Q2 2019 Earnings Call

[music]. Good morning, My name is Robin it will be your conference operator today at this time I would like to welcome everyone to the Q2 2019 Pentair earnings Conference call.

All lines have been placed on mute to prevent any background noise.

After your presenters remarks, there will be a question and answer session. If you'd like to ask a question during that time simply press Star then the number one on your telephone keypad, if youd like to withdraw. Your question you May press the pound key. Thank you Mr., Jim Lucas you May begin your conference.

Thanks, Rob and welcome to Pentair second quarter 2019 earnings Conference call. We're glad you could join US I'm, Jim Lucas Senior Vice President of Investor Relations and Treasurer and with me today is John Stout, our President and Chief Executive Officer, and Mark born our Chief Financial Officer.

On today's call, we will provide details on our second quarter 2019 performance as well as our third quarter and full year 2019 outlook as outlined in this mornings press release.

Before we begin let me remind you that any statements made about the company's anticipated financial results are forward looking statements subject to future risks and uncertainties such as the risks outlined in pentair as most recent Form 10-Q Form 10-K , and today's press release forward. Looking statements included herein are made as of today and the company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances actual results could differ materially from anticipated results. Today's webcast is accompanied by a presentation, which can be found in the investor Relations section of Pentair as web site.

We will reference these slides throughout our prepared remarks any references to non-GAAP financials are reconciled in the appendix of the presentation, 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 in order to ensure everyone an opportunity to ask their questions I will now turn the call over to John .

Thank you Jim and good morning, everyone.

Please turn to slide number four titled Executive summary.

We're pleased to deliver second quarter results in line with our expectations, even as weather issues lingered throughout the quarter.

We continue to believe that the underlying demand trends in our businesses remain healthy and we have plenty of growth opportunities ahead of us.

Our second half outlook demonstrates progress against unprecedented inflation inclusive of tariffs and we now believe that we will get back to 18% tax rate for the remainder of 2019 and for 2020.

Our recent acquisitions Aquion in Pelican are performing in line with expectations further both deals help us accelerate our residential water treatment strategy, which I will provide an update on later in the call.

We are continuing to invest in our top growth priorities and I will provide more color on are focused opportunities. After mark shares details on Q2, and our updated guidance I will now turn the call over to Mark.

Thank you John Please turn to slide five labeled Q2 19 pentair performance.

For the second quarter, we saw core sales increased 1%.

Segment income fall, 6% and adjusted EPS was down 3%.

We will provide more color on the individual segment performance shortly.

Below the line, we saw an adjusted tax rate of 18% net interest other expense of 10.6 million and our average shares in the quarter were $170.5 million.

We had originally expected our tax rate to increase in 2019 due to proposed IRS rule changes.

Because the proposed rules have not yet been finalized and enacted.

As well as the actions to help mitigate the expected impact we now believe our full year adjusted tax rate will be at the 18% level, we reported in 2018.

Finally free cash flow was well north of 300 million and in line with normal seasonal patterns.

As John mentioned in his opening remarks, we are pleased to deliver operational results in line with expectations. Despite the lingering weather issues.

Please turn to slide six labeled Q2, 19 Pentair segment performance.

This slide lays out the second quarter performance of our three segments.

As this slide illustrates two of our three segments delivered core sales growth in the quarter. The lone exception was aquatic which continues to be impacted by weather delays and excess channel inventory.

Aquatic saw segment income declined 4% on a 2% core sales decline.

Filtration solutions returned to growth delivering 1% core sales growth. We commented that the first quarter results were impacted by a number of onetime issues and we believe that the second quarter performance shows that many of those issues have moderated.

Segment income was down 4% and margins declined 250 basis points against a very tough comparison last last year and negative mix during the quarter.

We saw growth in our industrial and food and beverage businesses, while residential was relatively flat in the quarter.

We continue to focus on positioning filtration solutions to drive more consistent and predictable growth and anticipate margins mixing up overtime.

Flow technologies delivered 5% core sales growth as price continued to read out and we also saw improvement in our commercial and infrastructure businesses.

Although the agriculture markets continued to be down for US agriculture culture performed in line with our revised expectations.

Segment income declined 6%. However, the segment margin declined was half the rate we experienced in the first quarter.

