Watts Water Technologies, Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual filing; it also reports unaudited fourth-quarter results. Watts manufactures water flow-control, heating and gas, drainage and water-quality products for residential and commercial markets across the Americas, EMEA and Asia-Pacific.
Financial performance and position
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Net sales | $1,398.4 million | $1,467.7 million |
| Gross profit / margin | $565.6 million / 40.5% | $553.1 million / 37.7% |
| Operating income (loss) | $145.0 million | $(90.1) million |
| Adjusted operating income / margin (non-GAAP) | $160.0 million / 11.4% | $148.4 million / 10.1% |
| Net income (loss) | $84.2 million | $(112.9) million |
| Diluted EPS | $2.44 | $(3.24) |
| Cash from operating activities / free cash flow (non-GAAP) | $138.1 million / $102.2 million | $109.4 million / $81.8 million |
- Reported sales fell 4.7%; organic sales grew 1.0%, excluding acquisitions, divestitures and foreign exchange. Sales declines reflected the exit of non-core products ($98.0 million year over year) and currency effects; acquisitions added $24.0 million.
- By region, sales were $900.9 million in the Americas (down 7.9%), $442.3 million in EMEA (down 0.7%) and $55.2 million in Asia-Pacific (up 26.3%). Higher gross margin reflected product mix, manufacturing efficiencies and commodity savings.
- The 2015 comparison included a $129.7 million goodwill impairment, $64.7 million of long-term obligation settlement costs, and higher restructuring and transformation expenses. FY 2016 included $15.0 million of special-item operating adjustments, including $14.2 million of transformation and deployment costs, $4.7 million of restructuring charges, and an $8.7 million gain on sale of a China subsidiary. Adjusted measures are non-GAAP.
- Fourth-quarter 2016 sales were $342.0 million, gross profit $137.7 million, net income $17.5 million and diluted EPS $0.51.
- At year-end, cash and equivalents were $338.4 million, including approximately $309.0 million held by foreign subsidiaries. Total debt was $653.6 million; net debt was $312.0 million and net debt to capitalization was 29.8%, versus 28.5% in 2015.
- Working capital was $432.8 million, down from $514.0 million; the current ratio was 2.0, versus 2.7. The filing attributes much of the working-capital decline to the short-term euro term loan.
- Operating cash flow increased from $109.4 million to $138.1 million. Capital expenditures were $36.0 million, up from $27.7 million. Dividends paid were $24.5 million; stock repurchases were $26.8 million.
Outlook, commentary and risks
- Management provided no specific earnings or sales guidance. It expected 2017 capital expenditures of approximately $36–$40 million. Backlog was $83.2 million at January 29, 2017, compared with $88.6 million a year earlier; management expected the then-current backlog to convert to 2017 sales but cautioned backlog is not indicative of future results.
- The Americas and Asia-Pacific transformation was substantially complete in its second phase, with completion expected in 2017. The combined program’s estimated pretax cost was approximately $65 million, with costs expected through 2017. Management cited footprint reduction, better utilization, lower working capital and improved delivery as objectives.
- Management expected higher commodity prices in 2017, particularly copper and steel. It warned that inability to offset cost increases through pricing or productivity could pressure margins; falling costs could also prompt customer price-reduction demands. Other material exposures include economic cycles, competition, foreign exchange, regulatory changes, acquisitions, product defects and liability claims, and execution of restructuring and systems initiatives.
- Proposed connector class-action settlements totaled $14 million, with the company expecting to bear approximately $4.1 million after up to $9.9 million in insurance proceeds. Preliminary court approval had been granted, but final approval remained pending at the filing date. The company estimated reasonably possible legal losses above accrued amounts at approximately $4.0 million pretax. It also reported defending approximately 332 asbestos lawsuits; discovery had not identified substantial exposure to its products and no judgments had been entered.
- Watts reported compliance with debt covenants at year-end. Its $500 million revolving facility and $300 million term loan mature in 2021; a €110 million 364-day term loan was due in December 2017. The company reported $312.4 million of unused and available credit under the revolving facility. Foreign cash is intended to remain permanently invested; repatriation could result in taxes.
- The filing identifies a controlling-stockholder risk: Timothy P. Horne held approximately 69.1% of total voting power as of January 30, 2017, through high-vote Class B shares. Management and the auditor reported effective internal control over financial reporting, but PVI’s controls were excluded from the assessment following its 2016 acquisition.
Important facts for investors to verify
- How much of the reported earnings improvement reflects sustainable operating performance versus the unusually large 2015 impairment and pension-related charges, and the 2016 disposition and acquisition gains?
- Whether organic growth, gross-margin improvement and transformation savings continue, particularly given weaker reported sales in the Americas and subdued conditions in parts of EMEA.
- The final approval and insurance recovery for the connector settlements, and developments in other product-liability, environmental and asbestos matters.
- Repayment or refinancing of the euro term loan due in 2017, liquidity after near-term debt maturities, and the effect of cash held overseas.
- Whether commodity inflation, foreign exchange and the PVI acquisition affect margins, cash generation and debt levels as management anticipates.
- Governance implications of the controlling voting position and potential Class B share conversion or sale.