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EDITED TRANSCRIPT
PNR - Q1 2015 Pentair plc Earnings Call
APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
CORPORATE PARTICIPANTS
Jim Lucas Pentair plc - VP of IR
Randy Hogan Pentair plc - Chairman and CEO
John Stauch Pentair plc - EVP and CFO
PRESENTATION
Operator
Good morning. My name is Jody and I will be your conference operator today. At this time I would like to welcome everyone to the Pentair Q1 2015
earnings conference call. (Operator Instructions). Thank you.
Jim Lucas, VP of Investor Relations, you may begin your conference.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
We will be sure to reserve time for questions and answers after our prepared remarks. I would like to request that you limit your questions to one
and a follow-up, and get back in the queue for further questions in order to ensure everyone an opportunity to ask their questions.
I will now turn the call over to Randy.
APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Now let's turn to slide 7 for a more detailed look at the first-quarter results. Our 4% core sales decline consisted of 5 points of volume decline, and
1 point of positive contribution from price. FX subtracted another 6%. Adjusted operating income declined 15% in the quarter, and operating
margins contracted 60 basis points, even though we continue to see Lean, sourcing actions, and standardization efforts in G&A gain traction. We
are accelerating our cost actions to adjust to the reality of the FX environment and lower core volumes, which should reverse this operating margin
contraction.
Now let's turn to slide 8 for a review of our largest segment, Valves & Controls. Valves & Controls has seen a fair amount of quarter-to-quarter
volatility in its performance, and the first-quarter saw both sales and orders fall double digits.
North America was the one pocket of strength, particularly in process and with LNG customers. But all other geographies were down, with
double-digit declines in fast growth regions as customers seemed to be delaying, and, in some cases, canceling projects.
For the first-quarter, Valves & Controls' core sales declined 11% and FX translation was a further 8% headwind. Including significant adjustments
due to currency translation, the quarter-ending backlog declined 4% sequentially, following a 7% decline in the fourth-quarter of 2014.
Over half of this six-month backlog decline was a result of FX headwinds. Given the backlog is generally shippable in the next 6 to 12 months, we
feel it is prudent to adjust backlog for FX to give the most appropriate view of the state of the business.
Core orders declined 15%, which we will discuss in more detail in the next slide. Total orders declined 22% when including negative FX translation.
During the quarter we saw some customers directed delays of scheduled shipments, and this accelerated near the end of the quarter.
We anticipate some delays in expedites and shipments every quarter, but the first-quarter saw an even greater amount of net delays than we are
accustomed to seeing. We did not see a material increase in project cancellations, but we are seeing more customers requesting delayed deliveries,
which is not surprising within Oil & Gas, but we have also seen it in the process industries.
The right half of the page shows first-quarter Valves & Controls operating profits and margins. While our lean, sourcing, and standardization continue
to drive productivity within Valves & Controls, it was not enough to offset the volume drops in an already typically slow period. And FX translation
also had some impact in the 31% drop in operating income.
We're still making progress with our change agenda, and gross margins in Valves & Controls expanded as a result of strong productivity. So we
continue to feel good about our efforts underway, including lean transformation and the OMT initiative within Valves & Controls. While the strong
margin gains of the past two years are encouraging, there is much more to do. So we plan to go even more aggressively after the cost structure
and getting results from where we are investing for growth.
Now let's turn to slide 9 for a look at the orders and backlogs for Valves & Controls. As you can see on slide 9, Valves & Controls' backlog is broken
down into four key industries, three of which fall under our Energy vertical -- those being Oil & Gas, Power & Mining, and Industrial -- and one in
our Industrial vertical, which is called Process here.
Orders were down double-digits across all four industries in the quarter. While the impacts to our Energy-related businesses were not a surprise,
given the decline in oil prices, Process order weakness was not expected, and declined globally, with North America the lone bright spot.
We're not expecting orders to improve during 2015 as customers continue to reevaluate existing projects and their pipelines for planned projects.
Although backlog has been hurt by the stronger dollar, we saw a decline in our backlog in real business terms, as well.
