure will take effect. We believe this new segment structure will help us accelerate our efforts to improve customer service, differentiate our products, and drive profitability for our shareholders. Please turn to slide seven, labeled transformation to enhance value creation. As we have shared over the past several quarters, our transformation strategy is taking shape. We are creating new tools for our toolbox, and each business is identifying their own respective opportunities to transform their business models for future success. Overall, we are focused on four areas, pricing, sourcing, operations, and organizational effectiveness. The team has been working hard to build funnels in all four categories, and we are gaining significant traction within sourcing. During the second quarter, we held a supplier show and gathered over 800 attendees representing over 450 suppliers. We have identified additional suppliers as we evaluate the entire supply chain. This event showcased the diversity of our product offerings and many suppliers, both new and existing, have gained a better understanding of how to partner with Pentair going forward. We are well underway in our efforts of evaluating the larger supplier categories and are looking forward to sharing more on our progress in the future. We believe transformation is a key value created for Pentair longer term, and we look forward to updating you in more detail and sharing our detailed targets and expectations for 2023 and beyond early next year. I would now like to turn the call over to Bob to discuss our performance and our financial results in more detail.

Bob? Thank you, John. Please turn to slide eight labeled Q2 2022 Pentair Performance. We delivered second quarter sales growth of 13% with core sales increasing 12% with strong price contribution. We were particularly pleased with the top line performance, given the tough comparison to last year. As we indicated last quarter, we expected to see price outpace inflation starting in the second quarter, and it played out as anticipated. Consumer solutions delivered core sales growth of 15% against a tough comparison, and industrial and flow technologies grew core revenue 7%. Segment income increased 18% and return on sales was 19.3%, which represented a 70 basis point increase year over year and a 210 basis point improvement sequentially. We were pleased to see the strong price contribution more than offset inflation, but many of our businesses continue to face supply chain inefficiencies and we expect this to impact productivity in the near term. Below the line, net interest and other expense was just under $5 million. Our share count was $165.5 million, and the adjusted tax rate was 16%. Adjusted EPS grew 21% to $1.02 and exceeded our guidance for the quarter. Please turn to slide 9, labeled Q2 2022 Consumer Solutions Performance. Consumer Solutions delivered another strong quarter with sales growing 19% and core sales increasing 15%. Segment income grew 18% and price more than offset inflation in the quarter. Pool sales grew 20% in the quarter and we continue to see solid momentum as we continue through the 22 pool season. There's understandably a lot of focus on the pool industry given the significant growth over the past two years. The pandemic changed consumer behaviors early on, and whether it is moving to warmer climates, investing in the overall backyard, or the emergence of new traveling like Airbnb, consumers are using pools more and more. The industry is estimated to be roughly 60% serving the installed base, 20% major remodeling, and 20% new pool construction. New pool permits have historically run 10% of single family starts and have been a little ahead of that lately. But pool dealers remain constrained by labor availability. Remodeling activity has been strong, but the focus on new pools has kept some of the remodeling activity from occurring, leading to healthy backlogs for dealers. Further, pool attrition has been lower as pool owners have a renewed interest in maintaining their pools. There are roughly 5.4 million pools installed, and the average age of the installed base is approaching 20 years. The near-term focus for pool is managing the supply chain, keeping up with demand, and improving the inventory health of all product categories. While some categories like heaters, lighting, and cleaners have improved, inventory positions leading to elevated growth, other categories like variable speed pumps, automation, and sanitization still have healthy backlogs given the limited availability of chips that has impacted deliveries. We continue to believe in the long-term prospects for the pool industry and will provide further updates when we report third quarter earnings in October regarding channel inventory levels as the pool season ends in September. Water treatment grew sales 19%, which included some contribution from KBI. Residential water treatment continued to be focused on complexity reduction and improving margins. Sales were up mid-single digits for the residential business with positive contribution from both