WATTS WATER TECHNOLOGIES, INC. 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 we
cannot add value. Our goal is to be a solutions provider, not merely a
components supplier. We continually look for
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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 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. Our revenues for the second quarter endedJune 28, 2020 were adversely impacted as a result COVID-19. Demand for our products significantly decreased as compared to the same period in 2019 as the pandemic expanded and country and state stay-at-home orders were announced. However, as the second quarter progressed, we noted sequential monthly improvements in our order and sales rates as customers increased their operating levels as government restrictions and lockdowns eased. Future sales expansion or contraction is dependent on the duration and severity of the COVID-19 pandemic, including the resumption of stay-at-home orders and the reclosing of businesses in certain geographies, the time it takes for normal economic and operating conditions to resume, easing of the lending markets, improvements in overall investments and capital spending in building services construction markets, additional governmental actions that may be taken and/or extensions of time for restrictions that have been imposed to date, and numerous other uncertainties, including the time to develop an effective vaccine or therapeutic treatments. Our operations in the third quarter are expected to continue to be negatively impacted by COVID-19. Sequentially, we believe the impact should lessen when compared to the second quarter as our end markets gain some momentum with the forecasted sequential recovery in the global economy. Currently, we estimate third quarter sales may decline by 8% to 12% compared to prior-year. We continue to be concerned about the far reaching impacts of the pandemic on our business, operations, and financial results and conditions, directly and indirectly, including, without limitation, impacts on the health of our employees, manufacturing capabilities, supply chain, distribution networks, sales opportunities, 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 are uncertain. Many of our products qualify as "essential products" under local, state, and national guidelines and orders. 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 are in communication with both customers and suppliers, we established a COVID-19 customer hotline in the US to support critical infrastructure projects, and we worked with our suppliers to ensure they could obtain the "essential" product classification from various government organizations. In response to the business impact of the COVID-19 pandemic, we undertook 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 reductions-in-force and other exit activities initiated in the second quarter of 2020. We also implemented various measures to conserve cash. In addition to the cost actions noted above, we temporarily suspended our stock repurchase program, which was reinstated onJune 29, 2020 , 27
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continued to maintain a flat dividend rate, reduced planned capital expenditures
and deferred 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 ofour credit customers. Due to the above circumstances and as described generally in this Form 10-Q, the Company's results of operations for the second quarter and six months endedJune 28, 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 second quarter of 2020, sales decreased 18.7%, or$78.1 million , on a reported basis and 18.6%, or$77.4 million , on an organic basis, compared to the second quarter of 2019, primarily due to the impact of the COVID-19 pandemic across all of our operating segments. There was also a decline in sales from the impact of foreign exchange of 0.6%, or$2.9 million , primarily driven by a weaker euro and Canadian dollar. The reported decline was partially offset by an increase in acquired sales of$2.2 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$31.0 million decreased by$23.3 million , or 42.9%, in the second quarter of 2020 as compared to the second quarter of 2019. This decrease was primarily driven by volume declines as result of the COVID-19 pandemic, incremental strategic investments, increased restructuring costs and impairment charges, partially offset by benefits from price, productivity initiatives and cost reduction actions in response to the COVID-19 pandemic. Recent Developments OnJuly 27, 2020 , we 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 onSeptember 15, 2020 to stockholders of record on September
