Watts Water Technologies, Inc. - 10-Q Summary
Business Context and Reporting Period
This filing is a Quarterly Report on Form 10-Q for the period ended September 27, 2009. Watts Water Technologies, Inc. is a leading supplier of products for water quality, safety, flow control, and conservation markets. The company operates in three geographic segments: North America, Europe, and China. The fiscal year is a 52-week period ending on December 31.
Key Financial Metrics
| Metric | Q3 2009 | Q3 2008 | 9 Months 2009 | 9 Months 2008 |
|---|---|---|---|---|
| Net Sales | $303.8M | $372.0M | $902.7M | $1,089.8M |
| Gross Profit | $109.4M | $122.4M | $315.6M | $365.1M |
| Gross Margin | 36.0% | 32.9% | 35.0% | 33.5% |
| Operating Income | $24.3M | $30.2M | $68.3M | $90.3M |
| Net Income (Continuing Ops) | $11.6M | $16.3M | $30.9M | $47.0M |
| Net Income (Total) | $3.4M | $16.7M | $3.2M | $50.2M |
| Diluted EPS (Total) | $0.09 | $0.45 | $0.09 | $1.36 |
| Cash & Equivalents | $233.3M | $165.6M (Dec 2008) | N/A | |
| Free Cash Flow (9 Mo) | $132.5M | $70.2M | ||
| Long-Term Debt | $304.5M | $409.8M (Dec 2008) | N/A |
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 18.3% in Q3 and 17.2% for the nine months ended September 27, 2009, compared to the prior year. This was driven by organic volume declines in North America and Europe due to recessionary pressures in commercial and residential construction, as well as unfavorable foreign exchange impacts (strengthening U.S. dollar).
- Discontinued Operations: The company recorded significant losses from discontinued operations, totaling $8.2M in Q3 and $27.7M for the nine months. This includes a $5.9M write-down of net assets for Watts Valve (Changsha) Co., Ltd. (CWV) and a $18.8M loss from the deconsolidation of TEAM Precision Pipework, Ltd.
- Restructuring Charges: The company incurred $6.3M in restructuring and other charges in Q3 and $8.6M for the nine months. These included asset impairments (primarily in China) and severance costs related to footprint consolidation plans.
- Margin Expansion: Despite lower sales, gross margins improved (36.0% in Q3 vs. 32.9% in Q3 2008) due to lower raw material costs and cost-saving initiatives, partially offset by plant under-absorption.
Guidance, Outlook, and Risks
- Outlook: Management expects sales in 2009 to continue trending down compared to 2008 due to recessionary pressures. Savings from the 2009 manufacturing footprint consolidation program will not be realized until 2010.
- Restructuring: A footprint consolidation plan approved in February 2009 involves closing three plants and eliminating approximately 400 positions. Total pre-tax charges are estimated at $11.7 million, with remaining costs of $4.7 million expected to be incurred in 2009 and 2010.
- Liquidity: The company generated $147.8M in operating cash flow for the nine months ended September 27, 2009. It maintains a $350M revolving credit facility with $314.4M available. Management believes current funds are sufficient to meet operating requirements and the $50M senior note due in May 2010.
- Key Risks:
- FCPA Investigation: The company is investigating potential violations of the Foreign Corrupt Practices Act (FCPA) regarding payments made by employees of its CWV subsidiary to state-owned agency employees. This has been voluntarily disclosed to the DOJ and SEC.
- Auction Rate Securities (ARS): The company holds $5.3M in ARS investments that have experienced failed auctions and are currently illiquid. A settlement with UBS provides rights to sell these at par between 2010 and 2012.
- Commodity Prices: Copper prices increased significantly in the first nine months of 2009, though the company uses hedging strategies to manage this risk.
Investor Verification Checklist
- Verify the status and potential financial impact of the ongoing FCPA investigation into CWV.
- Monitor the liquidity status of the $5.3M in Auction Rate Securities and the timeline for the UBS settlement exercise.
- Track the progress of the manufacturing footprint consolidation and the realization of projected cost savings in 2010.
- Review the final settlement terms and approval status of the James Jones Litigation.
- Assess the impact of continued weakness in U.S. residential and commercial construction on future sales volumes.