Watts Water Technologies, Inc. — 2015 Form 10-K Summary
Business context and reporting period
For the fiscal year ended December 31, 2015, Watts Water Technologies designed, manufactured and sold products for controlling and conserving water and energy in residential and commercial buildings. Its reporting segments are Americas, EMEA, and Asia-Pacific. The filing also provides fourth-quarter results; this is an annual report, not a standalone quarterly filing.
Key financial metrics
| Metric | 2015 | 2014 |
|---|---|---|
| Net sales | $1,467.7 million | $1,513.7 million |
| Gross profit / gross margin | $553.1 million / 37.7% | $541.8 million / 35.8% |
| Operating income (loss) | $(90.1) million | $105.4 million |
| Net income (loss) | $(112.9) million; diluted EPS $(3.24) | $50.3 million; diluted EPS $1.42 |
| Cash from operating activities | $109.4 million | $135.2 million |
| Free cash flow (non-GAAP) | $81.8 million | $111.9 million |
| Cash and cash equivalents at year-end | $296.2 million | $301.1 million |
| Total debt, including current portion | $577.3 million | $579.7 million |
At year-end, working capital was $514.0 million and the current ratio was 2.7, compared with $528.6 million and 2.5, respectively, in 2014. Net debt was $281.1 million, and net debt to capitalization was 28.5%, up from 23.4%. About $243.6 million of cash was held by foreign subsidiaries. The company reported covenant compliance; its 2015 interest coverage ratio was 8.69 versus a 3.50 minimum, and leverage ratio was 1.59 versus a 3.25 maximum.
Material changes versus the prior comparable period
- Sales fell 3.0% ($46.0 million), while organic sales increased 0.5%. Foreign exchange reduced sales by $94.5 million; acquisitions and divestitures added a net $41.1 million.
- Americas sales rose to $978.5 million, supported by 2.1% organic growth and AERCO. EMEA sales declined to $445.5 million, including a 3.2% organic decline and substantial currency headwinds. Asia-Pacific sales increased to $43.7 million, with 12.6% organic growth from a small base.
- Gross margin improved 1.9 percentage points, but SG&A rose 20.7% to $491.3 million, or 33.5% of sales, reflecting a $64.7 million charge for pension and other long-term obligation settlements, higher product-liability costs, and acquisition costs.
- Goodwill and other long-lived asset impairment charges increased to $130.5 million from $14.2 million, including a $129.7 million EMEA goodwill impairment. EMEA reported an operating loss of $98.6 million versus operating income of $37.5 million in 2014.
- The company recorded a $21.4 million restructuring charge, versus $15.2 million in 2014. Cash from operations and free cash flow decreased, partly because of pension settlement funding.
Outlook, management commentary, risks and unusual items
- Management described 2015 as a year of change and transition. It cited stronger U.S. residential construction and moderate repair-and-replacement and commercial growth, challenging conditions in key European markets, and slower China growth in the second half.
- No formal consolidated revenue or earnings guidance is stated. Management expected 2016 capital expenditures of $35–$40 million. The Americas/Asia-Pacific transformation was estimated to cost $63–$68 million pre-tax through 2017, with phase-two annualized gross savings of about $10 million by 2018. The EMEA transformation was expected to yield about $10 million of annual net savings in 2016 and $14 million by 2018.
- The company exited low-margin product lines representing approximately $175 million of combined Americas and Asia-Pacific sales; assets associated with about $105 million of those revenues were sold for approximately $33.1 million. It expected to discontinue remaining rationalized products and sell a China manufacturing facility in the first half of 2016.
- In September 2015, the company settled its U.S. Pension Plan and SERP obligations, contributing $43.2 million in cash and recognizing $59.7 million of cumulative actuarial losses in expense. It also paid former CEO Timothy Horne $6 million to buy out most ongoing lifetime obligations, recording a $5 million pre-tax charge.
- After year-end, the company entered a new five-year credit agreement: a $500 million revolving facility and a $300 million term loan. It borrowed $200 million on the revolver and $300 million under the term loan on February 12, 2016, repaid the prior facility, and planned to use revolver borrowings to retire $225 million of 5.85% notes due in April 2016.
- After year-end, the company reached an agreement in principle to settle connector class actions for $14 million, expecting an approximately $4.1 million net cost after up to $9.9 million of insurance proceeds. Court approval and a final written agreement remained outstanding. A $14 million liability and $9.5 million insurance receivable were recorded at year-end; the recorded fourth-quarter charge was $3.5 million pre-tax.
- Key risks include persistent weakness in Europe, foreign exchange and commodity-price volatility, product-liability claims and self-insurance exposure, restructuring execution, impairment of goodwill, regulatory changes, cyber and operating disruptions, and risks of acquisitions. The company disclosed approximately 310 asbestos lawsuits; it reported no judgments and no evidence of substantial exposure to its products to date.
Important facts for investors to verify
- Whether EMEA trading and cash-flow assumptions support the remaining goodwill and whether further impairment is likely.
- Actual progress, costs, savings and timing for the Americas/Asia-Pacific and EMEA transformations, including facility and product-line exits.
- Final court approval, insurance recovery and cash settlement of the connector class actions.
- Post-refinancing debt balances, interest costs, maturity profile and covenant headroom, including repayment of the 2016 notes.
- Availability and tax consequences of foreign-held cash, and the impact of currency and commodity movements on margins and cash flow.
- Quarterly results show fourth-quarter 2015 sales of $358.3 million and a net loss of $118.2 million, largely reflecting the EMEA impairment; investors should distinguish these reported results from underlying operating trends.