WTS 10-Q
Watts Water Technologies Inc (WTS)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended
or
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission file number
WATTS WATER TECHNOLOGIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
(State or Other Jurisdiction of Incorporation or | (I.R.S. Employer Identification No.) | |
(Address of Principal Executive Offices) | (Zip Code) |
(
(Registrant’s Telephone Number, Including Area Code)
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report.)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Accelerated filer ☐ | ||
Non-accelerated filer ☐ | Smaller reporting company Emerging growth company | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class | Outstanding at April 25, 2021 | |
Class A Common Stock, $0.10 par value | ||
Class B Common Stock, $0.10 par value |
1
WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
INDEX
| 3 | ||
3 | |||
Consolidated Balance Sheets at March 28, 2021 and December 31, 2020 (unaudited) | 3 | ||
4 | |||
5 | |||
6 | |||
7 | |||
8 | |||
Management’s Discussion and Analysis of Financial Condition and Results of Operations | 22 | ||
30 | |||
31 | |||
31 | |||
31 | |||
31 | |||
31 | |||
33 | |||
34 | |||
2
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in millions, except share information)
(Unaudited)
March 28, | December 31, | |||||
| 2021 |
| 2020 | |||
ASSETS |
| |||||
CURRENT ASSETS: | ||||||
Cash and cash equivalents | $ | | $ | | ||
Trade accounts receivable, less reserve allowances of $ |
| |
| | ||
Raw materials | | | ||||
Work in process | | | ||||
Finished goods | | | ||||
Total Inventories | | | ||||
Prepaid expenses and other current assets |
| |
| | ||
Total Current Assets |
| |
| | ||
PROPERTY, PLANT AND EQUIPMENT |
|
| ||||
Property, plant and equipment, at cost | | | ||||
Accumulated depreciation | ( | ( | ||||
Property, plant and equipment, net | | | ||||
OTHER ASSETS: | ||||||
Goodwill |
| |
| | ||
Intangible assets, net |
| |
| | ||
Deferred income taxes |
| |
| | ||
Other, net |
| |
| | ||
TOTAL ASSETS | $ | | $ | | ||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||
CURRENT LIABILITIES: | ||||||
Accounts payable | $ | | $ | | ||
Accrued expenses and other liabilities |
| |
| | ||
Accrued compensation and benefits |
| |
| | ||
Total Current Liabilities |
| |
| | ||
LONG-TERM DEBT |
| |
| | ||
DEFERRED INCOME TAXES |
| |
| | ||
OTHER NONCURRENT LIABILITIES |
| |
| | ||
STOCKHOLDERS’ EQUITY: | ||||||
Preferred Stock, $ |
|
| ||||
Class A common stock, $ |
| |
| | ||
Class B common stock, $ |
| |
| | ||
Additional paid-in capital |
| |
| | ||
Retained earnings |
| |
| | ||
Accumulated other comprehensive loss |
| ( |
| ( | ||
Total Stockholders’ Equity |
| |
| | ||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | | $ | | ||
See accompanying notes to consolidated financial statements.
3
WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in millions, except per share information)
(Unaudited)
First Quarter Ended | ||||||
March 28, | March 29, | |||||
| 2021 |
| 2020 | |||
Net sales | $ | | $ | | ||
Cost of goods sold |
| |
| | ||
GROSS PROFIT |
| |
| | ||
Selling, general and administrative expenses |
| |
| | ||
Restructuring |
| |
| — | ||
OPERATING INCOME |
| |
| | ||
Other (income) expense: | ||||||
Interest income |
| — |
| ( | ||
Interest expense |
| |
| | ||
Other expense (income), net |
| ( |
| | ||
Total other expense |
| |
| | ||
INCOME BEFORE INCOME TAXES |
| |
| | ||
Provision for income taxes |
| |
| | ||
NET INCOME | $ | | $ | | ||
Basic EPS | ||||||
NET INCOME PER SHARE | $ | | $ | | ||
Weighted average number of shares |
| |
| | ||
Diluted EPS | ||||||
NET INCOME PER SHARE | $ | | $ | | ||
Weighted average number of shares |
| |
| | ||
Dividends declared per share | $ | | $ | | ||
See accompanying notes to consolidated financial statements.
4
WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in millions)
(Unaudited)
| First Quarter Ended | |||||
March 28, | March 29, | |||||
| 2021 |
| 2020 | |||
Net income | $ | | $ | | ||
Other comprehensive loss net of tax: | ||||||
Foreign currency translation adjustments |
| ( |
| ( | ||
Cash flow hedges | ( | ( | ||||
Other comprehensive loss |
| ( |
| ( | ||
Comprehensive income | $ | | $ | | ||
See accompanying notes to consolidated financial statements.
5
WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Dollars in millions)
(Unaudited)
Accumulated | ||||||||||||||||||||||
Class A | Class B | Additional | Other | Total | ||||||||||||||||||
(For the first quarter ended | Common Stock | Common Stock | Paid-In | Retained | Comprehensive | Stockholders’ | ||||||||||||||||
March 28, 2021) |
| Shares |
| Amount |
| Shares |
| Amount |
| Capital |
| Earnings |
| Loss |
| Equity | ||||||
Balance at December 31, 2020 |
| | $ | |
| | $ | | $ | | $ | | $ | ( | $ | | ||||||
Net income | — | — | — | — | — | | — | | ||||||||||||||
Other comprehensive loss | — | — | — | — | — | — | ( | ( | ||||||||||||||
Comprehensive income | | |||||||||||||||||||||
Shares of Class B common stock converted to Class A common stock |
| | — | ( | — | — | — | — | — | |||||||||||||
Stock-based compensation |
| — | — | — | — | | — | — | | |||||||||||||
Stock repurchase |
| ( | — | — | — | — | ( | — | ( | |||||||||||||
Net change in restricted and performance stock units | | — | — | — | | ( | — | ( | ||||||||||||||
Common stock dividends | — | — | — | — | — | ( | — | ( | ||||||||||||||
Balance at March 28, 2021 |
| | $ | |
| | $ | | $ | | $ | | $ | ( | $ | | ||||||
Accumulated | ||||||||||||||||||||||
Class A | Class B | Additional | Other | Total | ||||||||||||||||||
(For the first quarter ended | Common Stock | Common Stock | Paid-In | Retained | Comprehensive | Stockholders’ | ||||||||||||||||
March 29, 2020) |
| Shares |
| Amount |
| Shares |
| Amount |
| Capital |
| Earnings |
| Loss |
| Equity | ||||||
Balance at December 31, 2019 |
| | $ | |
| | $ | | $ | | $ | | $ | ( | $ | | ||||||
Net income | — | — | — | — | — | | — | | ||||||||||||||
Other comprehensive loss | — | — | — | — | — | — | ( | ( | ||||||||||||||
Comprehensive income | | |||||||||||||||||||||
Shares of Class B common stock converted to Class A common stock | | — | ( | — | — | — | — | — | ||||||||||||||
Stock-based compensation | — | — | — | — | | — | — | | ||||||||||||||
Stock repurchase | ( | — | — | — | — | ( | — | ( | ||||||||||||||
Net change in restricted and performance stock units | | — | — | — | | ( | — | ( | ||||||||||||||
Common stock dividends | — | — | — | — | — | ( | — | ( | ||||||||||||||
Balance at March 29, 2020 | | $ | | | $ | | $ | | $ | | $ | ( | | |||||||||
See accompanying notes to consolidated financial statements.
6
WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in millions)
(Unaudited)
First Quarter Ended | ||||||
March 28, | March 29, | |||||
| 2021 |
| 2020 | |||
OPERATING ACTIVITIES | ||||||
Net income | $ | | $ | | ||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | ||||||
Depreciation |
| |
| | ||
Amortization of intangibles |
| |
| | ||
Loss on disposal and impairment of property, plant and equipment and other |
| |
| — | ||
Stock-based compensation |
| |
| | ||
Deferred income tax |
| |
| | ||
Changes in operating assets and liabilities: | ||||||
Accounts receivable |
| ( |
| ( | ||
Inventories |
| ( |
| ( | ||
Prepaid expenses and other assets |
| ( |
| ( | ||
Accounts payable, accrued expenses and other liabilities |
| |
| ( | ||
Net cash provided by (used in) operating activities |
| |
| ( | ||
INVESTING ACTIVITIES | ||||||
Additions to property, plant and equipment |
| ( |
| ( | ||
Proceeds from the sale of property, plant and equipment |
| |
| | ||
Net cash used in investing activities |
| ( |
| ( | ||
FINANCING ACTIVITIES | ||||||
Proceeds from long-term borrowings | | | ||||
Payments of long-term debt |
| ( |
| — | ||
Payments for withholding taxes on vested awards |
| ( |
| ( | ||
Payments for finance leases and other | ( | ( | ||||
Payments to repurchase common stock |
| ( |
| ( | ||
Dividends |
| ( |
| ( | ||
Net cash (used in) provided by financing activities |
| ( |
| | ||
Effect of exchange rate changes on cash and cash equivalents |
| ( |
| ( | ||
INCREASE IN CASH AND CASH EQUIVALENTS |
| |
| | ||
Cash and cash equivalents at beginning of year |
| |
| | ||
CASH AND CASH EQUIVALENTS AT END OF PERIOD | $ | | $ | | ||
NON CASH INVESTING AND FINANCING ACTIVITIES | ||||||
Issuance of stock under management stock purchase plan | $ | | $ | | ||
CASH PAID FOR: | ||||||
Interest | $ | | $ | | ||
Income taxes | $ | | $ | | ||
See accompanying notes to consolidated financial statements.
7
WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included in the Watts Water Technologies, Inc. (the Company) Consolidated Balance Sheet as of March 28, 2021, the Consolidated Statements of Operations for the first quarters ended March 28, 2021 and March 29, 2020, the Consolidated Statements of Comprehensive Income for the first quarters ended March 28, 2021 and March 29, 2020, the Consolidated Statements of Stockholders’ Equity for the first quarters ended March 28, 2021 and March 29, 2020, and the Consolidated Statements of Cash Flows for the first quarters ended March 28, 2021 and March 29, 2020.
