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 22
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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 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 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 inChina 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 inthe 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 endedMarch 28, 2021 are not necessarily indicative of the results to be expected for the full fiscal year. 23 Table of Contents 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 . 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 OnMay 3, 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 onJune 15, 2021 to stockholders of record onJune 1, 2021 . OnMarch 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 andJPMorgan 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 fromFebruary 12, 2022 toMarch 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$15 million for swing line loans. Results of Operations
First Quarter Ended
First Quarter Ended First Quarter Ended
% Change to
March 28, 2021 March 29, 2020
Consolidated
Net Sales % Sales Net Sales % Sales Change Net Sales (dollars in millions) Americas$ 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 Table of Contents
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$ 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 theAmericas 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 inEurope 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
The net increase in sales due to foreign exchange was primarily due to the appreciation of the euro against theU.S. dollar in the first 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 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 Table of Contents 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
(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 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 27.5% 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 endedDecember 31, 2020 .
Operating Income. Operating income (loss) by segment for the first quarters of 2021 and 2020 was as follows:
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