Pentair Ltd. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 29, 2013; interim financial statements are unaudited. Pentair reports three segments: Water & Fluid Solutions, Valves & Controls, and Technical Solutions. Results are substantially affected by the September 2012 merger with Pentair, Inc.; comparisons with 2012 are not like-for-like because the 2013 periods include the acquired Flow Control businesses, including Valves & Controls.
Key financial results
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Net sales | $1,963.7 million | $941.5 million | $3,738.2 million | $1,799.7 million |
| Gross profit / margin | $667.4 million / 34.0% | $312.1 million / 33.1% | $1,191.2 million / 31.9% | $592.8 million / 32.9% |
| Operating income | $225.9 million | $119.3 million | $300.2 million | $205.8 million |
| Net income attributable to Pentair | $154.1 million | $72.7 million | $205.8 million | $134.5 million |
| Diluted EPS | $0.75 | $0.72 | $0.99 | $1.33 |
| Operating cash flow | Not presented separately for the quarter | $386.1 million | $166.8 million |
Q2 sales rose 108.6% and first-half sales rose 107.7%, mainly reflecting post-merger Flow Control sales ($964.4 million in Q2 and $1,852.5 million in the first half). Management also cited organic growth in pool products, agriculture, food and beverage, and fast-growth regions; industrial and infrastructure weakness partly offset growth. First-half diluted EPS declined despite higher net income, with weighted average diluted shares increasing to 206.9 million from 100.8 million, principally reflecting the merger.
Q2 gross margin improved 0.9 percentage points, while first-half gross margin fell 1.0 point. First-half results included $86.9 million of merger purchase-accounting charges for inventory step-up and customer backlog, plus raw-material and labor inflation. SG&A was 20.8% of Q2 sales and 22.1% of first-half sales, up from 18.3% and 19.2%, respectively, reflecting restructuring, merger integration, and intangible amortization. First-half net income included a $16.7 million gain on sale of a business.
Liquidity, debt, and capital allocation
- At June 29, cash was $253.1 million; current assets were $3,216.5 million and current liabilities $1,686.8 million.
- Total debt was $2,740.3 million, up from $2,457.4 million at year-end 2012. Commercial paper outstanding was $690.6 million, backed by a revolving credit facility; $736.6 million of facility availability remained. Pentair reported compliance with its debt covenants.
- First-half operating cash flow of $386.1 million less capital expenditures of $88.0 million, plus $3.6 million proceeds from property sales, produced reported free cash flow of $301.7 million, versus $140.4 million a year earlier.
- Financing cash use was $250.9 million, including $483.6 million of share repurchases and $94.0 million of dividends. Cash ended the period at $253.1 million, down $8.2 million from year-end.
- Shareholders approved quarterly dividends through Q2 2014, subject to the stated Swiss-franc contributed-surplus cap. The company had $375.5 million remaining under its share repurchase authorizations at June 29.
Outlook, commentary, and risks
- Management expected 2013 capital expenditures of approximately $200 million and continued to expect free cash flow above 100% of net income before noncontrolling interest. It stated a long-term goal of free cash flow at or above 100% of net income. No specific earnings or revenue guidance is provided in the filing text.
- Management cited opportunities in recovering housing and pool markets, fast-growth regions, new products, and operational improvements. Risks include uneven end-market demand, integration and synergy execution, pricing pressure, raw-material and currency volatility, and the ability to deliver project backlog.
- Restructuring initiatives reduced approximately 700 employees in the first half of 2013; costs were $48.3 million for the half. Merger-related amortization, integration costs, and purchase-accounting charges also affected margins.
- A significant contingent tax exposure arose after the IRS issued Tyco notices asserting $883.3 million of additional tax and $154 million of penalties for 1997–2000, excluding interest. Pentair’s potential share, if any, is governed by tax-sharing agreements; the company said resolution could take years and could materially affect future results, cash flows, or financial condition.
- Other contingencies include about 2,000 pending asbestos lawsuits, with a recorded liability of $227.9 million and related insurance receivable of $156.5 million; environmental reserves were $34.7 million. Management did not expect environmental matters to have a material adverse effect. The filing also identifies possible Swiss compensation legislation from 2014 and foreign-exchange limits on authorized dividends.
Most important facts for investors to verify
- How much of reported growth and earnings improvement reflects the merger versus organic performance, and how segment margins evolve as purchase-accounting effects and integration costs subside.
- The IRS dispute’s progress, the potential allocation of any liability to Pentair under the tax-sharing agreements, and whether subsequent filings update the exposure.
- Debt, commercial-paper reliance, covenant headroom, and the company’s ability to meet its free-cash-flow and capital-spending expectations.
- Whether asbestos insurance recoveries remain collectible and whether claim trends or other contingencies change materially.
- Whether dividends remain within the Swiss-franc authorization cap and whether share repurchases continue at a pace consistent with liquidity and debt priorities.