Pentair Ltd. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 29, 2014; comparisons are with the three months ended March 30, 2013. Amounts are in U.S. dollars and millions, except per-share data. Pentair reported four segments: Valves & Controls, Process Technologies, Flow Technologies, and Technical Solutions.
Financial performance
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Net sales | $1,725.2 | $1,774.5 |
| Gross profit / margin | $578.3 / 33.5% | $523.8 / 29.5% |
| Operating income / margin | $179.9 / 10.4% | $74.3 / 4.2% |
| Net income attributable to Pentair | $118.6 | $51.7 |
| Diluted EPS | $0.59 | $0.25 |
| Net cash from operating activities | $0.6 | $19.9 |
| Capital expenditures | $27.2 | $49.7 |
| Free cash flow | $(26.2) | $(28.9) |
Sales decreased 2.8%. Gross margin improved 4.0 percentage points and operating margin improved 6.2 points. Management attributed margin improvement principally to the absence of $76.8 million of prior-year merger purchase-accounting costs, productivity and supply-management savings, and price increases. Lower raw-material and labor costs were not cited; inflation remained a partial offset.
The comparison also includes unusual business-sale items: Q1 2014 recorded an $8.0 million loss on a Flow Technologies divestiture, versus a $16.7 million gain in Q1 2013. The effective tax rate fell to 24.3% from 28.2%, reflecting earnings mix and the timing of losses, partly offset by expiration of certain U.S. tax provisions.
Segment results
| Segment | Sales, Q1 2014 (change) | Operating income, Q1 2014 (Q1 2013) |
|---|---|---|
| Valves & Controls | $534.8 (down 8.7%) | $52.2 ($(18.6)) |
| Process Technologies | $418.3 (up 5.5%) | $46.3 ($43.4) |
| Flow Technologies | $364.1 (down 6.8%) | $27.5 ($31.4) |
| Technical Solutions | $415.3 (up 1.3%) | $76.2 ($53.3) |
Valves & Controls’ operating-income turnaround was substantially aided by the prior-year purchase-accounting charge not recurring. Process Technologies grew on pool products and food-and-beverage demand. Flow Technologies was affected by currency, a nonrecurring Australian project, divestitures, and cost inflation. Technical Solutions’ profit improvement reflected lower restructuring costs and operating savings.
Balance sheet, cash flow, and liquidity
At March 29, 2014, cash was $211.1, total debt was $2,936.6 (including $896.3 of commercial paper), and long-term debt was $2,933.8. Debt increased from $2,555.1 at year-end 2013. Current assets were $3,305.3 and current liabilities $1,528.1. Shareholders’ equity attributable to Pentair was $5,936.3. Commercial paper was classified as long-term based on management’s intent and ability to refinance under its revolving facility.
Operating cash flow was nearly flat as working capital used cash, including higher receivables and inventory ahead of the seasonal peak. Financing included $269.6 of share repurchases, $134.7 to acquire the remaining 19.9% of Pentair Residential Filtration, and $49.2 of dividends paid. Cash declined $54.0 during the quarter. The company reported $539.2 of availability under its main credit facility and compliance with debt covenants; $76.3 of cash was held in countries where repatriation is limited or could have significant tax consequences.
Outlook, commentary, and risks
- Management expected 2014 capital expenditures of approximately $185 million and continued to expect full-year free cash flow above 100% of net income. It reported a long-term goal of free-cash-flow conversion of at least 100%; no specific revenue or EPS guidance is provided in the filing.
- Management cited ongoing merger integration, growth in selected markets, product development, and operating-efficiency initiatives as priorities. It noted continued cost inflation, raw-material price volatility, foreign-currency exposure, economic uncertainty in Australia, and differing end-market conditions.
- The proposed redomicile would replace the Swiss parent with an Irish-incorporated parent intended to be centrally managed and tax resident in the U.K. Shareholder approval was scheduled for May 20, 2014; completion and expected benefits remained subject to conditions.
- Asbestos exposure included approximately 2,100 pending lawsuits and 2,300 outstanding claims. Recorded asbestos liabilities were $254.1 and related insurance receivables were $119.3; actual outcomes and recoveries could differ materially from estimates. Environmental reserves were $39.2.
- Outstanding bonds, letters of credit, and bank guarantees totaled $527.7. The filing says the potential amounts of certain indemnification obligations cannot be reasonably estimated. Management did not anticipate environmental matters or these uncertainties to have a material adverse effect, but outcomes remain uncertain.
Most important facts for investors to verify
- Whether improved margins and earnings persist after accounting for prior-year merger purchase-accounting charges and the differing business-sale results.
- Whether working-capital investment reverses seasonally and Pentair achieves its full-year free-cash-flow expectation.
- How commercial-paper borrowings, debt levels, interest costs, and credit-facility availability evolve.
- Progress and shareholder approval of the proposed redomicile, including its tax and financing implications.
- Developments in asbestos claims, insurance recoveries, environmental matters, and other guarantees or indemnities.