Watts Water Technologies, Inc. — Q2 2021 Form 10-Q
Business and period. Watts designs and supplies products for flow control, heating, drainage, water reuse and water quality in residential and commercial markets. It reports three geographic segments: Americas, Europe and APMEA. This unaudited filing covers the quarter and six months ended June 27, 2021; comparisons are with the corresponding periods ended June 28, 2020. Amounts below are in millions of dollars except per-share data.
Financial results
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Net sales | $467.0 | $338.7 | $880.3 | $721.3 |
| Gross profit / margin | $200.1 / 42.8% | $134.9 / 39.8% | $373.8 / 42.5% | $297.7 / 41.3% |
| Operating income | $52.7 | $31.0 | $112.3 | $78.8 |
| Net income | $37.5 | $20.2 | $79.2 | $52.2 |
| Diluted EPS | $1.11 | $0.59 | $2.34 | $1.53 |
- Q2 sales rose 37.9% reported and 32.1% organically; six-month sales rose 22.0% reported and 17.0% organically. Organic sales exclude foreign exchange and acquisitions/divestitures.
- Q2 operating income increased 70.0%; six-month operating income increased 42.5%. Gross margin improved in both comparisons. Higher volume, pricing and productivity benefits supported results, partly offset by inflation, freight costs, investments and restructuring.
- Q2 SG&A was $130.4, or 27.9% of sales, versus $97.6, or 28.8%. Six-month SG&A was $244.2, or 27.7% of sales, versus $212.6, or 29.5%.
- Interest expense declined to $1.5 in Q2 from $4.0 and to $3.5 for six months from $7.0, primarily reflecting lower interest rates and reduced debt. Effective tax rates were 27.5% for Q2 and 27.7% for six months.
Cash flow, debt and liquidity
- Six-month operating cash flow was $73.2, up from $47.3. Free cash flow, a company-defined non-GAAP measure, was $65.1 versus $25.0; the filing’s calculation subtracts capital expenditures and adds asset-sale proceeds.
- Cash and equivalents were $240.1 at June 27, 2021, compared with $218.9 at year-end 2020. Long-term debt was $191.5, with net cash of $48.6 and a net debt-to-capitalization ratio of (4.5%), as calculated by the company.
- The amended $800 million revolving facility matures March 30, 2026. At quarter-end, $195.0 was drawn, $14.0 of letters of credit were outstanding, and $591.0 of availability remained. The company reported covenant compliance. Weighted-average facility borrowing cost was 1.16%; including its interest-rate swap, the reported rate was 1.65%.
- Six-month financing cash outflow was $41.7, including $16.7 of dividends, $7.8 of share repurchases and $9.2 of tax withholding on vested awards. Investing cash outflow was $8.1. The company expects to spend approximately $20–$25 on capital equipment during the remainder of 2021.
Material changes and segment performance
- Sales increased in all three regions. Q2 Americas sales were $307.1, Europe $136.8 and APMEA $23.1. Six-month sales were $579.9, $259.7 and $40.7, respectively.
- Q2 segment operating income was $55.2 in Americas, $5.4 in Europe and $4.3 in APMEA, compared with $29.5, $9.2 and $0.8. Europe’s decline included the new France restructuring charge; corporate expense increased to $12.2 from $8.5.
- Management estimated that February 2021 severe weather in the South-Central U.S. contributed approximately 4% of Q2 consolidated incremental sales and approximately 5% of incremental Americas sales. Reopening and recovery versus the COVID-affected 2020 comparison also contributed to growth.
Outlook, risks and unusual items
- No formal full-year revenue or earnings guidance is stated. Management cautioned that interim results are not necessarily indicative of full-year results.
- A France restructuring program approved in June is expected to cost approximately $26.3 pre-tax (approximately $19.0 after tax), eliminate about 80 positions at the Mery facility and result in a net France headcount reduction of about 50. Costs are expected through the second half of 2022; estimated annual cash savings after tax are approximately $3.0, expected to be fully realized by 2023. Q2 included $18.0 of charges for the program.
- Management cited supply constraints, including semiconductors and other raw materials, shipping and trucking disruptions, higher expedited freight costs, and commodity and input-cost inflation. It said these factors could affect customer service, realization of price increases and margins in the second half of 2021. Future COVID-19 outbreaks, restrictions and recovery conditions remain uncertain.
- Other risks include foreign-exchange, floating-rate debt and commodity-price exposure. The company uses derivatives for hedging, not trading. At quarter-end, its $100 million interest-rate swap fixed the rate at 1.02975% through March 2026, subject to the swap terms.
- The company estimated approximately $4.0 of reasonably possible loss above accrued amounts for contingencies. It could not estimate a loss range for the Chemetco environmental matter. Gross unrecognized tax benefits were approximately $9.0; a further $4.6 increase related to a non-U.S. tax matter was reasonably possible within 12 months, while other balances could decrease by $2.0–$2.5.
- On August 2, 2021, the company declared a $0.26-per-share quarterly dividend, payable September 15, 2021. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether pricing and productivity can offset continuing inflation, freight and supply-chain costs, and whether those pressures affect second-half margins.
- How much Q2 and year-to-date growth reflects recovery from the pandemic-affected 2020 comparison and the temporary weather-related demand boost.
- Actual France restructuring costs, timing, execution and realized savings relative to management’s estimates.
- Cash conversion and working-capital trends: receivables and inventories increased during the first half and reduced operating cash flow.
- Available revolver capacity, variable-rate exposure, covenant headroom and foreign-cash accessibility; $193.4 of cash was held by foreign subsidiaries.
- Developments in the Chemetco environmental matter, other contingencies and the identified foreign tax exposure.