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Pentair PLC  (NYSE:PNR)
Q3 2018 Earnings Conference Call
Oct. 23, 2018, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Pentair Third Quarter 2018 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Mr. Lucas, please go ahead.

Jim Lucas -- Senior Vice President, Investor Relations and Treasurer

Thanks, Crystal, and welcome to Pentair's third quarter 2018 earnings conference call. We're glad you could join us today.

I'm Jim Lucas, Senior Vice President of Investor Relations and Treasurer, and with me today is John Stauch, our President and Chief Executive Officer; and Mark Borin, our Chief Financial Officer. On today's call, we will provide details on our third quarter 2018 performance, as well as our fourth quarter and full year 2018 outlook, as outlined in this morning's press release

Before we begin, let me remind you that any statements made about the company's anticipated financial results are forward-looking statements subject to future risks and uncertainties, such as the risks outlined in Pentair's most recent 10-Q, Form 10-K and today's press release. Forward-looking statements included herein are made as of today and the Company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances. Actual results could differ materially from anticipated results.

Today's webcast is accompanied by a presentation, which will be found in the Investor Relations section in Pentair's website. We will reference these slides throughout our prepared remarks. Any references to non-GAAP financials are reconciled in the appendix of the presentation.

We will be sure to reserve time for questions and answers after our prepared remarks. I would like to request that you limit your questions to one and a follow-up in order to ensure everyone an opportunity to ask their questions.

I will now turn the call over to John.

John L. Stauch -- President and Chief Executive Officer

Thank you, Jim and good morning, everyone. Please turn to slide number four, titled Executive Summary. We are pleased with our third quarter, as we are able to deliver results in line or better than our forecast on all of our key metrics marked by 6% core sales growth, 10% adjusted EPS growth and over $100 million of free cash flow generated in the quarter and $265 million year-to-date. All three segments contributed to the top line performance with Aquatic Systems delivering a strong 12% core sales growth in the quarter. We also used our strong balance sheet and cash flow to buy back $100 million of shares in the quarter and have purchased $400 million through the first three quarters.

For the full year, we've raised our core sales growth expectation by a full point to be 4% to 5%, and we're still expecting ROS expansion of approximately 50 basis points to 18%. We are also raising our adjusted EPS guidance to be approximately $2.33, which reflects the third quarter performance, as well as a small benefit from share repurchases in the quarter. This marks the second consecutive quarter that we've raised our expectations, driven in part by continued healthy end-markets, as well as continued execution across our portfolio.

I would now like to turn the call over to Mark to discuss the third quarter results and update you on the details of our full year 2018 outlook, before I provide an update on our key strategic growth initiatives.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Thank you, John. Please turn to slide five labeled Q3, 1'8 Pentair Performance. As John mentioned, core sales grew 6%. All three segments contributed this quarter with particular strength in Aquatic Systems. We will provide more color on the performance of all three segments shortly. Segment income increased 1%, while ROS contracted 40 basis points to 17.1% in line with expectations, as price increases implemented to offset inflation took effect late in the quarter. We will expand on the margin performance when discussing the individual segments.

Adjusted EPS grew 10% to $0.54 per share, which was $0.02 ahead of our prior guidance. Our adjusted tax rate remained 18% and our share count came in at 175.7 million shares benefiting in part from the $150 million in shares we repurchased during the second quarter and an additional $100 million we repurchased during the third quarter. Free cash flow was strong in the quarter at $108 million and we've generated $265 million in free cash flow year-to-date, which is in line with normal seasonal patterns.

Please turn to slide six labeled Q3, '18 Pentair Segment Performance. This slide lays out the performance of our three segments. Aquatic Systems delivered its strongest performance of the year with 12% core sales growth in the quarter, income growth of 13% and ROS expansion of 60 basis points. We saw strong demand in the quarter, favorable mix and continued dealer gains. In addition, we implemented our annual price increase in September, while continuing to increase our growth investments in this important segment. We believe the outlook for Aquatic Systems remains very favorable and we continue to believe in the long-term outlook of our franchise business.

Filtration Solutions returned to growth in the quarter with core sales increasing 2%. We continue to see pockets of strength in our important North American residential and commercial markets. We saw particular strength in our niche industrial businesses, but just as important, our food and beverage business showed signs of stabilizing after first half declines. Segment income decrease and ROS contracted 70 basis points to 16%. We implemented price increases in September to help mitigate increased inflation due in part to tariffs implemented in July, but we do not expect to see the full benefits of the price increase until the fourth quarter.

Flow Technologies reported its third consecutive quarter of core sales growth and its 5% core sales growth was its strongest performance of the year. We saw solid performance in our North American residential and irrigation business, and our large pump business showed further signs of stabilization. But we would remind everyone that this is the smallest part of our Flow Technology segment and tends to be longer cycle and therefore a bit lumpier than our other businesses in flow. Segment income was down 7% and ROS contracted 150 basis points to 15.4%. The margin performance was similarly impacted its Filtration Solutions due to the timing of inflationary pressures and the corresponding price realization.

Please turn to slide seven, labeled Balance Sheet and Cash Flow. This continues to be one of our favorite slide, as free cash flow remains strong and we have significantly reduced our debt levels during the year. As we pointed out last quarter, our debt is now at a level not seen since 2010. Given the strength of our balance sheet, we believe, we are well positioned to invest in the business, look at attractive strategically align tuck-in or bolt-on acquisition targets and continue to return cash to shareholders. We have bought back $400 million in shares year-to-date, and we would remind everyone that we have raised our dividend for 42 consecutive years.

Please turn to slide eight, labeled Q4, '18 Pentair Outlook. We anticipate fourth quarter core sales to grow 4% to 5% with all three segments contributing. We expect Aquatic Systems to be up 10% to 12%, Filtration Solutions up 1% to 2% and Flow Technologies to grow 2% to 3%. Segment income is anticipated to be up approximately 6%, while ROS is expected to expand roughly 30 basis points. Below the line, we expect the adjusted tax rate to be around 18%, net interest and other expense to be approximately $7 million and our share count to be around 176 million. Adjusted EPS is expected to be approximately $0.59 per share, which would be the fourth consecutive quarter of double-digit adjusted EPS growth.

