WTS

Watts Water Technologies, Inc. - 2009 10-K Summary

Business Context and Reporting Period

This summary covers the Annual Report on Form 10-K for Watts Water Technologies, Inc. for the fiscal year ended December 31, 2009. Watts is a global manufacturer of products and systems focused on water quality, conservation, safety, and flow control. The company operates in three geographic segments: North America, Europe, and China. The 2009 reporting period was significantly impacted by the global economic recession, which reduced commercial and residential construction starts, as well as unfavorable foreign exchange movements.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased by $205.5 million (14.4%) primarily due to organic volume declines in North America and Europe driven by the recession. Foreign exchange headwinds (depreciation of the Euro and Canadian Dollar) reduced sales by approximately $22.0 million.
• Discontinued Operations: Total Net Income was significantly impacted by a $23.6 million loss from discontinued operations. This included the liquidation of the TEAM Precision Pipework business in the U.K. and the sale of Watts Valve (Changsha) Co., Ltd. (CWV) in China. These disposals were offset by a $9.5 million gain from the settlement of the James Jones litigation.
• Margin Expansion: Despite lower volumes, gross margin improved by 180 basis points to 35.5%, driven by lower raw material costs (copper prices were lower in early 2009 before rising later in the year) and cost reduction initiatives.
• Restructuring: The company recorded $16.1 million in restructuring and other charges in 2009, compared to $5.6 million in 2008. This included asset impairments and severance costs associated with footprint consolidation in North America and China.
• Intangible Impairment: A $3.3 million non-cash charge was recorded for indefinite-lived intangible assets in 2009, compared to a $22.0 million goodwill impairment in 2008.

Guidance, Outlook, and Risks

• Restructuring Plans: In February 2010, the Board approved a new restructuring program for France involving the shutdown of three facilities, with expected pre-tax charges of $12.5 million and annual cash savings of $3.9 million by 2012. Savings from 2009 restructuring programs are expected to be realized in 2010.
• Commodity Risk: The spot price of copper increased approximately 153% from December 2008 to December 2009. Management warns that if commodity costs continue to rise and cannot be passed to customers, near-term margins in 2010 could decline.
• FCPA Investigation: The company is investigating potential violations of the Foreign Corrupt Practices Act (FCPA) regarding payments made by employees of its former Chinese subsidiary, CWV. The company voluntarily disclosed this to the DOJ and SEC. The outcome is uncertain but could result in fines or sanctions.
• Outlook: Management expects the entire current backlog of $86.6 million to convert to sales in 2010. Growth strategies include selective acquisitions, new product introductions, and continued cost reduction via Lean Six Sigma.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the final settlement amounts and tax implications of the CWV sale and TEAM liquidation, which drove the significant drop in total Net Income.
• FCPA Investigation Status: Monitor updates on the Department of Justice and SEC investigation regarding the former Chinese subsidiary to assess potential fines or reputational damage.
• Commodity Hedging: Review the company's ability to pass on the 153% increase in copper prices to customers in 2010 to protect gross margins.
• Restructuring Execution: Track the realization of cost savings from the 2009 and 2010 restructuring plans, particularly the new France consolidation.
• Liquidity Position: Confirm the company's ability to service its $354.9 million in total debt obligations, noting the $50.9 million current portion due in 2010, against its $258.2 million cash balance.