Pentair plc — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data. Pentair reported Water and Electrical as continuing segments. The Valves & Controls business was sold in April 2017 and is presented as discontinued operations.
Business context and results
Pentair is a diversified industrial manufacturer serving water-related markets and providing electrical products and solutions. The company said Water and Electrical represented approximately 58% and 42% of revenue, respectively, for the first nine months of 2017.
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $1,226.8 | $1,210.7 | $3,675.6 | $3,701.9 |
| Gross profit | $455.3 | $440.9 | $1,360.8 | $1,354.0 |
| Gross margin | 37.1% | 36.4% | 37.0% | 36.6% |
| Operating income | $192.2 | $182.8 | $543.4 | $538.9 |
| Operating margin | 15.7% | 15.1% | 14.7% | 14.6% |
| Continuing operations net income | $127.1 | $117.5 | $276.1 | $342.0 |
| Net income, including discontinued operations | $125.4 | $141.0 | $476.9 | $391.2 |
| Diluted EPS, continuing operations | $0.69 | $0.64 | $1.50 | $1.87 |
| Diluted EPS, total | $0.68 | $0.77 | $2.60 | $2.14 |
Cash flow, debt and liquidity
- Cash from continuing operating activities was $418.5 for the first nine months, down from $459.7. The company cited a $122.6 negative effect from changes in net working capital.
- Free cash flow from continuing operations, a non-GAAP measure, was $375.1 versus $389.3. Total free cash flow including discontinued operations was $311.9 versus $474.2.
- Cash from investing activities was $2,654.6, principally reflecting proceeds from the Valves & Controls sale. Capital expenditures were $50.5; acquisitions, net of cash acquired, were $59.5.
- Cash used in financing was $3,201.9, including $2,009.3 of long-term debt repayments, $842.3 of repayments of commercial paper and revolving debt, a $94.9 debt-extinguishment premium, $100.0 of share repurchases and $188.9 of dividends.
- At September 30, cash was $108.5 and long-term debt was $1,503.4, compared with total debt of $4,279.2 at December 31, 2016. The balance sheet reported no current debt maturities or short-term borrowings.
- Credit-facility availability was $2,366.8, limited to $1,828.4 by the leverage covenant; Pentair reported compliance with its debt covenants. Commercial paper outstanding was $116.0. The company also disclosed $60.2 of cash in countries where repatriation is limited by regulation or potential tax consequences.
Material changes and unusual items
- Q3 sales increased 1.3% year over year, while nine-month sales declined 0.7%. Management attributed the Q3 increase partly to acquisitions, favorable currency and U.S. industrial growth; lower project volumes and weakness in food and beverage offset growth. For the nine-month period, lower project sales and $9.7 of large-job sales adjustments weighed on revenue.
- Water Q3 sales rose 2.8% and segment income rose 9.6%; nine-month sales rose 1.3% and segment income rose 9.0%. Electrical Q3 sales fell 0.5% and segment income rose 1.6%; nine-month sales fell 3.3% and segment income fell 1.8%, reflecting, in part, the nonrecurrence of large Canadian oil sands projects.
- Management said margin gains reflected pricing, favorable mix and productivity savings, partly offset by labor and raw-material inflation. Nine-month restructuring expense was $38.6 versus $19.9 a year earlier; approximately 400 employees were reduced during the period.
- The Valves & Controls sale to Emerson closed April 28 for $3.15 billion, subject to working-capital adjustments, generating a $198.9 after-tax gain. Proceeds were used substantially to reduce debt.
- Repurchasing $1,659.3 of debt principal in May generated a $101.4 loss on early extinguishment. Net interest expense declined to $74.2 for nine months from $105.9, reflecting lower debt, partly offset by higher interest rates.
- Nine-month income from continuing operations before tax was $364.9 versus $435.7, despite slightly higher operating income; the debt-extinguishment loss and other items affected the comparison. The effective tax rate was 24.3% versus 21.5% for nine months.
Outlook, risks and contingencies
- Pentair expected to complete a tax-free spin-off of Electrical in Q2 2018, subject to board approval, tax opinions and rulings, SEC filings and other conditions. The filing cautions that timing and completion are not assured; reported results still include both Water and Electrical.
- Management expected capital-spending and maintenance deferrals to continue through 2017, particularly project-order headwinds in Electrical. It cited early signs of recovery, but also anticipated continued raw-material and other cost volatility. It expected restructuring and operating initiatives to support 2017 margin growth.
- Fiscal 2017 capital expenditures were expected to be approximately $80. Pentair’s stated priorities included reducing debt, improving cash flow, operational excellence and growth through products and market expansion. No specific earnings guidance was provided in the supplied filing text.
- Key risks include execution and potential costs of the proposed separation; cyclical end-market demand, project delays and pricing competition; inflation and foreign-exchange movements; acquisition and restructuring execution; and potential tax, regulatory and financing constraints.
- The company disclosed approximately 600 asbestos-related claims outstanding, environmental and product-liability matters, and indemnification obligations related to the Valves & Controls sale. Environmental reserves were described as not material; management said a material impact from the described claims was unlikely, while acknowledging uncertain litigation outcomes.
Investor verification points
- Check subsequent filings for separation milestones, conditions, costs and any change to the anticipated Q2 2018 timing.
- Assess continuing-operations earnings and cash generation separately from the Valves & Controls sale gain and debt-extinguishment charge.
- Monitor working capital, free cash flow, capital spending and progress in reducing debt while funding dividends and repurchases.
- Track Electrical project demand, Water end-market recovery, inflation and whether pricing and productivity continue to protect margins.
- Review developments in asbestos claims, tax-sharing and sale-related indemnities, and the availability of cash held in restricted-repatriation countries.