Please turn to slide nine labeled 2018 Pentair Outlook. This slide is one we first introduced at our Investor Day in February, and we wanted to provide an update, as we enter the homestretch of 2018. Given our strong year-to-date performance, we expected overall -- the expected overall sales number is slightly higher than our initial forecast for the year. All three of our businesses implemented price increases in September. Consistent with the second half outlook, we discussed in our second quarter earnings call in July, the price implementation is essentially in line with our prior expectations, and our full year outlook for inflation has not materially changed. The net result is that our full year segment income expectations have not changed, and we will continue to expect to drive productivity in addition to price increases we've implemented.

Please turn to slide 10 labeled Full Year 2018 Pentair Outlook. For the full year, we've raised our core sales growth forecast by a point and now expect core sales to increase 4% to 5%. We expect Aquatic Systems core sales to grow roughly 10%, Filtration Solutions to be up 1% to 2% and Flow Technologies to increase 2% to 3%. Segment income is expected to be up around 8%, while ROS is expected to end the year around 18%, which would represent an increase of roughly 50 basis points.

Below the line, we expect the full year adjusted tax rate to be around 18%, adjusted net interest and other expense to be roughly $30 million and shares to be around 178 million. For the full year, we now expect adjusted EPS to be around $2.33 per share and we continue to target free cash flow to approximate 100% of adjusted net income.

I would like to turn the call back to John.

John L. Stauch -- President and Chief Executive Officer

Thank you, Mark. Please turn to slide number 11 titled Pentair Strategy Summary. We've used this page consistently in our earnings presentations to remind everyone of our strategy to be the leading residential and commercial water treatment company and to share with you the areas, where we are investing in growth. Our focused areas of strategy remain on advancing growth in pool and accelerating residential and commercial water treatment, which requires investment at the business and the enterprise level.

Our approach to capital allocation remains disciplined, and we remain committed to maintaining our investment grade rating,. reinvesting in our most attractive core businesses and paying competitive dividend yield. We will also look at a balanced approach between M&A and intelligent buybacks with our M&A decisions being informed by overall valuations and the quality of assets available, as well as our ability to integrate them successfully.

Please turn to slide 12 labeled Focused Strategies. As we prioritize our growth priorities, we believe this allows us the best opportunity to drive differentiated growth in what we believe is a very attractive water quality space. I would like to give you a quick update on our progress regarding our two most important focused strategies. The first strategy is advancing pool growth. One of our biggest opportunities around automation and connected pools and products. We continue to increase our new product introductions inclusive of smart technologies and have launched two new automation systems.

Our IntelliConnect is an entry-level automation system that connects only a few existing pool products and we have also launched our next-generation of our more advanced IntelliConnect platform that provides the highest level of automation for our end consumers and pool dealers. Less than 10% of the 5 million installed in-ground pools today have some form of automation system, and we believe this represents a continued runway of growth, where we will continue to invest.

Our second key growth initiative is accelerating residential and commercial water treatment. We've conducted several consumer surveys to better understand the market, but equally important, we are engaging consumers through digital marketing to build brand strength and drive demand through our dealer network. We are in the early innings of moving up the value chain from being a leading component supplier to introducing smart connected branded products and solutions. We made several investments in China and Southeast Asia, as we see a lot of opportunities in this large market.

Please turn to slide number 13. This is a slide that we publicly introduced at the EPG Conference in May of this year. We wanted to remind everyone of our long-term goals. In the current inflationary environment, where price has been easier to get and assuming this continues, we would not be surprised to see core sales growth trending toward the upper end of the range, if not slightly better. We are currently expecting the pricing environment, coupled with productivity to generally offset inflation and we will provide more details on the impact to 2019 guidance, when we release our fourth quarter earnings at the end of January, but we wanted to remind everyone that our long-term goals have not changed.

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

Questions and Answers:

Operator

Thank you. (Operator Instructions) Your first question is from Deane Dray with RBC Market Capital -- Capital Markets.

Deane Dray -- RBC Capital Markets -- Analyst

Thank you. Good morning, everyone.

John L. Stauch -- President and Chief Executive Officer

Good morning, Deane.

Deane Dray -- RBC Capital Markets -- Analyst

Hey, start off with a congratulations on that pricing power in pool and last quarter, it was controversial at the time that you were the -- one of the few companies to hold off on implementing price increases for this one segment, but it certainly came through. Could you give us some color as to what that process was, how much price did you get, how much of it stuck and what you think the underlying growth in pool was in the quarter?

John L. Stauch -- President and Chief Executive Officer

Sure, Deane and thanks -- thanks for the comments and agree that the pool business certainly has the ability to control their pricing decisions and had a strong result. Pricing was in line with our expectations. As we -- as we discussed before, the price went in -- in mid-September, so in Q3 only saw a small impact of that for the pool business in the Q3 quarter, but we'll see the full benefit of that in Q4 and it's in line with our expectations overall and is part of the price that you see for the full year expectation on our full year walk.

The -- in terms of their growth split between price and -- and core growth, I think most of the growth in Q3 coming from volume rather than price, only maybe 1 point to 2 points of growth coming from price and then that grows about double that in Q4.

Deane Dray -- RBC Capital Markets -- Analyst

Got it. And then just could you clarify the outlook for this IntelliConnect product. This seems to us to be -- have the potential to be one of these revolutionary products, similar to the variable speed pump that you've introduced. So today, what's your expectation for growth in IntelliConnect. And do you have to retrofit pools in order to implement this system?

