Bob P. Fishman
Executive Vice President, Chief Financial Officer and Chief Accounting Officer at Pentair
Thank you, John, and good morning everyone. Let's start on Slide 12, titled Q3 2023 Pentair Performance. We delivered another strong quarter of significant margin expansion despite sales being down 4% year-over-year. The diversification of our portfolio and our transformation initiatives continued to more than offset Pool's lower volume impact on margins. Core sales for Q3 were down 7% year-over-year, driven by our residential businesses. Our commercial and industrial businesses performed well in the quarter. While Q3 sales declined primarily due to the volume headwind in Pool, the negative volume impact on Pentair and Pool improved sequentially from Q2.
Third quarter segment income increased 3% to $212 million and return on sales expanded 140 basis points year-over-year to 21%. This improvement was driven primarily by productivity from transformation, accretive margins from the Manitowoc Ice acquisition and some price versus cost benefit. We delivered adjusted EPS of $0.94. Net interest expense was nearly $29 million and our adjusted tax rate was 15% during the quarter with a share count of 166.6 million.
Please turn to Slide 13, labeled Q3 2023 Industrial & Flow Technologies Performance. Industrial & Flow Technologies sales increased 3% year-over-year, driven by commercial sales growth of 8%, and industrial sales growth of 12%, which more than offset a decline in residential sales of 7%. Segment income grew 18% and return on sales expanded 250 basis points to 19.4% marking the fifth consecutive quarter of equal to or greater than 200 basis points of improvement. The strong margin expansion was a result of continued progress on our transformation initiatives.
IFT's continued success was partly driven by a revised go-to-market strategy and industry leadership that has been underway over the last two years. For example, within our industrial businesses, our strong reputation and industry expertise is driving above-industry growth. We've been moving away from primarily project-led business to standardized solutions focused on ease of doing business with distributors. And our key accounts have begun to reinvest in sustainable product lines following the pandemic.
Within our commercial businesses in IFT, we are focused on driving business beyond warehouses and office space to datacenters and institutions such as universities, airports, hospitals, and government buildings. We also believe there are large opportunities in municipal infrastructure as driven by the Infrastructure Investment and Jobs Act legislation in the U.S. with a focus on investments in clean water, flood control and broadband. Interestingly, one of our customers is the leader in directional drilling equipment for fiber optic cables. We continue to believe the aftermarket is a good opportunity for future growth because of our significant product install base. Lastly, we believe we are in a strong position to benefit from the Build America, Buy America Act as our compliance is expected to give us a strategic advantage.
Within our residential businesses in IFT, we have seen a return to normalization. Recall that these products are typically not a discretionary spend. When a sump pump or a well pump breaks, it's critical to get it fixed.
Please turn to Slide 14, labeled Q3 2023 Water Solutions Performance. In Q3, Water Solutions sales increased 9% to $299 million, driven by our Manitowoc Ice acquisition and price. Segment income grew 40% to $69 million and return on sales expanded 510 basis points to 23%, driven primarily by our accretive Manitowoc Ice acquisition and productivity from our transformation initiatives. Margins have expanded over the last seven quarters from 10.8% in Q1 of 2022 to 23% in Q3 of 2023.
Within our residential business in Water Solutions, we noted last quarter that we are seeing North America stabilize. This was evident in Q3 as residential sales declines improved sequentially from Q2. Within our commercial business in Water Solutions, filtration sales in North America remained strong and Manitowoc Ice continued to exceed our expectations.
Please turn to Slide 15, labeled Q3 2023 Pool Performance. In Q3, Pool sales declined 21% to $309 million. The volume decline of 28 points was primarily due to continued channel inventory corrections in the quarter and reflects a strong Q3 2022 comparison. Sequentially, the negative impact of volume, significantly improved from Q2. The pricing benefit of 7 points helped partially offset the volume decline. Despite lower Pool sales in Q3, return on sales expanded 130 basis points due to price offsetting inflation, prior actions to rightsize direct labor to align with lower volumes, and improved productivity driven by our transformation initiatives.
Please turn to Slide 16, labeled Transformation Initiatives. Similar to last quarter, we believe this slide provides a good illustration of our transformation initiatives and our ultimate goal of driving margin expansion. For reference, our transformation initiatives focus on four key themes: pricing excellence, strategic sourcing, operations excellence and organizational effectiveness. As we've mentioned in past quarters, we expect strategic pricing actions to benefit the top line of all three of our segments. We expect our other three transformation initiatives to help improve our overall cost structure. As a result, we are targeting ROS of approximately 23% by the end of fiscal 2025, expanding margins over 400 basis points as compared to fiscal 2022.
Please turn to Slide 17, labeled Transformation Runway. As you look at each of the four key themes, you can see that the work within these transformation initiatives is in various different stages. For example, in 2023, we have begun to see early readouts from Wave 1 within pricing, sourcing and operations. We are beginning Wave 2 within each of these three themes and expect margin benefits to read out in 2024. You can see how each new wave is expected to compound on the others to drive expected margin expansion year-over-year through 2025 and beyond.
