Pentair PLC

NYSE:PNR

Earnings Call Analysis

Pentair's Q3 2024 Results Show Strong EPS Growth and Transformation Progress

In Q3 2024, Pentair reported $993 million in sales, down 2%, yet adjusted EPS grew 16% to $1.09, reflecting strong execution amid economic challenges. Their transformation initiatives drove adjusted operating income up 13% to $239 million, and return on sales expanded by 310 basis points to 24.1%. Pool sales notably increased by 7%, while Water Solutions and Flow faced declines. For 2024, they raised EPS guidance to approximately $4.27, hinting at a 14% year-over-year increase, while projecting overall sales between $4.75 billion to $4.85 billion. Pentair remains focused on executing their strategies to drive long-term shareholder value amid evolving market conditions.

Strong Performance Amidst Economic Challenges

Pentair reports another solid quarter, showcasing resilience in its operations despite challenges presented by the macroeconomic environment. For Q3 2024, sales reached $993 million, a slight decline of 2% year-over-year. However, the company demonstrated remarkable operational efficiency as adjusted operating income climbed 13% to $239 million, translating to a return on sales (ROS) increase of 310 basis points to 24.1%. This growth was primarily fueled by the company’s transformation initiatives, which are designed to enhance productivity and margin expansion.

Segment Performance Insights

The company’s balanced water portfolio was crucial in curbing the downward trends in some segments. The Flow segment saw a 7% decline in sales, while the Water Solutions segment also fell 3%. Conversely, the Pool segment achieved a 7% increase in sales, exemplifying its strategic strengths in aftermarket services despite slow demand for new pools. Notably, commercial sales in Flow rose 3%, continuing its streak of year-over-year growth. While higher interest rates have pressured residential markets, leading to an 11% decline in residential sales, the commercial vertical remains robust, indicating potential for growth as market conditions improve.

Transformation Initiatives Yielding Results

Pentair’s ongoing transformation efforts are showing promising results. The company achieved $70 million in transformation savings year-to-date, with a target of $100 million for the full year 2024. The transformation strategy includes implementing value-based pricing, optimizing its global footprint, and focusing on strategic segments of its portfolio. The company aims for a ROS of approximately 26% by 2026, with a goal of achieving $260 million in savings over that period, demonstrating a clear roadmap for continued efficiency gains.

Increased EPS Guidance Reflects Confidence

In light of its performance and transformation progress, Pentair has raised its full-year adjusted EPS guidance to approximately $4.27, representing a 14% increase year-over-year. This adjustment reflects the company's strong execution and solid cash flow performance, which amounted to a record $629 million so far this year. The confident outlook underscores the company’s ability to navigate economic challenges effectively while pursuing growth drivers.

Future Outlook and Positioning

Looking ahead, Pentair anticipates that favorable secular trends will continue to impact its business positively. The company highlights emerging customer concerns over water quality and sustainability, positioning itself well to address these heightened expectations. As more consumers and businesses seek solutions for clean and reliable water, Pentair's innovative product offerings, including new PFAS certified filtration systems, are expected to meet increasing demands. Moreover, the housing migration towards the Sun Belt states is projected to support growth in its Pool segment, alleviating some pressures from higher interest rates in residential markets.

Key Takeaways for Investors

Pentair's strong financial performance, strategic focus on transformation, and confident guidance place it in a favorable position for the future. The company’s ROS expansion and commitment to capital efficiency, including share repurchases and debt reduction, indicate disciplined financial management. While near-term challenges remain, particularly in residential and industrial markets, the long-term growth outlook is promising, supported by the sustained demand for clean water solutions and resilient performance across its diversified portfolio.

Earnings Call Transcript 2024-Q3

[Operator]

Welcome to the Pentair Third Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Shelly Hubbard, Vice President, Investor Relations. Please go ahead.

[Shelly Hubbard, executive]

Thank you, operator, and welcome to Pentair's Third Quarter 2024 Earnings Conference Call. On the call with me are 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 the morning's press release.

On the Pentair Investor Relations website, you can find our earnings release and slide deck, which is intended to supplement our prepared remarks during today's call and provide a reconciliation of differences between GAAP and non-GAAP financial measures that we will reference. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's performance in addition to the impact these items and events have on the financial results.

Before we begin, let me remind you that during our presentation today, we will make forward-looking statements, which are predictions, projections or other statements about future events. 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. Following our prepared remarks, we will open up the call for questions. [Operator Instructions] As a reminder, you can reference our Pentair investor overview and Investor Day presentations on our IR website. Please visit Pentair Investor Relations website to click and click on Events and presentations to find these materials.

I will now turn the call over to John.

[John Stauch, executive]

Thank you, Shelly, and good morning, everyone. Let's begin with the executive summary on Slide 4. We are very pleased with the strong performance of our balanced water portfolio. The success of our transformation initiatives and solid execution in a dynamic global macroeconomic and geopolitical environment. Our resilient strategy across our move, improve and enjoy Water segment was evident in our ability to diversify and mitigate risk as we drive long-term shareholder value.

For example, in the third quarter, we delivered double-digit adjusted operating income and adjusted EPS growth year-over-year the triple-digit margin expansion despite slightly lower sales. Adjusted operating income was up 13% and adjusted EPS was up 16%, while ROS expanded 310 basis points to 24.1%. Both Flow and Pool delivered triple-digit margin expansion and Pool grew sales by 7% in Q3. We achieved record free cash flow so far this year totaling $629 million. This sets a record post the invent spin-off from Pentair in 2018. We continue to follow a disciplined and balanced approach to capital allocation and are very proud of our dividend aristrocrat status, marking a 48-year streak of rising dividends.