John L. Stauch -- President and Chief Executive Officer

The answer to the last question is, no. I mean, it is an automation system that obviously works off of Wi-Fi or the Internet and then connects to the products to base, as we've been giving intelligent pool system being in. Yes, we do -- we do believe that you're talking about 5 million installed pools and less than 10% of them today run on some type of automation capability and that automation capability provides two opportunities, one is for dealers to remotely monitor pools and -- and manage the proper pool for composites for people.

But the other one is for the consumers themselves to interact with their pool more effectively, lighting, variable speed pumps, as you mentioned, salt water pools, the chemistry. So we see it as a revolutionary product for sure and this one is an easier one that creates over the air software updates and really has a better graphic user interface capability, and it's open architecture meaning it will work not only with Pentair products, but it will also work with our competitors' products as well, which we think is also revolutionary.

Deane Dray -- RBC Capital Markets -- Analyst

Good to hear. Thank you.

John L. Stauch -- President and Chief Executive Officer

Thank you, Deane.

Operator

Your next question comes from Joe Giordano with Cowen.

Joseph Giordano -- Cowen -- Analyst

Hey, guys. Good morning.

John L. Stauch -- President and Chief Executive Officer

Good morning.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Good morning.

Joseph Giordano -- Cowen -- Analyst

So if we look at the other non-core businesses, how do you feel like you are with your price increases, do you think you are forward thinking enough or were they large enough to deal with your forward expectations for inflation, how you see that kind of playing out over the next few quarters?

John L. Stauch -- President and Chief Executive Officer

Yeah. Yeah. We do. So again similar response for the other two businesses. The price kicked in the back half of September and the realization is consistent with expectations and it's -- we see that reading out as expected in Q4. We had a little bit of a pull in Q3 ahead of the price increase, which we had anticipated, so that reduces a little bit of the price expectation for the full year, but overall on a run rate basis, it's consistent with our expectations. And our views on inflation, which -- which price was put into offset or in mitigate remain unchanged, as well. So you can see the full year expectation on inflation remains about $80 million.

Joseph Giordano -- Cowen -- Analyst

And then as it relates to your China strategy, how do you -- however [ph] your discussions at least changed a little bit to consider what's going on trade wise and geopolitically there? And do you -- is there any alterations that you need to make to how you deploy that strategy?

John L. Stauch -- President and Chief Executive Officer

It's a great question. I mean, we do about $160 million in China and Southeast Asia overall from a revenue stream and most of that in our filtration businesses. We still are committed to our China strategy, primarily because they're advanced in the way that the market is evolving. I mean, the rate of pace, they're going to put 3000 new Starbucks stores in, there is a -- our competitor coffee chain called Luckin doing a 1,000 stores this year, 2,000 next year. These are some enormous growth -- growth rates.

We also have the context of -- we're working with the Internet there and the way that people buy off the Internet and looking at two hour to three hour delivery windows to the product, so I think it's an area that we're going to continue to participate in because we're learning and growing and establishing a lot of the tools and principles that I think ultimately are going to work themselves back into Europe, in the North America as well.

Joseph Giordano -- Cowen -- Analyst

And then last from me. It's still early days post split, but maybe can you -- John, can you just talk about maybe what are some of the biggest changes you've seen internally so far, and maybe, couple of example, something that's taking over longer than you'd like to move forward in the direction you see?

John L. Stauch -- President and Chief Executive Officer

Yeah. I'm -- I'm very impatient, so everything takes longer, but I'm very proud of the way the teams leaning in. Obviously, great results in the quarter, as evidenced by dealing with a late announcement of tariff impact and reacting to it the best we could and managing through those expectations and we are getting back to consistency and predictability. But what we're most excited about is, we're having discussions about winning at the product line level again.

We have some 30 major product lines and that's where there [ph] you win, you differentiate your product against the competition in the customers' eyes. And we're having good discussions about how to utilize technology and innovation and business model innovation to really differentiate that customer experience and that's going to take longer time, but that's ultimately how we are going to get back to the core organic growth that I know we can achieve.

Joseph Giordano -- Cowen -- Analyst

Thanks, guys.

Operator

Your next question comes from the line of Steve Tusa with JPMorgan.

Stephen Tusa -- JPMorgan -- Analyst

Hey guys, good morning.

John L. Stauch -- President and Chief Executive Officer

Good morning, Steve.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Good morning, Steve.

Stephen Tusa -- JPMorgan -- Analyst

Just on free cash flow, you guys, I think are running slightly ahead of net income, I don't know which net income you use whether it's adjusted or GAAP or whatever. Year-to-date and I think fourth quarter is usually relatively strong? Anything different about this year or am I just not getting the normal seasonality, right?

John L. Stauch -- President and Chief Executive Officer

You got it right, Steve. I mean, we are still targeting adjusted net income -- cash flow to be 100% of adjusted net income, and you know, obviously we'll work through the normal seasonality patterns and there's nothing really to update at this time.

Stephen Tusa -- JPMorgan -- Analyst

And anything unusual about the performance in the third quarter that stands out that's you know, not sustainable on the cash front?

John L. Stauch -- President and Chief Executive Officer

No.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

The third quarter was in line with the expectations and we don't see anything necessarily unusual in the fourth quarter as well.

Stephen Tusa -- JPMorgan -- Analyst

Okay. I don't know if anybody asked it yet, but tariffs, just kind of give us an update on how you're thinking about that and maybe just give us an update on or some color remind us about your kind of sourcing structure, I think you know, just anything from China is going to get marked up. So how are you guys thinking about it into 2019?

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Sure, Steve and the overall story on tariffs and inflation in general is, as I mentioned before it's just the consistency with our previous expectations. So as we look at the balance of the year, our inflation expectation remains at about $80 million that includes all the tariffs that have been announced and implemented, so it includes sort of the -- the people talk about lists one, two and three in the different sections that make that up. So that's all reflected in our expectations. So really no change from what we talked about before, as we -- we've already touched on pricing and our expectations there.