The consolidated balance sheet at December 31, 2020 has been derived from the audited consolidated financial statements at that date. The accounting policies followed by the Company are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020. The financial statements included in this report should be read in conjunction with the consolidated financial statements and notes included in the Annual Report on Form 10-K for the year ended December 31, 2020. Operating results for the interim periods presented are not necessarily indicative of the results to be expected for the year ending December 31, 2021, and may be further impacted by the effects of the Coronavirus Disease 2019 (“COVID-19”) global pandemic.
The Company operates on a -week fiscal year ending on December 31, with each quarter, except the fourth quarter, ending on a Sunday. Any quarterly data contained in this Quarterly Report on Form 10-Q generally reflect the results of operations for a -week period.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The COVID-19 pandemic has created significant uncertainty in the global economy. There have been no comparable recent events that provide guidance as to the effect COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of COVID-19 and the extent to which COVID-19 continues to impact the Company’s business, results of operations and financial condition will depend on future developments, which are highly uncertain and difficult to predict. We are not aware of any specific event or circumstance that would require updates to the Company’s estimates or judgments or require the Company to revise the carrying value of the Company’s assets or liabilities as of the date of issuance of this Quarterly Report on Form 10-Q. These estimates may change as new events occur and additional information is obtained. Actual results could differ from those estimates.
2. Accounting Policies
The significant accounting policies used in preparation of these consolidated financial statements for the first quarter ended March 28, 2021 are consistent with those discussed in Note 2 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
Recently Adopted Accounting Standards
In December 2019, the FASB issued ASU No. 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” This ASU simplifies the accounting for income taxes by clarifying and amending existing guidance related to the recognition of franchise tax, the evaluation of a step up in the tax basis of goodwill, and the effects of enacted changes in tax laws or rates in the effective tax rate computation, among other clarifications. The effective date for adoption of this ASU is the calendar year beginning January 1, 2021 with early adoption permitted. The Company
8
adopted this standard in the first quarter of 2021, and it did not have a material impact on the Company’s financial statements.
Accounting Standards Updates
In March 2020, the FASB issued ASU 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting." The amendments provide optional guidance for a limited time to ease the potential burden in accounting for reference rate reform. The new guidance provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts and hedging relationships that reference LIBOR or another reference rate expected to be discontinued due to reference rate reform. These amendments are effective immediately and may be applied prospectively to contract modifications made and hedging relationships entered into or evaluated on or before December 31, 2022. The Company is currently evaluating its contracts and the optional expedients provided by the new standard.
Shipping and Handling
Shipping and handling costs included in selling, general and administrative expenses amounted to $
Research and Development
Research and development costs included in selling, general and administrative expenses amounted to $
3. Revenue Recognition
The Company is a leading supplier of products that manage and conserve the flow of fluids and energy into, through and out of buildings in the commercial and residential markets of the Americas, Europe, and Asia-Pacific, Middle East, and Africa (“APMEA”). For over
The Company distributes products through
| ● | 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, thermostatic mixing valves and leak detection products. |
| ● | HVAC & gas products—includes commercial high-efficiency boilers, water heaters and heating solutions, hydronic and electric heating systems for under-floor radiant applications, custom heat and hot water solutions, 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. |
| ● | Drainage & 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 commercial, marine and residential applications. |
9
The following table disaggregates revenue, which is presented as net sales in the financial statements, for each reportable segment, by distribution channel and principal product line:
For the first quarter ended March 28, 2021 | ||||||||||||
(in millions) | ||||||||||||
Distribution Channel | Americas | Europe | APMEA | Consolidated | ||||||||
Wholesale | $ | | $ | | $ | | $ | | ||||
OEM | |
| |
| |
| | |||||
Specialty | |
| — |
| — |
| | |||||
DIY |
| |
| |
| — |
| | ||||
Total | $ | | $ | | $ | | $ | | ||||
For the first quarter ended March 28, 2021 | ||||||||||||
(in millions) | ||||||||||||
Principal Product Line | Americas | Europe | APMEA | Consolidated | ||||||||
Residential & Commercial Flow Control | $ | | $ | | $ | | $ | | ||||
HVAC and Gas Products | |
| |
| |
| | |||||
Drainage and Water Re-use Products | |
| |
| |
| | |||||
Water Quality Products |
| |
| |
| |
| | ||||
Total | $ | | $ | | $ | | $ | | ||||
For the first quarter ended March 29, 2020 | ||||||||||||
(in millions) | ||||||||||||
Distribution Channel | Americas | Europe | APMEA | Consolidated | ||||||||
Wholesale | $ | | $ | | $ | | $ | | ||||
OEM | |
| |
| |
| | |||||
Specialty | |
| — |
| |
| | |||||
DIY |
| |
| |
| — |
| | ||||
Total | $ | | $ | | $ | | $ | | ||||
For the first quarter ended March 29, 2020 | ||||||||||||
(in millions) | ||||||||||||
Principal Product Line | Americas | Europe | APMEA | Consolidated | ||||||||
Residential & Commercial Flow Control | $ | | $ | | $ | | $ | | ||||
HVAC and Gas Products | |
| |
| |
| | |||||
Drainage and Water Re-use Products | |
| |
| |
| | |||||
Water Quality Products |
| |
| |
| |
| | ||||
Total | $ | | $ | | $ | | $ | | ||||
The Company generally considers customer purchase orders, which in some cases are governed by master sales agreements, to represent the contract with a customer. The Company’s contracts with customers are generally for products only and typically do not include other performance obligations such as professional services, extended warranties, or other material rights. In situations where sales are to a distributor, the Company has concluded that its contracts are with the distributor as the Company holds a contract bearing enforceable rights and obligations only with the distributor. As part of its consideration of the contract, the Company evaluates certain factors including the customer’s ability to pay (or credit risk). For each contract, the Company considers the promise to transfer products, each of which is distinct, to be the identified performance obligations. In determining the transaction price, the Company evaluates whether the price is subject to refund or adjustment to determine the net consideration to which the Company expects to be entitled. As the Company’s standard payment terms are less than one year, the Company has elected not to assess whether a contract has a significant financing component. The Company allocates the transaction price to each distinct product based on its relative standalone selling price. The product price as specified on the purchase order is considered the standalone selling price as it is an observable input which depicts the price as if sold to a similar customer in similar circumstances. Revenue is recognized when control of the product is transferred to the customer (i.e., when the Company’s performance obligation is satisfied), which typically occurs at shipment from the Company’s manufacturing site or distribution center, or delivery to the customer’s named location. In certain circumstances, revenue from shipments to retail customers is recognized only when the product is consumed by the customer, as based on the terms of the arrangement, transfer of control is not satisfied until that point in time. In determining whether control has
10
transferred, the Company considers if there is a present right to payment, physical possession and legal title, along with risks and rewards of ownership having transferred to the customer. In certain circumstances, the Company manufactures customized product without alternative use for its customers. However, as these arrangements do not entitle the Company a right to payment of cost plus a profit for work completed, the Company has concluded that revenue recognition at the point in time control transfers is appropriate and not over time recognition.
At times, the Company receives orders for products to be delivered over multiple dates that may extend across reporting periods. The Company invoices for each delivery upon shipment and recognizes revenues for each distinct product delivered, assuming transfer of control has occurred. As scheduled delivery dates are within one year, under the optional exemption provided by the guidance, revenues allocated to future shipments of partially completed contracts are not disclosed.
The Company generally provides an assurance warranty that its products will substantially conform to the published specification. The Company’s liability is limited to either a credit equal to the purchase price or replacement of the defective part. Returns under warranty have historically been immaterial. The Company does not consider activities related to such warranty, if any, to be a separate performance obligation. For certain of its products, the Company will separately sell extended warranty and service policies to its customers. The Company considers these extended warranties and service policies to be separate performance obligations. These policies typically are for periods ranging from to
The timing of revenue recognition, billings and cash collections from the Company’s contracts with customers can vary based on the payment terms and conditions in the customer contracts. In some cases, customers will partially prepay for their goods; in other cases, after appropriate credit evaluations, payment is due in arrears. In addition, there are constraints which cause variability in the ultimate consideration to be recognized. These constraints typically include early payment discounts, volume rebates, rights of return, cooperative advertising, and market development funds. The Company includes these constraints in the estimated transaction price when there is a basis to reasonably estimate the amount of variable consideration. These estimates are based on historical experience, anticipated future performance and the Company’s best judgment at the time. When the timing of the Company’s recognition of revenue is different from the timing of payments made by the customer, the Company recognizes either a contract asset (performance precedes contractual due date) or a contract liability (customer payment precedes performance). Contracts with payment in arrears are recognized as receivables. The opening and closing balances of the Company’s contract assets and contract liabilities are as follows:
Contract | Contract | Contract | |||||||
Assets | Liabilities - Current | Liabilities - Noncurrent | |||||||
(in millions) | |||||||||
Balance - January 1, 2021 | $ | — | $ | | $ | | |||
Change in period | — | | ( | ||||||
Balance - March 28, 2021 | $ | — | $ | | $ | | |||
Balance - January 1, 2020 | $ | | $ | | $ | | |||
Change in period | ( | | ( | ||||||
Balance - March 29, 2020 | $ | | $ | | $ | | |||
The amount of revenue recognized that was included in the opening contract liability balance was $
The Company incurs costs to obtain and fulfill a contract; however, the Company has elected to recognize all incremental costs to obtain a contract as an expense when incurred if the amortization period is one year or less. The Company has elected to treat shipping and handling activities performed after the customer has obtained control of the
11
related goods as a fulfillment cost and the related cost is accrued for in conjunction with the recording of revenue for the goods.
