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, 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 products that will connect our customers with smart systems, control systems for optimal performance, and conserve critical resources by increasing operability, efficiency and safety. 25 Table of Contents 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, which was shortly after theWorld 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 and second 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 and maintaining our COVID-19 website for employees, which includes the latestCDC and other government protocols. 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 in the second quarter of 2021, and continue to invest for the future. Our experienced management team is proactively managing this situation and we are well positioned to respond to challenges presented by the COVID-19 pandemic as they arise. Our revenues improved in all three segments for the second quarter of 2021 as compared to the second quarter of 2020, primarily driven by the negative impact of COVID-19 last year. We have started to see recovery in certain markets, however, future sales expansion or contraction is dependent on the duration and severity of the evolving COVID-19 pandemic. Factors include supply chain constraints, the construction lending markets, investments and capital spending in building services construction markets, additional governmental actions that may or may not be taken, and numerous other uncertainties, including COVID-19 vaccination rates and the impact of the virus variants. As worldwide economies recover from the pandemic, increased market demand is straining suppliers' ability to fill orders. This has been compounded by logistical issues with respect to container capacity on ships, port congestion and in-road trucking. Increased demand following theFebruary 2021 South-Central severe weather freeze inthe United States has caused additional supply constraints. The global shortage of electronic components like semiconductors and other raw materials may continue to challenge our supply chain. 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 half of the year, we cannot predict how supply chain issues and related costs may impact our ability to service our customers, effectively roll out and realize price increases and impact our profit margins in the second 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 six months endedJune 27, 2021 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 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 endedDecember 31, 2020 . 26 Table of Contents Financial Overview
Second quarter 2021 sales increased 37.9%, or$128.3 million , on a reported basis and 32.1%, or$108.6 million , on an organic basis, compared to the second quarter of 2020, primarily driven by the global economic recovery across all of our operating segments following the significant negative effect of COVID-19 last year. This increase also included the growth in theAmericas due to positive demand driven by theFebruary 2021 severe freezing weather in the South-Central U.S. The severe freeze was estimated to have contributed approximately 4% of incremental sales during the second quarter at a consolidated level. The reported sales increase included the impact of foreign exchange of 4.8%, or$16.1 million , primarily driven by a stronger euro, and a net increase in acquired/divested sales of$3.6 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$52.7 million increased by$21.7 million , or 70.0%, in the second quarter of 2021 as compared to the second quarter of 2020. This increase was primarily driven by higher sales volume, price, productivity and savings from prior restructuring actions, partially offset by inflation, investments, the return of expenses related to business normalization and restructuring charges related to the closure of a facility in Méry,France . During the second quarter of 2021, we successfully completed negotiations to exit the facility and recorded pre-tax restructuring charges of$18.0 million in the quarter, with total expected pre-tax costs of$26.0 million estimated to be incurred through the second half of 2022. See Note 6 of Notes to Consolidated Financial Statements for more details. Recent Developments OnAugust 2, 2021 , we declared a quarterly dividend oftwenty-six cents ($0.26 ) per share on each outstanding share of Class A common stock and Class B common stock payable onSeptember 15, 2021 to stockholders of record on September
1, 2021. Results of Operations
Second Quarter Ended
Second Quarter Ended Second Quarter Ended % Change to June 27, 2021 June 28, 2020 Consolidated Net Sales % Sales Net Sales % Sales Change Net Sales (dollars in millions) Americas$ 307.1 65.8 %$ 237.4 70.1 %$ 69.7 20.6 % Europe 136.8 29.3 88.1 26.0 48.7 14.4 APMEA 23.1 4.9 13.2 3.9 9.9 2.9 Total$ 467.0 100.0 %$ 338.7 100.0 %$ 128.3 37.9 %
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$ 66.2 $ 36.4 $ 6.0 $ 108.6 19.5 % 10.8 % 1.8 % 32.1 % 27.9 % 41.3 % 51.0 % Foreign exchange 2.5 12.3 1.3 16.1 0.8 3.6 0.4 4.8 1.1 14.0 9.8 Acquired/divested, net 1.0 - 2.6 3.6 0.3 - 0.7 1.0 0.4 - 14.2 Total$ 69.7 $ 48.7 $ 9.9 $ 128.3 20.6 % 14.4 % 2.9 % 37.9 % 29.4 % 55.3 % 75.0 % 27 Table of Contents 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$ 44.4 $ 7.4 $ 1.5 $ 12.9 $ 66.2 33.9 % 44.2 % 8.4 % 17.9 % Europe 25.4 10.7 0.3 - 36.4 46.2 32.8 75.5 - APMEA 6.0 - - - 6.0 53.1 - - - Total$ 75.8 $ 18.1 $ 1.8 $ 12.9 $ 108.6
Organic net sales in theAmericas increased due to higher volume and price in the majority of our channels. The higher volume in 2021 was supported by the global economic recovery, as well as the continued positive impact on our wholesale and DIY channels from theFebruary 2021 severe weather freeze in the South-Central U.S. We estimate the severe weather freeze drove approximately 5% of incremental sales for the region in the second quarter of 2021.
Organic net sales in
Organic net sales in APMEA increased primarily due to higher volumes inChina andNew Zealand and from the global economic recovery.China's sales growth was primarily driven by higher demand for commercial valves within data centers. The net increase in sales due to foreign exchange was primarily due to the appreciation of the euro against theU.S. dollar in the second quarter of 2021. 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 second quarters of 2021 and 2020 were as follows:
Second Quarter Ended June 27, 2021 June 28, 2020 (dollars in millions) Gross profit $ 200.1 $ 134.9 Gross margin 42.8 % 39.8 %
Gross profit and gross margin increased primarily from higher sales volume, price and productivity savings, partially offset by investments, the return of expenses related to business normalization, higher freight costs to expedite components and product, and general inflation. 28 Table of Contents
Selling, General and Administrative Expenses. Selling, general and
administrative, or SG&A, expenses increased
(in millions) % Change Organic $ 27.0 27.7 % Foreign exchange 3.9 4.0 Acquired/divested, net 1.9 1.9 Total $ 32.8 33.6 %
The organic increase related to the return of expenses related to business normalization of$5.6 million , increased variable costs due to the higher sales volume of$7.8 million , an increase in short-term and long-term compensation related accruals due to adjustments to expected attainment levels of$10.2 million , an increase in investments of$3.8 million , including new products, commercial excellence, and technology, increased product liability costs of$1.7 million , as well as general inflation of$2.1 million compared to the second quarter of 2020. These increases were partially offset by restructuring savings of$2.3 million and$4.3 million due to productivity initiatives. 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 related to two immaterial acquisitions, one in the APMEA segment in the third quarter of 2020, and one in theAmericas 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 27.9% in the second quarter of 2021 compared to 28.8% in the second quarter of 2020. Restructuring. In the second quarter of 2021, we recorded a net restructuring charge of$17.0 million , which included an$18.0 million charge related to a 2021 French restructuring program that was approved in the second quarter of 2021. The charge was partially offset by adjustments reducing previous estimates related to severance accruals from the programs initiated in the second and third quarters 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 the Notes to Consolidated Financial Statements.
Operating Income. Operating income (loss) by segment for the second quarters of 2021 and 2020 was as follows:
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