UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10‑K10-K
☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 20162019
Or
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001‑11499001-11499
WATTS WATER TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
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Delaware |
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(State or Other Jurisdiction of | (I.R.S. Employer | |
Incorporation or Organization) | Identification No.) | |
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815 Chestnut Street, North Andover, MA | 01845 | |
(Address of Principal Executive Offices) | (Zip Code) |
Registrant’s telephone number, including area code: (978) 688‑1811(978) 688-1811
Securities registered pursuant to Section 12(b) of the Act:
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Title of | Trading Symbol(s) | Name of |
Class A common stock, par value $0.10 per share | WTS | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well‑knownwell-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒⌧ No ☐◻
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ ◻No ☒⌧
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒⌧ No ☐◻
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S‑TS-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒⌧ No ☐◻
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S‑K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10‑K or any amendment to this Form 10‑K. ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non‑non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”filer,” “smaller reporting company,” and “smaller reporting“emerging growth company” in Rule 12b‑212b-2 of the Exchange Act.
Large accelerated filer ☒ | Accelerated filer ☐ | Non-accelerated filer ☐ | Smaller reporting company ☐ |
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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. (Check one):◻
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑212b-2 of the Exchange Act). Yes ☐ No ☒
As of July 1, 2016,June 30, 2019, the aggregate market value of the registrant’s common stock held by non‑affiliatesnon-affiliates of the registrant was approximately $1,657,749,907$2,561,832,123 based on the closing sale price as reported on the New York Stock Exchange.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
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Class | Outstanding at January | |
Class A common stock, $0.10 par value per share | |
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Class B common stock, $0.10 par value per share | |
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement for its Annual Meeting of Stockholders to be held on May 17, 2017,13, 2020 are incorporated by reference into Part III of this Annual Report on Form 10‑K.10-K.
TABLE OF CONTENTS
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| MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 23 | |
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| CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | 36 | |
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| SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | 40 | |
| CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE | 40 | |
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PART I
Item 1. BUSINESS.
This Annual Report on Form 10‑K10-K contains statements that are not historical facts and are considered forward‑lookingforward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These forward‑lookingforward-looking statements contain projections of our future results of operations or our financial position or state other forward‑lookingforward-looking information. In some cases you can identify these forward‑lookingforward-looking statements by words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “should,” and “would” or similar words. You should not rely on forward‑lookingforward-looking statements because they involve known and unknown risks, uncertainties and other factors, some of which are beyond our control. These risks, uncertainties and other factors may cause our actual results, performance or achievements to differ materially from the anticipated future results, performance or achievements expressed or implied by the forward‑lookingforward-looking statements. Some of the factors that might cause these differences are described under Item 1A—“Risk Factors.” You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences. These forward‑lookingforward-looking statements were based on information, plans and estimates at the date of this report, and, except as required by law, we undertake no obligation to update any forward‑lookingforward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.
In this Annual Report on Form 10‑K,10-K, references to “the Company,” “Watts Water,” “we,” “us” or “our” refer to Watts Water Technologies, Inc. and its consolidated subsidiaries.
Overview
Watts Regulator Co. was founded by Joseph E. Watts in 1874 in Lawrence, Massachusetts. Watts Regulator Co. started as a small machine shop supplying parts to the New England textile mills of the 19th century and grew into a global manufacturer of products and systems focused on the control, conservation and quality of water and the comfort and safety of the people using it. Watts Water Technologies, Inc. was incorporated in Delaware in 1985 and becameis the parent company of Watts Regulator Co.
Our strategy is to be the preferred supplier of differentiated products, solutions and systems that manage and conserve the flow of fluids and energy into, through and out of buildings in the residentialcommercial and commercialresidential markets of the Americas, EMEA (Europe,Europe, and Asia-Pacific, Middle East and Africa) and Asia‑Pacific.Africa (“APMEA”), our three geographic segments. Within this framework, we focus upon three themes: safety & regulation, energy efficiency and water conservation. This strategy enables us to continue to increase our growth of earnings via increased sales growth, both organic and inorganic, and the systematic reduction of manufacturing costs and operational expenses.
We intend to continue to expand organically by introducing new complementary products and solutions in existing markets, by enhancing our preferred brands, by developing new complementary products, by promoting plumbing code development to drive the need for safety and water quality products and by continually improving merchandising in our wholesale distribution channels. We focus on selling solutions to our customers that integrate a variety of our product offerings. We target selected new productproducts and geographic markets based on growth potential, including our ability to leverage our existing distribution channels. Additionally, we leverage our distribution channels through the introduction of new products and solutions, as well as the integration of products of our acquired companies.
The Internet of Things “IoT” has allowed companies to transform components and products into smart and connected devices. We remain committed to enhancing our smart and connected capabilities by expanding our internal competencies and making strategic acquisitions. We continue to focus our efforts related to our Smart and Connected strategy by investing in IoT architecture development, enhancing digital tools used by our customers including Watts’ website, and investing in new smart and connected product development projects. Our strategy focuses on three dimensions: Connect, Control and Conserve. We have introduced and plan to continue offering new products that will connect our customers with smart systems, control systems for optimal performance, and conserve critical resources by increasing operability, efficiency and safety. Our goal is to derive 25 percent of our revenue from smart and connected products by 2023.
We intend to continue to generate incremental growth by targeting selectedselect acquisitions, both in our core markets as well asand in new complementary markets. We have completed 1112 acquisitions in the last decade. Our acquisition strategy focuses on
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businesses that manufacture preferred brand name products that address our themes of safety & regulation, energy efficiency and water conservation in our primary or related complementary markets.conservation. We target businesses that will provide us with one or more of the following: an entry into new markets, an increase in shelf space with existing customers, strong brand names, a new or improved technology or an expansion of the breadth of our product and solution offerings.
We are committed to reducing our manufacturing and operating costs using Lean methodologies to drive improvement across all key processes, and consolidating our diverse manufacturing operations and distribution centers in Americas, EMEA and Asia‑Pacific.processes. We have a number of manufacturing facilities in lower‑costlower-cost regions. In recent years, we have announced several global restructuring plans to reducewhich reduced our manufacturing and distribution footprint in order to reduce our costs and to realize additionalincremental operating efficiencies.
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Additionally, a majority of our manufacturing facilities are ISO 9000, 9001 or 9002 certified by the International Organization for Standardization.
ManyThe majority of our sales are for products that have been approved under regulatory standards incorporated into state and municipal plumbing, heating, building and fire protection codes in North America,the Americas, Europe, and certain countries within Asia-Pacific.APMEA. We have consistently advocated for the development and enforcement of plumbing codes and are committed to providing products to meet these standards, particularly for safety and control valve products.standards.
Our business is reported in three geographic segments: Americas, EMEA and Asia‑Pacific. The contributions of each segment to net sales, operating income and the presentation of certain other financial information by segment are reported in Note 16 of the Notes to Consolidated Financial Statements and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.Products
Products
We have a broad range of products in terms of design distinction, size and configuration. We classify our many products into four global product lines. These product lines are:
| 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. Residential & commercial flow control products accounted for approximately |
| HVAC & gas products—includes commercial |
| Drainage & water |
| Water quality products—includes |
Commercial and Operational Excellence
We strive to invest in product innovation that meets the wants and needs of our customers. Our focus is on differentiated products and solutions that will provide greater opportunity to distinguish and defend ourselves in the market place.marketplace. Conversely, we wantcontinue to migrate away from commoditized products where we cannotit is more difficult to add value. Our goal is to be a solutions provider, not merely a components supplier. We refer to this customer‑facingcustomer-facing mindset as commercial excellence, and we are continually looking for strategic opportunities to invest or divest, where necessary, in order to meet those objectives. In conjunction with this customer‑centriccustomer-centric focus, we continually review our operations to ensure we can efficiently and effectively produce and deliver products to customers. We are striving to simplify our administrative operations as well to drive further efficiencies. We call this aspect of our business operational excellence.
In 2015, our Board4
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we entered into an agreement to sell an operating subsidiary in China that was dedicated exclusively to the manufacturing of products being rationalized. We completed the sale in the second quarter of 2016. The second phase of the program is substantially complete and involved decreasing the square footage of our Americas facilities, which together with phase one, reduced the Americas net operating footprint by approximately 30%. The second phase is designed to improve the utilization of our remaining facilities, better leverage our cost structure, reduce working capital, and improve execution of customer delivery requirements. The second phase is expected to be complete in 2017. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion.
Customers and Markets
We sell our products to plumbing, heating and mechanical wholesale distributors and dealers, original equipment manufacturers (OEMs), specialty product distributors, and major DIYdo-it-yourself (DIY) and retail chains. In September 2015, as part of the first phase of our transformation of our Americas and Asia‑Pacific business, we divested a substantial portion of our DIY business in the Americas, which reduced the significance of DIY as a distribution channel for our products in 2016. In 2016, we added specialty as an additional primary distribution channel since this channel has become more prominent as a result of our acquisitions in recent years. This specialty channel is distinct and is managed separately from our traditional plumbing wholesale channel. The specialty channel was previously reported in the wholesale channel.
Wholesalers. Approximately 57%61% of our sales in 2016, 52%2019 and 2018, and approximately 63% of our sales in 2015, and 59% of our sales in 20142017, were to wholesale distributors for commercial and residential applications.
OEMs. Approximately 21%14%, 15% and 16% of our sales in 2016, 20% of our sales in 2015,2019, 2018 and 24% of our sales in 20142017, respectively, were to OEMs. In the Americas, our typical OEM customers are water heater manufacturers and equipment and water systems manufacturers needing flow control devices and other products. Our sales to OEMs in EMEAEurope are primarily to boiler manufacturers and radiant system manufacturers. Our sales to OEMs in Asia‑PacificAPMEA are primarily to boiler, water heater, air conditioning, and bath manufacturers, including manufacturers of faucetappliance manufacturers.
Specialty. Approximately 21%, 20% and shower products.
Specialty. Approximately 18%17% of our sales in 20162019, 2018 and 2015, and 4% of our sales in 20142017, respectively, were through our specialty channel. The specialty channel primarily includes sales related to high-efficiency boilers and water heaters, water filtration and conditioning products, specialty floor and tile products, and food service products.
DIY Chains. Approximately 4% of our sales in 2016, 10% of our sales in 20152019, 2018 and 13% of our sales in 20142017 were to DIY chains. The DIY channel primarily includes sales related to valves and a portion of our water quality products.
In 2016, 20152019, 2018 and 2014,2017, no customer accounted for more than 10% of our total net sales. Our top ten customers accounted for approximately $275.2$359.1 million, or 20% of our total net sales in 2016, $345.6 million, or 24%22.4%, of our total net sales in 2015; and $380.02019; $329.5 million, or 25%21.1%, of our total net sales in 2014.2018; and $300.6 million, or 21%, of our total net sales in 2017. Thousands of other customers constituted the balance of our net sales in each of those years.
Marketing and Sales
For product sales in the Americas, we rely primarily on commissioned manufacturers’ representatives to market our product lines, some of which maintain a consigned inventory of our products. These representatives sell primarily to plumbing and heating wholesalers and contractors or servicesupply DIY stores. Our specialty channel products in the Americas isare sold through independent representatives, dealers and distributors. We also sell products directly to wholesalers, OEMs and private label accounts primarily in EMEAEurope and Asia-Pacific,APMEA, and, to a lesser extent, in the Americas.
Manufacturing
Manufacturing
We have integrated and automated manufacturing capabilities, including a state of the art lead-free foundry anddedicated exclusively to the production of products that qualify as “lead-free” under the U.S. Safe Drinking Water Act, a traditional brass and bronze foundry, machining, plastic extrusion, and injection molding and assembly operations. Our foundry operations include metal pouring systems, automatic core making, and brass and bronze die‑castings.die-castings. Our machining operations feature computer‑controlledcomputer-controlled machine tools, high‑speedhigh-speed chucking machines with robotics, robotic assembly capability, laser cutting technology, and automatic screw machines for machining bronze, brass and steel components. Our heating and hot water product manufacturing capabilities include all phases of light and heavy gauge metal fabrication including laser cutting and the latest technology welding and brazing processes including automated and robotic applications, as well as metal finishing including chemical passivation of stainless steel. We have invested in recent years to expand our manufacturing capabilities and to ensure the availability ofadopt the most efficient and productive equipment. We are committed to maintaining our manufacturing equipment at a level consistent with current technology in order to
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maintain high levels of quality and manufacturing efficiencies. In 2016,2019, we continued to invest in our systems and in our manufacturing and training facilities.
Capital expenditures and depreciation for each of the last three years were as follows:
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Capital expenditures | | $ | 29.2 | | $ | 35.9 | | $ | 29.4 |
Depreciation | | $ | 31.0 | | $ | 28.9 | | $ | 29.7 |
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| $ | 27.7 |
| $ | 23.7 |
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| $ | 30.4 |
| $ | 31.6 |
| $ | 32.9 |
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Purchased Raw Materials and Components
We require substantial amounts ofOur products are made using various purchased components and raw materials, to produce our products, including primarily bronze, brass, cast iron, stainless steel, steel, plastic, and other materials used in our products.plastic. Substantially all of the raw materials we require to manufacture our products are purchased from outside sources. The commodity markets have experienced volatility over the past several years, particularly with respect to copper and stainless steel. BronzeTariffs impact the total cost of our products and brass are copper‑based alloys. The price of copper had steadily declined over the three previous years, however prices began to increase incomponents and raw materials that go into manufacturing them. Increased tariff costs could adversely impact the second half of 2016. We expect to see increased commodity pricing in 2017 particularly with respect to copper and steel. The fact thatgross margin we earn on our products. Because we internationally source a significant amount of raw materials means thatand components, several months of raw materials and work in process are moving through our supply chain at any point in time. We are not able to predict whether component costs or commodity costs, including copper and stainless steel, will significantly increase or decrease in the future. If component costs or commodity costs increase in the future and we are not able to reduce or eliminate the effect of the cost increases by reducing production costs or implementing price increases, our profit margins could decrease. If component costs or commodity costs were to decline, we may experience pressurespressure from customers to reduce our selling prices. The timing of any price reductions and decreases in commodity costs may not align. As a result, our margins could be affected.
With limited exceptions, we have multiple suppliers for our commoditiescomponents and other raw materials. We believe our relationships with our key suppliers are good and that an interruption in supply from any one supplier would not materially affect our ability to meet our immediate demands while another supplier is qualified. We regularly review our suppliers to evaluate their strengths. If a supplier is unable to meet our demands, we believe that in most cases our inventory of components and raw materials will allow for sufficient time to identify and obtain the necessary commodities and other raw materials from an alternate source. We believe that the nature of the commoditiescomponents and other raw materials used in our business are such that multiple sources are generally available in the market. However, our current and alternative suppliers are largely concentrated in China. The occurrence of natural disasters, public health crises such as pandemics or epidemics, political crises such as war, terrorism or political instability, or other events that result in widespread business or supply chain disruptions in China could have a material adverse effect on our ability to obtain necessary components and raw materials and our business and operating results could suffer.
The impact of the recent Novel Coronavirus (“COVID-19”) outbreak in China on our supply chain is still being assessed. We anticipate that there could be multiple logistical issues as a result of the COVID-19 outbreak depending on our ability and our supply chain’s ability to quickly ramp up production. In addition, transportation demands may cause further delays. We expect our domestic China business as well as our Americas, European and APMEA operations that rely on components and finished products from China will be impacted. See Item 1A. “Risk Factors,” and Recent Developments within Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion on the impact of the COVID-19 outbreak.
Code Compliance
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. Standards in the Americas are established by such industry test and certification organizations as the American Society of Mechanical Engineers (ASME), the America Water Works Association (AWWA), the Canadian Standards Association (CSA), the International Code Council (ICC), the American Society of Sanitary Engineering (ASSE), the American National Standards Institute—Leadership in Energy & Environmental Design (LEED), the University of Southern California Foundation for Cross‑ConnectionCross-Connection Control and Hydraulic Research (USC FCCC & HR), the International Association of Plumbing and Mechanical Officials (IAPMO), FM Global (FM), NSF International (NSF) and Underwriters Laboratories (UL), the National Board (NB), the Environmental Protection Agency (EPA), and the Californian Energy Commission (CEC), and the Plumbing and Drainage Institute (PDI). International standards are established by such organizations as the International Code Council (ICC) and the International Association of Plumbing and Mechanical Officials (IAPMO). Many of these standards are incorporated into state and municipal plumbing and heating, building and fire protection codes.
National regulatory standards in Europe vary by country. The major standards and/or guidelines that our products must meet are AFNOR (France), DVGW (Germany), UNI/ICIM (Italy), KIWA (Netherlands), SVGW (Switzerland), SITAC (Sweden), WRAS (United Kingdom) and CEN (Denmark). Further, there are local regulatory standards requiring compliance as well.
Together with our commissioned manufacturers’ representatives, weWe have consistently advocated for the development and enforcement of plumbing codes. We maintain stringent quality control and testing procedures at each of our manufacturing facilities in order to manufacture products that comply with
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code requirements. We believe that product‑testingproduct-testing capability and investment in plant and equipment are needed to manufacture products that comply with code requirements. Our product-testing capabilities and dedicated investments are areas of strength for the Company.
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us. Additionally, a majority of our manufacturing facilities are ISO 9000, 9001 or 9002 certified by the International Organization for Standardization.
New Product Development and Engineering
We retain our own product development staff, design teams, and testing laboratories in the Americas, EMEAEurope and Asia‑PacificAPMEA that work to enhance our existing products and develop new products.products and solutions with focus on innovation and smart and connected solutions. We maintain sophisticated product development and testing laboratories and are committedcontinue to investinginvest more in this area. In 2015, we re-engineered our new productWe employ a global new-product development process that is used to drive, manage and rolled out a uniform global program.invest in innovation and product offerings. In 2016,2019 and 2018, we drove innovation to our markets, including the successful roll-out of the Watts SentryPlus Alert™ connected backflow preventer, the expansion of our IntelliStation™ smart mixing system with the launch of our IntelliStation™ Junior smart mixing system, the launch of the Invita® thermostat with home automation voice recognition capabilities and the AERCO Benchmark® Platinum boiler with the new EDGE™ controller providing expanded remote monitoring and control. We continued to focus on and invest in our global new product development program and expect itto leverage our electronics capabilities to drive innovation to our markets more effectively. ResearchSmart and development costs included in selling, general, and administrative expense amounted to $26.5 million, $23.5 million and $22.5 million for the years ended December 31, 2016, 2015 and 2014, respectively.Connected strategy.
Competition
The domestic and international markets for safety & regulation, energy efficiency andefficient products, water conservation devices, and products that address the safety and regulation for the flow of fluids, are intensely competitive and require us to compete against some companies possessing greater financial, marketing and other resources than ours. Due to the breadth of our product offerings, the number and identities of our competitors vary by product line and market. We consider quality, brand preference, delivery times, engineering specifications, plumbing code requirements, price, technological expertise, breadth of product offerings and integratedsmart and connected products and solutions offerings to be the primary competitive factors. We believe that new product development and product engineering are also important to success in the water industry and that our position in the industry is attributable in part to our ability to develop new and innovative products quickly and to adapt and enhance existing products. We continue to develop new and innovative products to enhance our market position and are continuing to implementimplementing manufacturing and design programs to reduce costs. We cannot be certain that our efforts to develop new products will be successful or that our customers will accept our new products. Although we own certain patents and trademarks that we consider to be of importance, we do not believe that our business and competitiveness as a whole are dependent on any one of our patents or trademarks or on patent or trademark protection generally.
Backlog
Backlog was approximately $83.2$78.6 million at January 29, 2017December 31, 2019 and approximately $88.6$90.7 million at February 5, 2016.December 31, 2018. We do not believe that our backlog at any point in time is indicative of future operating results, and we expect our entire current backlog to be converted to sales in 2017.2020.
Employees
As of December 31, 2016,2019, we employed approximately 4,800 people worldwide. With the exception of two subsidiaries, one in Canada and the other in New York, none of our employees in North Americathe Americas or AsiaAPMEA are covered by collective bargaining agreements. In some European countries, our employees are subject to traditional national collective bargaining agreements. We believe that our employee relations are good.
Product Liability, Environmental and Other Litigation Matters
We are subject to a variety of potential liabilities connected with our business operations, including potential liabilities and expenses associated with possible product defects or failures and compliance with environmental laws. We maintain product liability and other insurance coverage, which we believe to be generally in accordance with industry practices. Nonetheless, such insurance coverage may not be adequate to protect us fully against substantial damage claims. See “Item 1A. Risk Factors” and Note 15 of the Notes to the Consolidated Financial Statements, both of which are incorporated herein by reference.
Contingencies7
Connector Class Actions
In November and December 2014, Watts Water Technologies, Inc. and Watts Regulator Co. were named as defendants in three separate putative nationwide class action complaints (Meyers v. Watts Water Technologies, Inc., United States District Court for the Southern DistrictTable of Ohio; Ponzo v. Watts Regulator Co., United States DistrictContents
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Court for the District of Massachusetts; Sharp v. Watts Regulator Co., United States District Court for the District of Massachusetts) seeking to recover damages and other relief based on the alleged failure of water heater connectors. On June 26, 2015, plaintiffs in the three actions filed a consolidated amended complaint, under the case captioned Ponzo v. Watts Regulator Co., in the United States District Court for the District of Massachusetts (hereinafter “Ponzo”). Watts Water Technologies was voluntarily dismissed from the Ponzo case. The complaint seeks among other items, damages in an unspecified amount, replacement costs, injunctive relief, declaratory relief, and attorneys’ fees and costs. On August 7, 2015, the Company filed a motion to dismiss the complaint, which motion was temporarily withdrawn pending final approval of the settlement. After initial discovery was conducted the parties agreed to a mediation of all claims, which resulted in the below-referenced settlement.
In February 2015, Watts Regulator Co. was named as a defendant in a putative nationwide class action complaint (Klug v. Watts Water Technologies, Inc., et al., United States District Court for the District of Nebraska) seeking to recover damages and other relief based on the alleged failure of the Company’s Floodsafe connectors (hereinafter “Klug”). On June 26, 2015, the Company filed a partial motion to dismiss the complaint. In response, on July 17, 2015, plaintiff filed an amended complaint which added additional named plaintiffs and sought to correct deficiencies in the original complaint, Klug v. Watts Regulator Co., United States District Court for the District of Nebraska. The complaint seeks among other items, damages in an unspecified amount, injunctive relief, declaratory relief, and attorneys’ fees and costs. On July 31, 2015, the Company filed a partial motion to dismiss the complaint which was granted in part and denied in part on December 29, 2015. The Company answered the amended complaint on February 2, 2016. No formal discovery has yet been conducted.
