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WTS > SEC Filings for WTS > Form 10-Q on 6-Aug-2014All Recent SEC Filings

Show all filings for WATTS WATER TECHNOLOGIES INC

Form 10-Q for WATTS WATER TECHNOLOGIES INC


6-Aug-2014

Quarterly Report


Item 2. Management's Discussion And Analysis Of Financial Condition And Results Of Operations

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 calendar year ending on December 31. Any quarterly data contained in this Quarterly Report on Form 10-Q generally reflect the results of operations for a 13-week period or 26-week period, respectively.

We are a leading supplier of products for use in the water quality, water safety, water flow control and water conservation markets in both the Americas and EMEA (Europe, Middle East and Africa), with a growing presence in Asia-Pacific. For 140 years, we have designed and manufactured products that promote 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 are:

Residential & commercial flow control products - includes products typically sold into plumbing and hot water applications such as backflow preventers, water pressure regulators, temperature and pressure relief valves, and thermostatic mixing valves.

HVAC & gas products - includes hydronic and electric heating systems for under-floor radiant applications, hydronic pump groups for boiler manufacturers and alternative energy control packages, and flexible stainless steel connectors for natural and liquid propane gas in commercial food service and residential applications. HVAC is an acronym for heating, ventilation and air conditioning.

Drains & water re-use products - includes drainage products and engineered rain water harvesting solutions for commercial, industrial, marine and residential applications.

Water quality products - includes point-of-use and point-of-entry water filtration, conditioning and scale prevention systems for both commercial and residential applications.

Our business is reported in three geographic segments: Americas, EMEA and Asia-Pacific. We distribute our products through three primary distribution channels: wholesale, do-it-yourself (DIY) and original equipment manufacturers (OEMs). Interest rates, the unemployment rate and credit availability 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 of these activities have an impact on our levels of sales and earnings. An additional factor that has an effect on our sales and operating income is fluctuation in foreign currency exchange rates, as approximately 44% of our sales in the second quarter ended June 29, 2014, and certain portions of our costs, assets and liabilities are denominated in currencies other than the U.S. dollar.

During the second quarter of 2014, sales increased $29.2 million as compared to the second quarter of 2013, primarily from an organic increase in sales of $23.7 million and a favorable foreign exchange movement of $5.5 million. The foreign exchange impact was primarily due to the appreciation of the euro against the U.S. dollar, partially offset by the weakening of the Canadian dollar against the U.S. dollar. Organic sales increased by 6.5% compared to last year's comparable period, primarily from increased sales in the Americas. Organic sales in the second quarter of 2014 increased in the Americas by $18.7 million, or 8.3%, an increase in EMEA of $3.1 million, or 2.3%, and an increase in Asia-Pacific by $1.9 million, or 22.9%. Organic sales growth excludes the impacts of acquisitions, divestitures and foreign exchange from year-over-year comparisons. We believe this provides investors with a more complete understanding of underlying sales trends by providing sales growth on a consistent basis. Gross margin decreased in the second quarter of 2014 as compared to 2013 by 1.1 percentage points. The decrease is due primarily to lower absorption, higher production costs and increased customer rebate expense in the Americas partially offset by production efficiencies, favorable material prices and cost containment in EMEA. Operating income of $36.6 million increased by 2.8% in the second quarter of 2014 as compared to the second quarter of 2013, driven primarily by cost control efforts in EMEA offset by increased selling, general and administrative expenses and restructuring costs. Included in selling, general and administrative expenses for the quarter was $1.6 million of EMEA transformation deployment costs.

The EMEA transformation program began in the fourth quarter of 2013 and is designed to realign our European operating strategy from being country specific to pan European focused. Under this initiative, we intend to (1) develop better sales capabilities through improved product management and enhanced product cross-selling efforts, (2) drive more efficient sourcing and logistics, and
(3) enhance our focus on emerging market opportunities. We plan to align our legal and tax structure in accordance with our business structure and take advantage of favorable tax rates where possible. We expect this project to be ongoing through 2016. We incurred non-recurring deployment costs of approximately $1.6 million and $5.1 million in the three and six month periods ended June 29,


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2014, respectively, and $6.3 million for the project to date. These non-recurring costs consist primarily of external consulting and IT related costs, and are exclusive of restructuring expense. A more detailed description of this program can be found in the Company's Annual Report on Form 10-K for the year ended December 31, 2013.

