Watts Water Technologies, Inc. — FY2017 Form 10-K
Business context and reporting period. The filing covers the fiscal year ended December 31, 2017. Watts manufactures water flow-control, HVAC and gas, drainage and water-reuse, and water-quality products for residential and commercial markets. It reports three geographic segments: Americas, Europe, and APMEA. In 2017, the company completed its Americas and APMEA transformation program, including exiting low-margin products and reducing the Americas operating footprint by about 30%.
Key financial metrics
| Metric | FY2017 | FY2016 |
|---|---|---|
| Net sales | $1,456.7 million | $1,398.4 million |
| Gross profit / margin | $602.4 million / 41.4% | $565.6 million / 40.5% |
| Operating income / margin | $162.3 million / 11.1% | $145.0 million / 10.4% |
| Net income | $73.1 million | $84.2 million |
| Diluted EPS | $2.12 | $2.44 |
| Operating cash flow | $155.9 million | $138.1 million |
| Free cash flow (non-GAAP) | $126.9 million | $102.2 million |
At year-end, cash and cash equivalents were $280.2 million, total debt was $499.5 million, and net debt was $216.9 million. The company had $327.3 million of unused revolving credit availability. Working capital was $456.2 million and the current ratio was 2.4, versus $393.9 million and 1.9, respectively, in 2016. Capital expenditures were $29.4 million. The annual dividend declared was $0.75 per share.
Material changes versus the prior period
- Sales rose 4.2% ($58.3 million), comprising $47.0 million from acquisitions, $7.0 million organic growth, and $7.8 million from foreign exchange, partly offset by $3.5 million of divested-product sales. Organic growth was 0.5% overall.
- Americas sales increased 5.6% on a reported segment basis and Europe sales increased 2.1%; APMEA sales declined 2.6%. Americas and Europe operating income improved, while APMEA operating income fell to $4.7 million from $15.1 million; 2016 APMEA results included an $8.7 million gain on a China subsidiary sale.
- Gross margin improved 0.9 percentage point, supported by volume, productivity, product mix, and transformation savings. Reported operating income increased 11.9%.
- Net income declined despite stronger operating results, mainly because the effective tax rate rose to 48.9% from 34.1%, including a provisional $25.1 million charge related to the 2017 Tax Act. Diluted EPS also includes the effects of other items; adjusted diluted EPS, a non-GAAP measure, was $3.02 versus $2.67.
- Cash from operations increased, and free cash flow rose to $126.9 million. Debt payments were $178.0 million; year-end total debt decreased from $653.6 million to $499.5 million.
Outlook, commentary, risks, and unusual items
- Management described 2017 performance as solid, citing growth in the Americas and Europe, productivity gains, and completion of the Americas/APMEA transformation program. Total pre-tax costs of that program were about $59.8 million; all its costs had been incurred by year-end.
- No specific 2018 revenue or earnings guidance is provided. Management expects the 2017 Tax Act to benefit the income tax rate in 2018 and expects to repatriate about $125 million of cash to the U.S. over the next 12 months, with debt reduction a priority. The estimated $23.3 million toll tax is payable over eight years beginning in 2018. Tax Act accounting amounts are provisional and may be revised.
- Management expects 2018 capital spending of $36 million to $40 million. Backlog was $86.3 million at January 28, 2018, compared with $83.2 million a year earlier; management expects current backlog to convert to 2018 sales but says backlog is not a reliable indicator of future results.
- Commodity-price exposure is material, especially copper; management expected elevated commodity pricing to continue in 2018. Inability to recover cost increases through pricing or productivity could pressure margins. Other cited risks include cyclical construction markets, intense competition, foreign-exchange movements, international supply disruptions, product defects and litigation, cyber and operational disruptions, and execution of acquisitions and restructuring.
- Connector class-action settlements became final in May 2017. The settlement amount was $14 million, with the company expected to bear about $4.1 million after insurance; $9.9 million of insurance proceeds were received in 2017. The filing estimates $6.1 million of reasonably possible legal losses above accrued amounts. The company also reported about 355 asbestos lawsuits, with no judgments and no evidence to date of substantial exposure to its products; environmental matters include a newly identified Superfund site for which the company could not estimate a loss range.
- Class B shares carry ten votes each. Timothy P. Horne held approximately 69.2% of total voting power as of January 28, 2018, enabling substantial influence over stockholder votes.
Important facts for investors to verify
- Review the final accounting and cash-payment schedule for the provisional Tax Act charge, including the toll tax and the planned repatriation of foreign cash.
- Assess whether organic sales growth and margins can improve, particularly in APMEA and in the tankless water heater and condensing boiler businesses.
- Verify that expected transformation and productivity savings persist as copper and other input costs rise, and compare actual 2018 capital spending with management’s range.
- Monitor debt reduction, cash deployment, and compliance with credit covenants; the company reported covenant compliance at year-end.
- Track legal and environmental exposures, including the remaining connector-settlement liability, the estimated reasonably possible legal losses, and the Chemetco site investigation.
- Consider the voting-control structure and the risks of a potential conversion or sale of Class B shares.