We participated in mediation sessions of the Ponzo and Klug cases in December 2015 and January 2016. On February 16, 2016, we reached an agreement in principle to settle all claims. The proposed total settlement amount is $14 million, of which we expect to pay approximately $4.1 million after insurance proceeds of up to $9.9 million. The parties executed final written settlement agreements in April 2016. Motions for preliminary approval of the settlements were submitted on May 4, 2016 before the District of Nebraska Federal Court. On December 7, 2016, the Court issued an order preliminarily approving the settlements. The settlements are subject to final court approval after a fairness hearing set for April 12, 2017. Accordingly, there can be no assurance that the proposed settlements will be approved in their current form. If the settlements are not approved, the Company intends to continue to vigorously contest the allegations in these cases.
Environmental Remediation
We have been named as a potentially responsible party with respect to a limited number of identified contaminated sites. The levels of contamination vary significantly from site to site as do the related levels of remediation efforts. Environmental liabilities are recorded based on the most probable cost, if known, or on the estimated minimum cost of remediation. Accruals are not discounted to their present value, unless the amount and timing of expenditures are fixed and reliably determinable. We accrue estimated environmental liabilities based on assumptions, which are subject to a number of factors and uncertainties. Circumstances that can affect the reliability and precision of these estimates include identification of additional sites, environmental regulations, level of clean‑upclean-up required, technologies available, number and financial condition of other contributors to remediation and the time period over which remediation may occur. We recognize changes in estimates as new remediation requirements are defined or as new information becomes available. See “Item 1A. Risk Factors” and Note 15 of the Notes to the Consolidated Financial Statements, both of which are incorporated herein by reference.
Asbestos Litigation
We are defending approximately 332300 lawsuits in different jurisdictions, alleging injury or death as a result of exposure to asbestos. The complaints in these cases typically name a large number of defendants and do not identify any of our particular products as a source of asbestos exposure. To date, discovery has failed to yield evidence of substantial exposure to any of our products and no judgments have been entered against us.
Other Litigation
Other lawsuits and proceedings or claims, arising from the ordinary course of operations, are also pending or threatened against us.
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Available Information
We maintain a website with the address www.wattswater.com. The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10‑K.10-K. Other than an investor’s own internet access charges, we make available free of charge through our website our Annual Report on Form 10‑K,10-K, quarterly reports on Form 10‑Q10-Q and current reports on Form 8‑K,8-K, and amendments to these reports, as soon as reasonably practicable after we have electronically filed such material with, or furnished such material to, the Securities and Exchange Commission (SEC).
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Information about Our Executive Officers and Directors
Set forth below are the names of our executive officers and directors, their respective ages and positions with our Company and a brief summary of their business experience for at least the past five years:
Executive Officers | Age | Position | ||
Robert J. Pagano, Jr. | |
| | Chief Executive Officer, President and Director |
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| | Chief Financial Officer |
Jennifer L. Congdon | |
| | Chief Human Resources Officer |
Kenneth R. Lepage | |
| | General Counsel, Executive Vice President & Secretary |
Elie A. Melhem | |
| | President, |
Munish Nanda | |
| | President, Americas & Europe |
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Christopher L. Conway(2)(3) | |
| | Director |
David A. Dunbar(1)(3) | |
| | Director |
Louise K. Goeser(2)(3) | | 66 | | Director |
Jes Munk Hansen(2)(3) | |
| | Director |
W. Craig Kissel(3) | |
| | Chairman of the Board and Director |
Joseph T. Noonan | |
| | Director |
Merilee Raines(1)(3) | |
| | Director |
Joseph W. Reitmeier(1)(3) | |
| | Director |
| (1) |
| Member of the Audit Committee |
| (2) |
| Member of the Compensation Committee |
| (3) |
| Member of the Nominating and Corporate Governance Committee |
Robert J. Pagano, Jr. has served as Chief Executive Officer, President and Presidenta director of our Company since May 2014. He also served as interim Chief Financial Officer from October 2014 to April 2015.2015 and from April 2018 to July 2018. Mr. Pagano previously served as Senior Vice President of ITT Corporation and President, ITT Industrial Process from April 2009 to May 2014. Mr. Pagano originally joined ITT in 1997 and served in several additional management roles during his career at ITT, including as Vice President Finance, Corporate Controller, and President of Industrial Products. ITT Corporation is a diversified manufacturer of highly engineered critical components and customized technology solutions for the energy, transportation and industrial markets. Prior to joining ITT, Mr. Pagano worked at KPMG LLP. Mr. Pagano is a Certified Public Accountant. Mr. Pagano has also served as a member of the Board of Directors of Applied Industrial Technologies, Inc. since August 2017. Applied Industrial Technologies is a distributor of bearings, power transmission products, fluid power components and other industrial supplies and provides engineering, design and systems integration for industrial and fluid power applications, as well as customized mechanical, fabricated rubber and fluid power shop services.
Todd A. TrappShashank Patel has served as Chief Financial Officer of our Company since April 2015.July 2018. Mr. TrappPatel previously worked at Xylem Inc. from the time of its spin-off from ITT Corporation in 2011 until June 2018. While at Xylem, Mr. Patel served as Vice President, of Financial Planning & Analysis of Honeywell International Inc.Finance for Xylem Applied Water Systems, Dewatering and the America’s Commercial Team from July 2017 to June 2018, Integration Leader for the Sensus business from August 20132016 to June 2017, Vice President, Finance for Global Operations from April 2015. Mr. Trapp originally joined Honeywell in 2002 and served in several senior financial roles, including as2016 to July 2016, Interim Chief Financial Officer of the Airlines Business UnitXylem from November 2010July 2015 to August 2013,March 2016, and Vice President, of Business Analysis & Planning for Honeywell’s Aerospace Division from 2008 to November 2010, Director of Finance for the TransportationApplied Water Systems Divisiondivision from 20062011 to 2008, DirectorJuly 2015. Mr. Patel also served in several leadership roles in finance, operations and engineering at ITT from 1996 until the spin-off of Business Analysis & Planning from 2005 to 2006, Investor Relations Manager
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from 2003 to 2005 and Senior Financial Analyst from 2002 to 2003. HoneywellXylem in 2011. Xylem is a Fortune 100 diversified technologyglobal designer, manufacturer and manufacturing leader, serving customers worldwide with aerospace productsequipment and services; control technologiesservice provider for buildings, homeswater and industry; turbochargers; and performance materials. Prior to joining Honeywell, Mr. Trapp worked as Assistant Treasurer at United Business Media Inc. and Manager of Treasury Services and Special Projects at Pearson Inc.wastewater applications.
Jennifer L. Congdon has served as Chief Human Resources Officer since December 2016. Ms. Congdon previously served as Vice President, Human Resources, Applied Water Systems and Business Transformation and Continuous Improvement with Xylem Inc. from August 2012 to December 2016. Xylem is a global designer, manufacturer and equipment and service provider for water and wastewater applications. From 2010 to August 2012, Ms. Congdon served
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as Vice President, Human Resources, Power Transmission for Rexnord Corporation. Rexnord Corporation is a multi-industry manufacturer and marketer of highly engineered mechanical power transmission components and water management products. From 2004 to 2010, Ms. Congdon held several human resources management positions of increasing responsibility with Honeywell International Inc. Prior to joining Honeywell, Ms. Congdon was a Human Resources Manager with Cisco Systems, Inc. and worked as a human resources consultant.
Kenneth R. Lepage has served as General Counsel, Executive Vice President and Secretary of the Company since August 2008. He also served as Executive Vice President of Human Resources from December 2009 to October 2015. Mr. Lepage originally joined our Company in September 2003 as Assistant General Counsel and Assistant Secretary. Prior to joining our Company, he was a junior partner at the law firm of Hale and Dorr LLP (now Wilmer Cutler Pickering Hale and Dorr LLP).
Elie A. Melhem has served as President, Asia‑Asia Pacific, Middle East & Africa since February 2016. Mr. Melhem originally joined our Company in July 2011 as President, Asia‑Asia Pacific. Mr. Melhem was previously the Managing Director of China for Ariston Thermo Group, a global manufacturer of heating and hot water products, from 2008 to July 2011. Prior to joining Ariston, Mr. Melhem spent eleven years with ITT Industries in China where he held several management positions, including serving as President of ITT’s Residential and Commercial Water Group in China and President of ITT’s Water Technology Group in Asia.
Munish Nanda has served as President, Americas & Europe since February 2016. Mr. Nanda originally joined our Company in April 2015 as President, Americas. Mr. Nanda previously served as President of Control Technologies for ITT Corporation from April 2011 to March 2015. Mr. Nanda also served as Group Vice President of ITT Corporation’s Fluid and Motion Control Group from April 2008 to April 2011. ITT Corporation is a diversified manufacturer of highly engineered critical components and customized technology solutions for the energy, transportation and industrial markets. Prior to joining ITT Corporation, Mr. Nanda held several operating leadership and general management positions with Thermo Fisher Scientific Corporation and Honeywell International Inc.
Robert L. Ayers Mr. Nanda has also served as a director of our Company since October 2006. He was Senior Vice President of ITT Industries and President of ITT Industries’ Fluid Technology from October 1999 until September 2005. Mr. Ayers continued to be employed by ITT Industries from September 2005 until his retirement in September 2006, during which time he focused on special projects for the company. Mr. Ayers joined ITT Industries in 1998 as President of ITT Industries’ Industrial Pump Group. Before joining ITT Industries, he was President of Sulzer Industrial USA and Chief Executive Officer of Sulzer Bingham, a pump manufacturer. Mr. Ayers served as a director of T‑3 Energy Services, Inc. from August 2007 to January 2011.
Bernard Baert has served as a director of our Company since August 2011. Mr. Baert served as Senior Vice President and President, Europe and International of PolyOne Corporation from January 2010 until his retirement in April 2012. Mr. Baert served as Senior Vice President and General Manager, Color and Engineered Materials—Europe and China for PolyOne Corporation from 2006 to December 2009 and as Vice President and General Manager, Color and Engineered Materials—Europe and China from 2000 to 2006. From 1995 to September 2000, Mr. Baert was General Manager, Color—Europe for M.A. Hanna Company, the predecessor to PolyOne Corporation. PolyOne Corporation is a worldwide provider of specialty polymer materials, services and solutions. Prior to joining M.A. Hanna, Mr. Baert was General Manager, Europe for Hexcel Corporation and spent 17 years with Owens Corning where he served as a plant manager and held various positions in the areas of cost control and production. On December 9, 2016, Mr. Baert informed us of his decision not to stand for re-election to our Board of Directors at our 2017 Annual Meeting of Stockholders.
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Richard J. Cathcart has served as a director of our Company since October 2007. He was Vice Chairman and a member of the Board of Directors of Pentair, Inc. from February 2005 until his retirement in September 2007. Pentair is a diversified manufacturing company consisting of three operating segments: Flow & Filtration Solutions, Water Quality SystemsCECO Environmental Corp. since June 2018. CECO Environmental provides air quality and Technical Solutions. He was appointed Presidentfluid handling products and Chief Operating Officer of Pentair’s Water Quality Systems group in January 2001solutions serving the energy, industrial and served in that capacity until his appointment as Vice Chairman in February 2005. He began his career at Pentair in March 1995 as Executive Vice President, Corporate Development, where he identified water as a strategic area of growth. In February 1996, he was named Executive Vice President and President of Pentair’s Water Technologies Group. Prior to joining Pentair, he held several management and business development positions during his 20‑year career with Honeywell International Inc. He is a director of Fluidra S.A., an international manufacturer of accessories and products for swimming pools, irrigation, and water treatment and purification systems.other niche markets.
Christopher L. Conway has served as a director of our Company since June 2015. Mr. Conway is currentlywas President, and Chief Executive Officer and Chairman of the Board of CLARCOR Inc. from December 2011 until it was acquired in February 2017. Mr. Conway has been employed byis now retired. Mr. Conway originally joined CLARCOR or its affiliates sincein 2006 when he was namedand served in several senior management roles prior to becoming President and Chief Executive Officer, including Chief Operating Officer, President of CLARCOR’s PECOFacet division, President of Facet USA, Inc., an affiliate of CLARCOR, and Vice President of Manufacturing of Baldwin Filters, Inc., an affiliate of CLARCOR. In September 2007, Mr. Conway was promoted to the position of President of Facet USA, Inc., another affiliate of CLARCOR. HeCLARCOR was then named President of CLARCOR’s PECOFacet division in December 2007 and continued in that role until being named as President and Chief Operating Officer of CLARCOR in May 2010. In December 2011, Mr. Conway assumed the position of President and Chief Executive Officer of CLARCOR. CLARCOR is a diversified marketer and manufacturer of mobile, industrial and environmental filtration products sold in domestic and international markets. Prior to joining CLARCOR, or its affiliates, Mr. Conway served for two years as the Chief Operating Officer of Cortron Corporation, Inc., a small manufacturing start‑upstart-up based in Minneapolis, Minnesota. Mr. Conway also served for seven years in various management positions at Pentair, Inc., an international provider of products, services, and solutions for its customers’customers' diverse needs in water and other fluids, thermal management, and equipment protection.protection.
David A. Dunbar has served as a director of our Company since February 2017. Mr. Dunbar has served as President and Chief Executive Officer and a member of the Board of Directors of Standex International Corporation since January 2014.2014, and as Chairman since October 2016. Standex is a global, multi-industry manufacturer in five broad business segments: Food Service Equipment Group, Engineering Technologies Group, Engraving Group, Electronics Group, and Hydraulics Group. Mr. Dunbar previously served as President of the valves and controls global business unit of Pentair Ltd. from October 2009 to December 2013. The unit was initially owned by Tyco Flow Control and Tyco Flow Control and Pentair merged in 2012. Pentair is a global provider of products and services relating to energy, water, thermal management and equipment protection. Prior to his tenure at Pentair, Mr. Dunbar held a number of senior positions at Emerson Electric Co., including President of each of the following: Emerson Process Management Europe; Machinery Health Management; and Emerson Climate Technologies Refrigeration.
Louise K. Goeser has served as a director of our Company since March 2018. Ms. Goeser served as President and Chief Executive Officer of Grupo Siemens S.A. de C.V. from March 2009 until her retirement in May 2018. In this position, Ms. Goeser was responsible for Siemens Mesoamérica, which is the Mexican, Central American and Caribbean unit of multinational Siemens AG, a global engineering company operating in the industrial, energy and healthcare sectors. Ms. Goeser previously served as President and Chief Executive Officer of Ford of Mexico from January 2005 to November 2008. Prior to this position, she served as Vice President, Global Quality for Ford Motor Company from 1999 to 2005.
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Prior to 1999, Ms. Goeser served as General Manager, Refrigeration and Vice President, Corporate Quality at Whirlpool Corporation and held various leadership positions with Westinghouse Electric Corporation. Ms. Goeser has served as a member of the Board of Directors of MSC Industrial Direct Co., Inc. since December 2009. MSC is a North American distributor of metal working and maintenance, repair, and operations products and services. Ms. Goeser previously served as a member of the boards of directors of Talen Energy from June 2015 to December 2016, PPL Corporation from March 2003 to June 2015, and Witco Corporation from 1997 to 1999.
Jes Munk Hansenhas served as a director of our Company since February 2017. Mr. Hansen hasjoined Terma A/S in April 2019 and became President and Chief Executive Officer of Terma on June 1, 2019. Terma develops and manufactures mission-critical products and solutions for the aerospace, defense and security sectors. Prior to Terma, Mr. Hansen served as Chief Executive Officer of OSRAM USA and Head of Global Sales for OSRAM GmbH from July 2018 to January 2019. OSRAM is a global lighting manufacturer with a portfolio ranging from high-tech applications based on semiconductor technology to smart and connected lighting solutions in buildings and cities. Mr. Hansen previously served as Chief Executive Officer of LEDVANCE GmbH sincefrom July 2015.2015 to December 2017. LEDVANCE is the general lighting lamps business unit of OSRAM GmbH. Prior to his tenure at LEDVANCE, Mr. Hansen previously served as Chief Executive Officer of the classical lamps and ballast business unit of OSRAM from January 2015 to July 2015 and as Chief Executive Officer of OSRAM Americas and President of OSRAM Sylvania from October 2013 to January 2015. OSRAM is a leading global lighting manufacturer. Prior to his tenure at OSRAM, Mr. Hansen served in several senior management roles with Grundfos from 2000 to October 2013, including as Chief Executive Officer and President of Grundfos North America from 2007 to October 2013. Grundfos is a leading global manufacturer of pumps as well as motors and electronics for monitoring and controlling pumps.
W. Craig Kissel has served as a director of our Company since NovemberOctober 2011. Mr. Kissel previously was employed by American Standard Companies Inc. from 1980 until his retirement in September, 2008. American Standard was a leading worldwide supplier of air conditioning and heating systems, vehicle control systems, and bathroom china and faucet‑faucet ware. During his time at American Standard, Mr. Kissel served as President of Trane Commercial Systems from 2004 to June, 2008, President of WABCO Vehicle Control Systems from 1998 to 2003, President of the Trane North American Unitary Products Group from 1994 to 1997, Vice President of Trane Marketing of the North American Unitary Products Group from 1992 to 1994 and he held various other management positions at Trane from 1980 to 1991. From 2001 to 2008, Mr. Kissel served as Chairman of American Standard’s Corporate Ethics and Integrity Council, which was responsible for developing the company’s ethical business standards. Mr. Kissel also served in the U.S. Navy from 1973 to 1978. Mr. Kissel has served as a director of Chicago Bridge & Iron Company sincefrom May 2009. Chicago Bridge & Iron Company engineers2009 until its merger with McDermott International, Inc. in May 2018 and constructs someMr. Kissel has served as a member of the world’s largestboard of directors of McDermott International since the merger. McDermott International is a global provider of technology, engineering and construction solutions for the energy infrastructure projects.industry.
Joseph T. Noonan has served as a director of our Company since May 2013. Mr. Noonan hasmost recently served as Founder and Chief Executive Officer of Linger Home, Inc., a direct-to-consumer home textile brand, from August 2018 to January 2020. From November 2013 to January 2018, Mr. Noonan served as Chief Executive Officer of Homespun Design, Inc. since November 2013. Homespun Design is a start‑up phase, an online retailer of American‑mademarketplace for American-made furniture and design founded by Mr. Noonan.home accents. Mr. Noonan previously worked as an independent digital strategy consultant from November 2012 to November 2013. Mr. Noonan was employed by Wayfair LLC from April 2008 to November 2012. During his time at Wayfair, Mr. Noonan served as Senior Director of Wayfair International from June 2011 to November 2012, Director of Category Management and Merchandising from February 2009 to June 2011 and Manager of Wayfair’s Business‑to‑BusinessBusiness-to-Business Division from April 2008 to February 2009. Wayfair is an online retailer of home furnishings, décor and home improvement products. Prior to joining Wayfair, Mr. Noonan worked as a venture capitalist at Polaris Partners and as an investment banker at Cowen & Company.
Merilee Raines has served as a director of our Company since February 2011. Ms. Raines served as Chief Financial Officer of IDEXX Laboratories, Inc. from October 2003 until her retirement in May 2013. Prior to becoming Chief Financial Officer, Ms. Raines held several management positions with IDEXX Laboratories, including Corporate Vice President of Finance, Vice President and Treasurer of Finance, Director of Finance, and Controller. IDEXX Laboratories develops, manufactures and distributes diagnostic and information technology‑basedtechnology-based products and services for companion animals, livestock, poultry, water quality and food safety, and human point‑of‑point of care diagnostics. Ms. Raines served as a member of the Board of Directors of Affymetrix, Inc., a provider of life science and molecular diagnostic products that enable analysis of biological systems at the gene, protein and cell level, from January 2015 until it was acquired in March 2016. Ms. Raines isalso served as a member of the Board of Directors of Aratana Therapeutics, Inc., a
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pet therapeutics company focused on licensing, developing and commercializing biopharmaceutical products for companion animals.animals, from February 2014 until it was acquired in July 2019. Ms. Raines also serves as a member of the Board of Directors of Benchmark Electronics, Inc., a worldwide provider of engineering services, integrated technology solutions and electronic manufacturing services.
Joseph W. Reitmeier has served as a director of our Company since February 2016. Mr. Reitmeier has served as Executive Vice President & Chief Financial Officer of Lennox International Inc. since July 2012. Mr. Reitmeier had served as Vice President of Finance for the LII Commercial business segment of Lennox International from 2007 to July 2012 and as Director of Internal Audit from 2005 to 2007. Lennox International is a leading global provider of climate control solutions and designs, manufactures and markets a broad range of products for the heating, ventilation, air conditioning and refrigeration markets. Before joining Lennox International, Mr. Reitmeier held financial leadership roles at Cummins Inc. and PolyOne Corporation.
Item 1A. RISK FACTORS.
Economic cycles, particularly those involving reduced levels of commercial and residential starts and remodeling, may have adverse effects on our revenues and operating results.
We have experienced and expect to continue to experience fluctuations in revenues and operating results due to economic and business cycles. The businesses of most of our customers, particularly plumbing and heating wholesalers and OEM manufacturers, are cyclical. Therefore, the level of our business activity has been cyclical, fluctuating with economic cycles. An economic downturn may also affect the financial stability of our customers, which could affect their ability to pay amounts owed to their vendors, including us. We also believe our level of business activity is influenced by commercial and residential starts and renovation and remodeling, which are, in turn, heavily influenced by interest rates, consumer debt levels, changes in disposable income, employment growth and consumer confidence. Credit market conditions may prevent commercial and residential builders or developers from obtaining the necessary capital to continue existing projects or to start new projects. This may result in the delay or cancellation of orders from our customers or potential customers and may adversely affect our revenues and our ability to manage inventory levels, collect customer receivables and maintain profitability. If economic conditions worsen in the future or if economic recovery were to dissipate, our revenues and profits could decrease or trigger additional goodwill, indefinite‑livedindefinite-lived intangible assets, or long‑livedlong-lived asset impairments and could have a material effect on our financial condition and results of operations.
We face intense competition and, if we are not able to respond to competition in our markets, our revenues and profits may decrease.
Competitive pressures in our markets could adversely affect our competitive position, leading to a possible loss of market share or a decrease in prices, either of which could result in decreased revenues and profits. We encounter intense competition in all areas of our business. Additionally, we believe our customers are attempting to reduce the
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number of vendors from which they purchase in order to reduce the size and diversity of their inventories and their transaction costs. To remain competitive, we will need to invest continually in manufacturing, product development, marketing, customer service and support and our distribution networks. We may not have sufficient resources to continue to make such investments and we may be unable to maintain our competitive position. In addition, we anticipate that we may have to reduce the prices of some of our products to stay competitive, potentially resulting in a reduction in the profit margin for, and inventory valuation of, these products. Some of our competitors are based in foreign countries and have cost structures and prices in foreign currencies. Accordingly, currency fluctuations could cause our U.S. dollar costed products to be less competitive than our competitors’ products costed in other currencies.