This was the last last tough comparison around inflation and we are expecting flow margins to turn positive in the second half.

Please turn to slide seven labeled balance sheet and cash flow.

We are pleased with our second quarter cash flow performance and delivered 343 million in free cash flow, which is in line with normal seasonal patterns.

During the quarter, we successfully completed a $400 million 10 year note offering which was used to repay debt incurred to fund our first quarter acquisitions and will also be used to help fund our second half debt maturities with a new offering our debt structure is now predominantly fixed and we continue to have strong balance sheet optionality.

Also in the second quarter, we repurchased $150 million of our shares in line with our annual share repurchase plan.

Please turn to slide eight labeled Q3 19 pentair outlook.

We anticipate third quarter sales core sales to decrease 1% to 3%.

We expect aquatic systems to be down 8% to 10% as we continue to focus on making sure channel inventories returned to more normalized levels by the end of the year.

We expect filtration solutions to be up 1% to 3% and flow technologies to be flat to up 2%.

We anticipate segment income to be approximately flat to up 2% as we expect inflation comparisons to ease and price to fully read out and we continue to drive productivity. We expect adjusted EPS to be in a range of 54 to 56 cents per share.

Below the line, we expect corporate expenses to be approximately 14 million to $15 million.

We expect our third quarter tax rate to be 18%.

We also expect net interest to other expense of roughly $9 million and shares to be approximately $169 million.

Please turn to slide nine labeled full year 2019 pentair outlook.

Slide nine looks at the different components of our updated 2019 outlook.

For the full year, we expect core sales to be flat to down 1% as we continue to expect price of roughly 3% for the full year.

We expect total.

Flat to up 1% with roughly 2% contribution from the recently announced acquisitions offset by a 1% headwind from FX.

We anticipate segment income to be approximately 2%, we expect full year adjusted EPS to be approximately $2.35 per share.

Other items embedded in our guidance include corporate expense of $60 million to $65 million a tax rate of 18%.

Net interest other expense of $37 million and an average share count for the year of 171 million shares.

As we look at our 2019 second half and full year expected performance. It is important to consider the unusual circumstances, we have experienced in 2018 and the first half of 2019.

Starting in the second half of 2018 and through the first half of 2019, we experienced significant material inflation, partially driven by tariffs of over $120 million and 2018, we implemented price increases in part to address this dramatic increase in inflation and the net result was a significant increase in inventory levels in our distribution channels.

Through the first half of 2019 as these elevated inventory levels are being worked down several of our key markets and pools and agriculture, we were hit with historically wet cold weather, resulting in a delay in inventory channel levels being worked down.

We believe this perfect storm of unusual external factors resulted in far from normal experience in the first two quarters of 2019.

As we look forward to 2020, we expect to return to a more normalized level of performance more in line with our long term expectations I would now like to turn the call back to John .

Thank you Mark.

Please turn to slide number 10 labeled focused strategies.

I wanted to provide an update on our two focused growth strategies. We recently completed a comprehensive north American residential consumer segmentation, which has provided great insights into how to better position two of our key businesses pool and residential commercial water filtration for differentiated growth.

The segmentation analysis gave us granularity as to our customers' needs behaviors in key attributes.

These insights allow us to better understand their buying behaviors as well as customer journey mapping in future product insights to meet their needs.

These insights are critical to driving our marketing efforts and to be more targeted in the type of person is that we want to engage with in the future and how to best connect them with our channel partners.

As we focus on advancing pool growth, we have opportunities in both the new and replacement markets.

Well there are only about 75000, new pools built the year, we see opportunities to increase our content per pool, particularly around automation and connected solutions as well as new products in the areas of remote monitoring advance energy efficiency and simplicity of maintenance.

These are also similar opportunities with the approximately 5 million installed in ground pools. We continue to look at the Coolpad is pools ecosystem.

Through this lens, we are developing more efficient treatment technologies as well as smart and I OTI enabled products that seamlessly configure and operate more effectively together.

These solutions are being managed by what we believe are best in class apps that enable a superior user experience as well as opportunities to drive improved levels of customer service.

Accelerating residential commercial water treatment is our other primary growth opportunity.

The first area, we're focusing on is end to end residential consumer filtration.

Here are two recent acquisitions are playing an important part.

Aquion brought to us systems capabilities as well as affiliated rain soft dealers.

