Watts Water Technologies, Inc. — Q2 2018 Form 10-Q
Reporting period: Second quarter and six months ended July 1, 2018; comparisons are to the periods ended July 2, 2017. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data.
Business context and results
Watts supplies products for flow control, heating and gas, drainage and water reuse, and water quality. It reports Americas, Europe, and APMEA segments and sells principally through wholesale, OEM, specialty, and DIY channels.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $407.9 | $378.5 | $786.4 | $725.7 |
| Gross profit / margin | $169.4 / 41.5% | $156.7 / 41.4% | $326.1 / 41.5% | $300.5 / 41.4% |
| Operating income / margin | $52.2 / 12.8% | $44.8 / 11.8% | $96.1 / 12.2% | $80.5 / 11.1% |
| Net income | $36.0 | $27.2 | $64.2 | $48.9 |
| Diluted EPS | $1.05 | $0.79 | $1.87 | $1.42 |
Financial position, cash flow, and liquidity
- Six-month operating cash flow was $1.5, down from $9.0. Capital expenditures were $15.2, producing non-GAAP free cash outflow of $13.7, compared with $1.9 outflow a year earlier.
- Cash and equivalents were $142.6 at July 1, 2018, versus $280.2 at year-end 2017; $127.8 was held by foreign subsidiaries. Cash declined $137.6 during the half.
- Balance-sheet debt was $409.2, comprising $26.2 current and $383.0 long-term; management-reported net debt was $266.6, up from $216.9 at year-end. The company reported $411.3 carrying value of long-term debt, including current portion, in its debt fair-value disclosure.
- The $500 million revolving facility had $70.0 drawn, $25.8 of letters of credit, and $404.2 of unused and available credit. The $300 million term loan had $266.3 outstanding. Both facilities mature February 12, 2021; the company reported covenant compliance.
- Current assets were $709.1 and current liabilities $309.2. The company declared a $0.21-per-share quarterly dividend after quarter-end, payable September 14, 2018.
Material changes versus prior period
- Q2 sales increased 7.8%; management attributed 5.1 percentage points to organic growth and 2.7 points to foreign exchange. Six-month sales rose 8.4%, including 4.7% organic growth and 3.7% foreign exchange.
- Americas led organic growth, supported by volume and pricing across valve, drainage, water-quality, and heating products. Europe organic sales were soft, particularly in HVAC and water/plumbing; APMEA grew, with strength outside China and in Chinese commercial valves.
- Operating income rose 16.5% in Q2 and 19.4% for the six-month period. Volume, pricing, productivity, restructuring savings, and foreign exchange helped; higher copper and stainless-steel costs, transportation, inflation, R&D, and growth investments partly offset gains.
- Net income benefited from higher operating income and a lower effective tax rate. The Q2 effective rate was 27.6% versus 31.7%; the six-month rate was 27.9% versus 30.7%, primarily reflecting the lower U.S. federal tax rate under 2017 tax reform.
- Cash generation weakened as working capital and tax-payment timing, including payments related to the 2017 Tax Act, offset higher earnings. Investing outflow increased with capital spending and small acquisitions; financing included $133.2 of debt repayments, $10.8 of share repurchases, and $13.9 of dividends.
Outlook, commentary, and risks
- No full-year earnings or sales guidance is provided in the filing. Management expected to spend approximately $20–25 million on capital equipment in the remainder of 2018.
- Management cited product innovation, selective acquisitions, water conservation and quality requirements, code enforcement, and economic conditions as factors affecting future growth. It also highlighted exposure to foreign exchange, commodity prices, and interest rates; higher material costs were already pressuring results.
- The company expects to repatriate approximately $125 million of cash in 2018; about $110 million had been repatriated by July 1, with most used to reduce debt. The estimated $23.3 million one-time repatriation tax is payable over eight years. Tax accounting for parts of the 2017 Tax Act remained provisional.
- Legal contingencies had an estimated $5.7 million of reasonably possible loss above accruals. A separate Chemetco Superfund matter had no estimable loss range because remediation costs and responsible-party shares were undetermined. Management said the known matters were not expected to materially affect financial condition, though a particular period’s results or cash flows could be affected.
- ASC 606 adoption was not material. The company planned to adopt lease accounting standard ASC 842 on January 1, 2019; it expected balance-sheet recognition of operating lease assets and obligations but could not yet quantify the impact.
- Management reported disclosure controls were effective and no material change in internal control over financial reporting, other than process and control updates for revenue recognition. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether operating cash flow recovers as working capital and tax-payment timing normalize, and how planned capital expenditures affect free cash flow.
- Whether organic growth and margin gains persist amid copper, stainless-steel, transportation, wage, and other inflation pressures.
- Debt reduction, availability under the revolving facility, and the effect of interest rates and foreign exchange on earnings and cash flows.
- Finalization of provisional 2017 Tax Act accounting and the timing and use of repatriated foreign cash.
- Developments in the Chemetco matter and other legal contingencies, including potential losses beyond recorded accruals.