We will continue to focus on capturing shorter cycle MRO business, which has remained somewhat stronger than projects. While we do not expect
the global capital strike to last forever, we are being cautious and are rightsizing in the current reality that Valves & Controls is likely to see top-line
pressure throughout the year.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
We continue to believe in the long-term prospects for Valves & Controls and the transformation is underway, but the next several quarters will be
focused more on costs while anticipating increasing price pressure on the existing business.
Now let's move to slide 10 for a look at Flow & Filtration Solutions. Flow & Filtration Solutions saw a 13% top-line decline as core sales fell 7% and
FX translation was an additional 6% impact.
All four verticals served by Flow & Filtration Solutions saw a decline. Residential & Commercial fell 11% as global weakness and destocking in some
of our North American distributor channels impacted the top line. Infrastructure was down 14% as municipalities continued to delay spending,
although we have remained more disciplined on pricing and believe we are seeing declines greater than the market. Food & Beverage was down
2% as the strength in global beer and dairy was not enough to offset declines in agriculture spending.
Segment income declined 16%, but margins contracted only 40 basis points despite the volume, FX, and mix drags during the quarter. Productivity
readout was strong, and we believe we continue to have a long runway for improvement in margins within Flow & Filtration Solutions. Given the
weaker top-line environment, we plan to go after more than just G&A standardization opportunities, and accelerate our rightsizing efforts within
this segment.
Now let's move to slide 11 for a look at Water Quality Systems. Water Quality Systems was a bright spot in the quarter, with core sales growth of
4%. The growth within Water Quality Systems was not a surprise given that they are over 70% in North America and mostly serve the Residential,
Commercial, and Food & Beverage verticals, which have been our two growth verticals recently. Our Aquatic Systems business started strong, and
we believe is well-positioned entering the pool use season. Our food service business continued to grow globally with core sales up 11% in the
quarter.
The right half of the page shows first-quarter Water Quality Systems operating profits and margins. Segment income grew 3% and margins expanded
40 basis points to 16.1%. Price and productivity offset inflation and new product development investments continue. Our outlook for Water Quality
Systems remains positive, and we expect to see solid growth and margin expansion for the full year.
Let's now turn to slide 12 for a look at Technical Solutions results. Technical Solutions saw core sales grow 1%, which was offset by a 6% FX translation
headwind. Energy was up 2% as our heat management solutions business entered the year with strong backlog, including two larger projects
beginning to ship. We will watch orders closely as the year progresses.
Industrial was flat as our equipment protection business was impacted by delays in industrial spending that occurred in the quarter. Residential &
Commercial grew nicely. And despite a tough comp, Infrastructure also was up modestly, driven by telecom.
The right half of the page shows first-quarter Technical Solutions operating profits and margins. Segment income declined 8%, and margins
contracted 70 basis points to 18.4%. With the absence of price in the quarter, productivity was not enough to offset inflation, and mix further
hampered the income and margin performance during the quarter. Negative FX transaction costs were a factor in margins as strong growth in
Canada, combined with a strengthening dollar, squeezed margins on our US-made products.
Following the end of the first-quarter, we closed a small, bolt-on acquisition within Technical Solutions for our thermal building solutions business,
which we believe has attractive growth opportunities. We have five criteria around acquisitions, and this transaction met all five. The deal made
strategic sense and made financial sense. We were the right buyers. We have a detailed integration plan, and we know who will lead that integration.
Although parts of Technical Solutions will be addressed in cost structure as a result of FX and mix, we believe we have an interesting M&A funnel
for this segment.
Now let's turn to slide 13 for a review of our key verticals and the expectations for growth in 2015. Given the difficult start to the year, we have
adjusted our expectations across all verticals.
Starting with Industrial, our largest vertical, representing roughly 29% of sales, we now expect core sales to decline 4% to 6% in 2015. While Valves
& Controls continue to see strength in sales and orders with its North American chemical customers in the first-quarter, the rest of the globe saw
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
a sharp decline in orders. The remaining parts of Valves & Controls' Industrial business also saw weakness, including industrial gas and shipbuilding.
We do not expect the channel and customer destocking to continue throughout the year, but pricing is something that we're actively managing.