Pelican brought an online capability that expands our omnichannel reach.

Similar to what we have done in aquatic systems, we have been looking at water treatment applications throughout the home as a system offering.

Through this work we have identified many customer back opportunities to create differentiated water treatment products and systems. We are developing more efficient treatment technologies tackling some of the challenges that are top of mind for consumers today, such as lead removal and delivering great tasting water that every tap in your home.

We also have been developing and will soon be launching the pentair home the pentair pro apps that bring our new suite of smart I OTI enabled products to life.

These sets of apps seamlessly connect consumers water treatment service providers and pentair to buy product performance monitoring control and service.

The second opportunity, we see is building our commercial filtration business. We've enjoyed a strong presence in foodservice historically and we plan to continue to focus in this area.

There are other areas such as commercial office water that offer additional growth opportunities over time.

We believe that these are two significant and focus growth opportunities that could accelerate our organic growth rates and create significant shareholder value.

I would now like to turn the call over to Rob for Queuing day, after which I will I will have a few closing remarks, Rob. Please open the line for questions. Thank you.

And thank you.

At this time I would like to remind everyone in order to ask a question. Please press Star then the number one on your telephone keypad.

We'll pause for just a moment to compile acuity roster.

Catsup mode, and we do think we'd be entering next year with a relatively healthy backlog correct.

Got it and then just one more on the the the more commercial filtration initiatives <unk>, what's your sense on the the channel penetration or you know kind of that channel build out your presence with dealers because I know you have a a great business I'm more the national account side, but you know in in markets that are perhaps a little bit more fragmented you are.

It sounds like there's something a lot of investment on the product, but is you know is their product in the right dealer's hands and you know is that Dior base something that you can penetrate easily.

Yeah that that's our opportunity Josh and I I wanted to call. It out today, because we are focused on building out the acquisitions around on the residential side, but we don't want to forget the fact that we have a really good commercial offering and we're also simultaneously working on that.

And what that means is getting back to what we used to be great at and what we are going to be great at which is selling the spec in working with our global partners to convince them that we have a superior product and that they should be designing and specking that that product into there.

Expansion's, they could global hotel chains think of all the hospitality efforts think of anybody who's moving their their stores overseas those are great opportunities for us to make sure that we're designing in our ever pure product and all of those instances.

Thanks to all either.

Your next question comes from Atlanta, Hammond from key Bank capital markets. Your line is.

Hi, good morning, yes.

Ornery, Jeff just wanted to go.

Kind of touch on price costs and productivity. It looks like you you kinda got price matching in place in this quarter you know how should we think about that in the second half and then I'm productivity.

You know I think your your nicely positive and one Q. and went negative I know you mentioned the one you know large pump business, but what's what's the change there.

Yeah. So so you kind of hit it on on price cost. So we do expect as we sort of thought throughout the year that that the price that we reference about three points of price should offset.

Inflation, so that that continues to be the point of view and then just on on productivity is we talked about there are some some negatives that affected us in in this quarter you know John reference. The fact that last year was a was a a pretty solid quarter for us. So the cop is there and that that kind of read its way through your over your productivity and then we got all the actions in place that that have been worked and we are starting to see read out through inventory that'll then find their way into the P. and I'll starting in Q3 in Q4. So we've got we've got good visibility to the actions and and the things that are going to take place.

In the flow infiltration businesses that that should drive that that incrementally improving productivity.

So price it versus inflation, you still think is neutral.

And the second half you don't get a a net positive with some of the deflation.

No I mean, no. Because then you get the deflation and also just the timing of price. So so nat Nat it continues to be kind of a plush.

Okay.

I mean, I think mark <unk>, putting labour inflation, there as well yeah total inflation bold not just the the just the material inflation.

And then just last one on aquatic <unk>.

If you kinda are successful kind of getting inventory down.

You know within within line with a with a kind of this new guidance, where do you see inventories entering 2020 versus normal.

Thanks, Yeah, our plan and what are what are updated guidance is reflective of is is in the Tory levels being brought to to a more normalized level. So and when we do that we look at sort of days on hand on a forward basis, and and think of it that way. So we're looking at it what it was historically and then bringing the m. and tori levels down to sort of that more normalized historical level on a daily basis.

Okay. Thanks, guys.