1, 2020. OnJuly 3, 2020 , we completed the acquisition of 100% of the shares ofAustralian Valve Group Pty Ltd ("AVG") in an all-cash transaction. AVG is based inPerth, Australia , and specializes in the design, marketing and distribution of heating control valves used in the Australian residential and commercial end markets. The acquisition of AVG aligns with our strategy to expand geographically into countries with mature and enforced plumbing codes. AVG will enhance our product offering and channel access into the Australian marketplace. The acquisition of AVG was deemed not to be material. 28 Table of Contents Results of Operations
Second Quarter Ended
Second Quarter Ended Second Quarter Ended % Change to
June 28, 2020 June 30, 2019 Consolidated
Net Sales % Sales Net Sales % Sales Change Net Sales
(dollars in millions)
Americas $ 237.4 70.1 % $ 287.0 68.9 % $ (49.6) (11.9) %
Europe 88.1 26.0 113.2 27.1 (25.1) (6.0)
APMEA 13.2 3.9 16.6 4.0 (3.4) (0.8)
Total $ 338.7 100.0 % $ 416.8 100.0 % $ (78.1) (18.7) %
The change in net sales was attributable to the following:
Change As a % Change As a %
of Consolidated Net Sales of Segment Net Sales
Americas Europe APMEA Total Americas Europe APMEA Total Americas Europe APMEA
(dollars in millions)
Organic $ (51.2) $ (23.2) $ (3.0) $ (77.4) (12.3) % (5.6) % (0.7) % (18.6) % (17.8) % (20.5) % (18.3) %
Foreign exchange (0.6) (1.9) (0.4) (2.9) (0.1) (0.4) (0.1) (0.6) (0.3) (1.7) (2.6)
Acquisition 2.2 - - 2.2 0.5 - - 0.5 0.8 - -
Total $ (49.6) $ (25.1) $ (3.4) $ (78.1) (11.9) % (6.0) % (0.8) % (18.7) % (17.3) % (22.2) % (20.9) %
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 $ (32.5) $ (5.2) $ 2.7 $ (16.2) $ (51.2) (20.1) % (23.7) % 17.8 % (18.5) %
Europe (18.8) (4.2) (0.2) - (23.2) (25.1) (11.2) (31.3) -
APMEA (4.0) 0.2 - 0.8 (3.0) (25.8) 50.4 - 121.6
Total $ (55.3) $ (9.2) $ 2.5 $ (15.4) $ (77.4) Organic net sales in the
Organic net sales in
Organic net sales in APMEA decreased primarily due to a decline in volume
related to the COVID-19 pandemic, primarily in
The net decrease in sales due to foreign exchange was primarily due to the
depreciation of the euro, Canadian dollar, and Chinese yuan, against the
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appreciate or depreciate against the
Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for the second quarters of 2020 and 2019 were as follows:
Second Quarter Ended
June 28, 2020 June 30, 2019
(dollars in millions)
Gross profit $ 134.9 $ 174.6
Gross margin 39.8 % 41.9 %
Gross profit and gross margin declined primarily from lower sales volume as a result of the COVID-19 pandemic, partially offset by benefits from price, productivity initiatives, government subsidies withinEurope and APMEA and cost reduction actions in response to the COVID-19 pandemic.
Selling, General and Administrative Expenses. Selling, general and
administrative, or SG&A, expenses decreased
(in millions) % Change
Organic $ (20.8) (17.4) %
Foreign exchange (0.6) (0.5)
Total $ (21.4) (17.9) %
The organic decrease was related to cost reduction actions in response to the
COVID-19 pandemic of $13.9 million , decreased variable costs due to the decline
in sales volume of $5.1 million , restructuring savings of $2.5 million , and
decreased stock compensation expense of $1.7 million due to a change in the
expected attainment of performance goals related to our performance stock units.
These decreases were partially offset by an increase in strategic investments of
$1.3 million , including investments in research and development for new
products, commercial excellence, and technology and information systems as well
as general inflation of $1.6 million compared to the second quarter of 2019. The
decrease in foreign exchange was mainly due to the depreciation of the euro,
Canadian dollar, and Chinese yuan against the U.S. dollar. Total SG&A expenses,
as a percentage of sales, were 28.8% in the second quarter of 2020 compared to
28.6% in the second quarter of 2019.
Restructuring. In the second quarter of 2020, we recorded a net charge of
$5.3 million compared to a net charge of $1.3 million in the second quarter of
2019. The charge for the second quarter of 2020 is primarily for severance
benefits related to reductions in force initiated in the second 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 6 of Notes to
Consolidated Financial Statements.
Other long-lived asset impairment charge. In the second quarter of 2020, we
recorded an impairment charge of $1.0 million in our Americas segment related to
a long-lived asset in which market value expectations indicated the carrying
amount of this asset was in excess of the fair value.
Operating Income. Operating income (loss) by segment for the second quarters of 2020 and 2019 was as follows:
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