UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x |
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
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For the quarterly period ended July 2, 2006 |
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or |
o |
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 |
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04-2916536 |
(State or other jurisdiction of |
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(I.R.S. Employer Identification No.) |
incorporation or organization) |
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815 Chestnut Street, North Andover, MA |
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01845 |
(Address of principal executive offices) |
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(Zip Code) |
Registrants telephone number, including area code: (978) 688-1811
(Former Name, Former Address and Former Fiscal year, if changed since last report.)
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 x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large Accelerated filer x |
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Accelerated filer o |
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Non-Accelerated filer o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Class |
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Outstanding at July 28, 2006 |
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Class A Common Stock, $.10 par value |
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25,366,795 |
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Class B Common Stock, $.10 par value |
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7,293,880 |
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WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
INDEX
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Consolidated Balance Sheets at July 2, 2006 and December 31, 2005 (unaudited) |
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Managements Discussion and Analysis of Financial Condition and Results of Operations |
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2
WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
(Amounts in thousands, except share information)
(Unaudited)
|
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July 2, |
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December 31, |
|
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ASSETS |
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|
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|
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CURRENT ASSETS: |
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|
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|
|
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Cash and cash equivalents |
|
$ |
109,364 |
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$ |
45,758 |
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Trade accounts receivable, less allowance for doubtful accounts of $9,632 at July 2, 2006 and $9,296 at December 31, 2005 |
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218,878 |
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177,364 |
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Inventories, net: |
|
|
|
|
|
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Raw materials |
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106,148 |
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84,087 |
|
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Work in process |
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31,548 |
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23,201 |
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Finished goods |
|
160,137 |
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135,549 |
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Total Inventories |
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297,833 |
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242,837 |
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Prepaid expenses and other assets |
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20,952 |
|
25,361 |
|
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Deferred income taxes |
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33,265 |
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27,540 |
|
||
Assets of discontinued operations |
|
8,055 |
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9,555 |
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Total Current Assets |
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688,347 |
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528,415 |
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PROPERTY, PLANT AND EQUIPMENT: |
|
|
|
|
|
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Property, plant and equipment, at cost |
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395,485 |
|
328,812 |
|
||
Accumulated depreciation |
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(179,991 |
) |
(163,813 |
) |
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Property, plant and equipment, net |
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215,494 |
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164,999 |
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OTHER ASSETS: |
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|
|
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Goodwill |
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346,815 |
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296,636 |
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Other, net |
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124,312 |
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110,920 |
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TOTAL ASSETS |
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$ |
1,374,968 |
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$ |
1,100,970 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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|
|
|
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CURRENT LIABILITIES: |
|
|
|
|
|
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Accounts payable |
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$ |
110,480 |
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$ |
91,053 |
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Accrued expenses and other liabilities |
|
83,218 |
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67,071 |
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Accrued compensation and benefits |
|
34,406 |
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28,496 |
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Current portion of long-term debt |
|
7,789 |
|
13,635 |
|
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Liabilities of discontinued operations |
|
23,003 |
|
23,068 |
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Total Current Liabilities |
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258,896 |
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223,323 |
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LONG-TERM DEBT, NET OF CURRENT PORTION |
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452,966 |
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293,350 |
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DEFERRED INCOME TAXES |
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40,280 |
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24,803 |
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OTHER NONCURRENT LIABILITIES |
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49,825 |
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32,187 |
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MINORITY INTEREST |
|
7,698 |
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7,831 |
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STOCKHOLDERS EQUITY: |
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Preferred Stock, $.10 par value; 5,000,000 shares authorized; no shares issued or outstanding |
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Class A Common Stock, $.10 par value; 80,000,000 shares authorized; 1 vote per share; issued and outstanding: 25,366,785 shares at July 2, 2006 and 25,205,210 shares at December 31, 2005 |
|
2,537 |
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2,521 |
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Class B Common Stock, $.10 par value; 25,000,000 shares authorized; 10 votes per share; issued and outstanding: 7,293,880 shares at July 2, 2006 and 7,343,880 shares at December 31, 2005 |
|
729 |
|
734 |
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Additional paid-in capital |
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145,677 |
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142,694 |
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Retained earnings |
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399,645 |
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368,264 |
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Accumulated other comprehensive income |
|
16,715 |
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5,263 |
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Total Stockholders Equity |
|
565,303 |
|
519,476 |
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TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
|
$ |
1,374,968 |
|
$ |
1,100,970 |
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See accompanying notes to consolidated financial statements.
3
WATTS WATER
TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share information)
(Unaudited)
|
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Second Quarter Ended |
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July 2, |
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July 3, |
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Net sales |
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$ |
300,175 |
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$ |
228,183 |
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Cost of goods sold |
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193,816 |
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147,000 |
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GROSS PROFIT |
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106,359 |
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81,183 |
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Selling, general & administrative expenses |
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73,799 |
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56,886 |
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Restructuring and other charges |
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(5,676 |
) |
96 |
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OPERATING INCOME |
|
38,236 |
|
24,201 |
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Other (income) expense: |
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Interest income |
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(891 |
) |
(329 |
) |
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Interest expense |
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4,952 |
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2,567 |
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Minority interest |
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58 |
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72 |
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Other |
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(986 |
) |
(90 |
) |
||
|
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3,133 |
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2,220 |
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INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES |
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35,103 |
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21,981 |
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Provision for income taxes |
|
12,560 |
|
7,993 |
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INCOME FROM CONTINUING OPERATIONS |
|
22,543 |
|
13,988 |
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Loss from discontinued operations, net of taxes |
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(97 |
) |
(75 |
) |
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NET INCOME |
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$ |
22,446 |
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$ |
13,913 |
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BASIC EPS |
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Income per share: |
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Continuing operations |
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$ |
.69 |
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$ |
.43 |
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Discontinued operations |
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NET INCOME |
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$ |
.69 |
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$ |
.43 |
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Weighted average number of shares |
|
32,654 |
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32,475 |
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DILUTED EPS |
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Income per share: |
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Continuing operations |
|
$ |
.68 |
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$ |
.42 |
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Discontinued operations |
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NET INCOME |
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$ |
.68 |
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$ |
.42 |
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Weighted average number of shares |
|
33,038 |
|
33,077 |
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Dividends per share |
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$ |
.09 |
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$ |
.08 |
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See accompanying notes to consolidated financial statements.
