Watts Water Technologies, Inc. — Q1 2023 Form 10-Q
Business context and reporting period. The company supplies flow-control, HVAC and gas, drainage, and water-quality products for building, commercial, industrial, and residential markets. It reports three geographic segments: Americas, Europe, and Asia-Pacific, Middle East and Africa (APMEA). This unaudited quarter ended March 26, 2023 and generally covered 13 weeks; comparative results are for the quarter ended March 27, 2022. Dollar amounts are in millions unless noted.
Financial performance and position
| Metric | Q1 2023 | Q1 2022 / prior date |
|---|---|---|
| Net sales | $471.7 | $463.2; up 1.8% reported and 3.9% organic |
| Gross profit / gross margin | $218.1 / 46.2% | $198.6 / 42.9% |
| Operating income / operating margin | $84.7 / 18.0% | $71.5 / 15.4% |
| Net income | $64.7 | $54.5 |
| Diluted EPS | $1.93 | $1.61 |
| Operating cash flow | $33.4 | $(2.0) |
| Free cash flow (company-defined non-GAAP) | $28.3 | $(7.6) |
- Revenue mix and regions: Americas sales were $323.2, Europe $128.3, and APMEA $20.2. Organic sales increased in each region, but reported Europe sales declined 1.2% as currency effects outweighed growth.
- Profitability: Gross margin expanded 3.3 percentage points. Operating income rose 18.5%; management attributed the improvement mainly to pricing, favorable mix, productivity, and savings from prior restructuring, partly offset by inflation, lower volumes, and investments. SG&A rose 6.0% to $133.7.
- Cash flow: Operating cash flow improved year over year, primarily on higher earnings and lower working-capital investment. Receivables and inventories were still cash uses in the quarter. Capital expenditures were $5.1.
- Liquidity and debt: Cash and equivalents were $311.8 at March 26, versus $310.8 at year-end. The balance sheet reported long-term debt of $147.8; the company disclosed $150.0 drawn on its revolving facility and $12.4 of letters of credit, leaving $637.6 of available facility capacity. It reported covenant compliance. Cash exceeded reported long-term debt; the company’s non-GAAP net debt-to-capitalization ratio was negative 13.9%.
- Other balance-sheet items: Total assets were $1,990.0 and stockholders’ equity was $1,345.8. Inventories were $401.2, up from $375.6 at year-end.
Material changes versus the prior comparable period
- Reported sales growth was modest, while organic growth was stronger; foreign exchange reduced sales by $9.4, or 2.1 percentage points. Management cited U.S. dollar appreciation against the euro, Canadian dollar, and Chinese yuan.
- Higher pricing contributed to organic sales growth, while lower volume partially offset it. Americas and Europe organic growth was primarily price-led; APMEA growth reflected demand in China, including commercial valves for data centers, and the Middle East.
- Net income increased $10.2 and diluted EPS rose $0.32. The effective tax rate increased to 22.5% from 22.0%.
- Q1 2023 included a $0.3 net restructuring benefit, compared with $1.0 of restructuring charges in Q1 2022. Management reported after-tax EPS effects of a $0.01 benefit in 2023 and a $0.02 charge in 2022.
- Share repurchases were $3.7 for approximately 22,000 shares, versus $42.9 for approximately 293,000 shares in Q1 2022. The quarterly dividend declared per share was $0.30 in Q1 2023, compared with $0.26 in Q1 2022.
Outlook, management commentary, risks, and unusual items
- Management described the 2023 economic outlook as uncertain: global GDP growth was forecast to be positive but lower than 2022; construction indicators were mixed; higher interest rates and inflation had slowed new residential construction; and the banking crisis could tighten credit and affect construction starts. The company continued to report material, labor, and overhead inflation.
- No full-year sales or earnings guidance is stated in the supplied filing text. Management cautioned that quarterly results are not necessarily indicative of full-year results and said it could not predict the full impact of the uncertainties discussed.
- For the remainder of 2023, the company expected capital expenditures of approximately $35–$40.
- Foreign exchange, commodity costs, interest rates, supply-chain and logistics disruption, and construction-market conditions are relevant risks. The company uses derivatives for hedging, not trading, and states that commodity-cost increases may adversely affect results if they cannot be passed on to customers.
- Contingencies: reasonably possible losses in excess of amounts accrued were estimated at approximately $3.6. Management did not expect the ultimate outcome of all matters to materially affect financial condition, but noted an unfavorable outcome could materially affect results or cash flow in a particular period. The company could not estimate a reasonably possible loss range for the Chemetco Superfund matter because remediation plans, costs, responsible-party shares, and timing remain undetermined.
- Subsequent events: the company completed the non-material, all-cash acquisition of Enware Australia on March 31, 2023. On May 2, it declared a $0.36 per-share dividend payable June 15; this declaration followed the reporting date.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It reported no material changes to the risk factors in its 2022 Form 10-K.
Important facts for investors to verify
- Whether pricing and productivity can continue to offset inflation and lower volumes, and how organic sales trends develop by region and channel.
- How much of the reported cash and available credit is practically accessible for U.S. obligations, given $201.2 of cash was held by foreign subsidiaries and the company’s stated intent to permanently reinvest foreign earnings.
- Debt and interest-rate exposure: reconcile the $147.8 balance-sheet debt carrying amount with the $150.0 revolving-facility draw, and monitor borrowing costs, swap coverage, and covenant headroom.
- Working-capital conversion, especially receivables and inventory, and delivery of the stated $35–$40 remaining-year capital expenditure plan.
- Potential outcomes and timing for the $3.6 reasonably possible loss estimate and the unquantified Chemetco remediation matter.
- Enware’s contribution after acquisition and the effect of currency, construction activity, commodity costs, and supply-chain conditions on future results.