And we certainly are going to continue to evaluate the overall supply chain and look for opportunities to be able to make changes to reduce the impact of tariffs long-term, now those things take a little bit longer obviously, but we're certainly looking at that. We have a factory in Suzhou, and so we'll evaluate what we do there and how our overall supply chain structure is organized.

John L. Stauch -- President and Chief Executive Officer

Yeah, I -- yeah, I guess, just more specifically, I mean, there -- you're only getting hit by part of this year and then there's other list, who knows, three, four, five, six, seven coming through. What do you see as of today assuming some of these things come through just using a kind of simplified view of what you're sourcing from China and then you know sticking some sort of a -- of an increase in cost on that, what would you expect that headwind in 2019 to be that you could overcome with productivity or whatever else you do?

Yeah. So Steve, just to reiterate. The 2018 -- for 2018 reflects everything that we currently get out of China, including direct and indirect sourcing. When we put the pricing forward on September 15th, we assume that we'd likely see another couple of points of inflation heading into 2019 that -- that is probably at least the likely scenario, given the fact that we're going to continue to see inflationary pressures come from all of these lists that happens. So I think right now, we feel like we've got things well contained, and we can only deal with what we know Steve. And if there's anything else that comes about, we reserve the right to go back with incremental price increases.

Stephen Tusa -- JPMorgan -- Analyst

Okay. What is sorry -- one last question. What is that bucket of cost that you talked about either direct or indirect coming from China?

John L. Stauch -- President and Chief Executive Officer

What do you mean Steve?

Stephen Tusa -- JPMorgan -- Analyst

What is the total cost of the stuff you're sourcing from over there so maybe, we can do the math ourselves?

John L. Stauch -- President and Chief Executive Officer

Think of it as roughly $300 million both direct and indirect.

Stephen Tusa -- JPMorgan -- Analyst

Great. Great. Great. Great. That's exactly what I was looking for. All right. Thanks a lot. Great color.

John L. Stauch -- President and Chief Executive Officer

Thank you.

Operator

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

Scott Graham -- BMO Capital Markets -- Analyst

Yeah. Hi, good morning. I guess, I just want to piggyback little bit on Steve's question here because if we look in the -- the third quarter, the waterfall, the inflation is a $24 million number, and I know, you guys indicated that it's still in line with your expectations, but the most recent lists, the most recent two lists are -- were post your second quarter earnings report and the 24 million does not seem to be yet fully loaded with inflation. So could you give us an idea, is there going to be a need to go out with more pricing let's say in pool? And have your price increases in the other two segments contemplated could be over $100 million number next year?

Mark C. Borin -- Executive Vice President and Chief Financial Officer

As we -- as we -- as John referenced before, I mean, our expectations haven't changed and the forecast that we've put forth of approximately $80 million reflects all the tariffs that have been announced and implemented, which there's nothing -- there's nothing new that's out there. The lists that you're referring to even though they hadn't been implemented and effective prior to our last quarter's guidance. They were -- there was enough information out there that we had some visibility to that.

And as John said, we frankly don't know what we don't know and so we reserve the ability and the right to be able to go back and adjust and go back for more price, if necessary. But the guidance that we have for the year stands on its own and remains unchanged from what we provided previously.

John L. Stauch -- President and Chief Executive Officer

Just adding to that (multiple speakers) just adding to that Scott [ph], as I said, I mean, we've put in price increases that not only reflected our 2018 expectations for inflation, but that inflation would continue. And so we're hopeful that we've got enough in there, if not we'll adjust accordingly.

Scott Graham -- BMO Capital Markets -- Analyst

Okay. Great. And then maybe just as a quick follow-up to that. I know that the model has been so far as an independent to sort of do the price plus productivity will offset inflation. I'm just wondering if given your answers to the above, you're thinking on the price increases, which you've answered affirmatively that they have contemplated more inflation. Could we get to where we are price cost neutral in the first half of next year, excluding productivity just pure price cost?

John L. Stauch -- President and Chief Executive Officer

I don't think so, Scott. I think we're counting on prices the majority of it, but we also need productivity. And keep in mind our sourcing teams are active every single day seeking alternative sourcing. So we even within the inflation number this year had favorable productivity and you see that in the column offsetting that. But I think we're going to need productivity and we're also going to need growth contributions, Scott. I think that's just the environment we're in right now.

Scott Graham -- BMO Capital Markets -- Analyst

I got you. And if I can just squeeze one more in, if you don't mind, and thank you for that answer. I was very interested in your comments John about the surveys understanding the market, which you and I've discussed before, how you're engaging consumers more the dealer network for whole thing. I was just wondering, if you can give us maybe a couple of win examples things that you're really excited about that the team actually was able to monetize over the last quarter?

John L. Stauch -- President and Chief Executive Officer

Yeah, I think, first of all, we really, I go three, I go across the segments. I think, pool really has a great dealer intimacy. And when I mentioned the dealer, it's the actual dealer talking to the consumer and working with the consumer. And what we're learning is that -- that consumer is becoming more and more educated and as they become more and more educated, we're able to create more content because as you put your pool in or you think about your retrofits to the pool, you're very excited about all of the other products that you can bring to the table. So we are clearly getting more content through to the aftermarket, and I do think that that's a result of learning that the consumer is important and hoping [ph] to influence that -- that and stay.

In Filtration, what we're learning, as you would expect it's not a national or a global issue, it's more local. You know, your city and where you live, where your water quality varies and obviously I've shared this with you, New York City is not a problem for water. As you start to move into other particular regions, you have challenges and getting more specific around the challenges to each region allows us to have the right products to our dealer channel to solve those issues. So very excited about our growth there.

And in Flow, I think we're starting to realize that we have a good brand across, where we have major brands that we are very well respected and that we need to continue to -- to work, to get those products and make those available to the end -- end customers. And we have to work through various distribution channels to do that since there isn't a large distributor, a large dealer that covers nationally.