affiliated dealers and components. Commercial water solutions continued to see a healthy recovery in its end markets resulting in healthy double-digit sales growth once again. The overall industry continued to improve, and KBI has strengthened and created new relationships for the business. Please turn to slide 10, labeled Q2 2022, Industrial and Flow Technologies Performance. Industrial and Flow Technologies grew sales 4% in the quarter, with core revenue increasing 7%. Segment income grew 4% and return on sales was flat at 15.7% as supply chain and plant inefficiency has continued. Residential flow grew sales 6% as demand in its channel remained solid and backlog returned naturally to historic levels as component availability improved. Price has read out quite well so far this year and capacity constraints in the plant have slowly improved as labor challenges have been addressed. We expect more normalized seasonality to end the year, but are encouraged as sell-through in the channel remains healthy. Commercial flow sales were down 6% as the timing of shipments impacted the quarter. Backlog remains healthy, and we expect improvements in the supply chain should result in these delayed shipments occurring in the second half. The business continued to make progress in driving complexity reduction. Industry solutions saw sales increase 9%. Backlog continued to be strong and orders were healthy in this longer cycle business, particularly within the sustainable gas solution business. Although this is a longer cycle business, it was encouraging to see healthy price readout in the quarter. Please turn to slide 11, labeled balance sheet and cash flow. The balance sheet ended the second quarter exceptionally strong with leverage at one time and return on invested capital just under 19%. Cash flow improved sequentially and was impacted some by higher inventory levels as supply chain inefficiencies continued. This is a combination of opportunistic raw material purchases and products that have been close to being completed while awaiting final components that have been delayed. Resins, drives, and electronics continue to be the categories impacted by availability challenges. We expect inventory levels to come down through the second half. During the quarter, we completed our financing for the pending Manitowoc ice acquisition. Given the rise in interest rates that occurred since we announced the transaction in March, we ended up with 75% of the debt variable to help mitigate some of the higher interest expense that will occur versus our original assumptions and to allow us to pay down the variable debt as free cash flow is generated. We repurchased $50 million of shares in the quarter. Our primary focus for the remainder of the year will be on debt reduction upon the closing of the Manitowoc ice acquisition. Please turn to slide 12 labeled Q3 and full year 2022 Pentair outlook. For the third quarter, we are introducing adjusted EPS guidance of 93 to 95 cents, which represents a year-over-year increase of 4 to 7%. We expect total sales to grow 3 to 5% against the tough comparison, as we expect seasonality for the business and channel inventory levels begin to normalize. We expect segment income to increase 5 to 7%. with corporate expense coming in around $20 million, net interest expense of $6 to $7 million, an adjusted tax rate of 16%, and a share count of $165 to $166 million. For the full year, we are adjusting our top line guidance to a range of 8 to 10% increase related primarily to a 1% higher FX headwind than previously forecasted. We expect segment income to increase 9 to 11%, as we expect price continues to exceed inflation in the back half of the year, offset by manufacturing inefficiencies in the near term, given ongoing component and labor availability. We expect adjusted EPS in a range of $3.70 to $3.75, or an increase of 9 to 10% for the year. We have reduced the high end of our previous guide by 5 cents to reflect FX and interest headwinds. Below the line, we expect corporate expense to be around $80 million, net interest expense of $21 to $23 million as interest rates have increased, an adjusted tax rate of approximately 16%, and shares to be around 165 to 166 million. We continue to target free cash flow to approximate net income. We are focused on bringing down inventory levels despite ongoing supply chain inefficiencies. Our third quarter and full year guidance does not include the impact of Manitowoc ice, which we expect to close later this week. For the balance of 2022, we would expect the acquisition to be neutral to earnings. We had previously communicated that we expect 25 cents of accretion in 2023. However, we now expect about a 15 cent headwind from higher interest expense as a result of rates rising since we announced the transaction in March. And we would now expect approximately 10 cents accretion in 2023. We continue to target 40 cents accretion by 2025. I would now like to turn the call over to Jamie for Q&A, after which John will have a few closing remarks. Jamie, please open the line for questions. Thank you.