We face risks related to the impact of COVID-19 that originated in China, which may reduce or halt the operations of our facilities or the facilities of third parties on which we depend, and could impact our supply chain and our ability to meet customer demand for our products.
A new coronavirus that was first detected in Hubei Province, China has spread rapidly in many parts of China and in a growing number of international locations. The virus has resulted in travel restrictions into and out of China, the temporary closure of stores and facilities operated by multinational corporations in China, and significantly reduced production capacity at many factories in China, including our own factory in Ningbo, China. The reduction in
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production capacity at factories in China may reduce or even halt the supply of finished goods and necessary components for many of our products, which could result in product shortages and an increase in our inventory of unfinished products. Further, there may be logistics issues, including our ability and our supply chain’s ability to quickly ramp up production, and transportation demands that may cause further delays. We expect our domestic China business as well as our Americas, European and APMEA operations that rely on components and finished products from China will be impacted through reduced sales and manufacturing absorption issues. We are presently estimating sales may be reduced by $10 million to $20 million in the first quarter of 2020 due to the impact of the COVID-19 outbreak. This assumes China production, supply chain, and logistics return to normal by early March. Given the matter’s complexity and recent timing we are closely monitoring the situation as it evolves. We have updated our full year 2020 outlook for the expected impact of the COVID-19 outbreak, which assumes returning to normal business operations by early March, but will continue to assess the full year impact as the matter progresses.
Changes in the costs of raw materials and purchased components, including imposition of or changes in tariff rates, could reduce our profit margins. Reductions or interruptions in the supply of raw materials, components or finished goods from international sources could adversely affect our ability to meet our customer delivery commitments.
We require substantial amounts ofOur products are made using various purchased components and raw materials, including primarily bronze, brass, cast iron, stainless steel, steel and plastic, and substantiallyplastic. Substantially all of the raw materials we require to manufacture our products are purchased from outside sources. The costs of raw materials and components may be subject to change due to, among other things, interruptions in production by suppliers, and changes in exchange rates, imposition of or changes in tariff rates, and worldwide price and demand levels. We typically do not enter into long‑termlong-term supply agreements. Our inability to obtain supplies of raw materials and purchased components for our products at favorable costs could have a material adverse effect on our business, financial condition or results of operations by decreasing our profit margins. The commodity marketsCommodity prices, particularly copper and stainless-steel prices, have experienced tremendous volatility over the past several years, particularly copper.years. Should commodity costs or purchased component costs increase substantially, we may not be able to recover such costs, through selling price increases to our customers or other product cost reductions, which would have a negative effect on our financial results. If commodity costs or purchased component costs decline, we may experience pressure from customers to reduce our selling prices. Additionally, we continue to purchase increased levels of components and finished goods from international sources. In limited cases, these components or finished goods are single‑sourced.single-sourced. The availability of components and finished goods from international sources could be adversely impacted by, among other things, interruptions in production by suppliers including due to pandemics or other public health crises, suppliers’ allocations to other purchasers and new laws, tariffs, or regulations.
We are subject to risks associated with changing technology, manufacturing techniques, distribution channels and business continuity, which could place us at a competitive disadvantage.
The successful implementation of our business strategy requires us to continually evolve our existing products and introduce new products to meet customers’ needs in the industries we serve, as evidenced by our investments into our Smart and Connected strategy. Many of our products are characterized by stringent performance and specification requirements that mandate a high degree of manufacturing, engineering, and technological expertise. If we fail to meet these requirements, or if our product offerings, including our smart and connected products, are not accepted by the market, our business could be at risk. We believe that our customers rigorously evaluate their suppliers on the basis of a number of factors, including product quality, price competitiveness, technical and manufacturing expertise, development and product design capability, new product innovation, reliability and timeliness of delivery, operational flexibility, customer service and overall management. Our success will depend on our ability to continue to meet customers’ changing specifications with respect to these criteria. We cannot ensure that we will be able to address technological advances or introduce new products that may be necessary to remain competitive within our business. We cannot ensure that we can adequately protect any of our technological developments to produce a sustainable competitive advantage. Furthermore, we may be subject to business continuity risk in the event of an unexpected loss of a material facility or operation. We cannot ensure that we adequately protect against such loss.
Our business and financial performance may be adversely affected by information technology and other business disruptions.
Our business may be impacted by disruptions, including information technology attacks or failures, threats to physical security, as well as damaging weather or other acts of nature. Our information technology risks relate to cyber security
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attacks and disruptions caused by potential failures in the performance of our primary enterprise resource planning (ERP) system. Cyber security attacks, in particular, are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and corruption of data. Cyber security may also be breached due to employee error, malfeasance, system errors or vulnerabilities, including vulnerabilities of our customers, vendors, suppliers, and their products. In addition, we have designed products and services that connect to and are part of the “Internet of Things” which may also be vulnerable to cyber security breaches. We attempt to provide adequate security measures to safeguard our products from cyber security attacks, however the potential for a breach remains. We have experienced cyber security attacks and may continue to experience them going forward, potentially with more frequency. We also may experience unplanned system interruptions or outages of our primary ERP system as it continues to age, which may affect our ability to support and maintain the system in an effective manner. Any disruptions, delays or deficiencies related to our primary ERP system could lead to substantial business interruption, including our ability to perform routine business transactions, which could have a material adverse effect on our financial results.
Given the unpredictability of the timing, nature and scope of such disruptions, we could potentially be subject to production downtimes, operational delays, other detrimental impacts on our operations or ability to provide products to our customers, the compromising of confidential or otherwise protected information, misappropriation, destruction or corruption of data, security breaches, other manipulation or improper use of our systems, networks or our products, financial losses from remedial actions, loss of business or potential liability, and/or damage to our reputation, any of which could have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.
Changes in regulations or standards could adversely affect our businessbusiness.
Our products and business are subject to a wide variety of statutory, regulatory and industry standards and requirements. A significant change to regulatory requirements, whether federal, foreign, state or local, or to industry standards, could substantially increase manufacturing costs, impact the size and timing of demand for our products, or put us at a competitive disadvantage, any of which could harm our business and have a material adverse effect on our financial condition, results of operations and cash flow.
Implementation of our acquisition strategy may not be successful, which could affect our ability to increase our revenues or our profitability.
One of our strategies is to increase our revenues and profitability and expand our business through acquisitions that will provide us with complementary products and increase market share for our existing product lines. We cannot be certain that we will be able to identify, acquire or profitably manage additional companies or successfully integrate such additional companies without substantial costs, delays or other problems. Also, companies acquired recently and in the future may not achieve anticipated revenues, cost synergies, profitability or cash flows that justify our investment in them. We have faced increasing competition for acquisition candidates, which has resulted in significant increases in the purchase prices of many acquisition candidates. This competition, and the resulting purchase price increases, may limit the number of acquisition opportunities available to us, possibly leading to a decrease in the rate of growth of our revenues and profitability. In addition, acquisitions may involve a number of risks, including, but not limited to:
| inadequate internal |
| adverse |
| diversion of management’s attention; |
| investigations of, or challenges to, acquisitions by competition authorities; |
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| loss of key personnel at acquired companies; |
| unanticipated management or operational problems or legal liabilities; and |
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| potential goodwill, |
We are subject to risks related to product defects, which could result in product recalls and could subject us to warranty claims in excess of our warranty provisions or which are greater than anticipated due to the unenforceability of liability limitations.
We maintain strictcannot be certain that our quality controls and procedures, including the testing of raw materials and safety testing of selected finished products. However, we cannot be certain that our testingproducts, will reveal latent defects in our products or the materials from which they are made, which may not become apparent until after the products have been sold into the market. We also cannot be certain that our suppliers will always eliminate latent defects in products we purchase from them. Accordingly, there is a risk that product defects will occur, which could require a product recall. Product recalls can be expensive to implement and, if a product recall occurs during the product’s warranty period, we may be required to replace the defective product. In addition, a product recall may damage our relationship with our customers and we may lose market share with our customers. Our insurance policies may not cover the costs of a product recall.
Our standard warranties contain limits on damages and exclusions of liability for consequential damages and for misuse, improper installation, alteration, accident or mishandling while in the possession of someone other than us. We may incur additional operating expenses if our warranty provision does not reflect the actual cost of resolving issues related to defects in our products. If these additional expenses are significant, it could adversely affect our business, financial condition and results of operations.
We face risks from product liability and other lawsuits, which may adversely affect our business.
We have been and expect to continue to be subject to various product liability claims or other lawsuits, including, among others, that our products include inadequate or improper instructions for use or installation, inadequate warnings concerning the effects of the failure of our products, alleged manufacturing or design defects, or allegations that our products containedcontain asbestos. If we do not have adequate insurance or contractual indemnification, damages from these claims would have to be paid from our assets and could have a material adverse effect on our results of operations, liquidity and financial condition. Like other manufacturers and distributors of products designed to control and regulate fluids and gases, we face an inherent risk of exposure to product liability claims and other lawsuits in the event that the use of our products results in personal injury, property damage or business interruption to our customers. We cannot be certain that our products will be completely free from defect. In addition, in certain cases, we rely on third‑partythird-party manufacturers for our products or components of our products. We cannot be certain that our insurance coverage will continue to be available to us at a reasonable cost, or, if available, will be adequate to cover any such liabilities. For more information, see “ItemItem 1. Business—Product Liability, Environmental and Other Litigation Matters.”Matters” and Note 15 of the Notes to the Consolidated Financial Statements, both of which are incorporated herein by reference.
We face risks from costs for environmental compliance and/or to address potential liabilities under environmental laws and regulations.
Our operations and facilities worldwide are subject to laws and regulations related to pollution and the protection of the environment, health and safety, including, but not limited to those governing air emissions, discharges to water, the generation, handling, storage, treatment and disposal of hazardous wastes and other materials, and the remediation of contaminated sites. A failure by us to comply with applicable requirements or maintain the permits required for our operations could result in civil or criminal fines, penalties, enforcement actions, third-party claims for property damage and personal injury, requirements to clean up property or to pay for the costs of cleanup or regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, including the installation of pollution control equipment or remedial actions.
Certain environmental laws and regulations impose on present and former owners and operators of facilities and sites, and on potentially responsible parties (“PRPs”) for sites to which such parties may have sent waste for disposal, requirements to investigate and remediate contamination. Such liability can be imposed without regard to fault and, under certain circumstances, may be joint and several, resulting in one PRP being held responsible for the entire obligation. Liability may also include damages to natural resources. On occasion we are involved in such investigations and/or cleanup, and also have been or could be named as a PRP in environmental matters.
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The discovery of additional contamination, including at acquired facilities, the imposition of more stringent environmental, health and safety laws and regulations, including cleanup requirements, or the insolvency, or other grounds for refusing to participate, of other responsible parties could require us to incur capital expenditures or operating costs materially in excess of our accruals. Future investigations we undertake may lead to discoveries of contamination that must be remediated, and decisions to close facilities may trigger remediation requirements that are not currently applicable. We may also face liability for alleged personal injury or property damage due to exposure to hazardous substances used or disposed of by us, contained within our current or former products, or present in the soil or groundwater at our current or former facilities. We could incur significant costs in connection with such liabilities. See Item 1. Business—Product Liability, Environmental and Other Litigation Matters and Note 15 of the Notes to the Consolidated Financial Statements, both of which are incorporated herein by reference.
Economic and other risks associated with international sales and operations could adversely affect our business and future operating results.
Since we sell and manufacture our products worldwide, our business is subject to risks associated with doing business internationally. Our business and future operating results could be harmed by a variety of factors, including:
| unexpected |
| our |
| trade protection measures and import or export duties or licensing requirements, which could increase our costs of doing business internationally; |
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| potentially negative consequences from changes in tax laws, which could have an adverse impact on our profits; |
| difficulty in staffing and managing widespread operations, which could reduce our productivity; |
| costs of compliance with differing labor regulations, especially in connection with restructuring our overseas operations; |
| laws of some foreign countries, which may not protect our intellectual property rights to the same extent as the laws of the U.S.; |
| unexpected changes in regulatory requirements, which may be costly and require time to implement; and |
| foreign exchange rate fluctuations, which could also materially affect our reported results. A portion of our sales and certain portions of our costs, assets and liabilities are denominated in currencies other than U.S. |
Our ability to achieve savings through our restructuring and business transformation activities may be adversely affected by management’s ability to fully execute the plans as a result of local regulations, geo‑politicalgeo-political risk or other factors within or beyond the control of management.
We have implemented a number of restructuring and business transformation activities, which include steps that we believe are necessary to enhance the value and performance of the Company, including reducing operating costs and increasing efficiencies throughout our manufacturing, sales and distribution footprint. Factors within or beyond the control of management may change the total estimated costs or the timing of when the savings will be achieved under the plans. Further, if we are not successful in completing the restructuring or business transformation activities timely or
16
if additional or unanticipated issues such as labor disruptions, inability to retain key personnel during and after the transformation or higher exit costs arise, our expected cost savings may not be met and our operating results could be negatively affected. In addition, our restructuring and transformation activities may place substantial demands on our management, which could lead to diversion of management’s attention from other business priorities and result in a reduced customer focus.
FutureOur operating results could be negatively affected by changes in tax rates, the resolutionadoption of new tax legislation, or exposure to additional tax liabilities.
As a global company, we are subject to taxation in numerous countries, states and other jurisdictions. As a result, our effective rate is derived from a combination of applicable tax rates in the various places that we operate. Our future taxes could be affected by numerous factors including changes in the mix of our profitability from country to country, the results of examinations and audits of our tax filings, adjustments to our uncertain tax positions, changes in accounting for income taxes and by potential changes toin tax incentives.laws.
In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Significant judgment is required in determining our worldwide provision for income taxes. We periodically assess our exposures related to our worldwideglobal provision for income taxes, deferred tax assets or liabilities, and in evaluating our tax positions. Although we believe that we have appropriately accrued taxes for contingencies. Any reduction of these contingent liabilities or additional assessment would increase or decrease income, respectively, in the period such determination was made. Our incomeour estimates are reasonable, our tax filings are regularly under audit by tax authorities and the final determination ofultimate tax audits could beoutcome may differ from the amounts recorded and may materially different than that which is reflected in historical income tax provisions and accruals. As issues arise during tax audits we adjustaffect our tax accrual accordingly. Additionally, we benefit from certain tax incentives offered by various jurisdictions. If certain tax incentives were discontinued or if we are unable to meet the requirements of such incentives, our inability to use these benefits could have a material negative effect on future earnings.
We are currently a decentralized company, which presents certain risks.
We are currently a decentralized company, which sometimes places significant control and decision‑making powersfinancial results in the hands of local management. This presents various risksperiod or periods for which such as the risk of being slower to identify or react to problems affecting a key business. Additionally, we are implementing in a phased approach a company‑wide initiative
14
to standardize and upgrade our enterprise resource planning (ERP) systems. This initiative could be more challenging and costly to implement because divergent legacy systems currently exist. Further, if the ERP updates are not successful, we could incur substantial business interruption, including our ability to perform routine business transactions, which could have a material adverse effect on our financial results.determination is made.
Our business and financial performance may be adversely affected by information technology and other business disruptions.
Our business may be impacted by disruptions, including information technology attacks or failures, threats to physical security, as well as damaging weather or other acts of nature, pandemics or other public health crises. Cyber security attacks, in particular, are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and corruption of data. We have experienced cyber security attacks and may continue to experience them going forward, potentially with more frequency. Given the unpredictability of the timing, nature and scope of such disruptions, we could potentially be subject to production downtimes, operational delays, other detrimental impacts on our operations or ability to provide products to our customers, the compromising of confidential or otherwise protected information, misappropriation, destruction or corruption of data, security breaches, other manipulation or improper use of our systems or networks, financial losses from remedial actions, loss of business or potential liability, and/or damage to our reputation, any of which could have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.
The requirements to evaluate goodwill, indefinite‑livedindefinite-lived intangible assets and long‑livedlong-lived assets for impairment may result in a write‑offwrite-off of all or a portion of our recorded amounts, which would negatively affect our operating results and financial condition.
As of December 31, 2016,2019, our balance sheet included goodwill, indefinite‑livedindefinite-lived intangible assets, amortizable intangible assets and property, plant and equipment of $532.7$581.1 million, $35.3$35.8 million, $167.2$115.6 million and $189.7$200.0 million, respectively. In lieu of amortization, we are required to perform an annual impairment review of both goodwill and indefinite‑livedindefinite-lived intangible assets. In performing our annual reviews in 2016, 20152019, 2018, and 2014, we recognized pre‑tax non‑cash indefinite‑lived intangible asset impairment charges of approximately $0.4 million, $0.6 million and $1.3 million, respectively. In 2016,2017, none of our goodwill reporting units or our indefinite lived tradenames were impaired. In 2015 and 2014, we did recognize pre‑tax non‑cash goodwill impairment charges of $129.7 million and $12.9 million, respectively. The $129.7 million charge in 2015 related to an impairment within the EMEA reporting unit and represented approximately 74% of the reporting unit’s goodwill balance. The $12.9 million charge in 2014 related to a full impairment within the Asia‑Pacific reporting unit. We are also required to perform an impairment review of our long‑livedlong-lived assets if indicators of impairment exist. In 2016, we recognized a pre‑tax non‑cash charge2019 and 2018, none of $0.1 million, andour long-lived assets were impaired. In 2017, we recognized a pre-tax non-cash charge of $0.3 million in 2015. There were no impairments recognized in 2014.$1.0 million.
There can be no assurances that future goodwill, indefinite‑livedindefinite-lived intangible assets or other long‑livedlong-lived asset impairments will not occur. We perform our annual test for indications of goodwill and indefinite‑livedindefinite-lived intangible assets impairment in the fourth quarter of our fiscal year or sooner if indicators of impairment exist.
The loss or financial instability of major customers could have an adverse effect on our results of operations.
In 2016,2019, our top ten customers accounted for approximately 20%22% of our total net sales with no one customer accounting for more than 10% of our total net sales. Our customers generally are not obligated to purchase any minimum volume of products from us and are able to terminate their relationships with us at any time. In addition, increases in the prices of our products could result in a reduction in orders from our customers. A significant reduction in orders from, or change in terms of contracts with, any significant customers could have a material adverse effect on our future results of operations.
Certain indebtedness may limit our ability to pay dividends, incur additional debt and make acquisitions and other investments.
Our revolving credit facility and other senior indebtedness contain operational and financial covenants that restrict our ability to make distributions to stockholders, incur additional debt and make acquisitions and other investments unless we satisfy certain financial tests and comply with various financial ratios. If we do not maintain
15
compliance with these covenants, our creditors could declare a default under our revolving credit facility or senior notes and our indebtedness could be declared immediately due and payable. Our ability to comply with the provisions of our indebtedness may be affected by changes in economic or business conditions beyond our control. Further, one of our strategies is to increase our revenues and profitability and expand our business through acquisitions. We may require capital in excess of our available cash and the unused portion of our revolving credit facility to make large acquisitions, which we would
17
generally obtain from access to the credit markets. There can be no assurance that if a large acquisition is identified that we would have access to sufficient capital to complete such acquisition. Should we require additional debt financing above our existing credit limit, we cannot be assured such financing would be available to us or available to us on reasonable economic terms.
One of our stockholders can exercise substantial influence over our Company.
As of January 30, 2017,December 31, 2019, Timothy P. Horne beneficially owned 6,329,2906,229,290 shares of Class B common stock and no shares of Class A common stock. Our Class B common stock entitles its holders to ten votes for each share and our Class A common stock entitles its holders to one vote per share. As of January 30, 2017,December 31, 2019, Timothy P. Horne beneficially owned approximately 18.5%18.4% of our outstanding shares of Class A common stock (assuming conversion of all shares of Class B common stock beneficially owned by Mr. Horne into Class A common stock) and approximately 99.2% of our outstanding shares of Class B common stock, which represents approximately 69.1%68.9% of the total outstanding voting power. As long as Mr. Horne controls shares representing at least a majority of the total voting power of our outstanding stock, Mr. Horne will be able to unilaterally determine the outcome of most stockholder votes, and other stockholders will not be able to affect the outcome of any such votes.
Conversion and subsequent sale of a significant number of shares of our Class B common stock could adversely affect the market price of our Class A common stock.
As of January 27, 2017,December 31, 2019, there were outstanding 27,811,14027,586,416 shares of our Class A common stock and 6,379,2906,279,290 shares of our Class B common stock. Shares of our Class B common stock may be converted into Class A common stock at any time on a one for one basis. Under the terms of a registration rights agreement with respect to outstanding shares of our Class B common stock, the holders of our Class B common stock have rights with respect to the registration of the underlying Class A common stock. Under these registration rights, the holders of Class B common stock may require, on up to two occasions that we register their shares for public resale. If we are eligible to use Form S‑3S-3 or a similar short‑formshort-form registration statement, the holders of Class B common stock may require that we register their shares for public resale up to two times per year. If we elect to register any shares of Class A common stock for any public offering, the holders of Class B common stock are entitled to include shares of Class A common stock into which such shares of Class B common stock may be converted in such registration. However, we may reduce the number of shares proposed to be registered in view of market conditions. We will pay all expenses in connection with any registration, other than underwriting discounts and commissions. If all of the available registered shares are sold into the public market the trading price of our Class A common stock could decline.
Item 1B. UNRESOLVED STAFF COMMENTS.
None.
Item 2. PROPERTIES.
We maintain 3032 principal manufacturing, warehouse and distribution centers worldwide, including our corporate headquarters located in North Andover, Massachusetts. Additionally, we maintain numerous sales offices and other smaller manufacturing facilities and warehouses. The principal properties in each of our three geographic segments and their location, principal use and ownership status are set forth below:
1618
Americas:
Americas:
Location | Principal Use | Owned/Leased | ||
North Andover, MA | | Corporate Headquarters | | Owned |
Burlington, ON, Canada | | Distribution Center | | Owned |
Export, PA | | Manufacturing | | Owned |
Franklin, NH | | Manufacturing/Distribution | | Owned |
St. Pauls, NC | | Manufacturing | | Owned |
Fort Worth, TX | | Manufacturing/Distribution | | Owned |
San Antonio, TX | | Warehouse/Distribution | | Owned |
Spindale, NC | | Distribution Center | | Owned |
Fort Myers, FL | | Manufacturing/Distribution | | Owned |
Blauvelt, NY | | Manufacturing/Distribution | | Leased |
Peoria, AZ | | Manufacturing/Distribution | | Leased |
| | Distribution Center | | Leased |
Vernon, BC, Canada | | Manufacturing/Distribution | | Leased |
Woodland, CA | | Manufacturing | | Leased |
Groveport, OH | | Distribution Center | | Leased |
Europe
Europe, Middle East and Africa:
Location | Principal Use | Owned/Leased | ||
Biassono, Italy | | Manufacturing/Distribution | | Owned |
Hautvillers, France | | Manufacturing | | Owned |
Landau, Germany | | Manufacturing/Distribution | | Owned |
| | Manufacturing | | Owned |
Plovdiv, Bulgaria | | Manufacturing | | Owned |
Sorgues, France | | Distribution Center | | Owned |
Vildbjerg, Denmark | | Manufacturing/Distribution | | Owned |
| | Manufacturing/Distribution | | Owned |
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|
| ||
Gardolo, Italy | | Manufacturing | | Leased |
Monastir, Tunisia | | Manufacturing | | Leased |
Rosières, France | | Manufacturing/Distribution | | Leased |
St. Neots, United Kingdom | |
| | Leased |
Asia-Pacific, Middle East, and Africa:
Asia‑Pacific:
Location | Principal Use | Owned/Leased | ||
Ningbo, Beilun, China | | Manufacturing | | Owned |
Shanghai, China | |
| | Leased |
Ningbo, Beilun District, China | | Distribution Center | | Leased |
Auckland, New Zealand | | Manufacturing/Distribution | | Leased |
Dubai, United Arab Emirates | | Distribution | | Leased |
Certain of our facilities are subject to mortgagescapital lease arrangements and collateral assignments under loan agreements with long‑termlong-term lenders. In general, we believe that our properties, including machinery, tools and equipment, are in good condition, well maintained and adequate and suitable for their intended uses.
