Watts Water Technologies, Inc. — 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010; filed March 1, 2011. This is an annual report, not a standalone fourth-quarter filing. The company manufactures water quality, safety, conservation and flow-control products, principally in North America and Europe, with operations in China.
Financial performance
| Metric | 2010 | 2009 | Change / context |
|---|---|---|---|
| Net sales | $1,274.6 million | $1,225.9 million | Up 4.0%; organic sales up 4.2% |
| Gross profit / margin | $464.9 million / 36.5% | $435.1 million / 35.5% | Margin improved 1.0 percentage point |
| Operating income | $114.2 million | $92.2 million | Up $22.0 million; operating margin approximately 9.0% versus 7.5% |
| Continuing-operations net income attributable to Watts | $63.1 million; diluted EPS $1.69 | $41.0 million; diluted EPS $1.10 | Up approximately 54% |
| Total net income attributable to Watts | $58.8 million; diluted EPS $1.57 | $17.4 million; diluted EPS $0.47 | Includes discontinued-operations losses of $4.3 million and $23.6 million, respectively |
| Cash from continuing operations | $113.4 million | $204.6 million | Down $91.2 million |
| Free cash flow (non-GAAP) | $91.0 million | $181.2 million | Down $90.2 million; defined as continuing operating cash flow less capital expenditures plus asset-sale proceeds |
| Cash and cash equivalents | $329.2 million | $258.2 million | Up $71.0 million |
| Total debt, including current maturities | $378.7 million | $354.9 million | Net debt was $49.5 million versus $96.7 million |
| Working capital / current ratio | $578.4 million / 3.1:1 | $489.8 million / 2.6:1 | Liquidity measures improved |
2010 capital expenditures were $24.6 million. The company paid $16.4 million in dividends and declared a quarterly dividend of $0.11 per share in February 2011. It reported $265.3 million of unused availability under its $300 million revolving facility at year-end, with no revolver borrowings and covenant compliance. The company issued $75 million of 5.05% notes due 2020 and repaid $50 million of notes at maturity.
Material changes and fourth-quarter context
- North America sales increased 6.4% and operating income rose to $106.4 million from $78.6 million. Europe sales were nearly flat, while operating income declined to $43.7 million from $51.0 million. China sales were essentially flat and its operating loss narrowed to $0.5 million from $6.6 million.
- Higher volume, factory absorption and Lean/Six Sigma productivity improved gross margin; rising commodity costs and restructuring inefficiencies partly offset those benefits. Copper spot prices rose 33.2% during 2010.
- Sales were stronger in the first half. Organic growth was 7% in each of the first two quarters, 5% in the third quarter, and down 1% in the fourth quarter. Fourth-quarter sales were $316.7 million versus $323.2 million; continuing-operations income was $11.4 million versus $10.1 million, and total net income was $11.3 million versus $14.2 million.
- 2010 results included $12.6 million of restructuring and other charges and $1.4 million of intangible-asset impairment charges. Continuing-operations results also benefited from a European valuation-allowance release; the effective tax rate declined to 33.2% from 43.3%.
- Two acquisitions—Austroflex and Blue Ridge Atlantic Enterprises—had an estimated aggregate purchase price of $36.1 million, including contingent consideration. The company also completed the sale of former Chinese subsidiary CWV in January 2010.
Outlook, commentary and risks
- Management planned 2011 pricing increases in most key markets to address higher commodity costs, but said their market acceptance was uncertain. Inability to recover material-cost increases could pressure margins.
- Management expected approximately $30 million of 2011 capital expenditures and expected the current backlog of $84.2 million (as of February 18, 2011) to convert to sales during 2011. The filing does not provide formal consolidated revenue or earnings guidance.
- Restructuring actions included consolidating five French facilities into two and closing two North Carolina manufacturing facilities; management expected announced programs to be completed by the end of 2011. Savings timing and execution remained subject to operational and regulatory factors.
- A proposed acquisition of Danfoss Socla was announced in February 2011, with an expected purchase price of €115–€120 million, subject to a definitive agreement and regulatory approvals. The transaction was not completed as of the filing.
- The nationwide Reduction of Lead in Drinking Water Act, signed in January 2011, sets a lower permissible lead content for relevant potable-water products effective January 2014. The company identified potential higher input costs, manufacturing challenges, supply constraints and obsolete inventory as risks.
- The company recorded an estimated $5.3 million pre-tax charge related to potential FCPA violations at former China subsidiary CWV. Negotiations with the SEC and DOJ had not produced a definitive agreement; the final loss could exceed the estimate. The charge was recorded in discontinued operations.
- Other exposures include economic weakness in construction and remodeling markets, foreign-exchange movements, customer credit risk, acquisition integration, environmental remediation, product liability and approximately 101 asbestos lawsuits. Management did not expect the environmental or asbestos matters to materially harm results or financial condition based on information then known.
- CEO Patrick O’Keefe resigned in January 2011 and David Coghlan was appointed CEO and president. O’Keefe’s separation-related pre-tax costs were estimated at $6.1 million for first-quarter 2011, with an additional approximately $1.5 million expected under the Management Stock Purchase Plan.
Investor verification priorities
- Reconcile growth in continuing-operations earnings with restructuring charges, the tax benefit and discontinued-operations losses; assess the sustainability of 2010 margins.
- Track operating cash flow and working-capital needs: 2010 cash from continuing operations and free cash flow fell sharply from unusually strong 2009 levels.
- Monitor copper and other input costs, pricing realization, and the timing and savings from North American and European restructuring.
- Confirm the final SEC/DOJ FCPA resolution and any amounts above the recorded $5.3 million estimate.
- Assess the cost and execution implications of lead-free product conversion and any Danfoss Socla transaction, including financing and integration.
- Review debt maturities, covenant headroom, pension funding requirements and management’s stated liquidity; year-end leverage ratios were within required levels.