Ladies and gentlemen, at this time, we'll begin that question and answer session. Once again, to join the question queue, you may press star and then one. To withdraw your questions, you may press star and two. Our first question today comes from Andy Kaplowitz from Citigroup. Please go ahead with your question.

Good morning, everyone. Good morning. John or Bob, could you give us some more color into how you're thinking about pool moving forward? I know you said you'd give us more of an update in October, but I think you did suggest earlier in the year that you expect some inventory correction in the channel and pool later in 22. So given the strength you saw in pool in Q2, but obviously more normalized inventory in the channel, do you expect a potential channel correction to be better or worse than your initial expectations And what could that mean for 23 pool demand?

Yeah, thank you for the question. From our perspective, the year is playing out very much like we thought it would be when we gave our initial guide at the beginning of the year. When we look at the business, we have a comparison to last year where, if you remember, Inflation started accelerating in Q2, Q3, and Q4 of 21, and price was still catching up. When we looked at the volume in last year's Q3 and Q4, really normal seasonality was not in play. Backlogs were high. We were shipping the products that were available to us, and revenue growth was primarily volume driven. As we built the guide for this year, our view was that price would start to read out quite effectively and price offset inflation in Q1 and then read out really nicely in the second quarter. And our view is price will continue to exceed inflation in the back half of the year. As we look at the back half of the year, price remains strong for the business. and channel inventories return to more normalized levels against tougher comparisons. So what that means is that our guide remains very consistent with what we said at the beginning of the year, and it sets us up for a more normalized pool season in 2023.

Bob, maybe I could ask you to elaborate on price versus cost dynamics and supply chain in the sense that You know, commodities have started to come down, but you definitely still talked about supply chain and efficiency. So is price versus cost or supply chain, you know, stabilizing with your expectations? Obviously, you were in the green in Q2. You know, expectation in the second half, is it better or worse than you had, kind of the same? You know, what are you seeing in terms of overall price versus cost?

Yeah, I'll break that into the two pieces, because we look at really inflation and supply availability in two different pieces. From an inflation perspective, our biggest challenges really are across metals, motors, drives, electrical, freight, including fuel charges, and labor. Patrick O' Of those pieces. Most are about the same with with commodity prices metals, copper, steel, showing some improvement, which would likely read out early next year. So our view is inflation gets a little bit better in the back half. Patrick O' But continues to be a challenge from a supply availability perspective. You know, heaters and lighting, cleaners have all improved. The challenge remains around variable speed pumps, automation, sanitization, really anything related to availability of chips. We also continue to have challenges around, you know, resins, drives, electronics. So supply availability, about the same. inflation getting a little bit better in the back half, but should read out in an improved fashion in 2023. Appreciate it.

Our next question comes from Joe Giordano from Cowan. Please go ahead with your question.

Hey, thanks, guys. You know, when you think about mass walk ice in the context of a potential recession and consumer weakening, I know you cut the accretion just like on the interest side, but how do you just think about the the underlying performance of a business like that relative to what maybe you thought when we made the announcement?

Yeah, I think we're still very positive about the outlook. I mean, one of the things that gives us that confidence is Everpure, which is our commercial water solutions business. You know, we've seen that business perform significantly well during cycles, I mean, other than COVID. And just as a reminder, we're not yet to the hospitality levels globally that we expect to Mike Valdes, To get back to. And so when that global travel starts to open up. Those are great markets that have been on pause for a little bit. Mike Valdes, In those spaces. So, you know, we share some of the same accounts and we have opportunities to to penetrate the complimentary accounts. Mike Valdes, And multiple and then we believe that the KPI service piece of it creates that ongoing service annuity around these two products. So no, we think it's going to perform well.

And then can you just touch on the leadership changes and kind of the flip-flop of responsibilities from one segment to another and what those individuals bring with a fresh set of eyes to those businesses?