Item 3. LEGAL PROCEEDINGS.
We are from time to time involved in various legal and administrative proceedings. See Item 1. “Business—Product Liability, Environmental and Other Litigation Matters,” and Note 1415 of the Notes to Consolidated Financial Statements, both of which are incorporated herein by reference.
19
17
PART II
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
The following table sets forth the high and low sales prices of ourOur Class A common stock is traded on the New York Stock Exchange during 2016 and 2015 and cash dividends declared per share.under the trading symbol “WTS.”
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| 2016 |
| 2015 |
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|
| High |
| Low |
| Dividend |
| High |
| Low |
| Dividend |
| ||||||
First Quarter |
| $ | 55.70 |
| $ | 44.94 |
| $ | 0.17 |
| $ | 64.16 |
| $ | 52.16 |
| $ | 0.15 |
|
Second Quarter |
|
| 60.55 |
|
| 53.95 |
|
| 0.18 |
|
| 56.53 |
|
| 52.03 |
|
| 0.17 |
|
Third Quarter |
|
| 65.90 |
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| 57.11 |
|
| 0.18 |
|
| 57.74 |
|
| 48.09 |
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| 0.17 |
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Fourth Quarter |
|
| 70.60 |
|
| 59.25 |
|
| 0.18 |
|
| 60.22 |
|
| 49.51 |
|
| 0.17 |
|
There is no established public trading market for our Class B common stock, which is held by members of the Horne family. The principal holders of such stock are subject to restrictions on transfer with respect to their shares. Each share of our Class B common stock (10 votes per share) is convertible into one share of Class A common stock (1 vote per share).
On February 8, 2017, we declared a quarterly dividendThe number of eighteen cents ($0.18) per share on each outstanding sharerecord holders of our Class A common stock andas of January 26, 2020 was 158. The number of record holders of our Class B common stock.stock as of January 26, 2020 was 11.
Aggregate common stock dividend payments in 20162019 were $24.5$30.9 million, which consisted of $20.0$25.3 million and $4.5$5.6 million for Class A shares and Class B shares, respectively. Aggregate common stock dividend payments in 20152018 were $23.1$28.3 million, which consisted of $18.8$23.1 million and $4.3$5.2 million for Class A shares and Class B shares, respectively. While we presently intend to continue to pay comparable cash dividends, the payment of future cash dividends depends upon the Board of Directors’ assessment of our earnings, financial condition, capital requirements and other factors.
The number of record holders of our Class A common stock as of January 27, 2017 was 150. The number of record holders of our Class B common stock as of January 27, 2017 was 8.
We satisfy the minimum withholding tax obligation due upon the vesting of shares of restricted stock and the conversion of restricted stock units into shares of Class A common stock by automatically withholding from the shares being issued a number of shares with an aggregate fair market value on the date of such vesting or conversion that would satisfy the withholding amount due.
The following table includes information with respect to shares of our Class A common stock withheld to satisfy withholding tax obligations during the quarter ended December 31, 2016.2019.
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| Issuer Purchases of Equity Securities |
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| (d) Maximum Number (or |
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| (a) Total |
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| (c) Total Number of |
| Approximate Dollar |
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| Number of |
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| Shares (or Units) |
| Value) of Shares (or |
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| Shares (or |
| (b) Average |
| Purchased as Part of |
| Units) that May Yet Be |
| |
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| Units) |
| Price Paid per |
| Publicly Announced |
| Purchased Under the |
| |
Period |
| Purchased |
| Share (or Unit) |
| Plans or Programs |
| Plans or Programs |
| |
October 3, 2016 - October 30, 2016 |
| 584 |
| $ | 63.83 |
| — |
| — |
|
October 31, 2016 - November 27, 2016 |
| 419 |
| $ | 59.25 |
| — |
| — |
|
November 28, 2016 - December 31, 2016 |
| — |
| $ | — |
| — |
| — |
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Total |
| 1,003 |
| $ | 61.92 |
| — |
| — |
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| | | | | | | | | |
| | Issuer Purchases of Equity Securities | |||||||
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| | |
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| (d) Maximum Number (or |
| | (a) Total | | | | | (c) Total Number of | | Approximate Dollar |
| | Number of | | | | | Shares (or Units) | | Value) of Shares (or |
| | Shares (or | | (b) Average | | Purchased as Part of | | Units) that May Yet Be | |
| | Units) | | Price Paid per | | Publicly Announced | | Purchased Under the | |
Period | | Purchased | | Share (or Unit) | | Plans or Programs | | Plans or Programs | |
September 30, 2019 – October 27, 2019 |
| 77 | | $ | 90.09 |
| — |
| — |
October 28, 2019 – November 24, 2019 |
| — | | $ | — |
| — |
| — |
November 25, 2019 - December 31, 2019 | | 693 | | $ | 98.50 | | — | | — |
Total |
| 770 | | $ | 97.66 |
| — |
| — |
1820
The following table includes information with respect to repurchases of our Class A common stock during the three‑monththree-month period ended December 31, 20162019 under our stock repurchase program.
| | | | | | | | | | |
| | Issuer Purchases of Equity Securities | ||||||||
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| | |
| |
| (d) Maximum Number (or | |
| | (a) Total | | | | | (c) Total Number of | | Approximate Dollar | |
| | Number of | | (b) Average | | Shares (or Units) | | Value) of Shares (or | ||
| | Shares (or | | Price Paid | | Purchased as Part of | | Units) that May Yet Be | ||
| | Units) | | per Share | | Publicly Announced | | Purchased Under the | ||
Period | | Purchased(1) | | (or Unit) | | Plans or Programs | | Plans or Programs | ||
September 30, 2019 – October 27, 2019 |
| 15,200 | | $ | 90.91 |
| 15,200 | | $ | 145,625,274 |
October 28, 2019 – November 24, 2019 |
| 15,140 | | $ | 94.69 |
| 15,140 | | $ | 144,191,659 |
November 25, 2019 - December 31, 2019 | | 18,940 | | $ | 97.92 | | 18,940 | | $ | 142,339,451 |
Total |
| 49,280 | | $ | 96.25 |
| 49,280 | | | |
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| Issuer Purchases of Equity Securities |
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| (d) Maximum Number (or |
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| (a) Total |
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| (c) Total Number of |
| Approximate Dollar |
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| Number of |
| (b) Average |
| Shares (or Units) |
| Value) of Shares (or |
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| Shares (or |
| Price Paid |
| Purchased as Part of |
| Units) that May Yet Be |
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| Units) |
| per Share |
| Publicly Announced |
| Purchased Under the |
| ||
Period |
| Purchased(1) |
| (or Unit) |
| Plans or Programs |
| Plans or Programs |
| ||
October 3, 2016 - October 30, 2016 |
| 22,050 |
| $ | 63.26 |
| 22,050 |
| $ | 59,063,231 |
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October 31, 2016 - November 27, 2016 |
| 20,550 |
| $ | 64.09 |
| 20,550 |
| $ | 57,746,208 |
|
November 28, 2016 - December 31, 2016 |
| 25,200 |
| $ | 68.30 |
| 25,200 |
| $ | 56,024,399 |
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Total |
| 67,800 |
| $ | 65.22 |
| 67,800 |
| $ | 56,024,399 |
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| (1) |
| On July 27, 2015, the Board of Directors authorized a |
Performance Graph
Set forth below is a line graph comparing the cumulative total shareholder return on our Class A common stock for the last five years with the cumulative return of companies on the Standard & Poor’s 500 Stock Index and the Russell 2000 Index. We chose the Russell 2000 Index because it represents companies with a market capitalization similar to that of
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Watts Water. The graph assumes that the value of the investment in our Class A common stock and each index was $100 at December 31, 20112014 and that all dividends were reinvested.
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COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Watts Water Technologies, Inc., the S&P 500 Index
and the Russell 2000 Index
*$100 invested on 12/31/11 in stock or index, including reinvestment of dividends. Fiscal year ending December 31.
Cumulative Total Return
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| 12/31/11 |
| 12/31/12 |
| 12/31/13 |
| 12/31/14 |
| 12/31/15 |
| 12/31/16 |
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| 12/31/14 |
| 12/31/15 |
| 12/31/16 |
| 12/31/17 |
| 12/31/18 |
| 12/31/19 | |||||||||||||
Watts Water Technologies, Inc. |
| 100 |
| 127.16 |
| 184.81 |
| 191.37 |
| 151.62 |
| 201.40 |
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| 100.00 | | 79.23 | | 105.24 | | 124.01 | | 106.50 | | 166.34 |
S & P 500 |
| 100 |
| 116.00 |
| 153.58 |
| 174.60 |
| 177.01 |
| 198.18 |
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| 100.00 | | 101.38 | | 113.51 | | 138.29 | | 132.23 | | 173.86 |
Russell 2000 |
| 100 |
| 116.35 |
| 161.52 |
| 169.43 |
| 161.95 |
| 196.45 |
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| 100.00 | | 95.59 | | 115.95 | | 132.94 | | 118.30 | | 148.49 |
The above Performance Graph and related information shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.
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Item 6. SELECTED FINANCIAL DATA.
The selected financial data set forth below should be read in conjunction with our consolidated financial statements, related Notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein.
FIVE‑YEAR22
FIVE-YEAR FINANCIAL SUMMARY
(Amounts in millions, except per share and cash dividend information)
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| Year Ended |
| Year Ended |
| Year Ended |
| Year Ended |
| Year Ended | |||||
| | 12/31/19(1) | | 12/31/18(2) | | 12/31/17(3) | | 12/31/16(4) | | 12/31/15(5) | |||||
Statement of operations data: | | | | | | | | | | | | | | | |
Net sales | | $ | 1,600.5 | | $ | 1,564.9 | | $ | 1,456.7 | | $ | 1,398.4 | | $ | 1,467.7 |
Net income (loss) | |
| 131.5 | |
| 128.0 | |
| 73.1 | |
| 84.2 | |
| (112.9) |
DILUTED EPS | | | | | | | | | | | | | | | |
Net income (loss) per share: | | | 3.85 | |
| 3.73 | |
| 2.12 | |
| 2.44 | |
| (3.24) |
Cash dividends declared per common share | | $ | 0.90 | | $ | 0.82 | | $ | 0.75 | | $ | 0.71 | | $ | 0.66 |
Balance sheet data (at year end): | | | | | | | | | | | | | | | |
Total assets | | $ | 1,723.1 | | $ | 1,653.7 | | $ | 1,736.5 | | $ | 1,763.2 | | $ | 1,692.8 |
Long-term debt, net of current portion | |
| 204.2 | |
| 323.4 | |
| 474.6 | |
| 511.3 | |
| 576.2 |
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| Year Ended |
| Year Ended |
| Year Ended |
| Year Ended |
| Year Ended |
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| 12/31/16(1) |
| 12/31/15(2) |
| 12/31/14(3) |
| 12/31/13(4)(6) |
| 12/31/12(5)(6) |
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Statement of operations data: |
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Net sales |
| $ | 1,398.4 |
| $ | 1,467.7 |
| $ | 1,513.7 |
| $ | 1,473.5 |
| $ | 1,427.4 |
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Net income (loss) from continuing operations |
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| 84.2 |
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| (112.9) |
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| 50.3 |
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| 60.9 |
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| 70.4 |
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Loss from discontinued operations, net of taxes |
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| — |
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| — |
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| — |
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| (2.3) |
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| (2.0) |
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Net income (loss) |
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| 84.2 |
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| (112.9) |
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| 50.3 |
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| 58.6 |
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| 68.4 |
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DILUTED EPS |
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Income (loss) per share: |
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Continuing operations |
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| 2.44 |
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| (3.24) |
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| 1.42 |
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| 1.71 |
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| 1.95 |
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Discontinued operations |
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| — |
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| — |
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| — |
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| (0.07) |
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| (0.05) |
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NET INCOME (LOSS) |
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| 2.44 |
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| (3.24) |
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| 1.42 |
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| 1.65 |
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| 1.90 |
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Cash dividends declared per common share |
| $ | 0.71 |
| $ | 0.66 |
| $ | 0.58 |
| $ | 0.50 |
| $ | 0.44 |
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Balance sheet data (at year end): |
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Total assets |
| $ | 1,800.3 |
| $ | 1,692.8 |
| $ | 1,948.0 |
| $ | 1,740.2 |
| $ | 1,709.0 |
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Long‑term debt, net of current portion |
|
| 511.3 |
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| 576.2 |
|
| 577.8 |
|
| 305.5 |
|
| 307.5 |
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| (1) |
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| (2) | For the year ended December 31, 2018, net income included pre-tax restructuring charges of $3.4 million, or $2.5 million net after-tax cost. Net income also included a tax benefit of $3.7 million related to the finalization of the impact of the 2017 Tax Act. |
| (3) | For the year ended December 31, 2017, net income included the following pre-tax costs: long-lived asset impairment charges of $1.0 million, deployment costs related to the Americas and Europe transformation programs of $2.9 million, restructuring charges of $6.8 million, and acquisition costs of $0.2 million. The net after-tax cost of these items was $7.3 million. Net income also included a tax charge of $25.1 million related to the provisional impact of the 2017 Tax Act. |
| (4) | For the year ended December 31, 2016, net income |
| (5) |
| For the year ended December 31, 2015, net loss |
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21
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Overview
We are a leading supplier of products, solutions and solutionssystems that manage and conserve the flow of fluids and energy into, through and out of buildings in the commercial and residential and commercial markets ofin the Americas, EMEAEurope and Asia‑Pacific.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
23
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 |
| Drainage & water |
| Water quality products—includes |
Our business is reported in three geographic segments: Americas, EMEA,Europe, and Asia-Pacific.APMEA. We distribute our products through four primary distribution channels: wholesale, original equipment manufacturers (OEMs), specialty, and do-it-yourself (DIY). In September 2015, we divested a substantial portion of our DIY business in the Americas, which reduced the significance of DIY as a distribution channel for our products in 2016. In 2016, we added specialty as an additional primary distribution channel since this channel has become more prominent as a result of our acquisitions in recent years. The specialty channel primarily includes independent representatives who sell high-efficiency boilers and water heaters, independent water filtration and conditioning dealers, specialty floor and tile distributors, and food service distributors. This specialty channel is distinct and is managed separately from our traditional plumbing wholesale channel. The specialty channel was previously reported in the wholesale channel.
We believe that the factors relating to our future growth include continued product innovation, including smart and connected products and solutions that meet 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 new 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; and a healthy economic environment.codes. We have completed 1112 acquisitions in the last decade. Our acquisition strategy focuses on businesses that promote our key macro themes around safety & 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.
We strive to invest in productOur innovation that meets the needs of our customers and our end markets. Our focusstrategy is focused on differentiated products and solutions that provide greater opportunity to distinguish ourselves in the market place and on
22
providing systemmarketplace. Conversely, we continue to migrate away from commoditized products where it is more difficult to add value. Our goal is to be a solutions to our customers rather than supplying components.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.
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. Together with our commissioned manufacturers’ representatives, weWe 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 the 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.
In 2016, we made significant progress on2019, our transformation programs (discussed below),financial performance was driven by strong organic sales growth in the Americas and modest growth in Europe and APMEA. We achieved margin expansion through price, volume and savings from productivity initiatives while simultaneously reinvesting in the business. We continued to drive commercial and operational excellence, and delivered on operational excellence. We completedinvest in product innovation, including our smart and connected products and solutions, as we strive to meet the integration of the Apex Valves Limited (“Apex”) and AERCO Korea Co., Ltd., (“AERCO Korea”) acquisitions, and added PVI Industries, LLC (“PVI”) to our portfolio late in the year. AERCO Korea was renamed Watts Korea in January 2017. Our financial performance in 2016 was mixed, driven by different economic and business dynamics within each region in which we operate. In the Americas, there was an overall decline in reported sales, which was primarily driven by the exitneeds of our non-core products in 2015customers.
Overall, sales for 2019 increased 2.3%, or $35.6 million, compared to 2018. The increase included organic sales growth of 4.0%, or $62.8 million, as well as lower than anticipated saleswe experienced growth across all of AERCO products primarily attributable to project timing. AERCO is a leading provider of commercial high-efficiency boilers, water heaters and heating solutions in North Americas.our segments. This decline was partially offset by growth in our drains business, control valves and specialty products. In EMEA, there was growth in our electronics platform due to new product introductions and growth in our HVAC market in Italy, offset by continued decline in the OEM boiler market in Germany as well as declines in the UK primarily related to the challenging economic environment. In Asia‑Pacific there was growth in 2016, primarily related to increased salesa decrease from foreign exchange of valves outside of China and strong demand for our underfloor heating products for residential applications in China.
Overall, reported sales for 2016 declined 4.7%1.8%, or $69.3$29.4 million, primarily due to the exit of non-core products, which causeddriven by a decrease of $98.0 million year over year. This decrease was partially offset by increases in sales from acquired companies of $24.0 million. Compared to 2015, reported sales in Americas and EMEA declined by 7.9% and 0.7%, respectively, while reported sales in Asia-Pacific grew by 26.3%. Organic sales for 2016 grew by 1.0%, or $13.1 million, as compared to 2015. Compared to 2015, organic sales in Americas and Asia‑Pacific grew by 0.8% and 11.8%, respectively, while organic sales in EMEA were essentially flat compared to 2015.weaker euro. Organic sales is a non-GAAP measure that excludes the impacts of acquisitions, divestitures and foreign exchange from year-over-year comparisons. Divested sales includes the exit of our non-core products through sale and through the discontinuation of product lines. Management believes reporting organic sales growth provides useful information to investors, potential investors and
24
others, because it allows for a more complete understanding of 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 $197.1 million increased by $8.7 million, or 4.6%, compared to 2018. This increase is primarily driven by price, volume and savings from productivity initiatives, including savings from restructuring actions, partially offset by higher general inflation including tariffs, strategic investments, and increased Corporate expenses.
In 2015, our Board of Directors approved a program relating to the transformationManagement’s discussion and analysis of our Americasfinancial condition, results of operations and Asia‑Pacific businesses. The first phase of the program primarily involved the exit of low‑margin, non‑core product lines and global sourcing actions. We eliminated approximately $165 million of our combined Americas and Asia‑Pacific net sales that primarily sold through our DIY distribution channel. We discontinued selling our remaining rationalized product linescash flows as of and for the endyear ended December 31, 2017 can be found in Item 7 of the first quarterPart II, “Management’s Discussion and Analysis of 2016. As partFinancial Condition and Results of the rationalization exercise, we entered into an agreement to sell an operating subsidiaryOperations,” in China that was dedicated exclusively to the manufacturing of products being rationalized. We completed the sale in the second quarter of 2016, recognized a pre-tax gain of $8.7 million and received total proceeds from the sale of $8.4 million. The pre-tax gain includes a non-cash accumulated currency translation adjustment of $7.3 million. The second phase of the program involves the consolidation of manufacturing facilities and distribution center network optimization in the Americas. Together with phase one, the transformation reduced the Americas net operating footprint by approximately 30%. The second phase is substantially complete and is designed to improve the utilization of our remaining facilities, better leverage our cost structure, reduce working capital, and improve execution of customer delivery requirements. The second phase is expected to be completed in 2017.
On a combined basis, the total estimated pre‑tax cost for our transformation program related to our Americas and Asia‑Pacific businesses is approximately $65 million, including restructuring costs of $19.5 million, goodwill and intangible asset impairments of $13.4 million and other transformation and deployment costs of approximately $32 million. Other transformation and deployment costs include consulting and project management fees and other
23
associated costs. Costs of the program are expected to be incurred through the middle of 2017. Refer to Notes 3 and 4 of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K for further details.the year ended December 31, 2018.
Acquisitions and Disposals
On November 2, 2016,In the third quarter of 2019 we acquired 100%purchased substantially all the assets of the shares of PVI Riverside Holdings, Inc., the parent company of PVI. The aggregate purchase price recorded, including an estimated working capital adjustment, was approximately $79.2 million, and is subject to final post-closing working capital adjustments. PVI is a leading manufacturer of commercial stainless steel water heating equipment, focused on the high capacity market in North America and isBackflow Direct LLC, based in Fort Worth, Texas. Its water heater product offering complements AERCO’s boiler products, allowing us to address customers’ total heatingRancho Cordova, California. Backflow Direct specializes in the design and hot water requirements.manufacture of backflow prevention valves used primarily in fire protection applications.
Recent Developments
On February 26, 2016, we acquired an additional 50% of the outstanding shares of AERCO Korea for an aggregate purchase price of approximately $4 million. Prior to February 26, 2016, we held a 40% interest in AERCO Korea, which operated as a joint venture. On December 30, 2016, we acquired the remaining 10% of the outstanding shares of AERCO Korea for $0.8 million. This acquisition is expected to expand both AERCO’s boiler market and the sale of Watts’ products in Asia.
On September 22, 2015, we signed an agreement to sell an operating subsidiary in China that was dedicated to the production of non-core products. The sale was finalized in the second quarter of 2016, and we received total proceeds of approximately $8.4 million from the sale as of the fourth quarter of 2016. We recognized a pre-tax gain of $8.7 million, which includes a non-cash accumulated currency translation adjustment of $7.3 million. The net after-tax gain was approximately $8.3 million.
On November 30, 2015, we completed the acquisition of 80% of the outstanding shares of Apex Valves Limited (“Apex”), a New Zealand company, with a commitment to purchase the remaining 20% ownership within three years of closing. The aggregate purchase price was approximately $20.4 million, and we recorded a liability of $5.5 million as the estimate of the acquisition date fair value on the contractual call option to purchase the remaining 20%. Apex manufactures high‑end valves for the New Zealand market that we believe could be introduced in the China market and other countries in South East Asia.