4. Goodwill & Intangibles
The Company operates in
March 28, 2021 | ||||||||||||||||||||||||
Gross Balance | Accumulated Impairment Losses | Net Goodwill | ||||||||||||||||||||||
Acquired | Foreign | |||||||||||||||||||||||
Balance | During | Currency | Balance | Balance | Impairment | Balance | ||||||||||||||||||
January 1, | the | Translation | March 28, | January 1, | Loss During | March 28, | March 28, | |||||||||||||||||
| 2021 |
| Period |
| and Other |
| 2021 |
| 2021 |
| the Period |
| 2021 |
| 2021 | |||||||||
(in millions) | ||||||||||||||||||||||||
Americas | $ | | — | $ | | $ | | $ | ( | — | $ | ( | $ | | ||||||||||
Europe |
| |
| — |
| ( |
| |
| ( |
| — |
| ( |
| | ||||||||
APMEA |
| |
| — |
| ( |
| |
| ( |
| — |
| ( |
| | ||||||||
Total | $ | | — | $ | ( | $ | | $ | ( | — | $ | ( | $ | | ||||||||||
December 31, 2020 | ||||||||||||||||||||||||
Gross Balance | Accumulated Impairment Losses | Net Goodwill | ||||||||||||||||||||||
Acquired | Foreign | |||||||||||||||||||||||
Balance | During | Currency | Balance | Balance | Impairment | Balance | ||||||||||||||||||
January 1, | the | Translation | December 31, | January 1, | Loss During | December 31, | December 31, | |||||||||||||||||
| 2020 |
| Period |
| and Other |
| 2020 |
| 2020 |
| the Period |
| 2020 |
| 2020 | |||||||||
(in millions) | ||||||||||||||||||||||||
Americas | $ | | $ | | $ | | $ | | $ | ( | $ | — | $ | ( | $ | | ||||||||
Europe |
| |
| — |
| |
| |
| ( |
| — |
| ( |
| | ||||||||
APMEA |
| |
| |
| |
| |
| ( |
| — |
| ( |
| | ||||||||
Total | $ | | $ | | $ | | $ | | $ | ( | $ | — | $ | ( | $ | | ||||||||
Goodwill and indefinite-lived intangible assets are tested for impairment at least annually or more frequently if events or circumstances indicate that it is “more likely than not” that they might be impaired, such as from a change in business conditions. The Company performs its annual goodwill and indefinite-lived intangible assets impairment assessment in the fourth quarter of each year. At the most recent annual impairment test which occurred in the fourth quarter of 2020, the Company performed qualitative fair value assessments, including an evaluation of certain key assumptions for all
Intangible assets include the following:
March 28, 2021 | December 31, 2020 | |||||||||||||||||
Gross | Net | Gross | Net | |||||||||||||||
Carrying | Accumulated | Carrying | Carrying | Accumulated | Carrying | |||||||||||||
| Amount |
| Amortization |
| Amount |
| Amount |
| Amortization |
| Amount | |||||||
(in millions) | ||||||||||||||||||
Patents | $ | | $ | ( | $ | | $ | | $ | ( | $ | | ||||||
Customer relationships |
| |
| ( |
| |
| |
| ( |
| | ||||||
Technology |
| |
| ( |
| |
| |
| ( |
| | ||||||
Trade names |
| |
| ( |
| |
| |
| ( |
| | ||||||
Other |
| |
| ( |
| |
| |
| ( |
| | ||||||
Total amortizable intangibles |
| |
| ( |
| |
| |
| ( |
| | ||||||
Indefinite-lived intangible assets |
| |
| — |
| |
| |
| — |
| | ||||||
$ | | $ | ( | $ | | $ | | $ | ( | $ | | |||||||
Aggregate amortization expense for amortized intangible assets for the first quarters ended March 28, 2021 and March 29, 2020 was $
12
5. Financial Instruments and Derivative Instruments
Fair Value
The carrying amounts of cash and cash equivalents, trade receivables and trade payables approximate fair value because of the short maturity of these financial instruments. The fair value of the Company’s borrowings under the Amended and Restated Credit Agreement entered into on April 24, 2020 (the “Amended Credit Agreement”) approximate their carrying value.
Financial Instruments
The Company measures certain financial assets and liabilities at fair value on a recurring basis, including deferred compensation plan assets and related liabilities, contingent consideration, and derivatives. The fair values of these financial assets and liabilities were determined using the following inputs at March 28, 2021 and December 31, 2020:
Fair Value Measurement at March 28, 2021 Using: | ||||||||||||
Quoted Prices in Active | Significant Other | Significant | ||||||||||
Markets for Identical | Observable | Unobservable | ||||||||||
Assets | Inputs | Inputs | ||||||||||
| Total |
| (Level 1) |
| (Level 2) |
| (Level 3) | |||||
(in millions) | ||||||||||||
Assets | ||||||||||||
Plan asset for deferred compensation(1) | $ | | $ | | $ | — | $ | — | ||||
Total assets | $ | | $ | | $ | — | $ | — | ||||
Liabilities | ||||||||||||
Plan liability for deferred compensation(2) | $ | | $ | | $ | $ | — | |||||
Designated foreign currency hedges (3) | $ | | $ | — | $ | | $ | — | ||||
Contingent consideration(4) | $ | | $ | — | $ | — | $ | | ||||
Total liabilities | $ | | $ | | $ | | $ | | ||||
Fair Value Measurements at December 31, 2020 Using: | ||||||||||||
Quoted Prices in Active | Significant Other | Significant | ||||||||||
Markets for Identical | Observable | Unobservable | ||||||||||
| Assets | Inputs | Inputs | |||||||||
Total |
| (Level 1) |
| (Level 2) |
| (Level 3) | ||||||
(in millions) | ||||||||||||
Assets | ||||||||||||
Plan asset for deferred compensation(1) | $ | | $ | | $ | — | $ | — | ||||
Total assets | $ | | $ | | $ | — | $ | — | ||||
Liabilities | ||||||||||||
Interest rate swaps(3) | $ | | — | | — | |||||||
Plan liability for deferred compensation(2) | $ | | $ | | $ | — | $ | — | ||||
Designated foreign currency hedge(3) | $ | | $ | — | $ | | $ | — | ||||
Contingent consideration(4) | $ | | $ | — | $ | — | $ | | ||||
Total liabilities | $ | | $ | | $ | | $ | | ||||
(1) | Included on the Company’s consolidated balance sheet in other assets (other, net). |
(2) | Included on the Company’s consolidated balance sheet in accrued compensation and benefits. |
(3)Included on the Company’s consolidated balance sheet in accrued expenses and other liabilities.
(4)Included on the Company’s consolidated balance sheet in other noncurrent liabilities and relates to contingent consideration as part of the acquisition of Australian Valve Group Pty Ltd (“AVG”).
13
The table below provides a summary of the changes in fair value of all financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the period December 31, 2020 to March 28, 2021.
Total realized and unrealized | ||||||||||||||||||
Balance | (gains) losses included in: | Balance | ||||||||||||||||
December 31, | Net earnings | Comprehensive | March 28, | |||||||||||||||
| 2020 |
| Settlements |
| Purchases |
| adjustments |
| income |
| 2021 | |||||||
(in millions) | ||||||||||||||||||
Contingent consideration | $ | | — | $ | — | — | $ | ( | $ | | ||||||||
In connection with the immaterial acquisition of AVG completed during the third quarter of 2020, a contingent liability of $
Cash equivalents consist of instruments with remaining maturities of three months or less at the date of purchase and consist primarily of money market funds, for which the carrying amount is a reasonable estimate of fair value.
The Company uses financial instruments from time to time to enhance its ability to manage risk, including foreign currency and commodity pricing exposures, which exist as part of its ongoing business operations. The use of derivatives exposes the Company to counterparty credit risk for nonperformance and to market risk related to changes in currency exchange rates and commodity prices. The Company manages its exposure to counterparty credit risk through diversification of counterparties. The Company’s counterparties in derivative transactions are substantial commercial banks with significant experience using such derivative instruments. The impact of market risk on the fair value and cash flows of the Company’s derivative instruments is monitored and the Company restricts the use of derivative financial instruments to hedging activities. The Company does not enter into contracts for trading purposes nor does the Company enter into any contracts for speculative purposes. The use of derivative instruments is approved by senior management under written guidelines.
Interest Rate Swaps
On February 12, 2016, the Company entered into a Credit Agreement (the “Prior Credit Agreement”) pursuant to which it received a funding commitment under a Term Loan of $
14
On March 30, 2021, the Company entered into the Second Amended and Restated Credit Agreement (the “Second Amended Credit Agreement”). The Second Amended Credit Agreement amends the Amended Credit Agreement to extend the maturity date of the $
In order to manage the Company’s exposure to changes in cash flows attributable to fluctuations in LIBOR-indexed interest payments related to the Company’s floating rate debt, the Company entered into an interest rate swap on March 30, 2021. Under the interest rate swap agreement, the Company receives the one-month USD-LIBOR subject to a
Designated Foreign Currency Hedges
The Company’s foreign subsidiaries transact most business, including certain intercompany transactions, in foreign currencies. Such transactions are principally purchases or sales of materials. The Company has exposure to a number of foreign currencies, including the Canadian dollar, the euro, and the Chinese yuan. The Company uses a layering methodology, whereby at the end of each quarter, the Company enters into forward exchange contracts hedging Canadian dollar to U.S. dollar, which hedge approximately
The notional amounts outstanding as of March 28, 2021 for the Canadian dollar to U.S. dollar contracts and the U.S. dollar to the Chinese yuan contracts were $
15
6. Earnings per Share and Stock Repurchase Program
The following tables set forth the reconciliation of the calculation of earnings per share:
For the First Quarter Ended March 28, 2021 | For the First Quarter Ended March 29, 2020 |
| |||||||||||||||
Income | Shares | Per Share | Income | Shares | Per Share | ||||||||||||
| (Numerator) |
| (Denominator) |
| Amount |
| (Numerator) |
| (Denominator) |
| Amount |
| |||||
(Amounts in millions, except per share information) |
| ||||||||||||||||
Basic EPS: | |||||||||||||||||
Net income | $ | | | $ | | $ | | | $ | | |||||||
Effect of dilutive securities: | |||||||||||||||||
Common stock equivalents | | — |
| | — | ||||||||||||
Diluted EPS: | |||||||||||||||||
Net income | $ | | | $ | | $ | |
| | $ | | ||||||
There were
On February 6, 2019, the Company’s Board of Directors authorized the repurchase of up to $
The following tables summarize the cost and the number of shares of Class A common stock repurchased under the repurchase program during the first quarters ended March 28, 2021 and March 29, 2020:
For the First Quarter Ended | For the First Quarter Ended | |||||||||
March 28, 2021 | March 29, 2020 | |||||||||
Number of shares | Cost of shares | Number of shares | Cost of shares | |||||||
| repurchased |
| repurchased |
| repurchased |
| repurchased | |||
(Amounts in millions, except share amount) | ||||||||||
Stock repurchase programs: | ||||||||||
$ | | $ | | | $ | | ||||
Total stock repurchased during the period: |
| | $ | |
| | $ | | ||
7. Stock-Based Compensation
The Company issued
The Company also grants performance stock units to key employees under the 2004 Stock Incentive Plan. Performance stock units vest in their entirety at the end of a performance period set by the Compensation Committee of the Board of Directors at the time of grant, which is currently
Under the Management Stock Purchase Plan (“MSPP”), the Company granted
16
key employees. On an annual basis, key employees may elect to receive a portion of their annual incentive compensation in RSUs instead of cash. Participating employees may use up to
The fair value of each share issued under the Management Stock Purchase Plan is estimated on the date of grant, using the Black-Scholes-Merton Model, based on the following weighted average assumptions:
| 2021 |
| 2020 |
| |
Expected life (years) | |||||
Expected stock price volatility |
| | % | | % |
Expected dividend yield |
| | % | | % |
Risk-free interest rate |
| | % | | % |
The risk-free interest rate is based upon the U.S. Treasury yield curve at the time of grant for the respective expected life of the RSUs. The expected life (estimated period of time outstanding) of RSUs and volatility were calculated using historical data. The expected dividend yield of stock is the Company’s best estimate of the expected future dividend yield.
