Pentair plc — Q1 2016 Form 10-Q
Business context and reporting period
Pentair is a diversified industrial manufacturer with four segments: Water Quality Systems, Flow & Filtration Solutions, Technical Solutions, and Valves & Controls. This filing covers the three months ended March 31, 2016. Pentair began using calendar quarters in 2016; the comparable 2015 period ended March 28 and was reported on a 13-week basis, so period lengths and timing may differ.
Financial performance and liquidity
| Metric | Q1 2016 | Comparable 2015 |
|---|---|---|
| Net sales | $1,575.5 million | $1,475.0 million |
| Gross profit / margin | $535.4 million / 34.0% | $510.2 million / 34.6% |
| Operating income / margin | $170.6 million / 10.8% | $171.2 million / 11.6% |
| Net income from continuing operations | $107.4 million | $118.2 million |
| Diluted continuing-operations EPS | $0.59 | $0.65 |
| Net cash used for continuing operating activities | $15.0 million | $126.2 million |
| Free cash flow | $(46.9) million | $(158.7) million |
Sales increased 6.8%; reported growth included an 8.0% acquisition contribution, 1.2% core growth, and a 2.4% adverse currency impact. Gross margin declined 0.6 percentage points, while operating margin declined 0.8 points. Net interest expense doubled to $36.4 million, primarily reflecting debt issued to fund the ERICO acquisition and higher rates. The effective tax rate fell to 20.5% from 23.0%.
At March 31, 2016, cash was $158.1 million and total debt was $4,837.8 million, versus $4,686.5 million at year-end. Current assets were $3,005.9 million and current liabilities $1,467.6 million. Credit-facility availability was reported as $1,000.6 million, but limited to $429.7 million by the leverage covenant. Pentair said it complied with all debt covenants. Q1 dividends paid were $60.1 million, or $0.33 per share.
Material changes and segment results
- Technical Solutions sales rose 32.5% to $524.6 million, including $120.1 million from ERICO; segment income increased to $112.8 million.
- Water Quality Systems sales increased 8.0% to $331.5 million, with segment margin improving to 18.6% from 16.9%.
- Flow & Filtration Solutions sales declined 3.5% to $337.7 million; segment margin improved to 11.7% from 10.4% through productivity and pricing actions.
- Valves & Controls sales fell 9.8% to $387.0 million, and segment income fell 54.3% to $25.3 million. Margin contracted to 6.5% from 12.9%, reflecting lower volumes, unfavorable mix and pricing, and inflation.
Outlook, commentary, risks and unusual items
Management cited continued 2016 headwinds from a strong U.S. dollar, weak energy and industrial demand, depressed oil prices, and slowing activity in some developing markets. Pentair expects restructuring actions to continue through 2016 and contribute to margin growth. Its stated priorities include improving cash flow and reducing debt, operating-cost initiatives, and growth through new products and market expansion. No specific revenue or EPS guidance is provided in the filing. Planned 2016 capital expenditures are approximately $150 million.
Operating cash flow remained negative, though less so than in the prior-year quarter; management attributed the 2016 use primarily to seasonal working-capital investment ahead of peak sales. The company expects to fund working capital, capital spending, debt service, and dividends from cash, internally generated funds, and credit facilities. It reported $89.8 million of cash in countries where repatriation is restricted or could have significant tax consequences.
ERICO’s preliminary purchase-price allocation remained subject to refinement, with completion expected in Q2 2016; goodwill was revised to $1,037.4 million. Q1 restructuring costs were $0.7 million, following approximately 3,000 employee reductions during 2015. Contingencies include approximately 4,000 outstanding asbestos claims; recorded asbestos liabilities were $235.4 million and related insurance receivables $110.3 million. Environmental reserves were $19.7 million. Management cautioned that actual asbestos liabilities or insurance recoveries could differ significantly from estimates.
Other identified risks include acquisition integration and realization of ERICO benefits, market and pricing pressures, raw-material and labor inflation, currency and commodity volatility, project execution, litigation, and compliance with increasingly restrictive leverage covenants. The company reported effective disclosure controls and no material changes to risk factors or market-risk disclosures during the quarter.
Important facts for investors to verify
- Whether seasonal working-capital outflows reverse as expected and cash generation supports the stated debt-reduction objective.
- Leverage-covenant headroom and the scheduled tightening of maximum leverage limits after June 2016.
- ERICO integration, realized synergies, and final purchase-price allocation.
- Whether weakness and margin pressure in Valves & Controls persist amid energy and industrial-market declines.
- Key assumptions underlying asbestos claims, insurance recoveries, and environmental reserves.