Recent Developments
On February 8, 2017,6, 2020, we declared a quarterly dividend of eighteentwenty-three cents ($0.18)0.23) per share on each outstanding share of Class A common stock and Class B common stock payable on March 16, 201713, 2020 to stockholders of record on March 2, 2017.February 28, 2020.
On February 8, 2017,A new coronavirus that was first detected in Hubei Province, China has spread rapidly in many parts of China and in a growing number of international locations. The virus has resulted in travel restrictions into and out of China, the Boardtemporary closure of Directors elected David A. Dunbarstores and Jes Munk Hansenfacilities operated by multinational corporations in China, and significantly reduced production capacity at many factories in China, including our own factory in Ningbo, China. The reduction in production capacity at factories in China may reduce or even halt the supply of finished goods and necessary components for many of our products, which could result in product shortages and an increase in our inventory of unfinished products. Further, there may be logistics issues, including our ability and our supply chain’s ability to serve as membersquickly ramp up production, and transportation demands that may cause further delays. Our management team is working to mitigate these risks and to limit the impact on our business. We are presently estimating sales may be reduced by $10 million to $20 million in the first quarter of 2020 due to the impact of the Board of Directors. Mr. Dunbar was appointedCOVID-19 outbreak. This assumes China production, supply chain and logistics return to normal by early March. Given the matter’s complexity and recent timing we are closely monitoring the situation as a memberit evolves. We have updated our full year 2020 outlook for the expected impact of the Audit Committee andCOVID-19 outbreak, which assumes returning to normal business operations by early March, but will continue to assess the Nominating and Corporate Governance Committee and Mr. Hansen was appointedfull year impact as a member of the Compensation Committee and the Nominating and Corporate Governance Committee.matter progresses.
Results of Operations
Year Ended December 31, 20162019 Compared to Year Ended December 31, 20152018
Net Sales. Our business is reported in three geographic segments: Americas, EMEAEurope and Asia‑Pacific.APMEA. Our net sales in each of these segments for the years ended December 31, 20162019 and December 31, 20152018 were as follows:
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| % Sales |
| Net Sales |
| % Sales |
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| | December 31, 2019 | | December 31, 2018 | | | | | Consolidated |
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| Net Sales |
| % Sales |
| Net Sales |
| % Sales |
| Change |
| Net Sales |
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Americas |
| $ | 900.9 |
| 64.5 | % | $ | 978.5 |
| 66.7 | % | $ | (77.6) |
| (5.3) | % | | $ | 1,084.1 | | 67.7 | % | $ | 1,032.1 | | 66.0 | % | $ | 52.0 | | 3.3 | % |
EMEA |
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| 442.3 |
| 31.6 |
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| 445.5 |
| 30.3 |
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| (3.2) |
| (0.2) |
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Asia‑Pacific |
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| 55.2 |
| 3.9 |
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| 43.7 |
| 3.0 |
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| 11.5 |
| 0.8 |
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Europe | |
| 451.0 |
| 28.2 | |
| 467.0 |
| 29.8 | |
| (16.0) |
| (1.0) | | ||||||||||||||||
APMEA | |
| 65.4 |
| 4.1 | |
| 65.8 |
| 4.2 | |
| (0.4) |
| — | | ||||||||||||||||
Total |
| $ | 1,398.4 |
| 100.0 | % | $ | 1,467.7 |
| 100.0 | % | $ | (69.3) |
| (4.7) | % | | $ | 1,600.5 |
| 100.0 | % | $ | 1,564.9 |
| 100.0 | % | $ | 35.6 |
| 2.3 | % |
2425
The change in net sales was attributable to the following:
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| of Segment Net Sales |
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| EMEA |
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| EMEA |
| Pacific |
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| EMEA |
| Pacific |
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| | | | | | | | | | | | | | Change As a % | | Change As a % |
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| | Americas | | Europe | | APMEA | | Total | | Americas | | Europe | | APMEA | | Total | | Americas | | Europe | | APMEA |
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Organic |
| $ | 7.7 |
| $ | 1.0 |
| $ | 4.4 |
| $ | 13.1 |
| 0.6 | % | 0.1 | % | 0.3 | % | 1.0 | % | 0.8 | % | 0.2 | % | 11.8 | % | | $ | 51.4 | | $ | 9.8 | | $ | 1.6 |
| $ | 62.8 |
| 3.3 | % | 0.6 | % | 0.1 | % | 4.0 | % | 5.0 | % | 2.1 | % | 2.4 | % |
Foreign exchange |
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| (2.4) |
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| (4.2) |
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| (1.8) |
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| (8.4) |
| (0.2) |
| (0.3) |
| (0.1) |
| (0.6) |
| (0.2) |
| (0.9) |
| (4.2) |
| |
| (1.6) | |
| (25.8) | |
| (2.0) | |
| (29.4) |
| (0.1) |
| (1.6) |
| (0.1) |
| (1.8) |
| (0.2) |
| (5.5) |
| (3.0) | |
Divested |
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| (91.8) |
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| (6.2) |
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| (98.0) |
| (6.3) |
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| (0.4) |
| (6.7) |
| (9.4) |
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Acquisitions |
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| 8.9 |
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| — |
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| 15.1 |
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| 24.0 |
| 0.6 |
| — |
| 1.0 |
| 1.6 |
| 0.9 |
| — |
| 34.5 |
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Acquisition | |
| 2.2 | |
| — | |
| — | |
| 2.2 |
| 0.1 |
| — |
| — |
| 0.1 |
| 0.2 |
| — |
| — | | |||||||||||||||||||||||||||
Total |
| $ | (77.6) |
| $ | (3.2) |
| $ | 11.5 |
| $ | (69.3) |
| (5.3) | % | (0.2) | % | 0.8 | % | (4.7) | % | (7.9) | % | (0.7) | % | 26.3 | % | | $ | 52.0 | | $ | (16.0) | | $ | (0.4) | | $ | 35.6 |
| 3.3 | % | (1.0) | % | — | % | 2.3 | % | 5.0 | % | (3.4) | % | (0.6) | % |
The change in organic net sales as a percentage of consolidated net sales and of segment net sales in the Americas and Asia-Pacific excludes divested sales for both periods presented.
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:
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| DIY |
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| OEMs |
| DIY |
| Specialty |
| Total |
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| OEMs |
| DIY | | Specialty |
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Americas |
| $ | 3.7 |
| $ | 1.0 |
| $ | 4.3 |
| $ | (1.3) |
| $ | 7.7 |
| 0.7 | % | 1.7 | % | 6.3 | % | (0.5) | % | | $ | 30.4 | | $ | 4.5 | | $ | 2.1 | | $ | 14.4 | | $ | 51.4 |
| 5.2 | % | 5.7 | % | 3.4 | % | 4.6 | % |
EMEA |
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| 1.8 |
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| (3.0) |
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| 2.2 |
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| — |
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| 1.0 |
| 0.7 |
| (35.6) |
| 1.0 |
| — |
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Asia‑Pacific |
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| 8.2 |
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| — |
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| (3.8) |
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| — |
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| 4.4 |
| 30.4 |
| — |
| (36.2) |
| — |
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Europe | |
| 8.3 | |
| 1.4 | |
| 0.1 | | | — | |
| 9.8 |
| 2.6 |
| 0.9 | | 5.2 | | — | | ||||||||||||||||||||||||
APMEA | |
| 1.0 | |
| 0.5 | |
| — | | | 0.1 | |
| 1.6 |
| 1.7 |
| 32.7 |
| — | | 1.7 | | ||||||||||||||||||||||||
Total |
| $ | 13.7 |
| $ | (2.0) |
| $ | 2.7 |
| $ | (1.3) |
| $ | 13.1 |
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| | $ | 39.7 | | $ | 6.4 | | $ | 2.2 | | $ | 14.5 | | $ | 62.8 | | | | | | | | | |
The changeincrease in Americas organic net sales by channel inwas primarily due to a combination of price and volume across our valve, drainage, and water quality products, which are sold through each of our channels, and our heating and hot water products, which are sold through the Americas and Asia-Pacific excludes divested sales for both periods presented.specialty channel.
Organic net sales in the AmericasEurope increased $7.7 million compared to 2015 primarily due to growthprice and volume. The increase in wholesale sales was driven by our wholesale marketsdrainage and valve products. The increase in OEM channels, particularly relatingsales was mainly due to backflow, valve,increases in certain HVAC and drainageelectronics products.
Organic net sales in EMEAAPMEA increased slightly compared to 2015 mainlyprimarily due to improved demandincreased commercial valve and underfloor heating sales in certain key markets like Italy and new product introductions in our electronics platform. These increases wereChina. This was partially offset by declines in the OEM boiler market in Germany, sales declines in France,softness within Korea and by project delays in our drains business partly driven by the impact of economic and political uncertainty in the UK.Australia.
Organic net sales in the Asia‑Pacific wholesale market increased as compared to 2015 primarily due to strong demand for our underfloor heating products for residential applications as well as for our water and plumbing products outside of China.
The net decrease in sales due to foreign exchange was primarily due to the depreciation of the euro, Chinese yuan, and the Canadian dollar against the U.S. dollar in 2016.2019 compared to 2018. We cannot predict whether foreign currencies will appreciate or depreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.
The decrease in total net sales due to divested products of $98.0 million was a result of the exit of our low margin, non-core products beginning after the first quarter 2015 in our Americas and Asia-Pacific segments. Divested sales includes the exit of our non-core products through sale and through the discontinuation of product lines.
The increase in net sales from acquisitions in Asia-Pacific is related to the fourth quarter 2015 acquisition of Apex and the first quarter 2016 acquisition of AERCO Korea. The increase in net sales from acquisitions in the Americas is related to the acquisition of PVI in the fourth quarter of 2016.
25
Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for 20162019 and 20152018 were as follows:
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| | December 31, 2019 | | December 31, 2018 | | |||||||||
| | (dollars in millions) |
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Gross profit |
| $ | 565.6 |
| $ | 553.1 |
| | $ | 677.5 | | $ | 656.5 | |
Gross margin |
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| 40.5 | % |
| 37.7 | % | |
| 42.3 | % |
| 42.0 | % |
Americas’Gross profit and gross margin percentage increased compared to 2015 due primarily to a favorable product mix, including the 2015 exit of our low-margin, non-core product lines, as well as manufacturing efficiencies and commodity cost savings. EMEA’s gross margin percentage increased marginally2018 due to manufacturingprice, volume, and savings from productivity restructuring savings and commodity cost savings, compared to 2015. Asia-Pacific’s gross margin percentage increased compared to 2015 primarily due to increased trade sales and product mix,initiatives, which were partially offset by the decreased intercompany activity. higher general inflation costs, including tariffs.
Selling, General and Administrative Expenses. Selling, general and administrative, or SG&A, expenses decreased $67.2increased $11.4 million, or 13.7%2.4%, in 20162019 compared to 2015.2018. The decreaseincrease in SG&A expenses was attributable to the following:
| | | | | | |
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| (in millions) |
| % Change |
| |
Organic | | $ | 18.8 |
| 4.0 | % |
Foreign exchange | |
| (7.4) |
| (1.6) | |
Total | | $ | 11.4 |
| 2.4 | % |
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| (in millions) |
| % Change |
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Organic |
| $ | (72.2) |
| (14.8) | % |
Foreign exchange |
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| (2.2) |
| (0.4) |
|
Acquisition |
|
| 7.2 |
| 1.5 |
|
Total |
| $ | (67.2) |
| (13.7) | % |
26
The organic decreaseincrease was related to strategic investments of $12.6 million, including investments in SG&A expensesresearch and development for new products, as well as smart and connected products, commercial excellence, and technology and information systems. The increase was primarilyalso due to the 2015 settlementgeneral inflation of certain long-term obligations, including our pension plan and supplemental employee retirement plan obligations of $64.7$5.3 million and a $6.0higher variable costs of $3.5 million charge incurred in 2015related to settle legacy product liability claims. Product liability expense decreased $2.8 million in 2016 compared to 2015 due to a reduction in the frequency of reported claims. These decreases were partially offset byincreased sales. There was also an increase in Corporate expenses, including higher professional fees of $3.1 million, acquisition related costs of $0.9 million, as well as increased stock compensation expense of $2.5$3.6 million in 2016 compared to 2015 mainly due to a change in timingthe expected attainment of performance goals related to our 2016 grants, whichperformance stock units. These increases were granted earlierpartially offset by a $3.8 million decrease in 2016 thanamortization costs for certain intangible assets that reached the end of their useful lives, incremental European restructuring savings of $2.8 million, and a reduction of certain selling and marketing costs of $2.3 million compared to 2018. The decrease in 2015. SG&A expenses from acquisitions relateforeign exchange was mainly due to the Apex, AERCO Korea, and PVI acquisitions.depreciation of the euro against the U.S. dollar. Total SG&A expenses, as a percentage of sales, were 30.3%29.7% in 2016 compared to 33.5% in 2015.2019 and 2018.
Restructuring. In 2016, 2019, we recorded a net charge of $4.7$4.3 million primarily for the transformation of our Americas and Asia‑Pacific businesses and involuntary terminations and other costs incurred as part of our EMEA restructuring plans, as compared to $21.4$3.4 million in 2015.2018, for additional severance benefits and cost-cutting actions related to our European restructuring plan initiated in the third quarter of 2018. For a more detailed description of our current restructuring plans, see Note 3 of Notes to Consolidated Financial Statements in this Annual Report on Form 10‑K.10-K.
Goodwill and Other Long‑Lived Asset Impairment Charges. In 2016, we recorded impairment charges of $0.5 million, primarily related to an indefinite lived tradename in the EMEA reporting unit. In 2015, we recorded impairment charges of $130.5 million, primarily relating to a $129.7 million goodwill impairment charge in the EMEA reporting unit. See Note 2 of Notes to Consolidated Financial Statements in this Annual Report on Form 10‑K for additional information regarding these impairments.
Gain on disposition. In the second quarter of 2016, we recorded a pre-tax gain of $8.7 million related to the sale of a China subsidiary that was dedicated to the production of non-core products and part of the transformation of our Americas and Asia‑Pacific businesses. The pre-tax gain includes a non-cash accumulated currency translation adjustment of $7.3 million.
26
Operating Income (Loss). Operating income (loss) by geographic segment for 20162019 and 20152018 was as follows:
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| | 2019 | | 2018 | | Change | | Income | | |||||||||||||||
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| (dollars in millions) | | | | |||||||||||||||||||
Americas |
| $ | 127.1 |
| $ | 109.9 |
| $ | 17.2 |
| 19.1 | % | | $ | 187.4 | | $ | 171.1 | | $ | 16.3 |
| 8.6 | % |
EMEA |
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| 40.8 |
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| (98.6) |
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| 139.4 |
| 154.6 |
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Asia‑Pacific |
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| 14.3 |
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| (0.5) |
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| 14.8 |
| 16.5 |
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Europe | |
| 49.9 | |
| 49.8 | |
| 0.1 |
| 0.1 | | ||||||||||||
APMEA | |
| 6.9 | |
| 7.2 | |
| (0.3) |
| (0.2) | | ||||||||||||
Corporate |
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| (37.2) |
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| (100.9) |
|
| 63.7 |
| 70.7 |
| |
| (47.1) | |
| (39.7) | |
| (7.4) |
| (3.9) | |
Total |
| $ | 145.0 |
| $ | (90.1) |
| $ | 235.1 |
| 260.9 | % | | $ | 197.1 | | $ | 188.4 | | $ | 8.7 |
| 4.6 | % |
The increase (decrease) in operating income (loss) is attributable to the following:
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| Americas |
| EMEA |
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| Corporate |
| Total |
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| Corporate |
| Total |
| Americas |
| EMEA |
| Pacific |
| Corporate |
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| | Americas | | Europe | | APMEA | | Corporate | | Total | | Americas | | Europe | | APMEA | | Corporate | | Total | | Americas | | Europe | | APMEA | | Corporate |
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Organic |
| $ | 10.5 |
| $ | 7.0 |
| $ | 0.8 |
| $ | 62.1 |
| $ | 80.4 |
| 11.6 | % | 7.8 | % | 0.9 | % | 68.9 | % | 89.2 | % | 7.0 | % | 7.1 | % | 151.2 | % | 61.5 | % | | $ | 16.5 | | $ | 4.1 | | $ | (0.1) | | $ | (7.4) | | $ | 13.1 | | 8.7 | % | 2.2 | % | (0.1) | % | (3.9) | % | 6.9 | % | 9.6 | % | 8.2 | % | (1.4) | % | (18.6) | % |
Foreign exchange |
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| (0.3) |
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| (0.3) |
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| (0.5) |
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| — |
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| (1.1) |
| (0.3) |
| (0.3) |
| (0.5) |
| — |
| (1.1) |
| (0.3) |
| (0.3) |
| (91.1) |
| — |
| | | (0.2) | | | (3.1) | | | (0.2) | | | — | | | (3.5) | | (0.1) | | (1.6) | | (0.1) | | — | | (1.8) | | (0.1) | | (6.2) | | (2.8) | | — |
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Acquisitions |
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| (1.4) |
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| — |
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| 1.8 |
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| — |
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| 0.4 |
| (1.6) |
| — |
| 2.0 |
| — |
| 0.4 |
| 1.3 |
| — |
| NMF |
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Restructuring, impairment charges and other |
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| 8.4 |
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| 132.7 |
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| 4.0 |
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| 1.6 |
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| 146.7 |
| 9.3 |
| 147.2 |
| 4.4 |
| 1.8 |
| 162.7 |
| 7.7 |
| 134.6 |
| NMF |
| 1.6 |
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Gain on disposition |
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| — |
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| — |
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| 8.7 |
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| 8.7 |
| — |
| — |
| 9.7 |
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| 9.7 |
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| — |
| NMF |
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Restructuring |
| | — |
| | (0.9) |
| | — |
| | — |
| | (0.9) |
| — |
| (0.5) |
| — |
| — |
| (0.5) |
| — |
| (1.8) |
| — |
| — | | ||||||||||||||||||||||||||||||||||
Total |
| $ | 17.2 |
| $ | 139.4 |
| $ | 14.8 |
| $ | 63.7 |
| $ | 235.1 |
| 19.0 | % | 154.7 | % | 16.5 | % | 70.7 | % | 260.9 | % | 15.7 | % | 141.4 | % | NMF | % | 63.1 | % | | $ | 16.3 | | $ | 0.1 | | $ | (0.3) | | $ | (7.4) | | $ | 8.7 |
| 8.6 | % | 0.1 | % | (0.2) | % | (3.9) | % | 4.6 | % | 9.5 | % | 0.2 | % | (4.2) | % | (18.6) | % |
OperatingOrganic operating income in 2016 of $145.0 million increased by $235.1$13.1 million in 2019 as compared to 2015.2018, mainly due to price, volume, and savings from productivity initiatives, including savings from restructuring actions. This increase is primarilyin operating income was partially offset by higher general inflation, including the impact of tariffs, strategic investments, Corporate professional fees and acquisition related to the $129.7 million goodwill impairment charge in the EMEA reporting unit, the 2015 settlement charge of $64.7 million for certain long-term obligations, including our pension plan and supplemental employee retirement plan, $16.7 million less in restructuring costs recognized in 2016 compared to 2015, as well as the $6.0 million charge to settle legacy product liability claims in 2015. We also recognized a gain of $8.7 million in the second quarter of 2016 on the disposition of a subsidiary in China. The remaining $9.3 million increase was due to favorable sales mix, favorable sourcing, and productivity.costs.
Interest Expense.Interest expense decreased $1.7$2.2 million, or 7%13.5%, in 20162019 as compared to 2015 primarily2018 due to a reduction in the retirementprincipal balance of debt outstanding. As a result of the 2017 Tax Act, we repatriated approximately $127 million of undistributed foreign earnings in April 20162018 and approximately $43 million in 2019; using a majority of a $225 million higher interest bearing private placement note that was replaced by $230 million drawn oncash to reduce our line of credit.outstanding debt. Refer to Note 1011 of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K
for further details.
Other income.Other income net. Other income, net, increased $2.0decreased $1.2 million to an income balance of $4.4 million in 2016 as compared to 2015,2018. The decrease was primarily due to the $1.7 million non-cash gain recognized on the acquisition of AERCO Korea in the first quarter of 2016. Refer to Note 5 of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K for further details on the acquisition. The remaining increase is due tolower net foreign currency transaction gains in 2016 as a result of the depreciation of the euro and the Canadian dollar against the U.S. dollar in 2016 compared to 2015.gains.
Income Taxes.Our effective income tax rate changedincreased to 34.1%28.5% in 2016,2019, from (1.7%)26.7% in 2015.2018. The significant change in the tax rate wasincreased primarily due to the 2018 rate including a one-time benefit as a result of finalizing the impact thatof the non-deductible and other income tax reserve items had on a loss before income taxes reported2017 Tax Act in 2015, primarily related to the goodwill impairment charge and the settlementfourth quarter of our pension plan and supplemental employee retirement plan obligations.2018.
27
Net Income (Loss).Income.Net income for 2019 was $84.2$131.5 million, or $2.45$3.85 per common share on a diluted basis, compared to a net loss of ($112.9)$128.0 million, or ($3.24)$3.73 per common share on a diluted basis, for 2018. Results for 2019 include an after-tax charge of $3.1 million, or $0.09 per common share, for 2015. Results for 2016 include after-tax benefits of $8.3 million, or $0.24 per common share, for a gain on disposition and $1.0 million, or $0.03 per common share, for a gain on acquisition of AERCO Korea, offset by an after-tax charge of $8.8 million, or $0.26 per common share, for the EMEA and Americas transformation deployment costs;Corporate professional fees; $3.2 million, or $0.09 per common share, for restructuring charges; $1.3$0.7 million, or $0.04 per common share for purchase accounting adjustments related to our acquisitions in 2016; $1.2
27
million, or $0.03 per common share for acquisition costs in 2016; and $2.6 million, or $0.08 per common share for other items, primarily related to tax charges related to the transformation.
Results for 2015 include an after‑tax charge of $126.8 million, or $3.63 per common share, for a goodwill and other long‑lived asset impairment charges; $44.6 million, or $1.28 per common share, for long‑term obligation settlements including pension obligations; $13.9 million, or $0.40 per common share, for restructuring; $9.0 million, or $0.26 per common share, for the EMEA and Americas transformation deployment costs; $3.7 million, or $0.11 per common share, for legal and other settlements; and $0.9 million, or $0.03$0.02 per common share, for acquisition related costs.
