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 toWatts 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 theAmericas ,Europe andAsia-Pacific ,Middle East andAfrica ("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, and thermostatic mixing valves. ? 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 12 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 23
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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 ("IoT") has allowed companies to transform components into smart and connected devices. Over the last few 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 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 global emergence of the COVID-19 pandemic presents significant risks to our company and we are not able to fully evaluate or forecast the impact on our business at the current time. We estimate the unfavorable impact of the COVID-19 pandemic on our sales across our regions to be approximately$10 million to$15 million in the first quarter endedMarch 29, 2020 . Demand for our products has decreased as the pandemic has expanded and country and state shelter-in-place orders have been announced. Construction projects and repair and replacement activity have been negatively affected by the shut-down of non-essential services. We believe demand may decrease further depending on the duration and severity of the COVID-19 pandemic, the length of time it takes for normal economic and operating conditions to resume, additional governmental actions that may be taken and/or extensions of time for restrictions that have been imposed to date, and numerous other uncertainties. The COVID-19 pandemic will impact our operations in the second quarter and may continue to do so for several quarters thereafter. As a result, we have retracted our full-year outlook and we are presently expecting second quarter sales may decline by 25% to 30% compared to prior-year from the impact of the COVID-19 pandemic. We expect that the COVID-19 pandemic may have far reaching impacts on our business, operations, and financial results and conditions, directly and indirectly, including, without limitation, impacts on the health of our management and employees, manufacturing capabilities, supply chain, distribution networks, marketing resources, sales opportunities, distribution channels, customer and consumer behaviors, and on the overall economy. The scope and nature of these potential impacts are pervasive, many are beyond our control, continue to evolve and their outcomes uncertain. Many of our products qualify as essential under local, state national guidelines and orders, as such we are considered an essential business providing essential products during this global emergency. As a provider of essential products, we have made significant efforts to continue to make our products available to our customers. We remain focused on protecting the health and safety of our employees and the communities in which we operate while maintaining the continuity of our business operations. The Company created aCOVID-19 Task Force to protect our employees while maintaining production capabilities, and we have implemented social distancing guidelines and temperature monitoring, provided personal protective equipment, established a COVID-19 website for employees, which includes the latest CDC and other government protocols and promoted work-from-home policies where practical. We have reached out to both customers and suppliers and established a COVID-19 customer hotline in the US to support critical infrastructure projects, and we are working with suppliers to ensure they can obtain the "essential" product classification from various government organizations. In response to the business impact of the COVID-19 pandemic, we have recently initiated several cost management actions in order to reduce ongoing costs, including merit deferrals, salary and incentive reductions, furloughs, reduced discretionary spending, factory overhead cost reductions, renegotiating material costs and a reduction-in-force initiated inApril 2020 . We also plan to undertake various measures to conserve cash, including the cost actions noted above, temporarily suspending our stock repurchase program, maintaining a flat dividend rate, reducing planned capital 24
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expenditures and are deferring employer payroll tax payments as permitted under the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"). We have also implemented additional procedures to manage risks related to our working capital, specifically the collectability of our trade accounts receivables, by monitoring the financial stability, credit rating, payment terms and credit limits of our credit customers. Due to the above circumstances and as described generally in this Form 10-Q, the Company's results of operations for the first quarter endedMarch 29, 2020 are not necessarily indicative of the results to be expected for the full fiscal year. Management cannot predict the full impact of the COVID-19 pandemic on the Company's sales, supply chain, manufacturing and distribution or to economic conditions generally, including the effects on customer spending. The extent of the effects of the COVID-19 pandemic on the Company is highly uncertain and will depend on future developments, and such effects could exist for an extended period of time even after the pandemic might end. For further information regarding the impact of COVID-19 on the Company, see Part II, Item 1A, "Risk Factors." Financial Overview
