Watts Water Technologies, Inc. - Q3 2008 10-Q Summary
Business Context and Reporting Period
This filing is a Quarterly Report on Form 10-Q for the period ended September 28, 2008. 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 report covers the third quarter and the first nine months of fiscal year 2008.
Key Financial Metrics
| Metric | Q3 2008 | Q3 2007 | 9 Months 2008 | 9 Months 2007 |
|---|---|---|---|---|
| Net Sales ($ millions) | $379.3 | $340.5 | $1,112.3 | $1,037.0 |
| Gross Profit ($ millions) | $123.9 | $110.5 | $371.0 | $339.8 |
| Gross Margin (%) | 32.7% | 32.4% | 33.4% | 32.8% |
| Operating Income ($ millions) | $30.7 | $30.1 | $92.2 | $90.8 |
| Net Income ($ millions) | $16.7 | $18.1 | $50.2 | $55.9 |
| Diluted EPS ($) | $0.45 | $0.46 | $1.36 | $1.43 |
| Cash from Operations ($ millions) | N/A | N/A | $91.5 | $21.8 |
| Cash & Equivalents ($ millions) | $129.4 | $290.3 (Dec 2007) | $129.4 | $290.3 (Dec 2007) |
| Total Debt ($ millions) | $417.8 | N/A | $417.8 | N/A |
Note: Total Debt calculated as Current portion of long-term debt ($3.1M) + Long-term debt ($414.7M).
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 11.4% in Q3 and 7.3% for the nine months, driven primarily by acquisitions (Blücher in Europe and Topway in North America) and favorable foreign exchange rates. Organic sales were flat or declined in North America and China due to economic softness.
- Profitability: Net income decreased 7.7% in Q3 and 10.2% for the nine months. This decline was due to higher SG&A expenses, restructuring charges, and lower interest income, despite improved gross margins.
- Segment Performance:
- North America: Sales up slightly; operating income increased due to price increases offsetting higher SG&A.
- Europe: Sales up significantly (33.9% in Q3) due to the Blücher acquisition and growth in the OEM market. Operating income improved.
- China: Sales declined; the segment reported an operating loss of $2.5M in Q3 (vs. profit of $0.7M in 2007) due to volume decreases, labor disputes, and underutilized capacity.
- Liquidity: Cash and cash equivalents dropped from $290.3 million to $129.4 million, primarily due to funding the Blücher acquisition ($170.1M cash) and stock repurchases ($44.5M).
Guidance, Outlook, and Risks
- Economic Outlook: Management expects the economic downturn and credit market crisis to negatively impact sales in North America (retail and wholesale) and Europe through 2009. They anticipate slower growth for the next several quarters.
- Cost Reductions: In response to the downturn, the company announced a reduction of the U.S. workforce in Q4 2008, a nine-month salary freeze in North America, and a review of discretionary spending. They are also evaluating manufacturing footprint consolidation.
- Acquisitions: The company acquired Blücher Metals A/S for approximately $183.5 million in May 2008. They also completed the acquisition of the remaining 40% of their China joint venture.
- Divestiture: The company entered an agreement to sell its equity interests in a domestic Chinese entity, expected to close in Q4 2008. This will not be treated as a discontinued operation.
- Key Risks:
- Credit Markets: Limited access to capital for large acquisitions and potential delays in commercial construction projects.
- Commodity Prices: Volatility in raw material costs (copper, brass). The company entered copper swaps which resulted in a $0.4M loss in Q3; further losses are possible if copper prices continue to drop.
- Auction Rate Securities (ARS): The company holds $7.9 million in ARS that have experienced failed auctions. While classified as temporary impairments, liquidity is restricted until auctions succeed or buyers are found.
- Legal: Ongoing James Jones Litigation related to discontinued operations.
Investor Verification Checklist
- Stock Repurchase Program: Verify the status of the temporarily suspended stock repurchase program and the remaining authorized shares (553,615 shares remaining as of Q3 end).
- Auction Rate Securities: Monitor the liquidity status of the $7.9 million ARS portfolio and any potential future impairments if auctions continue to fail.
- Restructuring Costs: Track the remaining $4.6 million in expected costs for the 2007 restructuring program, particularly the timing of costs in the Europe segment.
- China Segment Turnaround: Assess the impact of the pending sale of the domestic Chinese business and the resolution of labor disputes on future China segment profitability.
- Copper Swap Exposure: Review the potential for additional losses on open copper swap contracts if commodity prices continue to decline in Q4 2008.