Results of Operations
Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
Net Sales. Our business is reported in three geographic segments: Americas, EMEAcosts; and Asia‑Pacific. Our net sales in each of these segments for the years ended December 31, 2015 and 2014 were as follows:
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| December 31,2014 |
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| Consolidated | |||||||
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| Net Sales |
| % Sales |
| Net Sales |
| % Sales |
| Change |
| Net Sales |
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| (Dollars in millions) |
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Americas |
| $ | 978.5 |
| 66.7 | % | $ | 926.8 |
| 61.2 | % | $ | 51.7 |
| 3.4 | % |
EMEA |
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| 445.5 |
| 30.3 |
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| 546.4 |
| 36.1 |
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| (100.9) |
| (6.6) |
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Asia‑Pacific |
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| 43.7 |
| 3.0 |
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| 40.5 |
| 2.7 |
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| 3.2 |
| 0.2 |
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Total |
| $ | 1,467.7 |
| 100.0 | % | $ | 1,513.7 |
| 100.0 | % | $ | (46.0) |
| (3.0) | % |
The change in net sales was attributable to the following:
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| Americas |
| EMEA |
| Pacific |
| Total |
| Americas |
| EMEA |
| Pacific |
| Total |
| Americas |
| EMEA |
| Pacific |
| ||||
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| (Dollars in millions) |
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Organic |
| $ | 19.7 |
| $ | (17.4) |
| $ | 5.1 |
| $ | 7.4 |
| 1.3 | % | (1.1) | % | 0.3 | % | 0.5 | % | 2.1 | % | (3.2) | % | 12.6 | % |
Foreign exchange |
|
| (10.6) |
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| (83.5) |
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| (0.4) |
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| (94.5) |
| (0.7) |
| (5.5) |
| — |
| (6.2) |
| (1.1) |
| (15.3) |
| (1.0) |
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Acquired/divested, net |
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| 42.6 |
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| — |
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| (1.5) |
|
| 41.1 |
| 2.8 |
| — |
| (0.1) |
| 2.7 |
| 4.6 |
| — |
| (3.7) |
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Total |
| $ | 51.7 |
| $ | (100.9) |
| $ | 3.2 |
| $ | (46.0) |
| 3.4 | % | (6.6) | % | 0.2 | % | (3.0) | % | 5.6 | % | (18.5) | % | 7.9 | % |
Our products are sold to wholesalers, DIY chains, and OEMs. The change in organic net sales by channel was attributable to the following:
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| Wholesale |
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| Wholesale |
| DIY |
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| (dollars in millions) |
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Americas |
| $ | 20.9 |
| $ | (0.6) |
| $ | (0.6) |
| $ | 19.7 |
| 3.3 | % | (1.0) | % | (0.8) | % |
EMEA |
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| (8.2) |
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| (1.7) |
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| (7.5) |
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| (17.4) |
| (2.9) |
| (13.5) |
| (3.0) |
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Asia‑Pacific |
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| 6.0 |
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| — |
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| (0.9) |
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| 5.1 |
| 24.4 |
| — |
| (75.0) |
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Total |
| $ | 18.7 |
| $ | (2.3) |
| $ | (9.0) |
| $ | 7.4 |
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Organic net sales in the Americas increased $19.7 million compared to 2014 due to growth in our wholesale markets, particularly relating to commercial boilers, backflow and valve product sales and drainage products. Weather issues in the Northeast, Midwest and South Central U.S. over the first half of 2015 partially offset the sales increases during the year.
Organic net sales into the EMEA wholesale, DIY and OEM markets decreased as compared to 2014 primarily due to the struggling end-markets in France, Germany and Russia. These decreases were partially offset by increased sales in the Middle East and UK markets and in our electronics business.
28
Organic net sales in the Asia-Pacific wholesale market increased as compared to 2014 primarily due to increased sales of residential valve and heating products that were sold into expanded geographic regions within China. Outside China, we also increased sales in Australia during the year.
The net decrease in sales due to foreign exchange was primarily due to the depreciation of the euro and the Canadian dollar against the U.S. dollar in 2015. We cannot predict whether foreign currencies will appreciate or depreciate against the U.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 the acquisition of AERCO in December of 2014, which contributed $104.2 million in net sales in the first eleven months of 2015 and the acquisition of Apex on November 30, 2015, which contributed $0.9 million in the last month of 2015, offset by the divestiture of our non-core product lines in the Americas and Asia-Pacific that reduced net sales by $64.0 million compared to 2014.
Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for 2015 and 2014 were as follows:
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| 2015 |
| 2014 |
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Gross profit |
| $ | 553.1 |
| $ | 541.8 |
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Gross margin |
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| 37.7 | % |
| 35.8 | % |
Americas’ gross margin increased compared to 2014 due primarily to product mix, price realization, and material cost savings. The increase from product mix was largely due to the AERCO acquisition and the positive impact of divested products, while material cost savings improved in part due to lower copper prices. The Americas lead free foundry operated more efficiently than in the prior year. EMEA’s gross margin decreased primarily due to lower overhead absorption related to volume declines and unfavorable product mix that more than offset transformation and production efficiencies. Asia-Pacific’s gross margin increased primarily due to productivity initiatives and increased third-party sales offset partially by reduced intercompany activity.
Selling, General and Administrative Expenses. Selling, general and administrative, or SG&A, expenses increased $84.3$0.6 million, or 20.7%, in 2015 compared to 2014. The increase in SG&A expenses was attributable to the following:
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| (in millions) |
| % Change |
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Organic |
| $ | 76.7 |
| 18.9 | % |
Foreign exchange |
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| (23.9) |
| (5.9) |
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Acquisitions |
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| 31.5 |
| 7.7 |
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Total |
| $ | 84.3 |
| 20.7 | % |
The organic increase in SG&A expenses primarily related to the settlement of certain long-term obligations, including pension obligations, of $64.7 million, increased personnel costs of $9.3 million, increased legal costs of $3.5 million and increased product liability costs of $8.1 million, offset by decreased acquisition related costs of $4.4 million, and reduced commission and freight costs of $3.5 million. The increased personnel costs primarily relate to increased compensation costs of $4.4 million, increased stock-based compensation costs of $2.5 million, partially due to a benefit recognized in the prior year related to our former CEO’s forfeiture of unvested equity awards, increased pension costs of $1.7 million and increased other employee related costs of $0.7 million, partially offset by reduced relocation costs of $1.0 million. Incremental legal costs include the impact of a settlement in principle relating to two class action lawsuits regarding legacy products. The net settlement charged to operations amounted to $3.5 million in 2015. Refer to Note 14 of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K for more detail. The increased product liability cost in the Americas of $8.1 million was driven by a recent increase in reported claims, a majority of which relate to divested or discontinued products, and a $2.5 million charge related to the resolution of certain legacy claims for non-core products which we have exited. The decrease in SG&A expenses from foreign exchange was primarily due to the depreciation of the euro and the Canadian dollar against the U.S. dollar in 2015. Acquired SG&A costs relate to the AERCO and Apex acquisitions. Total SG&A expenses, as a percentage of sales, were 33.5% in 2015 and 26.9% in 2014.
29
Restructuring. In 2015, we recorded a net charge of $21.4 million primarily for the transformation of our Americas and Asia-Pacific businesses, involuntary terminations at Corporate and involuntary terminations and other costs incurred as part of our EMEA restructuring plans, as compared to $15.2 million in 2014. For a more detailed description of our current restructuring plans, see Note 3 of Notes to Consolidated Financial Statements in this Annual Report on Form 10-K.
Goodwill and Other Long‑Lived Asset Impairment Charges. In 2015, we recorded impairment charges of $130.5 million, primarily relating to a $129.7 million goodwill impairment charge in the EMEA reporting unit and trade name impairment charges of $0.5 million and $0.1 million in the Americas and EMEA, respectively, compared to $14.2 million in 2014. See Note 2 of Notes to Consolidated Financial Statements in this Annual Report on Form 10‑K for additional information regarding these impairments.
Operating (Loss) Income. Operating (loss) income by geographic segment for 2015 and 2014 was as follows:
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| % Change to |
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| Year Ended |
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| Consolidated |
| ||||
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| December 31, |
| December 31, |
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| Operating |
| ||
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| 2015 |
| 2014 |
| Change |
| Income |
| |||
|
| (Dollars in millions) |
| |||||||||
Americas |
| $ | 109.9 |
| $ | 110.3 |
| $ | (0.4) |
| (0.4) | % |
EMEA |
|
| (98.6) |
|
| 37.5 |
|
| (136.1) |
| (129.1) |
|
Asia‑Pacific |
|
| (0.5) |
|
| (6.5) |
|
| 6.0 |
| 5.7 |
|
Corporate |
|
| (100.9) |
|
| (35.9) |
|
| (65.0) |
| (61.7) |
|
Total |
| $ | (90.1) |
| $ | 105.4 |
| $ | (195.5) |
| (185.5) | % |
The change in operating income was attributable to the following:
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| Change as a % of |
| Change as a % of |
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| Consolidated Operating Income |
| Segment Operating Income |
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| Asia‑ |
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| Asia‑ |
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| Asia‑ |
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| |
|
| Americas |
| EMEA |
| Pacific |
| Corp. |
| Total |
| Americas |
| EMEA |
| Pacific |
| Corp. |
| Total |
| Americas |
| EMEA |
| Pacific |
| Corp. |
| |||||
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| (Dollars in millions) |
| |||||||||||||||||||||||||||||||
Organic |
| $ | (7.5) |
| $ | (4.7) |
| $ | (2.9) |
| $ | (64.7) |
| $ | (79.8) |
| (7.1) | % | (4.5) | % | (2.7) | % | (61.4) | % | (75.7) | % | (6.8) | % | (12.5) | % | 44.6 | % | (180.2) | % |
Foreign exchange |
|
| (2.0) |
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| (7.5) |
|
| — |
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| — |
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| (9.5) |
| (1.9) |
| (7.1) |
| — |
| — |
| (9.0) |
| (1.8) |
| (20.0) |
| — |
| — |
|
Acquisitions |
|
| 16.3 |
|
| — |
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| — |
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| — |
|
| 16.3 |
| 15.4 |
| — |
| — |
| — |
| 15.4 |
| 14.8 |
| — |
| — |
| — |
|
Restructuring, impairment charges and other |
|
| (7.2) |
|
| (123.9) |
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| 8.9 |
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| (0.3) |
|
| (122.5) |
| (6.8) |
| (117.5) |
| 8.4 |
| (0.3) |
| (116.2) |
| (6.5) |
| (330.4) |
| (136.9) |
| (0.8) |
|
Total |
| $ | (0.4) |
| $ | (136.1) |
| $ | 6.0 |
| $ | (65.0) |
| $ | (195.5) |
| (0.4) | % | (129.1) | % | 5.7 | % | (61.7) | % | (185.5) | % | (0.3) | % | (362.9) | % | (92.3) | % | (181.0) | % |
The decrease in consolidated operating income was largely due to non-cash goodwill impairment charge recorded in EMEA for $129.7 million, the settlement of certain long-term obligations, including pension obligations, of $64.7 million in Corporate and an increase in restructuring charges. Other factors contributing to the decrease included an increase in SG&A and unfavorable foreign exchange, offset partially by contribution from the AERCO acquisition. The Americas organic operating income decrease was primarily due to increased SG&A expenses related to product liability costs of $8.1 million and transformation-related costs of $7.1 million. EMEA organic operating income decrease was primarily due to volume decline.
Interest Expense. Interest expense increased $4.4 million, or 22.1%, in 2015 as compared to 2014 primarily due to the interest on borrowings used to purchase AERCO in December 2014.
Other (income) expense, net. Other (income) expense, net, fluctuated $5.5 million to an income balance of $2.4 million in 2015 as compared to 2014, primarily due to net foreign currency transaction gains in 2015 compared to losses in 2014 as a result of the depreciation of the euro, the Chinese yuan, and the Canadian dollar against the U.S. dollar and depreciation of the Canadian dollar against the euro in 2015.
Income Taxes. Our effective income tax rate changed to (1.7%) in 2015, from 39.5% in 2014. The significant change in the tax rate was due to the impact that non-deductible and other income tax reserve items had on a loss before income taxes reported in 2015 compared to 2014, primarily related to the goodwill impairment charge and the settlement of our pension plan and supplemental employee retirement plan obligations.
30
Net (Loss) Income. Net loss for 2015 was ($112.9) million, or ($3.24) per common share, compared to net income of $50.3 million, or $1.42$0.02 per common share for 2014. footprint optimization.
Results for 20152018 include $3.7 million, or $0.10 per common share, in a tax benefit related to the finalization of the 2017 Tax Act; offset by an after-tax charge of $126.8$2.5 million, or $3.63 per common share, for a goodwill and other long-lived asset impairment charge, $44.6 million, or $1.28 per common share, for long-term obligation settlements including pension obligations, $13.9 million, or $0.40$0.07 per common share, for restructuring; $9.0and other tax adjustments of $1.5 million, or $0.26$0.04 per common share, for the EMEA and Americas transformation deployment costs; $3.7 million, or $0.11 per common share, for legal and other settlements; and $0.9 million, or $0.03 per common share, for acquisition related costs.share.
Results for 2014 include net after-tax charges of $38.5 million, or $1.09 per common share, including acquisitions and impairment related costs of $0.51, restructuring charges of $0.39, and EMEA and Americas transformation deployment costs of $0.19.
Liquidity and Capital Resources
20162019 Cash Flows
In 2016, weWe generated $138.1$194.0 million of net cash from operating activities in 2019 as compared to $109.4$169.4 million in 2015. Cash flowsof net cash generated from operating activities in 2015 included a $49.2 million settlement of certain long‑term obligations, including pension obligations. We generated approximately $102.2 million of free cash flow (a non‑GAAP financial measure, which we reconcile below, defined as2018. The increase was primarily related to inventory reductions and higher net cash provided by operating activities minus capital expenditures plus proceeds from sale of assets),income compared to free cash flow of $81.8 million2018. Additionally, in 2015.2018 we made higher tax payments, including withholding taxes on repatriated cash.
In 2016, weWe used $114.0$71.8 million of net cash for investing activities in 2019 compared to $17.3$35.9 million in 2015.2018. The increase in cash used for investing activities was primarily due to $42.7 million of cash used for an immaterial acquisition in the Americas segment in the third quarter of 2019. We used $67.6$6.7 million moreless cash for capital expenditures in 2016 than 2015 relating2019 compared to the acquisitions of PVI and AERCO Korea. We also increased our purchases of capital equipment during 2016 by $8.3 million. In 2015, we received approximately $20.8 million more in cash proceeds from the sale of assets, primarily relating to the sale of non-core product lines in the Americas. 2018. We anticipate investing approximately $36between $35 million to $40 million in capital equipment in 20172020 to improve our manufacturing capabilities.
In 2016, we generated $27.7We used $105.6 million of net cash from financing activities as compared to $70.9 million of net cash used in 2015. The increase in cash generated is2019 primarily due to netpayments of long-term debt of $127.0 million, dividend payments of $31.4 million, and payments to repurchase approximately 228,000 shares of Class A common stock at a cost of $19.5 million. These outflows were partially offset by proceeds from long-term borrowingsadditional drawdowns on our Revolving Credit Facility of $74.4 million and $17.8 million less in stock repurchases in 2016. We also received an additional $5.7 million in cash proceeds from share transactions under employee stock plans in$82.0 million.
In February 2016, compared to 2015.
On February 12, 2016, we terminated our prior Credit Agreement and entered into a new Credit Agreement (the “Credit Agreement”) among the Company, certain subsidiaries of the Company who becamebecome borrowers under the Credit Agreement, JPMorgan Chase Bank, N.A., as Administrative Agent, Swing Line Lender and Letter of Credit Issuer, and the other lenders referred to therein. The Credit Agreement provides for a $500 million, five‑year,five-year, senior unsecured revolving credit facility (the “Revolving Credit Facility”) with a sublimit of up to $100 million in letters of credit. As of December 31, 2019, we had drawn $10.0 million against the Revolving Credit Facility. The Credit Agreement also providedprovides for a $300 million, five‑year,five-year, term loan facility (the “Term Loan Facility”) available to usthe Company in a single draw. The Credit Agreement matures ondraw, of which the entire $300 million had been drawn in February 12, 2021, subject to extension under certain circumstances and subject to the terms of the Credit Agreement. As of December 31, 2016, we2016. We had $300$225.0 million of borrowings outstanding on the term loan and $162 million drawn on the line of credit under the Credit Agreement. AsTerm Loan Facility as of December 31, 2016, we were in compliance with all covenants related to2019. We paid total installments on the Credit AgreementTerm Loan Facility of $30.0 million during 2019. We had $25.8 million of stand-by letters of credit outstanding and had $312.4$464.2 million of unused and available credit under the Credit Agreement and $25.6 million of stand-by letters of credit outstanding on the Credit Agreement.
Borrowings outstanding under the Revolving Credit Facility bear interest at a fluctuating rate per annum equalFacility.
We have historically financed our operating and capital needs primarily through cash flows generated by our operations. We expect to an applicable percentage defined as (i)continue funding future operating requirements principally through our cash flows from operations, in addition to existing cash resources. We believe that our existing funds, when combined with cash generated from operations and our ability to access additional financing resources, if needed, are sufficient to satisfy our operating, working capital, strategic investments, capital expenditure and debt service requirements for the caseforeseeable future, including repayment of Eurocurrency rate loans, the ICE Benchmark Administration LIBOR rate plus an applicable percentage, ranging from 0.975% to 1.45%, determined by reference to our consolidated leverage ratio, or (ii)$75 million senior notes due in the case of base rate loans and swing line loans, the highest of (a) the federal funds rate plus 0.5%, (b) the rate of interest in effect for such day as announced by JPMorgan Chase Bank, N.A. as its “prime rate,” and (c) the ICE Benchmark Administration LIBOR rate plus 1.0%, plus an applicable percentage, ranging from 0.00% to 0.45%, determined by reference to the Company’s consolidated leverage ratio. Borrowings outstanding under the Term Loan Facility will bear interest at a fluctuating rate per annum equal to an applicable percentage defined as the ICE Benchmark Administration LIBOR rate plus an applicable percentage, ranging from 1.125% to 1.75%, determined by
31
reference to the Company’s consolidated leverage ratio. The loan under the Term Loan Facility amortizes as follows: 0% per annum during the first year, 7.5% in the second and third years, 10% in the fourth and fifth years, and the remaining unpaid balance paid in full on the maturity date. Payments when due are made ratably each year in quarterly installments.June 2020. In addition, we may choose to paying interest under the Credit Agreement, we are also requiredopportunistically return cash to pay certain fees in connection with the credit facility,shareholders and pursue other business initiatives, including but not limited to, an unused facility fee and letter of credit fees.acquisition activities. We may, repay loans outstanding under the Credit Agreement from time to time, without premium or penalty, other than customary breakage costs, if any,also seek additional funding through a combination of equity and subject to the terms of the Credit Agreement.
On December 16, 2016, Watts International Holdings Limited (“Watts International”), our wholly owned subsidiary, entered intodebt financings should we identify a Facility Agreement (the “Facility Agreement”) among Watts International, as original borrower and original guarantor, Watts Water Technologies EMEA B.V., our wholly owned subsidiary (“Watts EMEA”), as original guarantor, JPMorgan Chase Bank, N.A., as sole bookrunner and sole lead arranger (“JP Morgan Chase Bank”), J.P. Morgan Europe Limited, as agent to the financial parties, and the other lenders referred to therein. The Facility Agreement provides for a €110 million, 364 day, term loan facility in a single draw. On December 20, 2016, Watts International borrowed the full amount available for borrowing under the Facility Agreement. The loan bears interest at a rate per annum equal to (i) the Euro InterBank Offered Rate (EURIBOR), provided that if such rate is less than zero, then EURIBOR shall be deemed to be zero, plus (ii) a margin of 1.875%, provided that if no event of default is continuing and Watts International’s consolidated leverage ratio is at a specified level, the margin shall decrease to 1.50%. Accrued interest on the loan is payable on the last day of each interest period. The first interest period is set at one month and may be changed subsequently to a period of one, two, or three months (or such other period agreed with all the lenders). The loan under the Facility Agreement is required to be repaid on the following schedule: €15,000,000 on June 30, 2017; €15,000,000 on September 29, 2017; and the remaining balance on December 19, 2017. Substantially all of the proceeds of the borrowings made on December 20, 2016 under the Facility Agreement were used to pay down $113 million previously outstanding under the Revolving Credit Facility.significant new opportunity.
As of December 31, 2016,2019, we held $338.4$219.7 million in cash and cash equivalents. Our ability to fund operations from cash and cash equivalents could be limited by market liquidity as well as possible tax implications of moving proceeds across jurisdictions. Of this amount, approximately $309.0$168.4 million of cash and cash equivalents werewas held by foreign subsidiaries. Our U.S. operations typically generate sufficient cash flows to meet our domestic obligations. We mayHowever, if we did have to borrow to fund some or all of our expected cash outlay, which we can do so at reasonable interest rates by utilizing the uncommitted borrowings under our Revolving Credit Agreement.Facility. Subsequent to recording the Toll Tax as part of the Tax Cuts and Jobs Act 2017, our intent is to permanently reinvest undistributed earnings of foreign
28
subsidiaries, and we do not have any current plans to repatriate foreign earnings to fund operations in the United States. However, if amounts held by foreign subsidiaries were needed to fund operations in the United States, we could be required to accrue and pay taxes to repatriate these funds. Such charges may include a federal tax of up to 35.0% on dividends received in the U.S., potential state income taxes and an additional withholdingother tax payable to foreign jurisdictions of up to 10.0%. However, our intent is to permanently reinvest undistributed earnings of foreign subsidiaries and we do not have any current plans to repatriate them to fund operations in the United States.charges.
Covenant compliance
Under the Credit Agreement, we are required to satisfy and maintain specified financial ratios and other financial condition tests as of December 31, 2016.2019. The financial ratios includedinclude a consolidated interest coverage ratio based on consolidated earnings before income taxes, interest expense, depreciation, and amortization (Consolidated EBITDA) to consolidated interest expense, as defined in the Credit Agreement. Our Credit Agreement defineddefines Consolidated EBITDA to exclude unusual or non‑recurringnon-recurring charges and gains. We wereare also required to maintain a consolidated leverage ratio of consolidated funded debt to Consolidated EBITDA. Consolidated funded debt, as defined in the Credit Agreement, includedincludes all long and short‑termshort-term debt, capital lease obligations and any trade letters of credit that are outstanding, less cash on the balance sheet that exceeded $50 million.
As of December 31, 2016,2019, our actual financial ratios calculated in accordance with our Credit Agreement compared to the required levels under the Credit Agreement were as follows:
| | | | | |
| ActualRatio | Required Level | |||
| |
|
| ||
|
| Minimum level | |||
Interest Charge Coverage Ratio |
|
|
| 3.50 to 1.00 | |
| | |
| Maximum level | |
Leverage Ratio |
|
|
| 3.25 to 1.00 |
32
As of December 31, 2016,2019, we were in compliance with all covenants related to the Credit Agreement.