Yeah. I mean, listen, Mario has brought a lot of great leadership capability to Pentair, and I'm sad by what we're doing here from the standpoint that we're almost a victim of our own success. I mean, Poole, as we mentioned, has almost doubled since 2018. And along the way, we're now competing directly with two standalone pool public companies. And that business needs a different level of agility and focus for it to deliver to the customer's expectations and be the premier pool provider. You know, on the water solution side, we're adding a commercial element that skews us more from a residential into a commercial aspect. So all of the great capability that Consumer Solutions built, you know, the stronger brand, the customer service, the connected solutions, the effortless customer experiences, all phenomenal progress over the last eight to 10 quarters. All of that capability to use, but I want to use it closer to the customer. So pool needs what it needs to do from those capabilities. And then we need to make sure we're not losing sight of servicing the food service customers in water solutions. So Jerome used to run pool. And so he's coming back to lead that segment. And within water solutions, Adrian has been very close to that process. through the transformation work and the onboarding of Manitowoc. And I feel like he's going to bring the right capability and leadership style. And Daman has run a pool business for the last three years. He's a long-term Pentair employee, and I think he's going to bring great capability to IFT. And Mario and I talked, and I think this is a great opportunity for him to use his skills and either take my job somewhere else or go lead a bigger segment somewhere else. So that's a little bit of color.

Thanks, guys. Thank you.

Our next question comes from Mike Halloran from Baird. Please go ahead with your question.

Hey, good morning, everyone. So just a clarification on the pool inventory levels from Bob's comments. Just want to make sure I understand. Essentially, you're saying you are at normal channel inventory levels for everything that really doesn't involve chips or electronics, whereas the pieces like Bob Traylor- variable speed motor standardization things like that those are not at normal levels, those are below normal levels from a channel inventory perspective is that is that accurate.

Bob Traylor- Well, I think I think i'm no one to put words in your mouth that that's an end of year forecasted statement. Bob Traylor- And we've got a fair amount of volume reduction in in our you know pool Q3 and Q4 year of year that would bring us into what we expect to be normalized levels by the end of the year correct.

Yeah, that's built into the guidance that we have. So, you know, our view is that still catching up on the heaters, lighting, still catching up on the variable speed pumps, the sanitization, the automation, and, you know, heaters, lightings, and cleaners will be, those backlogs will come down in Q3 and Q4.

Okay, so the commentary you made on the guidance piece of some destocking was primarily related to some of those pieces you just mentioned.

Yeah. So, you know, I think, you know, we had in our guide that we felt like we were going to the original guide. And as Bob said, our current guide is equal to that original guide. And we always forecasted that we would see those inventory levels start to come down as our lead times started to get better to the channel. I mean, historically, we were generally at five days out for any product we made. Clearly, when we were trying to catch up in 2021, that exceeded 180 days in some aspects. Those lead times are not yet back in line to the products that Bob mentioned, anything chip-related or IoT-related, and we expect that we'll begin to catch those up between Q3 and Q4 and get more normalized as we head into next year.

No, that makes sense.

And then within the resi flow piece here, maybe just talk about what the sequential dynamics look like and what kind of dynamics you're seeing on the stocking, destocking piece, kind of where end markets are tracking now versus where the inventory levels are.

Yeah, Rezzy, flow continues to remain strong from a demand perspective. Our bigger challenges around supply availability and labor. So, you know, backlog looks healthy. Inventory in the channel looks healthy. And, you know, in good shape, we just need to deliver that backlog in Q3 and Q4. Thanks for that. Appreciate it.

Thank you. Our next question.

Our next question comes from Brian Lee from Goldman Sachs. Please go ahead with your question. Hey, guys. Good morning. Thanks for taking the questions.