For our over 10,000 Pentair employees I want to thank you for your dedication to deliver for our customers and create value for our share owners. Your tireless hard work led to another quarter of impressive results. Thank you. I also want to extend my heartfelt sympathies for those affected by the recent hurricanes. I can only imagine how scary and devastating that can be.

Moving to guidance. We are raising our full year adjusted EPS guidance to around $4.27, representing an approximate 14% increase year-over-year. This is due to our strong performance year-to-date and confidence in our ongoing ability to operate effectively in a changing environment. Bob will provide more details later in the call.

Let's turn to Slide 5. As noted last quarter, when we look at each of our 3 segments and the verticals within each, we have seen areas of great opportunity and some that have remained slightly pressured. For example, in Flow, our commercial vertical reached another new sales record. Higher interest rates in a slow housing market continued to impact our residential vertical, and our industrial vertical has experienced the effects of delayed CapEx spend from customers. Within Water Solutions, our commercial filtration business remains strong, and our Manitowoc ICE business performed well amidst the normalizing environment and difficult year-over-year comparison. Higher interest rates continue to impact our residential business and global economic pressures have affected international business.

Our first commercial PFAS certified filtration product that was launched in Q2 had a solid start. We now have 10 products that meet the new NSF certification standard of 20 parts per trillion. Given the increasing focus on water quality and the rising interest in point-of-use filtration systems, are enthusiastic about the long-term growth potential of these products.

Lastly, in Pool, while sales grew year-over-year for the second consecutive quarter, sustained higher interest rates and a slower housing market continue to impact pool demand, predominantly in new and remodeled pools. As mentioned last quarter, new in-ground pools in 2024 are expected to be near the 60,000 range compared to roughly 17 -- 2,000 in 2023 to 78,000 in 2019 for industry data. That said, our aftermarket business continued to perform well in Q3. We believe the Pool industry is highly appealing with favorable mega trends and unique competitive advantages for Pentair.

For instance, with climate change being an important issue, we believe Pentair is in a strong position to meet the growing demand for smart, sustainable products. We have led the way by pioneering variable speed pumps that can serve energy and reduce costs, and we are continuing to innovate with smart, sustainable products. And we expect to continue to benefit from a favorable housing migration to the Sun Belt states, which represents a large mix of our pool sales. Despite the near-term economic challenges that we expect for new and remodeled pools, we remain confident in Pentair's ability to drive long-term growth and margin expansion.

In general, we are very pleased with success and diversification across our move, improve and enjoy water segment as we believe it enables us to manage risk effectively.

Let's turn to Slide 6. We have made steady progress with our transformation initiatives. As mentioned during our March 2024 Investor Day, we anticipate that the most substantial productivity savings for us will come from sourcing and operational excellence. To date, we have successfully completed and integrated a majority of wave 1 and 2 in sourcing. We are also optimizing our global footprint to better align with our focused and balanced water portfolio. We have implemented strategic value-based pricing across our portfolio, and we have taken actions to drive efficiencies across the organization to be our strategic objectives. We've also made progress on 80-20 even though it is still early in the stages.

During Q3, we completed the 80-20 analysis across most of our revenue streams, and we trained additional employees, bringing the total to over 1,200. We are executing action plans to achieve quick wins, such as exiting unprofitable and less profitable revenue in Quad 4, while focusing on driving profitable core sales growth in Quad 1 and 2. We are greatly motivated by the early insights of 80-20 and the proactive measures our teams are implementing to drive sustainable, profitable growth.

Before I turn it over to Bob, let's turn to Slide 7, which highlights our third quarter key takeaways. Importantly, Transformation continued to drive strong margin expansion, adjusted operating income and earnings growth despite little benefit from volume growth. Early insights into 80-20 are driving further confidence that it can accelerate our transformation initiatives to drive more focused and profitable growth. We increased our full year 2024 adjusted EPS guidance to approximately $4.27, reflecting an approximate 14% increase year-over-year driven by solid execution and strong year-to-date free cash flow.

Lastly, we believe we are well positioned to address opportunities for favorable secular trends, which include concerns about access to clean, safe and reliable water, increased awareness of human made contaminants impacting water composition taste and quality, growing environmental concerns driving consumers' desire to reduce their carbon footprint, aging commercial, public and municipal infrastructure, interest in outdoor healthy living with people gathering pools for exercise and fun and favorable housing migration of the Sun Belt states, which represents a large mix of our pool sales.

I will now pass the call over to Bob will discuss our performance and financial results in more detail. Bob?

[Robert Fishman, executive]

Good morning, everyone. Let's start on Slide 8. We achieved another strong quarter of quality earnings with triple-digit margin expansion and double-digit adjusted income and EPS growth despite lower volume. Sales outperformed our expectations as did margin and adjusted earnings.

In Q3, sales were $993 million, down 2%. Adjusted operating income increased 13% to $239 million. ROS expanded 310 basis points to 24.1%, driven primarily by Transformation and adjusted EPS increased 16% to $1.09. Core sales were down 1% year-over-year, driven by 8% growth in Pool, which was offset by a 7% decline in Flow and a 3% decline in Water Solutions. In the prior year period, both Flow and Water Solutions were able to ship orders from a larger backlog as the supply chain improved.

In 2024, our backlogs returned to more normalized levels. Similar to John's earlier comments, our results continue to highlight the power of our balanced water portfolio, the success of our transformation initiatives, and the dedication and hard work of our entire Pentair team globally.

