Pentair plc — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Amounts below are in millions of U.S. dollars, except per-share data. The filing is unaudited.
Business context
Pentair now reports three water-focused segments: Aquatic Systems, Filtration Solutions and Flow Technologies. The Electrical business was separated and distributed to shareholders as nVent on April 30, 2018; Pentair retained no ownership interest. Electrical results are classified as discontinued operations, so comparisons of consolidated net income and cash flow with 2017 are affected by the change in the businesses included.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $711.4 | $687.6 | $2,224.6 | $2,124.9 |
| Gross profit | $243.8 | $236.5 | $779.7 | $733.8 |
| Gross margin | 34.3% | 34.4% | 35.0% | 34.5% |
| Operating income | $108.4 | $101.8 | $323.7 | $292.9 |
| Operating margin | 15.2% | 14.8% | 14.6% | 13.8% |
| Continuing-operations net income | $91.2 | $48.9 | $227.5 | $58.2 |
| Total net income, including discontinued operations | $110.1 | $125.4 | $254.5 | $476.9 |
| Diluted EPS, continuing operations | $0.52 | $0.27 | $1.28 | $0.32 |
| Diluted EPS, total | $0.63 | $0.68 | $1.43 | $2.60 |
Sales rose 3.5% in Q3 and 4.7% for the first nine months. Management attributed growth mainly to volume and pricing; nine-month growth also benefited from currency. Q3 gross margin edged down amid labor and raw-material inflation, while nine-month gross margin improved with pricing, mix and productivity savings. Continuing-operations income rose substantially year over year, alongside lower interest expense and a lower effective tax rate. Total net income is not directly comparable: 2017 included discontinued-business earnings and a $198.9 million after-tax gain on the Valves & Controls sale.
Segments
| Segment | Q3 sales | Q3 segment income | Q3 margin | Nine-month sales | Nine-month segment income |
|---|---|---|---|---|---|
| Aquatic Systems | $232.7 (+9.9%) | $59.9 (+12.8%) | 25.7% (up 0.6 pts) | $749.3 (+8.9%) | $199.5 (+9.1%) |
| Filtration Solutions | $240.4 (-0.8%) | $38.4 (-5.0%) | 16.0% (down 0.7 pts) | $754.1 (+2.3%) | $124.4 (+9.7%) |
| Flow Technologies | $238.0 (+2.1%) | $36.6 (-6.9%) | 15.4% (down 1.5 pts) | $720.2 (+3.1%) | $119.7 (+6.2%) |
Segment sales and income comparisons are year over year. Q3 margins at Filtration Solutions and Flow Technologies were pressured by inflation; Aquatic Systems benefited from stronger volume and pricing.
Cash flow, debt and liquidity
- Cash from continuing operating activities was $299.2 for the first nine months, versus $147.6 in 2017. Continuing-operations free cash flow, a non-GAAP measure, was $265.0 versus $125.4. Total free cash flow, including discontinued operations, was $245.3 versus $311.9.
- Capital expenditures were $33.8. Cash and cash equivalents were $64.7 at September 30, 2018, down from $86.3 at year-end 2017.
- Reported debt was $798.8, down from $1,440.7 at December 31, 2017. Pentair used $993.6 received from nVent to repay borrowings and redeem or tender debt; the actions generated a $17.1 early-extinguishment loss for the nine months.
- The $800.0 revolving credit facility matures in 2023; availability was $691.6. Commercial paper outstanding was $99.0. Pentair reported compliance with debt covenants; the facility’s maximum leverage ratio is 3.75:1 and minimum interest coverage ratio is 3.00:1.
- Cash used in financing included $400.0 of share repurchases and $156.7 of dividends. The quarterly dividend was adjusted to $0.175 per share following the separation; $500.0 remained authorized for repurchases at quarter-end.
Outlook, risks and unusual items
- No specific revenue or earnings guidance for the next quarter or full year is provided in the supplied filing text. Management expects restructuring actions to contribute to margin growth in 2018 and 2019 and states a long-term goal of free cash flow equal to or greater than 100% of adjusted net income.
- Management cited ongoing material and labor-cost inflation, with pricing and productivity measures intended to mitigate it. Other stated risks include global economic conditions, housing and related markets, currency and commodity volatility including tariffs, competition, restructuring execution, and the ability to realize benefits from the nVent separation.
- Restructuring costs were $34.1 for the first nine months, compared with $18.9 in 2017; about 300 employees were reduced in 2018 initiatives. Separation-related costs reported in discontinued operations were $82.4 for the nine months.
- The effective tax rate was 10.4% in Q3 and 17.0% for the first nine months, versus 41.1% and 47.2%, respectively, in 2017. Management cited discrete tax items, earnings mix and U.S. tax reform. The tax accounting remained subject to analysis; uncertain tax position liabilities were $52.8, up from $12.0 at year-end 2017.
- A $171.9 lump-sum pension payment during Q3 triggered interim mark-to-market accounting. Pentair also disclosed approximately 600 outstanding asbestos claims; environmental reserves were not material. The filing says litigation outcomes are uncertain and that future adverse developments could result in material charges.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Separate ongoing water-business performance from discontinued Electrical and Valves & Controls results, especially when interpreting year-over-year earnings and cash flow.
- Assess how durable sales growth, segment margins and productivity gains are as inflation and pricing pressures continue.
- Review the drivers and sustainability of the unusually low 2018 tax rate, the $52.8 uncertain-tax-position liability and remaining U.S. tax-reform estimates.
- Monitor debt reduction, cash generation, revolving-facility availability, covenant compliance and capital returns after the nVent distribution.
- Track restructuring and separation costs, pension-plan termination accounting, and developments in asbestos, environmental and other legal matters.