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WTS Watts Water

Filed: 31 Oct 19, 11:04am

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 29, 2019

or

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from              to             

Commission file number 001-11499

WATTS WATER TECHNOLOGIES, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware

04-2916536

(State or Other Jurisdiction of Incorporation or
Organization)

(I.R.S. Employer Identification No.)

815 Chestnut Street, North Andover, MA

01845

(Address of Principal Executive Offices)

(Zip Code)

(978) 688-1811

(Registrant’s Telephone Number, Including Area Code)

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report.)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading

Symbol(s)

Name of each exchange on which registered

Class A common stock, par value $0.10 per share

WTS

New York Stock Exchange

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes    No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  

Accelerated filer  

Non-accelerated filer  

Smaller reporting company 

Emerging growth company 

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.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes    No 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class

Outstanding at October 27, 2019

Class A Common Stock, $0.10 par value

27,602,056

Class B Common Stock, $0.10 par value

6,279,290

1

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Amounts in millions, except share information)

(Unaudited)

September 29,

December 31,

    

2019

    

2018

ASSETS

    

CURRENT ASSETS:

Cash and cash equivalents

$

173.7

$

204.1

Trade accounts receivable, less allowance for doubtful accounts of $14.6 million at September 29, 2019 and $15.0 million at December 31, 2018

 

238.6

 

205.5

Inventories, net

 

Raw materials

88.2

87.4

Work in process

17.1

17.3

Finished goods

173.9

182.1

Total Inventories

279.2

286.8

Prepaid expenses and other current assets

 

22.6

 

24.9

Total Current Assets

 

714.1

 

721.3

PROPERTY, PLANT AND EQUIPMENT

 

 

Property, plant and equipment, at cost

542.0

537.4

Accumulated depreciation

(346.2)

(335.5)

Property, plant and equipment, net

195.8

201.9

OTHER ASSETS:

Goodwill

 

577.3

 

544.8

Intangible assets, net

 

154.2

 

165.2

Deferred income taxes

 

2.4

 

1.6

Other, net

 

52.5

 

18.9

TOTAL ASSETS

$

1,696.3

$

1,653.7

LIABILITIES AND STOCKHOLDERS’ EQUITY

CURRENT LIABILITIES:

Accounts payable

$

103.4

$

127.2

Accrued expenses and other liabilities

 

135.5

 

130.6

Accrued compensation and benefits

 

52.6

 

60.9

Current portion of long-term debt

 

105.0

 

30.0

Total Current Liabilities

 

396.5

 

348.7

LONG-TERM DEBT, NET OF CURRENT PORTION

 

238.5

 

323.4

DEFERRED INCOME TAXES

 

38.5

 

38.5

OTHER NONCURRENT LIABILITIES

 

80.8

 

51.8

STOCKHOLDERS’ EQUITY:

Preferred Stock, $0.10 par value; 5,000,000 shares authorized; 0 shares issued or outstanding

 

 

Class A common stock, $0.10 par value; 120,000,000 shares authorized; 1 vote per share; issued and outstanding, 27,617,045 shares at September 29, 2019 and 27,646,465 shares at December 31, 2018

 

2.8

 

2.8

Class B common stock, $0.10 par value; 25,000,000 shares authorized; 10 votes per share; issued and outstanding, 6,279,290 shares at September 29, 2019 and 6,329,290 shares at December 31, 2018

 

0.6

 

0.6

Additional paid-in capital

 

585.9

 

568.3

Retained earnings

 

494.9

 

440.7

Accumulated other comprehensive loss

 

(142.2)

 

(121.1)

Total Stockholders’ Equity

 

942.0

 

891.3

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

$

1,696.3

$

1,653.7

See accompanying notes to consolidated financial statements.

3

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in millions, except per share information)

(Unaudited)

Third Quarter Ended

Nine Months Ended

September 29,

September 30,

September 29,

September 30,

    

2019

    

2018

    

2019

    

2018

Net sales

$

394.7

$

390.9

$

1,200.2

$

1,177.3

Cost of goods sold

 

226.1

 

226.4

 

692.8

 

686.7

GROSS PROFIT

 

168.6

 

164.5

 

507.4

 

490.6

Selling, general and administrative expenses

 

119.8

 

114.2

 

354.9

 

344.2

Restructuring

 

 

3.4

 

2.7

 

3.4

OPERATING INCOME

 

48.8

 

46.9

 

149.8

 

143.0

Other (income) expense:

Interest income

 

(0.1)

 

(0.1)

 

(0.3)

 

(0.6)

Interest expense

 

3.5

 

3.9

 

10.8

 

12.6

Other income

 

(0.8)

 

(0.9)

 

(0.4)

 

(2.0)

Total other expense

 

2.6

 

2.9

 

10.1

 

10.0

INCOME BEFORE INCOME TAXES

 

46.2

 

44.0

 

139.7

 

133.0

Provision for income taxes

 

13.9

 

12.5

 

40.0

 

37.3

NET INCOME

$

32.3

$

31.5

$

99.7

$

95.7

Basic EPS

NET INCOME PER SHARE

$

0.95

$

0.92

$

2.92

$

2.79

Weighted average number of shares

 

34.0

 

34.3

 

34.1

 

34.3

Diluted EPS

NET INCOME PER SHARE

$

0.94

$

0.92

$

2.91

$

2.78

Weighted average number of shares

 

34.2

 

34.4

 

34.2

 

34.4

Dividends declared per share

$

0.23

$

0.21

$

0.67

$

0.61

See accompanying notes to consolidated financial statements.

4

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Amounts in millions)

(Unaudited)

    

Third Quarter Ended

    

Nine Months Ended

September 29,

September 30,

September 29,

September 30,

    

2019

    

2018

    

2019

    

2018

Net income

$

32.3

$

31.5

$

99.7

$

95.7

Other comprehensive (loss) income, net of tax:

Foreign currency translation adjustments

 

(15.8)

 

2.5

 

(16.9)

 

(14.4)

Cash flow hedges

(0.5)

(0.1)

(4.2)

3.7

Other comprehensive (loss) income

 

(16.3)

 

2.4

 

(21.1)

 

(10.7)

Comprehensive income

$

16.0

$

33.9

$

78.6

$

85.0

See accompanying notes to consolidated financial statements.

5

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Dollars in millions)

(Unaudited)

Accumulated

Class A

Class B

Additional

Other

Total

Common Stock

Common Stock

Paid-In

Retained

Comprehensive

Stockholders’

    

Shares

    

Amount

    

Shares

    

Amount

    

Capital

    

Earnings

    

Loss  

    

Equity

Balance at December 31, 2018

 

27,646,465

$

2.8

 

6,329,290

$

0.6

$

568.3

$

440.7

$

(121.1)

$

891.3

Net income

99.7

99.7

Other comprehensive loss

(21.1)

(21.1)

Comprehensive income

78.6

Shares of Class B common stock converted to Class A common stock

 

50,000

(50,000)

Shares of Class A common stock issued upon the exercise of stock options

19,155

1.0

1.0

Stock-based compensation

 

13.3

13.3

Stock repurchase

 

(178,340)

(14.8)

(14.8)

Net change in restricted and performance stock units

79,765

3.3

(7.1)

(3.8)

Common stock dividends

(23.6)

(23.6)

Balance at September 29, 2019

 

27,617,045

$

2.8

 

6,279,290

$

0.6

$

585.9

$

494.9

$

(142.2)

$

942.0

Accumulated

Class A

Class B

Additional

Other

Total

Common Stock

Common Stock

Paid-In

Retained

Comprehensive

Stockholders’

    

Shares

    

Amount

    

Shares

    

Amount

    

Capital

    

Earnings

    

Loss  

    

Equity

Balance at June 30, 2019

 

27,657,544

$

2.8

 

6,279,290

$

0.6

$

581.1

$

475.6

$

(125.9)

$

934.2

Net income

32.3

32.3

Other comprehensive loss

(16.3)

(16.3)

Comprehensive income

16.0

Shares of Class A common stock issued upon the exercise of stock options

3,368

0.2

0.2

Stock-based compensation

 

4.6

4.6

Stock repurchase

 

(47,943)

(4.5)

(4.5)

Net change in restricted and performance stock units

4,076

(0.1)

(0.1)

Common stock dividends

(8.4)

(8.4)

Balance at September 29, 2019

 

27,617,045

$

2.8

 

6,279,290

$

0.6

$

585.9

$

494.9

$

(142.2)

$

942.0

See accompanying notes to consolidated financial statements.

6

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (CONTINUED)

(Dollars in millions)

(Unaudited)

Accumulated

Class A

Class B

Additional

Other

Total

Common Stock

Common Stock

Paid-In

Retained

Comprehensive

Stockholders’

    

Shares

    

Amount

    

Shares

    

Amount

    

Capital

    

Earnings

    

Loss  

    

Equity

Balance at December 31, 2017

 

27,724,192

$

2.8

 

6,379,290

$

0.6

$

551.8

$

372.9

$

(99.1)

$

829.0

Reporting Comprehensive Income change in accounting principle (ASU 2018-02)

(0.7)

(0.7)

Net income

95.7

95.7

Other comprehensive loss

(10.7)

(10.7)

Comprehensive income

85.0

Shares of Class B common stock converted to Class A common stock

50,000

(50,000)

Shares of Class A common stock issued upon the exercise of stock options

37,632

2.1

2.1

Stock-based compensation

10.0

10.0

Stock repurchase

(195,790)

(15.5)

(15.5)

Issuance of net shares of restricted Class A common stock

114,461

(3.1)

(3.1)

Net change in restricted and performance stock units

50,932

0.6

(2.1)

(1.5)

Common stock dividends

(21.1)

(21.1)

Balance at September 30, 2018

27,781,427

$

2.8

6,329,290

$

0.6

$

564.5

$

426.1

$

(109.8)

884.2

��

Accumulated

Class A

Class B

Additional

Other

Total

Common Stock

Common Stock

Paid-In

Retained

Comprehensive

Stockholders’

    

Shares

    

Amount

    

Shares

    

Amount

    

Capital

    

Earnings

    

Loss  

    

Equity

Balance at July 1, 2018

 

27,803,429

$

2.8

 

6,329,290

$

0.6

$

559.6

$

407.4

$

(112.2)

$

858.2

Net income

31.5

31.5

Other comprehensive income

2.4

2.4

Comprehensive income

33.9

Shares of Class A common stock issued upon the exercise of stock options

25,049

2.1

2.1

Stock-based compensation

3.7

3.7

Stock repurchase

(57,156)

(4.7)

(4.7)

Issuance of net shares of restricted Class A common stock

17,988

(0.9)

(0.9)

Net change in restricted and performance stock units

(7,883)

(0.9)

(0.9)

Common stock dividends

(7.2)

(7.2)

Balance at September 30, 2018

27,781,427

$

2.8

6,329,290

$

0.6

$

564.5

$

426.1

$

(109.8)

884.2

See accompanying notes to consolidated financial statements.

7

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in millions)

(Unaudited)

Nine Months Ended

September 29,

September 30,

    

2019

    

2018

OPERATING ACTIVITIES

Net income

$

99.7

$

95.7

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation

 

22.7

 

21.5

Amortization of intangibles

 

11.6

 

15.2

Loss (gain) on disposal and impairment of property, plant and equipment and other

 

0.7

 

(0.1)

Stock-based compensation

 

13.3

 

10.0

Deferred income tax

 

2.0

 

(4.0)

Changes in operating assets and liabilities, net of effects from business acquisitions:

Accounts receivable

 

(36.5)

 

(17.4)

Inventories

 

5.1

 

(35.4)

Prepaid expenses and other assets

 

0.2

 

(4.9)

Accounts payable, accrued expenses and other liabilities

 

(23.9)

 

(14.0)

Net cash provided by operating activities

 

94.9

 

66.6

INVESTING ACTIVITIES

Additions to property, plant and equipment

 

(19.1)

 

(24.1)

Proceeds from the sale of property, plant and equipment

 

0.1

 

0.1

Net proceeds from the sale of assets, and other

0.2

Business acquisitions, net of cash acquired and other

 

(42.7)

 

(2.2)

Net cash used in investing activities

 

(61.7)

 

(26.0)

FINANCING ACTIVITIES

Proceeds from long-term borrowings

82.0

50.0

Payments of long-term debt

 

(92.5)

 

(168.9)

Payments for tax withholdings on vested stock awards, finance leases and other

 

(11.1)

 

(6.4)

Proceeds from share transactions under employee stock plans

 

1.0

 

2.1

Payments to repurchase common stock

 

(14.8)

 

(15.5)

Dividends

 

(23.6)

 

(21.1)

Net cash used in financing activities

 

(59.0)

 

(159.8)

Effect of exchange rate changes on cash and cash equivalents

 

(4.6)

 

(4.2)

DECREASE IN CASH AND CASH EQUIVALENTS

 

(30.4)

 

(123.4)

Cash and cash equivalents at beginning of year

 

204.1

 

280.2

CASH AND CASH EQUIVALENTS AT END OF PERIOD

$

173.7

$

156.8

NON CASH INVESTING AND FINANCING ACTIVITIES

Acquisition of businesses:

Fair value of assets acquired

$

43.3

$

4.1

Cash paid, net of cash acquired

 

42.7

 

1.7

Liabilities assumed

$

0.6

$

2.4

Issuance of stock under management stock purchase plan

$

1.6

$

1.5

CASH PAID FOR:

Interest

$

12.0

$

13.6

Income taxes

$

38.9

$

49.5

See accompanying notes to consolidated financial statements.