We believe that the factors relating to our future growth include the demand for clean water around the world, a healthy economic environment 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 and geographic regions and the successful completion of selective acquisitions. Our acquisition strategy focuses on businesses that manufacture preferred brand name or specified products that address our themes of water quality, water conservation, water safety, water flow control, HVAC and related complementary markets and geographies. We target businesses that will provide us with one or more of the following: an entry into new markets and geographies, an increase in business 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 and HVAC products for the residential, commercial and light industrial markets. We have completed 36 acquisitions since 1999.

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.

Historically, we have faced a risk relating to our ability to respond to raw material cost fluctuations. 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, purchasing forward commitments for raw materials, when available, implementing cost reduction programs and passing increases in costs to our customers in the form of price increases.

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, quality and breadth of product offerings to be the primary competitive factors. We believe that product development, product testing capability, breadth of product offerings and investment in plant and equipment needed to manufacture products in compliance with code requirements represent a competitive advantage for us. We expect to spend approximately $25 to $28 million during 2014 for purchases of capital equipment to continue to improve our manufacturing capabilities.

Recent Events

Dividend Declared

On July 29, 2014, we declared a quarterly dividend of fifteen cents ($0.15) per share on each outstanding share of Class A common stock and Class B common stock payable on August 29, 2014 to stockholders of record at the close of business on August 18, 2014.

Termination of Pension Plans

On April 28, 2014, our Board of Directors voted to terminate the Watts Water Technologies, Inc. Pension Plan (the "Pension Plan") and the Watts Water Technologies, Inc. Supplemental Employees Retirement Plan (the "SERP"). These terminations follow amendments to the Pension Plan and SERP to cease (or "freeze") benefit accruals for eligible employees under those plans effective December 31, 2011.

The Pension Plan was terminated effective July 31, 2014. Distribution of plan assets pursuant to the termination will not be made until the plan termination satisfies the regulatory requirements prescribed by the Internal Revenue Service and the Pension Benefit Guaranty Corporation, which is expected to occur in late 2015. The SERP was terminated effective May 15, 2014. We will settle all liabilities under the SERP in accordance with Section 409A of the Internal Revenue Code by paying lump sums to plan participants at least twelve and no more than twenty four months following the termination date. The Board of Directors authorized us to make such contributions to the Pension Plan and SERP as may be necessary to make the plans sufficient to settle all plan liabilities.

Trabakoolas et al., v, Watts Water Technologies, Inc., et al.,

On March 8, 2012, Watts Water Technologies, Inc., Watts Regulator Co., and Watts Plumbing Technologies Co., Ltd., among other companies, were named as defendants in a putative nationwide class action complaint filed in the U.S. District Court for the Northern District of California seeking to recover damages and other relief based on the alleged failure of toilet connectors. The complaint seeks among other items, damages in an unspecified amount, replacement costs, injunctive relief, and attorneys' fees and costs.


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On December 12, 2013, we reached an agreement in principle to settle all claims. The total settlement amount is $23.0 million, of which we would be responsible for $14.0 million after insurance proceeds of $9.0 million. The settlement was subject to review by the Court at a preliminary approval hearing held on February 12, 2014. The Court granted preliminary approval on February 14, 2014. On July 18, 2014, the Court granted final approval of the class settlement at a fairness hearing, and issued a subsequent written order formalizing the approval on August 5, 2014. The order will become final unless an appeal is taken within thirty days.

Results of Operations

Second Quarter Ended June 29, 2014 Compared to Second Quarter Ended June 30, 2013

Net Sales. Our business is reported in three geographic segments: Americas, EMEA and Asia-Pacific. Our net sales in each of these segments for each of the second quarters of 2014 and 2013 were as follows:

                 Second Quarter Ended        Second Quarter Ended                % Change to
                     June 29, 2014               June 30, 2013                   Consolidated
                Net Sales      % Sales      Net Sales      % Sales     Change     Net Sales
                                           (dollars in millions)
Americas       $     241.8          61.1 % $     224.4          61.2 % $  17.4            4.7 %
EMEA                 143.9          36.3         134.1          36.5       9.8            2.7
Asia-Pacific          10.3           2.6           8.3           2.3       2.0            0.6
Total          $     396.0         100.0 % $     366.8         100.0 % $  29.2            8.0 %

The change in net sales was attributable to the following:

                                                                                 Change                                Change
                                                                    As a % of Consolidated Net Sales         As a % of Segment Net Sales
                                            Asia-                                        Asia-                                      Asia-
                    Americas     EMEA      Pacific     Total     Americas      EMEA     Pacific   Total     Americas       EMEA    Pacific
                                                                                          (dollars in millions)
Organic            $     18.7   $   3.1   $     1.9   $  23.7          5.1 %     0.9 %      0.5 %    6.5 %         8.3 %     2.3 %    22.9 %
Foreign exchange         (1.3 )     6.7         0.1       5.5         (0.4 )     1.8        0.1      1.5          (0.5 )     5.0       1.2
Total              $     17.4   $   9.8   $     2.0   $  29.2          4.7 %     2.7 %      0.6 %    8.0 %         7.8 %     7.3 %    24.1 %

Our products are sold to wholesalers, DIY chains, and OEMs. The change in organic net sales by channel was attributable to the following:

                                                                   Change
                                                         As a % of Prior Year Sales
                Wholesale     DIY     OEMs    Total     Wholesale        DIY     OEMs
                                       (dollars in millions)
Americas       $      17.5   $ 1.3   $ (0.1 ) $ 18.7           10.9 %      2.9 % (0.5 )%
EMEA                  (1.4 )  (0.4 )    4.9      3.1           (2.0 )    (10.3 )  8.2
Asia-Pacific           1.9       -        -      1.9           22.9          -      -
Total          $      18.0   $ 0.9   $  4.8   $ 23.7

Organic net sales in the Americas wholesale and DIY markets increased in the second quarter of 2014, compared to the second quarter of 2013, mainly due to increased sales in residential and commercial flow product lines.

Organic net sales in the EMEA wholesale market decreased as compared to the second quarter of 2013 primarily due to a general wholesale market decline including slower Italian and Middle East markets and a slight decrease in the drains market. These decreases were offset by increased sales in the German OEM market and our electronic controls business.

Organic net sales in the Asia-Pacific wholesale market increased as compared to the second quarter of 2013 primarily due to increased sales in residential valve and heating products.

The net increase in sales due to foreign exchange was primarily due to the appreciation of the euro and the Chinese yuan against the U.S. dollar offset partially by the depreciation of the Canadian dollar against the U.S. dollar. We cannot predict whether foreign currencies will appreciate or 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.


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Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for the second quarters of 2014 and 2013 were as follows:

                          Second Quarter Ended
                    June 29, 2014          June 30, 2013
                (dollars in millions)
Gross profit   $                 139.0    $         132.8
Gross margin                      35.1 %             36.2 %

Americas' gross margin decreased compared to the second quarter of 2013 due primarily to higher production costs mainly in our lead free foundry and increased customer rebates. EMEA's gross margin increased primarily due to production efficiencies, favorable material prices and cost containment.

Selling, General and Administrative Expenses. Selling, general and administrative, or SG&A, expenses for the second quarter of 2014 increased $4.6 million, or 4.8%, compared to the second quarter of 2013. The increase in SG&A expenses was attributable to the following:

                    (in millions)    % Change

Organic            $           3.3        3.5 %
Foreign exchange               1.3        1.3
Total              $           4.6        4.8 %

The organic increase in SG&A expenses was primarily due to EMEA transformation non-recurring deployment costs of $1.6 million, increased commission and freight costs of $1.2 million associated with increased sales, increased personnel costs of $0.8 million, and increased product liability and workers compensation costs of $0.6 million, partially offset by a decrease in legal expense of $0.7 million due to fewer ongoing legal matters. The non-recurring EMEA deployment costs of $1.6 million consist primarily of external consulting and IT related costs. The increase in SG&A expenses from foreign exchange was primarily due to the appreciation of the euro against the U.S. dollar in 2014. Total SG&A expenses, as a percentage of sales, were 25.2% in the second quarter of 2014 and 26.0% in the second quarter of 2013.

Restructuring and Other Charges, Net. In the second quarter of 2014, we recorded a net charge of $2.6 million primarily for involuntary terminations and other costs incurred as part of our EMEA restructuring plans and a reduction-in-force in the Americas, as compared to $2.0 million of restructuring charges for the second quarter of 2013. For a more detailed description of our current restructuring plans, see Note 5 of Notes to Consolidated Financial Statements.

Operating Income. Operating income (loss) by geographic segment for the second quarters of 2014 and 2013 were as follows:

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