Watts Water Technologies, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 28, 2015; comparisons are to the periods ended June 29, 2014. Amounts are in millions except per-share data. Watts supplies water-quality, safety, flow-control and conservation products, as well as HVAC products, across the Americas, EMEA and Asia-Pacific.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Net sales | $386.9 | $396.0 | $743.1 | $761.2 |
| Gross profit / margin | $145.8 / 37.7% | $139.0 / 35.1% | $276.3 / 37.2% | $272.3 / 35.8% |
| Operating income / margin | $34.8 / 9.0% | $36.6 / 9.2% | $57.6 / 7.8% | $62.4 / 8.2% |
| Net income | $19.3 | $21.3 | $30.9 | $35.4 |
| Diluted EPS | $0.55 | $0.60 | $0.88 | $1.00 |
| Operating cash flow | Not presented quarterly | $41.9 | $18.4 | |
| Free cash flow | Not presented quarterly | $29.5 | $8.0 |
Q2 sales fell 2.3%; first-half sales fell 2.4%. For Q2, $32.4 of AERCO acquired sales partly offset $28.0 of unfavorable currency effects and a $13.5 organic sales decline. First-half movements were $54.6 acquired sales, a $52.2 foreign-exchange headwind and a $20.5 organic decline. AERCO contributed $32.4 of Q2 and $54.6 of first-half revenue. Sales and operating income were pressured by EMEA volume weakness and currency; AERCO, productivity, cost savings and improved Americas gross margin provided offsets.
Q2 net income decreased 9.4%; first-half net income decreased 12.7%. First-half SG&A increased 4.4% to $212.0, and interest expense rose 20.4% to $11.8, primarily reflecting borrowing to acquire AERCO. The effective tax rate was 34.6% for Q2 and 34.0% for the first half, versus 33.4% and 32.7%, respectively.
Cash, debt and liquidity
At June 28, 2015, cash was $284.6, total debt was $578.5 and net debt was $293.9; net debt-to-capitalization was 25.2%, up from 23.4% at year-end 2014. Cash declined $16.5 during the first half, including a $13.5 adverse foreign-exchange effect. Working capital was $316.3, versus $528.6 at year-end, partly because $225.0 of 5.85% notes due April 2016 was reclassified as current. The current ratio was 1.6, compared with 2.5 at year-end.
The company had $275.0 outstanding under its $500 million revolving facility, with $200.2 of unused available credit and $24.8 of letters of credit; it reported compliance with covenants. Approximately $244.2 of cash was held by foreign subsidiaries, and repatriating funds could trigger taxes. First-half financing cash use was $33.2, including $19.5 of share repurchases and $11.3 of dividends.
Material changes, outlook and risks
- Restructuring and product sale: The Americas and Asia-Pacific transformation is expected to eliminate $175–$200 of combined sales, primarily in DIY. On July 29, 2015, Watts agreed to sell certain Americas fittings, brass and tubular, and vinyl tubing product lines to Sioux Chief for approximately $35.5, with closing expected by the end of Q3, subject to customary conditions. The company estimated total pre-tax program costs near the midpoint of its previously disclosed $27–$50 range, including $17–$25 of non-cash charges and $22–$40 of net after-tax charges. Q2 restructuring and other charges were $4.7.
- Pension settlements: Watts expected to contribute approximately $40–$45 in Q3 2015 to complete pension-plan terminations and expected plan distributions and SERP payments to be completed by the end of Q3. Final cash requirements and an associated accumulated pension loss reclassification depend on market and participant factors.
- Spending and savings outlook: Management expected $17–$22 of capital equipment spending in the rest of 2015, and approximately $30–$35 for full-year 2015. EMEA transformation annual savings were expected to be about $11 in 2015 and $19 by 2018; approximately $5 was achieved in 2014. Management anticipated about $5 of EMEA deployment costs in 2015. No consolidated earnings guidance is provided in the filing.
- Capital returns: A new $100 share-repurchase authorization was approved July 27, 2015; the company said it would complete purchases under the prior program first. A quarterly dividend of $0.17 per share was declared July 28.
- Risks and contingencies: Demand is exposed to construction and remodeling conditions, competition, raw-material prices, foreign exchange and regulatory/product-performance requirements. The filing disclosed connector-related class actions, other litigation and asbestos cases; aggregate reasonably possible legal losses above accruals were estimated at $4.5 pre-tax, while losses for the connector class actions could not be estimated. Management said litigation outcomes could materially affect a particular period, though it did not expect a material adverse effect on overall financial condition.
Most important facts for investors to verify
- Whether the Sioux Chief transaction closed on schedule and at the expected price, and whether transformation costs and sales exits remain within estimates.
- Final pension funding, distribution costs and the earnings impact of recognizing accumulated pension losses.
- How much of reported Americas growth and margin improvement reflects AERCO, and whether organic sales recover in EMEA and the DIY channel.
- Financing plans for the $225.0 of notes due in April 2016, and the implications of foreign-held cash and facility covenants.
- Developments in connector litigation, including class certification, potential exposure and adequacy of product-liability accruals.