8

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included in the Watts Water Technologies, Inc. (the Company) Consolidated Balance Sheet as of September 29, 2019, the Consolidated Statements of Operations for the third quarters and nine months ended September 29, 2019 and September 30, 2018, the Consolidated Statements of Comprehensive Income for the third quarters and nine months ended September 29, 2019 and September 30, 2018, the Consolidated Statements of Stockholders’ Equity for the third quarters and nine months ended September 29, 2019 and September 30, 2018, and the Consolidated Statements of Cash Flows for the nine months ended September 29, 2019 and September 30, 2018.

The consolidated balance sheet at December 31, 2018 has been derived from the audited consolidated financial statements at that date. The accounting policies followed by the Company are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. The financial statements included in this report should be read in conjunction with the consolidated financial statements and notes included in the Annual Report on Form 10-K for the year ended December 31, 2018. Operating results for the interim periods presented are not necessarily indicative of the results to be expected for the year ending December 31, 2019.

The Company operates on a 52-week fiscal year ending on December 31.  Any quarterly data contained in this Quarterly Report on Form 10-Q generally reflect the results of operations for a 13-week period.

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

2. Accounting Policies

The significant accounting policies used in preparation of these consolidated financial statements for the third quarter and nine months ended September 29, 2019 are consistent with those discussed in Note 2 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, with the exception of the Company’s change in its accounting policy for Leases resulting from the adoption of ASC 842 as of January 1, 2019 described herein.

Leases

The Company has leases for the following classes of underlying assets: real estate, automobiles, manufacturing equipment, facility equipment, office equipment and certain service arrangements that are dependent on an identified asset. The Company determines if an arrangement qualifies as a lease at its inception. The Company, as the lessee, recognizes in the statement of financial position a liability to make lease payments and a right-of-use asset (“ROU”) representing the right to use the underlying asset for both finance and operating leases with a lease term longer than twelve months. The Company elected the short-term lease recognition exemption for all leases that qualify and does not recognize ROU assets or lease liabilities for short-term leases. The Company recognizes short-term lease payments on a straight-line basis over the lease term in the consolidated statement of operations. The Company determines the initial classification and measurement of its ROU assets and lease liabilities at the lease commencement date and thereafter if modified.

9

For operating leases, the lease liability is initially and subsequently measured at the present value of the unpaid lease payments at the lease commencement date. For finance leases, the lease liability is initially measured in the same manner and date as operating leases and is subsequently measured at amortized cost using the effective interest method.

Measuring the lease liability requires certain estimates and judgements. These estimates and judgments include how the Company determines 1) the discount rate it uses to discount the unpaid lease payments to present value; 2) lease term; and 3) lease payments.

The present value of lease payments is determined using the interest rate implicit in the lease, if that rate is readily determinable; otherwise, the Company uses its incremental borrowing rate. Generally, the Company cannot determine the interest rate implicit in the lease because it does not have access to the lessor’s estimated residual value or the amount of the lessor’s deferred initial direct costs. Therefore, the Company uses the incremental borrowing rate as the discount rate for the lease. The Company’s incremental borrowing rate for a lease is the rate of interest it would have to pay on a collateralized basis to borrow an amount equal to the lease payments under a similar term. The Company’s incremental borrowing rate is determined by using a portfolio approach by geographic region, considering many factors, such as the Company’s specific credit risk, the amount of the lease payments, collateralized nature of the lease, both borrowing term and the lease term, and geographical economic considerations.
The lease term for all of the Company’s leases includes the fixed, noncancelable term of the lease plus (a) all periods, if any, covered by options to extend the lease if the Company is reasonably certain to exercise that option, (b) all periods, if any, covered by an option to terminate the lease if the Company is reasonably certain not to exercise that option, and (c) all periods, if any, covered by an option to extend (or not to terminate) the lease in which exercise of the option is controlled by the lessor. When determining if a renewal option is reasonably certain of being exercised, the Company considers several economic factors, including but not limited to, the significance of leasehold improvements incurred on the property, whether the asset is difficult to replace, underlying contractual obligations, or specific characteristics unique to that particular lease that would make it reasonably certain to exercise such option.
Lease payments included in the measurement of the lease liability include the following:
oFixed payments, including in-substance fixed payments, owed over the lease term (which includes termination penalties the Company would owe if the lease term assumes Company exercise of a termination option), less any lease incentives paid or payable to the Company;
oVariable lease payments that depend on an index or rate initially measured using the index or rate at the commencement date;
oAmounts expected to be payable under a Company-provided residual value guarantee;
oThe exercise price of a Company option to purchase the underlying asset if the Company is reasonably certain to exercise that option; and
oFees paid by the Company to the owners of a special purpose entity for structuring the transaction.

The ROU asset is initially measured at cost, which comprises the initial amount of the lease liability adjusted for the lease payments made at or before the lease commencement date, plus any initial direct costs incurred less any lease incentives received.

For operating leases, the ROU asset is subsequently measured throughout the lease term at the carrying amount of the lease liability, plus initial direct costs, plus (minus) any prepaid (accrued) lease payments, less the unamortized balance of lease incentives received. Lease expense for operating leases is recognized on a straight-line basis over the reasonably assured lease term based on the total lease payments and is included in cost of goods sold or within selling, general and administrative expenses in the consolidated statements of operations, based on the primary use of the ROU asset.

For finance leases, the Company recognizes the amortization of the ROU asset on a straight-line basis from the lease commencement date to the earlier of the end of the useful life or the end of the lease term unless the lease transfers ownership of the underlying asset to the Company or the Company is reasonably certain to exercise an option to purchase the underlying asset. In those cases, the ROU asset is amortized over the useful life of the underlying asset. Amortization of the ROU asset is recognized in depreciation in the consolidated statements of operations. The interest expense related to finance leases is recognized using the effective interest method and is included within interest expense.

10

Variable lease payments associated with the Company’s leases are recognized in the period when the event, activity, or circumstance in the lease agreement on which those payments are assessed occurs and are included in cost of goods sold or within selling, general and administrative expenses in the consolidated statements of operations, based on the primary use of the ROU asset.

ROU assets for operating and finance leases are periodically reduced by impairment losses. The Company uses the long-lived assets impairment guidance in ASC Subtopic 360-10, Property, Plant, and Equipment- Overall, to determine whether an ROU asset is impaired, and if so, the amount of the impairment loss to recognize.

The Company monitors for events or changes in circumstances that require a reassessment of one of its leases. When a reassessment results in a remeasurement of a lease liability, a corresponding adjustment is made to the carrying amount of the corresponding ROU asset unless doing so would reduce the carrying amount of the ROU asset to an amount less than zero. In that case, the amount of the adjustment that would result in a negative ROU asset balance is recorded in the statement of operations.

Recently Adopted Accounting Standards

In August 2017, the Financial Accounting Standards Board (“FASB”) issued ASU 2017-12 “Derivatives and Hedging (Topic 815)-Targeted Improvements to Accounting for Hedging Activities.” ASU 2017-12 amends the hedge accounting guidance to improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in the financial statements. This guidance permits hedge accounting for risk components in hedging relationships that involve nonfinancial risk, reduces complexity in hedging for fair value hedges of interest rate risk, eliminates the requirement to separately measure and report hedging ineffectiveness, and simplifies certain hedge effectiveness assessment requirements. This standard is effective for fiscal years beginning after December 15, 2018, including interim periods within that reporting period. The Company adopted this standard in the first quarter of 2019, and it did not have a material impact on the Company’s financial statements.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” ASU 2016-02 requires a lessee to recognize in the statement of financial position a liability to make lease payments and an ROU asset representing the right to use the underlying asset for the lease term for both finance and operating leases with a term longer than twelve months. Topic 842 was subsequently amended by ASU 2018-01, “Land Easement Practical Expedient for Transition to Topic 842,” ASU 2018-10, “Codification Improvements to Topic 842, Leases,” and ASU 2018-11 “Targeted Improvements.” ASU 2016-02 is effective for financial statements issued for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Under ASC 842, leases are classified as finance or operating, with the classification determining the pattern and classification of expense recognition in the income statement.

A modified retrospective transition approach was required, applying the new standard to all leases existing at the date of initial application. The Company could choose to use either 1) the effective date of the standard or 2) the beginning of the earliest comparable period presented in the financial statements as the date of initial application. The Company adopted the new standard on January 1, 2019 and used the effective date of the standard as the date of the Company’s initial application. By electing this approach, the financial information and the disclosures required under the new standard are not provided for dates and periods before January 1, 2019. The Company designed the necessary changes to its existing processes and configured all system requirements that were necessary to implement this new standard.

 

The new standard provides a number of optional practical expedients throughout the transition. The Company elected the “package of practical expedients,” which permitted the Company to not reassess under the new standard the Company’s prior conclusions about lease identification, lease classification, and initial direct costs. The Company did not elect the use-of-hindsight or the practical expedient pertaining to land easements, the latter not being applicable to the Company. The Company also elected the practical expedient to not separate lease and non-lease components for all of the Company’s leases.

 

As a result of adopting ASC 842, the Company recorded operating ROU assets of $33.6 million and operating lease liabilities of $33.9 million as of January 1, 2019 on the consolidated balance sheet. The difference between the ROU assets and lease liabilities related to the impact of eliminating deferred and prepaid lease payments recognized under the previous lease accounting standard. The Company’s adoption of ASC 842 did not result in a change to the Company’s recognition of its existing finance leases as of January 1, 2019. The adoption of the new lease accounting standard did not have a material impact on either the consolidated statement of operations or the consolidated statement of cash flows.

11

However, ASU 2016-02 has significantly affected the Company’s disclosures about noncash activities related to leases. Additionally, the Company’s lease-related disclosures have significantly increased as of and for the period ended September 29, 2019 as compared to prior years. See Note 4 to the consolidated financial statements.

Shipping and Handling

Shipping and handling costs included in selling, general and administrative expenses amounted to $14.5 million and $14.2 million for the third quarters of 2019 and 2018, respectively, and were $43.0 million and $42.1 million for the first nine months of 2019 and 2018, respectively.

Research and Development

Research and development costs included in selling, general and administrative expenses amounted to $9.8 million and $8.7 million for the third quarters of 2019 and 2018, respectively, and were $28.6 million and $25.5 million for the first nine months of 2019 and 2018, respectively.

3. Revenue Recognition

The Company is a leading supplier of products that manage and conserve the flow of fluids and energy into, through and out of buildings in the residential and commercial markets of the Americas, Europe, and Asia-Pacific, Middle East, and Africa (“APMEA”). For over 140 years, the Company has designed and produced valve systems that safeguard and regulate water systems, energy efficient heating and hydronic systems, drainage systems and water filtration technology that helps purify and conserve water.

The Company distributes products through 4 primary distribution channels: wholesale, original equipment manufacturers (OEMs), specialty, and do-it-yourself (DIY). The Company operates in 3 geographic segments: Americas, Europe, and APMEA. Each of these segments sells similar products, which are comprised of the following principal product lines:

Residential & commercial flow control products—includes products typically sold into plumbing and hot water applications such as backflow preventers, water pressure regulators, temperature and pressure relief valves, and thermostatic mixing valves.
HVAC & gas products—includes commercial high-efficiency boilers, water heaters and heating solutions, hydronic and electric heating systems for under-floor radiant applications, custom heat and hot water solutions, hydronic pump groups for boiler manufacturers and alternative energy control packages, and flexible stainless steel connectors for natural and liquid propane gas in commercial food service and residential applications. HVAC is an acronym for heating, ventilation and air conditioning.
Drainage & water re-use products—includes drainage products and engineered rain water harvesting solutions for commercial, industrial, marine and residential applications.
Water quality products—includes point-of-use and point-of-entry water filtration, conditioning and scale prevention systems for commercial, marine and residential applications.

