Watts Water Technologies, Inc. — Q1 2018 Form 10-Q
Business and period: The company supplies water-flow, heating, drainage, and water-quality products for residential and commercial markets. The quarter ended April 1, 2018, and generally represents 13 weeks. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $378.5 | $347.2 | +9.0% |
| Gross profit / margin | $156.7 / 41.4% | $143.8 / 41.4% | Profit increased; margin unchanged |
| Operating income | $43.9 | $35.7 | +22.9% |
| Net income | $28.2 | $21.7 | +30.0% |
| Diluted EPS | $0.82 | $0.63 | +$0.19 |
| Operating cash flow | $(26.1) | $(9.1) | Greater cash use |
| Capital expenditures | $7.3 | $5.8 | +$1.5 |
- Sales growth comprised 4.1% organic growth ($14.3) and 4.9% foreign-exchange benefit ($17.0), principally from the stronger euro.
- Regional sales were Americas $241.1 (+5.4%), Europe $123.0 (+17.3%), and APMEA $14.4 (+5.9%). Europe’s reported increase was largely currency-driven; its organic growth was 2.1%.
- Management attributed stronger operating income to volume, pricing, foreign exchange, and productivity and restructuring savings. Higher copper and stainless-steel costs, transportation costs, wage inflation, and increased R&D spending partly offset these gains. SG&A was $112.8, up 4.8%, but declined to 29.8% of sales from 31.0%.
- The effective tax rate was 28.2%, versus 29.5%. The company reported no additional Q1 provisional tax expense or benefit from the 2017 Tax Act; certain related tax amounts remain provisional.
Cash, debt, and liquidity
- Cash and cash equivalents were $184.7 at April 1, down from $280.2 at year-end; approximately $169.5 was held by foreign subsidiaries.
- Company-defined net debt was $261.9, compared with $216.9 at December 31, 2017. Net debt to capitalization increased to 23.4% from 20.7%.
- The company reported $271.9 outstanding on its term loan and $102.0 drawn on its $500 million revolver. It had $372.3 of unused and available revolver capacity and was in compliance with debt covenants. Both facilities mature February 12, 2021.
- Financing cash outflow was $63.9, including $70.6 of debt payments, $6.7 of dividends, and $6.2 of share repurchases, partly offset by $20.0 of additional borrowing. Operating cash use reflected working-capital movements, including increases in receivables and inventory and decreases in payables and accrued liabilities.
Outlook, risks, and notable items
- No full-year revenue or earnings guidance is provided in the supplied filing text. Management expected approximately $30 million of capital-equipment investment for the remainder of 2018.
- Management cited product innovation, selective acquisitions, water conservation and safety regulation, code enforcement, and economic conditions as factors affecting future growth. It also noted uncertainty about future currency movements and its ability to pass commodity-cost increases on to customers.
- The company expected to repatriate approximately $125 million of cash to the U.S. during 2018; approximately $71 million had been repatriated by April 1, with most used to reduce debt. The estimated $23.3 million toll-tax obligation is payable in installments over eight years.
- Legal matters include ordinary-course product liability, environmental, and commercial claims. Management estimated reasonably possible legal losses above amounts accrued at approximately $6.0 million pre-tax. A separate Superfund-site matter is not quantifiable at this stage; management did not expect the investigation-study costs to materially affect financial condition.
- The company adopted ASC 606 in Q1 using the modified retrospective method, with no material impact. It planned to adopt the lease standard in 2019 and expected recognition of operating-lease assets and liabilities on the balance sheet; the impact was not yet quantified.
- A quarterly dividend of $0.21 per share was declared May 7, payable June 15, 2018. The Q1 dividend declared was $0.19 per share.
Important facts for investors to verify
- Whether cash conversion improves after Q1’s $26.1 operating cash outflow and elevated working-capital use.
- How much reported sales and earnings growth persists after separating organic performance from the favorable foreign-exchange effect.
- Whether pricing and productivity continue to offset copper, stainless-steel, freight, and wage-cost pressure.
- Updates to provisional Tax Act estimates, foreign cash repatriation, and related tax payments.
- Developments in the legal contingencies, particularly the currently unquantifiable Superfund-site exposure.
- Debt repayment, revolver usage, planned capital spending, and implementation effects of the 2019 lease-accounting standard.