Watts Water Technologies, Inc. — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014. This is an annual filing, not a standalone quarterly report; selected fourth-quarter results are included below. The company designs, manufactures and sells water flow-control, HVAC and gas, drainage and water-reuse, and water-quality products across the Americas, EMEA, and Asia-Pacific.
Financial results and liquidity
| Metric | 2014 | 2013 |
|---|---|---|
| Net sales | $1,513.7 million | $1,473.5 million |
| Organic sales growth | 2.6% | Not stated here |
| Gross profit / gross margin | $541.8 million / 35.8% | $526.5 million / 35.7% |
| Operating income | $105.4 million | $111.5 million |
| Net income from continuing operations | $50.3 million | $60.9 million |
| Diluted EPS | $1.42 | $1.71 |
| Cash from continuing operating activities | $135.2 million | $118.3 million |
| Free cash flow (non-GAAP) | $111.9 million | $92.1 million |
| Cash and cash equivalents at year-end | $301.1 million | $267.9 million |
| Total debt, including current portion | $579.7 million | $307.7 million |
| Working capital / current ratio | $528.6 million / 2.5 | $530.2 million / 2.6 |
Sales increased 2.7% overall, reflecting organic growth and $5.3 million of AERCO sales, partly offset by foreign exchange. Americas sales rose to $926.8 million, EMEA sales fell to $546.4 million, and Asia-Pacific sales rose to $40.5 million. Americas and Asia-Pacific organic sales increased 5.5% and 22.6%, respectively; EMEA organic sales declined 3.1%.
Operating cash flow increased largely due to inventory reductions and strong receivables collections. Investing activities used $295.5 million, including the $272.2 million AERCO purchase and $23.7 million of capital expenditures. Financing activities provided $220.8 million, principally from $275.0 million of credit-facility borrowings. Net debt to capitalization rose to 23.4% from 3.8%. The company reported $201.4 million of unused available credit and compliance with debt covenants at year-end.
Material changes and unusual items
- December 2014 acquisition of AERCO for approximately $272.2 million, funded with credit-facility borrowings. AERCO contributed $5.3 million of reported 2014 revenue and a $1.4 million operating loss after acquisition accounting charges.
- 2014 operating income included $15.2 million of restructuring and other charges and $14.2 million of goodwill and other long-lived asset impairment charges. The $12.9 million Asia-Pacific goodwill impairment fully wrote off that reporting unit’s goodwill.
- Continuing-operations net income included $38.5 million of net after-tax unusual costs, compared with $18.3 million in 2013. These items included acquisition-related costs, restructuring, impairment, and transformation deployment costs. The 2014 effective tax rate rose to 39.5% from 30.6%, principally due to the non-deductible Asia-Pacific goodwill impairment and earnings mix.
- The fourth quarter reported a $7.7 million loss from continuing operations, compared with $8.2 million of income in Q4 2013. Q4 2014 included impairment, restructuring, transformation deployment, and AERCO acquisition costs.
- Other comprehensive loss was $101.1 million, driven principally by $90.8 million of foreign-currency translation losses and pension-related losses.
Outlook, risks and contingencies
- No consolidated 2015 revenue or earnings guidance is provided. Management cited improving U.S. residential construction and repair-and-replace demand, moderate U.S. commercial growth, weaker European markets, and growth in Asia-Pacific.
- In February 2015, the board approved an Americas and Asia-Pacific product-rationalization program expected to eliminate $175–$200 million of combined annual sales, mainly in DIY. Estimated total pre-tax charges are $40–$50 million, with $25–$30 million non-cash; remaining costs were expected in 2015. Management estimated an approximately 1.0 percentage-point increase in consolidated operating margins by 2017 and about $5 million of after-tax asset-sale proceeds by the end of 2017.
- The EMEA transformation program is expected to continue through 2018. Management estimated $5.0 million of gross savings in 2014, $11.3 million in 2015, and annual savings of $19.7 million by 2018; approximately $5.5 million of 2015 deployment costs were anticipated.
- The Pension Plan and SERP were terminated. Management estimated 2015 cash funding and settlement outflows of approximately $40–$45 million; the plans’ liabilities were classified as current at year-end.
- The settled Trabakoolas toilet-connector class action had a $23.0 million settlement, of which the company bore $14.0 million after insurance. $8.8 million remained payable at year-end over four annual installments.
- New putative class actions alleging water-heater connector failures and a February 2015 action alleging FloodSafe connector failures were disclosed. The company could not estimate reasonably possible losses for these matters. It estimated aggregate reasonably possible losses above amounts accrued for disclosed legal contingencies at approximately $5.8 million pre-tax.
- Other principal risks include economic and construction cycles, competition and pricing, commodity costs and supply availability, foreign exchange, execution of restructuring and acquisitions, product liability, environmental matters, tax uncertainty, cybersecurity and other business disruptions, and goodwill impairment. Approximately $250.7 million of year-end cash was held by foreign subsidiaries; repatriation could trigger taxes.
Investor verification priorities
- Review the complete financial statements and notes for AERCO purchase accounting, acquisition financing, and the effect of its limited inclusion in 2014 results.
- Track actual sales exits, charges, cash costs, savings, and margin effects from the Americas/Asia-Pacific rationalization and EMEA transformation programs against management estimates.
- Verify pension-plan settlement amounts and timing, and the resulting cash and income-statement effects.
- Monitor outcomes, accruals, and insurance recoveries for the connector litigation, as well as environmental and asbestos matters.
- Assess debt maturities, covenant headroom, foreign-held cash accessibility, and the effect of currency movements on cash flows and reported results.
The filing reports unqualified audit opinions on the financial statements and internal control over financial reporting. The auditor’s internal-control assessment excluded AERCO.