The above assumptions were used to determine the weighted average grant-date fair value of the discount on RSUs granted in 2021 and 2020 of $
A more detailed description of each of these plans can be found in Note 13 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
8. Segment Information
The Company operates in
17
The following is a summary of the Company’s significant accounts and balances by segment, reconciled to its consolidated totals:
First Quarter Ended | ||||||
March 28, | March 29, | |||||
| 2021 |
| 2020 | |||
(in millions) | ||||||
Net sales |
|
| ||||
Americas | $ | | $ | | ||
Europe |
| |
| | ||
APMEA |
| |
| | ||
Consolidated net sales | $ | | $ | | ||
Operating income (loss) | ||||||
Americas | $ | | $ | | ||
Europe |
| |
| | ||
APMEA |
| |
| ( | ||
Subtotal reportable segments |
| |
| | ||
Corporate(*) |
| ( |
| ( | ||
Consolidated operating income |
| |
| | ||
Interest income |
| — |
| ( | ||
Interest expense |
| |
| | ||
Other expense (income), net |
| ( |
| | ||
Income before income taxes | $ | | $ | | ||
Capital expenditures | ||||||
Americas | $ | | $ | | ||
Europe |
| |
| | ||
APMEA |
| — |
| | ||
Consolidated capital expenditures | $ | | $ | | ||
Depreciation and amortization | ||||||
Americas | $ | | $ | | ||
Europe |
| |
| | ||
APMEA |
| |
| | ||
Consolidated depreciation and amortization | $ | | $ | | ||
Identifiable assets (at end of period) | ||||||
Americas | $ | | $ | | ||
Europe |
| |
| | ||
APMEA |
| |
| | ||
Consolidated identifiable assets | $ | | $ | | ||
Property, plant and equipment, net (at end of period) | ||||||
Americas | $ | | $ | | ||
Europe |
| |
| | ||
APMEA |
| |
| | ||
Consolidated property, plant and equipment, net | $ | | $ | | ||
* Corporate expenses are primarily for administrative compensation expense, compliance costs, professional fees, including corporate-related legal and audit expenses, shareholder services and benefit administration costs.
The above operating segments are presented on a basis consistent with the presentation included in the Company’s December 31, 2020 consolidated financial statements included in its Annual Report on Form 10-K.
The U.S. property, plant and equipment of the Company’s Americas segment was $
18
The following includes U.S. net sales of the Company’s Americas segment (in millions):
First Quarter Ended | ||||||
March 28, | March 29, | |||||
| 2021 |
| 2020 | |||
U.S. net sales | $ | | $ | | ||
The following includes intersegment sales for Americas, Europe and APMEA (in millions):
First Quarter Ended | ||||||
March 28, | March 29, | |||||
| 2021 |
| 2020 | |||
Intersegment Sales |
|
| ||||
Americas | $ | | $ | | ||
Europe |
| |
| | ||
APMEA |
| |
| | ||
Intersegment sales | $ | | $ | | ||
9. Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss consists of the following:
|
|
| Accumulated | ||||||
Foreign | Other | ||||||||
Currency | Cash Flow | Comprehensive | |||||||
| Translation |
| Hedges (1) |
| Loss | ||||
(in millions) | |||||||||
Balance December 31, 2020 | $ | ( | $ | ( | $ | ( | |||
Change in period |
| ( |
| ( |
| ( | |||
Balance March 28, 2021 | $ | ( | $ | ( | $ | ( | |||
Balance December 31, 2019 | $ | ( | $ | | $ | ( | |||
Change in period |
| ( |
| ( |
| ( | |||
Balance March 29, 2020 | $ | ( | $ | ( | $ | ( | |||
| (1) | Cash flow hedges include interest rate swaps and designated foreign currency hedges. See Note 5 for further details. |
10. Debt
In February 2016, the Company entered into the Prior Credit Agreement. The Prior Credit Agreement provided for a $
On April 24, 2020, the Company entered into the Amended Credit Agreement. The Amended Credit Agreement amended and restated the Prior Credit Agreement in its entirety while increasing the amount of revolving credit available from $
19
such day plus
In addition to paying interest under the Amended Credit Agreement, the Company is also required to pay certain fees in connection with the Revolving Credit Facility, including, but not limited to, an unused facility fee and letter of credit fees.
On March 30, 2021, at the beginning of the second quarter of 2021, the Company entered into the Second Amended Credit Agreement. The Second Amended Credit Agreement amends the Amended Credit Agreement to extend the maturity date of the $
The senior unsecured revolving credit facility under the Second Amended Credit Agreement (the “New Revolving Credit Facility”) also includes sublimits of $
In addition to paying interest under the Second Amended Credit Agreement, the Company is also required to pay certain fees in connection with the New Revolving Credit Facility, including, but not limited to, an unused facility fee and letter of credit fees.
The Second Amended Credit Agreement matures on March 30, 2026, subject to extension under certain circumstances and subject to the terms of the Second Amended Credit Agreement. The Company may repay loans outstanding under the Second Amended Credit Agreement from time to time without premium or penalty, other than customary breakage costs, if any, and subject to the terms of the Second Amended Credit Agreement.
Both the Amended Credit Agreement and the Second Amended Credit Agreement impose various restrictions on the Company and its subsidiaries, including restrictions pertaining to: (i) the incurrence of additional indebtedness, (ii) limitations on liens, (iii) making distributions, dividends and other payments, (iv) mergers, consolidations and acquisitions, (v) dispositions of assets, (vi) certain consolidated leverage ratios and consolidated interest coverage ratios, (vii) transactions with affiliates, (viii) changes to governing documents, and (ix) changes in control.
The Company maintains letters of credit that guarantee its performance or payment to third parties in accordance with specified terms and conditions. Amounts outstanding were $
11. Contingencies and Environmental Remediation
In the ordinary course of business, the Company is involved in disputes, litigation, and governmental or regulatory inquiries and investigations, both pending and threatened, including those involving product liability, environmental matters, and commercial disputes.
20
Other than the items described below, significant commitments and contingencies at March 28, 2021 are consistent with those discussed in Note 15 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
As of March 28, 2021, the Company estimates that the aggregate amount of reasonably possible loss in excess of the amount accrued for its contingencies is approximately $
Chemetco, Inc. Superfund Site, Hartford, Illinois
In August 2017, Watts Regulator Co. (a wholly-owned subsidiary of the Company) received a “Notice of Environmental Liability” from the Chemetco Site Group (“Group”) alleging that it is a potentially responsible party for the Chemetco, Inc. Superfund Site in Hartford, Illinois (the “Site”) because it arranged for the disposal or treatment of hazardous substances that were contained in materials sent to the Site and that resulted in the release or threat of release of hazardous substances at the Site. The letter offered Watts Regulator Co. the opportunity to join the Group and participate in the Remedial Investigation and Feasibility Study (“RI/FS”) for a portion of the Site. Watts Regulator Co. joined the Group in September 2017 and was added in March 2018 as a signatory to the Administrative Settlement Agreement and Order on Consent with the United States Environmental Protection Agency (“USEPA”) governing completion of the RI/FS. The Remedial Investigation report has been completed, and the draft Feasibility Study report is due to be submitted to U.S. Environmental Protection Agency (USEPA) near the end of May, 2021. Based on information currently known to it, management believes that Watts Regulator Co.’s share of the costs of the RI/FS is not likely to have a material adverse effect on the financial condition of the Company, or have a material adverse effect on the Company’s operating results for any particular period. The Company is unable to estimate a range of reasonably possible loss for the above matter in which damages have not been specified because: (i) the RI/FS for the first portion of the Site has not been completed, and the RI/FS process for the remainder of the Site has not yet been initiated, to determine what remediation plans will be implemented and the costs of such plans; (ii) the total amount of material sent to the Site, and the total number of potentially responsible parties who may or may not agree to fund or perform any remediation, have not been determined; (iii) the share contribution for potentially responsible parties to any remediation has not been determined; and (iv) the number of years required to implement a remediation plan acceptable to USEPA is uncertain.
