Overview

The following discussion and analysis are provided to increase understanding of, and should be read in conjunction with, the accompanying unaudited consolidated financial statements and notes. In this quarterly report on Form 10-Q, references to "the Company," "Watts," "we," "us" or "our" refer to Watts Water Technologies, Inc. and its consolidated subsidiaries.

We operate on a 52-week fiscal year ending on December 31. Any second quarter ended data contained in this Quarterly Report on Form 10-Q reflects the results of operations for the 13-week period ended on the Sunday nearest June 30th of the respective year.

We are a leading supplier of products for use in the water quality, water safety, water flow control and water conservation markets in both North America and Europe with an emerging presence in China. For over 130 years, we have designed and manufactured products that promote the comfort and safety of people and the quality and conservation of water used in commercial and residential applications. We earn revenue and income almost exclusively from the sale of our products. Our principal product lines include:

† water quality products, including backflow preventers and check valves for preventing reverse flow within water lines and fire protection systems and point-of-use water filtration and reverse osmosis systems for both commercial and residential applications;

† a wide range of water pressure regulators for both commercial and residential applications;

† drainage products for industrial, commercial, marine and residential applications;

† water supply products for commercial and residential applications;

† temperature and pressure relief valves for water heaters, boilers and associated systems;

† thermostatic mixing valves for tempering water in commercial and residential applications;

† systems for under-floor radiant applications and hydraulic pump groups for gas boiler manufacturers and renewable energy applications, including solar and heat pump control packages;

† flexible stainless steel connectors for natural and liquid propane gas in commercial food service and residential applications;and

† large diameter butterfly valves for use in China's water infrastructure.

Our business is reported in three geographic segments: North America, Europe and China. We distribute our products through three primary distribution channels:
wholesale, do-it-yourself (DIY) and original equipment manufacturers (OEMs). Interest rates have an indirect effect on the demand for our products due to the effect such rates have on the number of new residential and commercial construction starts and remodeling projects. All three of these activities have an impact on our levels of sales and earnings. An additional factor that has had an effect on our sales is fluctuation in foreign currencies, as a portion of our sales and certain portions of our costs, assets and liabilities are denominated in currencies other than the U.S. dollar.

Our sales in the first six months continued to be affected by downward pressure from a weak U.S. commercial construction marketplace. In addition, U.S. residential construction activity is at historically low levels. We continued to see marked reductions in European sales as the European economy has migrated into recession. Presently, we believe sales in 2009 will continue to trend down when compared to 2008 as a result of the recessionary pressures. Plant under-absorption and negative foreign currency movements affected operating results in the first six months of 2009. Plant under-absorption costs were partially offset by our cost saving initiatives. Foreign currency movements, mainly related to the strengthening of the U.S. dollar against the euro and Canadian dollar, negatively impacted the second quarter and first six months of 2009 diluted earnings per share by $0.03 and $0.07, respectively, compared to the comparable periods of 2008. Additionally, the credit market crisis continues to create concerns for our performance in 2009. In response to these concerns, we are taking steps to ensure we remain on a firm fiscal platform. In the latter half of 2008, we announced a reduction of the United States workforce, implemented a nine-month salary freeze in North America and initiated a review of discretionary spending in order to reduce operating expenses. In 2009, we have expanded our cost savings programs on a worldwide basis. We have initiated salary reductions, worker furloughs and other cost reductions in an effort to leverage our costs against anticipated lower sales volumes. Additionally, in February 2009, we expanded our restructuring program to consolidate our manufacturing footprint in North America and China. Savings from this program will not be realized until 2010. However, we did record a $3.9 million tax charge in the first quarter of 2009 for the expected tax recapture from a previously awarded tax holiday program. Lastly, we are continuing our implementation of lean manufacturing and Six Sigma disciplines to partially offset any negative pressures to operating income.

We believe that the factors relating to our future growth include the demand for clean water around the world, regulatory requirements relating to the quality and conservation of water, continued enforcement of plumbing and building codes, our ability to grow organically in select attractive market segments, the successful completion of selective acquisitions, both in our core markets as

well as in new complementary markets, and a healthy economic environment. We have completed 32 acquisitions since divesting our industrial and oil and gas business in 1999. Our acquisition strategy focuses on businesses that manufacture preferred brand name products that address our themes of water quality, water conservation, water safety and water flow control and related complementary markets. We target businesses that will provide us with one or more of the following: an entry into new markets, an increase in shelf space with existing customers, a new or improved technology or an expansion of the breadth of our water quality, water conservation, water safety and water flow control products for the residential and commercial markets.

