Pentair plc — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Amounts are in U.S. dollars; financial figures are in millions except per-share data.
Business context and reporting period
Pentair reported Water and Electrical as continuing segments. On April 28, 2017, it completed the sale of Valves & Controls to Emerson for $3.15 billion, subject to working-capital adjustments; that business is reported as discontinued operations. On May 9, Pentair announced a planned tax-free spin-off of Electrical, expected in Q2 2018, subject to approvals and other conditions.
Financial performance and material changes
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $1,265.3 | $1,301.2 | $2,448.8 | $2,491.2 |
| Gross profit | $483.2 | $481.8 | $905.5 | $913.1 |
| Gross margin | 38.2% | 37.0% | 37.0% | 36.7% |
| Operating income | $212.8 | $203.4 | $351.2 | $356.1 |
| Income from continuing operations | $68.3 | $132.7 | $149.0 | $224.5 |
| Net income | $263.7 | $142.8 | $351.5 | $250.2 |
| Diluted EPS | $1.43 | $0.78 | $1.91 | $1.37 |
| Operating cash flow, continuing operations | — | — | $210.9 | $320.9 |
Q2 sales fell 2.8% year over year; first-half sales fell 1.7%. Lower volume and unfavorable currency were partly offset by acquisitions, pricing, and Water residential and commercial growth. Operating income rose 4.6% in Q2 despite lower sales, while first-half operating income declined 1.4%. Gross-margin improvement reflected productivity, pricing, and mix.
Q2 net income included a $200.6 million after-tax gain on the Valves & Controls sale and a $5.2 million after-tax discontinued-operations loss. Continuing-operations income was reduced by a $101.4 million loss on early debt extinguishment. Thus, reported net income and EPS are not a direct measure of underlying continuing-business performance. Net interest expense declined as debt levels fell.
Segment results: Water Q2 sales were $753.7 million, down 1.1%, and segment income was $161.0 million, up 4.8%; first-half sales rose 0.6% and segment income rose 8.7%. Electrical Q2 sales were $513.2 million, down 5.1%, and segment income was $112.8 million, up 1.1%; first-half sales fell 4.7% and segment income fell 3.6%. Energy and infrastructure project weakness weighed on Electrical.
Cash, debt, and liquidity
At June 30, cash was $177.8 million, versus $238.5 million at year-end 2016. Long-term debt was $1,698.9 million, with $0.3 million of current maturities and short-term borrowings. Pentair used sale proceeds to repay commercial paper and revolving debt and repurchase $1,659.3 million of notes, paying a $94.9 million cash premium. Debt-extinguishment costs totaled $101.4 million.
First-half continuing operating cash flow was $210.9 million versus $320.9 million; continuing free cash flow was $177.1 million versus $264.5 million. Total free cash flow, including discontinued operations, was $115.0 million versus $304.4 million. Sale proceeds contributed $2,765.6 million to investing cash flow; financing activities used $2,926.8 million, including debt repayments, the $100.0 million share repurchase, and dividends.
Credit-facility availability was $2.5 billion, limited to $2,070.4 million by the leverage covenant; Pentair reported compliance with all debt covenants. Commercial paper outstanding was zero. The company also disclosed $63.2 million of cash in countries where repatriation is restricted or may have significant tax consequences.
Outlook, management commentary, and risks
Management expected industrial capital-spending and maintenance deferrals, energy and infrastructure project headwinds, and unfavorable currency effects to continue through 2017. It cited restructuring, lean and supply-management initiatives, pricing, and growth investments as responses. Planned 2017 capital expenditures were approximately $90 million. No specific earnings or revenue guidance was provided in the filing text.
During the first half, restructuring initiatives reduced headcount by approximately 300 employees; restructuring costs were $33.7 million, versus $12.6 million in the prior-year period. The principal identified risks include execution and tax treatment of the proposed spin-off; cyclical demand, project delays, competition and cost inflation; foreign-exchange exposure; and legal, environmental, product-liability and asbestos matters. Approximately 600 asbestos claims were outstanding at June 30; environmental reserves were described as not material. The filing also notes potential indemnification and shared tax liabilities, whose ultimate outcomes are uncertain.
Most important facts for investors to verify
- Whether the Valves & Controls sale proceeds, sale-related costs, and resulting debt reduction are fully reflected in subsequent-period cash, debt, and interest expense.
- Progress, costs, approvals, tax opinions, and timing of the proposed Electrical spin-off; completion was not assured.
- Whether sales and project demand recover, particularly in Electrical energy and infrastructure and Water industrial and food-and-beverage markets.
- Whether restructuring and productivity savings offset inflation, currency effects, and lower volumes, and how much of reported profit reflects unusual items.
- Debt refinancing and covenant headroom, including the disclosed $350 million of fixed-rate notes maturing in September 2017 and management’s stated intent and ability to refinance.
- Developments in asbestos litigation, indemnification obligations, and shared tax matters that could change the company’s estimated liabilities.