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 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 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
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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 unprecedented 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 third quarter endedSeptember 27, 2020 were adversely impacted as a result COVID-19. Demand for our products decreased as compared to the same period in 2019 as the pandemic continued and various governmental measures were imposed to combat the spread of the virus. Third quarter sales improved when compared to the second quarter of 2020. However, as the third quarter progressed, we noted sequential monthly declines in our order and sales rates as some restocking orders early in the quarter did not repeat. The exact timing and pace of the recovery remain uncertain and are impacted by certain markets which are now experiencing a resurgence of COVID-19 cases. Future sales expansion or contraction is dependent on the duration and severity of the COVID-19 pandemic, including, the time it takes for normal economic and operating conditions to resume, easing of the construction lending markets, improvements in overall investments and capital spending in building services construction markets, additional governmental actions that may be taken, and numerous other uncertainties, including the time to develop an effective vaccine or therapeutic treatments. Our operations in the fourth quarter are expected to continue to be negatively impacted by COVID-19. Currently, we estimate fourth quarter sales may decline by 4% to 8% 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 develop and implement a coordinated response 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 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 costs, including merit deferrals, salary and incentive reductions, furloughs, reduced discretionary spending, factory overhead cost reductions, renegotiated material costs and reductions-in-force and other exit activities initiated in the second and third quarters 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 during the second quarter, which was reinstated onJune 29, 2020 , maintained a flat dividend rate, 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 receivable, 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 third quarter and nine months endedSeptember 27, 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, 28
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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 ends. For further information regarding the impact of COVID-19 on the Company, see Part II, Item 1A, "Risk Factors." Financial Overview During the third quarter of 2020, sales decreased 2.7%, or$10.8 million , on a reported basis and 5.0%, or$19.7 million , on an organic basis, compared to the third quarter of 2019, primarily due to the impact of the COVID-19 pandemic across all of our operating segments. The reported decline was partially offset by an increase in sales from the impact of foreign exchange of 1.3%, or$4.9 million , primarily driven by a stronger euro, and a net increase in acquired/divested sales of$4.0 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$47.9 million decreased by$0.9 million , or 1.8%, in the third quarter of 2020 as compared to the third quarter of 2019. This decrease was primarily driven by lower sales volume as a result of the COVID-19 pandemic, higher general inflation, including tariffs, strategic investments and incremental restructuring costs, partially offset by benefits from productivity initiatives, reduced long-term incentive costs, lower Corporate related professional fees, and benefits from cost reduction actions in response to the COVID-19 pandemic. Recent Developments OnNovember 2, 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 onDecember 15, 2020 to stockholders of record
onDecember 1, 2020 . Results of Operations
Third Quarter Ended
Third Quarter Ended Third Quarter Ended % Change to
September 27, 2020 September 29, 2019 Consolidated
Net Sales % Sales Net Sales % Sales Change Net Sales
(dollars in millions)
Americas $ 261.5 68.1 % $ 270.3 68.5 % $ (8.8) (2.2) %
Europe 106.7 27.8 107.9 27.3 (1.2) (0.3)
APMEA 15.7 4.1 16.5 4.2 (0.8) (0.2)
Total $ 383.9 100.0 % $ 394.7 100.0 % $ (10.8) (2.7) %
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 $ (10.1) $ (6.2) $ (3.4) $ (19.7) (2.6) % (1.5) % (0.9) % (5.0) % (3.7) % (5.7) % (21.8) %
Foreign exchange (0.2) 5.0 0.1 4.9 - 1.2 - 1.2 (0.1) 4.6 0.8
Acquired/divested, net 1.5 - 2.5 4.0 0.4 - 0.7 1.1 0.5 - 16.6
Total $ (8.8) $ (1.2) $ (0.8) $ (10.8) (2.2) % (0.3) % (0.2) % (2.7) % (3.3) % (1.1) % (4.4) %
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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 $ (1.8) $ (0.4) $ 1.8 $ (9.7) $ (10.1) (1.2) % (2.2) % 12.2 % (11.6) %
Europe (6.1) (0.2) 0.1 - (6.2) (8.4) (0.6) 19.9 -
APMEA (3.4) - - - (3.4) (22.6) - - -
Total $ (11.3) $ (0.6) $ 1.9 $ (9.7) $ (19.7)
Organic net sales in the Americas decreased primarily due to a decline in volume
in the majority of our channels, with the most significant decline in our
specialty channel. The decrease within our specialty channel primarily relates
to our heating and hot water products and is due to project timing impacted by
the COVID-19 pandemic. This decrease was partially offset by increased volume
within our DIY channel as many DIY customers continued working on residential
projects.
Organic net sales inEurope decreased primarily due to lost volume related to the COVID-19 pandemic within the majority of our regions and across most of
our product lines.
Organic net sales in APMEA decreased primarily due to a decline in volume
related to the COVID-19 pandemic, primarily in the
The net increase in sales due to foreign exchange was primarily due to the appreciation of the euro against theU.S. dollar in the third 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.
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
Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for the third quarters of 2020 and 2019 were as follows:
Third Quarter Ended
September 27, 2020 September 29, 2019
(dollars in millions)
Gross profit $ 158.5 $ 168.6
Gross margin 41.3 % 42.7 %
Gross profit and gross margin declined primarily from lower sales volume as a result of the COVID-19 pandemic, partially offset by 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
(in millions) % Change
Organic $ (15.4) (13.0) %
Foreign exchange 1.1 1.0
Acquired/divested, net 1.1 1.0
Total $ (13.2) (11.0) %
The organic decrease was related to cost reduction actions taken in response to
the COVID-19 pandemic of $7.2 million , decreased variable costs due to the
decline in sales volume of $2.3 million , restructuring savings of $3.5 million ,
decreased stock compensation expense of $1.2 million primarily due to
adjustments to expected attainment levels of
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performance goals related to our performance stock units, and a decrease of Corporate related professional fees of$2.3 million . These decreases were partially offset by an increase in strategic investments of$1.5 million , including investments in research and development for new products, commercial excellence, and technology and information systems as well as general inflation of$0.6 million compared to the third quarter of 2019. The increase in foreign exchange was mainly due to the appreciation of the euro against theU.S. dollar. The acquired/divested, net SG&A costs were related to two immaterial acquisitions, one in the APMEA segment in the third quarter of 2020, and one in theAmericas segment in the third quarter of 2019, 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 27.8% in the third quarter of 2020 compared to 30.4% in the third quarter of 2019. Restructuring. In the third quarter of 2020, we recorded a net charge of$3.4 million primarily for severance benefits related to reductions in force 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 6 of Notes to Consolidated Financial Statements.
Loss on disposition. In the third quarter of 2020, we recorded a pre-tax loss on
disposition of
Operating Income. Operating income (loss) by segment for the third quarters of 2020 and 2019 was as follows:
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