Watts Water Technologies, Inc. — Q1 2014 Form 10-Q
Reporting period: First quarter ended March 30, 2014, generally a 13-week period; comparable quarter ended March 31, 2013. Amounts are in U.S. dollars unless noted. Watts supplies water-quality, safety, flow-control and conservation products, principally in the Americas and EMEA, with a growing Asia-Pacific presence.
Financial performance
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Net sales | $365.2 million | $358.9 million |
| Gross profit / margin | $133.3 million / 36.5% | $128.9 million / 35.9% |
| Operating income | $25.8 million | $28.6 million |
| Income from continuing operations | $14.1 million | $16.3 million |
| Net income | $14.1 million | $16.1 million |
| Diluted EPS | $0.40 | $0.45 |
| Cash used in operating activities | $18.7 million | $2.0 million |
| Capital expenditures | $5.0 million | $11.0 million |
Sales rose 1.8%. Management attributed the $6.3 million increase to $3.0 million of organic growth and $3.3 million of favorable currency translation. Organic sales increased 3.7% in the Americas and 1.5% in Asia-Pacific, but declined 3.5% in EMEA. Gross margin improved 0.6 percentage points, primarily on EMEA production efficiencies and higher Americas volume. Operating income fell 9.8%, reflecting higher SG&A and restructuring costs. Diluted EPS from continuing operations declined from $0.46 to $0.40.
By segment, sales were $219.1 million in the Americas, $139.1 million in EMEA and $7.0 million in Asia-Pacific. Operating income was $22.6 million, $8.9 million and $0.9 million, respectively; EMEA and Asia-Pacific operating income each declined $2.0 million year over year.
Liquidity, debt and capital allocation
- At March 30, 2014, cash and equivalents were $225.0 million, down from $267.9 million at year-end 2013; approximately $200.0 million was held by foreign subsidiaries. The company noted potential tax costs if foreign cash is repatriated and said it currently intends to permanently reinvest undistributed foreign earnings.
- Current assets were $839.1 million and current liabilities $307.0 million; the current ratio was 2.7 to 1. Working capital was $532.1 million.
- Total debt, including current maturities, was $307.3 million, compared with $307.7 million at year-end. Net debt was $82.3 million versus $39.8 million, and net debt to capitalization rose to 7.6% from 3.8% as cash declined.
- A new $500 million, five-year unsecured revolving facility was signed in February 2014, maturing February 2019. There were no borrowings outstanding; $476.4 million was available after $23.6 million of letters of credit. Watts reported compliance with its debt covenants.
- Operating cash outflow increased mainly because of working-capital investment, including higher inventory related to the U.S. lead-free transition and lower accounts payable. Free cash outflow was $23.6 million, versus $13.0 million a year earlier.
- Watts repurchased approximately 161,000 shares for $9.4 million and paid $4.6 million in dividends during the quarter. A $90 million repurchase authorization remained in place. The quarterly dividend was raised to $0.15 per share in April.
Outlook, commentary and notable items
- Management expected $20–$25 million of capital expenditures for the remainder of 2014, and approximately $25–$30 million for full-year 2014. It also expected to invest approximately $30 million in the stock repurchase program for the remainder of 2014. No earnings or revenue guidance is stated in the provided filing text.
- The EMEA transformation, intended to shift European operations to a pan-European model and improve sales, sourcing, logistics and emerging-market focus, is expected to continue through 2016. Q1 deployment costs were $3.5 million, primarily consulting and IT costs. The company reported $4.2 million of restructuring and other charges, versus $2.2 million a year earlier; the EMEA footprint program is expected to incur about $9.5 million of additional pre-tax costs after March 30 and be completed by the end of Q4 2015.
- Q1 SG&A included a $1.9 million accrual for additional U.S. import duties and fees relating to the prior five years. Management also cited increased commission and freight costs, partly offset by lower personnel and legal expenses.
- The proposed $23.0 million Trabakoolas class-action settlement would leave the company responsible for $14.0 million after expected insurance proceeds of $9.0 million. Preliminary court approval had been granted, but final approval was pending, with a fairness hearing scheduled for July 16, 2014. The remaining recorded liability was $21.4 million at March 30. Separately, estimated reasonably possible legal losses above accrued amounts totaled approximately $11.5 million, pre-tax; management said outcomes could affect results or cash flows for a particular period.
- After quarter-end, the board voted to terminate the frozen Pension Plan and SERP and authorized contributions as necessary to settle plan liabilities. The Pension Plan termination was effective July 31, 2014, with asset distributions expected after regulatory approval in late 2015; the SERP termination was effective May 15, 2014, with lump-sum settlements scheduled 12 to 24 months later. The filing does not quantify the expected termination cost or required contributions.
- After quarter-end, Robert J. Pagano, Jr. was appointed CEO effective upon starting May 27, 2014. Other stated risks include economic and construction cycles, competition and pricing, raw-material costs, foreign-exchange movements, lead-free production efficiency, product liability and litigation.
Key facts for investors to verify
- Whether working-capital investment and negative operating cash flow reverse in subsequent quarters, particularly as lead-free inventory builds.
- Whether organic growth improves outside the Americas, especially in EMEA, and whether the margin gains persist.
- The realized cost, savings and timing of the EMEA transformation and restructuring programs, including the remaining expected charges.
- Final approval and payment mechanics of the Trabakoolas settlement, including insurance recovery and any changes to legal-loss estimates.
- The funding requirements and accounting effects of pension-plan termination, and the pace of planned capital spending, dividends and share repurchases.