Watts Water Technologies, Inc. — Q3 2021 Form 10-Q
Reporting period: Third quarter and nine months ended September 26, 2021; comparisons are to periods ended September 27, 2020. Amounts are in U.S. dollars.
Business context
Watts supplies products and systems for flow control, HVAC and gas, drainage and water reuse, and water quality. It operates in the Americas, Europe, and Asia-Pacific, Middle East and Africa (APMEA), selling primarily through wholesale, OEM, specialty, and DIY channels.
Financial performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net sales | $455.0m | $383.9m | $1,335.3m | $1,105.2m |
| Gross profit | $194.0m | $158.5m | $567.8m | $456.2m |
| Gross margin | 42.6% | 41.3% | 42.5% | 41.3% |
| Operating income | $64.7m | $47.9m | $177.0m | $126.7m |
| Net income | $46.4m | $32.9m | $125.6m | $85.1m |
| Diluted EPS | $1.37 | $0.97 | $3.70 | $2.50 |
- Q3 sales increased 18.5% reported and 17.2% organically. Nine-month sales rose 20.8% reported and 17.1% organically. Growth reflected recovery across markets and pricing; foreign exchange and acquisitions also contributed to reported growth.
- Q3 operating income grew 35.1%; nine-month operating income grew 39.7%. Gross margin improved in both periods. Management cited volume, pricing, productivity, and prior restructuring savings, partly offset by material and labor inflation, freight and logistics costs, compensation, and business-normalization expenses.
- Q3 diluted EPS included a $0.02-per-share after-tax restructuring charge. Nine-month diluted EPS included $0.40 per share of after-tax restructuring charges, including the France program.
- Operating cash flow was $134.9m for nine months, versus $127.4m. Free cash flow, a non-GAAP measure, was $120.2m versus $95.1m; conversion of free cash flow to net income was 95.7% versus 111.8%. Receivables and inventory used $49.6m and $93.4m of cash, respectively, partly offset by a $110.9m source from payables, accrued expenses, and other liabilities.
- Cash was $238.7m at September 26, 2021, including $190.4m held by foreign subsidiaries. Long-term debt was $151.7m; net cash was $87.0m, and the company reported a net-debt-to-capitalization ratio of negative 8.2% (non-GAAP).
- The $800m revolving facility matures March 30, 2026. The company had drawn $155.0m, with $14.0m in letters of credit and $631.0m of unused available capacity. Weighted average facility interest was 1.16%; including the interest-rate swap, it was 1.77%. The company reported compliance with its debt covenants.
- Inventories rose to $352.7m from $263.6m at year-end 2020; current assets were $863.0m and current liabilities $417.8m.
Changes, outlook, and key commentary
- All three segments grew in Q3: Americas sales were $309.1m, Europe $124.1m, and APMEA $21.8m. Nine-month sales increased in each region; Americas remained the largest contributor.
- Management cited supply shortages and inflation for raw materials and components, including semiconductors and stainless steel, shipping and port congestion, higher freight costs, and labor disruptions. It warned these could affect customer service, pricing realization, and margins; duration and impact remain uncertain.
- COVID-19 continued to create uncertainty, including possible outbreaks and restrictions and uneven end-market recovery. The filing states interim results are not necessarily indicative of full-year results; it provides no explicit full-year earnings or revenue guidance.
- For Q4 2021, management expected approximately $13m–$15m of capital expenditures.
- The France restructuring, approved in June 2021, is expected to cost approximately $26.3m pre-tax ($19.0m after tax), eliminate about 80 positions at the Mery facility and result in a net reduction of about 50 positions in France. Completion is expected in the second half of 2022; annual after-tax cash savings of about $3.0m are expected to be fully realized by 2023.
- After quarter-end, Watts acquired Sentinel Hydrosolutions on September 30, 2021, in an all-cash transaction deemed immaterial. On November 1, it declared a $0.26-per-share quarterly dividend, payable December 15, 2021.
Risks, contingencies, and unusual items
- Management estimated reasonably possible losses from contingencies in excess of accrued amounts at approximately $5.9m pre-tax. It said an unfavorable outcome could materially affect results or cash flows in a particular period, though it did not expect a material adverse effect on overall financial condition.
- The Chemetco Superfund matter remains under investigation and remediation planning; the company could not estimate a reasonably possible loss range.
- Gross unrecognized tax benefits were approximately $8.9m. Certain benefits could increase by $4.6m in the next twelve months; other matters could decrease by $2.0m–$2.4m through settlements or statute expirations.
- The filing added supply-chain and logistics disruption as a risk factor. It reported no material changes to other previously disclosed risk factors and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether pricing keeps pace with inflation in materials, labor, and freight, and whether inventory and working-capital requirements remain elevated.
- Progress toward the France restructuring’s cost, timing, headcount, and savings targets, including remaining expected costs.
- Availability and cost of revolving-credit borrowing, covenant headroom, and the company’s foreign-held cash and ability to use it domestically.
- Developments in the Chemetco matter and tax uncertainties, including the unrecognized-tax-benefit amounts.
- Sentinel acquisition terms and performance, which the filing describes as immaterial but does not quantify.