Watts Water Technologies, Inc. — Q3 2020 Form 10-Q
Reporting period: Third quarter ended September 27, 2020; year-to-date figures cover the nine months ended that date. Comparisons are with the corresponding 2019 periods. Dollars are in millions except per-share amounts.
Business context and results
Watts supplies water flow-control, heating, drainage and water-quality products across the Americas, Europe and Asia-Pacific, Middle East and Africa (APMEA). COVID-19-related restrictions and weaker customer demand affected all three regions. Management said third-quarter sales improved from Q2, but monthly order and sales rates declined as the quarter progressed, partly because early-quarter restocking did not repeat.
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $383.9 | $394.7 | $1,105.2 | $1,200.2 |
| Gross profit / margin | $158.5 / 41.3% | $168.6 / 42.7% | $456.2 / 41.3% | $507.4 / 42.3% |
| Operating income | $47.9 | $48.8 | $126.7 | $149.8 |
| Net income | $32.9 | $32.3 | $85.1 | $99.7 |
| Diluted EPS | $0.97 | $0.94 | $2.50 | $2.91 |
| Operating cash flow | Not separately provided | Not separately provided | $127.4 | $94.9 |
| Free cash flow (company-defined, non-GAAP) | Not separately provided | Not separately provided | $95.1 | $75.9 |
Financial position and cash
- At September 27, 2020, cash and equivalents were $188.3, current assets $699.6 and current liabilities $295.2. Cash included $125.1 held by foreign subsidiaries.
- Long-term debt was $247.9, with no current portion reported; net debt was $59.6, down from $89.5 at year-end 2019. Net debt to capitalization declined to 5.5% from 8.4%.
- The amended $800 million revolving facility matures in February 2022. The company had drawn $250.0, had $16.2 of letters of credit outstanding and reported $533.8 of available capacity. It was in compliance with covenants; the reported facility rate was 2.5%.
- Nine-month investing cash outflow was $39.1, including $33.8 of capital expenditures and $7.7 for acquisitions. Financing cash outflow was $119.5, including debt repayments, dividends of $23.2 and share repurchases of $24.8. Cash decreased $31.4 to $188.3.
Changes versus prior periods
- Q3 reported sales fell 2.7%; organic sales, excluding acquisitions, divestitures and foreign exchange, fell 5.0%. The nine-month reported decline was 7.9%, with organic sales down 8.5%. All regions declined year to date; DIY sales partly offset declines in other channels.
- Q3 net income rose modestly despite lower sales, while nine-month net income fell 14.6%. Q3 gross margin declined 1.4 percentage points; the nine-month margin declined 1.0 point. Lower volumes pressured profit, partly offset by productivity and cost reductions.
- Nine-month operating cash flow increased by $32.5, primarily from lower working capital, including reduced receivables, more than offsetting lower earnings. Capital spending increased to $33.8 from $19.1.
- SG&A declined 11.0% in Q3 and 10.1% year to date, reflecting pandemic-related cost actions, lower variable and incentive costs, and reduced professional fees; strategic investment and inflation partly offset savings.
Outlook, risks and unusual items
- Management estimated Q4 2020 sales could decline 4%–8% versus Q4 2019. It expected COVID-19 to continue affecting operations and planned approximately $5–$10 of Q4 capital investment. The filing provides no full-year earnings guidance.
- COVID-19 risks include uncertain demand and recovery, renewed restrictions, supply-chain disruption, production constraints, employee absenteeism, delayed customer payments and reduced customer spending. Management said it did not anticipate difficulty paying debt as due, but the ultimate pandemic impact remained uncertain.
- 2020 restructuring charges were $8.7 through September, with total expected charges revised to approximately $11.0; remaining costs were expected to be completed by the first half of 2021. Q3 also included a $0.6 loss on an immaterial APMEA divestiture; year-to-date results included a $1.0 long-lived-asset impairment.
- After the April credit-agreement amendment changed the LIBOR floor, existing interest-rate swaps no longer qualified for hedge accounting. A $0.7 accumulated loss was expected to be reclassified to interest expense through February 2021; subsequent fair-value changes are recognized in earnings.
- Management found no goodwill impairment trigger at quarter-end, but identified the Heating and Hot Water Solutions reporting unit as more exposed if prolonged pandemic effects materially change valuation assumptions.
- The company estimated reasonably possible legal losses above accrued amounts at approximately $6.1 pre-tax. It could not estimate a loss range for the Chemetco environmental matter; management said the known matters were not expected to materially affect overall financial condition.
Important facts for investors to verify
- Whether Q4 sales tracked the disclosed 4%–8% year-over-year decline estimate, and whether sequential order trends improved or weakened.
- Whether gross-margin pressure, cost savings and restructuring charges persisted, and how much of reported earnings reflected unusual items.
- Cash conversion and working-capital trends, capital spending, share repurchases and dividends relative to available cash and debt capacity.
- Credit-facility borrowings, covenant compliance, floating-rate exposure and the effect of swap mark-to-market changes.
- COVID-19 effects on customers, suppliers and facilities, along with goodwill valuation assumptions and developments in legal and environmental contingencies.