Watts Water Technologies, Inc. — FY 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012. This is an annual report, not a standalone fourth-quarter filing; Q4 results are separately summarized below. Watts designs and manufactures water quality, safety, conservation and flow-control products, reported across North America, EMEA and Asia.
Financial performance
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Net sales | $1,445.6 million | $1,428.1 million |
| Gross profit / margin | $517.5 million / 35.8% | $512.8 million / 35.9% |
| Operating income | $123.4 million | $116.7 million |
| Continuing-operations net income | $70.6 million | $64.4 million |
| Net income | $68.4 million | $66.4 million |
| Diluted EPS | $1.90 ($1.96 continuing operations) | $1.78 ($1.72 continuing operations) |
| Operating cash flow from continuing operations | $131.9 million | $127.4 million |
| Free cash flow (non-GAAP) | $104.8 million | $105.6 million |
Sales increased 1.2%; organic sales growth was 0.7%, with currency translation reducing sales by $44.3 million and acquisitions adding $51.5 million. North America sales rose to $835.0 million, EMEA fell to $583.8 million, and Asia grew to $26.8 million. Operating income improved overall, but North America operating income declined $15.1 million and Asia declined $5.7 million; EMEA rose $23.9 million.
Q4 2012: Net sales were $359.2 million versus $357.5 million in Q4 2011; gross profit was $129.7 million versus $127.9 million; continuing-operations income was $18.4 million versus $17.2 million. Net income was $15.5 million versus $17.0 million, reflecting the Flomatic disposal loss.
Cash, debt and liquidity
- Cash and cash equivalents were $271.8 million at year-end, including $131.8 million held by foreign subsidiaries. Working capital was $448.0 million and the current ratio was 2.2, down from 2.9, partly because $75 million of notes due in May 2013 was classified as current.
- Total debt was $384.6 million, including $77.1 million current and $307.5 million long-term; net debt was $112.8 million. Net debt to capitalization fell to 10.7% from 13.9%.
- No revolver borrowings were outstanding; $265.4 million of credit was available, with $34.6 million of standby letters of credit. The company was in compliance with its debt covenants.
- Investing activities used $42.7 million, including $30.6 million of capital expenditures and $17.5 million for tekmar. Financing activities used $80.7 million, including $65.8 million to repurchase two million shares and $16.0 million of dividends.
Material changes and unusual items
- Continuing-operations net income rose to $70.6 million from $64.4 million. FY 2012 results included $8.0 million of net after-tax costs, including restructuring, impairments, a TWVC disposal-gain adjustment, former CFO retention costs, and legal/customs costs; FY 2011 included $17.0 million of net after-tax costs.
- Gross margin was nearly unchanged. North American results were pressured by lead-free transition costs, production inefficiencies, product mix and selective price concessions; these costs eased in the second half. EMEA margin benefited in part from the absence of Socla acquisition accounting charges recorded in 2011.
- Flomatic was sold in December 2012; the disposal generated a $3.8 million loss and contributed to a $2.2 million loss from discontinued operations for the year. The company also acquired tekmar in January 2012 for an initial $17.8 million, with additional earn-out consideration subject to performance.
- Capital spending was $30.6 million, up from $22.6 million in 2011. The company had spent $7 million on a new U.S. lead-free foundry and expected to spend a further $13 million through 2013 to complete it.
Outlook, commentary and risks
Management reported a beginning recovery in U.S. residential markets, continued weakness in commercial construction, mixed conditions in Europe and solid growth in Asia. It did not provide formal revenue or earnings guidance. It expected approximately $41 million of 2013 capital expenditures and anticipated the new lead-free foundry would come online in Q2 2013; additional commissioning costs were possible in the first half. Backlog was $84.5 million in February 2013, expected to convert to sales during 2013, but management cautioned that backlog is not indicative of future results.
- Federal lead-content limits take effect nationwide in January 2014. Risks include higher or constrained material supply, manufacturing challenges, commissioning delays, insufficient compliant-product capacity and obsolete legacy inventory.
- Approximately 48.3% of FY 2012 sales were outside the U.S.; foreign exchange reduced 2012 results, and Europe remained exposed to economic weakness and Euro Zone uncertainty. Commodity volatility, especially copper, may also pressure margins if cost increases cannot be passed through.
- Other risks include cyclical construction demand, competition, acquisition integration, restructuring execution, product liability and supply-chain interruptions. The filing estimates reasonably possible legal losses above accrued amounts at approximately $4.2 million pre-tax; one putative class action concerning toilet connectors has unspecified damages. Approximately 42 asbestos lawsuits were being defended, with prior cases dismissed before trial.
- The $75 million 5.47% note matures in May 2013; management expected to repay it with cash, revolver borrowings, or both. Foreign cash may incur tax costs if repatriated; the company intended to keep foreign earnings invested abroad.
The company reported effective disclosure controls and internal control over financial reporting; KPMG issued unqualified opinions on the financial statements and internal controls.
Most important facts for investors to verify
- Whether the lead-free foundry was commissioned on schedule and whether transition costs, product availability and margins improved.
- How the $75 million May 2013 note was repaid and the resulting cash, debt and revolver balances.
- Whether organic growth strengthened, particularly in North America and EMEA, and how currency movements affected reported results.
- Actual 2013 capital expenditures versus the approximately $41 million plan, including lead-free investment.
- Developments in the toilet-connector lawsuit, other legal exposures, and product-liability accruals.
- Capital allocation, including dividends and any further share repurchases; the filing declared a quarterly dividend of $0.11 per share in February 2013.
- Governance implications of the dual-class shares: Timothy P. Horne held approximately 69.2% of voting power as of January 31, 2013.