During the first quarter of 2020, sales decreased 1.6%, or$6.1 million , on a reported basis and 1.2%, or$4.6 million , on an organic basis, compared to the first quarter of 2019. There was also a decline in sales from the impact of foreign exchange of 1.1%, or$4.1 million , primarily driven by a weaker euro. The estimated sales loss from the COVID-19 pandemic was approximately$10 million to$15 million in the first quarter endedMarch 29, 2020 . The organic decline in sales was also due to one less shipping day compared to the first quarter of 2019. These declines on a reported basis were partially offset by an increase in acquired sales of$2.6 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$47.8 million increased by$1.1 million , or 2.4%, in the first quarter of 2020 as compared to the first quarter of 2019. This increase was primarily driven by savings from productivity initiatives, decreased restructuring costs, and cost reduction actions in response to the COVID-19 pandemic, partially offset by lower sales volume, higher general inflation including tariffs, and strategic investments. Recent Developments OnMay 4, 2020 , the Company declared a quarterly dividend oftwenty-three cents ($0.23 ) per share on each outstanding share of Class A common stock and Class B common stock payable onJune 15, 2020 to stockholders of record onJune 1, 2020 . OnApril 24, 2020 , we entered into an Amended and Restated Credit Agreement (the "New Credit Agreement") among the Company, certain subsidiaries of the Company who become borrowers thereunder,JPMorgan Chase Bank, N.A ., as Administrative Agent, SwingLine Lender and Letter of Credit Issuer, and the other lenders referred to therein. The New Credit Agreement amends and restates our 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 toFebruary 2022 . This senior unsecured revolving credit facility (the "Revolving Credit Facility") also includes sublimits of$100 million for letters of credit and$15 million for swing line loans. The existing term loan was paid off onApril 24, 2020 with funds from the Revolving Credit Facility. 25 Table of Contents Results of Operations
First Quarter Ended
First Quarter Ended First Quarter Ended
% Change to
March 29, 2020 March 31, 2019
Consolidated
Net Sales % Sales Net Sales % Sales Change
(dollars in millions) Americas$ 262.4 68.6 %$ 258.9 66.6 %$ 3.5 0.9 % Europe 110.2 28.8 116.3 29.9 (6.1)
(1.6)
APMEA 10.0 2.6 13.5 3.5 (3.5)
(0.9)
Total
(1.6) %
The change in net sales was attributable to the following:
Change As a % Change As a % of ConsolidatedNet Sales of SegmentNet Sales Americas Europe APMEA TotalAmericas Europe APMEA TotalAmericas Europe APMEA (dollars in millions) Organic$ 1.0 $ (2.6) $ (3.0) $ (4.6) 0.3 % (0.7) % (0.8) % (1.2) % 0.4 % (2.3) % (22.5) % Foreign exchange (0.1) (3.5) (0.5) (4.1) (0.1) (0.9) (0.1) (1.1) (0.1) (2.9) (3.0) Acquisition 2.6 - - 2.6 0.7 - - 0.7 1.0 - - Total$ 3.5 $ (6.1) $ (3.5) $ (6.1) 0.9 % (1.6) % (0.9) % (1.6) % 1.3 % (5.2) % (25.5) % 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$ (0.2) $ (1.4) $ 0.7 $ 1.9 $ 1.0 (0.1) % (6.5) % 4.1 % 2.5 % Europe (2.0) (0.5) (0.1) - (2.6) (2.6) (1.3) (17.4) - APMEA (3.0) (0.3) - 0.3 (3.0) (23.4) (51.9) - 47.6 Total$ (5.2) $ (2.2) $ 0.6 $ 2.2 $ (4.6) Organic net sales in theAmericas increased primarily due to increased volume within our heating and hot water and water quality products, which are sold through our specialty channel, as well as increased volume within our DIY channel. The increase was also due to a general price increase across the majority of our channels. This was partially offset by a decrease in OEM and wholesale sales that were affected by the impact of the COVID-19 pandemic towards the end of the quarter. Organic net sales inEurope decreased due to lost volume related to the COVID-19 pandemic, primarily inItaly andFrance at the end of March. This decrease was partially offset by increased sales in our marine-based drains products, as
well as price.
Organic net sales in APMEA decreased primarily due to a decline in volume
related to the COVID-19 pandemic, primarily in
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The net decrease in sales due to foreign exchange was primarily due to the depreciation of the euro and Chinese yuan, against theU.S. dollar in the first quarter of 2020. We cannot predict whether foreign currencies will appreciate or depreciate against theU.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.
Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for the first quarters of 2020 and 2019 were as follows:
First Quarter Ended March 29, 2020 March 31, 2019 (dollars in millions) Gross profit $ 162.8 $ 164.2 Gross margin 42.6 % 42.2 %
Although gross profit declined
Selling, General and Administrative Expenses. Selling, general and
administrative, or SG&A, expenses decreased
(in millions) % Change Organic $ (0.1) (0.1) % Foreign exchange (1.0) (0.9) Total $ (1.1) (1.0) %
The decrease in foreign exchange was mainly due to the depreciation of the euro and Chinese yuan against theU.S. dollar. The organic decrease was related to cost reduction actions in response to the COVID-19 pandemic of$2.5 million , decreased stock compensation expense of$0.7 million , and incremental European restructuring savings of$0.7 million from prior restructuring actions. These decreases were partially offset by strategic investments of$2.0 million , including investments in research and development for new products, commercial excellence, and technology and information systems as well as general inflation of$1.9 million compared to the first quarter of 2019. Total SG&A expenses, as a percentage of sales, were 30.1% in the first quarter of 2020 compared to 29.9% in the first quarter of 2019.
Restructuring. In the first quarter of 2019, we recorded a net charge of
Operating Income. Operating income (loss) by segment for the first quarters of 2020 and 2019 was as follows:
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