Watts Water Technologies, Inc. — 2019 Form 10-K
Business context and reporting period. The filing covers the fiscal year ended December 31, 2019; quarterly figures below include the unaudited fourth quarter. Watts makes water flow-control, HVAC and gas, drainage, and water-quality products for residential and commercial markets. It reports Americas, Europe, and APMEA segments. The company described 2019 performance as supported by organic growth, pricing, productivity savings, and reinvestment in products and operations.
Financial performance
| Metric | 2019 | 2018 |
|---|---|---|
| Net sales | $1,600.5 million | $1,564.9 million |
| Gross profit / margin | $677.5 million / 42.3% | $656.5 million / 42.0% |
| Operating income / margin | $197.1 million / 12.3% | $188.4 million / 12.0% |
| Net income | $131.5 million | $128.0 million |
| Diluted EPS | $3.85 | $3.73 |
| Cash from operations | $194.0 million | $169.4 million |
| Capital expenditures | $29.2 million | $35.9 million |
| Free cash flow (non-GAAP) | $164.9 million | $135.7 million |
Reported sales rose 2.3%; organic sales growth was 4.0%, offset in part by a 1.8% foreign-exchange headwind, primarily from a weaker euro. Americas sales increased 5.0%; Europe declined 3.4% and APMEA declined 0.6%, each including currency effects. Operating income rose 4.6%. Gross-margin improvement reflected price, volume, and productivity savings, partly offset by inflation and tariffs. Adjusted diluted EPS, a non-GAAP measure, was $4.07 versus $3.74.
Fourth quarter: Sales were $400.3 million versus $387.6 million a year earlier; net income was $31.8 million versus $32.3 million; diluted EPS was $0.93 versus $0.94.
Cash, debt, and liquidity
- Cash and cash equivalents were $219.7 million at year-end, including $168.4 million held by foreign subsidiaries. Working capital was $315.6 million versus $372.6 million; the current ratio was 1.8 versus 2.1, largely reflecting reclassification of debt due in 2020.
- Total debt was $310.0 million, down from $355.0 million; net debt was $89.5 million versus $149.3 million. Net debt to capitalization fell to 8.4% from 14.3%.
- Debt included $75 million of 5.05% senior notes due June 2020, a $225 million term loan due February 2021, and $10 million drawn on the revolving facility. The company reported $464.2 million of unused and available revolving credit and compliance with its debt covenants.
- Operating cash flow improved by $24.6 million, mainly due to inventory reductions and higher earnings; 2018 had higher tax payments, including withholding taxes on repatriated cash. Financing cash outflows included $127 million of debt payments, $31.4 million of dividends, and $19.5 million of share repurchases.
Material changes and notable items
- SG&A increased 2.4% to $476.1 million; as a share of sales it remained 29.7%. Higher strategic investment, inflation, variable selling costs, professional fees, and stock compensation were partly offset by foreign exchange, lower amortization, and restructuring savings.
- Net income included $7.6 million of after-tax special-item costs, including restructuring, corporate professional fees, acquisition costs, and footprint optimization. The 2018 comparison included a $3.7 million tax benefit related to finalizing the 2017 Tax Act.
- The company acquired Backflow Direct LLC in the third quarter for $42.7 million net cash consideration. It also repatriated approximately $43 million of foreign earnings in 2019, using most of the cash to reduce debt.
- Dividends declared per share rose to $0.90 from $0.82. The board authorized a new $150 million repurchase program in February 2019; approximately $142.3 million remained authorized at year-end.
Outlook, risks, and contingencies
- COVID-19: At the filing date, the company expected a $10–$20 million reduction in first-quarter 2020 sales, assuming China production, supply chains, and logistics returned to normal by early March. Its Ningbo factory and operations relying on China-sourced components or finished goods were exposed to disruption. Management said it had updated its 2020 outlook for the expected impact, but the filing text does not provide a clear numerical full-year outlook.
- Management anticipated 2020 capital equipment investment of $35–$40 million. The company expected its year-end backlog of $78.6 million to convert to sales during 2020, while cautioning that backlog is not indicative of future operating results.
- Key risks include economic and construction cycles, intense competition, commodity and tariff costs, foreign exchange, supply-chain concentration in China, cyber and ERP disruption, product defects and liability, regulatory changes, and acquisition and restructuring execution.
- The product-liability accrual was $22.2 million. The company estimated reasonably possible legal losses above amounts accrued at approximately $5.6 million before tax. It was defending approximately 300 asbestos-related lawsuits; the complaints generally did not identify its products, discovery had not shown substantial exposure to them, and no judgments had been entered. Environmental remediation exposure also remained subject to estimation uncertainty.
- One shareholder’s Class B holdings represented approximately 68.9% of total voting power at year-end. Class B shares carry ten votes each, compared with one vote for Class A shares.
- Management and the auditor concluded internal control over financial reporting was effective at year-end; a previously identified material weakness related to accounting for the 2017 Tax Act was reported remediated.
Most important facts for investors to verify
- Whether COVID-19 disruptions exceeded the filing’s first-quarter sales estimate and its early-March normalization assumption.
- The repayment or refinancing of the $75 million senior notes due June 2020 and subsequent debt, cash, and liquidity levels.
- Whether organic growth, margin gains, and free cash flow persisted after the 2019 inventory reduction and productivity savings.
- Actual restructuring and strategic-investment costs, and the degree to which expected savings were realized.
- Developments in product-liability, asbestos, and environmental matters relative to recorded accruals and the disclosed possible loss estimate.
- Progress toward the company’s goal of deriving 25% of revenue from smart and connected products by 2023.