Watts Water Technologies, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. The company supplies flow-control, HVAC and gas, drainage and water-reuse, and water-quality products across the Americas, Europe, and Asia-Pacific, Middle East and Africa (APMEA). This unaudited filing covers the quarter ended September 29, 2019, and the nine months ended that date, compared with the respective 2018 periods.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $394.7m | $390.9m | $1,200.2m | $1,177.3m |
| Gross profit / margin | $168.6m / 42.7% | $164.5m / 42.1% | $507.4m / 42.3% | $490.6m / 41.7% |
| Operating income | $48.8m | $46.9m | $149.8m | $143.0m |
| Net income | $32.3m | $31.5m | $99.7m | $95.7m |
| Diluted EPS | $0.94 | $0.92 | $2.91 | $2.78 |
- Q3 sales rose 1.0%; organic sales growth was 2.4%, partly offset by a 1.4% foreign-exchange headwind. Nine-month sales increased 2.0%, with 4.1% organic growth offset by a 2.1% FX headwind.
- Q3 gross margin increased 0.6 percentage points; nine-month margin increased 0.6 points. Management attributed improvement to pricing, volume, and productivity savings, partly offset by inflation and tariffs.
- Q3 SG&A rose 4.9% to $119.8m, and was 30.4% of sales versus 29.2%. Nine-month SG&A rose 3.1% to $354.9m and was 29.6% of sales versus 29.2%.
- Operating income increased 4.1% in Q3 and 4.8% for the nine-month period. Americas and Europe improved; APMEA operating income declined, and higher corporate costs partly offset segment gains.
Cash flow, liquidity, and debt
- Nine-month operating cash flow was $94.9m versus $66.6m. Capital expenditures were $19.1m versus $24.1m; company-defined free cash flow was $75.9m versus $42.6m. Management cited inventory reductions, higher earnings, lower capital spending, and higher prior-year tax payments as factors in the improvement.
- Cash and cash equivalents were $173.7m at September 29, 2019, down from $204.1m at year-end 2018; $132.3m was held by foreign subsidiaries. Current assets were $714.1m and current liabilities $396.5m.
- The company reported $437.2m of unused and available revolving credit, after $37.0m drawn and $25.8m of letters of credit. It reported compliance with credit-agreement and note-agreement covenants.
- Balance-sheet current and long-term debt totaled $343.5m ($105.0m current and $238.5m long-term). The company’s net-debt reconciliation reported $169.8m of net debt and a 15.3% net-debt-to-capitalization ratio, up from 14.3% at year-end. Note 7 separately states debt carrying value of $344.5m; see investor verification items below.
- Nine-month financing cash outflows included $92.5m of debt payments, $23.6m of dividends, and $14.8m of share repurchases; these were partly offset by $82.0m of borrowing proceeds. The 2015 repurchase authorization was completed; $147.0m remained under the 2019 authorization.
Material changes, outlook, and commentary
- Americas sales grew 2.9% in Q3 and 5.2% for the nine months; Europe declined 3.3% and 4.1%, respectively, including substantial FX effects. APMEA sales were broadly flat in Q3 and down 6.4% for the nine months. Management cited Middle East project delays and softness in Korea, partly offset by growth in China and New Zealand in Q3.
- The company completed an acquisition of Backflow Direct in Q3 for $42.7m net cash, recording $38.3m of goodwill. It also paid approximately $2.8m to acquire the remaining 10% of Apex Valves.
- Management expected approximately $11m of capital-equipment investment for the remainder of 2019. The filing provides no specific full-year revenue or earnings guidance and cautions that interim results are not necessarily indicative of full-year results.
- Management’s stated growth priorities include product innovation, selective acquisitions, water conservation and safety-related offerings, and smart/connected products. Risks discussed include foreign-exchange movements, commodity costs and tariffs, inflation, economic conditions, and demand/project variability.
- Q3 results included after-tax charges of $2.3m for corporate professional fees, $0.7m for acquisition costs, and $0.3m for footprint optimization. Nine-month results also included $1.9m of after-tax restructuring charges. The European restructuring program had incurred approximately $6.7m of expected pre-tax costs; a $2.4m reserve remained at quarter-end.
- Reasonably possible legal losses in excess of recorded accruals were estimated at approximately $5.3m pre-tax. The company could not estimate a loss range for the Chemetco Superfund matter because the remediation plan, costs, and allocation among potentially responsible parties were undetermined.
- Disclosure controls and procedures were reported ineffective at quarter-end due to a previously disclosed material weakness in internal control over financial reporting. Management expected remediation before fiscal year-end 2019, subject to controls operating effectively for a sufficient period and successful testing.
Most important facts for investors to verify
- Reconcile the debt disclosures: balance-sheet debt components total $343.5m, while Note 7 states a $344.5m carrying amount; confirm the correct debt figure and its relationship to reported net debt of $169.8m.
- Track remediation and testing of the material weakness; the filing says controls were still ineffective at September 29, 2019.
- Assess whether operating cash generation and working-capital improvements are sustainable, and monitor the planned remaining-2019 capital spending.
- Monitor Europe and APMEA demand, currency effects, tariffs and input-cost pass-through, and the unresolved Chemetco remediation exposure and other legal contingencies.
- Evaluate acquisition spending, integration, share repurchases, and the company’s substantial foreign-held cash alongside its debt and liquidity position.