Products representing a majority of our sales are subject to regulatory standards and code enforcement, which typically require that these products meet stringent performance criteria. Together with our commissioned manufacturers' representatives, we have consistently advocated for the development and enforcement of such plumbing codes. We are focused on maintaining stringent quality control and testing procedures at each of our manufacturing facilities in order to manufacture products in compliance with code requirements and take advantage of the resulting demand for compliant products. We believe that the product development, product testing capability and investment in plant and equipment needed to manufacture products in compliance with code requirements, represent a barrier to entry for competitors. We believe there is a demand among consumers for products to ensure water quality, which creates growth opportunities for our products.

We require substantial amounts of raw materials to produce our products, including bronze, brass, cast iron, steel and plastic, and substantially all of the raw materials we require are purchased from outside sources. The commodity markets have experienced tremendous volatility over the past several years, particularly copper. The market prices of many commodities decreased during the latter half of 2008, but increased during the first half of 2009. Bronze and brass are copper-based alloys. The spot price of copper during the second quarter and first six months of 2009 increased approximately 29.4% and 75.5%, respectively. We typically carry several months of inventory on-hand primarily due to the significant extent of our international sourcing.

Historically, a risk we face is our ability to deal effectively with increases in raw material costs. We manage this risk by monitoring related market prices, working with our suppliers to achieve the maximum level of stability in their costs and related pricing, seeking alternative supply sources when necessary, implementing cost reduction programs and passing increases in costs on to our customers. During 2008, we entered into a series of copper swaps to fix the price per pound of copper. These financial instruments are classified as economic hedges, as more fully explained in the Notes to the Consolidated Financial Statements. For the period ended June 28, 2009, the changes in fair market value associated with these copper swaps recorded in other income was approximately $0.3 million. If copper prices continue to increase or decrease, the open copper swap contracts will result in additional income or losses which may occur in a period different from when that cost is recovered.

Another risk we face in all areas of our business is competition. We consider brand preference, engineering specifications, code requirements, price, technological expertise, delivery times and breadth of product offerings to be the primary competitive factors. As mentioned previously, we believe that the product development, product testing capability and investment in plant and equipment needed to manufacture products in compliance with code requirements represent a barrier to entry for competitors. We are committed to maintaining our capital equipment at a level consistent with current technologies, and thus we expect to spend approximately $22.0 to $27.0 million in 2009.

During the quarter ended June 28, 2009, we exited our TEAM Precision Pipework, Ltd. (TEAM) business as more fullydescribed in Note 3 of notes to consolidated financial statements. We classified TEAM's results of operations and the loss from deconsolidation as discontinued operations for all periods presented.

Results of Operations

Second Quarter Ended June 28, 2009 Compared to Second Quarter Ended June 29, 2008

Net Sales. Our business is reported in three geographic segments: North America, Europe and China. Our net sales in each of these segments for each of the second quarters of 2009 and 2008 were as follows:

                         Second Quarter Ended         Second Quarter Ended                 % Change to
                             June 28, 2009                June 29, 2008                    Consolidated
                        Net Sales      % Sales       Net Sales      % Sales      Change     Net Sales
                                                    (dollars in millions)
North America          $     194.4          62.2 %  $     234.6          61.0 % $  (40.2 )        (10.4 )%
Europe                       109.1          34.9          135.1          35.1      (26.0 )         (6.8 )
China                          8.9           2.9           15.2           3.9       (6.3 )         (1.6 )
Total                  $     312.4           100 %  $     384.9           100 % $  (72.5 )        (18.8 )%

The increase (decrease) in net sales in each of the three geographic segments is attributable to the following:

                                                                             Change                                  Change
                                                                As a % of Consolidated Net Sales          As a % of Segment Net Sales
                    North                                    North                                        North
                   America    Europe     China     Total    America      Europe     China     Total      America       Europe     China
                                                                   (dollars in millions)
Organic            $  (37.7 ) $ (22.6 ) $  (3.2 ) $ (63.5 )     (9.8 )%     (5.9 )%   (0.8 )%  (16.5 )%     (16.0 )%     (16.7 )%  (21.1 )%
Foreign exchange       (2.5 )   (14.0 )     0.1     (16.4 )     (0.6 )      (3.7 )       -      (4.3 )       (1.1 )      (10.4 )     0.7
Acquisition               -      10.6         -      10.6          -         2.8         -       2.8            -          7.9         -
Disposal                  -         -      (3.2 )    (3.2 )        -           -      (0.8 )    (0.8 )          -            -     (21.1 )
Total              $  (40.2 ) $ (26.0 ) $  (6.3 ) $ (72.5 )    (10.4 )%     (6.8 )%   (1.6 )%  (18.8 )%     (17.1 )%     (19.2 )%  (41.5 )%

The organic decline in net sales in North America was primarily due to decreased unit sales of our backflow, plumbing and heating and gas connector product lines. Organic sales into the North American wholesale market in the second quarter of 2009 declined by 18.2% compared to the second quarter of 2008. This was primarily due to decreased unit sales across most of our product lines. Organic sales into the North American DIY market in the second quarter of 2009 decreased 6.7% compared to the second quarter of 2008 primarily due to decreased unit sales, offset by incremental product line penetration at certain retail customers, selected market share gains and new product roll-outs.

Organic net sales declined in Europe primarily due to decreased sales in European wholesale and OEM markets. Our sales into the European wholesale market in the second quarter of 2009 decreased by 9.3% and our sales into the European OEM market decreased by 24.4% compared to the second quarter of 2008 primarily due to the markets in Germany being soft. Export sales to Eastern Europe were particularly weak. Acquired sales growth in Europe was due to the inclusion of Blücher Metal A/S (Blücher), acquired on May 30, 2008.

Organic net sales declined in China primarily due to decreased sales in the Chinese export markets. China sales were also negatively affected as compared to 2008 from the disposal of Tianjin Tanggu Watts Valve Co. Ltd. (TWT) during the fourth quarter of 2008.

The decreases in net sales due to foreign exchange in North America and Europe were primarily due to the depreciation of the Canadian dollar and the euro, respectively, against the U.S. dollar. We cannot predict whether these currencies will continue to depreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.

Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for the second quarters of 2009 and 2008 were as follows:

Second Quarter Ended

                June 28,       June 29,     Point
                  2009           2008       Change
                 (dollars in millions)
Gross profit   $     110.5    $     132.0
Gross margin          35.4 %         34.3 %    1.1 %

Gross margin increased 1.1% in the second quarter of 2009 compared to second quarter of 2008. The increase was primarily the result of improved margins in Europe and China offset slightly by a decline in North America. The European margin increased primarily due to the inclusion of a full quarter of higher margin Blücher sales in the second quarter of 2009, fewer Blücher acquisition charges in 2009 and to cost saving measures, offset partially by plant under absorption issues. Our China segment's gross margin increased as a result of operational improvements and the divestiture of TWT. The North American margin decreased due to plant under absorption primarily due to recessionary unit volume sales declines, partially offset by cost savings initiatives.

Selling, General and Administrative Expenses. Selling, General and Administrative, or SG&A, expenses for the second quarter of 2009 decreased $14.7 million, or 15.3%, compared to the second quarter of 2008. The decrease in SG&A expenses was attributable to the following:

                    (in millions)    % Change

Organic            $         (12.9 )    (13.4 )%
Foreign exchange              (3.6 )     (3.8 )
Acquisition                    3.6        3.8
Disposal                      (1.8 )     (1.9 )
Total              $         (14.7 )    (15.3 )%

The organic decrease in SG&A expenses was primarily due to decreased variable selling expenses due to lower sales, the settlement of two lawsuits and various cost savings measures including salary rollbacks, worker furloughs and discretionary spending reductions. The decrease in SG&A expenses from foreign exchange was primarily due to the depreciation of the euro against the U.S. dollar. The increase in SG&A expenses from acquisition was due to the inclusion of Blücher. The reduction due to the disposal relates to the sale of TWT. Total SG&A expenses, as a percentage of sales, were 26.0% in the second quarter of 2009 compared to 24.9% in the second quarter of 2008.

Restructuring and Other Charges. In the second quarter of 2009, we recorded $0.8 million primarily for severance and relocation costs in all three segments. In the second quarter of 2008, we recorded $1.0 million for severance and relocation costs in North America and China.

Operating Income. Operating income (loss) by geographic segment for the second quarters of 2009 and 2008 was as follows: