PENTAIR Plc quarterly report, Q2 FY2022

Pentair plc — Q2 2022 Form 10-Q

Business context and reporting period. Pentair supplies water-treatment, pool, pumping and flow products through Consumer Solutions and Industrial & Flow Technologies. This unaudited filing covers the quarter and six months ended June 30, 2022; comparisons are with the corresponding 2021 periods unless noted.

Financial results and liquidity

• Q2 revenue: $1,064.2 million, up 13.1%. Price contributed 14.5 percentage points, acquisitions 3.0 points, while volume and currency each reduced growth by 2.2 points.
• Q2 profitability: Gross profit was $359.5 million, up 5.4%, but gross margin fell to 33.8% from 36.2%, reflecting inflation in materials, logistics and labor. Operating income rose 17.9% to $190.8 million; operating margin increased to 17.9% from 17.2%. Net income was $152.9 million versus $132.1 million, and diluted EPS was $0.92 versus $0.79.
• First-half results: Revenue increased 14.2% to $2,063.8 million. Operating income rose 5.6% to $336.6 million, while operating margin declined to 16.3% from 17.6%. Net income was $270.5 million versus $260.7 million; diluted EPS was $1.63 versus $1.55.
• Segments, Q2: Consumer Solutions revenue rose 18.9% to $686.2 million; segment margin was 24.7% versus 24.9%. Industrial & Flow Technologies revenue rose 3.7% to $377.4 million; segment margin was unchanged at 15.7%. Price increases and acquisitions supported growth, while inflation, currency and weaker volumes in some businesses offset gains.
• Cash flow: First-half operating cash flow from continuing operations was $176.3 million, down from $361.0 million. Free cash flow, a company-defined non-GAAP measure, was $138.1 million versus $340.0 million. Pentair attributed the operating cash-flow decline principally to working-capital outflows, including a $144.1 million increase in inventories in the cash-flow statement; inventory was also higher due to inflation and supply-chain inefficiencies.
• Balance sheet and liquidity: Cash was $135.1 million at June 30, versus $94.5 million at December 31, 2021. Total current assets were $1,462.6 million and current liabilities $1,056.1 million. Reported long-term debt was $911.5 million, net of issuance costs and discounts; the debt table reports $922.6 million before those deductions. The revolving facility had $685.0 million of availability. Pentair said existing liquidity and expected operating cash flows should meet ordinary-course needs for the next 12 months.
• Capital returns: First-half dividends paid were $69.5 million and share repurchases were $50.0 million. The quarterly dividend declared was $0.21 per share.

Material changes versus the prior period

• Revenue growth was led by price increases and Consumer Solutions; consolidated volume was slightly negative in Q2. Gross margin contracted in both Q2 and the first half despite pricing actions.
• First-half operating cash flow fell substantially, with working capital—especially inventory—an important use of cash. Capital expenditures increased to $40.1 million from $24.3 million.
• Net interest expense rose to $9.2 million in Q2 from $3.8 million, and to $14.9 million in the first half from $8.9 million. Pentair cited financing commitment fees related to the planned acquisition and higher variable-rate borrowing.
• Backlog declined 17.0% from December 31, 2021 to $1,261.6 million. Consumer Solutions backlog fell 30.0% to $752.1 million; Industrial & Flow Technologies backlog increased 14.2% to $509.5 million.

Outlook, commentary, risks and unusual items

• Outlook: The filing gives no specific numeric revenue or earnings guidance. Management expected supply-chain challenges and inflation in materials, logistics, transportation and labor to continue through the remainder of 2022. Pricing and productivity initiatives were intended to help offset cost pressure.
• Management said Q2 Consumer Solutions shipments outpaced new orders as customers balanced demand and channel inventories, and expected backlog to move toward historical levels. Backlog is not necessarily an indicator of expected 2022 sales.
• Manitowoc Ice acquisition: Pentair agreed to acquire the business for approximately $1.6 billion, with closing expected around July 28, 2022, subject to customary conditions. As of June 30, no borrowings were outstanding under the acquisition term-loan or bridge facilities. Subsequent to quarter-end, Pentair issued $400 million of 5.900% senior notes due 2032 and eliminated the remaining bridge commitments; the company intended to use financing, cash and/or revolving borrowings for the purchase and related costs. The acquisition was expected to increase leverage materially and carries integration, execution and potential undisclosed-liability risks.
• Effective January 1, 2023, Pentair planned to report three segments, splitting Consumer Solutions into Pool and Water Solutions; the planned Water Solutions segment was to include Manitowoc Ice if the acquisition closed.
• Unusual first-half items included $5.9 million of Russia business-exit costs in segment reconciliation, including inventory and contract/order write-offs and uncollectible receivables. Transformation costs were $10.7 million in the first half, versus $1.9 million a year earlier; deal-related costs were $8.0 million versus $1.7 million.
• Other risks discussed include COVID-19 effects, supply constraints, inflation, foreign-exchange movements, Russia-Ukraine-related conditions, seasonal demand and litigation. Environmental reserves were not material. Outstanding bonds, letters of credit and bank guarantees totaled $106.1 million. Management reported disclosure controls were effective and no material change in internal control during the quarter.

Important facts for investors to verify

1. Whether the Manitowoc Ice acquisition closed on the expected terms and timing, its final funding mix, resulting debt and leverage, and integration performance.
2. Whether pricing continues to offset inflation without weakening demand, and whether supply constraints, labor costs and productivity affect margins.
3. Whether inventory and other working-capital balances normalize and operating cash flow recovers; compare cash generation with the company’s free-cash-flow measure.
4. Whether Consumer Solutions backlog declines further and channel inventory changes affect orders and shipments.
5. Debt covenant headroom, refinancing of $88.3 million of senior notes maturing in 2022, and the impact of higher interest costs.
6. Developments in litigation, product-liability claims, guarantees and other contingencies, as well as risks associated with the Russia business exit.