Please turn to Slide 9. Flow sales declined 7% year-over-year compared to a near record quarter last year. Residential sales declined 11% as higher interest rates continued to pressure residential end markets. Commercial sales rose 3%, marking the ninth consecutive quarter of year-over-year sales growth. And industrial sales were down 10%, driven largely by delayed CapEx. As we noted last quarter, we were starting to see signs of economic uncertainty causing the delay in projects that we had scheduled for the second half of 2024. Segment income grew 7%, and return on sales expanded 280 basis points to 22.2%, marking the first time Flows ROS has reached or exceeded 22%. The strong margin expansion was a result of continued progress on our transformation initiatives and favorable mix.

Please turn to Slide 10. In Q3, Water Solutions sales declined 3% to $290 million, driven by declines in both commercial and residential. We expected our commercial business to be down in 2024 in light of a record prior year, which was driven by Manitowoc Ice's ability to deliver on significant backlog orders and a larger commercial services project rollout. Manitowoc Ice continued to exceed our expectations by achieving our acquisition business case target 2 years early in 2023. Within Commercial Water Solutions, filtration sales grew again in Q3. Segment income declined 6% to $64 million and return sales contracted 80 basis points to 22.2% as higher productivity was more than offset by higher inflation and lower volume. ROS has expanded 820 basis points over the last 3 years.

Please turn to Slide 11. In Q3, Pool sales increased 7% to $331 million. Segment income was $113 million, up 24% and return on sales increased 470 basis points to 34%, driven by sales growth and transformation.

Please turn to Slide 12. We are very pleased with the success of our transformation initiatives. We are committed to a goal of 24% return on sales by 2026 year-end as mentioned at our March 2024 Investor Day. We are off to a fast start after increasing our initial 2024 ROS guide of 22% to our current guide of 23%. We have achieved $70 million of transformation savings year-to-date on our way to an expected $100 million for the full year. These 2024 savings are part of our aspiration of $260 million of savings by 2026 year-end, which, in that case, would drive a ROS of approximately 26%.

Please turn to Slide 13. On the left side, the 4 quadrants illustrate how we are prioritizing our business through the lens of customers and products. Those falling quadrant 1 are our highest revenue customers and products, while those in quadrant 4 reflect the opportunity to reduce the complexity and cost to serve across our portfolio. As we take actions across all 4 quadrants, we expect 80-20 to accelerate our transformation efforts and drive core sales growth and further margin expansion in the years ahead. As John mentioned, we are in the early stages of 80-20 and making good progress.

Please turn to Slide 14. In Q3, we delivered strong free cash flow of $234 million, driven by higher net income from continuing operations and significant improvement in working capital. Year-to-date, we achieved record free cash flow of $629 million post the invent separation. We also deployed capital through reinvestment to drive future growth, repay variable rate debt, repurchase shares and pay quarterly dividends. Our net debt leverage ratio is now 1.4x, down from 2.1x a year ago. During the quarter, we repurchased $50 million of shares for a total of $100 million this year. We have an additional $500 million available on our share repurchase program.

Lastly, our ROIC was over 15%. Long term, we are targeting high teens ROIC. We plan to remain disciplined with our capital and have flexibility to strategically allocate additional capital to area with the highest shareholder returns.

Moving to Slide 15. For the full year, we are increasing our adjusted EPS guidance to approximately $4.27, which is up roughly 14% year-over-year. Also for the full year, we expect sales to be approximately $4.75 billion to $4.85 billion or roughly flat to down 1%, driven by a challenging economy. This is unchanged from our previous guidance. We expect adjusted operating income to increase approximately 11%. We continue to drive approximately $100 million in transformation savings this year.

For the fourth quarter, we expect sales to be approximately $965 million to $975 million, down approximately 1% to 2%. We expect fourth quarter adjusted operating income to increase approximately 13%. We're also introducing strong adjusted EPS guidance for the fourth quarter of approximately $1.02 up roughly 17%. This guidance reflects continued global macroeconomic challenges and strategic actions to improve our water portfolio's profitability and growth opportunities. We're excited about the progress we have made this year on Transformation, which has been a significant cultural change for our company. We're also very pleased with the early stages of 80-20 and expect the long-term benefits of both Transformation and 80-20 to drive long-term shareholder value.

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

[Operator]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Deane Dray with RBC Capital Markets.

[Deane Dray, analyst]

Thank you. Good morning, everyone. Maybe we can start with value-based pricing because this can really be a needle mover for you. Can you give us a sense of how much of this is automated? Can you size the impact? And just to confirm, is this now enterprise-wide implementation?

[John Stauch, executive]

So thank you for the question, Deane. I think, first of all, I'd say it is going to be and can be a value mover. But I would say to your second part of that question, we're in the early stages. And as a reminder, across all these transformation initiatives it's what prompts me to go back to 80-20 because it's a lot easier to do the value-based pricing in quad 1 and to make sure that you're getting that right on those products that are most liable to your customers and they go to your -- pretty standard and best customers versus trying to focus your time on quad 4, 2 and 3.

And I think when we started the value-based pricing exercise, we were doing it pretty much across all quadrants. We have introduced and rolled this out this playbook to every business. But I think we're farther along in areas like Pool and some of the global businesses are further behind, Deane. So great opportunity in the future for sure.

[Deane Dray, analyst]

Great to hear. And then just can you give some context about -- there was reference about some delays in CapEx spending by customers we're not surprised. Maybe it's related to the election, but can you just tie that together in terms of demand sentiment projects getting pushed, et cetera?

[John Stauch, executive]

Yes. I mean this primarily relates to our Flow business and some of the larger projects on Beer Membranes and some of our larger beverage customers. And I think that we still feel optimistic that we're going to see those projects come through. But I think the investment profile isn't at the level for our customers that they're comfortable with yet. So I think they're delaying them several quarters. That's really what it relates to Deane.

