Pentair Ltd. — Q1 2013 Form 10-Q
Business context and period. The filing covers the 13 weeks ended March 30, 2013. Pentair’s current business was formed in September 2012 through the Flow Control spin-off and merger with Pentair, Inc. It reports Water & Fluid Solutions, Valves & Controls, and Technical Solutions. Unless noted, financial amounts are in millions of dollars.
Comparability caution: Q1 2013 includes Flow Control after the merger; reported Q1 2012 results do not. The year-over-year increases in consolidated revenue and other measures therefore are not directly comparable. Management says the merger contributed $888 million of Q1 2013 sales.
Key financial results
| Metric | Q1 2013 | Q1 2012 |
|---|---|---|
| Net sales | $1,774 | $858 |
| Gross profit / gross margin | $524 / 29.5% | $281 / 32.7% |
| Operating income | $74 | $86 |
| Net income attributable to Pentair | $52 | $62 |
| Diluted EPS | $0.25 | $0.62 |
| Net cash from operating activities | $20 | $(68) |
| Free cash flow | $(29) | $(82) |
- Revenue rose 106.8%, primarily because the post-merger period includes Flow Control. Organic growth included stronger pool and agriculture-related demand and growth in the Middle East and Latin America; weaker developed-market Asia and Europe partly offset gains.
- Gross margin declined 3.2 percentage points. Management cited $77 million of merger purchase-accounting inventory and customer-backlog step-up costs, plus raw-material and labor inflation.
- SG&A was $416 million, or 23.4% of sales, versus $174 million, or 20.3%. Merger-related amortization, integration and restructuring costs, and labor costs contributed to the increase.
- Operating results by segment: Water & Fluid Solutions income was $75 million (9.6% margin), versus $64 million (10.9%); Valves & Controls recorded a $19 million operating loss, including $70 million of purchase-accounting step-up costs; Technical Solutions earned $53 million (13.0% margin), versus $50 million (18.3%). Segment comparisons are affected by the merger.
- Q1 net income included a $17 million gain on sale of a Technical Solutions business; proceeds were $30 million net of transaction costs. The sale remains subject to a working-capital adjustment.
- Effective tax rate was 28.4%, compared with 13.7%, mainly because favorable U.S. tax-audit resolutions benefited the prior-year quarter and because of the timing of losses in jurisdictions where tax benefits are not recognized. Net interest expense was $17 million, up from $15 million, reflecting higher post-merger debt, partly offset by lower rates and higher cash balances.
Balance sheet, cash flow, and liquidity
- At March 30, 2013, cash was $215 million; total assets were $11.721 billion; current assets were $3.290 billion and current liabilities $1.483 billion.
- Total debt was $2.598 billion, including $527 million of commercial paper; long-term debt was $2.592 billion. Debt increased from $2.457 billion at year-end 2012. Cash was partly constrained: $141 million was held in countries where repatriation is limited by regulation or potential tax consequences.
- The $1.450 billion revolving credit facility had $886 million available; commercial paper is backed by the facility. The company reported compliance with debt covenants at quarter-end. It also had $88 million of availability under other credit facilities, with $3 million outstanding.
- Operating cash flow improved to $20 million from an outflow of $68 million, but receivables increased with sales. Capital expenditures were $50 million, versus $16 million. Free cash flow, defined by the company as operating cash flow less capital expenditures plus asset-sale proceeds, was negative $29 million.
- Financing cash outflow was $38 million, including $140 million of share repurchases and $47 million of dividends, partly offset by $140 million of net receipts from commercial paper and revolving debt. Cash declined $46 million during the quarter.
Outlook, commentary, and risks
- Management expected 2013 capital expenditures of approximately $200 million and continued to expect full-year free cash flow above 100% of net income before noncontrolling interest. Its longer-term objective is free-cash-flow conversion of at least 100% of net income.
- Management cited improving housing and pool markets, but noted uncertainty in end markets, continued weakness in Western Europe, volatile raw-material costs, and the need to offset inflation through productivity and selective pricing. Priorities include merger integration, growth in fast-growing regions, product innovation, and operating-efficiency initiatives.
- Q1 restructuring initiatives reduced approximately 400 positions and generated $22 million of restructuring costs; the restructuring accrual was $59 million at quarter-end. Management also described approximately 1,000 positions eliminated in 2012.
- The preliminary merger purchase-price allocation remained subject to refinement, with completion expected in Q3 2013; final adjustments could be material. The company recorded $4.867 billion of goodwill and $1.859 billion of net intangible assets at quarter-end.
- Contingencies include approximately 1,900 pending asbestos lawsuits and 2,300 outstanding claims. The recorded asbestos liability was $234 million and related insurance receivable $157 million; actual liabilities and recoveries may differ materially. Environmental reserves were $36 million. Outstanding bonds, letters of credit, and bank guarantees totaled $514 million.
- Potential shared tax liabilities under agreements with Tyco and ADT could exceed Pentair’s agreed share in certain circumstances. Open IRS matters concerning Tyco’s 1997–2004 tax years were expected to proceed to litigation; resolution could adversely affect Pentair if it is responsible for shared liabilities.
- The board recommended dividends of $0.25 per share for each of Q3 and Q4 2013 and Q1 and Q2 2014, subject to shareholder approval. The proposed total is subject to a Swiss-franc contributed-surplus cap; exchange-rate changes could reduce dividends. The company also disclosed that future dividends are not assured.
- Management identified merger integration, global economic conditions, pricing and competition, currency and commodity volatility, housing-market trends, backlog execution, and litigation and regulatory outcomes as risks. It reported disclosure controls were effective and no material change in market risk during the quarter.
Investor verification priorities
- Separate organic performance from the merger’s revenue and earnings contribution; confirm the eventual purchase-price allocation and integration costs.
- Track segment margins, particularly the Valves & Controls loss, and the effects of purchase-accounting charges, amortization, restructuring, and inflation.
- Assess working-capital conversion, capital spending, and progress toward management’s full-year free-cash-flow objective.
- Monitor debt, commercial-paper reliance, credit-facility availability, covenant compliance, and cash subject to repatriation limits.
- Review developments in shared tax matters, asbestos claims and insurance recoveries, and the proposed dividend authorization and Swiss-franc cap.