And in China, Southeast Asia, as I mentioned people want to buy in the Internet. They want ready-now products. They want an experienced center. And I do think, all of those things we are doing in China that we've learned from -- from connecting with the consumer, we've worked our way in the North American market as well. So thanks for asking, Scott.

Scott Graham -- BMO Capital Markets -- Analyst

Thanks a lot for that answer. I appreciate it.

Operator

Your next question comes from the line of Mike Halloran with Baird.

Michael Halloran -- Baird -- Analyst

Hey, good morning, guys.

John L. Stauch -- President and Chief Executive Officer

Good morning.

Michael Halloran -- Baird -- Analyst

So on the -- on the food and beverage side, you're starting to see some stabilization there. Maybe just dig a little bit more granularly into what you're seeing in the market, why the stabilization is occurring and how you're thinking about that as we move into the fourth quarter next year?

John L. Stauch -- President and Chief Executive Officer

Yeah. Sure. As we've talked before that businesses experienced challenges and has -- has been shrinking for quite a while, frankly, it's gotten to a point, where it's a smaller portion of the portfolio and it's really not something that's going to drive our overall performance. And so it's -- feel like it sort of hit the bottom, and we're seeing some signs of life and then -- and decent order rates. And it's something frankly that we hope to not have to continue talking about because it's a -- it's just a small piece of the overall picture and we're focused on more importantly on our residential, commercial side of the business.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

And Mike, just to remind you the market is growing and we're growing with the market, but we have a very high value membrane, and we have products that are really helpful in the overall food and beverage processing. What we're no longer doing is building the systems and the scheds [ph] around them and just assembling other people's products to go forward. So that's what really drove the decline. And we feel confident that we have a product that other people can buy and assemble and put into the process, and that's really where we think we should be long term. It's also better margins for us and better predictability and consistency, as our future revenue streams. So it was all conscious and it was all an effort that we put in this year.

Michael Halloran -- Baird -- Analyst

Makes sense. And then on the capital deployment side obviously you've been running the buybacks through pretty aggressively last few quarters. You know, I know, balances what you're thinking about on a forward basis, but it takes time to build the funnel backup, how are you thinking about that M&A funnel? And how are you thinking about balancing the two M&A, first buybacks obviously dividends are core part, but that's been pretty consistent?

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Yeah. I think our first goal was to get back to predictable and consistent results and I'm pleased that we are making progress on that. I think we've got three quarters now, where we're starting to build that consistency. And we're starting to also understand strategically, where our best businesses are and how those business are positioned and we're really aligned not only as a management team, but with our Board of where we'd like to make those acquisitions and you know, the tuck-ins and cores like basically bolt-on. And so I do think we're starting to build a really robust funnel and I really, I'm hopeful that we'll be able to get some things done over the next year.

Michael Halloran -- Baird -- Analyst

Great. Appreciate it. Thank you.

John L. Stauch -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Steven Winoker with UBS.

Steven Winoker -- UBS Research -- Analyst

Thanks. Good morning all.

John L. Stauch -- President and Chief Executive Officer

Hi, Steve. Good morning.

Steven Winoker -- UBS Research -- Analyst

Hey, so just on the thoughts around holding, I think you still expect ROS to be about 50 basis points up, but why not more given the additional point of growth and particularly the concentration of Aquatics, I think I -- if you could just talk through the puts and takes there a little bit that explain why there's not more ROS coming in?

John L. Stauch -- President and Chief Executive Officer

Sure. I mentioned it earlier, as we -- we're coming through September, we did see some pull in to beat the price increase. So we do have slightly less price benefiting the year than we had previously forecasted. I mean, and we're continuing to see sort of the ramp in our growth investments, as we move through the balance of the year. So -- so when you think of those two things on balance, overall, that's where we've landed at maintaining our guidance on income.

Steven Winoker -- UBS Research -- Analyst

How much do you think that took away from -- if you were to quantify that the impact that you would have otherwise had?

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Well, the price change was about $3 million -- $2 million to $3 million and the investment is probably couple of million dollars.

Steven Winoker -- UBS Research -- Analyst

Okay, great. And just as you guys were thinking about that growth for the fourth quarter also coming off the 6% to 4% to 5%, I mean, these are exceptional growth rates, but just any thoughts on slowing mostly comps, other factors here?

John L. Stauch -- President and Chief Executive Officer

No. I mean part of it is, as I mentioned, it's the -- the price increase acceleration that we experienced in Q3. So Q3 was higher than expected driven maybe half of that increase was driven by the pull in to be priced. And so we don't see that continuing into the fourth quarter. (multiple speakers) we're talking about a point of -- we're going from 6% to 4% to 5% on the Q4 and right now, we don't see as you -- as you ask, we don't see market slowing. I mean, we still feel good.

Remind you, Steve, you know this, but in our residential, commercial businesses, this is primarily an installed base that we serve. It isn't a new housing start really phenomenon or anything. As a matter of fact we shared this before, but a lot of new housing starts are actually urban, which don't utilize our water systems, as much as they do out in the rural areas. So we really just believe there is a consumer pull on, demand on the aftermarket channel, and we see consistency so far on those -- those outlooks.

Steven Winoker -- UBS Research -- Analyst

Great, John, that's actually leading to my follow-up, which was within that all of this great pool growth, more than three quarters or roughly the business is usually aftermarket, I suppose. So maybe just any way chance you can break down your thoughts around how much is coming from new installation versus the existing installed base on this growth and the new product introductions like connected that you mentioned?

John L. Stauch -- President and Chief Executive Officer

Yeah. I mean we've seen, this is general rule of thumb for that business. Again, you take housing starts, which is somewhere around 1.2 million housing starts and about 10% or 11% of those are generally pulling pool permits, and I think it's just the way the demographics generally workout. So think about 120,000 to 130,000 new pools, which if you really think about what that's up versus last year, it's -- it's not up very much, you need to be talking about single-digit.