[Operator]

The next question comes from Andy Kaplowitz with Citigroup.

[Andrew Kaplowitz, analyst]

Morning everyone. John could you talk about what you're seeing in Pool after your price increase in early September and how you would assess the channel inventory headed into '25 in Pool? And then obviously, you mentioned strong price in Pool overall. I think in the past, you've been a bit concerned regarding price versus inflation, but would you say pricing is holding up well versus inflation at this point?

[John Stauch, executive]

Yes, I'll take the first part. I'll let Bob chime in here a little as well. I think, first of all, I think the market and the industry is playing out generally the way we expected it to after we tweaked it slightly after our Q2 earnings. We're seeing some of the stronger key states continue to have sell-through, and we feel like the inventory is pretty well balanced. And then I think we're going to see a little bit extra demand coming out of Florida here with hurricanes, and we got to make sure we're ramping up and able to facilitate that as well.

On the pricing side, they have, as I mentioned earlier, have been further along in the value-based pricing, and we also have pretty good mix that we're able to pull the levers on to help optimize the pricing overall, which is really just the overall receipts of the revenue and making sure that our customers and customers' customers are buying the higher-end solutions.

So overall, I think the year is playing out where we wanted it to, and we're still very optimistic that next year will be even a better year since we think the overall pool builds are at a lower end. And we're going to see a recovery in the aftermarket and the remodeling next year. So we're feeling pretty optimistic about 2025. Bob, I don't know if you want to add?

[Robert Fishman, executive]

Yes, just on price and inflation, I would say we've done a pretty good job of forecasting price and inflation. We had said roughly 2 points would read out at the company level. And that's about what we saw. We saw 3 points in Q1, 1 point in Q2, 2 points in Q3 and then, call it, 1 to 2 points in Q4. Some of that movement is due to product mix in the quarter. Some of it is due to the compare versus the previous year. But overall, it's been pretty level pricing at that 2 points. From an inflation perspective, we had guided to 2% to 3% of the total cost, and that's roughly how it's playing out as well.

[Andrew Kaplowitz, analyst]

John, I know it's early, but can I ask you a follow-up on the hurricane impact, like maybe what you've seen in the past, give us some perspective on what it could look like? I assume there's a delayed sort of remodeling impact or something like that, that maybe impacts next year? And any sizing might be helpful.

[John Stauch, executive]

Yes. First of all, hurricanes devastating for those involved. So we certainly don't root for weather events. But we're servicing a channel and servicing dealers, and it's all hands on deck to make sure that our customers are being able to serve their customers. So we usually see pumps, which are the main demand product that could be affected, certainly from water damage. And people, if they can, want to get those tools up and running and make sure that they stay clear. So every hurricane is different, there is no playbook and model. Florida is a pretty important pool state for us, and I'm sure we'll see some -- a little bit of demand here that we factored into our guide.

[Operator]

The next question comes from Julian Mitchell with Barclays.

[Julian Mitchell, analyst]

Maybe just first off, I wanted an update on the productivity savings outlook. I think before you guided about 100 million for the year, so maybe 30 million or so left in Q4, a strong run rate entering the new year next year. So maybe help us understand kind of what sort of productivity we should expect in '25 when you're taking the aggregate of 80-20 and the base transformation plan, please?

[Robert Fishman, executive]

Yes. Thanks for the question, Julian. Again, we were very pleased with the transformation readout in the third quarter, to your point, are tracking towards that $100 million of transformation savings this year. after doing roughly $70 million last year, which means another $30 million in Q4.

Overall, back at the March Investor Day, we had talked about driving to an aspirational 26% ROS, which would include $260 million of savings in '24, '25 '26. By doing $100 million this year, I would say we're off to a good start. So think about $160 million spread over the next 2 years, call it, 80-80 would be a good starting point from a transformation perspective.

And again, we're not committing to the 26% right now. We're still on that 24%. But overall, this fast start to the transformation savings is giving us a lot more confidence.

[Julian Mitchell, analyst]

And maybe just my follow-up would be around the pace of sort of revenue turnaround in Water and Flow. Understanding Flow, you've got these project delays and maybe a low visibility on where the projects start to move more freely. And then Water, you had the sort of the tough comp in Manitowoc Ice, for example. Maybe just help us understand kind of the confidence in either of those seeing a positive sort of sales trend year-on-year in the next 12 months?

[John Stauch, executive]

Yes. First of all, I think that we're very pleased with the way our commercial revenue streams have held up and even though we had some more difficult year-over-year comps, we're still seeing sequential movement that gives us an encouraging outlook for those businesses. We are still 50% exposed across the portfolio to residential. And that's where we've seen almost 6 to some quarters in a row now of year-over-year challenges. And clearly, as a company, we're rooting for interest rate movements and hoping that mortgage rates decline and overall get a little jump start in the residential movement, meaning people removing houses or people building houses. And we still think that's several quarters away. And so we're continuing to work the transformation levers. We are encouraged by the prospects of growth next year and we do see early signs that, that will be achievable.

And as a reminder, to add to Bob's transformation, growth will help productivity. So we've been doing a lot of this without the contribution of growth in the transformation. So if we can continue these programs and get growth on top, we're pretty encouraged on what we can achieve.

[Operator]

The next question comes from Steve Tusa with JPMorgan.

[C. Stephen Tusa, analyst]

Can you just clarify maybe how much of the revenue decline in Flow and Water the non-pool stuff was -- is that all market? Or is that some of this 80-20 initiatives? And then just on the pool pricing, I mean it did accelerate quite a bit here. I think quarter-to-quarter, what do you expect for full pricing heading into the fourth quarter and into next year?

