Pentair plc — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited results. On April 30, 2018, Pentair completed the separation of its Electrical business to shareholders through nVent Electric plc; Pentair retained no equity interest. Electrical results are reported as discontinued operations, so continuing-operations results reflect the remaining water businesses: Aquatic Systems, Filtration Solutions and Flow Technologies.
Key financial results
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $780.6 million | $754.0 million | $1,513.2 million | $1,437.3 million |
| Gross profit | $282.6 million | $273.6 million | $535.9 million | $497.3 million |
| Gross margin | 36.2% | 36.3% | 35.4% | 34.6% |
| Operating income | $122.6 million | $129.2 million | $215.3 million | $191.1 million |
| Continuing-operations income (loss), net of tax | $77.9 million | $(3.4) million | $136.3 million | $9.3 million |
| Net income | $41.5 million | $263.7 million | $144.4 million | $351.5 million |
| Diluted earnings per share | $0.23 | $1.43 | $0.80 | $1.91 |
Q2 operating margin was 15.7%, versus 17.1% a year earlier; first-half operating margin was 14.2%, versus 13.3%. Q2 net income included a $36.4 million after-tax loss from discontinued operations. First-half net income also reflects $8.1 million of discontinued-operations income. Prior-year net income benefited from the $200.6 million after-tax gain on the Valves and Controls sale and substantial discontinued-business earnings; headline net income and EPS are therefore not directly comparable as measures of ongoing performance.
- Sales and segments: Continuing net sales rose 3.5% in Q2 and 5.3% in the first half. Q2 segment sales were $276.2 million for Aquatic Systems (+8.9%), $262.1 million for Filtration Solutions (-0.6%) and $241.9 million for Flow Technologies (+2.4%). First-half segment income increased in all three segments: Aquatic Systems $139.6 million, Filtration Solutions $86.0 million and Flow Technologies $83.1 million.
- Cash flow: First-half operating cash flow from continuing operations was $177.8 million, versus $84.9 million; capital expenditures were $20.3 million. Continuing-operations free cash flow, a non-GAAP measure, was $157.0 million, versus $66.2 million. Total free cash flow, including discontinued operations, was $146.0 million, versus $115.0 million.
- Debt and liquidity: Long-term debt was $779.9 million at June 30, 2018, down from $1,440.7 million at December 31, 2017. Cash was $78.7 million. The $800 million revolving credit facility had $707.4 million available; the company reported compliance with debt covenants. Commercial paper outstanding was $78.0 million.
- Capital returns: Pentair repurchased $300 million of shares during the first half and paid $125.9 million of dividends. The quarterly dividend declared was $0.35 per share.
Material changes and unusual items
- The nVent separation generated a $993.6 million cash distribution to Pentair. Proceeds were used to repay borrowings and retire or tender debt. Debt-extinguishment losses were $17.1 million in 2018, compared with $101.4 million in the prior-year periods.
- Q2 SG&A rose 11.2% to $140.9 million, including $25.0 million of restructuring costs versus $5.9 million a year earlier. First-half restructuring costs were $30.6 million, including $20.6 million of asset impairment and contract-termination costs. The company reported headcount reductions of 250 employees in the first half.
- Q2 gross margin edged down 0.1 percentage point, with raw-material inflation partly offset by pricing. First-half gross margin improved 0.8 point, supported by pricing, mix and productivity savings; labor and materials inflation remained a drag.
- The first-half effective tax rate was 20.8%, versus 65.9% in 2017; management attributed the change to discrete tax items, earnings mix, U.S. tax reform and lower nondeductible interest allocated to continuing operations. The company’s accounting for the tax law remained provisional pending further analysis.
- Adoption of income-tax accounting guidance reduced opening retained earnings by $215.8 million. Revenue-standard adoption had no material opening retained-earnings impact and was expected to have an immaterial ongoing net-income effect.
Outlook, risks and contingencies
No specific full-year revenue, earnings or cash-flow guidance is provided in the supplied filing text. Management’s 2018 priorities include completing the separation transition, pursuing revenue growth through new products and market expansion, improving operating excellence and cash flow, and developing global talent. Management expected restructuring actions to contribute to margin growth in 2018.
Management cited ongoing material and other cost inflation, raw-material price volatility, and uncertainty about the timing and effect of these changes. Other disclosed risks include global economic conditions, housing and related markets, currency and tariff movements, competitive pricing, execution of restructuring and separation benefits, market acceptance of new products, and litigation and regulatory outcomes. Pentair reported approximately 600 asbestos claims outstanding; environmental reserves were not material. The company stated that it did not expect known environmental matters to have a material adverse effect, while noting that unknown conditions or changing requirements could create additional liabilities. Bonds, letters of credit and bank guarantees totaled $117.5 million.
Most important facts for investors to verify
- Assess post-separation performance using continuing operations, and account for the substantial discontinued-operation and sale-gain effects in prior-year comparisons.
- Check whether pricing and productivity continue to offset labor, raw-material and other cost inflation, particularly given Q2 margin pressure and higher restructuring expense.
- Track cash conversion and working capital: management reported a $48.1 million adverse working-capital effect on first-half continuing operating cash flow.
- Monitor debt, facility availability, covenant compliance and the impact of continued share repurchases and dividends on liquidity.
- Follow completion of the nVent transition, tax-law accounting, restructuring savings and developments in litigation, indemnities and other contingencies.