So we -- we continually work the dealers and the installed base to convince people that more larger systems and more capability in their pool is the way for them to reduce their energy costs both in LED lighting, and also the efficiencies that they can get on the variable speed pump. And then as I mentioned in my comments, you know, giving them easier ways like their iPhone and or remote monitoring to actually manage their pool and that's what's driving a lot of the content and capability. And so we're really growing the content on the pad fairly significantly, and then taking more share through our dealer channel within that growing content. That's been our (multiple speakers) model.

Steven Winoker -- UBS Research -- Analyst

And you said converting dealers as well, right? Is there a number around them?

John L. Stauch -- President and Chief Executive Officer

Yeah. Absolutely, yeah.

Steven Winoker -- UBS Research -- Analyst

Any percentage or any numbers around that?

John L. Stauch -- President and Chief Executive Officer

No.

Steven Winoker -- UBS Research -- Analyst

Okay. All right. Thanks a lot.

John L. Stauch -- President and Chief Executive Officer

Right. Thank you, Steve.

Operator

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

Nathan Jones -- Stifel -- Analyst

Good morning, everyone.

John L. Stauch -- President and Chief Executive Officer

Good morning.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Good morning.

Nathan Jones -- Stifel -- Analyst

I'd like to pick up the productivity side of the price cost productivity equation. You guys had $20 million of productivity improvements in the first half dropped to one in the third quarter, and I think the implication is about five in the fourth quarter. Can you talk about the things that have driven those gains down in the back half? Is that comp issues, timing of projects whatever color you can shed on that?

John L. Stauch -- President and Chief Executive Officer

Yeah. So I mean, I would start with, you know, as Mark mentioned that we're ramping up the growth investments. You know, we -- in the beginning of the year, we are identifying where we should place our bets, working on our strategies and making sure, we are all aligned, and as we went through the year, we're starting to see our innovation centers for technology, certainly our digital marketing, our consumer insights and putting more spending in first of all, and that's really what you're seeing is generally offset in the productivity, Nathan.

Nathan Jones -- Stifel -- Analyst

Okay. So growth investments kind of against your productivity number?

John L. Stauch -- President and Chief Executive Officer

Correct.

Nathan Jones -- Stifel -- Analyst

Underlying that, has the productivity number improved, declined, stayed started about the same, as we've gone through the year, if you excluded the growth investments?

John L. Stauch -- President and Chief Executive Officer

It's improving primarily because we started the year with significant inflationary pressures on the materials side, we mentioned, and then we have begun to work sourcing alternatives and opportunities, which tend to take time, and those have started to ramp up here, as we head into the back half of the year.

Nathan Jones -- Stifel -- Analyst

If you think a little bit longer time, as a percentage of revenue, what kind of number, would you expect to be able to get out in terms of productivity every year, it's a 1 point, 2 point, if we exclude growth investments from the equation?

John L. Stauch -- President and Chief Executive Officer

I mean, it's a question that I don't want to dance around. I mean in a normal environment, we would -- we would seek for productivity less inflation on a -- on a gross margin basis to drive 100 basis points to 150 basis points of expansion. And then we would look to offset with somewhere around 50 basis points to 100 basis points of growth investment that's a normalized model. Obviously, we're not in normal times. And so I think we're still thinking we can get continued margin expansion and still invest.

Nathan Jones -- Stifel -- Analyst

And then, just want to follow-up on some of these revenue numbers. I think Mark you said about half of the organic growth rate in 3Q, '18 you thought was pull-forward from 4Q 18?

Mark C. Borin -- Executive Vice President and Chief Financial Officer

No, that's not true.

John L. Stauch -- President and Chief Executive Officer

Yeah, no sorry to clarify that, half of the beat in the third quarter. So we were higher than expected by about $10 million, about half of that came from -- from the pull in.

Nathan Jones -- Stifel -- Analyst

Got it. That makes sense.

John L. Stauch -- President and Chief Executive Officer

(multiple speakers) yeah.

Nathan Jones -- Stifel -- Analyst

Okay. Thanks very much.

John L. Stauch -- President and Chief Executive Officer

Clarifying questions. Thank you.

Operator

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

Brian Lee -- Goldman Sachs -- Analyst

Hey guys, thanks for taking the questions. Maybe staying on the revenue topic here for a moment just, when you think about the pool business, I know this may be tough to quantify, but can you give us some sense of how much of the strength in Aquatics was just broader volume based versus how much was maybe driven by mix of new products and increased share that specific to you, just trying to get a sense for maybe what the markets underlying growth is versus how much share expansion, you guys are seeing right now?

John L. Stauch -- President and Chief Executive Officer

We think we're taking somewhere in the 1% to 2% share range and the rest would represent the market growth that we think broadly others are experiencing as well.

Brian Lee -- Goldman Sachs -- Analyst

And then when you think about the new product introductions and sort of the vitality index if you will, as you -- as you look into next year, is that still the same range of target share outcomes you'd be -- you'd be hoping for? Or does that start to accelerate even further?

John L. Stauch -- President and Chief Executive Officer

I mean if you took kind of where we are, you know, you take double-digit growth, we think about half of that is coming from new content adds. You know that we're going out and creating more content on what we call the pad. So what used to be a pump and a filter gets expanded into the automation, gets expanded to lighting, gets expanded to a coordinator, saltwater pool, those types of things and we think that adds about half of the growth and then as I mentioned, the rest is share.

Brian Lee -- Goldman Sachs -- Analyst

Okay. That's helpful. And then maybe just last one from me, I'll pass it on. The -- I guess specific to China, some of your industrial peers have alluded to weaker volumes in various end markets and the macro recently. Can you level set us a bit on your China exposure and then how you're comping there versus maybe some of the more cautious commentary that's been -- that's been starting to pop up as of late?

John L. Stauch -- President and Chief Executive Officer

Yeah. I'll start with the fact that we're not as big as some of those -- those peers. I mean, keep in mind that as I mentioned, we're $160 million total in the China and Southeast Asia region. So we're not, you know, anywhere, some of our competitors are two times our size and those comps get harder. I also think that we are definitely growing double-digit, but we're also working through changing channels over there in China, as well and making sure we're controlling our own destiny.