Core sales in our second-largest vertical, Residential & Commercial, are still expected to grow 2% to 3% for the full-year. But the slow start to the
year has led us to shave a couple of points off of our expected full-year growth rate. We believe that our aquatic systems business within Water
Quality Systems is well positioned for another strong pool season in North America. And while a smaller piece of our vertical, we expect improvements
in non-residential construction as well.
Roughly 10% of our sales are within our Food & Beverage vertical, which we expect to grow 5% to 7% on a core basis for the full-year. This is on
the anticipated strength of our global beverage and food service businesses. Food service had a great first-quarter and should stay strong through
2015. While core sales growth in beverage is also expected to be strong, this is a global business that we expect to be negatively impacted by FX
translation.
The strength in Food & Beverage is in both beer and dairy. Within Food & Beverage we also include the agriculture-related businesses in Flow &
Filtration Solutions. While we are driving differentiated growth in agriculture, it will likely continue to be a drag on growth in our Food & Beverage
vertical.
Within our Infrastructure vertical, which accounts for less than 10% of our overall sales, we are now anticipating a modest decline in core sales for
2015. We knew our Electronics Protection business in Technical Solutions faced a tough comparison to start the year, but we are encouraged to
see modest growth in the first quarter.
We expect our Infrastructure-related businesses within Flow & Filtration Solution serving global desalinization, water treatment, and water supply
to continue to be challenged. While it appears that municipal desalination markets have bottomed, we do not expect any recovery this year. Within
North America, the Infrastructure break and fix business is expected to remain mixed, with continued price competition.
We now expect Energy core sales to decline 6% to 8% for the year. This includes Oil & Gas, Power, and Mining industries for us. The upstream
business has been as weak as we had anticipated. We now expect a continued pause in shorter cycle downstream business as capital spending
delays or reductions have spread to midstream and downstream as well. We saw continued strength in North American LNG, but the majority of
global Oil & Gas was as weak, if not weaker, than we were expecting entering 2015.
Let's now turn to slide 14 for a look at our updated 2015 adjusted EPS guidance. As we take into account the challenging start to the year and the
pause in global capital spending, we are adjusting our guidance to approximately $3.80 per share from a range of $4.10 to $4.25 per share.
The volume shortfalls will not be overcome in one quarter. We are taking corrective cost actions that we expect to begin to read out in the second
half of 2015 and also benefit 2016.
We do not foresee the Industrial pause continuing indefinitely, but until we see customers beginning to spend again, we will remain cautious. In
the meantime, we plan to continue to invest for the long-term. Not all of our businesses have been impacted in the short-term; and with our strong
balance sheet and cash flow, we will be thoughtful as we look at M&A opportunities.
With that, I will turn the call over to John to give more details on the cost actions we are taking, and provide additional color on the outlook. John?
APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
If the dollar weakens, we would expect to benefit, but we are not counting on it. The cost actions will primarily be in Valves & Controls and Flow &
Filtration Solutions, the two segments hit hardest by the global capital spending pause. We expect these actions will yield $40 million in savings
in 2015 and a cumulative $100 million-plus in 2016. We plan to continue to focus on G&A and variable labor, but we are also expanding our cost
actions to our fixed cost structure.
Please turn to slide number 16, labeled 2015 Current Outlook. This slide looks at the changes that have occurred since we last updated our forecasts
in early February. We experienced lower-than-expected volumes in two of our larger verticals, Energy and Industrial. And we are now anticipating
pricing to be flat for the year, and down for the next three quarters as our Valves & Controls segment is expected to see increasing pricing pressure
as the year progresses. Within the Residential & Commercial vertical, we expect another strong year in North America, while anticipating residential
spending around the globe at slower levels.
We believe that Food & Beverage will continue to be a bright spot, where we expect benefits from commercial expansion. We do not expect the
negative operating leverage from lower volumes to be offset immediately, and the translation impact discussed previously has become more
challenging. We plan to continue to drive productivity, and expect the cost savings from our actions to read out in the second half and to help
mitigate some of the top-line challenges. We still expect operating margins to expand approximately 50 basis points to 15% for the full year.
Please turn to slide number 17, labeled Balance Sheet and Cash Flow. Quarter-ending debt was approximately $3.4 billion, or $3.3 billion on a net
debt basis, inclusive of global cash on hand.