I guess, you know, first one, just kind of going back to your comments, Bob, around, and I don't want to put words in your mouth, but you sort of suggested normal pool season dynamics in 23. I mean, historically, is that sort of a framework of, low single-digit price, mid-single-digit volume, or could we expect there's still some additional price in 23 that persists from these kind of levels? And then maybe conversely, some volume headwinds given tougher comps and maybe a slower new pool market. Just trying to get a frame of reference when you're talking about sort of the normal, if there's a new normal or it's sort of the historical metrics you would be referencing.

Yeah, it's still very early to give our view of the 2023 pool season, but certainly what we see today suggests more of a normal environment. So we spoke about inventory in the channels at the end of the year being more in line. And then that allows us to have some amount of price carry over from 2022, but more normalized seasonality in the business. So that's our view right now. We'll let the Q3 and the pool season ends in October and then have a better perspective on our next earnings call.

All right, fair enough. And then in IFT, I'm not sure if you provided color on this, but this was, I guess, the second straight quarter, no volume growth in IFT. Maybe just level set us a bit. Where are we in the cycle? Just kind of thoughts on volume growth in this segment moving through the rest of 2022.

Yeah, I just want to give some color and then Bob will take it a little deeper. I mean, just a reminder that in the flow and our IFT side, we struggle with some of the same challenges we're struggling with on the consumer solutions regarding variable speed and the availability of those drives. So we are still seeing a shortage of those products, and that's where we're having trouble getting the backlog out, as well as, as Bob mentioned, some of the labor and some of the premium freight associated with that lingering around the cost side. So Bob, I don't know if you want to provide any more color there. Yeah, it's really three different business.

So we spoke about residential flow, and that business continues to have good demand. Commercial sales was down. That's primarily due to us needing to improve some supply chain inefficiencies. And then the longer cycle industrial solutions business, is doing well, led by sustainable gas. So, again, a mix of businesses, but overall, you know, pleased with the 7% core growth in IFT.

Okay. Thanks a lot, guys. I'll pass it on.

Our next question comes from Seri Boroditsky from Jefferies. Please go ahead with your question.

Hi. Good morning. So just given the significant growth in pool demand over the last couple of years, I know you're not forecasting 2023 today, but if you do see some declines in demand into next year, what kind of levers do you have to keep profitability?

Yeah, we have a number of levers. I'll start with transformation. The transformation program is really gaining momentum. We're seeing some small benefit this year in 22, but a significant funnel being built in the transformation. We talked about 300 basis points improvement for the overall Pentair business to 2025. We're certainly on track to deliver that. It starts with transformation. Then we have a number of inefficiencies, to be honest, in the 2022 P&L. Peter Haslund, In the process of looking at those as we build out our our plans for next year, but everything from you know air freighting product to you know, having. Peter Haslund, Our Labor and certain manufacturing and efficiencies in our in our factories so overall you know lots of opportunity to expand margins next year through the transformation and being laser focused on the inefficiencies this year.

Thank you. And then just given the addition of Manitowoc ice in a couple of days, could you give us an update on how you're thinking about the contribution to revenues for this year and then earnings into 2023? Yeah.

So we have a page in the deck that talks about Manitowoc being around $325 million of revenue. If you took five twelfths of that, you can be pretty close to the revenue number. And then from an income perspective, you know, we've talked about that being a 30%. EBITDA margin business. And so, again, if you took 512s of that, you come up with roughly what the EBITDA would be for the business.

Great. Thanks for taking the questions for the day.

And our next question comes from Brian Blair from Oppenheimer. Please go ahead with your question.

Thanks. Good morning, guys. uh something you could offer a little more detail on underlying trends in commercial water treatment you know prepared remarks sound pretty bullish on uh trajectory there just curious if there's any discernible shift in underlying demand as q2 progressed or what you're seeing in the early part of q3 yeah i mean you know it's a it's a steady mid single digit grower um normalized and we continue to see it um clipping along at that rate you know i i think

You know, there's always a little bit of headlines on restaurants that are challenged, but then you always see or don't hear about the new restaurants that come online. And so, you know, while restaurants might not be able to fill out their capacity levels because of labor constraints, it doesn't mean that they're necessarily using less water. And that water in most of our restaurants is filtered to a high quality standard. So, I mean, we're seeing good progress there. And we'll continually be bullish on that particular space.

