Pentair plc — Q1 2018 Form 10-Q
Business context and period. The unaudited quarter ended March 31, 2018. Pentair reported Water and Electrical segments; the disposed Valves & Controls business is presented as discontinued operations. On April 3, 2018, the board approved the planned separation of Electrical as nVent, with distribution expected April 30, 2018, at one nVent share per Pentair share held on the April 17 record date. This was a subsequent event, not completed at quarter-end.
Financial results
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $1,269.7 million | $1,183.5 million |
| Gross profit / margin | $462.0 million / 36.4% | $422.3 million / 35.7% |
| Operating income / margin | $152.3 million / 12.0% | $140.6 million / 11.9% |
| Continuing-operations net income | $104.2 million | $80.7 million |
| Net income | $102.9 million | $87.8 million |
| Diluted EPS | $0.57 ($0.58 continuing operations) | $0.48 ($0.44 continuing operations) |
| Operating cash flow, continuing operations | $(166.9) million | $(88.7) million |
| Free cash flow | $(182.1) million | $(133.3) million |
| Cash and cash equivalents | $907.5 million | $113.3 million at Dec. 31, 2017 |
| Total debt | $2,673.3 million | $1,440.7 million at Dec. 31, 2017 |
Sales increased 7.3% year over year, including 3.9% core growth and 3.4% favorable currency impact. The effective tax rate was 20.9%, down from 22.1%. Q1 dividend paid was $0.35 per share; the company reported 178.4 million shares issued at March 31.
Material changes and drivers
- Water: Sales rose 7.2% to $732.3 million; segment income grew 14.3% to $132.7 million, with margin up 1.1 percentage points to 18.1%. Growth reflected higher volumes, currency and pricing, partly offset by Middle East declines.
- Electrical: Sales rose 7.3% to $538.9 million; segment income increased 1.9% to $106.3 million, while margin fell 1.1 percentage points to 19.7%. Inflation, lower energy project volume and costs tied to footprint rationalization and a new U.S. distribution center weighed on margin.
- Consolidated gross margin improved 0.7 percentage points, supported by pricing, favorable mix, productivity and the absence of prior-year large-job adjustments. SG&A rose 11.1%; the company cited $24.6 million of separation costs, growth investment and a prior-year indemnification-liability reversal. Restructuring expense was $10.8 million versus $20.9 million.
- Net interest expense decreased 60.6% to $13.8 million, mainly reflecting lower debt after the 2017 Valves & Controls sale proceeds were used to repay debt.
Liquidity, debt and cash flow
Operating cash use from continuing operations widened year over year, primarily because working capital used $317.2 million, including higher receivables ahead of the seasonal peak sales period. Financing provided $997.8 million, including $800 million of nVent-related notes issued in March; cash also reflects $150 million of share repurchases and $63.3 million of dividends paid.
Debt included $257.8 million of commercial paper and $800 million of nVent notes due 2023 and 2028. Pentair reported compliance with debt covenants. Its $2.5 billion credit facility had $2,220.1 million of stated availability, but availability was limited to $183.4 million by the facility’s maximum leverage ratio. The company said it expected nVent to have $200 million drawn on its term loan at separation and expected to use cash transferred from nVent to repay certain Pentair debt.
Outlook, unusual items and risks
- Management expected restructuring actions to contribute to 2018 margin growth. Priorities included completing the separation, operating-efficiency initiatives, revenue growth, product innovation and talent development. No consolidated numerical earnings or sales guidance is provided in the supplied filing text.
- The company cited ongoing labor and raw-material inflation and uncertainty around raw-material price volatility. Other stated risks include separation execution and costs, independent-company readiness, global economic conditions, competition, project/backlog execution, foreign exchange, and litigation.
- Adoption of the new revenue standard increased reported Q1 sales by $8.6 million and continuing-operations net income by $1.8 million; prior-year comparisons were not restated. Adoption of a tax accounting standard reduced opening retained earnings by $215.8 million.
- The quarter included a $5.3 million loss on sale of a business and $24.6 million in separation costs. The company disclosed approximately 600 outstanding asbestos claims; environmental reserves were not material. Management stated that a future adverse litigation development could nevertheless have a material impact.
- The 2017 sale of Valves & Controls generated a $181.1 million after-tax gain in 2017; discontinued operations contributed a $1.3 million loss in Q1 2018 versus $7.1 million income in Q1 2017.
Investor verification priorities
- Confirm completion, final terms and costs of the nVent separation, including the allocation of debt, cash and guarantees between the companies.
- Track working-capital recovery and operating/free cash flow through the seasonal sales peak.
- Verify covenant headroom and refinancing plans, particularly given stated credit-facility availability limited by the leverage covenant.
- Assess whether price increases and productivity can continue to offset labor and materials inflation, especially in Electrical.
- Monitor separation-related expenses, remaining tax-reform accounting estimates, and developments in asbestos, environmental and other litigation matters.