Income Taxes
In determining our provision for income taxes, we make certain judgments and interpretations with respect to tax laws in jurisdictions in which we have business operations. Because of the complex nature of these laws, in the normal course of our business, we are subject to challenges from U.S. and non-U.S. income tax authorities regarding the amount of income taxes due. These challenges may result in adjustments to the timing or amount of taxable income or deductions or the allocation of taxable income among tax jurisdictions. We recognize a tax benefit when it is more likely than not that our position will result in a tax deduction or credit. As of March 28, 2021, the Company had gross unrecognized tax benefits of approximately $
21
12. Subsequent Events
On May 3, 2021, the Company declared a quarterly dividend of
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following discussion and analysis are provided to increase the understanding of, and should be read in conjunction with, the accompanying unaudited consolidated financial statements and related 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 are a leading supplier of products, solutions and systems that manage and conserve the flow of fluids and energy into, through and out of buildings in the commercial and residential markets in the Americas, Europe and Asia-Pacific, Middle East and Africa (“APMEA”). For over 140 years, we have designed and produced valve systems that safeguard and regulate water systems, energy efficient heating and hydronic systems, drainage systems and water filtration technology that helps purify and conserve water. We earn revenue and income almost exclusively from the sale of our products. Our principal product lines include:
● 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, thermostatic mixing valves and leak detection products.
● HVAC & gas products—includes commercial high-efficiency boilers, water heaters and heating solutions, hydronic and electric heating systems for under-floor radiant applications, custom heat and hot water solutions, 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.
● Drainage & 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 commercial, marine and residential applications.
We believe that the factors relating to our future growth include continued product innovation that meets the needs of our customers and our end markets; our ability to continue to make selective acquisitions, both in our core markets as well as in complementary markets; regulatory requirements relating to the quality and conservation of water and the safe use of water; increased demand for clean water; and continued enforcement of plumbing and building codes. We have completed 11 acquisitions in the last decade. Our acquisition strategy focuses on businesses that promote our key macro themes around safety and regulation, energy efficiency and water conservation. We target businesses that will provide us with one or more of the following: an entry into new markets and/or new geographies, improved channel access, unique and/or proprietary technologies, advanced production capabilities or complementary solution offerings.
Our innovation strategy is focused on differentiated products and solutions that will provide greater opportunity to distinguish ourselves in the marketplace. Conversely, we continue to migrate away from commoditized products where we cannot add value. Our goal is to be a solutions provider, not merely a components supplier. We continually look for strategic opportunities to invest in new products and markets or divest existing product lines where necessary in order to meet those objectives.
The Internet of Things has allowed companies to transform components into smart and connected devices. Over the past several years we have been building our smart and connected foundation by expanding our internal capabilities and making strategic acquisitions. Our strategy is to deliver superior customer value through smart and connected products and solutions. This strategy focuses on three dimensions: Connect, Control and Conserve. We intend to introduce
22
products that will connect our customers with smart systems, control systems for optimal performance, and conserve critical resources by increasing operability, efficiency and safety.
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. 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 product development, product testing capability and investment in plant and equipment needed to manufacture products in compliance with code requirements, represent a competitive advantage for us.
COVID-19 Pandemic
The COVID-19 pandemic materially impacted our operating results in 2020. The impact was most pronounced during the second quarter of 2020 when the World Health Organization declared COVID-19 a global pandemic and government authorities around the world imposed lockdowns and restrictions. However, as the second half of 2020 progressed and government-imposed restrictions subsided, we noted market activity levels increasing with sales and profits improving sequentially from the second to fourth quarters. Profits improved in part from better volumes and in part from the cost actions we executed in response to the pandemic. Entering 2021, first quarter results continued that trend of improved top line growth and profit performance. However, there are still end markets we serve that may take time to recover and future regional COVID-19 outbreaks and lockdowns may occur that could further impact our operating results.
We remain diligent as a company to mitigate future outbreaks in our facilities by taking precautions to reduce the spread of COVID-19 while maintaining our production capabilities. We continue to focus on the health and safety of our employees, including ongoing social distancing guidelines and temperature monitoring, providing personal protective equipment, maintaining our COVID-19 website for employees, which includes the latest CDC and other government protocols, and continuing to promote work-from-home where practical.
Further, we believe the actions we have taken over the last several years to strengthen our portfolio and increase customer intimacy, along with aggressively paying down debt, have put us in a strong financial position. We maintain ample liquidity to work through these uncertain times, including the refinancing of our credit facility noted below, and we expect to continue to invest for the future. Our experienced management team is proactively managing this situation, and we are well positioned to continue to respond to challenges presented by the COVID-19 pandemic as they arise.
Our revenues improved in all three segments for the first quarter of 2021 as compared to the first quarter of 2020. Americas’ sales grew in part due to increased demand associated with severe freezing weather in the South-Central United States in the first quarter of 2021. APMEA sales were higher in the first quarter of 2021 relative to the first quarter of 2020 due to the early impact of COVID-19 in China during the first quarter of 2020. Europe’s growth was led by strength in our plumbing products. The exact timing and pace of the recovery remain uncertain. Future sales expansion or contraction is dependent on the duration and severity of the COVID-19 pandemic. Factors include the construction lending markets, investments and capital spending in building services construction markets, supply chain disruptions, additional governmental actions that may or may not be taken, and numerous other uncertainties, including the timing of the rollout of effective COVID-19 vaccines and reaching effective vaccine adoption rates.
Of particular concern is the impact that the recovering economy is having on our supply chain. As economies begin to recover from the pandemic, increased market demand is straining suppliers’ ability to fill orders. This has been compounded by further logistical issues with respect to container capacity on ships, port congestion and in-road trucking. Additional strain has stemmed from the increased demand following the South-Central severe weather freezing in the United States. Our most immediate concern has been the worldwide shortage of electronic components like semiconductors, but our supply chain is being challenged in other areas as well. We are also experiencing higher transportation costs, including expedited freight cost, as well as rising prices for commodities and other raw materials. While we were able to effectively manage these issues during the first quarter, we cannot predict how supply chain issues and related costs may impact our ability to service our customers and impact our profit margins, especially in the latter half of 2021.
Due to the above circumstances and as described generally in this Form 10-Q, the Company’s results of operations for the first quarter ended March 28, 2021 are not necessarily indicative of the results to be expected for the full fiscal year.
23
Management cannot predict the full impact of the COVID-19 pandemic on the Company’s sales, supply chain, manufacturing and distribution or on economic conditions generally, including the effects on customer spending. The extent of the effects of the COVID-19 pandemic on the Company remains uncertain and will depend on future developments, and such effects could exist for an extended period of time even after the pandemic ends. For further information regarding the impact of COVID-19 on the Company, see Part I, Item 1A, “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
Financial Overview
First quarter 2021 sales increased 8%, or $30.7 million, on a reported basis and 3.7%, or $14.1 million, on an organic basis, compared to the first quarter of 2020, primarily due to increased demand across all of our operating segments. This increase included additional sales attributable to the severe freezing weather in the South-Central United States estimated to be 3% of incremental sales in the first quarter of 2021. APMEA sales were higher in the first quarter of 2021 relative to the first quarter of 2020 as the APMEA region was negatively impacted by COVID-19 in the first quarter of 2020. The reported sales increase included the impact of foreign exchange of 3.4%, or $12.8 million, primarily driven by a stronger euro, and a net increase in acquired/divested sales of $3.8 million. Organic sales is a non-GAAP financial measure that excludes the impacts of acquisitions, divestitures and foreign exchange from year-over-year comparisons. Management believes reporting organic sales growth provides useful information to investors, potential investors and others, because it allows for additional insight into underlying sales trends by providing sales growth on a consistent basis. We reconcile the change in organic sales to our reported sales for each region within our results below. Operating income of $59.6 million increased by $11.8 million, or 24.7%, in the first quarter of 2021 as compared to the first quarter of 2020. This increase was primarily driven by higher sales volume, price, productivity and cost actions, partially offset by inflation and investments.
Recent Developments
On May 3, 2021, we declared a quarterly dividend of twenty-six cents ($0.26) per share on each outstanding share of Class A common stock and Class B common stock payable on June 15, 2021 to stockholders of record on June 1, 2021.
On March 30, 2021, we entered into a Second Amended and Restated Credit Agreement by and among the Company, certain subsidiaries of the Company, the lenders and other parties from time to time party thereto and JPMorgan Chase Bank, N.A., as administrative agent (the “Second Amended Credit Agreement”). The Second Amended Credit Agreement amends and restates the Amended Credit Agreement, extending the maturity date of the $800 million senior unsecured revolving credit facility from February 12, 2022 to March 30, 2026. Among other changes, the Second Amended Credit Agreement also increases the Company’s maximum consolidated leverage ratio (including both the base ratio and the ratio permitted during temporary step-ups following certain acquisitions), adjusts certain fees to reflect market conditions and reduces the 1.00% floor on the adjusted LIBOR rate to 0.00%. The senior unsecured revolving credit facility under the Second Amended Credit Agreement (the " New Revolving Credit Facility") also includes sublimits of $100 million for letters of credit and $15 million for swing line loans.