12

The following table disaggregates revenue, which is presented as net sales in the financial statements, for each reportable segment, by distribution channel and principal product line:

For the third quarter ended September 29, 2019

For the nine months ended September 29, 2019

(in millions)

(in millions)

Distribution Channel

Americas

Europe

APMEA

Consolidated

Americas

Europe

APMEA

Consolidated

Wholesale

$

152.1

$

72.2

$

15.0

$

239.3

$

459.8

$

226.9

$

43.2

$

729.9

OEM

20.0

 

35.1

 

0.4

 

55.5

62.7

 

108.5

 

1.2

 

172.4

Specialty

83.6

 

 

1.1

 

84.7

247.5

 

 

2.2

 

249.7

DIY

 

14.6

 

0.6

 

 

15.2

 

46.2

 

2.0

 

 

48.2

Total

$

270.3

$

107.9

$

16.5

$

394.7

$

816.2

$

337.4

$

46.6

$

1,200.2

For the third quarter ended September 29, 2019

For the nine months ended September 29, 2019

(in millions)

(in millions)

Principal Product Line

Americas

Europe

APMEA

Consolidated

Americas

Europe

APMEA

Consolidated

Residential & Commercial Flow Control

$

151.0

$

41.1

$

10.6

$

202.7

$

459.7

$

130.1

$

32.9

$

622.7

HVAC and Gas Products

73.4

 

44.7

 

4.4

 

122.5

221.9

 

139.0

 

10.0

 

370.9

Drainage and Water Re-use Products

20.7

 

21.5

 

1.3

 

43.5

60.4

 

66.4

 

3.0

 

129.8

Water Quality Products

 

25.2

 

0.6

 

0.2

 

26.0

 

74.2

 

1.9

 

0.7

 

76.8

Total

$

270.3

$

107.9

$

16.5

$

394.7

$

816.2

$

337.4

$

46.6

$

1,200.2

For the third quarter ended September 30, 2018

For the nine months ended September 30, 2018

(in millions)

(in millions)

Distribution Channel

Americas

Europe

APMEA

Consolidated

Americas

Europe

APMEA

Consolidated

Wholesale

$

146.7

$

73.5

$

14.8

$

235.0

$

433.9

$

234.7

$

44.4

$

713.0

OEM

19.4

 

37.5

 

0.3

 

57.2

58.6

 

114.9

 

1.1

 

174.6

Specialty

82.7

 

 

1.5

 

84.2

236.4

 

 

4.3

 

240.7

DIY

 

13.9

 

0.6

 

 

14.5

 

46.9

 

2.1

 

 

49.0

Total

$

262.7

$

111.6

$

16.6

$

390.9

$

775.8

$

351.7

$

49.8

$

1,177.3

For the third quarter ended September 30, 2018

For the nine months ended September 30, 2018

(in millions)

(in millions)

Principal Product Line

Americas

Europe

APMEA

Consolidated

Americas

Europe

APMEA

Consolidated

Residential & Commercial Flow Control

$

144.4

$

40.2

$

11.2

$

195.8

$

435.3

$

132.2

$

33.8

$

601.3

HVAC and Gas Products

77.1

 

49.4

 

4.3

 

130.8

220.2

 

152.7

 

13.6

 

386.5

Drainage and Water Re-use Products

19.8

 

21.7

 

0.7

 

42.2

55.2

 

65.9

 

1.4

 

122.5

Water Quality Products

 

21.4

 

0.3

 

0.4

 

22.1

 

65.1

 

0.9

 

1.0

 

67.0

Total

$

262.7

$

111.6

$

16.6

$

390.9

$

775.8

$

351.7

$

49.8

$

1,177.3

The Company considers customer purchase orders, which in some cases are governed by master sales agreements, to represent the contract with a customer. The Company’s contracts with customers are generally for products only and typically do not include other performance obligations such as professional services, extended warranties, or other material rights. In situations where sales are to a distributor, the Company has concluded that its contracts are with the distributor as the Company holds a contract bearing enforceable rights and obligations only with the distributor. As part of its consideration of the contract, the Company evaluates certain factors including the customer’s ability to pay (or credit risk). For each contract, the Company considers the promise to transfer products, each of which is distinct, to be the identified performance obligations. In determining the transaction price, the Company evaluates whether the price is subject to refund or adjustment to determine the net consideration to which the Company expects to be entitled. As the Company’s standard payment terms are less than one year, the Company has elected not to assess whether a contract has a significant financing component. The Company allocates the transaction price to each distinct product based on its relative standalone selling price. The product price as specified on the purchase order is considered the standalone selling price as it is an observable input which depicts the price as if sold to a similar customer in similar circumstances. Revenue is recognized when control of the product is transferred to the customer (i.e., when the Company’s performance

13

obligation is satisfied), which typically occurs at shipment from the Company’s manufacturing site or distribution center, or delivery to the customer’s named location. In certain circumstances, revenue from shipments to retail customers is recognized only when the product is consumed by the customer, as based on the terms of the arrangement, transfer of control is not satisfied until that point in time. In determining whether control has transferred, the Company considers if there is a present right to payment, physical possession and legal title, along with risks and rewards of ownership having transferred to the customer. In certain circumstances, the Company manufactures customized product without alternative use for its customers. However, as these arrangements do not entitle the Company a right to payment of cost plus a profit for work completed, the Company has concluded that revenue recognition at the point in time control transfers is appropriate and not over time recognition.

At times, the Company receives orders for products to be delivered over multiple dates that may extend across reporting periods. The Company invoices for each delivery upon shipment and recognizes revenues for each distinct product delivered, assuming transfer of control has occurred. As scheduled delivery dates are within one year, under the optional exemption provided by the guidance, revenues allocated to future shipments of partially completed contracts are not disclosed.

The Company generally provides an assurance warranty that its products will substantially conform to the published specification. The Company’s liability is limited to either a credit equal to the purchase price or replacement of the defective part. Returns under warranty have historically been immaterial. The Company does not consider activities related to such warranty, if any, to be a separate performance obligation. For certain of its products, the Company will separately sell extended warranty and service policies to its customers. The Company considers the sale of the extended warranty a separate performance obligation. These policies typically are for periods ranging from one to three years. Payments received are deferred and recognized over the policy period. For all periods presented, the revenue recognized and the revenue deferred under these policies is not material to the consolidated financial statements.

The timing of revenue recognition, billings and cash collections from the Company’s contracts with customers can vary based on the payment terms and conditions in the customer contracts. In some cases, customers will partially prepay for their goods; in other cases, after appropriate credit evaluations, payment is due in arrears. In addition, there are constraints which cause variability in the ultimate consideration to be recognized. These constraints typically include early payment discounts, volume rebates, rights of return, cooperative advertising, and market development funds. The Company includes these constraints in the estimated transaction price when there is a basis to reasonably estimate the amount of variable consideration. These estimates are based on historical experience, anticipated future performance and the Company’s best judgment at the time. When the timing of the Company’s recognition of revenue is different from the timing of payments made by the customer, the Company recognizes either a contract asset (performance precedes contractual due date) or a contract liability (customer payment precedes performance). Contracts with payment in arrears are recognized as receivables. The opening and closing balances of the Company’s contract assets and contract liabilities are as follows:

Contract

Contract

Contract

Assets

Liabilities - Current

Liabilities - Noncurrent

(in millions)

Balance - January 1, 2019

$

1.0

$

11.3

$

2.7

Change in period

(0.7)

0.1

Balance - March 31, 2019

$

0.3

$

11.4

$

2.7

Change in period

(0.2)

0.7

0.1

Balance - June 30, 2019

$

0.1

$

12.1

$

2.8

Change in period

(0.3)

0.2

Balance - September 29, 2019

$

0.1

$

11.8

$

3.0

Balance - January 1, 2018

$

0.6

$

11.3

$

2.1

Change in period

1.1

0.2

0.3

Balance - April 1, 2018

$

1.7

$

11.5

$

2.4

Change in period

(0.3)

0.1

0.3

Balance - July 1, 2018

$

1.4

$

11.6

$

2.7

Change in period

0.4

(0.4)

Balance - September 30, 2018

$

1.8

$

11.2

$

2.7

14

The amount of revenue recognized during the third quarter and nine months ended September 29, 2019 that was included in the opening contract liability balance was $3.1 million and $9.2 million, respectively. The amount of revenue recognized during the third quarter and nine months ended September 30, 2018 that was included in the opening contract liability balance was $5.4 million and $11.5 million, respectively. This revenue consists primarily of revenue recognized for shipments of product which had been prepaid as well as the amortization of extended warranty and service policy revenue. The Company did not recognize any material revenue from obligations satisfied in prior periods. There were 0 impairment losses related to Contract Assets for the third quarter and nine months ended September 29, 2019.

The Company incurs costs to obtain and fulfill a contract; however, the Company has elected to recognize all incremental costs to obtain a contract as an expense when incurred if the amortization period is one year or less. The Company has elected to treat shipping and handling activities performed after the customer has obtained control of the related goods as a fulfillment cost and the related cost is accrued for in conjunction with the recording of revenue for the goods.

4. Leases

The Company adopted ASC 842 effective January 1, 2019. The Company has a variety of categories of lease arrangements, including real estate, automobiles, manufacturing equipment, facility equipment, office equipment and certain service arrangements that are dependent on an identified asset. The Company’s real estate leases, which consist primarily of manufacturing facilities, office space and warehouses, represent approximately 85% of the Company’s operating lease liabilities and generally have a lease term between 2 and 15 years. The remaining leases primarily consist of automobiles, machinery and equipment used in the manufacturing processes (e.g., forklifts and pallets), general office equipment and certain service arrangements, each with various lease terms. The Company’s automobile leases typically have terms ranging from 3 to 5 years. The Company’s remaining population of leases have terms ranging from 2 to 15 years. Certain lease arrangements may contain renewal terms ranging from 1 to 5 years. The majority of the Company’s real estate, automobile, and equipment leases consist of fixed lease payments plus, for many of the Company’s leases, variable payments. For the Company’s real estate leases, variable payments include those for common area maintenance, property taxes, and insurance. For automobile leases, variable payments primarily include maintenance, taxes, and insurance. For equipment leases, variable payments include maintenance and payments based on usage. The Company has elected to account for lease and non-lease components as a single component for all leases. Therefore, all fixed costs within a lease arrangement are included in the fixed lease payments for the single, combined lease component and used to measure the lease liability. Variable lease costs are recognized in the period when the event, activity, or circumstance in the lease agreement occurs.

Some of the Company’s lease agreements include Company options to either extend and/or early terminate the lease, the costs of which are included in the Company’s lease liability to the extent that such options are reasonably certain of being exercised. Renewal options are generally not included in the lease term for the Company’s existing leases because the Company is not reasonably certain to exercise these renewal options. The Company does not generally enter into leases involving the construction or design of the underlying asset, and nearly all of the assets the Company leases are not specialized in nature. The Company’s leases generally do not include termination options for either party to the lease or restrictive financial or other covenants. The Company’s lease agreements generally do not include residual value guarantees.

Right-of-use asset amounts reported in the consolidated balance sheet by asset category as of September 29, 2019 were as follows:

September 29, 2019

(in millions)

Operating Leases (1)

Real Estate

$

31.0

Automobile

 

3.0

Machinery and equipment

 

3.1

Total operating lease ROU Asset

$

37.1

Finance Leases (2)

Real Estate

$

14.1

Machinery and equipment

 

4.4

Less: Accumulated depreciation

 

(8.3)

Finance Leases, net

$

10.2

15

(1)

Included on the Company’s consolidated balance sheet in other assets (other, net).

(2)

Included on the Company’s consolidated balance sheet in property, plant and equipment.

