Watts Water Technologies, Inc. - Q2 2009 10-Q Summary
Business Context and Reporting Period
This report covers the quarterly period ended June 28, 2009. Watts Water Technologies, Inc. is a leading supplier of products for water quality, safety, flow control, and conservation markets, operating in North America, Europe, and China. The company operates on a 52-week fiscal year. The reporting period reflects the impact of a global recession, weak commercial and residential construction markets, and significant restructuring activities.
Key Financial Metrics
| Metric | Q2 2009 | Q2 2008 | YTD 2009 | YTD 2008 |
|---|---|---|---|---|
| Net Sales | $312.4 million | $384.9 million | $605.9 million | $724.6 million |
| Gross Profit | $110.5 million | $132.0 million | $207.9 million | $245.4 million |
| Gross Margin | 35.4% | 34.3% | 34.3% | 33.9% |
| Operating Income | $28.4 million | $35.0 million | $43.5 million | $60.9 million |
| Net Income (Loss) from Continuing Ops | $15.1 million | $19.2 million | $18.9 million | $31.4 million |
| Net Income (Loss) Attributable to Watts | $(3.6) million | $19.8 million | $(0.2) million | $33.5 million |
| Diluted EPS (Continuing Ops) | $0.41 | $0.54 | $0.51 | $0.90 |
| Diluted EPS (Net) | $(0.10) | $0.54 | $(0.01) | $0.91 |
| Cash and Cash Equivalents | $178.6 million | $165.6 million (Dec 2008) | $178.6 million | $109.5 million (Jun 2008) |
| Free Cash Flow (YTD) | $66.0 million (vs $27.5 million YTD 2008) | |||
| Long-Term Debt | $367.1 million | $409.8 million (Dec 2008) | $367.1 million | $409.8 million (Dec 2008) |
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 18.8% in Q2 and 16.4% YTD compared to 2008. The decline was driven by organic volume decreases in North America (wholesale and DIY markets) and Europe (recessionary pressures), partially offset by the inclusion of the Blücher acquisition in Europe.
- Discontinued Operations: The company recorded a significant loss from discontinued operations of $18.7 million in Q2 and $19.1 million YTD. This was primarily due to the deconsolidation of TEAM Precision Pipework, Ltd. (TEAM) in the U.K., resulting in an $18.8 million non-cash loss.
- Restructuring Charges: The company recorded $0.8 million in Q2 and $2.3 million YTD in restructuring and other charges. A major 2009 restructuring plan was announced in February to consolidate manufacturing footprints in North America and China, with expected pre-tax charges of $11.7 million.
- Foreign Exchange Impact: The strengthening of the U.S. dollar against the Euro and Canadian dollar negatively impacted sales and diluted EPS by $0.03 in Q2 and $0.07 YTD.
- Tax Rate Increase: The effective tax rate for continuing operations increased to 34.2% in Q2 (from 31.2% in 2008) and 43.0% YTD (from 32.3% in 2008), largely due to a $3.9 million tax charge related to the recapture of previously realized tax benefits associated with restructuring.
Guidance, Outlook, and Risks
- Outlook: Management expects sales in 2009 to continue to trend down compared to 2008 due to recessionary pressures. Savings from the 2009 restructuring program will not be realized until 2010.
- Capital Expenditures: The company expects to spend approximately $22.0 to $27.0 million in 2009 on capital equipment.
- Liquidity: The company maintains a $350.0 million revolving credit facility with $301.8 million available as of June 28, 2009. Management believes available funds are sufficient to meet operating requirements and the $50 million principal due on senior notes in May 2010.
- Key Risks:
- Legal Proceedings: An agreement in principle was reached to settle the "James Jones Litigation," though final approval is pending. The company does not expect a material adverse effect.
- FCPA Investigation: The company is investigating possible improper payments to foreign government officials by a subsidiary in China (Watts Valve (Changsha) Co., Ltd.) and has voluntarily disclosed this to the DOJ and SEC. The outcome is uncertain.
- Auction Rate Securities (ARS): The company holds $6.7 million in ARS with failed auctions. While a settlement with UBS provides rights to sell at par between 2010-2012, liquidity is currently restricted.
- Commodity Prices: Copper prices increased significantly in the first half of 2009, impacting raw material costs.
Investor Verification Checklist
- Verify the final status and financial impact of the "James Jones Litigation" settlement.
- Monitor the outcome of the Foreign Corrupt Practices Act (FCPA) investigation regarding the China subsidiary.
- Track the liquidity status of the $6.7 million in Auction Rate Securities (ARS) and the exercise of UBS settlement rights.
- Assess the progress and cost realization of the 2009 manufacturing footprint consolidation plan.
- Review the impact of foreign currency fluctuations on future earnings, given the significant exposure to the Euro and Canadian Dollar.