Watts Water Technologies, Inc. — Q2 2022 Form 10-Q
Reporting period: Second quarter and six months ended June 26, 2022; comparative periods ended June 27, 2021. Amounts are in U.S. dollars. Watts supplies water-flow, heating, drainage, and water-quality products across the Americas, Europe, and APMEA.
Financial performance
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Net sales | $526.6 million | $467.0 million | $989.8 million | $880.3 million |
| Gross profit | $239.2 million | $200.1 million | $437.8 million | $373.8 million |
| Gross margin | 45.4% | 42.8% | 44.2% | 42.5% |
| Operating income | $95.9 million | $52.7 million | $167.4 million | $112.3 million |
| Net income | $69.7 million | $37.5 million | $124.2 million | $79.2 million |
| Diluted EPS | $2.07 | $1.11 | $3.68 | $2.34 |
- Q2 reported sales rose 12.8%; organic sales growth was 16.2%, excluding foreign exchange and acquisitions. Six-month reported sales rose 12.4%, with organic growth of 15.2%.
- Q2 operating income increased 82.0%; six-month operating income increased 49.1%. Management attributed gains mainly to pricing, sales volume, productivity, and lower restructuring charges, partly offset by material, labor, freight, and other inflation, investments, and normalized operating expenses.
- Americas sales increased 14.8% in Q2 and 19.0% for the six months. Europe sales declined 6.5% in Q2 and 0.7% for the six months, largely reflecting unfavorable foreign exchange; organic sales increased in both periods. APMEA sales were broadly flat in Q2 and increased 3.7% for the six months.
- Cash from operations was $44.9 million for the first six months, versus $73.2 million a year earlier. Free cash flow, a non-GAAP measure, was $32.6 million versus $65.1 million; cash conversion from net income was 26.2% versus 82.2%. Higher inventories and receivables, restructuring payments, and employee and customer incentives weighed on cash generation.
- At June 26, cash and equivalents were $230.0 million, current assets $967.7 million, and current liabilities $421.1 million. Long-term debt was $202.2 million, up from $141.9 million at year-end 2021. Net cash, defined by the company as cash less debt, was $27.8 million; net debt to capitalization was negative 2.4%.
- The $800 million revolving credit facility had $205.0 million drawn, $12.1 million in letters of credit, and $582.9 million available. The weighted average facility borrowing rate was 2.31% (2.29% including the interest-rate swap). The company reported compliance with its debt covenants.
Material changes and notable items
- Q2 and six-month results benefited from substantially lower restructuring costs than in 2021, when the French program generated a $18.0 million charge in Q2. 2022 restructuring charges were $1.7 million for Q2 and $2.7 million for the six months.
- Foreign exchange reduced Q2 sales by $18.2 million and six-month sales by $28.2 million, primarily due to the stronger U.S. dollar against the euro. The company stopped direct sales into Russia effective April 1, 2022; management estimated an approximately $3 million sales impact in Europe.
- Inventory rose to $431.7 million from $370.7 million at year-end 2021 as the company built stock amid demand and supply-chain constraints. Cash declined from $242.0 million at year-end.
- The company repurchased 433,623 Class A shares for $61.1 million in the first six months, compared with 62,070 shares for $7.8 million in the prior-year period. $36.3 million remained authorized under the $150 million program at quarter-end. Six-month dividends paid were $19.3 million.
- Foreign-currency translation contributed to a $27.9 million six-month other comprehensive loss. Total stockholders’ equity was $1,186.5 million at quarter-end.
Outlook, risks, and contingencies
- The filing provides no specific full-year revenue or earnings guidance and cautions that interim results are not necessarily indicative of full-year performance.
- Management expected approximately $22–$27 million of capital equipment investment for the remainder of 2022 and approximately $5 million of remaining cash spending on the French restructuring program. The program was expected to finish in the second half of 2022; annual after-tax savings of about $3 million were expected to be fully realized by 2023.
- Management cited commodity and raw-material inflation, energy and transportation costs, labor shortages, supply-chain and electronic-component constraints, COVID-related disruptions, and the Ukraine war as ongoing uncertainties. Price increases helped offset inflation, but future effects on customer service and margins were uncertain.
- The company estimated reasonably possible losses on contingencies in excess of accrued amounts at approximately $4.5 million pre-tax. For the Chemetco Superfund matter, it could not estimate a loss range because remediation scope, costs, and allocation among potentially responsible parties remained undetermined. Management did not expect the matters, based on information then available, to materially adversely affect financial condition, though a particular period’s results or cash flows could be affected.
- The French facility consolidation had estimated total pre-tax costs of $22.9 million, with $22.0 million incurred by June 26, 2022. The company also expected $1.1 million of additional facility-exit charges in the third and fourth quarters.
- On July 19, Watts announced Andre Dhawan’s appointment as COO effective August 15, 2022; Munish Nanda would step down as President of the Americas & Europe and assist with transition ahead of planned retirement in May 2023. A quarterly dividend of $0.30 per share was declared August 1, payable September 15.
Most important facts for investors to verify
- Whether price increases and productivity can continue to offset inflation and freight, labor, and material costs, and whether demand and order fulfillment remain resilient.
- Whether inventory growth converts to sales and cash, given the decline in operating cash flow and free cash flow versus the prior year.
- Debt and liquidity trends, including variable-rate exposure, available revolving capacity, and covenant compliance.
- Execution and remaining costs of the French restructuring, including realization of projected savings by 2023.
- Developments in foreign exchange, Europe/Russia exposure, supply-chain disruption, and the unresolved environmental and other contingencies.