The maturity of the Company’s operating and finance lease liabilities as of September 29, 2019 was as follows:

September 29, 2019

    

Operating Leases

    

Finance Leases

(in millions)

2019 (excluding the nine months ended September 29, 2019)

$

2.7

$

0.5

2020

 

10.7

 

1.8

2021

 

6.6

 

1.0

2022

 

4.5

 

0.6

2023

 

3.4

 

0.3

Thereafter

 

18.2

 

0.1

Total undiscounted minimum lease payments

$

46.1

$

4.3

Less imputed interest

6.8

0.2

Total lease liabilities

$

39.3

$

4.1

Included in the consolidated balance sheet

Current lease liabilities (included in other current liabilities)

 

10.1

 

1.7

Non-Current lease liabilities (included in other non-current liabilities)

 

29.2

 

2.4

Total lease liabilities

$

39.3

$

4.1

The total lease cost consisted of the following amounts:

Third Quarter Ended

Nine Months Ended

September 29, 2019

September 29, 2019

(in millions)

Operating lease cost

$

3.0

$

8.9

Amortization of finance lease right-of-use assets

 

0.3

 

0.9

Interest on lease liabilities

 

0.1

 

0.2

Variable lease cost

0.8

2.3

Total lease cost

$

4.2

$

12.3

The following information represents supplemental disclosure for the statement of cash flows related to operating and finance leases:

September 29, 2019

(in millions)

Operating cash flows from operating leases

$

8.8

Operating cash flows from finance leases

 

0.2

Financing cash flows from finance leases

 

1.2

Total cash paid for amounts included in the measurement of lease liabilities

 

10.2

Finance lease liabilities arising from obtaining right-of-use assets

1.1

Operating lease liabilities arising from obtaining right-of-use assets

11.8

The following summarizes additional information related to operating and finance leases:

September 29, 2019

Weighted-average remaining lease term - finance leases

2.9

years

Weighted-average remaining lease term - operating leases

 

7.5

years

Weighted-average discount rate - finance leases

 

3.8

%

Weighted-average discount rate - operating leases

 

3.7

%

16

5. Goodwill & Intangibles

The Company operates in 3 geographic segments: Americas, Europe, and APMEA. During the third quarter ended September 29, 2019, the Company completed an acquisition within the Americas segment resulting in $38.3 million of goodwill. The acquisition is not considered material to the Company’s consolidated financial statements. The changes in the carrying amount of goodwill by geographic segment are as follows:

September 29, 2019

Gross Balance

Accumulated Impairment Losses

Net Goodwill

Acquired

Foreign

Balance

During

Currency

Balance

Balance

Impairment

Balance

January 1,

the

Translation

September 29,

January 1,

Loss During

September 29,

September 29,

    

2019

    

Period

    

and Other

    

2019

    

2019

    

the Period

    

2019

    

2019

(in millions)

Americas

$

438.1

38.3

$

0.3

$

476.7

$

(24.5)

$

(24.5)

$

452.2

Europe

 

243.7

 

 

(5.0)

 

238.7

 

(129.7)

 

 

(129.7)

 

109.0

APMEA

 

30.1

 

 

(1.1)

 

29.0

 

(12.9)

 

 

(12.9)

 

16.1

Total

$

711.9

38.3

$

(5.8)

$

744.4

$

(167.1)

$

(167.1)

$

577.3

December 31, 2018

Gross Balance

Accumulated Impairment Losses

Net Goodwill

Acquired

Foreign

Balance

During

Currency

Balance

Balance

Impairment

Balance

January 1,

the

Translation

December 31,

January 1,

Loss During

December 31,

December 31,

    

2018

    

Period

    

and Other

    

2018

    

2018

    

the Period

    

2018

    

2018

(in millions)

Americas

$

437.4

$

1.5

$

(0.8)

$

438.1

$

(24.5)

$

$

(24.5)

$

413.6

Europe

 

249.3

 

 

(5.6)

 

243.7

 

(129.7)

 

 

(129.7)

 

114.0

APMEA

 

30.9

 

 

(0.8)

 

30.1

 

(12.9)

 

 

(12.9)

 

17.2

Total

$

717.6

$

1.5

$

(7.2)

$

711.9

$

(167.1)

$

$

(167.1)

$

544.8

Intangible assets include the following:

September 29, 2019

December 31, 2018

Gross

Net

Gross

Net

Carrying

Accumulated

Carrying

Carrying

Accumulated

Carrying

    

Amount

    

Amortization

    

Amount

    

Amount

    

Amortization

    

Amount

(in millions)

Patents

$

16.1

$

(15.8)

$

0.3

$

16.1

$

(15.8)

$

0.3

Customer relationships

 

232.3

 

(154.0)

 

78.3

 

232.9

 

(146.9)

 

86.0

Technology

 

56.8

 

(30.5)

 

26.3

 

54.6

 

(27.3)

 

27.3

Trade names

 

25.8

 

(12.7)

 

13.1

 

26.1

 

(11.5)

 

14.6

Other

 

4.3

 

(3.6)

 

0.7

 

4.3

 

(3.5)

 

0.8

Total amortizable intangibles

 

335.3

 

(216.6)

 

118.7

 

334.0

 

(205.0)

 

129.0

Indefinite-lived intangible assets

 

35.5

 

 

35.5

 

36.2

 

 

36.2

$

370.8

$

(216.6)

$

154.2

$

370.2

$

(205.0)

$

165.2

Aggregate amortization expense for amortized intangible assets for the third quarters ended September 29, 2019 and September 30, 2018 was $3.8 million and $4.5 million, respectively, and for the first nine months of 2019 and 2018 was $11.6 million and $15.2 million, respectively. As a result of the acquisition completed in the third quarter of 2019, the Company recorded $2.2 million of intangible assets related to developed technology.

6. Restructuring

The Company’s Board of Directors approves all major restructuring programs that may involve the discontinuance of significant product lines or the shutdown of significant facilities. From time to time, the Company takes additional restructuring actions, including involuntary terminations that are not part of a major program. The Company accounts for these costs in the period that the liability is incurred. These costs are included in restructuring charges in the Company’s consolidated statements of operations.

17

In the third quarter of 2018, management initiated restructuring actions primarily associated with the Company’s European headquarters as well as cost savings initiatives at certain European manufacturing facilities.  These actions included reductions in force and other related costs within the Company’s Europe segment.  The total restructuring charges associated with the program were initially estimated to be approximately $5.0 million. The Company increased its total expected pre-tax charges for the program to approximately $6.7 million as of June 30, 2019, primarily related to increased severance and other related costs, at which time costs associated with the 2018 program had been fully incurred. Through September 29, 2019 the Company paid approximately $4.1 million of severance benefits and other related costs. The restructuring reserve associated with these actions as of September 29, 2019 was approximately $2.4 million, and primarily relates to severance benefits.

7. Financial Instruments and Derivative Instruments

Fair Value

The carrying amounts of cash and cash equivalents, trade receivables and trade payables approximate fair value because of the short maturity of these financial instruments.

The fair value of the Company’s 5.05% senior notes due 2020 is based on quoted market prices of similar notes (level 2). The fair value of the Company’s borrowings outstanding under the Credit Agreement and the Company’s variable rate debt approximates its carrying value. The carrying amount and the estimated fair market value of the Company’s long-term debt, including the current portion, are as follows:

September 29,

December 31,

    

2019

    

2018

(in millions)

Carrying amount

$

344.5

$

355.0

Estimated fair value

$

345.3

$

355.4

Financial Instruments

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including deferred compensation plan assets and related liabilities, redeemable financial instruments, and derivatives. The fair values of these financial assets and liabilities were determined using the following inputs at September 29, 2019 and December 31, 2018:

Fair Value Measurement at September 29, 2019 Using:

Quoted Prices in Active

Significant Other

Significant

Markets for Identical

Observable

Unobservable

Assets

Inputs

Inputs

    

Total

    

(Level 1)

    

(Level 2)

    

(Level 3)

(in millions)

Assets

Plan asset for deferred compensation(1)

$

2.4

$

2.4

$

$

Interest rate swaps (1)

$

1.5

$

$

1.5

$

Total assets

$

3.9

$

2.4

$

1.5

$

Liabilities

Plan liability for deferred compensation(2)

$

2.4

$

2.4

$

$

Designated foreign currency hedges (4)

$

0.3

$

$

0.3

$

Total liabilities

$

2.7

$

2.4

$

0.3

$

18

Fair Value Measurements at December 31, 2018 Using:

Quoted Prices in Active

Significant Other

Significant

Markets for Identical

Observable

Unobservable

    

Assets

Inputs

 Inputs

Total

    

(Level 1)

    

(Level 2)

    

(Level 3)

(in millions)

Assets

Plan asset for deferred compensation(1)

$

2.6

$

2.6

$

$

Interest rate swaps (1)

$

6.5

$

$

6.5

$

Total assets

$

9.1

$

2.6

$

6.5

$

Liabilities

Plan liability for deferred compensation(2)

$

2.6

$

2.6

$

$

Redeemable financial instrument(3)

$

2.8

$

$

$

2.8

Total liabilities

$

5.4

$

2.6

$

$

2.8

(1)

Included on the Company’s consolidated balance sheet in other assets (other, net).

(2)

Included on the Company’s consolidated balance sheet in accrued compensation and benefits.

(3)

Included on the Company’s consolidated balance sheet in accrued expenses and other liabilities and relates to a mandatorily redeemable equity instrument as part of the Apex Valves Limited (“Apex”) acquisition in 2015.

(4)

Included on the Company’s consolidated balance sheet in accrued expenses and other liabilities.

On November 30, 2015, the Company acquired 80% of the outstanding shares of Apex. The aggregate purchase price was $20.4 million and the Company recorded a long-term liability of $5.5 million as the estimate of the acquisition date fair value on the contractual call option to purchase the remaining 20% within three years of closing. The Company acquired an additional 10% ownership in the first quarter of 2017 for $2.9 million, increasing the Company’s ownership to 90% of Apex outstanding shares. In the fourth quarter of 2018, the Company executed an agreement to extend the exercise of the contractual call option. The Company exercised the contractual call option to purchase the remaining 10% of Apex shares in the third quarter of 2019 for approximately $2.8 million.

Cash equivalents consist of instruments with remaining maturities of three months or less at the date of purchase and consist primarily of money market funds, for which the carrying amount is a reasonable estimate of fair value.

The Company uses financial instruments from time to time to enhance its ability to manage risk, including foreign currency and commodity pricing exposures, which exist as part of its ongoing business operations. The use of derivatives exposes the Company to counterparty credit risk for nonperformance and to market risk related to changes in currency exchange rates and commodity prices. The Company manages its exposure to counterparty credit risk through diversification of counterparties. The Company’s counterparties in derivative transactions are substantial commercial banks with significant experience using such derivative instruments. The impact of market risk on the fair value and cash flows of the Company’s derivative instruments is monitored and the Company restricts the use of derivative financial instruments to hedging activities. The Company does not enter into contracts for trading purposes nor does the Company enter into any contracts for speculative purposes. The use of derivative instruments is approved by senior management under written guidelines.

Interest Rate Swaps

On February 12, 2016, the Company entered into a 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 $37.0 million had been drawn as of September 29, 2019. Both facilities mature on February 12, 2021. For each facility, the Company 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’s exposure to changes in cash flows attributable to fluctuations in LIBOR-indexed interest payments related to the Company’s floating rate debt, the Company entered into 2 interest rate swaps. For each interest rate swap, the Company receives the three-month USD-LIBOR subject to a 0% floor, and pays a fixed rate of 1.31375% on a notional amount of $225.0 million. The swaps mature on February 12, 2021. The Company formally documents the hedge relationships at hedge inception to ensure

19

that its interest rate swaps qualify for hedge accounting. On a quarterly basis, the Company assesses whether the interest rate swaps are highly effective in offsetting changes in the cash flow of the hedged item. The Company does not hold or issue interest rate swaps for trading purposes. The swaps are designated as cash flow hedges. For the third quarter and nine months ended September 29, 2019, a loss of $0.5 million and $3.6 million, respectively, was recorded in Accumulated Other Comprehensive Loss to recognize the effective portion of the fair value of interest rate swaps that qualify as a cash flow hedge. For the third quarter and nine months ended September 30, 2018, a gain of $0.1 million and $2.4 million, respectively, was recorded in Accumulated Other Comprehensive Loss to recognize the effective portion of the fair value of interest rate swaps that qualify as a cash flow hedge.

Designated Foreign Currency Hedges

The Company’s foreign subsidiaries transact most business, including certain intercompany transactions, in foreign currencies. Such transactions are principally purchases or sales of materials. The Company has exposure to a number of foreign currencies, including the Canadian dollar, the euro, and the Chinese yuan. Since the first quarter of 2018, the Company has used a layering methodology, whereby at the end of each quarter, the Company enters into forward exchange contracts hedging Canadian dollar to U.S. dollar, which hedge approximately 70% to 80% of the forecasted intercompany purchase transactions between one of the Company’s Canadian subsidiaries and the Company’s U.S. operating subsidiaries for the next twelve months. Beginning in the first quarter of 2019, the Company has used the similar layering methodology and entered into forward exchange contracts hedging U.S. dollar to the Chinese yuan, which hedge up to 60% of the forecasted intercompany sales transactions between one of the Company’s Chinese subsidiaries and one of the Company’s U.S. operating subsidiaries for the next twelve months. As of September 29, 2019, all designated foreign exchange hedge contracts were cash flow hedges under ASC 815, Derivatives and Hedging ("ASC 815"). The Company records the effective portion of the designated foreign currency hedge contracts in other comprehensive income until inventory turns and is sold to a third-party. Once the third-party transaction associated with the hedged forecasted transaction occurs, the effective portion of any related gain or loss on the designated foreign currency hedge will be reclassified into earnings within cost of goods sold. In the event the notional amount of the derivatives exceeds the forecasted intercompany purchases for a given month, the excess hedge position will be attributed to the following month’s forecasted purchases. However, if the following month’s forecasted purchases cannot absorb the excess hedge position from the current month, the effective portion of the hedge recorded in other comprehensive income will be reclassified to earnings.

