Watts Water Technologies, Inc. — Q3 2017 Form 10-Q
Reporting period: Third quarter and nine months ended October 1, 2017; comparable periods ended October 2, 2016. Financial statements are unaudited. Watts supplies water-flow, heating, drainage, and water-quality products, primarily to residential and commercial markets, across the Americas, Europe, and APMEA.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $364.7m | $341.1m | $1,090.4m | $1,056.4m |
| Gross profit / margin | $152.7m / 41.9% | $142.0m / 41.6% | $453.2m / 41.6% | $427.9m / 40.5% |
| Operating income | $44.3m | $36.5m | $124.8m | $113.4m |
| Net income | $26.5m | $21.9m | $75.4m | $66.7m |
| Diluted EPS | $0.77 | $0.63 | $2.19 | $1.93 |
| Operating cash flow | — | — | $73.4m | $69.6m |
| Free cash flow* | — | — | $56.7m | $43.3m |
*Company-defined non-GAAP measure: operating cash flow less capital expenditures, plus proceeds from property sales. Q3 sales rose 6.9%, while reported sales for the first nine months rose 3.2%. The filing does not provide a separately stated consolidated operating margin; operating income was approximately 12.1% of sales in Q3 and 11.4% year to date.
Liquidity, debt, and capital allocation
- At October 1, 2017, cash was $246.6m, total debt was $523.1m based on the balance-sheet current and long-term debt lines, and company-defined net debt was $276.5m. Net debt to capitalization was 25.0%, down from 29.8% at December 31, 2016.
- The company reported $312.3m of unused and available revolving credit; $162.0m was drawn on its $500m revolver. It was in compliance with applicable debt covenants. The separate €110m facility was repaid in full during the first nine months.
- Cash declined $91.8m from year-end. Financing activities used $168.4m, including $151.8m of debt payments, $19.4m of dividends, and $13.6m of share repurchases; borrowings provided $20.0m.
- Capital expenditures were $17.1m year to date. Management expected approximately $13–16m of capital spending in Q4 2017. Cash held by foreign subsidiaries was approximately $218.7m; management said it intended to keep undistributed foreign earnings permanently reinvested and noted potential taxes if funds were repatriated.
Changes versus comparable periods
- Q3 sales growth reflected $14.4m of PVI acquisition sales, $5.9m from foreign exchange, and $3.3m of organic growth. Organic sales increased in the Americas but declined in Europe and APMEA. PVI was acquired in November 2016.
- For the first nine months, organic sales declined $3.1m (0.3%); acquisitions added $43.2m and divestitures reduced sales by $3.5m. Foreign exchange reduced sales by $2.6m. APMEA year-to-date operating income fell to $3.3m from $13.1m, while Americas and Europe operating income increased.
- Q3 operating income increased 21.3%; management cited higher volume, PVI, productivity and transformation savings, and lower transformation costs. Year-to-date operating income increased 10.1%, despite the prior-year period including an $8.7m gain on a China subsidiary disposition.
- Year-to-date interest expense declined $2.6m, reflecting lower debt balances and borrowing costs. The effective tax rate was 31.5% year to date versus 33.8% in 2016, principally due to worldwide earnings mix and a prior-year tax-audit reserve.
Outlook, commentary, and notable items
- No full-year earnings or sales guidance is stated in the provided filing text. Management identified product innovation, selective acquisitions, water conservation and safety regulation, code enforcement, and economic conditions as factors supporting potential growth.
- The Americas/APMEA transformation program was substantially complete and expected to finish by year-end 2017. Estimated total pretax program costs were reduced to approximately $60m; approximately $59m had been incurred by October 1. Europe’s 2015 restructuring was also expected to conclude in 2017, with approximately $1.6m of costs remaining.
- Q3 net income included an after-tax restructuring charge of $0.9m ($0.03 per share). Year-to-date results included transformation and restructuring charges, partly offset by tax benefits. The 2016 comparison included disposition and acquisition-related gains as well as transformation and restructuring charges.
- Risks highlighted include housing and construction market conditions, raw-material availability and prices, competition, floating-rate debt, foreign exchange, acquisitions, product development and safety compliance, environmental costs, product liability, and litigation.
- Legal contingencies: management estimated reasonably possible losses above amounts accrued of approximately $4.5m pretax. A new Chemetco Superfund matter had no estimable loss range. The connector class-action settlements became final in May 2017; $5.3m of the recorded liability remained payable over three years. The company received $9.9m of related insurance proceeds.
- Management reported disclosure controls and procedures were effective and no material change to internal control over financial reporting during the quarter. A quarterly dividend of $0.19 per share was declared after quarter-end, payable December 15, 2017.
Key facts for investors to verify
- How much of revenue and operating-income growth is sustainable organic growth versus PVI, currency effects, and restructuring or productivity savings?
- What is driving the marked year-to-date decline in APMEA operating income, and are project timing and product rationalization still affecting that segment?
- Confirm debt and liquidity figures, including the $312.3m reported available revolver capacity, debt maturities, and the concentration of cash in foreign subsidiaries.
- Track completion and remaining costs of the transformation and Europe restructuring programs, and whether expected savings materialize.
- Monitor the Chemetco environmental investigation and legal exposures; the filing says the Chemetco loss range cannot yet be estimated.