Results of Operations
First Quarter Ended March 28, 2021 Compared to First Quarter Ended March 29, 2020
Net Sales. Our business is reported in three geographic segments: Americas, Europe and APMEA. Our net sales in each of these segments for each of the first quarters of 2021 and 2020 were as follows:
First Quarter Ended | First Quarter Ended | % Change to |
| |||||||||||||
March 28, 2021 | March 29, 2020 | Consolidated |
| |||||||||||||
| Net Sales |
| % Sales |
| Net Sales |
| % Sales |
| Change |
| Net Sales |
| ||||
(dollars in millions) |
| |||||||||||||||
Americas | $ | 272.8 | 66.0 | % | $ | 262.4 | 68.6 | % | $ | 10.4 | 2.7 | % | ||||
Europe |
| 122.9 |
| 29.7 |
| 110.2 |
| 28.8 |
| 12.7 |
| 3.3 | ||||
APMEA |
| 17.6 |
| 4.3 |
| 10.0 |
| 2.6 |
| 7.6 |
| 2.0 | ||||
Total | $ | 413.3 |
| 100.0 | % | $ | 382.6 |
| 100.0 | % | $ | 30.7 |
| 8.0 | % | |
24
The change in net sales was attributable to the following:
Change As a % | Change As a % |
| |||||||||||||||||||||||||||||||||||||||||
of Consolidated Net Sales | of Segment Net Sales |
| |||||||||||||||||||||||||||||||||||||||||
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Americas | Europe | APMEA | Total | Americas | Europe | APMEA | Total | Americas | Europe | APMEA |
| ||||||||||||||||||||||||||||||||
(dollars in millions) |
| ||||||||||||||||||||||||||||||||||||||||||
Organic | $ | 8.1 | $ | 1.9 | $ | 4.1 |
| $ | 14.1 |
| 2.1 | % | 0.5 | % | 1.1 | % | 3.7 | % | 3.1 | % | 1.7 | % | 43.2 | % | |||||||||||||||||||
Foreign exchange |
| 1.0 |
| 10.8 |
| 1.0 |
| 12.8 |
| 0.3 |
| 2.8 |
| 0.3 |
| 3.4 |
| 0.4 |
| 9.8 |
| 10.0 | |||||||||||||||||||||
Acquired/divested, net |
| 1.3 |
| — |
| 2.5 |
| 3.8 |
| 0.3 |
| — |
| 0.6 |
| 0.9 |
| 0.5 |
| — |
| 22.8 | |||||||||||||||||||||
Total | $ | 10.4 | $ | 12.7 | $ | 7.6 | $ | 30.7 |
| 2.7 | % | 3.3 | % | 2.0 | % | 8.0 | % | 4.0 | % | 11.5 | % | 76.0 | % | ||||||||||||||||||||
Our products are sold to wholesalers, OEMs, DIY chains, and through various specialty channels. The change in organic net sales by channel was attributable to the following:
Change As a % |
| |||||||||||||||||||||||
of Prior Year Sales |
| |||||||||||||||||||||||
| Wholesale |
| OEMs |
| DIY |
| Specialty |
| Total |
| Wholesale |
| OEMs |
| DIY | Specialty |
| |||||||
| (dollars in millions) | |||||||||||||||||||||||
Americas | $ | 9.1 | $ | 1.0 | $ | 3.6 | $ | (5.6) | $ | 8.1 |
| 6.2 | % | 5.1 | % | 20.9 | % | (7.2) | % | |||||
Europe |
| (1.3) |
| 3.0 |
| 0.2 | — |
| 1.9 |
| (1.7) |
| 8.6 | 37.4 | — | |||||||||
APMEA |
| 4.0 |
| 0.1 |
| — | — |
| 4.1 |
| 43.6 |
| 56.9 |
| — | — | ||||||||
Total | $ | 11.8 | $ | 4.1 | $ | 3.8 | $ | (5.6) | $ | 14.1 | ||||||||||||||
Organic net sales in the Americas increased primarily due to higher volume and price in the majority of our channels, partially offset by a decline in our specialty channel. Our wholesale and DIY channels were positively impacted from the severe weather freeze in the South-Central United States, which was estimated to be 4% of incremental sales for the region in the first quarter of 2021. The decrease within our specialty channel primarily relates to our heating and hot water and water quality products.
Organic net sales in Europe increased primarily due to higher volume in our OEM channel with strength in our HVAC products. Our wholesale channel experienced continued softness in our drains products, which were partially offset by higher volumes in our plumbing products.
Organic net sales in APMEA increased primarily due to higher volumes as the prior year was negatively impacted by the COVID-19 pandemic. The current quarter volume increase is primarily related to higher commercial valves sales in China.
The net increase in sales due to foreign exchange was primarily due to the appreciation of the euro against the U.S. dollar in the first quarter of 2021. 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.
The change in net sales due to acquired/divested relates to two immaterial acquisitions, one in the APMEA segment in the third quarter of 2020, and one in the Americas segment in the fourth quarter of 2020, partially offset by an immaterial divestiture in our APMEA segment during the third quarter of 2020.
Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for the first quarters of 2021 and 2020 were as follows:
First Quarter Ended |
| ||||||
March 28, 2021 | March 29, 2020 | ||||||
(dollars in millions) |
| ||||||
Gross profit | $ | 173.7 | $ | 162.8 | |||
Gross margin |
| 42.0 | % |
| 42.6 | % | |
25
Gross profit increased primarily from higher sales volume, while gross margin declined primarily due to product mix, higher freight costs to expedite components and product, and general inflation which more than offset benefits from productivity initiatives and cost reduction actions implemented in response to the COVID-19 pandemic.
Selling, General and Administrative Expenses. Selling, general and administrative, or SG&A, expenses decreased $1.2 million, or 1.0%, in the first quarter of 2021 compared to the first quarter of 2020. The decrease in SG&A expenses was attributable to the following:
| (in millions) |
| % Change |
| ||
Organic | $ | (5.7) |
| (5.0) | % | |
Foreign exchange |
| 3.0 |
| 2.6 | ||
Acquired/divested, net | 1.5 | 1.4 | ||||
Total | $ | (1.2) |
| (1.0) | % | |
The organic decrease related to cost reduction actions taken in response to the COVID-19 pandemic of $5.9 million, restructuring savings of $3.8 million, decreased stock compensation expense of $0.8 million, and a decrease in SG&A of $2.4 million due to productivity initiatives. These decreases were partially offset by increased variable costs due to the higher sales volume of $1.3 million, an increase in compensation related accruals of $2.9 million, an increase in investments of $2.1 million, including new products, commercial excellence, and technology, as well as general inflation of $1.3 million compared to the first quarter of 2020. The increase in foreign exchange was mainly due to the appreciation of the euro against the U.S. dollar. The acquired/divested, net SG&A costs related to two immaterial acquisitions, one in the APMEA segment in the third quarter of 2020, and one in the Americas segment in the fourth quarter of 2020, partially offset by SG&A costs related to an immaterial divestiture in our APMEA segment. Total SG&A expenses, as a percentage of sales, were 27.5% in the first quarter of 2021 compared to 30.1% in the first quarter of 2020.
Restructuring. In the first quarter of 2021, we recorded a net charge of $0.3 million primarily for accelerated depreciation related to ongoing programs initiated in the second and third quarter of 2020 in response to the economic challenges from the COVID-19 pandemic. For a more detailed description of our current restructuring plans, see Note 3 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
Operating Income. Operating income (loss) by segment for the first quarters of 2021 and 2020 was as follows:
% Change to |
| |||||||||||
|
|
| Consolidated |
| ||||||||
First Quarter Ended | Operating |
| ||||||||||
March 28, | March 29, | |||||||||||
2021 | 2020 | Change | Income | |||||||||
| (dollars in millions) | |||||||||||
Americas | $ | 48.5 | $ | 43.4 | $ | 5.1 |
| 10.7 | % | |||
Europe |
| 19.5 |
| 13.7 |
| 5.8 |
| 12.1 | ||||
APMEA |
| 2.3 |
| (0.1) |
| 2.4 |
| 5.0 | ||||
Corporate |
| (10.7) |
| (9.2) |
| (1.5) |
| (3.1) | ||||
Total | $ | 59.6 | $ | 47.8 | $ | 11.8 |
| 24.7 | % | |||
The increase (decrease) in operating income (loss) was attributable to the following:
Change As a % of | Change As a % of |
| ||||||||||||||||||||||||||||||||
Consolidated Operating Income | Segment Operating Income |
| ||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Americas | Europe | APMEA | Corporate | Total | Americas | Europe | APMEA | Corporate | Total | Americas | Europe | APMEA | Corporate |
| ||||||||||||||||||||
(dollars in millions) |
| |||||||||||||||||||||||||||||||||
Organic | $ | 4.9 | $ | 4.1 | $ | 1.9 | $ | (1.5) | $ | 9.4 | 10.3 | % | 8.5 | % | 3.9 | % | (3.1) | % | 19.6 | % | 11.3 | % | 29.8 | % | 1,781.3 | % | (16.3) | % | ||||||
Foreign exchange | 0.1 | 1.7 | 0.3 | — | 2.1 | 0.3 | 3.5 | 0.5 | — | 4.4 | 0.4 | 12.4 | 246.6 | — |
| |||||||||||||||||||
Acquired/divested, net | 0.1 | — | 0.5 | — | 0.6 | 0.2 | — | 1.1 | — | 1.3 | 0.2 | — | 509.3 | — |
| |||||||||||||||||||
Restructuring, impairment charges |
| — |
| — |
| (0.3) |
| — |
| (0.3) |
| — |
| — |
| (0.6) |
| — |
| (0.6) |
| — |
| — |
| (248.5) |
| — | ||||||
Total | $ | 5.1 | $ | 5.8 | $ | 2.4 | $ | (1.5) | $ | 11.8 |
| 10.8 | % | 12.1 | % | 5.0 | % | (3.1) | % | 24.7 | % | 11.9 | % | 42.1 | % | 2,288.7 | % | (16.3) | % | |||||
The increase in organic operating income was due to higher sales volumes, price, benefits from productivity initiatives, and from cost reduction actions in response to the COVID-19 pandemic. These increases were partially offset by higher freight, general inflation, compensation accruals and investments.
26
Interest Expense. Interest expense in the first quarter of 2021 decreased $1.0 million, or 33.3%, compared to the first quarter of 2020 due to a decline in interest rates as well as reduction in the principal balance of debt outstanding in the first quarter of 2021 compared to the first quarter of 2020. Refer to Note 11 of the Notes to Consolidated Financial Statements for further details.
Other (income) expense, net. Other (income) expense increased $0.6 million to an income balance of $0.3 million compared to the first quarter of 2020. The increase was primarily due to higher net foreign currency gains.
Income Taxes. Our effective income tax rate decreased to 28.0% in the first quarter of 2021, from 28.3% in the first quarter of 2020. The lower rate is primarily related to the impact of changes in the worldwide earnings mix.