Appreciate the color. And just to level set, are there any operational factors that are restricting Manitowoc ice secretion this year or lowering the 2023 outlook? Sounds like it's strictly interest expense. Just want to make sure that that is the case.

Okay. Just interest. The business is tracking well, and our goal is to be focused on synergies next year in addition to that.

Got it. Thanks for taking my questions.

Our next question comes from Nathan Jones from Stiefel. Please go ahead with your question. Good morning, everyone.

Good morning.

Question on the... Question on the inventory comments. You talked about looking to take inventory down in the second half of the year despite supply chain challenges. Is that more related to the seasonality in the business that you're looking to take inventory down? Or is there a move at the moment to structurally reduce inventory that you may have been carrying because of those supply chain challenges?

Both. I mean, I think Bob mentioned that we're going to have a normal seasonality next year. Just to be clear, regardless of what the pool outlook is for 2023, we think it'll be back in line with the historical patterns of peak performance in Q2, a little lighter in Q1 and Q4 regarding that pattern. And that's what we think to happen. And what we expect to be at is that we're back to more normalized inventory that would reflect no more further significant supply chain issues. We need a couple more quarters to catch up. We're still short, as you've heard from some of our key customers, and they need those variable speed pumps. They need the sanitizers, and when we finish those out and get those to them, they can get to close the pool pads out, and then that brings the inventory back in line.

Okay, makes sense. And one on the transformation, you guys have been talking about the funnel of opportunities for transformation continuing to build, but I noted in the in their press release today that there's no expected expenses for transformation in the second half of the year. Can you just talk about, you know, are these things self-funding now, or why are they not expenses related to transformation, but you're talking about a building pipeline of opportunity?

Yeah, we typically would not forecast transformation expenses. We do forecast the amortization on intangibles going forward, but we would not forecast that. You can expect us to continue at about the same rate as what you saw in Q1 and Q2 in the back half of the year as we spend money on third-party consultants to help us drive primarily pricing and sourcing.

That makes more sense. Thanks for taking my questions.

Our next question comes from Julian Mitchell from Barclays. Please go ahead with your question.

Hi, you have Matthew Schaefer on from Julian Mitchell's team. My first question was for IFT, you guys had good margin expansion year over year in 2021, but that seemed to run out of steam in 2022. What are your expectations for margin expansion in the division for the remainder of the year? And then can you just remind us, too, of the IFT complexity reduction initiatives and the expected impacts there?

We are pleased with the IFT Ross improvement in the business. We do expect to finish the year with return on sales higher than the prior year. You'll remember that last year they started benefiting from complexity reduction in the back half. That trend has continued and we continue to have momentum in that business. Overall, we were flat for Q2, but do expect in the back half of the year to see Ross expansion in that business.

And as I said in my comments, you know, we had a supplier show, and you probably heard me talk about all the great opportunity to partner differentially with supply partners. You should read into that a lot of complexity of product, both in the form of castings as well as, you know, semiconductors and PCB boards and et cetera. And so as we go forward, the opportunity to consolidate those designs is a big piece of how we think we're going to drive longer-term margins in IFT. And consumer solutions, of course, but we'll see it in IFT as well.

Great. Thank you very much on that. And then the second half, sales growth, why be low single digits, mid-single digits for the company? How much of that growth will be from price versus volume or any detail there would be very helpful.

You know, we expect price to continue to be strong at that double digit rate. So we did, you know, 10% in Q1 and 14% in Q2. So think, you know, double digits in the back half is our assumption.

And then it actually continues to be the headwind on a year-over-year basis. And you can back into the volume, which is a comparison to higher levels in Q3 and Q4. And then also, as we mentioned, our views of what the inventory correction will be in the channel due to supply chain catching up.