As I said, most of the consumers want to deal directly with the Internet and then they want to connect directly with the experienced center and the company themselves. And so I think our comps are little easier from where we're starting from, but I also, I am very excited about what the team's doing over there, and I really like how we're going about winning and just the innovation and the excitement that we have for our new products and new product introductions.

Brian Lee -- Goldman Sachs -- Analyst

Okay. Fair enough. Thanks guys.

John L. Stauch -- President and Chief Executive Officer

Thank you.

Operator

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

Jeffrey Hammond -- KeyBanc Capital Markets -- Analyst

Hey, good morning guys.

John L. Stauch -- President and Chief Executive Officer

Good morning Jeff.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Good morning.

Jeffrey Hammond -- KeyBanc Capital Markets -- Analyst

Hey, just on the, it looks like your divestiture number was about 2%, is that were there discrete divestitures in there, is that just runoff of product lines that you're ramping down and how -- how does that look kind of into 4Q and into '19?.

John L. Stauch -- President and Chief Executive Officer

That really is -- there is no -- no new discrete divestitures there. It's the product line exits that we've talked about previously.

Jeffrey Hammond -- KeyBanc Capital Markets -- Analyst

Okay. And when -- when do we -- when do we done seeing those?

John L. Stauch -- President and Chief Executive Officer

It completes in Q4 and so I've a little bit of that in the first half of the year, but then it will lap itself.

Jeffrey Hammond -- KeyBanc Capital Markets -- Analyst

Okay. And then what -- went on with interest expense, it was a little bit lower and how should we run rate that going forward?

John L. Stauch -- President and Chief Executive Officer

Well, we gave you the Q4 numbers.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Yeah. We're, I mean, we're still thinking around -- around $7 million has become, frankly, it's a relatively small number given our overall debt levels, and so it can -- it can bounce around a little bit really mainly driven by how much interest income we had. So that's why it was a little bit lower in Q3.

Jeffrey Hammond -- KeyBanc Capital Markets -- Analyst

Okay. Thanks, guys.

John L. Stauch -- President and Chief Executive Officer

Thank you, Jeff.

Operator

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

John L. Stauch -- President and Chief Executive Officer

Hey, Brian. Brian.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Brian. Mute button.

Brian Drab -- William Blair & Co LLC -- Analyst

There we go. All right.

John L. Stauch -- President and Chief Executive Officer

Welcome back.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Good morning.

Brian Drab -- William Blair & Co LLC -- Analyst

Yeah. My kids were running around in the background, so I -- forget I press that button.

John L. Stauch -- President and Chief Executive Officer

Right.

Brian Drab -- William Blair & Co LLC -- Analyst

I just have one question at this point the aquaculture and agriculture end markets. I don't believe were mentioned on the call here at least not significantly, I joined a little bit late. But what percentage of revenue roughly do those account for it today? And are you seeing any growth off the bottom here in Ag? And just any update on aquaculture, which I think has been a good growth market for you?

John L. Stauch -- President and Chief Executive Officer

Yeah. I mean it's that those two things total somewhere around $150 million of total revenue. So not really a big piece of the overall Pentair and not really worth mentioning to be honest. But I think ultimately, those are cyclical markets and they have been in -- they've been performing well lately.

Brian Drab -- William Blair & Co LLC -- Analyst

Okay. I'll follow-up more later. Thank you.

Operator

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

Walter Liptak -- Seaport Global -- Analyst

Hi, thanks for taking my question. Good morning, guys.

John L. Stauch -- President and Chief Executive Officer

Hi, Walter.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Good morning.

Walter Liptak -- Seaport Global -- Analyst

I have a question about weather. We haven't talked about that at all in this call, but there's been a couple of big storms and I wonder about any third quarter impact and if you're seeing any pipeline for renovations of pools, especially in the fourth quarter?

John L. Stauch -- President and Chief Executive Officer

No, I will -- I will say, you know, it's just really thank you to our team, and I'm sure a lot of companies had this as well. But we -- we do have a -- our pool businesses in Cary, North Carolina, and I can't thank the team enough for how they stepped in and we've lost a few days of deliveries due to the hurricane, but they were able to recover all those shipments in Q3 and did a marvelous job, just protecting the plant, protecting the assets, protecting the people and then outsourcing the product out. But other than that, there is no meaningful amount of revenue one way or the other that we can track to weather.

Walter Liptak -- Seaport Global -- Analyst

Okay. And in the fourth quarter, you're tracking [ph] the pools that were damaged by flooding pumps, filters that maybe able to replace?

John L. Stauch -- President and Chief Executive Officer

Not on a real-time basis, no. I mean we -- we usually expect and do see a little uptick in the aftermarket, the repair business there and we'll see that in the order rate, as it comes through Q4, but not able to track the specific amount.

Walter Liptak -- Seaport Global -- Analyst

Okay. Great. And then staying in Aquatics and the price increase. I wonder if you could walk us through, you know, the pricing that you guys did and the competitive situation, your competitors take a pricing earlier in the year and so, you're just playing catch up, how -- what -- were -- where is your supply chain, I guess, versus some of your competitors?

John L. Stauch -- President and Chief Executive Officer

We -- we did our price increase on cycle, which was in mid-September. Our competitors did -- do some target price increases earlier for various reasons, but we chose to continue to stick with our standard timeline. We implemented a 5.5% price increase and that's been consistent with what we have communicated previously, and it's -- our expectations have been consistent.

Walter Liptak -- Seaport Global -- Analyst

Okay. Are your competitors in the same kind of supply chain situation with you, where tariffs impact them and they have to react?