The notional amounts outstanding as of September 29, 2019 for the Canadian dollar to U.S. dollar contracts and the U.S. dollar to the Chinese yuan contracts were $13.7 million and $5.2 million, respectively. The combined fair value of the Company’s designated foreign hedge contracts outstanding as of September 29, 2019 was a liability balance of $0.3 million. As of September 29, 2019, the amount expected to be reclassified into cost of goods sold from other comprehensive income in the next twelve months for both programs is a loss of $0.2 million.

8. Earnings per Share and Stock Repurchase Program

The following tables set forth the reconciliation of the calculation of earnings per share:

For the Third Quarter Ended September 29, 2019

For the Third Quarter Ended September 30, 2018

 

Income

Shares

Per Share

Income

Shares

Per Share

    

(Numerator)

    

(Denominator)

    

Amount

    

(Numerator)

    

(Denominator)

    

Amount

 

(Amounts in millions, except per share information)

 

Basic EPS:

Net income

$

32.3

34.0

$

0.95

$

31.5

34.3

$

0.92

Effect of dilutive securities:

Common stock equivalents

0.2

(0.01)

 

0.1

Diluted EPS:

Net income

$

32.3

34.2

$

0.94

$

31.5

 

34.4

$

0.92

20

For the Nine Months Ended September 29, 2019

For the Nine Months Ended September 30, 2018

Income

Shares

Per Share

Income

Shares

Per Share

    

(Numerator)

    

(Denominator)

    

Amount

    

(Numerator)

    

(Denominator)

    

Amount

(Amounts in millions, except per share information)

Basic EPS:

Net income

$

99.7

34.1

$

2.92

$

95.7

34.3

$

2.79

Effect of dilutive securities:

Common stock equivalents

0.1

(0.01)

 

0.1

(0.01)

Diluted EPS:

Net income

$

99.7

34.2

$

2.91

$

95.7

 

34.4

$

2.78

There were 0 options to purchase Class A common stock outstanding during the third quarters and nine months ended September 29, 2019 or September 30, 2018 that would have been anti-dilutive.

On July 27, 2015, the Company’s Board of Directors authorized the repurchase of up to $100 million of the Company’s Class A common stock from time to time on the open market or in privately negotiated transactions. On February 6, 2019, the Board of Directors authorized an additional stock repurchase program of up to $150 million of the Company’s Class A common stock to be purchased from time to time on the open market or in privately negotiated transactions. For both stock repurchase programs, the Company has entered into a Rule 10b5-1 plan, which permits shares to be repurchased when the Company might otherwise be precluded from doing so under insider trading laws. The repurchase program may be suspended or discontinued at any time, subject to the terms of the Rule 10b5-1 plan the Company entered into with respect to the repurchase program. The July 27, 2015 stock repurchase program was completed in August 2019 after the Company expended the entire $100 million authorized under the program. As of September 29, 2019, there was approximately $147.0 million remaining authorized for share repurchases under the February 6, 2019 program.

The following table summarizes the cost and the number of shares of Class A common stock repurchased under the July 27, 2015 and February 6, 2019 programs during the third quarter and nine months ended September 29, 2019 and September 30, 2018:

For the Third Quarter Ended

For the Third Quarter Ended

September 29, 2019

September 30, 2018

Number of shares

Cost of shares

Number of shares

Cost of shares

    

repurchased

    

repurchased

    

repurchased

    

repurchased

(Amounts in millions, except share amount)

Stock repurchase programs:

July 27 2015

15,907

$

1.5

57,156

$

4.7

February 6, 2019

32,036

3.0

Total stock repurchased during the period:

 

47,943

$

4.5

 

57,156

$

4.7

For the Nine Months Ended

For the Nine Months Ended

September 29, 2019

September 30, 2018

Number of shares

Cost of shares

Number of shares

Cost of shares

    

repurchased

    

repurchased

    

repurchased

    

repurchased

(Amounts in millions, except share amount)

Stock repurchase programs:

July 27 2015

146,304

$

11.8

195,790

$

15.5

February 6, 2019

32,036

3.0

Total stock repurchased during the period:

 

178,340

$

14.8

 

195,790

$

15.5

9. Stock-Based Compensation

The Company issued 94,849 and 140,937 shares of restricted stock and deferred shares during the first nine months of 2019 and 2018, respectively. The company grants these awards to key employees and stock awards to non-employee members of the Company’s Board of Directors under the 2004 Stock Incentive Plan. Stock awards to employees typically vest over a three-year period and awards to non-employee members of the Company’s Board of Directors vest immediately.

21

The Company also grants performance stock units to key employees under the 2004 Stock Incentive Plan. Performance stock units cliff vest at the end of a three-year performance period with the number of shares of the Company’s Class A common stock awarded to each performance stock unit recipient determined based on the Company’s performance relative to certain performance goals set at the time the performance stock units were granted. The performance stock units are amortized to expense over the vesting period, and based on the Company’s performance relative to the performance goals, which may be adjusted with changes to the related expense recorded in the period of adjustment. If the performance goals are not met, no awards are earned and previously recognized compensation expense is reversed. The Company granted 82,898 and 96,128 performance stock units during the first nine months of 2019 and 2018, respectively.

Under the Management Stock Purchase Plan (“MSPP”) the Company granted 37,486 restricted stock units (“RSUs”) and 36,208 RSUs during the first nine months of 2019 and 2018, respectively. The MSPP allows for the granting of RSUs to key employees. On an annual basis, key employees may elect to receive a portion of their annual incentive compensation in RSUs instead of cash. Participating employees may use up to 50% of their annual incentive bonus to purchase RSUs for a purchase price equal to 80% of the fair market value of the Company’s Class A common stock as of the date of grant.

The fair value of each share issued under the Management Stock Purchase Plan is estimated on the date of grant, using the Black-Scholes-Merton Model, based on the following weighted average assumptions:

    

2019

    

2018

    

Expected life (years)

3.0

3.0

Expected stock price volatility

 

23.3

%  

24.1

%  

Expected dividend yield

 

1.1

%  

1.0

%  

Risk-free interest rate

 

2.5

%  

2.4

%  

The risk-free interest rate is based upon the U.S. Treasury yield curve at the time of grant for the respective expected life of the RSUs. The expected life (estimated period of time outstanding) of RSUs and volatility were calculated using historical data. The expected dividend yield of stock is the Company’s best estimate of the expected future dividend yield.

The above assumptions were used to determine the weighted average grant-date fair value of RSUs granted of $22.16 and $21.80 in 2019 and 2018, respectively.

A more detailed description of each of these plans can be found in Note 14 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

10. Segment Information

The Company operates in 3 geographic segments: Americas, Europe, and APMEA. Each of these segments sells similar products and has separate financial results that are reviewed by the Company’s chief operating decision-maker. Each segment earns revenue and income almost exclusively from the sale of its products. The Company sells its products into various end markets around the world, with sales by region based upon location of the entity recording the sale. See Note 3 for further detail on the product lines sold into by region. All intercompany sales transactions have been eliminated. The accounting policies for each segment are the same as those described in Note 2 above and in Note 2 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

22

The following is a summary of the Company’s significant accounts and balances by segment, reconciled to its consolidated totals:

Third Quarter Ended

Nine Months Ended

September 29,

September 30,

September 29,

September 30,

    

2019

    

2018

    

2019

    

2018

(in millions)

Net Sales

    

    

    

    

Americas

$

270.3

$

262.7

$

816.2

$

775.8

Europe

 

107.9

 

111.6

 

337.4

 

351.7

APMEA

 

16.5

 

16.6

 

46.6

 

49.8

Consolidated net sales

$

394.7

$

390.9

$

1,200.2

$

1,177.3

Operating income

Americas

$

48.5

$

45.0

$

142.3

$

128.1

Europe

 

12.1

 

9.4

 

38.1

 

37.2

APMEA

 

1.4

 

2.5

 

3.9

 

5.5

Subtotal reportable segments

 

62.0

 

56.9

 

184.3

 

170.8

Corporate(*)

 

(13.2)

 

(10.0)

 

(34.5)

 

(27.8)

Consolidated operating income

 

48.8

 

46.9

 

149.8

 

143.0

Interest income

 

(0.1)

 

(0.1)

 

(0.3)

 

(0.6)

Interest expense

 

3.5

 

3.9

 

10.8

 

12.6

Other income, net

 

(0.8)

 

(0.9)

 

(0.4)

 

(2.0)

Income before income taxes

$

46.2

$

44.0

$

139.7

$

133.0

Capital Expenditures

Americas

$

3.1

$

5.1

$

10.5

$

15.0

Europe

 

1.5

 

3.4

 

8.1

 

8.1

APMEA

 

0.1

 

0.4

 

0.5

 

1.0

Consolidated capital expenditures

$

4.7

$

8.9

$

19.1

$

24.1

Depreciation and Amortization

Americas

$

7.3

$

7.4

$

21.6

$

21.7

Europe

 

3.6

 

3.7

 

10.7

 

13.1

APMEA

 

0.7

 

0.6

 

2.0

 

1.9

Consolidated depreciation and amortization

$

11.6

$

11.7

$

34.3

$

36.7

Identifiable assets (at end of period)

Americas

$

1,098.1

$

1,024.2

Europe

 

504.6

 

520.2

APMEA

 

93.6

 

105.2

Consolidated identifiable assets

$

1,696.3

$

1,649.6

Property, plant and equipment, net (at end of period)

Americas

$

113.5

$

113.0

Europe

 

76.4

 

78.9

APMEA

 

5.9

 

6.6

Consolidated property, plant and equipment, net

$

195.8

$

198.5

*     Corporate expenses are primarily for administrative compensation expense, compliance costs, professional fees, including corporate-related legal and audit expenses, shareholder services and benefit administration costs.

The above operating segments are presented on a basis consistent with the presentation included in the Company’s December 31, 2018 consolidated financial statements included in its Annual Report on Form 10-K.

The U.S. property, plant and equipment of the Company’s Americas segment was $109.6 million and $109.0 million at September 29, 2019 and September 30, 2018, respectively.

23

The following includes U.S. net sales of the Company’s Americas segment:

Third Quarter Ended

Nine Months Ended

September 29,

September 30,

September 29,

September 30,

    

2019

    

2018

    

2019

    

2018

(in millions)

U.S. net sales

$

252.0

$

245.5

$

764.9

$

725.1

The following includes intersegment sales for Americas, Europe and APMEA:

Third Quarter Ended

Nine Months Ended

September 29,

September 30,

September 29,

September 30,

    

2019

    

2018

    

2019

    

2018

(in millions)

Intersegment Sales

    

    

    

    

Americas

$

3.2

$

3.7

$

9.1

$

9.7

Europe

 

3.4

 

3.7

 

11.3

 

10.6

APMEA

 

17.7

 

27.3

 

53.4

 

68.7

Intersegment sales

$

24.3

$

34.7

$

73.8

$

89.0

11. Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss consists of the following:

    

    

    

Accumulated 

Foreign

Other

Currency

Cash Flow

Comprehensive

    

Translation

    

Hedges (1)

    

Loss

(in millions)

Balance December 31, 2018

$

(126.3)

$

5.2

$

(121.1)

Change in period

 

(4.6)

 

(1.3)

 

(5.9)

Balance March 31, 2019

$

(130.9)

$

3.9

$

(127.0)

Change in period

 

3.5

 

(2.4)

 

1.1

Balance June 30, 2019

$

(127.4)

$

1.5

$

(125.9)

Change in period

 

(15.8)

 

(0.5)

 

(16.3)

Balance September 29, 2019

$

(143.2)

$

1.0

$

(142.2)

Balance December 31, 2017

$

(102.6)

$

3.5

$

(99.1)

Change in period

 

9.7

 

2.8

 

12.5

Balance April 01, 2018

$

(92.9)

$

6.3

$

(86.6)

Change in period

 

(26.6)

 

1.0

 

(25.6)

Balance July 01, 2018

$

(119.5)

$

7.3

$

(112.2)

Change in period

 

2.5

 

(0.1)

 

2.4

Balance September 30, 2018

$

(117.0)

$

7.2

$

(109.8)

(1)Cash flow hedges include interest rate swaps and designated foreign currency hedges. See Note 7 for further details.