<unk>.

Your next question comes from lineup, Brian Lee from Goldman Sachs. Your line is open.

Hey, guys come morning, Thanks for taking the questions.

Just maybe on filtration again can you elaborate a bit on the trends you're saying there. It seems like you had a nice rebound off of one Q. you had the one time issues there, but you mentioned food and beverage was read these down in the quarter, maybe anymore color there and also the the trends you're expecting a heading into the second half.

Sure. Yeah. So just you know thinking about the different businesses residential and commercial think of them as sort of flat in the corridor and then as I mentioned industrial was was strong and food and beverage was was moderating well you know we see those trends kinda kind of continuing we start continue to see residential and commercial improving as we work our way through the year within residential is where are those two acquisitions exists of those as a as we referenced are performing in line with expectations, but we're we're really seeing some exciting opportunities from a growth perspective, there and starting to see you know the the rationale for why we did those deals starting to read out and and really giving us some confidence that there's some great ideas, they're they're going to help us continue to to to grow those businesses. But then also help us think about the broader residential portfolio. So overall you know we're seeing the trends going in the right direction. Then you know say that continue through Q3 in Q4.

Okay.

Fair enough and then just maybe a follow up on you know since you bring it up.

The new acquisitions I noticed that you know settle pre k., but it seemed like you're taking down the four year contribution from 3%.

Ah to 2% in the updated guidance, maybe if you could comment on on what's driving that as well.

Sure. The the we haven't talked about it necessarily but we did announce earlier in the quarter that we were getting out of what we refer to as the aquaculture business. So that wasn't actually reflected in our original plan or guidance and so that's the slight tweak. It's so it's not that the acquisitions aren't performing at a level of expectation. It's that we've included an additional divestiture or that right. That's pulling down the the top line acquisition number.

Alright that makes sense thanks, guys.

So he.

Your next question comes from line of Julian Mitchell from Barclays airline is open.

Hi, guys is just because you on for Julia How're you.

Good morning.

Doing all right I'm, just a couple of quick ones on filtration and flow in general trends I know you guys have said that the residential and commercial trends are improving throughout the quarter I just kind of wanted to clarify that that is sort of an underlying demand commentary and not a reversal of maybe sort of one time issues that you saw in in both of those businesses in Q1, and you know if so is there any sort of bifurcation in the differences of strength between the residential commercial underlined markets.

Let me hit part of that first I mean, just as you recall and we talked about putting in the price increases last year in September .

Relative to the tariff and the inflationary impacts I, we did see some inventory pull heads in the residential.

And commercial flown filtration space as well we felt like we worked through all of those in Q1 in work those inventory issues behind us. So we had already started in a better inventory positioning cute too and that is you know continue to read out here as we head into Q3 Q4 meaning that we don't have those same challenges that we had an aquatic.

If you want to add.

No I think that I mean, I think you pick and picked up on that correctly. So it's not it's it's underlying you know.

Fundamentals, rather then reversal of of anything specifically one time other than the things down that you mentioned.

But but I guess just as a quick quick follow up would you characterize the underlying demand as sort of improving or is this sort of just an inventory issue that was being worked through as a result of price increases put across last year, I guess, what I'm trying to get as it sort of you know are the customer conversations getting better or is it you know.

The issues that were present in Q1 are just completely behind you and and now Q2, and Q4 etell sort of a different story.

I'm filtration residential commercial are improving we're excited about the awareness of the products and the the offerings available in the channel and the migration towards more of those making into the consumers hands.

In irrigation flow I'd say no you know the weather patterns, you know did not read down in Q2, and we we think we're going to be relatively I'm experiencing this shipment demand as we head into Q3 in Q4 as well because those a submersible wells.

Understood. Thank you for your time.

Your next question comes from line of Walter <unk> Global.

Caroline Hi.

Hi, Thanks.

I've got a a question you come into about the perfect storm or in the the channel inventory and I Wonder you know persons that.

Or is it far enough behind us, where we could do a post mortem.

On you know the situation with you know the inventory build from tariffs and weather.

And then and then you know I don't mean to Monday morning quarterback but.

You know have you learned anything from it like what could you have done differently, because I don't think that you know the terror issues or whether we're going to go away.

Know what it is about the channel that you can do to you know keep this from happening again.