In the first-quarter, we returned $258 million in cash to shareholders in the form of dividends and share repurchases. We completed $200 million
in share repurchases during the quarter, and we have $800 million left under our current $1 billion authorization.
Our ROIC ended the quarter at 10.9%. The first-quarter has historically been a seasonal usage of cash, just as it was this year, but we expect strong
cash flow during the second-quarter and throughout the second half of the year.
Please turn to slide number 18, labeled 2015 Forecasted Cash Flow Usage and Capital Allocation. For the full-year, we are expecting free cash flow
of approximately $900 million, or greater than 120% of net income. We anticipate returning nearly $200 million to shareholders through additional
dividends for the remainder of the year. We remain committed to our investment grade rating and will remain disciplined in our capital allocation
approach.
We expect to continue to fund organic growth opportunities, and that capital expenditures will be slightly ahead of depreciation. We still see select
opportunity for M&A in some of our businesses. If these deals do not materialize as we get later into the year, we will consider incremental share
repurchases.
Please turn to slide number 19, labeled Q2 2015 Pentair outlook. For the second quarter we expect core sales to decline approximately 3% to 4%,
and FX to present a 7% headwind.
On a core basis, we expect Valves & Controls sales to be down 13% to 15% based on the shippable backlog and what we expect to be further project
delays. Flow & Filtration Solutions' core sales are anticipated to be down 3% to 4% on slower Industrial and Infrastructure business. Water Quality
Systems' core sales are expected to grow 6% to 7% as we enter the peak period for North American residential, which includes another expected
strong pool season.
Finally, Technical Solutions' core sales are anticipated to be up 3% to 5% on the strength of Energy backlog in our heat management solutions
business, and some expected increase in Industrial capital spending as the quarter progresses.
We are expecting adjusted operating income to be down roughly 10%, and adjusted operating margins to contract 10 basis points to 15.1%. Below
the operating line, we anticipate our tax rate to be approximately 23%; net interest and other to be around $18 million; and the share count to be
approximately 182 million. Our second-quarter adjusted EPS range of $0.95 to $0.96 represents a decline of roughly 6% year over year. As mentioned
previously, we are expecting a strong quarter of cash flow.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Please turn to slide number 20, labeled full-year 2015 Pentair outlook. For the full-year, we are now expecting adjusted EPS of roughly $3.80, as
the cost actions we are implementing in the second quarter are not anticipated to be enough to fully offset the volume shortfall and negative FX
translation impact that hit our first-quarter results.
For the full-year, we expect core sales to decline 2% to 3%, and FX to be around a 6% headwind. Valves & Controls' sales are anticipated to be down
8% to 10% on a core basis. Flow & Filtration Solutions' sales are expected to be down 4% to 6% on a core basis. Water Quality Systems' sales are
anticipated to be up 6% to 7% on a core basis. And Technical Solutions' sales are expected to be up 2% to 4% on a core basis.
We anticipate growth in our Residential & Commercial and Food & Beverage verticals, with Energy and Industrial declines expected to continue.
We expect adjusted operating income to be down 5% for the year, and adjusted operating margins to expand 50 basis points to 15%. We will
continue to right size our cost structure for the economic realities we are facing, but it will take time for those savings to begin to materialize.
We expect overall corporate costs to be approximately $100 million; net interest and other to be around $73 million, and our full-year tax rate
around 23%; and the share count for the full-year to be approximately 182 million. Adjusted EPS is expected to be roughly flat in the pause year
we are anticipating. Finally, we expect another strong year of free cash flow at approximately $900 million, or greater than 120% of net income.
Jody, can you please open the line for questions? Thank you.
APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Operator
Joe Ritchie, Goldman Sachs.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
your organic growth guidance for the year of down 2% to down 3%, comps get tougher. Organic growth was down 4% in the first quarter. I'm just
trying to get a sense for what gives you the confidence that you'll get some improvement as the year progresses.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Operator
Steve Tusa, JP Morgan.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Steve Tusa - JPMorgan - Analyst
And then I think you said in Valves & Controls next year, just kind of at a high level, 100 to 200 basis points is not out of the question. As we move
through the quarter here and see what you are seeing on your dashboard, is that now maybe a little bit too aggressive? Could we see more -- we
just haven't lucked out with these price declines in a long time in any of the markets we cover, so the magnitude is always kind of tough. Could it
be worse than that, do you think, in 2016?