24

12. Debt

In February 2016, the Company entered into the Credit Agreement among the Company, certain subsidiaries of the Company who become 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, senior unsecured revolving credit facility (the “Revolving Credit Facility”) with a sublimit of up to $100 million in letters of credit. As of September 29, 2019, the Company had drawn $37.0 million on this line of credit and had $25.8 million in letters of credit outstanding, which resulted in a $437.2 million of unused and available credit under the Revolving Credit Facility. The Credit Agreement also provides for a $300 million, five-year, term loan facility (the “Term Loan Facility”) available to the Company in a single draw, of which the entire $300 million had been drawn in February 2016. The Company had $232.5 million of borrowings outstanding on the Term Loan Facility as of September 29, 2019 and $260.6 million outstanding as of September 30, 2018. The Company paid total installments on the Term Loan Facility of $22.5 million during the first nine months of 2019. The interest rates as of September 29, 2019 on the Revolving Credit Facility and on the Term Loan Facility were 3.11% and 3.43%, respectively. The terms of Credit Agreement are further detailed in Note 12 of the Notes to Consolidated Financial Statements of the Annual Report on Form 10-K for the year ended December 31, 2018. As of September 29, 2019, the Company was in compliance with all covenants related to the Credit Agreement.

The Company maintains letters of credit that guarantee its performance or payment to third parties in accordance with specified terms and conditions. Amounts outstanding were $25.8 million as of September 29, 2019 and September 30, 2018. The Company’s letters of credit are primarily associated with insurance coverage. The Company’s letters of credit generally expire within one year of issuance and are drawn down against the Revolving Credit Facility. These instruments may exist or expire without being drawn down. Therefore, they do not necessarily represent future cash flow obligations.

The Company is a party to a note agreement as further detailed in Note 12 of the Notes to Consolidated Financial Statements of the Annual Report on Form 10-K for the year ended December 31, 2018.  This note agreement requires the Company 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 September 29, 2019, the Company was in compliance with all covenants regarding this note agreement.

13. Contingencies and Environmental Remediation

The Company is a defendant in numerous legal matters arising from its ordinary course of operations, including those involving product liability, environmental matters, and commercial disputes.

Other than the items described below, significant commitments and contingencies at September 29, 2019 are consistent with those discussed in Note 16 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

As of September 29, 2019, the Company estimates that the aggregate amount of reasonably possible loss in excess of the amount accrued for its legal contingencies is approximately $5.3 million pre-tax. With respect to the estimate of reasonably possible loss, management has estimated the upper end of the range of reasonably possible loss based on (i) the amount of money damages claimed, where applicable, (ii) the allegations and factual development to date, (iii) available defenses based on the allegations, and/or (iv) other potentially liable parties. This estimate is based upon currently available information and is subject to significant judgment and a variety of assumptions, and known and unknown uncertainties. The matters underlying the estimate will change from time to time, and actual results may vary significantly from the current estimate. In the event of an unfavorable outcome in one or more of the matters, the ultimate liability may be in excess of amounts currently accrued, if any, and may be material to the Company’s operating results or cash flows for a particular quarterly or annual period. However, based on information currently known to it, management believes that the ultimate outcome of all matters, as they are resolved over time, is not likely to have a material adverse effect on the financial condition of the Company, though the outcome could be material to the Company’s operating results for any particular period depending, in part, upon the operating results for such period.

25

Chemetco, Inc. Superfund Site, Hartford, Illinois

In August 2017, Watts Regulator Co. (a wholly-owned subsidiary of the Company) received a “Notice of Environmental Liability” from the Chemetco Site Group (“Group”) alleging that it is a potentially responsible party for the Chemetco, Inc. Superfund Site in Hartford, Illinois (the “Site”) because it arranged for the disposal or treatment of hazardous substances that were contained in materials sent to the Site and that resulted in the release or threat of release of hazardous substances at the Site. The letter offered Watts Regulator Co. the opportunity to join the Group and participate in the Remedial Investigation and Feasibility Study (“RI/FS”) at the Site.  Watts Regulator Co. joined the Group in September 2017 and was added in March 2018 as a signatory, together with 43 other new Group members, to the Administrative Settlement Agreement and Order on Consent with the United States Environmental Protection Agency (“USEPA”) governing completion of the RI/FS. Based on information currently known to it, management believes that Watts Regulator Co.’s share of the costs of the RI/FS is not likely to have a material adverse effect on the financial condition of the Company, or have a material adverse effect on the Company’s operating results for any particular period. The Company is unable to estimate a range of reasonably possible loss for the above matter in which damages have not been specified because: (i) the RI/FS has not been completed to determine what remediation plan will be implemented and the costs of such plan; (ii) the total number of potentially responsible parties who may or may not agree to fund or perform any remediation has not yet been determined; (iii) the share contribution for potentially responsible parties to any remediation has not been determined; and (iv) the number of years required to implement a remediation plan acceptable to USEPA is uncertain.

26

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The following discussion and analysis are provided to increase the understanding of, and should be read in conjunction with, the accompanying unaudited consolidated financial statements and related notes. In this quarterly report on Form 10-Q, references to “the Company,” “Watts,” “we,” “us” or “our” refer to Watts Water Technologies, Inc. and its consolidated subsidiaries.

We are a leading supplier of products, solutions and systems that manage and conserve the flow of fluids and energy into, through and out of buildings in the commercial and residential markets in the Americas, Europe and Asia-Pacific, Middle East and Africa (“APMEA”). For over 140 years, we have designed and produced valve systems that safeguard and regulate water systems, energy efficient heating and hydronic systems, drainage systems and water filtration technology that helps purify and conserve water. We earn revenue and income almost exclusively from the sale of our products. Our principal product lines include:

Residential & commercial flow control products—includes products typically sold into plumbing and hot water applications such as backflow preventers, water pressure regulators, temperature and pressure relief valves, and thermostatic mixing valves.

HVAC & gas products—includes commercial high-efficiency boilers, water heaters and heating solutions, hydronic and electric heating systems for under-floor radiant applications, custom heat and hot water solutions, hydronic pump groups for boiler manufacturers and alternative energy control packages, and flexible stainless steel connectors for natural and liquid propane gas in commercial food service and residential applications. HVAC is an acronym for heating, ventilation and air conditioning.

Drainage & water re-use products—includes drainage products and engineered rain water harvesting solutions commercial, industrial, marine and residential applications.

Water quality products—includes point-of-use and point-of-entry water filtration, conditioning and scale prevention systems for commercial, marine and residential applications.

We believe that the factors relating to our future growth include continued product innovation that meets the needs of our customers and our end markets; our ability to continue to make selective acquisitions, both in our core markets as well as in complementary markets; regulatory requirements relating to the quality and conservation of water and the safe use of water; increased demand for clean water; continued enforcement of plumbing and building codes; and a healthy economic environment. We have completed 12 acquisitions in the last decade. Our acquisition strategy focuses on businesses that promote our key macro themes around safety and regulation, energy efficiency and water conservation. We target businesses that will provide us with one or more of the following: an entry into new markets and/or new geographies, improved channel access, unique and/or proprietary technologies, advanced production capabilities or complementary solution offerings.

Our innovation strategy is focused on differentiated products and solutions that will provide greater opportunity to distinguish ourselves in the marketplace. Conversely, we want to migrate away from commoditized products where we cannot add value. Our goal is to be a solutions provider, not just a components supplier. We continually look for strategic opportunities to invest in new products, solutions and markets or divest existing product lines where necessary in order to meet this goal.

The Internet of Things (“IoT”) has allowed companies to transform components into smart and connected devices.  Over the last few years we have been building our smart and connected foundation by expanding our internal capabilities and making strategic acquisitions. In 2018, we began accelerating our efforts and product innovation initiatives related to our Smart and Connected strategy by investing in IoT architecture development, enhancing digital tools used by our customers, launching our new Watts website, and investing in several new smart and connected product development projects. In 2019, we continue to focus on these efforts and initiatives. Our strategy is to deliver superior customer value through smart and connected products and solutions. This strategy focuses on three dimensions: Connect, Control and Conserve. We intend to introduce products that will connect our customers with smart systems, control systems for optimal performance, and conserve critical resources by increasing operability, efficiency and safety. 

27

Products representing a majority of our sales are subject to regulatory standards and code enforcement, which typically require that these products meet stringent performance criteria. We have consistently advocated for the development and enforcement of such plumbing codes. We are focused on maintaining stringent quality control and testing procedures at each of our manufacturing facilities in order to manufacture products in compliance with code requirements and take advantage of the resulting demand for compliant products. We believe that product development, product testing capability and investment in plant and equipment needed to manufacture products in compliance with code requirements, represent a competitive advantage for us.

During the third quarter of 2019, sales increased 1.0%, or $3.8 million, compared to the third quarter of 2018. The increase included organic sales growth of 2.4%, or $9.5 million, primarily within the Americas and Europe segments. This was partially offset by a decrease from foreign exchange of 1.4%, or $5.7 million, primarily driven by a weaker euro. Organic sales is a non-GAAP financial measure that excludes the impacts of acquisitions, divestitures and foreign exchange from year-over-year comparisons. Management believes reporting organic sales growth provides useful information to investors, potential investors and others, because it allows for additional insight into underlying sales trends by providing sales growth on a consistent basis. We reconcile the change in organic sales to our reported sales for each region within our results below. Operating income of $48.8 million increased by $1.9 million, or 4.1%, in the third quarter of 2019 as compared to the third quarter of 2018. This increase is primarily driven by price, volume, lower restructuring costs and savings from productivity initiatives, partially offset by higher general inflation including tariffs, investments in strategic growth initiatives, and increased Corporate expenses, including higher professional fees and acquisition related costs.

Recent Events

In the third quarter of 2019 we completed an immaterial acquisition to purchase substantially all the assets of Backflow Direct LLC, based in Rancho Cordova, California. Backflow Direct specializes in the design and manufacture of backflow prevention valves used primarily in fire protection applications.

Results of Operations

Third Quarter Ended September 29, 2019 Compared to Third Quarter Ended September 30, 2018

Net Sales. Our business is reported in three geographic segments: Americas, Europe and APMEA. Our net sales in each of these segments for each of the third quarters of 2019 and 2018 were as follows:

Third Quarter Ended

Third Quarter Ended

% Change to

 

September 29, 2019

September 30, 2018

Consolidated

 

    

Net Sales

    

% Sales

    

Net Sales

    

% Sales

    

Change

    

Net Sales

 

(dollars in millions)

 

Americas

$

270.3

68.5

%  

$

262.7

67.2

%  

$

7.6

1.9

%

Europe

 

107.9

 

27.3

 

111.6

 

28.6

 

(3.7)

 

(0.9)

APMEA

 

16.5

 

4.2

 

16.6

 

4.2

 

(0.1)

 

Total

$

394.7

 

100.0

%  

$

390.9

 

100.0

%  

$

3.8

 

1.0

%

The change in net sales was attributable to the following:

Change As a %

Change As a %

 

of Consolidated Net Sales

of Segment Net Sales

 

    

    

    

    

 

Americas

Europe

APMEA

Total

Americas

Europe

APMEA

Total

Americas

Europe

APMEA

 

(dollars in millions)

 

Organic

$

7.9

$

1.4

$

0.2

    

$

9.5

 

1.9

%   

0.4

%   

0.1

%  

2.4

%  

3.0

%   

1.3

%   

1.2

%

Foreign exchange

 

(0.3)

 

(5.1)

 

(0.3)

 

(5.7)

 

 

(1.3)

 

(0.1)

 

(1.4)

 

(0.1)

 

(4.6)

 

(1.8)

Total

$

7.6

$

(3.7)

$

(0.1)

$

3.8

 

1.9

%  

(0.9)

%  

%  

1.0

%  

2.9

%  

(3.3)

%  

(0.6)

%

28

Our products are sold to wholesalers, OEMs, DIY chains, and through various specialty channels. The change in organic net sales by channel was attributable to the following:

Change As a %

 

of Prior Year Sales

 

    

Wholesale

    

OEMs

    

DIY

    

Specialty

    

Total

    

Wholesale

    

OEMs

    

DIY

Specialty

 

 

(dollars in millions)

Americas

$

5.6

$

0.6

$

0.7

$

1.0

$

7.9

 

3.8

%  

2.8

%  

5.1

%

1.2

%

Europe

 

2.1

 

(0.8)

 

0.1

 

1.4

 

2.9

 

(2.0)

11.8

APMEA

 

0.4

 

0.1

 

(0.3)

 

0.2

 

3.0

 

29.9

 

(22.5)

Total

$

8.1

$

(0.1)

$

0.8

$

0.7

$

9.5

The increase in Americas organic net sales was primarily due to a combination of price across many of our product lines and volume within our valve, drainage, and water quality products, which are sold through each of our channels. This was partially offset by a decrease in volume within our heating and hot water products.