Net Income. Net income was $41.7 million, or $1.23 per common share on a diluted basis, for the first quarter of 2021, compared to $32.0 million, or $0.94 per common share on a diluted basis, for the first quarter of 2020. Results for the first quarter of 2021 include an after-tax charge of $0.3 million, or $0.01 per common share, for restructuring.
Results for the first quarter of 2020 include an after-tax charge of $0.3 million, or $0.01 per common share, for footprint optimization.
Liquidity and Capital Resources
We generated $33.9 million of net cash from operating activities in the first quarter of 2021 as compared to $0.9 million of net cash used in operating activities in the first quarter of 2020. The increase in cash was primarily related to improved working capital management and higher net income.
We used $2.0 million of net cash for investing activities in the first quarter of 2021 compared to $7.5 million used in the first quarter of 2020. We used $4.0 million less cash for capital expenditures in the first quarter of 2021 compared to the first quarter of 2020. We received $2.9 million in cash proceeds from the sale of property, plant and equipment and the sale of assets in the first quarter of 2021. For the remainder of 2021, we expect to invest approximately $30 million to $35 million in capital equipment as part of our ongoing commitment to improve our operating capabilities.
We used $21.2 million of net cash in financing activities in the first quarter of 2021 primarily due to dividend payments of $7.8 million, tax withholding payments on vested stock awards of $9.2 million, and payments of $3.8 million to repurchase approximately 31,000 shares of Class A common stock. In the first quarter of 2020, we generated $39.1 million of net cash from financing activities, primarily through proceeds from drawdowns on our Revolving Credit Facility.
In February 2016, we and certain of our subsidiaries entered into a Credit Agreement (the “Prior Credit Agreement”) with JPMorgan Chase Bank, N.A., as Administrative Agent, Swing Line Lender and Letter of Credit Issuer, and the other lenders referred to therein. The Prior Credit Agreement provided for a $500 million, five-year, senior unsecured revolving credit facility (the “Prior Revolving Credit Facility”) with a sublimit of up to $100 million in letters of credit. The Prior Credit Agreement also provided for a $300 million, five-year, term loan facility (the “Term Loan Facility”) available to us in a single draw, of which the entire $300 million had been drawn in February 2016.
On April 24, 2020, we and certain of our subsidiaries entered into an Amended and Restated Credit Agreement (the "Amended Credit Agreement") with JPMorgan Chase Bank, N.A., as Administrative Agent, Swing Line Lender and Letter of Credit Issuer, and the other lenders referred to therein. The Amended Credit Agreement amended and restated the Prior Credit Agreement in its entirety while increasing the amount of revolving credit available from $500 million to $800 million and extending the maturity by one additional year to February 2022. The senior unsecured revolving credit facility (the "Revolving Credit Facility") also included sublimits of $100 million for letters of credit and $15 million for swing line loans. As of March 28, 2021, we had drawn down $200.0 million on this line of credit and had $13.9 million in letters of credit outstanding, which resulted in $586.1 million of unused and available credit under the Revolving Credit Facility. The term loan facility under the Prior Credit Agreement was terminated and paid off effective April 24, 2020, with funds from the Revolving Credit Facility. Borrowings outstanding under the Revolving Credit Facility bear interest at a fluctuating rate per annum equal to an applicable percentage defined as (i) in the case of Eurocurrency rate loans, the adjusted British Bankers Association LIBOR rate (which at all times will not be less than 1.00%) plus an applicable percentage, ranging from 1.50% to 2.10%, determined by reference to the Company's consolidated leverage
27
ratio, or (ii) in the case of alternate base rate loans and swing line loans, interest (which at all times will not be less than 2.00%) at the greatest of (a) the Prime Rate in effect on such day, (b) the FRBNY Rate in effect on such day plus 0.5% and (c) the adjusted LIBOR rate plus 1.0% for a one month interest period in dollars. The interest rate as of March 28, 2021 on the Revolving Credit Facility was 2.5%. As of March 28, 2021, we were in compliance with all covenants related to the Amended Credit Agreement.
On March 30, 2021, we and certain of our subsidiaries entered into a Second Amended and Restated Credit Agreement (the “Second Amended Credit Agreement”) with JPMorgan Chase Bank, N.A., as administrative agent. The Second Amended Credit Agreement amends and restates the Amended Credit Agreement to extend the maturity date of the $800 million senior unsecured revolving credit facility from February 12, 2022 to March 30, 2026. Our Netherlands subsidiary, WWT International Holding B.V., has been added as a borrower under the Second Amended Credit Agreement in the place of Watts EMEA Holding B.V., which had been a borrower under the Amended Credit Agreement. Among other changes, the Second Amended Credit Agreement also increases our maximum consolidated leverage ratio (including both the base ratio and the ratio permitted during temporary step-ups following certain acquisitions), adjusts certain fees to reflect market conditions and reduces the 1.00% floor on the adjusted LIBOR rate to 0.00%.The senior unsecured revolving credit facility under the Second Amended Credit Agreement (the " New Revolving Credit Facility") also includes sublimits of $100 million for letters of credit and $15 million for swing line loans. Borrowings outstanding under the New Revolving Credit Facility will bear interest at a fluctuating rate per annum equal to an applicable percentage defined as (i) in the case of Eurocurrency rate loans, the adjusted British Bankers Association LIBOR rate plus an applicable percentage, ranging from 1.075% to 1.325%, determined by reference to our consolidated leverage ratio, or (ii) in the case of alternate base rate loans and swing line loans, interest (which at all times will not be less than 1.00%) at the greatest of (a) the Prime Rate in effect on such day, (b) the FRBNY Rate in effect on such day plus 0.5% and (c) the adjusted LIBOR rate plus 1.0% for a one month interest period in dollars. In addition to paying interest under the Second Amended Credit Agreement, we are also required to pay certain fees in connection with the New Revolving Credit Facility, including, but not limited to, an unused facility fee and letter of credit fees. The Second Amended Credit Agreement matures on March 30, 2026, subject to extension under certain circumstances and subject to the terms of the Second Amended Credit Agreement. We may repay loans outstanding under the Second Amended Credit Agreement from time to time without premium or penalty, other than customary breakage costs, if any, and subject to the terms of the Second Amended Credit Agreement.
As of March 28, 2021, we held $225.4 million in cash and cash equivalents. Of this amount, $175.4 million of cash and cash equivalents were held by foreign subsidiaries. Our U.S. operations typically generate sufficient cash flows to meet our domestic obligations. However, if we did have to borrow to fund some or all of our expected cash outlays, we can do so at reasonable interest rates by utilizing the undrawn borrowings under our New Revolving Credit Facility. We believe that our financial resources allow us to manage the anticipated impacts of the COVID-19 pandemic on our business operations for the foreseeable future. We anticipate the impacts of COVID-19 will continue to evolve, and, as a result we will continue to evaluate our financial position as additional information becomes available, particularly relating to COVID-19. Subsequent to recording the Toll Tax as part of the Tax Cuts and Jobs Act of 2017, our intent is to permanently reinvest undistributed earnings of foreign subsidiaries, and we do not have any current plans to repatriate post-Toll Tax foreign earnings to fund operations in the United States. However, if amounts held by foreign subsidiaries were needed to fund operations in the United States, we could be required to accrue and pay taxes to repatriate these funds. Such charges may include potential state income taxes and other tax charges.
Non-GAAP Financial Measures
In accordance with the SEC's Regulation G and Item 10(e) of Regulation S-K, the following provides definitions of the non-GAAP financial measures used by management. We believe that these measures provide additional insight into underlying business results and trends. These non-GAAP financial measures are not intended to be considered by the user in place of the related GAAP financial measure, but rather as supplemental information to more fully understand our business results. These non-GAAP financial measures may not be the same as similar measures used by other companies due to possible differences in method and in the items or events being adjusted.
Organic sales growth is a non-GAAP financial measure of sales growth that excludes the impacts of acquisitions, divestitures and foreign exchange from period-over-period comparisons. A reconciliation to the most closely related U.S. GAAP financial measure, net sales, has been included in our discussion within “Results of Operations” above. Organic net sales should be considered in addition to, and not as a replacement for or as a superior measure to net sales.
28
Management believes reporting organic sales growth provides useful information to investors, potential investors and others, by facilitating easier comparisons of our revenue performance with prior and future periods.
Free cash flow is a non-GAAP financial measure that does not represent cash provided by operating activities in accordance with U.S. GAAP. Therefore, it should not be considered an alternative to net cash provided by or used in operating activities as an indication of our performance. The cash conversion rate of free cash flow to net income is also a measure of our performance in cash flow generation. We believe free cash flow to be an appropriate supplemental measure of our operating performance because it provides investors with a measure of our ability to generate cash, repay debt, pay dividends, repurchase stock and fund acquisitions.
A reconciliation of net cash provided by (used in) operating activities to free cash flow is provided below:
First Quarter Ended | |||||||
March 28, | March 29, | ||||||
2021 | 2020 | ||||||
(in millions) | |||||||
Net cash provided by (used in) operating activities | $ | 33.9 | $ | (0.9) | |||
Less: additions to property, plant, and equipment |
| (4.9) |
| (8.9) | |||
Plus: proceeds from the sale of property, plant, and equipment |
| 2.9 |
| 1.4 | |||
Free cash flow | $ | 31.9 | $ | (8.4) | |||
Net income —as reported | $ | 41.7 | $ | 32.0 | |||
Cash conversion rate of free cash flow to net income |
| 76.5 | % |
| (26.6) | % | |
Free cash flow improved in the first quarter of 2021 when compared to the first quarter of 2020 primarily driven by improved working capital management, higher net income and lower net capital expenditures.
Our net debt to capitalization ratio, a non-GAAP financial measure used by management, at March 28, 2021 was (2.5%) compared to net debt (2%) at December 31, 2020. The increase was driven by an increase in net cash outstanding during the first quarter of 2021 of $6.1 million. Management believes the net debt to capitalization ratio is an appropriate supplemental measure because it helps investors understand our ability to meet our financing needs and serves as a basis to evaluate our financial structure. Our computation may not be comparable to other companies that may define their net debt to capitalization ratios differently.