[John Stauch, executive]

I'll take the first one, and I'll have Bob answer the second one. This is generally what I would say is all market, primarily residential and agriculture spaces, Steve, and we're probably thinking in the second half, we'd see better forms of recovery here, and we just haven't -- as we adjusted in the 6 plus 6, we're not counting on that now. And so I think they're doing a good job on cost, and they're working through this. Obviously, these are easier comparisons as we wrap into next year. But right now, it's pretty much the residential and agricultural markets that are challenged.

[Robert Fishman, executive]

And on pricing for Pool to get to the 2% for the total company, Pool will be somewhere for the year between 2.5% to 3%. And again, they've gone from 4% in Q1 to 1% in Q2 to 4% here in Q3, and then that moderates a little bit in Q4. So that lumpiness, again, attributable to value-based pricing, the mix of the products, those types of things and the compare versus the prior year. So overall, feeling good that 2.5% to 3% price reading out for Pool this year after such large increases in the previous years.

[Operator]

The next question comes from Bryan Blair with Oppenheimer.

[Bryan Blair, analyst]

Thank you. So level set on Transformation, Bob, you mentioned the $150 million remaining [ 80-80 ] or thereabout in terms of the 2025, '26 outlook? Is it fair to say that you're pacing ahead of the initial plan and perhaps there's as much as you've been referencing the 26% and the [ 20% ] contribution toward that is aspirational that you're perhaps going to see runway above that in terms of transformation savings and an even higher loss target in time?

[Robert Fishman, executive]

Certainly, that's our goal. I mean, again, we're looking to return to growth and drive transformation. The 260 that we gave back at Analyst Day, got off a faster start. We had guided to 75 at the beginning of the year and are now at $100 million. So the transformation savings were led by sourcing. If you'll remember, Wave 1 and Wave 2 are complete this year. Wave 3 will complete next year, and then we'll start that process over again. What I really liked about the third quarter, though, is we had balanced really across sourcing, manufacturing and operational spend below the line. So good balance across those 3 areas from a transformation perspective.

The other thing that's really increasing our confidence is 80-20 and that being an enabler to the transformation. While it really is a growth play, we are very focused right now on Quad 4 and reducing a lot of the complexity within Quad 4. There's a number of techniques now that we've rolled out the 80-20 training to over 1,200 people in the company, there's different techniques that we're using in Quad 1 versus Quad 4. And again, think of Quad 4 as being our B customers, our B products roughly 4% of our revenue. And we're looking at things there like reducing the number of SKUs, being able price, providing a standard size, minimum order quantities, extending lead times, offering fewer but standard options.

So those are the techniques that the teams are using there. Again, our goal is to treat all of our customers fairly, but differently. So there is an opportunity to reduce the complexity in Quad 4. As a reminder, the cost to serve in Quad 4 is somewhere between 15% to 25% of our overall costs. And so that creates an opportunity as well. And we have lots of really great examples so far now that we've rolled it out to the team, we've freed up capacity in a number of our manufacturing sites. We've reduced the resources to support, we've reallocated dollars from Quad 4 to improve the customer experience in Quad 1.

So it's really starting to take traction and improve our overall transformation story. And again, once we eliminate that complexity in Quad 4, we can start to spend more time on improving the customer experience, which we've already started in the first quadrant. And so again, think about 65% of our revenue sitting in that Quad 1, where we have the opportunity to improve product availability, lead times, on-time delivery, provide better service to our channel, either through automation, to training, insight into their businesses, product information.

So again, it's a major cultural change as we embark on 80-20. And we think that's going to be a huge accelerator for the transformation plan.

[Bryan Blair, analyst]

That all makes sense, and trends are very encouraging. Given the operational cadence that you now have, if we do have a stronger growth environment in 2025, you're obviously well positioned to lever that. In addition, your balance sheet is now in pretty good shape. I can't imagine that being any pushback there. How is your deal pipeline looking at this point? And is your team focused on capital deployment over the near term to hopefully further lever a stronger demand environment going forward?

[John Stauch, executive]

Always looking right now, I think we are very mindful of making sure that anything we look at has to drive returns. And I would say the pipeline is a trickle. It isn't gushing and so we're mindful of how precious our capital is, and we're putting it to the best use possible given all the global and economic environment that we're working within.

[Robert Fishman, executive]

And to answer your question, we are very pleased with the leverage within the company. When we closed on the Manitowoc deal back in July of 2022, we had levered up to 2.7, 2.8x. A year ago, we were at 2.1 and now we're at 1.4x. So it really is a testament to the EBITDA that we've driven, the EBITDA will be over $1 billion this year and driving that free cash flow to repay the debt and overall, improve our leverage multiple. The balance that we had in Q3 from a capital perspective was very strong. We were able to continue to invest in growth. We paid down some of the debt, continued with the share repurchase and obviously continued with that dividend streak.

[Operator]

The next question comes from Saree Boroditsky with Jefferies.

[Unknown Analyst]

This is James on for Saree. I wanted to kind of go back on 80-20. So I know that it's still in the early stage but you did analysis on most of the revenue stream here. So can you kind of provide more color on when you expect to realize the benefit from 80-20? And like what percentage of revenue do you expect to like discontinue due to unprofitable mature products?

[John Stauch, executive]

Yes. As Bob said, I mean, if you look across the portfolio, what mathematically a normalized environment would be in what we call Quad 4 would be roughly 4% of the company. It's very improbable and unlikely that you could get out of all of that revenue in any 12-month period of time. You have contracts, you have obligations. You have certain requirements of how you serve distributors and where those dealers can buy. So this would be in a best case scenario from an exiting standpoint, probably half of that would be the opportunity.

And then mostly over a 12, 18 months period, you'd expect to recover most of that lost volume that would be transferred into the A customer streams. So overall, 80-20 should not be a revenue reduction. What it should allow you to do is prioritize your resources and efforts, as Bob said, to taking care of your best customers around your top products and really allow you to free up resources to drive innovation and drive higher long-term organic growth.

So I think where we're really got to get paid, right? So the way we expect to get paid is by reducing that complexity in Quad 4 and ultimately then being able to reinvest in the future growth of the company. So I think in a 12-month period, the amount of revenue lost is nominal, but it is a transfer and you should see it in the margin and the transformation pipe from the efforts that we're driving through 80-20.

[Unknown Analyst]

Got it. And a follow-up on the Pool business here. So can you discuss more on the like [indiscernible] and you saw from the prebuy and when you kind of expect to ship those orders?

[John Stauch, executive]

Yes. We take the -- we put in our price increases generally as a reminder, first of all, the purpose of early buy is to balance our factories and not whipsaw our labor teams and have to hire a bunch of people and then let them go. So we work with the channel to make sure that we could have minimal requirements in Q4 and Q1 that allow us to keep our talented workforce. So with that in mind, we put in prices in Q3. We announced what those price increases will be on the new product. And then our channel places early buy orders at the old prices and then they get terms that allow them to pay us later for that business. Think about it in a normal setting as a rough quarters worth of revenue that we generally ship in Q4 and Q1.

And then through those quarters, we still take standard orders for the states that are still open and the product that's still needed, and that's what level loads the Q4 and Q1 revenue streams.

[Operator]

The next question comes from Jeff Hammond with KeyBanc Capital Markets Inc.

[Jeffrey Hammond, analyst]

Just maybe go back to the 80-20. One, you mentioned this 15% to 25% cost on the 4% of sales. I'm just wondering as you kind of go through that assessment, maybe cut half of those sales, what do you do with that 15% to 25% of cost? And is there a cost savings number over and above the 260 to think about with 80-20?

[John Stauch, executive]

So first of all, I don't think it's all addressable because you have like overhead depreciation, factory cost insurance that obviously is more fixed. But think of -- I think there's at least a 10% cost opportunity in Quad 4 related to the efforts, even compliance and sustainability efforts in addition to shipping, packaging all kinds of different work streams that aren't as efficient for the B products going to be customers that we're expecting to reduce. And so what we expect to do with the cost is to get rid of them. And that is the goal, Jeff, and that will show up in the transformation savings.

And as Bob has mentioned, we did not have 80-20 expectations in the original transformation guides, right? And so at some point in time, as we know what these are valued at, we'll have to update our long-term productivity guidance and targets to reflect what we think the 80-20 benefits would be. As a reminder, we're doing things in waves just like we did in transformation. So we've addressed about 50% of the revenue from an action orientation this year. We expect that to read out next year. And then we finally train everybody in 80-20 and we'd probably expect that to be the second half of next year.

[Jeffrey Hammond, analyst]

Okay. And then just a couple of clicks on Pool one back to the early buy. Just how should we think about the balance of early buy timing between 4Q and first half '25, I know you were pretty balanced last year. And then just any green shoots on new or remodel as we start to see at least some rate cuts, I know that the mortgage rates have been slower to move, but just any green shoots. Thanks.

[John Stauch, executive]

Yes, Jeff. I mean, first of all, we -- I would define this early buy is completely normal. I think we're back to a more normalized view of it. And so I think growth next year will be more reliant on what happens with new pool builds and also what happens with remodeling and aftermarket. We don't know those predictions and forecasts yet. We're -- we run monthly dealer, voice of customer, and we do dealer and channel checks to make sure that we understand what the thinking is so that we could be prepared from supply chain to address that. And we'll be in a position to share that when we do the guide for next year on the Q4 earnings announcement. It's too premature to call that yet.

[Operator]

The next question comes from Andrew Krill with Deutsche Bank.

[Andrew Krill, analyst]

Let me get some help on the implied margins for 4Q this year. I'm getting around 23%, down about 100 bps sequentially. Just can you walk us through, I guess, how the kind of the moving pieces on why you're expecting margins to be down sequentially? I think normally, they're a bit more flattish quarter-over-quarter?

[John Stauch, executive]

Well, first of all, you're directionally close. So I mean, I think that would be an appropriate view. We tend to see a drop from Q3 to Q4 historically and traditionally, Q2 and Q3 are our peak quarters, that's when we're fully utilizing our factories and our teams and applying the revenue off the full cost base. So typically, we take a little drop down from Q4 or Q3 to Q4 in revenue, and that's generally why the margins become a little softer.

A couple of that is the holidays and also the way that the schedules work, by the way we work with the dealer and the distribution channel that tends to ease off on its purchases towards the end of the year due to the holiday season and a lot of their customers don't want people servicing their houses during those holiday periods.

[Robert Fishman, executive]

And from a year-on-year perspective, we do expect the ROS to be up significantly in the fourth quarter, similar to how it was in the third quarter. Good news in Q4 is we're going to see better balance across all 3 segments, Flow, Water Solutions and Pool all contributing to that ROS expansion story.

[Andrew Krill, analyst]

Great. Very helpful. And then going back to the transformation savings and the final $30 million or so you expect [indiscernible] for 4Q. Any help by segment, which could benefit more or less? Or should we think about them being pretty evenly spread among the [indiscernible]?

