Watts Water Technologies, Inc. — FY2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013; the filing also reports fourth-quarter results. Amounts are in U.S. dollars. The company designs and manufactures water safety, flow-control, conservation, HVAC, drainage and water-quality products, reported across the Americas, EMEA and Asia Pacific.
Financial performance and liquidity
| Metric | FY2013 | FY2012 |
|---|---|---|
| Net sales | $1,473.5 million | $1,427.4 million |
| Gross profit / gross margin | $526.5 million / 35.7% | $513.5 million / 36.0% |
| Operating income / operating margin | $111.5 million / 7.6% | $123.3 million / 8.6% |
| Income from continuing operations | $60.9 million | $70.4 million |
| Net income | $58.6 million | $68.4 million |
| Diluted EPS, continuing operations / total | $1.71 / $1.65 | $1.95 / $1.90 |
| Cash from continuing operating activities | $118.3 million | $130.3 million |
| Free cash flow (company-defined, non-GAAP) | $92.1 million | $103.0 million |
FY2013 sales increased 3.2% reported and 2.1% organically. Gross margin declined 0.3 percentage points; operating income fell 9.6%. SG&A rose 6.5% to $405.7 million, including higher legal and product-liability costs. Continuing-operations earnings included $18.3 million of net after-tax special charges, versus $8.1 million in 2012.
Fourth quarter: Sales were $376.0 million versus $354.5 million a year earlier; gross profit was $130.9 million versus $128.6 million. Continuing-operations income was $8.2 million versus $18.2 million, and net income was $8.2 million versus $15.5 million. The 2013 quarter included a $13.6 million net settlement expense and approximately $3.0 million of customer rebate accrual adjustments.
Balance sheet and liquidity at December 31, 2013: Cash and cash equivalents were $267.9 million, including approximately $214.4 million held by foreign subsidiaries. Total debt was $307.7 million, including current maturities; net debt was $39.8 million, compared with $113.3 million in 2012. Working capital was $530.2 million and the current ratio was 2.6, up from 2.2. No revolving-credit borrowings were outstanding at year-end. The company reported $1,002.1 million in stockholders’ equity and $1,740.2 million in total assets.
Cash from operations declined by $12.0 million, primarily due to lower net income and cash used for increased lead-free inventory. Capital expenditures were $27.7 million; the company forecast approximately $27.0 million for 2014. The company paid $17.7 million in dividends and repurchased approximately $23.0 million of shares during 2013.
Material changes versus the prior comparable period
- Americas sales rose 5.2% on a segment basis, supported by residential construction recovery, repair-and-replace demand, and customer conversion to lead-free products. Americas operating income declined to $90.4 million from $96.5 million.
- EMEA sales declined 0.6% on a segment basis, including a 3.6% organic decline amid weak European conditions. Segment operating income decreased to $46.9 million from $52.5 million.
- Asia Pacific sales increased 22.4% on a segment basis, with organic growth of 20.5%; operating income rose to $9.7 million from $6.5 million.
- Interest expense decreased to $21.5 million from $24.6 million, largely after repayment of $75 million of senior notes at maturity in May 2013. The company’s net debt-to-capitalization ratio fell to 3.8% from 10.8%.
- Austroflex was sold in August 2013 for net cash proceeds of $7.9 million; its operating results and disposal loss are reported in discontinued operations. The 2013 discontinued-operations loss was $2.3 million.
Outlook, management commentary, risks and contingencies
- The filing gives no consolidated revenue or earnings guidance. Management described improving U.S. residential conditions, continued weakness in parts of Europe and solid Asia Pacific growth.
- The European transformation, launched in late 2013, is intended to shift toward pan-European operations, improve sourcing and logistics, and pursue emerging markets. Management estimated $12.2 million in non-recurring external deployment costs, including approximately $9.0 million in 2014; projected annual savings are $18.0 million by 2018. The company also expects infrastructure costs to increase by approximately $3.5 million in 2014 and $4.0 million annually by 2018.
- A separate EMEA footprint-restructuring program is expected to cost approximately $14.0 million pre-tax, with completion targeted by the end of 2015. The company also reported $5.8 million of 2013 transition costs related to lead-free manufacturing. Management said production was ramping up, most customers had converted by year-end, and gross-margin percentages had been maintained despite higher alloy costs.
- The U.S. lead-free requirements took effect January 4, 2014. Risks include higher material costs, limited alternative-alloy suppliers, production challenges and inability to pass all cost increases through to customers.
- Trabakoolas litigation: The proposed class-action settlement totals $23.0 million, with $9.0 million expected from insurance and $14.0 million borne by the company. The court granted preliminary approval in February 2014; final approval remained pending, with a fairness hearing scheduled for July 16, 2014. The company recorded a $22.6 million liability and a $9.0 million insurance receivable at year-end. The filing estimates approximately $11.2 million of reasonably possible legal losses above amounts accrued across its legal matters.
- The company was defending approximately 44 asbestos lawsuits; it reported obtaining dismissal before trial in every case to date. It also disclosed environmental remediation matters and other ordinary-course claims.
- On January 9, 2014, CEO and President David J. Coghlan resigned. CFO Dean P. Freeman became interim CEO and President while the board began a search for a successor.
- On February 18, 2014, the company entered a new five-year, $500 million unsecured revolving credit facility, with a potential increase of up to $500 million subject to conditions. This was subsequent to year-end and replaced the prior facility.
- Other notable risks include economic and construction cycles, competition and pricing pressure, commodity and foreign-exchange volatility, international supply reliance, product liability, acquisition integration, restructuring execution, impairment risk, tax uncertainties, cybersecurity and the controlling voting power associated with Class B shares.
Important facts for investors to verify
- Whether the Trabakoolas settlement receives final court approval, and whether the expected insurance proceeds and company-funded amount are realized as disclosed.
- Whether lead-free production reaches stable capacity and maintains margins as nationwide demand and material costs evolve.
- Whether the European transformation achieves its stated savings and cost targets, and how much of the planned savings reaches operating income.
- How 2014 operating cash flow and inventory levels develop after the lead-free inventory build, and whether forecast capital spending is achieved.
- Debt maturities and covenant compliance, particularly the $225 million of senior notes due in 2016; also assess foreign cash availability and repatriation-tax implications.
- Leadership succession following the CEO’s resignation, and whether the operating outlook in EMEA improves or remains a drag.