WATTS WATER TECHNOLOGIES INC quarterly report, Q3 FY2023

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Watts Water Technologies, Inc. — Q3 2023 Form 10-Q

Reporting period: Third quarter ended September 24, 2023; year-to-date period covers nine months ended September 24, 2023. Comparatives are the third quarter and nine months ended September 25, 2022. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.

Business context

Watts supplies water flow-control and protection, HVAC and gas, drainage and water-reuse, and water-quality products. It reports three geographic segments: Americas, Europe, and Asia-Pacific, Middle East and Africa (APMEA). Sales are principally product sales through wholesale, OEM, specialty, and DIY channels.

Financial performance

  • Q3 revenue: Net sales were $504.3 million, up 3.4% from $487.8 million. Organic sales were approximately flat; reported growth included $9.0 million of acquired sales and a $6.0 million favorable foreign-exchange impact.
  • Q3 by region: Americas sales were $351.0 million, up 0.3%; Europe $120.2 million, up 6.3% (primarily favorable FX, while organic sales declined 0.5%); APMEA $33.1 million, up 32.9%, substantially reflecting the acquisition, with organic growth of 0.8%.
  • Q3 earnings and margins: Gross profit was $234.4 million versus $217.9 million; gross margin expanded to 46.5% from 44.7%. Operating income rose 8.3% to $87.1 million. Net income increased to $65.8 million from $58.7 million; diluted EPS was $1.96 versus $1.75. SG&A was 29.1% of sales versus 27.8%.
  • Nine-month results: Sales were $1,508.8 million, up 2.1%; gross profit was $705.3 million and gross margin was 46.7%, compared with $655.7 million and 44.4%. Operating income increased 9.9% to $272.2 million; net income rose to $206.4 million from $182.9 million. Diluted EPS was $6.15 versus $5.43.
  • Cash flow: Nine-month operating cash flow was $200.9 million, up from $86.3 million. Capital expenditures were $19.0 million; company-defined free cash flow was $181.9 million versus $67.0 million, and its cash conversion rate was 88.1% versus 36.6%.
  • Liquidity and debt: Cash and equivalents were $362.7 million at September 24, 2023, compared with $310.8 million at year-end 2022. Long-term debt was $98.2 million versus $147.6 million; the company reported no current portion. It had $100.0 million drawn on its $800 million revolving facility, $12.5 million of letters of credit, and $687.5 million of available capacity. The weighted-average facility borrowing rate was 6.50%; including the interest-rate swap, the reported weighted-average rate was 2.12%. The company was in compliance with facility covenants.
  • Capital returns: Dividends declared were $0.36 per share in Q3, versus $0.30 a year earlier. Nine-month dividends paid were $34.4 million. Share repurchases totaled $11.7 million in the first nine months, compared with $65.1 million in 2022.

Material changes and management commentary

  • Q3 gross margin benefited from pricing, product mix, and productivity, partly offset by inflation and lower volume. Operating income also benefited from prior restructuring savings; incremental investment, inflation, lower volume, and acquisition-related costs were offsets.
  • Nine-month organic sales increased 1.3%. Organic growth in Europe and APMEA was partly offset by lower volumes in portions of the Americas business. APMEA reported growth included $16.5 million of acquired sales for the nine-month period.
  • SG&A increased 7.0% year to date, including investment in smart and connected initiatives and commercial excellence, inflation, and higher compensation costs. Productivity, lower freight expense, and restructuring savings partially offset these increases.
  • Management described the economic outlook as uncertain into the remainder of 2023 and 2024, citing high interest rates, tighter lending, inflation, a weakening European economy, slower growth in China, and heightened geopolitical risks. It expects to continue investing in products, connected solutions, growth, and productivity. Results for the interim period are not necessarily indicative of full-year results.

Outlook, acquisitions, risks, and unusual items

  • No specific full-year revenue or earnings guidance is provided in the supplied filing text. Management expected approximately $10 million to $15 million of capital expenditures in Q4 2023.
  • On October 23, 2023, after quarter-end, Watts completed its acquisition of Bradley Corporation for approximately $303 million, subject to a final working-capital adjustment. It funded the transaction with $210 million of revolver borrowings and cash on hand. Bradley has annual net sales of approximately $200 million; purchase accounting was not yet complete.
  • On October 30, 2023, the company declared a $0.36-per-share quarterly dividend, payable December 15, 2023.
  • Q3 2023 included $2.6 million of after-tax restructuring and acquisition-related charges ($0.08 per diluted share); the comparable 2022 quarter included $1.3 million ($0.04 per share). Nine-month 2023 included $4.8 million ($0.15 per share), versus $3.3 million ($0.10 per share) in 2022.
  • The company estimated reasonably possible contingency losses above accrued amounts of approximately $3.3 million. It could not estimate a loss range for the Chemetco Superfund matter because remediation plans, costs, responsible parties, and allocation of costs remain undetermined. Management did not expect the ultimate outcome of all matters to materially harm the company’s financial condition, based on information then available.
  • Risk exposures include foreign-exchange movements, floating interest rates, and commodity costs. The company uses derivatives for hedging, not trading, and notes that it may not be able to pass all cost increases to customers. Management reported no material changes to the risk factors in its 2022 Form 10-K.
  • Q3 foreign-currency translation reduced accumulated other comprehensive income by $17.3 million; nine-month foreign-currency translation adjustments were a $9.2 million loss. Management said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  • Whether organic sales and volumes improve, particularly in Europe and in weaker product/channel areas, and how much future reported growth depends on acquisitions and currency.
  • Whether price, mix, and productivity continue to offset inflation, lower volumes, and higher investment and SG&A.
  • Bradley’s final purchase-price allocation, integration costs and results, and the effect of its debt-funded acquisition on leverage, interest expense, and liquidity.
  • Cash conversion and working-capital trends, capital spending, and continued availability and covenant compliance under the revolving credit facility.
  • Developments in the Chemetco remediation process and other contingencies, including whether potential losses exceed recorded accruals.