Watts Water Technologies, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods. Amounts are in U.S. dollars unless noted.
Business context
Watts supplies water-flow control, HVAC and gas, drainage and water-reuse, and water-quality products to residential and commercial markets. It reports three geographic segments: Americas, Europe, and Asia-Pacific, Middle East and Africa (APMEA). Revenue is derived primarily from product sales.
Financial highlights
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $416.8m | $407.9m | $805.5m | $786.4m |
| Gross profit / margin | $174.6m / 41.9% | $169.4m / 41.5% | $338.8m / 42.1% | $326.1m / 41.5% |
| Operating income | $54.3m | $52.2m | $101.0m | $96.1m |
| Net income | $36.4m | $36.0m | $67.4m | $64.2m |
| Diluted EPS | $1.06 | $1.05 | $1.97 | $1.87 |
- Q2 sales increased 2.2%; management reported organic growth of 4.3%, partly offset by a 2.1% foreign-exchange headwind. First-half sales rose 2.4%, with 5.0% organic growth and a 2.6% FX drag.
- Americas sales grew to $287.0m in Q2 from $272.0m, while Europe declined to $113.2m from $117.1m and APMEA to $16.6m from $18.8m. Management attributed Americas and Europe organic growth mainly to pricing and volume; APMEA was weaker, including softness in Korea, Australia, and the Middle East.
- Q2 operating income rose 4.0%. Price and productivity savings supported results, partly offset by inflation, tariffs, strategic-growth investment, and higher restructuring costs. First-half operating income increased 5.1%.
- Cash from operations was $19.7m in the first half, versus $1.5m in 2018. Capital expenditures were $14.3m, producing reported free cash flow of $5.4m versus negative $13.7m.
- Cash and equivalents were $166.8m at June 30, down from $204.1m at year-end. Current assets were $728.4m and current liabilities $391.6m.
- Balance-sheet debt was $343.8m, including $105.0m current and $238.8m long-term. Net debt was $177.0m; net debt to capitalization increased to 15.9% from 14.3% at year-end. The company had $444.2m of unused revolver capacity and reported compliance with debt covenants.
Material changes, outlook, and notable items
- Management expects capital-equipment investment of approximately $22m–$25m for the remainder of 2019. The filing provides no revenue or earnings guidance.
- European restructuring actions initiated in 2018 generated $1.3m of Q2 and $2.7m of first-half 2019 charges. Total expected program costs increased to approximately $6.7m; $3.5m remained accrued at June 30. Q2 and first-half net income included after-tax restructuring charges of $0.9m and $1.9m, respectively.
- Adoption of lease accounting standard ASC 842 on January 1, 2019 added $33.6m of operating right-of-use assets and $33.9m of lease liabilities. Management said the adoption did not materially affect the income statement or cash flows.
- Disclosure controls and procedures were not effective at quarter-end because of a material weakness previously reported in the 2018 Form 10-K. Management expected remediation before year-end 2019; the weakness was not yet considered remediated.
- Legal matters included an estimated $5.2m of reasonably possible losses in excess of accrued amounts. For the Chemetco Superfund matter, the company could not estimate a reasonably possible loss range; management said the known share of investigation costs was not expected to materially affect financial condition.
- Foreign-currency movements, interest-rate exposure, and commodity-price increases are identified risks. Management notes that higher material costs could hurt results if not passed through to customers. It also states that foreign cash may incur tax costs if repatriated.
- After quarter-end, the company declared a $0.23-per-share quarterly dividend, payable September 13, 2019. The filing also states the purchase of the remaining 10% of Apex was completed in Q3 2019.
Most important facts for investors to verify
- Progress and testing of remediation for the material weakness in financial reporting controls.
- Whether organic growth and margin improvement continue, particularly in the Americas, and whether Europe and APMEA stabilize.
- Cash conversion and working-capital trends, given the first-half operating cash flow improvement and the decline in cash balances.
- Debt maturity and refinancing exposure, including the $105.0m current debt classification and the credit facilities maturing in 2021.
- Potential effects of tariffs, commodity costs, foreign exchange, legal contingencies, and restructuring spending on future results.