A reconciliation of long-term debt (including current portion) to net debt and our net debt to capitalization ratio is provided below:
March 28, | December 31, | |||||
2021 | 2020 | |||||
(in millions) | ||||||
Current portion of long‑term debt |
| $ | — | $ | — | |
Plus: long-term debt, net of current portion |
| 198.6 |
| 198.2 | ||
Less: cash and cash equivalents |
| (225.4) |
| (218.9) | ||
Net debt | $ | (26.8) | $ | (20.7) | ||
A reconciliation of capitalization is provided below:
March 28, | December 31, | ||||||
2021 | 2020 | ||||||
(in millions) |
| ||||||
Net debt | $ | (26.8) | $ | (20.7) | |||
Total stockholders’ equity |
| 1,081.2 |
| 1,069.8 | |||
Capitalization | $ | 1,054.4 | $ | 1,049.1 | |||
Net debt to capitalization ratio |
| (2.5) | % |
| (2.0) | % | |
29
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Application of Critical Accounting Policies and Key Estimates
We believe that our critical accounting policies are those related to revenue recognition, inventory valuation, goodwill and other intangibles, product liability costs, legal contingencies and income taxes. We believe these accounting policies are particularly important to an understanding of our financial position and results of operations and require application of significant judgment by our management. In applying these policies, management uses its judgment in making certain assumptions and estimates. Our accounting policies are more fully described under the heading “Accounting Policies” in Note 2 of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K as filed with the SEC on February 18, 2021.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We use derivative financial instruments primarily to reduce exposure to adverse fluctuations in foreign exchange rates, interest rates and costs of certain raw materials used in the manufacturing process. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all derivative positions are used to reduce risk by hedging underlying economic exposure. The derivatives we use are instruments with liquid markets. See Note 5 of Notes to the Consolidated Financial Statements for further details.
Our consolidated earnings, which are reported in United States dollars, are subject to translation risks due to changes in foreign currency exchange rates. This risk is concentrated in the exchange rate between the U.S. dollar and the euro; the U.S. dollar and the Canadian dollar; and the U.S. dollar and the Chinese yuan.
Our non-U.S. subsidiaries transact most business, including certain intercompany transactions, in foreign currencies. Such transactions are principally purchases or sales of materials and are denominated in European currencies or the U.S. or Canadian dollar. We use foreign currency forward exchange contracts from time to time to manage the risk related to intercompany loans, intercompany purchases and intercompany sales that occur during the course of a year, and certain open foreign currency denominated commitments to sell products to third parties. We have entered into forward exchange contracts which hedge approximately 80% to 85% of the forecasted intercompany purchases between one of our Canadian subsidiaries and our U.S. operating subsidiaries for the next twelve months. We also entered into forward exchange contracts which hedge up to 60% of the forecasted intercompany sales transactions between one of our Chinese subsidiaries and one of our U.S. operating subsidiaries for the next twelve months. We record the effective portion of the designated foreign currency hedge contracts in other comprehensive income until inventory turns and is sold to a third-party. Once the third-party transaction associated with the hedged forecasted transaction occurs, the effective portion of any related gain or loss on the designated foreign currency hedge is reclassified into cost of goods sold within earnings. The fair value of the Company’s designated foreign hedge contracts outstanding as of March 28, 2021 was a liability of $0.3 million.
Under the Prior Credit Agreement, we could choose either an Adjusted LIBOR or Alternative Base Rate (“ABR”). Accordingly, our earnings and cash flows were exposed to interest rate risk from changes in Adjusted LIBOR. In order to manage our exposure to changes in cash flows attributable to fluctuations in LIBOR-indexed interest payments related to our floating rate debt, we entered into two interest rate swaps. For each interest rate swap, we receive the three-month USD-LIBOR subject to a 0% floor, and pays a fixed rate of 1.31375% on a notional amount of $225.0 million. As a result of entering the Amended Credit Agreement, interest rate swaps as referred to in Note 5 of Notes to the Consolidated Financial Statements were no longer effective in offsetting changes in the cash flow of the hedged item as the critical terms of the Amended Credit Agreement did not match to the hedged item. We recognized the mark-to-market fair value adjustments on a monthly basis in the consolidated statement of operations and continued to do so through the expiration date of the swaps, which was February 12, 2021. Information about our long-term debt including principal amounts and related interest rates appears in Note 10 of Notes to the Consolidated Financial Statements.
We purchase significant amounts of bronze ingot, brass rod, cast iron, stainless steel and plastic, which are utilized in manufacturing our many product lines. Our operating results can be adversely affected by changes in commodity prices
30
if we are unable to pass on related price increases to our customers. 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 and passing increases in commodity costs to our customers, to the maximum extent possible, when they occur.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended, or Exchange Act, as of the end of the period covered by this report, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily applies its judgment in evaluating and implementing possible controls and procedures. The effectiveness of our disclosure controls and procedures is also necessarily limited by the staff and other resources available to us and the geographic diversity of our operations. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act are accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
There was no change in our internal control over financial reporting that occurred during the first quarter ended March 28, 2021, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. We will continue to review and document our disclosure controls and procedures, including our internal control over financial reporting, and we may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
As disclosed in Part I, Item 1, “Product Liability, Environmental and Other Litigation Matters” and Item 3, “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2020, we are party to certain litigation. There have been no material developments with respect to our contingencies and environmental remediation proceedings during the quarter ended March 28, 2021, other than as described in Note 11 of the Notes to Consolidated Financial Statements, which is incorporated herein by reference.
Item 1A. Risk Factors
There have been no material changes to the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2020, which risk factors are incorporated herein by reference.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
We satisfy the minimum withholding tax obligation due upon the vesting of shares of restricted stock and the conversion of restricted stock units into shares of Class A common stock by automatically withholding from the shares being issued a number of shares with an aggregate fair market value on the date of such vesting or conversion that would satisfy the withholding amount due.
31
The following table includes information with respect to shares of our Class A common stock withheld to satisfy withholding tax obligations during the first quarter ended March 28, 2021.
Issuer Purchases of Equity Securities | |||||||||
|
|
|
| (d) Maximum Number (or | |||||
(a) Total | (c) Total Number of | Approximate Dollar | |||||||
Number of | Shares (or Units) | Value) of Shares (or | |||||||
Shares (or | (b) Average | Purchased as Part of | Units) that May Yet Be | ||||||
Units) | Price Paid per | Publicly Announced | Purchased Under the | ||||||
Period | Purchased | Share (or Unit) | Plans or Programs | Plans or Programs | |||||
January 1, 2021 – January 24, 2021 |
| — | $ | — |
| — |
| — | |
January 25, 2021 – February 21, 2021 |
| 34,109 | $ | 129.20 |
| — |
| — | |
February 22, 2021 - March 28, 2021 | 28,982 | $ | 122.00 | — | — | ||||
Total |
| 63,091 | $ | 125.89 |
| — |
| — | |
The following table includes information with respect to repurchases of our Class A common stock during the first quarter ended March 28, 2021 under our stock repurchase program.
Issuer Purchases of Equity Securities | ||||||||||
|
|
|
| (d) Maximum Number (or | ||||||
(a) Total | (c) Total Number of | Approximate Dollar | ||||||||
Number of | (b) Average | Shares (or Units) | Value) of Shares (or | |||||||
Shares (or | Price Paid | Purchased as Part of | Units) that May Yet Be | |||||||
Units) | per Share | Publicly Announced | Purchased Under the | |||||||
Period | Purchased(1) | (or Unit) | Plans or Programs | Plans or Programs | ||||||
January 1, 2021 – January 24, 2021 |
| 7,390 | $ | 125.75 |
| 7,390 | $ | 112,492,269 | ||
January 25, 2021 – February 21, 2021 |
| 10,012 | $ | 124.64 |
| 10,012 | $ | 111,244,387 | ||
February 22, 2021 - March 28, 2021 | 13,751 | $ | 118.62 | 13,751 | $ | 109,612,904 | ||||
Total |
| 31,153 | $ | 122.23 |
| 31,153 | ||||
| (1) | On February 6, 2019, the Board of Directors authorized a stock repurchase program of up to $150 million of the Company’s Class A common stock to be purchased from time to time on the open market or in privately negotiated transactions. The timing and number of shares repurchased will be determined by the Company’s management based on its evaluation of market conditions and other factors. |
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Item 6. Exhibits
Exhibit No. |
| Description |
|---|---|---|
3.1 | ||
3.2 | ||
10. 1† | ||
10.2 | ||
10.3 | ||
31.1† | ||
31.2† | ||
32.1†† | Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350 | |
32.2†† | Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350 | |
101.INS* | Inline XBRL Instance Document | |
101.SCH* | Inline XBRL Taxonomy Extension Schema Document | |
101.CAL* | Inline XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF* | Inline XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB* | Inline XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE* | Inline XBRL Taxonomy Extension Presentation Linkbase Document | |
104 | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) |
† Filed herewith.
†† Furnished herewith.
* Attached as Exhibit 101 to this report are the following formatted in Inline XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets at March 28, 2021 and December 31, 2020, (ii) Consolidated Statements of Operations for the First Quarters ended March 28, 2021 and March 29, 2020, (iii) Consolidated Statements of Comprehensive Income for the First Quarters ended March 28, 2021 and March 29, 2020, (iv) Consolidated Statements of Stockholders’ Equity for the First Quarters ended March 28, 2021 and March 29, 2020, (v) Consolidated Statements of Cash Flows for the First Quarters Ended March 28, 2021 and March 29, 2020, and (vi) Notes to Consolidated Financial Statements.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
WATTS WATER TECHNOLOGIES, INC. | ||
Date: May 5, 2021 | By: | /s/ Robert J. Pagano, Jr. |
Robert J. Pagano, Jr. | ||
Chief Executive Officer (principal executive officer) | ||
Date: May 5, 2021 | By: | /s/ Shashank Patel |
Shashank Patel Chief Financial Officer (principal financial officer) | ||
Date: May 5, 2021 | By: | /s/ Virginia A. Halloran |
Virginia A. Halloran Chief Accounting Officer (principal accounting officer) |
34