Watts Water Technologies, Inc. — Q3 2015 Form 10-Q
Reporting period: Third quarter and nine months ended September 27, 2015; results are unaudited. The company supplies water quality, safety, flow-control and conservation products across the Americas, EMEA and Asia-Pacific.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $366.3 million | $376.0 million | $1,109.4 million | $1,137.2 million |
| Gross profit / margin | $142.2 million / 38.8% | $138.1 million / 36.7% | $418.5 million / 37.7% | $410.4 million / 36.1% |
| Operating income (loss) | $(30.2) million | $42.7 million | $27.4 million | $105.1 million |
| Net income (loss) | $(25.7) million | $22.6 million | $5.2 million | $58.0 million |
| Diluted EPS | $(0.73) | $0.64 | $0.15 | $1.64 |
- Q3 sales declined 2.6%; nine-month sales declined 2.4%. In Q3, $24.2 million of unfavorable foreign exchange and $18.2 million of divested sales were partly offset by $34.9 million of AERCO sales. Organic sales decreased 0.6% in Q3.
- Nine-month operating cash flow was $41.9 million versus $73.5 million; free cash flow, a company-defined non-GAAP measure, was $22.8 million versus $57.8 million. Capital expenditures were $19.2 million.
- At September 27, cash was $288.8 million, total debt was $578.0 million, and net debt was $289.2 million. Working capital was $333.8 million and the current ratio was 1.6, down from 2.5 at year-end 2014. Net debt to capitalization was 25.2%, compared with 23.4% at year-end.
- Available revolving credit was $200.2 million, with $275 million drawn and $24.8 million of letters of credit outstanding. The company reported covenant compliance. Cash included $255.7 million held by foreign subsidiaries.
- Dividends were $0.17 per share in Q3 and $0.49 per share for the nine-month period. The company repurchased approximately 584,000 shares for $32.0 million during the nine months.
Material changes and unusual items
- A $59.7 million pension and supplemental retirement plan settlement charge, plus a $5.0 million charge from a lump-sum buyout of former CEO Timothy Horne’s benefits, drove a total $64.7 million long-term-obligation settlement charge in Q3 SG&A. The pension-plan settlement also involved $43.2 million of company cash contributions. Management reported Q3 net income would have been reduced by $1.27 per share after tax by the settlement charge.
- Excluding the settlement charge, Q3 operating income decreased $8.2 million, or 19.2%, year over year. Factors included weaker EMEA volumes, foreign exchange, restructuring and transformation costs; AERCO, cost savings and productivity partly offset these pressures.
- Gross margin improved, reflecting Americas product mix, manufacturing efficiencies and material savings, partly offset by weaker EMEA volume absorption and mix. EMEA sales were pressured by economic weakness in France, Germany and Russia and project delays; Americas organic sales rose in Q3.
- The September sale of non-core Americas product-line assets generated approximately $33.1 million net cash proceeds and a $0.3 million pretax loss. The company had also agreed to sell a non-core China manufacturing facility, expected to close in the first half of 2016.
Outlook, risks and contingencies
- No specific consolidated revenue or earnings guidance was provided. Management expected the full-year 2015 tax rate to be more comparable to 2014, assuming expected Q4 income.
- Americas/Asia-Pacific transformation phase one and two costs were estimated at $63 million to $68 million pretax, with costs expected through 2017; the combined program was expected to reduce the Americas operating footprint by approximately 30%. The company expected $175 million to $200 million of combined Americas and Asia-Pacific sales to be eliminated, primarily in DIY products.
- For the EMEA transformation, management expected approximately $7 million of annual net savings in 2015 and approximately $9 million by 2018; the project was expected to continue through 2018. Management said it would continue assessing further EMEA restructuring needs.
- Management expected $25 million to $30 million of capital equipment spending for 2015, including $5 million to $10 million in Q4. It also signed an agreement to acquire 80% of New Zealand’s Apex Valves for approximately $22 million, with an obligation to acquire the remaining 20% within three years; closing was expected in Q4.
- $225 million of 5.85% notes due April 2016 were classified as current. The company said it would review financing options over the following six months. It noted that using foreign-held cash in the U.S. could trigger taxes and that it had no current plan to repatriate undistributed foreign earnings.
- Legal contingencies included water-heater and Floodsafe connector class actions; the company could not estimate a loss range for those cases. Aggregate reasonably possible losses above amounts accrued for legal contingencies were estimated at approximately $4.4 million pretax. The company also faced product-liability, environmental and approximately 280 asbestos lawsuits; management said outcomes could affect results or cash flows in a particular period.
- Key exposures include foreign currency movements, construction and remodeling demand, raw-material prices, competition, product liability, litigation, environmental costs, and execution and savings assumptions for transformation programs. The company reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of the earnings decline reflects recurring operating performance versus the $64.7 million settlement charge and other restructuring or transformation costs.
- Whether Americas/Asia-Pacific and EMEA transformation milestones, spending, sales reductions and projected savings are achieved.
- Plans and funding for the $225 million April 2016 notes, covenant headroom, and the practical availability of foreign-held cash.
- Progress and financial impact of the DIY product divestiture, China facility sale and proposed Apex acquisition.
- Developments in connector, product-liability and asbestos litigation, including any change to the disclosed loss estimates.