John L. Stauch -- President and Chief Executive Officer

They -- some of our competitors have similar supply chain, some of them don't. I mean, everybody is a little -- looks a little bit different than us. But as we've talked about, it's not just the direct impact, it's the impact is ultimately and maybe more importantly just seeing what the indirect impact ends up being as tariffs start to impact the overall pricing, not just from China suppliers, but -- but others as well.

Walter Liptak -- Seaport Global -- Analyst

Okay. Great. All right. Thanks for taking my questions.

John L. Stauch -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Brett Lindsay [ph] with Vertical Research [ph].

Brett Lindsay -- Vertical Research -- Analyst

Hi, good morning all.

John L. Stauch -- President and Chief Executive Officer

Good morning.

Brett Lindsay -- Vertical Research -- Analyst

Hey, so just want to talk about some of the regional growth. I mean, obviously US was strong, mostly driven by pool, you talked a little bit about China. Could you just maybe walk around some of the major international markets you serve? And then any -- any concern or on the pace or tenure within your European business?

John L. Stauch -- President and Chief Executive Officer

Yeah. I mean, we -- just generally overall you've got it. North American been relatively strong this year. China, as I mentioned, there's been a growth there for us. We've selectively chosen to get out of lot of geographies, which is part of the product line exits that Mark has referenced in our divestiture line, geographies, where it's not so much a geography call, we just didn't have scale or didn't have the appropriate presence in those areas to compete long-term. And then Europe has not been a robust growth environment. It's been relatively muted most of the year. And so we don't see that picking up in the back half of the year, but we also don't see it declining in the back half of the year.

Brett Lindsay -- Vertical Research -- Analyst

Okay. And then maybe just back to growth investments. I think you had previously said this year, your incremental investment was around $20 million. What have you spent year-to-date? How Q3 look? And then as we look into 2019, you're broadening out the China and Southeast Asia strategy, does that incremental number step up 2019 versus 2018?

John L. Stauch -- President and Chief Executive Officer

Yeah. I don't -- I don't know if we're -- we're certainly not going to give it in detail by quarter, but we are -- for the full year, we expect still to be in that range for 2018. And I would say, as we think about going forward maybe $5 million to $10 million incremental next year is the way we're thinking about it for primarily digital investment, and also our R&D and innovation activities, we have identified this year, but not a meaningful step up from where we are currently.

Brett Lindsay -- Vertical Research -- Analyst

Okay, great. I appreciate the color.

John L. Stauch -- President and Chief Executive Officer

Thank you.

Operator

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

Unidentified Participant -- -- Analyst

Hi guys, this is Jason on for Julian. Just looking at the Aquatic Systems demand and taking into account that the 1% to 2% of share gain is roughly consistent with the color given on Q2. Backing out the demand you saw as a result of pre-buy does this imply given the tougher year-over-year comp in Q3 versus Q2 that there were sort of a end market demand acceleration here. And then what was the cadence of that demand acceleration going into the quarter, was it stronger in September, et cetera.

John L. Stauch -- President and Chief Executive Officer

I mean, no, I don't think there was anything unusual about the end market demand in the quarter. It was strong in September, but that's not unusual and some of that was driven by the price increase timing. I mean and when -- you have seen the guidance for Q4, we don't see a significant slowdown, as we look at the Q4 run rate and expectation on growth in pool.

Unidentified Participant -- -- Analyst

Understood. And just going back to the pricing increases you did a -- there was sort of an acknowledgment that if there were -- was further inflation sort of seen in the pipeline, there would be -- there would have to be pricing increases put into net that out, sort of just on the pace of those increases. What would be the lag post the acknowledgment of further inflation, i.e. like 30 days to 60 days or maybe a quarter in terms of how long it would take to -- for those pricing increases to be effective?

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Sure. And then maybe to clarify, we said that we will continue to use price as a lever, and we didn't say that we would have to do that in light of inflation.

Unidentified Participant -- -- Analyst

You're right, right, right. Sorry, sorry.

Mark C. Borin -- Executive Vice President and Chief Financial Officer

But it's a lever in and it would take approximately 90 days to get that price fully implemented.

John L. Stauch -- President and Chief Executive Officer

That being said it -- it's also about 90 days for us to see the impact of increases from our suppliers as well. So what was unusual about Q3, if -- if you recall was the timing of the tariff announcement and the increase of that. I'm coming pretty quickly and not having the time to react.

Unidentified Participant -- -- Analyst

Understood. Thank you.

Operator

And presenters, do you have any closing remarks?

John L. Stauch -- President and Chief Executive Officer

Yes, I do. So thank you everybody for joining us today. And I hope you agree that we delivered a solid third quarter and that we are demonstrating our ability to use agility and prioritization to meet our commitments. By building of track record of meeting and exceeding commitments, we hope to earn the trust and right to pursue a compounding strategy that allows us not only achieve core growth and earnings, but to also utilize our strong cash flow and capital structure to pursue strategic, targeted and accretive bolt-on and tuck-in acquisitions. Thank you for your continued interest. Crystal, you can conclude the call.

Operator

Thank you, sir. This concludes today's conference call. You may now disconnect.

Duration: 54 minutes

Call participants:

Jim Lucas -- Senior Vice President, Investor Relations and Treasurer

John L. Stauch -- President and Chief Executive Officer

Mark C. Borin -- Executive Vice President and Chief Financial Officer

Deane Dray -- RBC Capital Markets -- Analyst

Joseph Giordano -- Cowen -- Analyst

Stephen Tusa -- JPMorgan -- Analyst

Scott Graham -- BMO Capital Markets -- Analyst

Michael Halloran -- Baird -- Analyst

Steven Winoker -- UBS Research -- Analyst

Nathan Jones -- Stifel -- Analyst

Brian Lee -- Goldman Sachs -- Analyst

Jeffrey Hammond -- KeyBanc Capital Markets -- Analyst

Brian Drab -- William Blair & Co LLC -- Analyst

Walter Liptak -- Seaport Global -- Analyst

Brett Lindsay -- Vertical Research -- Analyst

Unidentified Participant -- -- Analyst

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