Great. Thank you, guys.

Our next question comes from Jeff Hammond from KeyBank Capital Markets. Please go ahead with your question.

Hey, good morning, guys.

Morning.

Hey, just can you give us the – like what's your assumption for the volume decline and pool in the second half and then just on the – Third quarter, I think you're saying 3% to 5% growth. Is there much differentiation between the two segments?

Yeah, we don't really want to get into all the specific pieces for each of the different segments. I would say that overall for the company, we've talked about price reading out double digits. You can think about acquisitions. roughly offsetting FX and then the rest is volume. So think about volume as being down low single digits to mid single digits in the back half.

Okay. And then, um, can you, can you give us any color on how to think about Manitowoc ice seasonality? Is it, is it pretty, you know, ratable quarter to quarter?

Yeah, pretty, pretty, pretty, uh, flat, uh, quarter to quarter.

Okay. And then just last on transformation, just, you know, you guys have been talking about it for a while. What do you think is the timing where you start to, you know, kind of spike out, you know, kind of the different buckets and, you know, cost savings, et cetera?

I think early next year, in accordance with when we provide the guidance, we would expect to give you the transformation expectations and break out some of the components of how we're going to achieve that. Okay.

Appreciate it.

Our next question comes from Scott Graham from Loop. Please go ahead with your question.

Yeah, hi. Good morning, John, Bob, Jim. I wanted to ask you, Loop, and maybe to develop your answer to a previous question, I think, about one business for July. How are things in July in general? Is there any big change, one segment versus another versus the second quarter? Just maybe whatever you can tell us about July would be helpful.

Off to a good start in July. You know, a lot of it comes down to the allocation of key product, and so we're on track to deliver the quarter based on the start in July. Got it. Thank you.

And forgive me for not having to put pen to paper on your last answer on down low to mid-single for the second half in the volumes, but is the second quarter pricing Is that kind of the peak, and then we kind of moderate a little bit because the second half of last year you started to see the ramp?

That's exactly right. Still double digits, but starts to moderate. That's great. Thanks.

If I could just squeeze in this last one. You've got a pretty healthy incremental margin implied in your third quarter guidance. Is that mostly a widening of the price-cost gap, or is there something else?

Price-cost stays about the same, and I think the Q3 RAS is roughly in line with the first half.

Very good. Thank you.

And our next question comes from Rob Wartheimer from Mellius Research. Please go ahead with your question.

Hi. Good morning, everybody. Good morning. Good morning. So I had two questions. One is simply on gross margin where you noted, obviously, prices catching up and nicely so to some of the cost increases you've seen. Is there still 100 BIP or more tailwind as that continues to happen and you revert back to prior gross margin levels? I know there's issues of mix. I know there's issues of you don't necessarily get margin on pricing. So is there still continued tailwind on gross margin?

Yeah, I'll take the first part, and then Bob will give you a little bit more color. I'm looking at 19, and I'm looking at my gross margins at 19. And as you recall, we took a small dip in 20 as COVID started to unfold, and we've been catching up ever since. And so our gross margins are still down from 19, and we still believe, when we look at our transformation savings, that we're using that historical point and then seeking to drive significant gross margin expansion from there. So as we think of pricing, as we think of sourcing, It's not just about getting back to that level. We want to be back to that level and then some, which would get after the right pricing dynamics that we're seeking in each of our industries, as well as getting real sourcing benefits from our supply partners and from, as I mentioned earlier, reducing the complexity of our designs through our centers of excellence. Bob, I don't know if you want to bring more color.

Yeah, all of our transformation initiatives are focused on sustainable gross margin improvement. So when we talk about 300 basis points of ROS, you can basically equate that to 300 basis points minimum of gross margin.

Perfect. And then from here, is that more pricing catching up or is that more just like reducing all the inefficiencies and then doing all the things you're talking about transformation just to get there?

