Pentair plc — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual filing; fourth-quarter figures are included in the audited annual results. Dollar amounts are in millions unless stated otherwise.
Business context
Pentair is a global water-solutions manufacturer focused on pool equipment, water filtration and treatment, and pumps and flow products. Its 2019 reporting segments were Aquatic Systems, Filtration Solutions and Flow Technologies. From the first quarter of 2020, it planned to report two segments: Consumer Solutions and Industrial & Flow Technologies. Pentair acquired residential water-treatment businesses Aquion and Pelican in February 2019 for a combined $284.5 million, net of cash acquired.
Financial performance and liquidity
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net sales | $2,957.2 | $2,965.1 | (0.3)% |
| Gross profit / margin | $1,051.5 / 35.6% | $1,047.7 / 35.3% | Margin +0.3 pts |
| Operating income / margin | $432.5 / 14.6% | $436.7 / 14.7% | (1.0)% |
| Continuing-operations net income | $361.7 | $321.7 | +12.4% |
| Net income, including discontinued operations | $355.7 | $347.4 | +2.4% |
| Diluted EPS from continuing operations | $2.12 | $1.81 | +17.1% |
| Operating cash flow from continuing operations | $345.2 | $458.1 | (24.6)% |
| Free cash flow from continuing operations | $287.3 | $410.1 | (29.9)% |
Free cash flow is a non-GAAP measure defined by Pentair as continuing-operations operating cash flow less capital expenditures, plus proceeds from property and equipment sales. Total free cash flow, including discontinued operations, was $295.1 versus $386.0 in 2018.
- Segment sales / income: Aquatic Systems $985.3 / $268.9; Filtration Solutions $1,066.9 / $171.3; Flow Technologies $903.6 / $138.4. Segment income excludes specified items, so it is not equivalent to GAAP operating income.
- Balance sheet: Cash and equivalents were $82.5, total debt $1,029.1, total assets $4,139.5 and equity $1,953.9 at year-end. Debt increased from $787.6 at year-end 2018.
- Liquidity and maturities: Current assets were $1,061.9 and current liabilities $749.0. Availability under the Senior Credit Facility was $746.4; commercial paper outstanding was $117.8. The company reported compliance with debt covenants. It had $74.0 of fixed-rate notes due in 2020, classified as long-term because management intended and was able to refinance them.
- Capital returns: Pentair repurchased $150.0 of shares and paid $122.7 of dividends in 2019. The quarterly dividend was increased from $0.18 to $0.19 per share, payable in February 2020.
Material changes versus 2018
- Sales were broadly flat: lower volume across all three segments and unfavorable currency effects were largely offset by pricing and the Aquion and Pelican acquisitions. Organic core growth was down 1.3%.
- Continuing-operations earnings rose despite lower operating income, helped by lower interest expense and a lower effective tax rate (11.2%, versus 15.3%). The filing attributes the tax-rate decline mainly to earnings mix, lower nondeductible interest allocation, and lower valuation allowances.
- Gross margin improved on pricing and productivity savings, but inflation in raw materials and labor continued. Lower volume and unfavorable mix pressured operating leverage and segment results.
- Cash generation weakened, including a $105.4 negative working-capital impact and higher pension contributions. Investing cash use increased, principally reflecting the two acquisitions.
- Filtration Solutions sales rose 6.6%, largely from acquisitions; Aquatic Systems sales declined 4.0% and Flow Technologies declined 3.5%. Aquatic segment income fell 3.1%, Filtration rose 1.7%, and Flow Technologies fell 4.9%.
Outlook, risks and unusual items
- Management expected 2019 restructuring actions to contribute to margin growth in 2020, but provided no quantified 2020 earnings or revenue guidance in the supplied filing text. Its stated priorities included growth in pool and water-treatment markets, new products, digital transformation, acquisition integration and productivity.
- Management identified the COVID-19 outbreak as a potential threat to employees, customers and global supply chains; the impact and duration were unclear at filing. China accounted for approximately 3–4% of revenue, and the company sourced materials and products from China and other potentially affected regions.
- Other key risks include economic cycles, weather-driven seasonality, competition and pricing pressure, foreign exchange, raw-material inflation, tariffs and trade policy, Brexit uncertainty, customer concentration, acquisition integration, debt and covenant exposure, cyber and privacy risks, environmental obligations and litigation. Pool Corporation represented about 15% of consolidated sales in each of 2017–2019.
- Unusual items included $21.2 of cost-method investment impairments in 2019, $14.0 of restructuring costs, and an $11.8 non-cash pension settlement gain. No goodwill impairment was recorded; goodwill and intangible assets totaled $2,597.5, or 63% of total assets.
- Approximately 730 asbestos-related claims were outstanding at year-end, substantially related to discontinued operations. Environmental reserves were described as not material; management said existing proceedings were not expected to have a material impact, while acknowledging litigation outcomes are uncertain.
- The CFO had announced plans to resign after a successor search, and the Chief Supply Chain Officer had stated an intention to resign effective February 26, 2020.
Important facts for investors to verify
- Whether the expected 2020 restructuring benefits materialized and whether volume, pricing and inflation trends improved.
- Acquisition performance and integration of Aquion and Pelican, including the final purchase-price allocations and resulting goodwill and intangible-asset valuations.
- Cash conversion and working-capital trends, given the marked year-over-year decline in continuing-operations operating cash flow and free cash flow.
- Debt refinancing, interest costs, covenant headroom and liquidity, particularly around the 2020 maturity and variable-rate borrowing exposure.
- COVID-19 and supply-chain effects, and any subsequent developments in customer concentration, asbestos claims, environmental matters or tax positions.
The auditor issued an unqualified opinion on the financial statements and internal control over financial reporting. The filing identifies indefinite-lived trade-name valuation and completeness of uncertain tax positions as critical audit matters.