Organic net sales in Europe increased primarily due to price and higher volume. The increase in wholesale sales was driven by our drainage and valve products. The decrease in OEM sales was mainly due to a decrease in volume of our electronics products.

Organic net sales in APMEA increased primarily due to increased sales in China and New Zealand. This was partially offset by decreased sales within the Middle East due to project delays as well as softness within Korea.

The net decrease in sales due to foreign exchange was primarily due to the depreciation of the euro, Chinese yuan, and Canadian dollar against the U.S. dollar in the third quarter of 2019. 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.

Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for the third quarters of 2019 and 2018 were as follows:

Third Quarter Ended

 

September 29, 2019

September 30, 2018

(dollars in millions)

 

Gross profit

$

168.6

$

164.5

Gross margin

 

42.7

%  

 

42.1

%

Gross profit and gross margin percentage increased compared to the third quarter of 2018 due to price, higher volume, and savings from productivity initiatives, which were partially offset by higher general inflation costs, including tariffs.

Selling, General and Administrative Expenses. Selling, general and administrative, or SG&A, expenses increased $5.6 million, or 4.9%, in the third quarter of 2019 compared to the third quarter of 2018. The increase in SG&A expenses was attributable to the following:

    

(in millions)

    

% Change

 

Organic

$

7.0

 

6.1

%

Foreign exchange

 

(1.4)

 

(1.2)

Total

$

5.6

 

4.9

%

The organic increase was related to investments in strategic growth initiatives of $3.0 million, including investments in research and development for new products, commercial excellence, and technology and information systems. The increase was also due to increased Corporate expenses, including higher professional fees of $2.3 million and acquisition related costs of $0.9 million, general inflation of $1.6 million, increased product liability costs of $1.0 million, and an increase in stock compensation expense of $0.8 million due to a change in the expected attainment of performance goals related to our performance stock units. These increases were partially offset by a $0.5 million decrease in amortization costs for certain intangible assets that reached the end of their useful lives, incremental European restructuring savings of $0.5 million, and a reduction of certain selling and marketing costs of $0.7 million compared to the third quarter of 2018. The decrease in foreign exchange was mainly due to the depreciation of the euro against the U.S. dollar. Total SG&A expenses, as a percentage of sales, were 30.4% in the third quarter of 2019 compared to 29.2% in the third quarter of 2018.

29

Operating Income. Operating income (loss) by segment for the third quarters of 2019 and 2018 was as follows:

% Change to

 

    

Third Quarter Ended

    

    

Consolidated

 

September 29,

September 30,

Operating

 

2019

2018

Change

Income

 

(dollars in millions)

Americas

$

48.5

$

45.0

$

3.5

 

7.4

%

Europe

 

12.1

 

9.4

 

2.7

 

5.8

APMEA

 

1.4

 

2.5

 

(1.1)

 

(2.3)

Corporate

 

(13.2)

 

(10.0)

 

(3.2)

 

(6.8)

Total

$

48.8

$

46.9

$

1.9

 

4.1

%

The increase (decrease) in operating income (loss) was attributable to the following:

Change As a % of

Change As a % of

 

Consolidated Operating Income

Segment Operating Income

 

    

    

    

    

    

    

    

    

    

    

    

    

    

    

 

Americas

Europe

APMEA

Corporate

Total

Americas

Europe

APMEA

Corporate

Total

Americas

Europe

APMEA

Corporate

 

(dollars in millions)

 

Organic

$

3.5

$

(0.1)

$

(1.0)

$

(3.2)

$

(0.8)

7.4

%

(0.2)

%

(2.1)

%

(6.8)

%

(1.7)

%

7.8

%

(1.1)

%

(40.0)

%

(32.0)

%

Foreign exchange

(0.6)

(0.1)

(0.7)

(1.3)

(0.2)

(1.5)

(6.4)

(4.0)

 

Restructuring, impairment charges

 

 

3.4

 

 

 

3.4

 

 

7.3

 

 

 

7.3

 

 

36.2

 

 

Total

$

3.5

$

2.7

$

(1.1)

$

(3.2)

$

1.9

 

7.4

%

5.8

%

(2.3)

%

(6.8)

%

4.1

%

7.8

%

28.7

%

(44.0)

%

(32.0)

%

Organic operating income decreased by $0.8 million compared to the third quarter of 2018. Increases in operating income were due to price, volume and savings from productivity initiatives including savings from restructuring actions. These increases were more than offset by increased Corporate expenses including higher professional fees and acquisition related costs, higher general inflation including the impact of tariffs, investments in strategic growth initiatives and the impact in APMEA of the reduction in affiliate volume.

Interest Expense. Interest expense decreased $0.4 million, or 10.3%, compared to the third quarter of 2018 due to a reduction in the principal balance of debt outstanding. As a result of the 2017 Tax Act, we repatriated approximately $127 million of undistributed foreign earnings in 2018 and $37 million through September 29, 2019, and used the majority of that cash to reduce our outstanding debt. Refer to Note 12 of the Notes to Consolidated Financial Statements for further details.

Other income. Other income decreased $0.1 million compared to the third quarter of 2018. The decrease was primarily due to lower net foreign currency gains.

Income Taxes. Our effective income tax rate increased to 30.1% in the third quarter of 2019, from 28.4% in the third quarter of 2018. The higher rate is primarily related to the impact of changes in the worldwide earnings mix.

Net Income. Net income was $32.3 million, or $0.94 per common share, for the third quarter of 2019, compared to $31.5 million, or $0.92 per common share, for the third quarter of 2018. Results for the third quarter of 2019 include an after-tax charge of $2.3 million, or $0.07 per common share, for Corporate professional fees; $0.7 million, or $0.02 per common share, for acquisition related costs, and $0.3 million, or $0.01 per common share for footprint optimization costs. Results for the third quarter of 2018 include an after-tax charge of $2.5 million, or $0.07 per common share, for restructuring.

30

Nine Months Ended September 29, 2019 Compared to Nine Months Ended September 30, 2018

Net Sales. Our business is reported in three geographic segments: Americas, Europe and APMEA. Our net sales in each of these segments for the first nine months ended 2019 and 2018 were as follows:

Nine Months Ended

Nine Months Ended

% Change to

 

September 29, 2019

September 30, 2018

Consolidated

 

    

Net Sales

    

% Sales

    

Net Sales

    

% Sales

    

Change

    

Net Sales

 

 

(dollars in millions)

Americas

$

816.2

 

68.0

%  

$

775.8

 

65.9

%  

$

40.4

 

3.5

%

Europe

 

337.4

 

28.1

 

351.7

 

29.9

 

(14.3)

 

(1.2)

APMEA

 

46.6

 

3.9

 

49.8

 

4.2

 

(3.2)

 

(0.3)

Total

$

1,200.2

 

100.0

%  

$

1,177.3

 

100.0

%  

$

22.9

 

2.0

%

The change in net sales was attributable to the following:

Change as a %

Change as a %

 

of Consolidated Net Sales

of Segment Net Sales

 

    

    

    

    

    

    

    

    

    

    

    

 

Americas

Europe

APMEA

Total

Americas

Europe

APMEA

Total

Americas

Europe

APMEA

 

(dollars in millions)

 

Organic

$

42.1

$

7.7

$

(1.7)

$

48.1

 

3.6

%  

0.7

%  

(0.2)

%  

4.1

%  

5.4

%  

2.2

%  

(3.4)

%

Foreign exchange

 

(1.7)

 

(22.0)

 

(1.5)

 

(25.2)

 

(0.1)

 

(1.9)

 

(0.1)

 

(2.1)

 

(0.2)

 

(6.3)

 

(3.0)

Total

$

40.4

$

(14.3)

$

(3.2)

$

22.9

 

3.5

%  

(1.2)

%  

(0.3)

%  

2.0

%  

5.2

%  

(4.1)

%  

(6.4)

%

Our products are sold to wholesalers, OEMs, DIY chains, and through various specialty channels. The change in organic net sales by channel was attributable to the following:

Change As a %

of Prior Year Sales

    

Wholesale

    

OEMs

    

DIY

    

Specialty

    

Total

    

Wholesale

    

OEMs

    

DIY

Specialty

 

(dollars in millions)

 

Americas

$

27.3

$

4.1

$

(0.5)

$

11.2

$

42.1

 

6.3

%  

7.0

%  

(1.1)

%

4.7

%

Europe

 

7.0

 

0.6

 

0.1

 

 

7.7

 

3.0

 

0.6

 

4.5

APMEA

 

0.1

 

0.2

 

 

(2.0)

 

(1.7)

 

0.4

 

15.8

 

(47.2)

Total

$

34.4

$

4.9

$

(0.4)

$

9.2

$

48.1

The increase in Americas organic net sales was 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. We also had higher price in our heating and hot water products, which are sold through the specialty channel.

Organic net sales in Europe increased primarily due to price and volume. The increase in wholesale sales was driven by our drainage and valve products. The increase in OEM sales was mainly due to increases in certain HVAC products.

Organic net sales in APMEA decreased primarily due to project delays within the Middle East and softness within Korea, partially offset by increased commercial valve sales in China.

The net decrease in sales due to foreign exchange was primarily due to the depreciation of the euro, Chinese yuan, and Canadian dollar against the U.S. dollar in the first nine months 2019. 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.

31

Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for the first nine months of 2019 and 2018 were as follows:

Nine Months Ended

 

September 29, 2019

September 30, 2018

(dollars in millions)

 

Gross profit

$

507.4

$

490.6

Gross margin

 

42.3

%  

 

41.7

%

Gross profit and gross margin percentage increased compared to the first nine months of 2018 due to price, volume, and savings from productivity initiatives, which were partially offset by higher general inflation costs, including tariffs.

Selling, General and Administrative Expenses. SG&A expenses for the first nine months of 2019 increased $10.7 million, or 3.1%, compared to the first nine months of 2018. The increase in SG&A expenses was attributable to the following:

    

(in millions)

    

% Change

 

Organic

$

17.1

 

5.0

%

Foreign exchange

 

(6.4)

 

(1.9)

Total

$

10.7

 

3.1

%

The organic increase was related to investments in strategic growth initiatives of $8.4 million, including investments in research and development for new products, commercial excellence, and technology and information systems. The increase was also due to increased Corporate expenses, including higher professional fees of $2.3 million and acquisition related costs of $0.9 million, higher variable costs related to increased sales totaling $2.8 million, general inflation of $5.1 million, increased product liability costs of $1.5 million, and an increase in stock compensation expense of $3.0 million due to a change in the expected attainment of performance goals related to our performance stock units. These increases were partially offset by a $3.3 million decrease in amortization costs for certain intangible assets that reached the end of their useful lives, incremental European restructuring savings of $2.3 million, and a reduction of certain selling and marketing costs of $1.2 million compared to the first nine months of 2018. The decrease in foreign exchange was mainly due to the depreciation of the euro against the U.S. dollar. Total SG&A expenses, as a percentage of sales, were 29.6% in the first nine months of 2019 compared to 29.2% in the first nine months of 2018.

Restructuring.  In the first nine months of 2019, we recorded a net charge of $2.7 million 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 6 of Notes to Consolidated Financial Statements.

Operating Income. Operating income (loss) by segment for the first nine months of 2019 and 2018 was as follows:

% Change to

 

Nine Months Ended

Consolidated

 

    

September 29,

    

September 30,

    

    

Operating

 

 

2019

 

2018

Change

Income

 

(Dollars in millions)

Americas

$

142.3

$

128.1

$

14.2

 

9.9

%

Europe

 

38.1

 

37.2

 

0.9

 

0.7

APMEA

 

3.9

 

5.5

 

(1.6)

 

(1.1)

Corporate

 

(34.5)

 

(27.8)

 

(6.7)

 

(4.7)

Total

$

149.8

$

143.0

$

6.8

 

4.8

%

The increase (decrease) in operating income (loss) was attributable to the following:

Change as a % of

Change as a % of

 

Consolidated Operating Income

Segment Operating Income

 

    

    

    

    

    

    

    

    

    

    

    

    

    

    

 

Americas

Europe

APMEA

Corporate

Total

Americas

Europe

APMEA

Corporate

Total

Americas

Europe

APMEA

Corporate

 

(Dollars in millions)

 

Organic

$

14.4

$

2.8

$

(1.3)

$

(6.7)

$

9.2

 

10.1

%  

2.0

%  

(0.9)

%  

(4.7)

%  

6.5

%  

11.2

%  

7.5

%  

(23.6)

%  

(24.1)

%

Foreign exchange

 

(0.2)

 

(2.6)

 

(0.3)

 

 

(3.1)

 

(0.2)

 

(1.8)

 

(0.2)

 

 

(2.2)

 

(0.2)

 

(7.0)

 

(5.5)

 

Restructuring

 

 

0.7

 

 

 

0.7

 

 

0.5

 

 

 

0.5

 

 

1.9

 

 

Total

$

14.2

$

0.9

$

(1.6)

$

(6.7)

$

6.8

 

9.9

%  

0.7

%  

(1.1)

%  

(4.7)

%  

4.8

%  

11.0

%  

2.4

%  

(29.1)

%  

(24.1)

%

32

Organic operating income increased by $9.2 million compared to the first nine months of 2018, mainly due to price, volume, and savings from productivity initiatives, including savings from restructuring actions. This increase in operating income was partially offset by higher general inflation, including the impact of tariffs, investments in strategic growth initiatives, Corporate professional fees and acquisition related costs, and the impact in APMEA of the reduction in affiliate volume.