Operator
Steven Winoker, Bernstein.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Steven Winoker - Sanford C. Bernstein & Company - Analyst
I want to stick on the pricing and margins theme for a minute. We're entering this environment, you've had significant material deflation and I think
is a tailwind, as well as pricing up until now has been helpful. Now those are both going against you.
And my question is, given that you don't know how long this will last, the restructuring that you've already taken, and that is going to be fairly
aggressive here, how much more can you do there? Because there seems to be some risk to the margin opportunity going forward.
APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
This business bolt-on has augmented our offering, gives us more to put through our distribution channel. So it fit those five questions. It fit our
strategy well; so our strategy to drive growth, profitable growth, it fit it well. The financials made sense. We were able to do that deal with a
comfortable set of financials that we know we can execute. We were the right buyer. We had the best fit, that's why the financials were the best.
And the last two things, we don't do a deal unless, one, we understand how we're going to integrate it into the Company; and then, two, we know
who's going to be in charge of the integration, and we trust them to execute it well.
And so we're going to keep to that discipline and make sure -- we might start at the bottom and say which businesses are ready, which businesses
are both strategically ready and capacity ready. And we always do that, but I think you should all count on us to continue to do that, put that first.
Operator
Scott Graham, Jefferies.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Randy Hogan - Pentair plc - Chairman and CEO
We also don't think that the MRO decline we saw in the first quarter -- the short cycle MRO decline is going to be as acute as it was in the third-quarter
-- I mean, as it was in the first-quarter.
Operator
Shannon O'Callaghan, UBS.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
But on the fast growth side, both China and Brazil were down significant double-digits in the quarter. And Brazil, I guess, isn't that surprising. China
was more surprising than we expected, and that was in chemicals as well as Oil & Gas, I mean in Industrial.
Operator
Nathan Jones, Stifel.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Nathan Jones - Stifel Nicolaus - Analyst
There's been a lot of talk about the pricing pressure that you guys are feeling and are planning on feeling. Can you discuss a little bit more where
the opportunities are for you to put pressure on your suppliers in terms of pricing to participate in the pain, if you will?
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
So we're trying to keep pricing disciplines that reflect our margin goals, but also where we make things in that Infrastructure space.
On the Residential & Commercial side, I would say we haven't really seen pricing pressure. We feel pretty good about that. In some of the areas
that we are weaker in residential are not in North America. They are Europe and the Middle East, but we think Europe is actually showing some
signs of life in Residential & Commercial. We didn't see it clearly in the first-quarter, but we saw some promising signs. So I'd say the pricing is really
more of a concern in Energy and in Industrial, not in Residential & Commercial.
Operator
Jeff Hammond, KeyBanc Capital Markets.
Operator
Brian Konigsberg, Vertical Research Partners.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Brian Konigsberg - Vertical Research Partners - Analyst
New bids only, okay. And then lastly, are you seeing any trends where, for larger projects, you are seeing the customer base or potentially even the
E&Cs substitute -- start to substitute maybe some of the domestic, higher-quality suppliers of Valves & Controls with -- maybe in some of the
non-critical applications, with some of the lower cost and potentially lower quality suppliers, potentially out of Asia?
Operator
Brian Drab, William Blair.
APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Operator
Christopher Glynn, Oppenheimer.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Christopher Glynn - Oppenheimer & Co. - Analyst
Fair enough. And then just quickly the MRO side, I think that pressure would be more concentrated in the first quarter. Can you just elaborate briefly
on that?
Operator
Josh Pokrzywinski, Buckingham Research.
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APRIL 21, 2015 / 1:00PM, PNR - Q1 2015 Pentair plc Earnings Call
Operator
Thank you for participating in today's earnings conference call. This call will be available for replay beginning at 11 o'clock a Central Time today,
April 21, 2015, through midnight on May 29, 2015. The conference ID number for the replay is 22709435. The number to dial for the replay is
855-859-2056.
And this concludes today's conference call. You may now disconnect.
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