Watts Water Technologies, Inc. — Q1 2021 Form 10-Q
Business context and period. Watts supplies products and systems for managing water and energy in residential and commercial buildings. It reports three geographic segments: Americas, Europe, and Asia-Pacific, Middle East and Africa (APMEA). This unaudited quarter ended March 28, 2021; the comparable quarter ended March 29, 2020. Amounts below are in U.S. dollars unless noted.
Financial performance
| Metric | Q1 2021 | Q1 2020 / comparison |
|---|---|---|
| Net sales | $413.3 million | $382.6 million; up 8.0% reported and 3.7% organic |
| Gross profit / margin | $173.7 million / 42.0% | $162.8 million / 42.6% |
| Operating income / margin | $59.6 million / 14.4% | $47.8 million / 12.5%; income up 24.7% |
| Net income / diluted EPS | $41.7 million / $1.23 | $32.0 million / $0.94 |
| Operating cash flow | $33.9 million | $(0.9) million |
| Free cash flow (non-GAAP) | $31.9 million | $(8.4) million |
| Cash and cash equivalents | $225.4 million | $218.9 million at December 31, 2020 |
| Long-term debt | $198.6 million | $198.2 million at December 31, 2020 |
Gross margin declined 0.6 percentage points, as product mix, expedited freight and inflation more than offset productivity and cost savings. SG&A was $113.8 million, down 1.0% year over year and 27.5% of sales versus 30.1%. The effective tax rate was 28.0%, compared with 28.3%.
Cash used in investing activities was $2.0 million, including $4.9 million of capital expenditures and $2.9 million in proceeds from asset sales. Cash used in financing activities was $21.2 million, including dividends of $7.8 million, share repurchases of $3.8 million and withholding taxes on vested awards of $9.2 million. Working-capital increases included $44.0 million of cash used by receivables and $18.8 million by inventory.
Current assets were $774.6 million and current liabilities were $345.2 million. Reported net cash (cash less debt) was $26.8 million, compared with $20.7 million at year-end; the company reported a net debt-to-capitalization ratio of negative 2.5%. Of cash, $175.4 million was held by foreign subsidiaries.
Changes versus the prior comparable period
- Sales rose across all three segments: Americas $272.8 million (up 4.0%), Europe $122.9 million (up 11.5%) and APMEA $17.6 million (up 76.0%, from a pandemic-affected comparison).
- Sales growth comprised $14.1 million organic growth, $12.8 million from foreign exchange and $3.8 million net from acquisitions and divestitures. Severe South-Central U.S. freezing weather contributed an estimated 3% of incremental consolidated sales.
- Operating income increased $11.8 million, reflecting volume, price, productivity and cost actions. Segment operating income improved in all regions; corporate expenses increased $1.5 million.
- Operating cash flow improved from cash use to cash generation, attributed primarily to higher income and working-capital management. Capital expenditures were lower year over year.
Outlook, commentary and risks
- The filing provides no quantified full-year revenue or earnings guidance and cautions that quarterly results are not necessarily indicative of full-year results. Management expected to invest approximately $30–$35 million in capital equipment during the remainder of 2021.
- Management described continued uncertainty from COVID-19 and recovery timing, including possible renewed outbreaks and restrictions, construction-market conditions and customer spending.
- Supply constraints were a key concern: shortages of electronic components, including semiconductors, logistical bottlenecks and higher transportation costs, alongside rising commodity and raw-material prices. Management said these pressures could affect customer service and margins, particularly in the latter half of 2021; first-quarter performance had managed them effectively.
- The $800 million unsecured revolving credit facility had $200.0 million drawn and $13.9 million of letters of credit outstanding at March 28, leaving $586.1 million available. The company reported covenant compliance. A March 30 amendment extended facility maturity to March 30, 2026 and changed pricing and other terms.
- Management reported approximately $5.9 million of reasonably possible contingency losses in excess of accruals. It said outcomes were not expected to materially harm financial condition, though an individual period’s results or cash flows could be affected. The company could not estimate a loss range for the Chemetco environmental matter.
- Gross unrecognized tax benefits were approximately $12.0 million; one non-U.S. tax matter could increase them by $4.6 million over the next 12 months, while other matters could decrease them by $3.0–$4.0 million.
- Q1 included a $0.3 million restructuring charge, primarily accelerated depreciation. The company declared a subsequent quarterly dividend of $0.26 per share, up from $0.23 declared for Q1. No material changes to previously reported risk factors or material off-balance-sheet arrangements were disclosed.
Important facts for investors to verify
- Whether organic growth persists after separating foreign-exchange and acquisition effects, and as the prior-year pandemic comparison and severe-weather demand normalize.
- Whether component shortages, freight and input-cost inflation are offset by pricing and productivity, and how these affect gross margins in later 2021 periods.
- Available revolver capacity, debt levels, covenant headroom and the terms of the March 30, 2021 credit amendment.
- Developments in the Chemetco environmental review and other contingencies, as well as changes in uncertain tax positions.
- Delivery of the stated capital-spending plan and the cash implications of dividends, repurchases and foreign-held cash.