Yeah, you know, I think in our distribution and dealer-based businesses, we're pretty confident having been through these cycles before that, you know, our customers understand that labor is a big piece of the price that, you know, the price efforts we've put into place, we would expect to be more sustainable levels. When you get a more project of the OEM-related businesses, I mean, there is a dynamic where we would expect to see pricing headwinds in those businesses, and we'd need to capture more sourcing savings to drive those gross margins as we go forward. So it is different depending on what business you're looking at, but it's a combination of both of those things. Perfect.

And if I can, I mean, there's a lot of questions really on the consumer, obviously, the big thing that's seen in the quarter, and you have some natural strengths. I mean, the pool has a lot of stability, too, a lot of backlog, a lot of different things. I'm curious if you're able to look through all that and whether – consumer water treatment or anything else on just what the current mood is. If you're seeing any downturn or any inflection on near-term purchases that would indicate a change in trends.

And I'll stop there. Thank you. Yeah, I think it's hard to see the immediate reactions. I mean, it's logical to think that higher interest rates are going to put a pinch on consumer spending. And I would say that we break those into two categories. What's the discretionary piece and what's the non-discretionary piece? you know we don't see pool owners in particular on the high end really changing behavior at all you know houses still continue to transact some of those are or most of those I should say are cash based and you know they're still going to seek those pool I think where we may or may not see it as we look into 2023 and 24 is on remodeling you know home remodeling and or you know what is a non discretionary purchase of a higher end water softener, water treatment system, et cetera. That's where we'd see it. We have not seen it yet, but that's where we would expect to see and measure the consumer sentiment regarding our products. The rest is break and fix, and I'd call that non-discretionary. You need a pump, you need a pump. You need a filter replaced, you need a filter replaced.

Our next question comes from Damian Karras from UBS. Please go ahead with your question.

Hey, good morning, everyone. Morning. Just have a follow-up question on price. You mentioned you're expecting up double digits in the second half. Is that primarily just coming from prior price actions? And how should we be thinking about, you know, what your refreshed pricing that usually hits in September is? is going to be aligned i mean is there some incremental price that's it's likely to happen and just you know we're talking lower relative to um you know actions from from the past year or you know given materials deflation that we've been seeing recently is is it you know possibly just more of a pause on on kind of the september um price refresh

So to answer your first question, the price reading out in the back half of the year is based on all of the price actions that we have taken over the last couple of quarters. So those are locked in. As we think about price moving forward in the back half of the year, price increases, I would expect at this point that there will be some price increases. Labor continues to be high. While we are seeing some relief in commodity, we continue to see pressure on other pieces of the supply chain. So definitely, you know, moderating, but at least at this point suggesting, you know, some small price increase.

Okay, that's helpful. And Bob, you talked about the higher interest expense and variable debt. Could you maybe just give us your updated thinking on capital structure and your capital deployment priorities post closure of the Manitowoc deal?

So from a capital allocation perspective, you know, maintaining our investment grade is extremely important to us. So I typically start with that. In terms of, you know, paying our dividend, we've increased our dividend 46 years in a row. That's important as well. Near-term focus will be on debt reduction as we bring down that interest cost. And then from an M&A perspective, we are entirely focused on the successful integration of Manitowoc ice and driving the synergies that we've discussed previously. So from a capital allocation perspective, those would be the key priorities.

Got it. Thanks very much. Best of luck. Thank you.

And ladies and gentlemen, with that, we'll conclude today's question and answer session. I'd like to turn the floor back over to John Stout, President and Chief Executive Officer, for any closing remarks.

Thank you for joining us today. It's an exciting time for Pentair. We are preparing to make the most of it. We expect Bands to Walk Ice and our new segmentation to be accelerators for all of our stakeholders, and we look forward to updating you on our progress in the future. Jamie, you can conclude the call. Thank you.

Ladies and gentlemen, with that, we'll conclude today's conference call. We thank you for attending today's presentation. You may now disconnect your lines.