Interest Expense.  Interest expense decreased $1.8 million, or 14.3%, in the first nine months of 2019 as compared to the first nine months of 2018 due to a reduction in the principal balance of debt outstanding. As a result of the 2017 Tax Act, we repatriated approximately $127 million of undistributed foreign earnings in 2018 and $37 million through September 29, 2019, and used the majority of that cash to reduce our outstanding debt. Refer to Note 12 of the Notes to Consolidated Financial Statements for further details.

 

Other income.  Other income decreased $1.6 million compared to the first nine months 2018. The decrease was primarily due to lower net foreign currency gains.

 

Income Taxes.  Our effective income tax rate increased to 28.6% in the first nine months of 2019, from 28.0% in the first nine months of 2018. The higher rate is primarily related to the impact of changes in the worldwide earnings mix.

Net Income. Net income was $99.7 million, or $2.91 per common share, for the first nine months of 2019, compared to $95.7 million, or $2.78 per common share, for the first nine months of 2018. Results for the first nine months of 2019 include an after-tax charge of $2.3 million, or $0.07 per common share, for Corporate professional fees; $1.9 million, or $0.06 per common share, for restructuring charges; $0.7 million, or $0.02 per common share, for acquisition related costs; and $0.3 million, or $0.01 per common share for footprint optimization costs. Results for the first nine months of 2018 include an after-tax charge of $2.5 million, or $0.08 per common share, for restructuring.

Liquidity and Capital Resources

We generated $94.9 million of net cash in operating activities in the first nine months of 2019 as compared to $66.6 million of net cash provided by operating activities in the first nine months of 2018. The increase was primarily related to inventory reductions and higher net income compared to the first nine months of 2018. Additionally, in 2018 we made higher tax payments, including withholding taxes on repatriated cash.

We used $61.7 million of net cash for investing activities compared to $26.0 million used in the in the first nine months of 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 $5.0 million less cash for capital expenditures in the first nine months of 2019 compared to the first nine months of 2018. For the remainder of 2019, we expect to invest approximately $11 million in capital equipment as part of our ongoing commitment to improve our operating capabilities. 

We used $59.0 million of net cash from financing activities in the first nine months of 2019 primarily through long-term debt repayments of $92.5 million, dividend payments of $23.6 million, payments for finance leases and tax withholding on vested stock awards totaling $8.3 million, share repurchases of approximately 178,000 shares of Class A common stock at a cost of $14.8 million, and payment of a contractual call option to purchase the remaining 10% of Apex shares of $2.8 million. These cash outflows were partially offset by proceeds from additional draws on our line of credit totaling $82.0 million during the first nine months of 2019.

In February 2016, we entered into the Credit Agreement among the Company, certain subsidiaries of the Company who become 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, senior unsecured revolving credit facility (the “Revolving Credit Facility”) with a sublimit of up to $100 million in letters of credit. As of September 29, 2019, we had drawn $37.0 million against the Revolving Credit Facility. The Credit Agreement also provides for a $300 million, five-year, term loan facility (the “Term Loan Facility”) available to the Company in a single draw, of which the entire $300 million had been drawn in February 2016. We had $232.5 million of borrowings outstanding on the Term Loan Facility as of September 29, 2019. We paid total installments on the Term Loan Facility of $22.5 million during the first nine months of 2019. We had $25.8 million of stand-by letters of credit outstanding and had $437.2 million of unused and available credit under the Revolving Credit Facility. As of September 29, 2019, we were in compliance with all covenants related to the Credit Agreement.

33

As of September 29, 2019, we held $173.7 million in cash and cash equivalents. Of this amount, $132.3 million of cash and cash equivalents were held by foreign subsidiaries. Our U.S. operations typically generate sufficient cash flows to meet our domestic obligations. However, if we did have to borrow to fund some or all of our expected cash outlay, we can do so at reasonable interest rates by utilizing the uncommitted borrowings under our Revolving Credit 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 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 potential state income taxes and other tax charges.

Non-GAAP Financial Measures

In accordance with the SEC's Regulation G and Item 10(e) of Regulation S-K, the following provides definitions of the non-GAAP financial measures used by management. We believe that these measures provide additional insight into underlying business results and trends. These non-GAAP financial measures are not intended to be considered by the user in place of the related GAAP financial measure, but rather as supplemental information to more fully understand our business results. These non-GAAP financial 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 financial 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. GAAP financial 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.

Free cash flow is a non-GAAP financial measure that does not represent cash provided by 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.

A reconciliation of net cash provided by operating activities to free cash flow is provided below:

Nine Months Ended

September 29,

September 30,

2019

2018

(in millions)

Net cash provided by operating activities

$

94.9

$

66.6

Less: additions to property, plant, and equipment

 

(19.1)

 

(24.1)

Plus: proceeds from the sale of property, plant, and equipment

 

0.1

 

0.1

Free cash flow

$

75.9

$

42.6

Net income —as reported

$

99.7

$

95.7

Cash conversion rate of free cash flow to net income

 

76.1

%

 

44.5

%  

Our free cash flow increased in the first nine months of 2019 when compared to the first nine months of 2018 primarily from inventory reductions, higher net income, and lower capital expenditures in 2019. Additionally, in 2018 we made higher tax payments, including withholding taxes on repatriated cash.

Our net debt to capitalization ratio, a non-GAAP financial measure used by management, at September 29, 2019 was 15.3% compared to 14.3% at December 31, 2018. The increase was driven by an increase in net debt outstanding at September 29, 2019 primarily from a decrease in cash and cash equivalents compared to December 31, 2018 of $30.4 million, partially offset by a decrease in debt during the first nine months of 2019 of $9.9 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.

34

A reconciliation of long-term debt (including current portion) to net debt and our net debt to capitalization ratio is provided below:

September 29,

December 31,

2019

2018

(in millions)

Current portion of long‑term debt

 

$

105.0

$

30.0

Plus: long-term debt, net of current portion

 

238.5

 

323.4

Less: cash and cash equivalents

 

(173.7)

 

(204.1)

Net debt

$

169.8

$

149.3

A reconciliation of capitalization is provided below:

September 29,

December 31,

2019

2018

(in millions)

 

Net debt

$

169.8

$

149.3

Total stockholders’ equity

 

942.0

 

891.3

Capitalization

$

1,111.8

$

1,040.6

Net debt to capitalization ratio

 

15.3

%  

 

14.3

%

Off-Balance Sheet Arrangements

We have no off-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 is material to investors.

Application of Critical Accounting Policies and Key Estimates

We believe that our critical accounting policies are those related to revenue recognition, inventory valuation, goodwill and other intangibles, product liability costs, legal contingencies and income taxes. We believe these accounting policies are particularly important to an understanding of our financial position and results of operations and requires application of significant judgment by our management. In applying these policies, management uses its judgment in making certain assumptions and estimates. Our accounting policies are more fully described under the heading “Accounting Policies” in Note 2 of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K as filed with the SEC on February 22, 2019, with the exception of the change in our lease accounting policy resulting from the adoption of ASC 842 as described in Note 2 in the Notes to Consolidated Financial Statements in this Form 10-Q.

Item 3.   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 7 of Notes to the Consolidated Financial Statements for further details.

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.

Our non-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. Beginning in the first quarter of 2018, we entered into forward exchange contracts which hedge 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.

35

Beginning in the first quarter of 2019, we entered into forward exchange contracts which hedge up to 60% 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 hedge contracts in other comprehensive income until inventory turns and is sold to a third-party. Once the third-party transaction associated with the hedged forecasted transaction occurs, the effective portion of any related gain or loss on the designated foreign currency hedge is reclassified into cost of goods sold within earnings. The fair value of our designated foreign hedge contracts outstanding as of September 29, 2019 was a liability balance of $0.3 million.

Under the Credit Agreement, we can choose either an Adjusted LIBOR or Alternative Base Rate (“ABR”). Accordingly, our earnings and cash flows are exposed to interest rate risk from changes in Adjusted LIBOR. In order to manage our exposure to changes in cash flows attributable to fluctuations in LIBOR-indexed interest payments related to our floating rate debt, we entered into two interest rate swaps. For each interest rate swap, we receive the three-month USD-LIBOR subject to a 0% floor, and pays a fixed rate of 1.31375% on a notional amount of $225.0 million. Information about our long-term debt including principal amounts and related interest rates appears in Note 7 of Notes to the Consolidated Financial Statements.

We purchase significant amounts of bronze ingot, brass rod, cast iron, stainless steel and plastic, 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 4.   Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As required by Rule 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 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 not effective as of that date due to a material weakness in internal control over financial reporting that was disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Management’s Plan to Remediate the Material Weakness

As previously described in Part II, Item 9A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, we began implementing a remediation plan to address the material weakness mentioned above. The weakness will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. We expect that the remediation of this material weakness will be completed prior to the end of fiscal 2019.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the third quarter ended September 29, 2019, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting, with the exception of 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. 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

36

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.

Part II. OTHER INFORMATION

Item 1.   Legal Proceedings

As disclosed in Part I, Item 1, “Product Liability, Environmental and Other Litigation Matters” and Item 3, “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2018, we are party to certain litigation.  There have been no material developments with respect to our contingencies and environmental remediation proceedings during the quarter ended September 29, 2019, other than as described in Note 13 of the Notes to Consolidated Financial Statements, which is incorporated herein by reference.

Item 1A.   Risk Factors

There have been no material changes to the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2018, which risk factors are incorporated herein by reference.

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds

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 third quarter ended September 29, 2019.

Issuer Purchases of Equity Securities

    

    

    

    

(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

July 1, 2019 – July 28, 2019

 

1,499

$

91.97

 

 

July 29, 2019 – August 25, 2019

 

522

$

91.59

 

 

August 26, 2019 - September 29, 2019

$

Total

 

2,021

$

91.87

 

 

37

The following table includes information with respect to repurchases of our Class A common stock during the third quarter ended September 29, 2019 under our stock repurchase program.

Issuer Purchases of Equity Securities

    

    

    

    

(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

July 1, 2019 – July 28, 2019

 

14,586

$

91.81

 

14,586

$

150,132,849

July 29, 2019 – August 25, 2019

 

15,177

$

92.87

 

15,177

$

148,713,648

August 26, 2019 - September 29, 2019

18,180

$

93.87

18,180

$

147,007,058

Total

 

47,943

$

92.93

 

47,943

(1)On July 27, 2015, the Board of Directors authorized a stock repurchase program of up to $100 million of the Company’s Class A common stock to be purchased from time to time on the open market or in privately negotiated transactions. This repurchase program was completed in August 2019 after the Company expended the entire $100 million authorized under the program. On February 6, 2019, the Board of Directors authorized an additional stock repurchase program of up to $150 million of the Company’s Class A common stock to be purchased from time to time on the open market or in privately negotiated transactions. The timing and number of shares repurchased will be determined by the Company’s management based on its evaluation of market conditions and other factors.

Item 6.    Exhibits

Exhibit No.

    

Description

3.1

Restated Certificate of Incorporation, as amended. Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2019 (File No. 001-11499).

3.2

Amended and Restated By-Laws. Incorporated by reference to the Registrant’s Current Report on Form 8-K dated July 27, 2015 (File No. 001- 11499).

31.1†

Certification of Principal Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended

31.2†

Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended

32.1††

Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350

32.2††

Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350

101.INS*

Inline XBRL Instance Document

101.SCH*

Inline XBRL Taxonomy Extension Schema Document

101.CAL*

Inline XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF*

Inline XBRL Taxonomy Extension Definition Linkbase Document

101.LAB*

Inline XBRL Taxonomy Extension Label Linkbase Document

101.PRE*