[Robert Fishman, executive]

Yes. From our perspective, because the ROS increase for all 3 segments, you can expect transformation really benefiting all 3 of those segments in the fourth quarter.

[Operator]

The next question comes from Nathan Jones with Stifel.

[Nathan Jones, analyst]

I guess I'm going to ask a bit more of a philosophical question about interest rate cuts. You've got a few businesses that you called out has negatively impacted residential flow, new pool construction, that kind of stuff. Can you talk about typically what kind of lag you say interest rate cuts before it begins to start impacting those businesses?

[John Stauch, executive]

Yes. I think it's 6 to 9 months to see meaningful impact, Nathan. Obviously, just a feeling that they're going to continue to head down would start the encouragement of people being able to think that they could go out, for instance, get a variable rate mortgage maybe refinance later. But we're not yet seeing the credit markets reflect the lower rates, and you probably saw that even mortgage rates ticked up and borrowing rates did not necessarily go down. So I think while we're encouraged by a single larger movement, we're still going to need a few more before we've got a bunch of consumers and customers that are confident that their borrowing rates are going to be lower in the future.

[Nathan Jones, analyst]

And maybe it starts to impact second half of next year and into the first half of the year after?

[John Stauch, executive]

Probably a good assumption. Up as we finish Q4 and have better understanding, but that would be a reasonable way to look at it.

[Nathan Jones, analyst]

There's a couple of the pillars on your transformational initiatives that we haven't talked too much today around operational excellence, organizational effectiveness. Can you just give us an update on the initiatives there and the expected impacts you're looking for?

[John Stauch, executive]

Yes, there are 2 big work streams. I mean the organizational excellence is one that we're really working as more of an offset, right? We want to drive some of the nonproductive activities out of the organization and reinvest in innovation and sales and marketing and certainly supporting our customers more effectively. So we haven't talked a lot about being a significant positive to the P&L, but it's important because it'll free up resources to invest.

On the operational footprint, we've made great progress, but growth will help a lot, and we need to get leverage across the factory footprint. And then while we've overdriven a lot of the activities, we've seen some headwinds, as I'm sure most companies have, from insurance, utilities, property taxes, those types of things that actually negatively impact the operational piece of the P&L. So while we probably haven't highlighted enough, we're making great progress there. And we're just trying to get ahead of some of those inflationary elements that have hit the manufacturing side harder than they probably hit across the overall P&L.

[Operator]

The next question comes from Mike Halloran with Baird.

[Michael Halloran, analyst]

Two quick ones here. One, on the commercial side on the Water Solutions, just any variance between the Everpure and ICE businesses? And then maybe just talk a little bit to how cross-selling is going on that side of things.

[Robert Fishman, executive]

Yes. Again, from our perspective, pleased with how commercial filtration is performing this year for Manitowoc Ice, just as a reminder, this year, we had guided down roughly mid-single digits after their record 445 year last year. We do expect them to return to growth next year. Overall, those businesses from a ROS perspective continue to perform very well. So pleased with commercial filtration and Manitowoc Ice. Overall for the portfolio under a little bit of pressure in the third quarter, Water Solutions in total. That has to do with compare we faced last year but also with some of the selling efforts within commercial filtration, where we lead with the system and then benefit from the recurring revenue down the road.

So overall, you make an investment today in the systems and then drive that recurring revenue stream. So a few things at play there, but generally pleased with the performance in commercial water for the quarter and for the year.

[John Stauch, executive]

And then to your question on cross synergies, I couldn't be more pleased. And that's what you're seeing a lot of the filtration revenue this year is the synergies we talked about in the Manitowoc Ice side. It was Manitowoc pulling Everpure it wasn't really going to come the other way around. So when we look at that deal model, we're ahead of our expectations and expect 2025 to be on or above those expectations. So really feel good about the performance of this business and the synergies that we committed to.

[Michael Halloran, analyst]

And then following up on a question earlier on the capital usage side of things. I certainly understand the M&A piece. In light of that, what's the equation from your perspective on how to approach buybacks from here? Are you doing something consistent as it sits here today. What would it take in your mind to lean in a little bit more and maybe walk through that thought process?

[John Stauch, executive]

Yes. I think Bob and I are most pleased that we're starting to really generate cash at the levels that we expected to. As a reminder, we still have a lot of transformation headwinds and restructuring that we still see as an opportunity in '25 and '26 as we ramp that down. And that's going to give us more confidence in our ability to continue to pay off the debt and have a lot more flexibility as far as what we want to accomplish. $1 billion EBITDA, we always want to have a little acquisition powder for the strategic acquisitions. We are a collection of acquisitions some of those completely strategic to what we want to be as a company and some that weren't. And so I think what we want to do is when we look at the acquisitions in the pipeline, we want to make sure that they're synergistic to things that we do today and we want to make sure that we're giving our customers more product that they want to buy from us. So being really disciplined in what we're looking at. And we want to make sure it has the type of returns that our shareholders expect.

So in the meantime, we're continuing to buy back shares and pay down the debt. That's where the focus has been.

[Operator]

The next question comes from Joe Giordano with TD Cowen.

[Joseph Giordano, analyst]

Highlighted in the slide some of the PFAS products that you guys have developed. And I'm just curious, like what's been the early uptake there? Like who's buying? Has it been more like industrial customers, municipalities and maybe if you can scale the opportunity there?

[John Stauch, executive]

Yes. So first of all, I mean, it's -- on a percentage basis, immensely huge growth, but we're still in the early stages of revenue there. So let's say, north of $1 million. But I think we're most encouraged that we have several sets of customers that are extremely interested. First of all, our distributors and dealers are excited and enthusiastic that they're working with a partner like Pentair who's put a product line out there that can solve their needs and it gives them something new to talk to their customers about.