We have one senior note agreement as further detailed in Note 1011 of Notes to Consolidated Financial Statements in this Annual Report Form 10-K. This senior note agreement requires us to maintain a fixed charge coverage ratio of consolidated EBITDA plus consolidated rent expense during the period to consolidated fixed charges. Consolidated fixed charges are the sum of consolidated interest expense for the period and consolidated rent expense.
As of December 31, 2016,2019, our actual fixed charge coverage ratio calculated in accordance with our senior note agreementsagreement compared to the required ratio therein was as follows:
| | | | | |
| Actual Ratio | Required Level | |||
| |
|
| ||
|
| Minimum level | |||
Fixed Charge Coverage Ratio |
|
|
| 2.00 to 1.00 |
Under the Facility Agreement, we are required to satisfy and maintain specified financial ratios and other financial condition tests as of December 31, 2016. The financial ratios relate to the accounts of Watts International and its wholly-owned subsidiaries and includes a consolidated leverage ratio calculated as consolidated total gross debt to consolidated EBITDA. Consolidated total gross debt, as defined in the Facility Agreement, includes all long and short-term debt, capital lease obligations, and any trade letters of credit that are outstanding. Consolidated EBITDA, as defined in the Facility Agreement, includes consolidated earnings before income taxes, interest expense, depreciation and amortization and excludes unusual or non-recurring charges and gains. Watts International is also required to maintain a minimum consolidated cash balance ratio, defined as the cash balance held by the company to consolidated total gross debt. Cash balance, as defined, includes cash and cash equivalents.
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As of December 31, 2016, we were in compliance with all covenants related to the Facility Agreement.
In addition to financial ratios, the Credit Agreement, Facility Agreement and senior note agreement contain affirmative and negative covenants that include limitations on disposition or sale of assets, prohibitions on assuming or incurring any liens on assets with limited exceptions and limitations on making investments other than those permitted by the agreements.
Working capital (defined as current assets less current liabilities) as of December 31, 20162019 was $432.8$315.6 million compared to $514.0$372.6 million as of December 31, 2015.2018. The ratio of current assets to current liabilities was 2.01.8 to 1 as of December 31, 20162019 compared to 2.72.1 to 1 as of December 31, 2015.2018. The decrease in working capital is primarily related to an increase in the short-term Facility Agreement entered into in 2016.
2015 Cash Flows
In 2015, we generated $109.4 millioncurrent portion of cash from operating activities as compared to $135.2 million in 2014. The decrease was primarilylong-term debt due to the $49.2 million settlementreclassification of certain long‑term obligations, including the pension plan, offset by inventory reduction efforts and stronger accounts receivable collections. We generated approximately $81.8 millionsenior note from long-term debt to current portion of free cash flow (a non‑GAAP financial measure,long-term debt. The senior note, which we reconcile below, defined as net cash provided by continuing operating activities minus capital expenditures plus proceeds from saleis described further in Note 11 of assets), compared to free cash flow of $111.9 million in 2014.
In 2015, we used $17.3 million of net cash for investing activities, including $20.4 million for the purchase of Apex and $27.7 million of cash for capital equipment, offset by cash proceeds of approximately $33.1 million for the sale of certain assets relating to divested product lines in the Americas.
In 2015, we used $70.9 million of net cash from financing activities including $44.6 million used to repurchase approximately 813,000 shares of Class A common stock and $23.1 million used to pay dividends.
33
2014 Cash Flows
In 2014, we generated $135.2 million of cash from operating activities. We generated approximately $111.9 million of free cash flow (a non‑GAAP financial measure, which we reconcile below, defined as net cash provided by continuing operating activities minus capital expenditures plus proceeds from sale of assets. Free cash flow as a percentage of net income from continuing operations was 222.5% in 2014.
In 2014, we used $295.5 million of net cash for investing activities, including $272.2 million for the purchase of AERCO and $23.7 million of cash for capital equipment.
In 2014, we generated $220.8 million of net cash from financing activities. Cash provided by financing activities was primarily dueNotes to the $275.0 million borrowings under our Prior Credit Agreement to fund the AERCO acquisition and by proceedsConsolidated Financial Statements in this Annual Report 10-K, is due in June of $11.8 million from option exercises under the employee stock plans, offset by payments to repurchase approximately 670,000 shares of Class A common stock at a cost of $39.6 million and payment of dividends of $20.5 million.2020.
Non‑GAAPNon-GAAP Financial Measures
In accordance with the SEC's Regulation G and itemItem 10(e) of Regulation S-K, the following provides definitions of the non-GAAP measures used by management. We believe that these measures provide for a more complete perspectiveenhance the overall understanding of underlying business results and trends. These non-GAAP measures are not intended to be considered by the user in place of the related GAAP measure, but rather as supplemental information to more fully understand our business results.
29
These non-GAAP measures may not be the same as similar measures used by other companies due to possible differences in method and in the items or events being adjusted.
Organic sales growth is a non-GAAP measure of sales growth that excludes the impacts of acquisitions, divestitures and foreign exchange from period-over-period comparisons. A reconciliation to the most closely related U.S.GAAPU.S. GAAP measure, net sales, has been included in our discussion within “Results of Operations” above. Organic net sales should be considered in addition to, and not as a replacement for or as a superior measure to net sales. Management believes reporting organic sales growth provides useful information to investors, potential investors and others, by facilitating easier comparisons of our revenue performance with prior and future periods.
Adjusted operating income, adjusted operating margins, adjusted net income, and adjusted earnings per share are non-GAAP measures that exclude certain expenses incurred and benefits recognized in the periods presented that relate primarily to our global restructuring programs, deployment costs,professional fees incurred to optimize and simplify our European legal structure and gain a deeper understanding of our product/customer profitability by end market, acquisition related costs, purchase accounting adjustments, gains on acquisition and disposition, goodwill and other long-lived asset impairments, Defined Benefit Plans settlement, certain other costs andfootprint optimization, the related income tax impacts on these items and other tax adjustments.adjustments, including the impact of the 2017 Tax Act. Management believes reporting these financial measures provides useful information to investors, potential investors and others, by facilitating easier comparisons of our performance with prior and future periods.
34
A reconciliation of U.S. GAAP results to these adjusted non-GAAP measures is provided below:
| | | | | | |
| | | | | | |
|
| Year Ended | ||||
| | December 31, | | December 31, | ||
| | 2019 | | 2018 | ||
| | | | | | |
Net sales | | $ | 1,600.5 | | $ | 1,564.9 |
| | | | | | |
Operating income - as reported | | | 197.1 | | | 188.4 |
Operating margin % | | | 12.3% | | | 12.0% |
| | | | | | |
Adjustments for special items: | |
| | |
| |
Restructuring | | | 4.3 | | | 3.4 |
Professional fees | | | 3.1 | | | — |
Acquisition related costs | | | 0.9 | | | — |
Footprint optimization | | | 0.8 | | | — |
Total adjustments for special items | | $ | 9.1 | | $ | 3.4 |
| | | | | | |
Operating income - as adjusted | | $ | 206.2 | | $ | 191.8 |
Adjusted operating margin % | | | 12.9% | | | 12.3% |
| | | | | | |
Net income - as reported | | $ | 131.5 | | $ | 128.0 |
| | | | | | |
Adjustments for special items - tax effected: | | | | | | |
Restructuring | | | 3.2 | | | 2.5 |
Professional fees | | | 3.1 | | | — |
Acquisition related costs | | | 0.7 | | | — |
Footprint optimization | | | 0.6 | | | — |
Other tax items | | | — | | | 1.5 |
The 2017 Tax Act | | | — | | | (3.7) |
Total adjustments for special items - tax effected: | | $ | 7.6 | | $ | 0.3 |
| | | | | | |
Net income as adjusted | | $ | 139.1 | | $ | 128.3 |
| | | | | | |
Diluted earnings per share - as reported | |
| 3.85 | |
| 3.73 |
Adjustments for special items | |
| 0.22 | |
| 0.01 |
Diluted earnings per share - as adjusted | | $ | 4.07 | | $ | 3.74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Year Ended | ||||
|
| December 31 |
| December 31 | ||
|
| 2016 |
| 2015 | ||
|
|
|
|
|
|
|
Net sales |
| $ | 1,398.4 |
| $ | 1,467.7 |
|
|
|
|
|
|
|
Operating income (loss) - as reported |
|
| 145.0 |
|
| (90.1) |
Operating margin % |
|
| 10.4% |
|
| -6.1% |
|
|
|
|
|
|
|
Adjustments for special items: |
|
|
|
|
|
|
Goodwill and other long-lived asset impairment charges |
|
| 0.5 |
|
| 130.5 |
Acquisitions/divestiture related (benefits)/costs |
|
| (4.7) |
|
| 1.6 |
Restructuring |
|
| 4.7 |
|
| 21.4 |
Transformation and deployment costs |
|
| 14.2 |
|
| 14.3 |
Other costs/long-term obligation settlements |
|
| 0.3 |
|
| 70.7 |
Total adjustments for special items |
| $ | 15.0 |
| $ | 238.5 |
|
|
|
|
|
|
|
Operating income - as adjusted |
| $ | 160.0 |
| $ | 148.4 |
Adjusted operating margin % |
|
| 11.4% |
|
| 10.1% |
|
|
|
|
|
|
|
Net income (loss) - as reported |
| $ | 84.2 |
| $ | (112.9) |
|
|
|
|
|
|
|
Adjustments for special items - tax affected: |
|
|
|
|
|
|
Goodwill and other long-lived asset impairment charges |
|
| 0.4 |
|
| 126.8 |
Acquisitions/divestiture related (benefits)/costs |
|
| (6.8) |
|
| 0.9 |
Restructuring |
|
| 3.2 |
|
| 13.9 |
Transformation and deployment costs |
|
| 8.8 |
|
| 9.0 |
Other costs/long-term obligation settlements |
|
| 2.6 |
|
| 46.7 |
Total Adjustments for special items - tax affected: |
| $ | 8.2 |
| $ | 197.3 |
|
|
|
|
|
|
|
Net income as adjusted |
| $ | 92.4 |
| $ | 84.4 |
|
|
|
|
|
|
|
Diluted earnings per share - as reported |
|
| 2.44 |
|
| (3.24) |
Adjustments for special items |
|
| 0.23 |
|
| 5.65 |
Diluted earnings per share - as adjusted |
| $ | 2.67 |
| $ | 2.41 |
30
Free cash flow is a non-GAAP measure that does not represent cash generated from operating activities in accordance with U.S. GAAP. Therefore it should not be considered an alternative to net cash provided by operating activities as an indication of our performance. The cash conversion rate of free cash flow to net income is also a measure of our performance in cash flow generation. We believe free cash flow to be an appropriate supplemental measure of our operating performance because it provides investors with a measure of our ability to generate cash, repay debt, pay dividends, repurchase stock and fund acquisitions.
35
A reconciliation of net cash provided by operating activities to free cash flow and calculation of our cash conversion rate is provided below:
|
|
|
|
|
|
|
|
|
|
| |||||||
|
| Year Ended December 31, |
| ||||||||||||||
|
| 2016 |
| 2015 |
| 2014 |
| ||||||||||
|
| (in millions) |
| ||||||||||||||
| | | | | | | | ||||||||||
| | Year Ended December 31, | |||||||||||||||
|
| 2019 |
| 2018 |
| ||||||||||||
| | (in millions) | |||||||||||||||
Net cash provided by operating activities |
| $ | 138.1 |
| $ | 109.4 |
| $ | 135.2 |
| | $ | 194.0 | | $ | 169.4 | |
Less: additions to property, plant, and equipment |
|
| (36.0) |
|
| (27.7) |
|
| (23.7) |
| |
| (29.2) | |
| (35.9) | |
Plus: proceeds from the sale of property, plant, and equipment |
|
| 0.1 |
|
| 0.1 |
|
| 0.4 |
| |
| 0.1 | |
| 2.2 | |
Free cash flow |
| $ | 102.2 |
| $ | 81.8 |
| $ | 111.9 |
| | $ | 164.9 | | $ | 135.7 | |
Net income (loss)—as reported |
| $ | 84.2 |
| $ | (112.9) |
| $ | 50.3 |
| |||||||
Cash conversion rate of free cash flow to net (loss) income |
|
| 121.4 | % |
| NM | % |
| 222.5 | % | |||||||
Free cash flow |
| $ | 102.2 |
| $ | 81.8 |
| $ | 111.9 |
| |||||||
Plus: payments made on long‑term obligations |
|
| — |
|
| 49.2 |
|
| — |
| |||||||
Free cash flow—as adjusted |
| $ | 102.2 |
| $ | 131.0 |
| $ | 111.9 |
| |||||||
Net income —as reported | | $ | 131.5 | | $ | 128.0 | | ||||||||||
Cash conversion rate of free cash flow to net income | |
| 125.4 | % |
| 106.0 | % | ||||||||||
Our free cash flow as adjusted decreasedincreased in 20162019 when compared to the free cash flow as adjusted for 20152018 primarily due to the increasefrom inventory reductions, higher net income, and lower capital expenditures in cash used for capital investments2019. Additionally, in 2018 we made in 2016, as well as the impact of paying certain legal settlements in 2016.higher tax payments, including withholding taxes on repatriated cash.
Our net debt to capitalization ratio, a non‑GAAPnon-GAAP financial measure used by management, increaseddecreased to 29.8%8.4% for 20162019 from 28.5% for 2015.14.3% in 2018. The increasedecrease was driven by an increasea decrease in net debt outstanding at December 31, 2016 used2019, primarily due to fund the PVI acquisition.paying down approximately $30 million of our outstanding Term Loan Facility as well as approximately $15 million on our Revolving Credit Facility. The decrease in net debt was also due to an increase in cash and cash equivalents of $15.6 million. Management believes the net debt to capitalization ratio is an appropriate supplemental measure because it helps investors understand our ability to meet our financing needs and serves as a basis to evaluate our financial structure. Our computation may not be comparable to other companies that may define their net debt to capitalization ratios differently.
A reconciliation of long‑termlong-term debt (including current portion) to net debt and our net debt to capitalization ratio is provided below:
|
|
|
|
|
|
|
| ||||||
|
| December 31, |
| ||||||||||
|
| 2016 |
| 2015 |
| ||||||||
|
| (in millions) |
| ||||||||||
Current portion of long‑term debt |
|
| 139.1 |
| $ | 1.1 |
| ||||||
Plus: long‑term debt, net of current portion |
|
| 511.3 |
|
| 574.2 |
| ||||||
| | | | | | | |||||||
| | December 31, | | December 31, | |||||||||
| | 2019 | | 2018 | |||||||||
| | (in millions) | |||||||||||
Current portion of long‑term debt |
| $ | 105.0 | | $ | 30.0 | |||||||
Plus: long-term debt, net of current portion |
| | 204.2 | |
| 323.4 | |||||||
Less: cash and cash equivalents |
|
| (338.4) |
|
| (296.2) |
|
| | (219.7) | |
| (204.1) |
Net debt |
| $ | 312.0 |
| $ | 279.1 |
| | $ | 89.5 | | $ | 149.3 |
A reconciliation of capitalization is provided below:
| | | | | | | |
| | December 31, | | December 31, | | ||
| | 2019 | | 2018 | | ||
| | (in millions) |
| ||||
Net debt | | $ | 89.5 | | $ | 149.3 | |
Total stockholders’ equity | |
| 978.0 | |
| 891.3 | |
Capitalization | | $ | 1,067.5 | | $ | 1,040.6 | |
Net debt to capitalization ratio | |
| 8.4 | % |
| 14.3 | % |
|
|
|
|
|
|
|
|
|
| December 31, |
| ||||
|
| 2016 |
| 2015 |
| ||
|
| (in millions) |
| ||||
Net debt |
| $ | 312.0 |
| $ | 281.1 |
|
Total stockholders’ equity |
|
| 736.3 |
|
| 704.9 |
|
Capitalization |
| $ | 1,048.3 |
| $ | 986.0 |
|
Net debt to capitalization ratio |
|
| 29.8 | % |
| 28.5 | % |
31
36
Contractual Obligations
Our contractual obligations as of December 31, 20162019 are presented in the following table:
| | | | | | | | | | | | | | | |
| | Payments Due by Period | |||||||||||||
|
| | |
| Less than |
| | |
| | |
| More than | ||
Contractual Obligations | | Total | | 1 year | | 1‑3 years | | 4‑5 years | | 5 years | |||||
| | (in millions) | |||||||||||||
Long-term debt obligations, including current maturities(a)(c) | | $ | 310.0 | | $ | 105.0 | | $ | 205.0 | | $ | — | | $ | — |
Operating lease obligations (d) | |
| 51.2 | |
| 11.0 | |
| 11.8 | |
| 6.9 | |
| 21.5 |
Finance lease obligations(a) | |
| 4.3 | |
| 1.9 | |
| 1.8 | |
| 0.5 | |
| 0.1 |
Pension contributions | |
| 10.8 | |
| 0.8 | |
| 1.0 | |
| 1.2 | |
| 7.8 |
Interest | |
| 8.3 | |
| 7.5 | |
| 0.8 | |
| — | |
| — |
2017 Tax Act Toll Tax payable | | | 18.9 | | | — | | | 3.8 | | | 15.1 | | | — |
Other(b) | |
| 61.7 | |
| 55.1 | |
| 2.6 | |
| 0.8 | |
| 3.2 |
Total | | $ | 465.2 | | $ | 181.3 | | $ | 226.8 | | $ | 24.5 | | $ | 32.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Payments Due by Period |
| |||||||||||||
|
|
|
|
| Less than |
|
|
|
|
|
|
| More than |
| ||
Contractual Obligations |
| Total |
| 1 year |
| 1‑3 years |
| 4‑5 years |
| 5 years |
| |||||
|
| (in millions) |
| |||||||||||||
Long‑term debt obligations, including current maturities(a)(c) |
| $ | 653.6 |
| $ | 139.1 |
| $ | 52.5 |
| $ | 462.0 |
| $ | — |
|
Operating lease obligations |
|
| 26.6 |
|
| 7.8 |
|
| 10.6 |
|
| 4.4 |
|
| 3.8 |
|
Capital lease obligations(a) |
|
| 4.0 |
|
| 1.0 |
|
| 1.9 |
|
| 1.1 |
|
| — |
|
Pension contributions |
|
| 7.1 |
|
| 0.4 |
|
| 0.8 |
|
| 1.0 |
|
| 4.9 |
|
Interest |
|
| 61.6 |
|
| 18.8 |
|
| 33.3 |
|
| 9.5 |
|
| — |
|
Redeemable financial instrument(a) |
|
| 5.8 |
|
| — |
|
| 5.8 |
|
| — |
|
| — |
|
Other(b) |
|
| 26.4 |
|
| 23.3 |
|
| 2.8 |
|
| 0.1 |
|
| 0.2 |
|
Total |
| $ | 785.1 |
| $ | 190.4 |
| $ | 107.7 |
| $ | 478.1 |
| $ | 8.9 |
|
| (a) |
| as recognized in the consolidated balance |
| (b) |
| the majority relates to commodity and capital commitments at December 31, |
| (c) |
| the payment in less than one year represents the |
| (d) | includes obligations as recognized in the consolidated balance sheet as well as operating lease commitments with a commencement date after December 31, 2019. |
We maintain letters of credit that guarantee our performance or payment to third parties in accordance with specified terms and conditions. Amounts outstanding were approximately $25.6$25.8 million as of December 31, 20162019 and $24.8 million as of December 31, 2015.2018. Our letters of credit are primarily associated with insurance coverage and, to a lesser extent, foreign purchases and generally expire within one year of issuance. These instruments may exist or expire without being drawn down; therefore they do not necessarily represent future cash flow obligations.obligations and are not included in the table above.
Off‑BalanceOff-Balance Sheet Arrangements
Except for operating lease commitments, weWe have no off‑balanceoff-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that isare material to investors.
Application of Critical Accounting Policies and Key Estimates
The preparation of our consolidated financial statements in accordance with U.S. GAAP requires management to make judgments, assumptions and estimates that affect the amounts reported. A critical accounting estimate is an assumption about highly uncertain matters and could have a material effect on the consolidated financial statements if another, also reasonable, amount were used, or, a change in the estimate is reasonably likely from period to period. We base our assumptions on historical experience and on other estimates that we believe are reasonable under the circumstances. Actual results could differ significantly from these estimates. In 2016, we removed workers compensation costs and pension benefits from our critical accounting policies as they are no longer considered critical. There were no other significant changes in our accounting policies or significant changes in our accounting estimates during 2016.2019, with the exception of the change in our lease accounting policy resulting from the adoption of ASC 842 as described in Note 5 in the Notes to the Consolidated Financial Statements in this Annual Report on Form 10-K.
We periodically discuss the development, selection and disclosure of the estimates with our Audit Committee. Management believes the following critical accounting policies reflect our more significant estimates and assumptions.
32
37
Revenue recognition
We recognize revenue when allunder the core principle to depict the transfer of control to our customers in an amount reflecting the consideration to which we expect to be entitled. In order to achieve that core principle, we apply the following criteria are met:five-step approach: (1) we have entered intoidentify the contract with a binding agreement,customer, (2) identify the product has shipped and title has passed,performance obligations in the contract, (3) determine the salestransaction price, (4) allocate the transaction price to the customer is fixed or is determinableperformance obligations in the contract, and (4) collectability is reasonably assured. We(5) recognize revenue based uponwhen a determination that all criteriaperformance obligation is satisfied. Our revenue for revenue recognition have been met, which, basedproduct sales is recognized on a point in time model, at the majority of our shipping terms, is consideredpoint control transfers to have occurred upon shipment of the finished product. Some shipping terms require the goods to be received by the customer, before title passes. In those instances, revenueswhich is generally when products are not recognized untilshipped from the customer has receivedCompany’s manufacturing or distribution facilities or when delivered to the goods. We record estimated reductionscustomer’s named location. Sales tax, value-added tax, or other taxes collected concurrent with revenue producing activities are excluded from revenue. Freight costs billed to customers for shipping and handling activities are included in revenue with the related cost included in selling, general and administrative expenses. See Note 4 for customer returnsfurther disclosures and allowances and for customer programs. Provisions for returns and allowances are made at the time of sale, derived from historical trends and form a portion of the allowance for doubtful accounts. Customer programs, which are primarily annual volume incentive plans, allow customers to earn credit for attaining agreed upon purchase targets from us. We record estimated reductions todetail regarding revenue made at the time of sale, for customer programs based on estimated purchase targets.recognition.
