Pentair Ltd. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 28, 2013. The interim financial statements are unaudited. Pentair’s current business took shape in the September 28, 2012 merger with Pentair, Inc.; consequently, 2012 comparisons do not include a full period of the acquired Flow Control businesses and are not directly comparable.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $1,824.8 million | $865.5 million | $5,563.0 million | $2,665.2 million |
| Gross profit | $637.6 million | $278.1 million | $1,828.8 million | $870.9 million |
| Gross margin | 34.9% | 32.1% | 32.9% | 32.7% |
| Operating income | $240.0 million | $55.2 million | $540.2 million | $261.0 million |
| Net income attributable to Pentair | $172.8 million | $31.4 million | $378.6 million | $165.9 million |
| Diluted EPS | $0.85 | $0.31 | $1.84 | $1.63 |
- Reported sales rose 110.8% in Q3 and 108.7% year to date. Management attributed most of the increase to Flow Control sales included after the merger; organic growth also came from pool products, agriculture, and food and beverage demand. Industrial-related volume was weaker.
- Q3 gross margin improved 2.8 percentage points, supported by acquired business mix, pricing, and operating-efficiency savings. Year-to-date gross margin increased 0.2 percentage points. Inflation in materials and labor and merger-related purchase-accounting costs partly offset improvement.
- Cash from operations was $629.8 million for nine months, versus $247.4 million a year earlier. Capital expenditures were $126.3 million, yielding reported free cash flow of $507.2 million, compared with $202.6 million. Free cash flow is a company-defined, non-GAAP measure.
- Cash was $237.7 million at quarter-end. Total debt was $2,573.7 million, including $539.1 million of commercial paper; long-term debt was $2,570.7 million. Revolving-facility availability was $903.3 million, and the company reported compliance with debt covenants. It also disclosed $158.6 million of cash held in countries where repatriation is limited or could have significant tax consequences.
- Current assets were $3,211.3 million and current liabilities $1,678.4 million. Dividends paid were $143.9 million year to date; share repurchases were $540.3 million for 9.7 million shares.
Material changes and unusual items
- The newly reported Valves & Controls segment contributed $611.5 million of Q3 sales and $1,817.2 million year to date; it had no comparable 2012 segment results in this presentation. Water & Fluid Solutions and Technical Solutions also include acquired Flow Control sales.
- Year-to-date SG&A included $52.3 million of restructuring costs, associated with initiatives that reduced approximately 700 positions in 2013. Q3 restructuring costs were $4.0 million.
- Merger purchase accounting increased year-to-date cost of goods sold by $87.0 million through inventory fair-value step-up and customer backlog charges. Merger-related intangible amortization also affected expenses.
- A Technical Solutions business sale generated $30.1 million of net cash proceeds and a $16.8 million gain. Nine-month net income also reflects a 24.3% effective tax rate, up from 20.4% in 2012; the earlier period benefited from resolution of tax audits.
Outlook, risks, and contingencies
- Management expected 2013 capital expenditures of approximately $200 million and free cash flow above 100% of net income, consistent with its long-term conversion goal. It cited integration, cost savings, working-capital reduction, product development, and growth in international markets as priorities.
- Management identified uncertainty around global economic conditions, housing and pool markets, industrial demand, pricing and input-cost volatility, merger integration and synergy realization, project backlog, and new-product acceptance. It reported no material change in market risk during the quarter.
- Tyco received IRS notices asserting $883.3 million of additional taxes plus $154 million of penalties, excluding interest, relating to 1997–2000 tax years. The IRS challenge concerns intercompany debt treatment and could also affect deductions in later periods. Pentair’s potential responsibility, if any, is governed by tax-sharing agreements; the company said an adverse outcome could materially affect future results, cash flows, or financial condition. Tyco intended to contest the assessment.
- At quarter-end, asbestos-related liabilities were $266.3 million, with $130.1 million of estimated insurance recoveries; approximately 1,800 lawsuits and 2,100 claims were pending. Environmental reserves were $41.4 million. The company cautioned that actual asbestos liabilities and recoveries could differ materially from estimates.
- Future dividends are subject to shareholder approval and other constraints. The filing also highlighted possible Swiss compensation legislation from 2014 that could affect recruitment and retention.
Important facts for investors to verify
- Separate acquired-business contribution from organic growth when assessing the sharp year-over-year sales and earnings increases.
- Track merger integration, purchase-accounting charges, restructuring costs, and whether stated operating savings and free-cash-flow targets are achieved.
- Monitor the Tyco IRS dispute, the tax-sharing allocation, and any change in Pentair’s estimated exposure.
- Review debt maturities, commercial-paper refinancing capacity, covenant headroom, and the availability of cash held abroad.
- Assess the assumptions behind asbestos insurance recoveries and liabilities, and confirm the company’s ability to maintain dividends and repurchases.