But most of the uptake has predominantly been in the commercial and hospitality areas where they really, really care about the quality of the water that they are servicing and giving to their customers. But we have seen a little bit of encouragement in people up paying in the residential markets as well.

So overall, enthused about the start, and we're hopeful that it's really just wakening people's mindset to water quality and starting to spur a conversation of paying a little bit more for a little bit -- well, a lot more value and feeling confident in the water their drinking.

[Joseph Giordano, analyst]

And then just last for me. You mentioned like the delays on the industrial side and CapEx projects. And you mentioned it could be several quarters like I guess when we talk to other industrial companies, no one's talking about cancellations, but everyone is talking about significant pushouts. And I guess like one does one become the other.

[John Stauch, executive]

Yes. I think when it goes several more quarters, I think you should think about it leaving the funnel and not being in the funnel. I always look at front log, which is the types of things and projects that we're quoting. Usually, that's not a good indication because engineers always stay busy in the project front line side, backlog is meaningful. And what you'd expect is that you're starting to grow that backlog because people are still placing those projects and then they're timing them maybe.

This isn't that meaningful for us. It's just more of a relative comment that there's a piece of our business that could have been double-digit growth that's now coming back to flattish growth.

[Operator]

The next question comes from Brett Linzey with Mizuho.

[Unknown Analyst]

This is [ Peter Koss ] on for Brett Linzey. So just one more on the 80-20 after you guys went through all the revenue streams and product lines. How are you thinking about the opportunity by segment?

[John Stauch, executive]

As Bob mentioned, we always have a favorite segment at the moment, but the opportunity is equal across all 3 segments. It is really a combination of longevity, global P&Ls, our desire to chase adjacencies over time to sign up customers who we thought would be bigger than they are today. Those opportunities are equal across all 3 segments. And we're working through the playbooks, and we're very confident that all 3 of our segments are going to get an equal participation in 80-20.

Some will be more margin focused, and I think that will slide to flow into Water Solutions, especially on the residential end and others will be a growth capability, which would be Pool in probably areas like Manitowoc and Everpure but all of the businesses have an equal opportunity.

[Operator]

The next question comes from Scott Graham with Seaport Research.

[Scott Graham, analyst]

So implied from your third quarter guidance, there was a fourth quarter implication that it looks like your new fourth quarter guidance is a little bit lower than on the sales side. And I was wondering if that's because of both the prebuy and the industrial project pushouts? So again, the implied slower sales, are those the reasons for the fourth quarter?

[John Stauch, executive]

Our guide remains the same. I will acknowledge that consensus might have been slightly higher, but our guide that we put out, and this forecast is equal to what we had in the last forecast, Scott. I think we're managing through the growth and transformation opportunities we have. And I think the way that the year is playing out is consistent with the way we saw it last quarter.

[Scott Graham, analyst]

Okay. I'll check that math with Shelly. I follow it up no problem. For Pool, so the full year guide of sort of mid-single would imply a slightly down fourth quarter. And what I'm wondering is if this year's prebuy is largely equal to last year's prebuy in terms of the mechanics we took it in the level loading into the fourth quarter. Why would fourth quarter sales in Pool be implied down?

[Robert Fishman, executive]

Yes. Within our guide for the fourth quarter, we actually have Pools slightly up and Flow and Water Solutions slightly down to get our overall guidance for the quarter. So Pool is up in the fourth quarter.

[Scott Graham, analyst]

Okay. I guess, thank you. The last question there is, so both Water Solutions and Flow had productivity, which if you x out some transformation benefit dollar number would imply that the productivity was actually maybe negative in those areas. Was that simply all from the negative volumes?

[John Stauch, executive]

No. I mean we were more challenged in the productivity side of Water Solutions this quarter. That business is extremely global. And we've been working really hard to get some of the global cost out, but it generally takes longer to attack the cost bases outside the United States. So we still expect those to be opportunities in the future. And as Bob said, we had a year-over-year compare in Water Solutions last year, which was record and those margins were challenged. I think you'll see margin improvement return in Q4 there, and we're confident about what it can do in 2025.

[Robert Fishman, executive]

And Flow really did have a nice Q3 from a ROS expansion story. The price that they were able to drive along with transformation will more than offset the inflation.

[Operator]

And I understand there is time for a last questioner, and that will be Damian Karas with UBS.

[Damian Karas, analyst]

Covered a lot of ground. Just a quick question related to free cash flow. It's been pretty strong year-to-date. I'm just wondering for the fourth quarter, is there anything beyond the typical seasonal factors that you'd kind of expect to happen. It just seems like you're well above the 100% conversion guide for the year.

[Robert Fishman, executive]

We expect a pretty typical Q4 and to the point you made, seasonality does play in, in Q4 and Q1 with Q2 being our largest free cash flow quarter.

[John Stauch, executive]

Thank you for joining us. In closing, I wanted to reiterate our key themes. First, solid execution across our balanced water portfolio drove significant margin expansion for the tenth consecutive quarter. Second, we are increasing our 2024 adjusted EPS guidance which reflects continued confidence in our strategy and our ability to mitigate risk where we can and maintain agility in a dynamic environment. Third, we expect our transformation initiatives in our 80-20 to continue to drive strong margin expansion and adjusted EPS growth. And finally, we believe our focused water strategy and solid execution are building a foundation to continue to deliver value creation beyond the 2024 fiscal year. Thank you, everyone, and have a great day.

[Operator]

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