Allowance for doubtful accounts
The allowance for doubtful accounts is established to represent our best estimate of the net realizable value of the outstanding accounts receivable. The development of our allowance for doubtful accounts varies by region but in general is based on a review of past due amounts, historical write‑off experience, as well as aging trends affecting specific accounts and general operational factors affecting all accounts. In addition, factors are developed in certain regions utilizing historical trends of sales and returns and allowances and cash discount activities to derive a reserve for returns and allowances and cash discounts.
We uniformly consider current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. We also aggressively monitor the creditworthiness of our largest customers, and periodically review customer credit limits to reduce risk. If circumstances relating to specific customers change or unanticipated changes occur in the general business environment, our estimates of the recoverability of receivables could be further adjusted.
Inventory valuation
Inventories are stated at the lower of cost or marketnet realizable value with costs determined primarily on a first‑in first‑outfirst-in first-out basis. We utilize both specific product identification and historical product demand as the basis for determining our excess or obsolete inventory reserve. We identify all inventories that exceed a range of one to three years in sales. This is determined by comparing the current inventory balance against unit sales for the trailing twelve months. New products added to inventory within the past twelve months are excluded from this analysis. A portion of our products contain recoverable materials, therefore the excess and obsolete reserve is established net of any recoverable amounts. Changes in market conditions, lower‑than‑lower-than- expected customer demand or changes in technology or features could result in additional obsolete inventory that is not saleable and could require additional inventory reserve provisions.
In certain countries, additional inventory reserves are maintained for potential shrinkage experienced in the manufacturing process. The reserve is established based on the prior year’s inventory losses adjusted for any change in the gross inventory balance.
Goodwill and other intangibles
We have made numerous acquisitions over the years and have recognized a significant amount of goodwill. Goodwill is tested for impairment annually or more frequently if an event or circumstance indicates that an impairment loss may have been incurred. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, and determination of the fair value of each reporting unit. We estimate the fair value of our reporting units using an income approach based on the present value of estimated future cash flows, and when appropriate, guideline public company and guideline transaction market approaches.
Accounting guidance allows us to review goodwill for impairment utilizing either qualitative or quantitative analyses. We have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its
38
carrying amount. If, after assessing the totality of events and circumstances, we determine it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then performing the two‑step (quantitative)quantitative impairment test is unnecessary.
We first identify those reporting units that we believe could pass a qualitative assessment to determine whether further impairment testing is necessary. For each reporting unit identified, our qualitative analysis includes:
| 1)A review of the most recent fair value calculation to identify the extent of the cushion between fair value and carrying amount, to determine if a substantial cushion existed. |
| 2)A review of events and circumstances that have occurred since the most recent fair value calculation to determine if those events or circumstances would have affected our previous fair value assessment. Items identified and reviewed include macroeconomic conditions, industry and market changes, cost factor changes, events that affect the reporting unit, and financial performance against expectations and the reporting unit’s performance relative to peers. |
33
We then compile this information and make our assessment of whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If we determine it is not more likely than not, then no further quantitative analysis is required.
In 2016,2019, we had eightseven reporting units. One of these reporting units, Water Quality, had no goodwill. We performed a qualitative analysis for each of the six remaining reporting units, which include Blücher, Dormont, US Drains, AERCO, EMEA, ResidentialFluid Solutions-Europe, Fluid Solutions-Americas, Heating and Commercial,Hot Water Solutions (“HHWS”) and Asia-Pacific. APMEA.
As of our October 30, 201627, 2019 testing date, we had approximately $493.4$579.4 million of goodwill on our balance sheet. As a result of our qualitative analyses, we determined that the fair values of the six reporting units noted above were more likely than not greater than the carrying amounts. In 2016,2019, we did not need to proceed beyond the qualitative analysis, and no goodwill impairments were recorded.
In 2015, we recognized a pre‑tax impairment charge of $129.7 million in the EMEA reporting unit. The remaining goodwill balance as of December 31, 2015 in this reporting unit was $46.4 million.
During the fourth quarter of 2014, we recognized a pre‑tax non‑cash goodwill impairment charge of $12.9 million. The charge in 2014 related to the Asia‑Pacific reporting unit. As of December 31, 2014, goodwill for the Asia‑Pacific reporting unit was fully impaired.
Intangible assets such as trademarks and trade names are generally recorded in connection with a business acquisition. Values assigned to intangible assets are typically determined by an independent valuation firm based on our estimates and judgments regarding expectations of the success and life cycle of products and technology acquired. Accounting guidance allows us to perform a qualitative impairment assessment of indefinite‑livedindefinite-lived intangible assets consistent with the goodwill guidance noted previously. For our 20162019 impairment assessment, which occurred as of October 30, 2016,27, 2019, we performed a qualitative assessment for certain tradenames where the fair value significantly exceeded the carrying value in the 2018 quantitative assessments for all indefinite‑lived intangible assets.assessment, had sales growth in 2019, and no other indicators of impairment were present. For the remaining tradenames in 2019, the Company performed a quantitative assessment. The methodology we employed for the quantitative assessments was the relief from royalty method, a subset of the income approach. During 2016 we2019, 2018, and 2017, no impairment was recognized a non‑cash pre‑tax charge of approximately $0.4 million related to an indefinite lived tradename inon our EMEA reporting unit. In 2015 and 2014, we recognized non-cash pre-tax impairment charges of $0.6 million and $1.3 million, respectively, as an impairment of certain of our indefinite‑livedindefinite-lived intangible assets.
Product liability
Because of retention requirements associated with our insurance policies, we are generally self‑insuredself-insured for potential product liability claims. We are subject to a variety of potential liabilities in connection with product liability cases, and for our most significant volume of liability matters, we maintain a high self‑insuredself-insured retention limit within our product liability and general liability coverage, which we believe to be generally in accordance with industry practices. We maintain excess liability insurance to minimize our risks related to claims in excess of our primary insurance policies. The product liability accrual is established after considering any applicable insurance coverage.
For our product liability cases in the U.S., management establishes itswe establish a product liability accrual, which includes legal costs associated with accrued claims, by utilizing third‑partyclaims. For our most significant volume of liability matters, we utilize third-party actuarial valuations which incorporate historical trend factors and our specific claims experience derived from loss reports provided by third‑party administrators. Thethird-party claims administrators to establish our product liability accrual. For the remainder of our product liability accrual, is established after considering any applicablewhere we do not utilize third-party actuarial valuations, we maintain insurance coverage.and calculate potential product liability accruals which includes legal costs associated with the accrued claims on a case by case basis. Changes in the nature of product liability claims, legal costs, or the actual settlement amounts could affect the adequacy of the estimates and require changes to the accrual. Because the liability is an estimate, the ultimate liability may be more or less than reported.
39
We determine the trend factors for product liability based on consultation with outside actuaries. We maintain excess liability insurance to minimize our risks related to claims in excess of our primary insurance policies. Any material change in the aforementioned factors could have an adverse impact on our operating results.
Legal contingencies
We are a defendant in numerous legal matters including those involving environmental issues and product liability as discussed in more detail in Part I, Item 1. “Business—Product Liability, Environmental and Other Litigation Matters.”Matters” and Note 15. As required by GAAP, we determine whether an estimated loss from a loss contingency should be accrued by assessing whether a loss is deemed probable and the loss amount can be reasonably estimated. When it is possible to estimate reasonably possible loss or range of loss above the amount accrued, that estimate is aggregated and disclosed. Estimates of potential outcomes of these contingencies are often developed in consultation with outside counsel. While this assessment is based upon all available information, litigation is inherently uncertain and the actual liability to fully resolve litigation cannot be predicted with any assurance of accuracy. In the event of an unfavorable outcome in one or more legal matters, the ultimate liability may be in excess of amounts currently accrued, if any, and may be material to our operating results or cash flows for a particular quarterly or annual period. However, based on information currently known to us, management believes that the ultimate outcome of all legal contingencies, as they are resolved over time, is
34
not likely to have a material adverse effect on our financial condition, though the outcome could be material to our operating results for any particular period depending, in part, upon the operating results for such period.
Income taxes
We are subject to income taxes in the U.S. (federal and state) and foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes.
We estimate and use our expected annual effective income tax rates to accrue income taxes. Effective tax rates are determined based on budgeted earnings before taxes, including our best estimate of permanent items that will affect the effective rate for the year. Management periodically reviews these rates with outside tax advisors and changes are made if material variances from expectations are identified.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
A valuation allowance is provided to offset any net deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. We consider estimated future taxable income and future reversals of the deferred tax liabilities in assessing the need for a valuation allowance.
The 2017 Tax Act was enacted on December 22, 2017 and introduced significant changes to U.S. income tax law. Effective in 2018, the 2017 Tax Act reduced the U.S. statutory tax rate from 35% to 21% and created new taxes on certain foreign-sourced earnings and certain related-party payments, which are referred to as the global intangible low-taxed income tax and the base erosion tax, respectively. In addition, in 2017 we were subject to the Toll Tax, a one-time transition tax on accumulated foreign subsidiary earnings not previously subject to U.S. income tax. Accounting for the income tax effects of the 2017 Tax Act at December 31, 2017 required significant judgments and estimates in the interpretation and calculations of the provisions of the 2017 Tax Act.
We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the Toll Tax, remeasuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. Due to the timing of the enactment and the complexity involved in applying the provisions of the 2017 Tax Act, we made reasonable estimates of the effects and recorded provisional amounts in our financial statements for the year ended December 31, 2017. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. December 22, 2018 marked the end of the measurement period for purposes of SAB 118. As such, we completed the analysis based on legislative updates relating to the Act currently available, which resulted in an additional tax benefit of $3.7 million in the fourth quarter of 2018 and a final total tax charge of $21.4 million related to implementation of the 2017 Tax Act.
New Accounting Standards
A discussion of recent accounting pronouncements is included in Note 2 of the Notes to Consolidated Financial Statements in this Annual Report on Form 10‑K.10-K.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We use derivative financial instruments primarily to reduce exposure to adverse fluctuations in foreign exchange rates, interest rates and costs of certain raw materials used in the manufacturing process. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all derivative positions are used to reduce risk by hedging underlying economic exposure. The derivatives we use are instruments with liquid markets. See Note 1516 of Notes to the Consolidated Financial Statements in this Annual Report on Form 10‑K.for further details.
35
Our consolidated earnings, which are reported in United States dollars, are subject to translation risks due to changes in foreign currency exchange rates. This risk is concentrated in the exchange rate between the U.S. dollar and the euro; the U.S. dollar and the Canadian dollar; and the U.S. dollar and the Chinese yuan; and the Hong Kong Dollar and the euro.yuan.
40
Our foreignnon-U.S. subsidiaries transact most business, including certain intercompany transactions, in foreign currencies. Such transactions are principally purchases or sales of materials and are denominated in European currencies or the U.S. or Canadian dollar. We use foreign currency forward exchange contracts from time to time to manage the risk related to intercompany loans, intercompany purchases and intercompany sales that occur during the course of a year, and certain open foreign currency denominated commitments to sell products to third parties. At December 31, 2016,Beginning in the first quarter of 2018, we have one openentered into forward exchange contractcontracts that settle quarterly and which washedge approximately 70% to 80% of the forecasted intercompany purchases between one of our Canadian subsidiaries and our U.S. operating subsidiaries for the next twelve months. Beginning in the first quarter of 2019, we entered into forward exchange contracts which hedge up to manage60% of the forecasted intercompany sales transactions between one of our Chinese subsidiaries and one of our U.S. operating subsidiaries for the next twelve months. We record the effective portion of the designated foreign currency rate exposure betweenhedge contracts in other comprehensive income until inventory turns and is sold to a third-party. Once the Hong Kong dollar andthird-party transaction occurs associated with the euro regarding an intercompany loan. This forward contract is marked-to-market with changes inhedged forecasted transaction, the effective portion of any related gain or loss on the designated foreign currency hedge will be reclassified into earnings. The fair value recorded to earnings.
Prior to 2016, we generally had a low exposure on the cost of our debt to changes in interest rates. On February 12, 2016, the Company entered into a new Credit Agreement (the “Credit Agreement”) pursuant to which it received a funding commitment under a Term Loan of $300 million, of which the entire $300 million has been drawn on, and a Revolving Commitment (“Revolver”) of $500 million, of which $162 million has been drawndesignated foreign hedge contracts outstanding as of December 31, 2016. Both facilities mature on February 12, 2021. For each facility,2019 was a liability balance of $0.2 million.
Under the CompanyCredit Agreement, we can choose either an Adjusted LIBOR or Alternative Base Rate (“ABR”). Accordingly, the Company’s earnings and cash flows are exposed to interest rate risk from changes in Adjusted LIBOR. In order to manage the Company’sour exposure to changes in cash flows attributable to fluctuations in LIBOR-indexed interest payments related to our floating rate debt, the Companywe entered into two interest rate swaps. For each interest rate swap, the Company receiveswe receive the three-month USD-LIBOR subject to a 0% floor, and payspay a fixed rate of 1.31375% on a notional amount of $225.0 million. Information about our long‑termlong-term debt including principal amounts and related interest rates appears in Note 1011 of Notes to the Consolidated Financial Statements in this Annual Report on Form 10‑K for the year ended December 31, 2016.Statements.
We purchase significant amounts of bronze ingot, brass rod, cast iron, stainless steel, steel, plastic and plastic,other materials, which are utilized in manufacturing our many product lines. Our operating results can be adversely affected by changes in commodity prices if we are unable to pass on related price increases to our customers. We manage this risk by monitoring related market prices, working with our suppliers to achieve the maximum level of stability in their costs and related pricing, seeking alternative supply sources when necessary and passing increases in commodity costs to our customers, to the maximum extent possible, when they occur.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements listed in section (a) (1) of “Part IV, Item 15. Exhibits, and Financial Statement Schedules” of this Annual Report are incorporated herein by reference.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
Item 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a‑15(b)13a-15(b) under the Securities Exchange Act of 1934, as amended, or Exchange Act, as of the end of the period covered by this report, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily applies its judgment in evaluating and implementing possible controls and procedures. The effectiveness of our disclosure controls and procedures is also necessarily limited by the staff and other resources available to us and the geographic diversity of our operations. Based upon that
36
evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective, in that they provideprovided reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and in that such controls are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act areis accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
41
There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2016, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. In connection with these rules, we will continue to review and document our disclosure controls and procedures, including our internal control over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.
Management’s Annual Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a‑15(f)13a-15(f) and 15d‑15(f)15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:
| (i)pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; |
| (ii)provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and |
| (iii)provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. |
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management, including our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016.2019. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework (2013).
Based on ourthis assessment, and those criteria, management believeshas concluded that the Company maintained effectiveour internal control over financial reporting was effective as of December 31, 2016.2019.
On November 2, 2016, the Company completed the acquisition of PVI Riverside Holdings, Inc. (“PVI”). The audited consolidated financial statements of the Company include the results of PVI, including total assets of $79.2 million (of which $70.1 million represents goodwill and intangible assets included within the scope of the assessment) and total revenue of $8.9 million, but management’s assessment does not include an assessment of the internal control over financial reporting of PVI.
The independent registered public accounting firm that audited the Company’s consolidated financial statements included elsewhere in this Annual Report on Form 10‑K10-K has issued an audit report onalso audited the Company’s internal control over financial reporting. That report appears immediately following this report.
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Reporteffectiveness of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Watts Water Technologies, Inc.:
We have audited Watts Water Technologies, Inc.’sthe Company’s internal control over financial reporting as of December 31, 2016,2019, as stated in this Annual Report on Form 10-K under the heading, “Report of Independent Registered Public Accounting Firm.”
Remediation of Previously Identified Material Weakness
As disclosed in our 2018 Annual Report on Form 10-K, management identified a material weakness related to our not having an effective risk assessment process to identify all relevant risks within the process we implemented to account for changes resulting from the Tax Cuts and Jobs Act of 2017.
Management is committed to maintaining a strong internal control environment. In response to the identified material weakness, management, with the oversight of the Audit Committee of the Board of Directors, took comprehensive actions to remediate the material weakness in internal control over financial reporting, including enhancing our risk assessment process, process level controls and procedures over the judgments and estimates included in new and emerging financial reporting matters, including the involvement of external experts when necessary. The remediation efforts both addressed the identified material weakness and also enhanced our overall financial reporting control
37
environment. As of December 31, 2019, we have determined that our previously reported material weakness has been remediated.
Changes in Internal Control Over Financial Reporting
Except for the remediation efforts described above, and except for the change in our leasing controls resulting from the adoption of ASC 842 as described in Note 2 in the Notes to Consolidated Financial Statements, there were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2019, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Although the new leasing standard did not have a material impact on our consolidated statement of operations or our consolidated statement of cash flows, it did have a material impact on our consolidated balance sheet and disclosures. We implemented changes to our processes related to lease accounting and the control activities within them. These included the development of new policies based on the requirements of ASC 842, including new training, new lease authorization requirements, ongoing contract review, certification requirements, system controls and review, and gathering information provided for disclosures. We will continue to review and document our disclosure controls and procedures, including our internal control over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Watts Water Technologies, Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited Watts Water Technologies, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Watts Water Technologies, Inc.’sCommission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes and financial statement Schedule II – Valuation and Qualifying Accounts (collectively, the consolidated financial statements), and our report dated February 20, 2020 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Overover Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
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Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Watts Water Technologies, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Watts Water Technologies, Inc. acquired PVI Industries, LLC (“PVI”) during 2016, and management excluded from its assessment of the effectiveness of Watts Water Technologies, Inc.’s internal control over financial reporting as of December 31, 2016, PVI’s internal control over financial reporting associated with total assets of $79.2 million (of which 70.1 million represents goodwill and intangible assets included within the scope of the assessment) and total revenue of $8.9 million included in the consolidated financial statements of Watts Water Technologies, Inc. and subsidiaries as of and for the year ended December 31, 2016. Our audit of internal control over financial reporting of Watts Water Technologies, Inc. also excluded an evaluation of the internal control over financial reporting of PVI.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Watts Water Technologies, Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016, and our report dated February 24, 2017 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Boston, Massachusetts
February 20, 2020
February 24, 2017
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Item 9B. OTHER INFORMATION.
None.
PART III
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Information with respect to the executive officers of the Company is set forth in Part I, Item 1 of this Report under the caption “Executive“Information about Our Executive Officers and Directors” and is incorporated herein by reference. The information provided under the captions “Information as to Nominees for Director,”Director” and “Corporate Governance,” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive Proxy Statement for our 20172020 Annual Meeting of Stockholders to be held on May 17, 201713, 2020 is incorporated herein by reference.
We have adopted a Code of Business Conduct applicable to all officers, employees and Board members. The Code of Business Conduct is posted in the Investors section of our website, www.wattswater.com. We will provide you with a print copy of our Code of Business Conduct free of charge on written request to Kenneth R. Lepage,our Corporate Secretary, Watts Water Technologies, Inc., 815 Chestnut Street, North Andover, MA 01845. Any amendments to, or waivers of, the Code of Business Conduct which apply to our Chief Executive Officer, Chief Financial Officer, Corporate Controller or any person performing similar functions will be disclosed on our website promptly following the date of such amendment or waiver.
Item 11. EXECUTIVE COMPENSATION.
The information provided under the captions “Director Compensation,” “Corporate Governance,” “Compensation Discussion and Analysis,” “Executive Compensation,” “Compensation Committee Interlocks and Insider Participation,” and “Compensation Committee Report” in our definitive Proxy Statement for our 20172020 Annual Meeting of Stockholders to be held on May 17, 201713, 2020 is incorporated herein by reference.
The “Compensation Committee Report” contained in our Proxy Statement shall not be deemed “soliciting material” or “filed” with the Securities and Exchange Commission or otherwise subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any filings under the Securities Act of 1933 or the Exchange Act, except to the extent we specifically request that such information be treated as soliciting material or specifically incorporate such information by reference into a document filed under the Securities Act or Exchange Act.
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Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The information appearing under the caption “Principal Stockholders” in our definitive Proxy Statement for our 20172020 Annual Meeting of Stockholders to be held on May 17, 201713, 2020 is incorporated herein by reference.
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Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2016,2019, about the shares of Class A common stock that may be issued upon the exercise of stock options, settlement of performance stock awards and vesting of deferred stock awards issued under the Company’s Second Amended and Restated 2004 Stock Incentive Plan, and the settlement of restricted stock units granted under our Management Stock Purchase Plan as well as the number of shares remaining for future issuance under our Second Amended and Restated 2004 Stock Incentive Plan and Management Stock Purchase Plan.
| | | | | | | | |
| | Equity Compensation Plan Information |
| |||||
|
| |
| | |
| Number of securities remaining |
|
| | Number of securities to be | | | | | available for future issuance |
|
| | issued upon exercise of | | Weighted‑average exercise | | under equity compensation |
| |
| | outstanding options, | | price of outstanding options, | | plan (excluding securities |
| |
| | warrants and rights | | warrants and rights | | reflected in column (a)) |
| |
Plan Category | | (a) | | (b) | | (c) |
| |
Equity compensation plans approved by security holders |
| 453,240 | (1) | $ | — |
| 1,889,955 | (2) |
Equity compensation plans not approved by security holders |
| None | |
| None |
| None | |
Total |
| 453,240 | (1) | $ | — |
| 1,889,955 | (2) |
|
|
|
|
|
|
|
|
|
|
| Equity Compensation Plan Information |
| |||||
|
|
|
|
|
|
| Number of securities remaining |
|
|
| Number of securities to be |
|
|
|
| available for future issuance |
|
|
| issued upon exercise of |
| Weighted‑average exercise |
| under equity compensation |
| |
|
| outstanding options, |
| price of outstanding options, |
| plan (excluding securities |
| |
|
| warrants and rights |
| warrants and rights |
| reflected in column (a)) |
| |
Plan Category |
| (a) |
| (b) |
| (c) |
| |
Equity compensation plans approved by security holders |
| 567,420 | (1) | $ | — |
| 2,206,142 | (2) |
Equity compensation plans not approved by security holders |
| None |
|
| None |
| None |
|
Total |
| 567,420 | (1) | $ | — |
| 2,206,142 | (2) |
| (1) |
| Represents |
| (2) |
| Includes |
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information provided under the captions “Corporate Governance” and “Certain Relationships and Related Transactions” in our definitive Proxy Statement for our 20172020 Annual Meeting of Stockholders to be held on May 17, 201713, 2020 is incorporated herein by reference.
Item 14. PRINCIPAL ACCOUNTANTACCOUNTING FEES AND SERVICES.
The information provided under the caption “Ratification of Independent Registered Public Accounting Firm” in our definitive Proxy Statement for our 20172020 Annual Meeting of Stockholders to be held on May 17, 201713, 2020 is incorporated herein by reference.
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PART IV
Item 15. EXHIBITS, AND FINANCIAL STATEMENT SCHEDULES.
(a)(1) Financial Statements
The following financial statements are included in a separate section of this Report commencing on the page numbers specified below:
(a)(2) Schedules
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