Watts Water(WTS) - 2019 Q2 - Quarterly Report

Part I Financial Statements The company's financial statements for Q2 and H1 2019 show growth in net sales and income, with improved operating cash flow Consolidated Balance Sheets Total assets and stockholders' equity slightly increased as of June 30, 2019, while total liabilities also rose Consolidated Balance Sheet Summary (in millions) | Account | June 30, 2019 | December 31, 2018 | | :--- | :--- | :--- | | Total Current Assets | $728.4 | $721.3 | | Total Assets | $1,678.4 | $1,653.7 | | Total Current Liabilities | $391.6 | $348.7 | | Total Liabilities | $744.2 | $654.0 | | Total Stockholders' Equity | $934.2 | $891.3 | Consolidated Statements of Operations Net sales and net income increased year-over-year for both Q2 and H1 2019, with corresponding diluted EPS growth Statement of Operations Highlights (in millions, except per share data) | Metric | Q2 2019 | Q2 2018 | 6 Months 2019 | 6 Months 2018 | | :--- | :--- | :--- | :--- | :--- | | Net sales | $416.8 | $407.9 | $805.5 | $786.4 | | Gross Profit | $174.6 | $169.4 | $338.8 | $326.1 | | Operating Income | $54.3 | $52.2 | $101.0 | $96.1 | | Net Income | $36.4 | $36.0 | $67.4 | $64.2 | | Diluted EPS | $1.06 | $1.05 | $1.97 | $1.87 | Consolidated Statements of Cash Flows Operating cash flow significantly improved in H1 2019, while overall cash and cash equivalents decreased due to financing activities Cash Flow Summary for Six Months Ended (in millions) | Activity | June 30, 2019 | July 1, 2018 | | :--- | :--- | :--- | | Net cash provided by operating activities | $19.7 | $1.5 | | Net cash used in investing activities | $(14.3) | $(16.8) | | Net cash used in financing activities | $(42.5) | $(118.1) | | Decrease in Cash and Cash Equivalents | $(37.3) | $(137.6) | Notes to Consolidated Financial Statements Key accounting policies, restructuring charges, derivative usage, and dividend declarations are detailed in the financial statement notes - The company adopted the new lease accounting standard ASC 842 on January 1, 2019, recording operating Right-of-Use (ROU) assets of $33.6 million and operating lease liabilities of $33.9 million on the consolidated balance sheet[38] - A European restructuring program initiated in Q3 2018 has incurred total costs of $6.7 million to date, with $2.7 million charged in the first six months of 2019 for severance and other cost-cutting actions[59] - The company uses interest rate swaps to manage exposure on its floating-rate debt and forward exchange contracts to hedge forecasted intercompany transactions in Canadian dollars and Chinese yuan[69][70] - On July 29, 2019, the company declared a quarterly dividend of $0.23 per share, payable on September 13, 2019[96] Management's Discussion and Analysis of Financial Condition and Results of Operations The company achieved organic sales and operating income growth in Q2 and H1 2019, significantly improving cash flow despite increased net debt Overview The company's growth strategy focuses on product innovation, acquisitions, and its 'Smart and Connected' IoT initiative - The company's growth strategy focuses on product innovation, selective acquisitions, and capitalizing on regulatory requirements for water quality and conservation[100] - A key strategic initiative is the 'Smart and Connected' strategy, focusing on IoT-enabled products that 'Connect, Control and Conserve' to deliver superior customer value[102] Results of Operations Q2 and H1 2019 saw net sales and operating income growth, driven by organic performance and improved gross margin Q2 2019 vs Q2 2018 Net Sales Change (in millions) | Region | Organic Change | Foreign Exchange | Total Change | | :--- | :--- | :--- | :--- | | Americas | $15.6 | $(0.6) | $15.0 | | Europe | $3.2 | $(7.1) | $(3.9) | | APMEA | $(1.4) | $(0.8) | $(2.2) | | Total | $17.4 | $(8.5) | $8.9 | - Gross margin for Q2 2019 increased to 41.9% from 41.5% in Q2 2018, driven by price and productivity savings that offset higher inflation and tariffs[109] - Q2 2019 SG&A expenses increased organically by $4.1 million, primarily due to $2.8 million in investments for strategic growth initiatives[110] - For the first six months of 2019, the company recorded a $2.7 million restructuring charge related to its European plan[121] Liquidity and Capital Resources Liquidity remains strong with significantly improved operating and free cash flow, though the net debt to capitalization ratio increased - Net cash from operating activities increased to $19.7 million in the first six months of 2019, up from $1.5 million in the prior-year period, mainly due to inventory reductions and higher net income[127] Free Cash Flow Reconciliation (in millions) | | 6 Months 2019 | 6 Months 2018 | | :--- | :--- | :--- | | Net cash provided by operating activities | $19.7 | $1.5 | | Less: additions to property, plant, and equipment | (14.3) | (15.2) | | Free cash flow (outflow) | $5.4 | $(13.7) | - As of June 30, 2019, the company had $444.2 million of unused credit under its Revolving Credit Facility and was in compliance with all debt covenants[130][89] Net Debt to Capitalization Ratio | Metric | June 30, 2019 | December 31, 2018 | | :--- | :--- | :--- | | Net Debt (in millions) | $177.0 | $149.3 | | Capitalization (in millions) | $1,111.2 | $1,040.6 | | Net debt to capitalization ratio | 15.9% | 14.3% | Quantitative and Qualitative Disclosures About Market Risk The company manages foreign currency, interest rate, and commodity price risks using derivative instruments, not for speculative purposes - The company's primary market risks are foreign currency translation, interest rate changes on variable-rate debt, and commodity price volatility[142][143][148] - To manage interest rate risk on its floating-rate debt, the company entered into two interest rate swaps with a total notional amount of $225.0 million, effectively converting variable LIBOR-based payments to a fixed rate of 1.31375%[147] - The company hedges a significant portion (60-80%) of its forecasted Canadian dollar and Chinese yuan intercompany transactions for the next twelve months using forward exchange contracts[144][146] Controls and Procedures Disclosure controls were ineffective as of June 30, 2019, due to a material weakness, with a remediation plan underway - The Chief Executive Officer and Chief Financial Officer concluded that disclosure controls and procedures were not effective as of June 30, 2019, due to a previously identified material weakness[149] - A remediation plan to address the material weakness is in progress and is expected to be completed prior to the end of fiscal 2019[150] - Changes were made to internal controls over financial reporting during the quarter to accommodate the adoption of the new lease accounting standard, ASC 842[151] Part II Legal Proceedings There have been no material developments in the company's legal proceedings during the quarter ended June 30, 2019, other than those already described in Note 13 of the Notes to Consolidated Financial Statements - No material developments occurred in legal proceedings during the quarter, with existing matters detailed in Note 13[154] Risk Factors There have been no material changes to the risk factors previously disclosed in the company's Annual Report on Form 10-K for the year ended December 31, 2018 - No material changes to risk factors were reported for the quarter[155] Unregistered Sales of Equity Securities and Use of Proceeds The company repurchased 55,988 shares for $4.7 million in Q2 2019 under its stock repurchase programs Q2 2019 Stock Repurchases | Period | Shares Purchased | Average Price | Total Cost (millions) | | :--- | :--- | :--- | :--- | | Q2 2019 | 55,988 | $84.87 | $4.7 | - On February 6, 2019, the Board of Directors authorized an additional stock repurchase program of up to $150 million[74][160] Exhibits The report includes several exhibits, such as the Restated Certificate of Incorporation, officer certifications as required by the Sarbanes-Oxley Act, and financial statements formatted in Inline XBRL - Exhibits filed with the report include CEO and CFO certifications (Rule 13a-14(a) and Section 1350) and Inline XBRL data files[161]