Watts Water Technologies, Inc. — Q2 2010 Form 10-Q
Business context and reporting period. Watts supplies water quality, safety, flow-control and conservation products, principally in North America and Europe, with a smaller China business. The fiscal second quarter ended July 4, 2010; comparisons are with the quarter ended June 28, 2009. The six-month period included four additional working days versus 2009. Financial amounts below are in millions except per-share data.
Financial performance
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net sales | $324.0 | $308.2 | $643.3 | $598.9 |
| Gross profit / margin | $120.6 / 37.2% | $109.2 / 35.4% | $238.2 / 37.0% | $206.2 / 34.4% |
| Operating income / margin | $33.3 / 10.3% | $28.5 / 9.2% | $59.3 / 9.2% | $44.0 / 7.3% |
| Income from continuing operations | $22.2 | $15.2 | $34.4 | $19.3 |
| Net income (loss) | $22.1 | $(3.6) | $30.2 | $(0.2) |
| Diluted EPS | $0.59 | $(0.10) | $0.81 | $(0.01) |
- Sales increased 5.1% in Q2 and 7.4% for the first six months. Organic sales grew 7.1% and 6.9%, respectively; acquisitions added 0.1 percentage point in each period. Q2 foreign exchange reduced reported sales by $6.5.
- Q2 segment sales were North America $206.3, Europe $112.1 and China $5.6. First-half sales were $404.8, $228.6 and $9.9, respectively. North America led operating-income improvement; Europe’s results included restructuring effects, and China reported a first-half operating loss of $0.3.
- Continuing-operations income improved substantially; the prior-year net loss included the $18.8 TEAM deconsolidation loss in discontinued operations. First-half 2010 discontinued-operations loss was $4.2, including $5.6 of FCPA-related costs, partly offset by a $1.6 tax benefit.
- Cash from continuing operating activities was $33.2 for the first half, down from $73.5. Free cash inflow, as defined by the company, was $21.7 versus $65.3. Receivables and inventory absorbed cash, with management citing sales timing and European safety-stock needs.
- Capital expenditures were $12.0 for the first half. The company expected to invest approximately $18.8 more during the remainder of 2010.
Balance sheet, debt and liquidity
- At July 4, 2010, cash and cash equivalents were $254.7, short-term investments $4.0, and total assets $1,596.0. Working capital was $537.6; the current ratio was 2.9:1, versus 2.6:1 at year-end 2009.
- Total debt, including current maturities, was $378.8, compared with $354.9 at December 31, 2009. The company issued $75.0 of 5.05% senior notes due 2020 and repaid $50.0 of notes at maturity. Cash less total debt was approximately $124 million.
- A new $300 million, five-year revolving credit facility had no borrowings outstanding; $264.9 was unused and available, with $35.1 of standby letters of credit outstanding. The company reported compliance with debt covenants.
- Cash declined $3.5 from year-end. Investing activities used $45.1, primarily for acquisitions and capital equipment; financing activities provided $14.1.
Material changes, outlook and risks
- Management attributed improved margins mainly to higher volume, better factory absorption, productivity initiatives and, in Europe, product mix. These benefits were partly offset by higher raw-material costs, customer credits and restructuring inefficiencies. SG&A rose 6.1% in Q2 and 8.3% year to date, including higher legal, personnel and variable selling costs.
- Management said the U.S. commercial marketplace remained weak and did not expect improvement there during the balance of 2010. Repair and remodeling, retail restocking, new products and European product-line gains supported sales. No full-year earnings or sales guidance is provided in the supplied filing text.
- Second-quarter continuing-operations tax rate fell to 22.9% from 34.2%, primarily after releasing a European net-operating-loss valuation allowance. The tax benefit contributed $0.08 per diluted share. Euro depreciation reduced Q2 diluted earnings by $0.03 per share; management noted future currency effects are uncertain.
- Restructuring continued, including European footprint actions and the closure of the Tianjin Watts Valve Company facility. The company expected $2.3 of remaining costs for its 2010 restructuring program and expected to complete the TWVC sale before year-end, subject to approvals, for net proceeds of $5.9. Restructuring charges were $2.5 in the Q2 income statement and $5.8 for the first half; note disclosures also include accelerated depreciation charged to cost of goods sold, resulting in total program charges of $3.1 and $6.9, respectively.
- Two acquisitions were completed: BRAE, a rainwater-harvesting business, and Austroflex, a European pre-insulated pipe-systems manufacturer. Net cash paid for acquisitions was $36.1 for the first half; acquired businesses were not material to reported results during the period.
- Key risks include economic weakness affecting construction and remodeling, commodity-cost volatility and ability to pass costs through, competition, foreign-exchange movements, product liability, environmental matters, restructuring execution and litigation. The company continued an investigation into possible FCPA violations related to CWV; the filing reports no other material developments in litigation or environmental remediation during the period. The FCPA investigation and associated costs remain an important contingency.
- Foreign-currency translation and pension adjustments reduced accumulated other comprehensive income from $30.1 at year-end to a loss of $34.0 at July 4; first-half total comprehensive loss was $33.9 despite net income of $30.2.
Important facts for investors to verify
- Whether organic sales growth and margin gains persist, particularly given the weak U.S. commercial market and the four extra working days in the first-half comparison.
- The cash-conversion outlook: first-half continuing operating cash flow and free cash inflow fell sharply year over year as working capital increased.
- Final costs, timing and realized savings from restructuring; approval and proceeds from the planned TWVC sale.
- Developments, ultimate costs and potential consequences of the CWV-related FCPA investigation, including whether the recorded reserve proves adequate.
- Integration and performance of Austroflex and BRAE, including Austroflex purchase accounting and contingent consideration for BRAE.
- Debt covenant headroom, refinancing needs and exposure to interest rates, currencies and raw-material prices; the filing states the company was covenant-compliant at quarter-end.