In pricing excellence, the strategic pricing playbook has been developed, which is just beginning to roll out across segments and categories. For example, in Q3, we began to implement strategic pricing actions across select products within our Pool segment. Within these price actions, while these price actions are reflected in our recent annual price increase, please note that these strategic actions differ from annual price increases. Typically, on an annual basis, we evaluate overall inflation, both materiality costs to determine the appropriate price increase across our products. With regards to strategic price actions, we are evaluating all products through a value-based model and identifying which ones have opportunities for adjustments. Recall that in the past, we primarily evaluated pricing through a cost-plus approach.
In sourcing excellence, the implementation of Wave 1 is underway with savings currently reading out. As a reminder, Wave 1 included materials such as electronics, motors, maintenance, repair and operations spend, packaging and logistics. Additionally, we successfully kicked off Wave 2 this summer with over 800 suppliers attending our supplier show. For reference, Wave 2 materials include metals, moldings, resins, ocean freight and purchase finished goods. We expect Wave 2 to begin to read out beginning in 2024. Incremental to our strategic sourcing waves, we have seen benefit from our rapid renegotiation process that is a part of our transformed sourcing excellence work.
In operational excellence, we have completed the consolidation of three facilities while continuing our execution on lean transformation plans across our sites. In organizational effectiveness, we are in the earlier stages with Wave 1 and expect margins benefits to be realized beginning in 2024. Due to the staggered nature of these transformation initiatives, we expect Wave 3 to begin to read out post 2025 in operations excellence and organizational effectiveness.
Overall, we are excited about the savings we have begun to realize from the early waves and remain confident that our teams can execute on pricing actions and savings we have identified particularly in sourcing.
Please turn to Slide 18, labeled Balance Sheet and Cash Flow. In Q3, we generated $143 million in free cash flow, up nearly 100% year-over-year, reflecting another strong quarter. Year-to-date, our free cash flow was $453 million, up nearly 115% year-over-year. Our net debt leverage ratio was 2.1 times, down from 2.6 times in Q1 and 2.2 times in Q2. Our maturity stack is very manageable. Total debt is now less than $2 billion. And the average rate is approximately 5.3%. Our ROIC was 14.1%, exceeding our cost-of-capital and includes debt from the Manitowoc Ice acquisition. We continue to target high-teens ROIC in the long term. We plan to remain disciplined with our capital and continue to focus on debt reduction amid the higher interest rate environment.
Moving to Slide 19, titled Q4 and Full Year 2023 Pentair Outlook. For the full year, we are updating our adjusted EPS guidance to approximately $3.70 to $3.75 from our previous range of $3.65 to $3.75. Also for the full year, we expect sales to be roughly down 1%; segment income to increase 10% to 11% with corporate expense of approximately $85 million to $90 million; net interest expense of roughly $123 million to $125 million; and adjusted tax rate of approximately 15%; and a share count of 166 million.
For the fourth quarter, we expect sales to be down approximately 3% to 4%. This is mainly attributable to expected lower Pool volume year-over-year and the return of seasonality in our business now that lead times have normalized. We expect fourth quarter segment income to increase 3% to 8% with corporate expense of roughly $23 million; net interest expense of roughly $28 million to $30 million; and adjusted tax rate of approximately 15%; and a share count of 166 million. We are also introducing adjusted EPS guidance for the fourth quarter of approximately $0.82 to $0.87.
Moving to slide 20, titled Full Year 2023 Guidance at Midpoint. We continue to expect total Pentair sales in fiscal 2023 to be approximately $4.1 billion or down about 1%. We continue to expect IFT sales to be up mid single digits and Water Solutions sales to be up high-teens. For Pool sales, we have made a slight adjustment to down high-teens from previous guidance of down mid-teens at the high end of the range. Segment income is expected to increase approximately 10% to 11% with ROS expansion of over 200 basis points to 20.9%.
Moving to slide 21 titled Q3 Progress Summary. We are very pleased with our Q3 and year-to-date performance. As John mentioned earlier, our third quarter marked the sixth consecutive quarter of sales over $1 billion, and the sixth consecutive quarter of adjusted margin expansion. We have executed well in a dynamic environment and delivered on our commitments. Specifically, our diversified water portfolio and transformation initiatives have driven significant margin expansion despite Pool's volume decline. Our Manitowoc Ice acquisition has exceeded our expectations. We have instilled performance accountability across the organization, which is being measured through key metrics. We have a very strong balance sheet and free cash flow generation. And we have a disciplined capital allocation strategy that aligns to our high-teens ROIC target.
I'd now like to turn the call over to the operator for Q&A, after which John will have a few closing remarks. Anthony, please open the line for questions. Thank you.