Yeah. We're we're hopeful that this goes in the category like Oh, eight or nine financial crisis of the learning that we don't have to ever use again, you know when you think about you know 10 per cent material inflation over the over the course of a couple of years.

And then raising prices to mitigate that impact you know we did not anticipate that the channel would buy so much ahead of of that demand you know when we we realize that and we corrected course as as you now what did we learn from that I I think we have a lotta sell through metrics. We have a lot of information available to us that we're now looking at to make our own assumptions of what's in the channel. So that we will rely on partners. That's one thing, but we also want to make sure that we're triangulating that information and ensuring that we feel like the cell through is reflecting what we know it to be.

So there's always a learning and I'd say, that's the learning and I think we're more informed now and we have a better idea of what our actual and sales are through the channel versus into the channel.

Okay great.

And then.

Switching gears over to your comments about a segmentation.

We've seen other companies like I. next do a really incredible job with segmentation.

Yeah, and it sounds like you're doing product segmentation I wonder if you're doing channel.

Where customers segmentation too.

And then as a.

As a follow on on the the product question.

You know the the R. and D. spending you know what do you do you into track some of the incremental R. and D. you know how much use r. and d. going up.

You know just <unk>.

You know looking for some data or details about.

You know the kind of return.

You're expecting from some of these investments.

Well first of all thank you for noticing the segmentation comment it is in fact, a consumer and user segmentation and it it was pretty exhaustive.

And a particular piece of marking that we're using significantly and you can sense by our confidence level that that gives us.

Extreme confidence because as we start to target these personas or we start to understand these person is better and we've used a marketing campaigns, we're actually seeing the results from it and you know these personas and the consumer you know needs attributes and behaviors that we're spending time to understand our true and the ringing out and now we're building products sets and you know customer support around those so that we can continue to grow faster. So thanks for noticing on the R. and D. you know I've I'm, a big advocate that we need to spend more and have the right differentiated in innovative product I think these marketing insights that we're creating will give us a better connectivity to what's needed. So I don't know in the short run into spending more it's spending more wisely and having the right products available to the right customer sets.

Okay alright, thank you.

Thank you.

And again that star one if you would like to ask a question. Your next question comes from Atlanta Lindsey from vertical research partners airline it's open.

Hi, good morning, all.

Morning running.

They just want to come back to Q3, if I just assume normal incremental margins in progression you talked about inflow infiltration.

You know basically implies you need some margin expansion and aquatic <unk> included three to get to the mid point of the Guy that's want to make sure I'm thinking about that that right.

Yeah.

<unk>, maybe slightly but but that.

But but not not the margin decline that we've seen in the first you know in the first quarter and the second part of it.

Okay, we'll come out as what we had half a month's worth the price benefit last year and we're getting a you know that we're getting the carry over this year of that price and what we're seeing is the price and inflation headwind Europe years significantly positive across all three businesses.

So despite the lower absorption you expect to see it you think you can you can overcome all that.

Yes, yeah, Okay. Good and then just geographically maybe just walk around the different regions. We didn't really talk about China I think last quarter. You said Europe was a little bit weaker than you had expected how was Europe , specifically in the corridor and then maybe any color on China, and what you're seeing there.

Sure Yeah. So so overall you know we we saw Europe kind of get back from some of the negative commentary made in Q1 to two growth in Q2. So so Europe was it was a positive story and.

And we think that that's going to continue to the rest of the year China continues to grow on me. So as we've talked before it's not a huge market for its overall, but we see strong growth in China.

That's a continuation from the trend that we saw in in Q1, continuing in Q2, and we expect to see that as well continuing through the balance of the year.

Okay. Good thanks, a lot of basketball.

Thank you.

Alright.

Today, we continue to believe that will exit 2019 position to look for more normalized performance in 2020, we're accelerating pens and sourcing and strengthening our productivity culture.

We're funding the two key strategies discussed early in the call and we hope you Sharon our excitement for these two p. growth strategies, we have a strong capital structure solid free cash flow generation and we will continue to invest in our strategy be leading residential and commercial water treatment company.

Thank you for your continued interest Rob you can conclude the golf.

Thank you Sir.

And ladies and gentlemen, thank you for your participation today. This does conclude today's conference call and you may now disconnect.

Yeah.