Watts Water Technologies, Inc. — Q1 2013 Form 10-Q
Business context and period: The filing covers the 13 weeks ended March 31, 2013, compared with the first quarter ended April 1, 2012. Watts supplies water quality, safety, flow-control and conservation products, primarily in North America and EMEA, with a growing presence in Asia. Results are unaudited and in U.S. dollars; amounts below are in millions except per-share data.
Financial performance and position
- Revenue: Net sales were $362.1, up $0.9 (0.2%). Organic sales declined 0.3%; foreign exchange added $1.3 and acquired sales added $0.7. North America sales rose to $213.0, EMEA declined to $142.4, and Asia increased to $6.7.
- Profit and margins: Gross profit was $129.5 versus $128.5; gross margin was 35.7% versus 35.6%. Operating income increased 6.4% to $28.3. Net income from continuing operations was $16.1 versus $15.5; diluted EPS was $0.45 versus $0.42. The effective tax rate was 27.8%, compared with 28.0%.
- Cash flow: Continuing operating activities used $2.7 of cash, versus generating $3.0 a year earlier. Capital expenditures were $11.0 versus $4.9; free cash outflow was $13.7 versus $1.6. Management attributed weaker cash flow primarily to lead-free-transition inventory and increased capital spending.
- Liquidity: Cash and cash equivalents were $251.0, down from $271.8 at year-end; working capital was $457.1 and the current ratio was 2.3. Approximately $137.2 of cash was held by foreign subsidiaries, and repatriation could entail taxes. The $300.0 revolving credit facility had no borrowings, $270.4 of unused availability, and $29.6 of letters of credit outstanding. The company reported covenant compliance.
- Debt: Total debt, including current maturities, was $383.8. Net debt was $132.8, and net debt to capitalization increased to 12.4% from 10.7%. A $75.0 senior-note maturity was due May 15, 2013; management expected to pay it from cash on hand.
Changes, outlook and risks
- EMEA organic sales fell $8.2 (5.5%), primarily amid weak conditions in France and weather-related customer delays in Germany. North America organic sales rose $5.4 (2.6%); Asia rose $1.7 (34.0%).
- North America operating income improved to $24.0 from $19.9; EMEA declined to $10.6 from $12.8. Corporate costs rose to $9.2 from $7.5, including increased personnel, stock-option and legal costs.
- Restructuring and other charges were $2.2, including European manufacturing-relocation actions. Total expected costs for the relocation activities were $5.0, with after-tax charges expected through mid-2014.
- Management expected approximately $41 million of 2013 capital spending, including lead-free production conversion; approximately $30 million was expected for the remainder of the year. It anticipated about $23 million of share repurchases during the remainder of 2013. The board authorized repurchases of up to $90 million on April 30, 2013. A quarterly dividend of $0.13 per share was also declared, up from the $0.11 paid in Q1.
- No specific earnings or revenue guidance was provided. Management cited housing and construction activity, lead-free conversion costs and execution, raw-material prices and availability, competition, foreign exchange, product liability, environmental costs and litigation as risks.
- Legal matters include approximately $8.3 of reasonably possible loss above accrued amounts in aggregate. The company could not estimate a loss range for a putative class action alleging toilet-connector failures. Management stated that current information did not indicate a material effect on the company’s financial position, while noting unfavorable outcomes could affect results or cash flows.
- Foreign-currency translation produced a $19.9 quarterly loss in other comprehensive income; total comprehensive loss was $3.6. No goodwill impairment was recorded in the quarter.
Important facts for investors to verify
- Whether working-capital investment and lead-free-transition spending continue to pressure operating cash flow and free cash flow.
- Completion and cost of the European restructuring and lead-free foundry conversion, and whether anticipated 2013 capital spending is achieved.
- Repayment of the $75.0 note maturity and the timing and amount of any share repurchases under the new authorization.
- Developments in EMEA demand, the toilet-connector litigation and other legal contingencies, including potential losses beyond recorded accruals.
- Access to foreign-held cash, foreign-exchange exposure, and the company’s continued compliance with debt covenants.