4
WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share information)
(Unaudited)
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Six Months Ended |
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July 2, |
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July 3, |
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Net sales |
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$ |
575,125 |
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$ |
447,210 |
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Cost of goods sold |
|
372,948 |
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288,649 |
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GROSS PROFIT |
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202,177 |
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158,561 |
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Selling, general & administrative expenses |
|
142,850 |
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112,592 |
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Restructuring and other charges |
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(5,441 |
) |
458 |
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OPERATING INCOME |
|
64,768 |
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45,511 |
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Other (income) expense: |
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Interest income |
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(1,309 |
) |
(638 |
) |
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Interest expense |
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9,144 |
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5,088 |
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Minority interest |
|
142 |
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137 |
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Other |
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(1,386 |
) |
(177 |
) |
||
|
|
6,591 |
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4,410 |
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INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES |
|
58,177 |
|
41,101 |
|
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Provision for income taxes |
|
20,547 |
|
14,716 |
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INCOME FROM CONTINUING OPERATIONS |
|
37,630 |
|
26,385 |
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Loss from discontinued operations, net of taxes |
|
(221 |
) |
(114 |
) |
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NET INCOME |
|
$ |
37,409 |
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$ |
26,271 |
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BASIC EPS |
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Income per share: |
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|
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Continuing operations |
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$ |
1.15 |
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$ |
.81 |
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Discontinued operations |
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NET INCOME |
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$ |
1.15 |
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$ |
.81 |
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Weighted average number of shares |
|
32,623 |
|
32,442 |
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DILUTED EPS |
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Income per share: |
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Continuing operations |
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$ |
1.14 |
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$ |
.80 |
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Discontinued operations |
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(.01 |
) |
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NET INCOME |
|
$ |
1.13 |
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$ |
.80 |
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Weighted average number of shares |
|
33,015 |
|
33,032 |
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Dividends per share |
|
$ |
.18 |
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$ |
.16 |
|
See accompanying notes to consolidated financial statements.
5
WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
|
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Six Months Ended |
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|
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July 2, |
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July 3, |
|
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OPERATING ACTIVITIES |
|
|
|
|
|
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Income from continuing operations |
|
$ |
37,630 |
|
$ |
26,385 |
|
Adjustments to reconcile net income from continuing operations to net cash provided by (used in) continuing operating activities: |
|
|
|
|
|
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Depreciation |
|
13,703 |
|
12,189 |
|
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Amortization |
|
3,195 |
|
1,037 |
|
||
|
1,215 |
|
|
|
|||
Deferred income taxes |
|
(3,348 |
) |
(1,343 |
) |
||
(Gain) loss on disposal of property, plant and equipment |
|
(6,655 |
) |
223 |
|
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Other |
|
(688 |
) |
|
|
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Changes in operating assets and liabilities, net of effects from business acquisitions and divestitures: |
|
|
|
|
|
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Accounts receivable |
|
(16,375 |
) |
(25,780 |
) |
||
Inventories |
|
(24,959 |
) |
(17,783 |
) |
||
Prepaid expenses and other assets |
|
(3,544 |
) |
(3,051 |
) |
||
Accounts payable, accrued expenses and other liabilities |
|
9,976 |
|
281 |
|
||
Net cash provided by (used in) operating activities |
|
10,150 |
|
(7,842 |
) |
||
|
|
|
|
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INVESTING ACTIVITIES |
|
|
|
|
|
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Additions to property, plant and equipment |
|
(29,792 |
) |
(9,338 |
) |
||
Proceeds from the sale of property, plant and equipment |
|
26,486 |
|
122 |
|
||
Proceeds from sale of securities |
|
|
|
26,600 |
|
||
Increase in other assets |
|
(670 |
) |
(223 |
) |
||
Business acquisitions, net of cash acquired |
|
(82,014 |
) |
(28,178 |
) |
||
Net cash used in investing activities |
|
(85,990 |
) |
(11,017 |
) |
||
|
|
|
|
|
|
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FINANCING ACTIVITIES |
|
|
|
|
|
||
Proceeds from long-term borrowings |
|
339,775 |
|
32,584 |
|
||
Payments of long-term debt |
|
(192,393 |
) |
(9,869 |
) |
||
Proceeds from exercise of stock options |
|
1,528 |
|
2,380 |
|
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Tax benefit of options exercised |
|
251 |
|
|
|
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Debt issue costs |
|
(2,414 |
) |
|
|
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Payment of capital lease |
|
(3,181 |
) |
|
|
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Dividends |
|
(6,028 |
) |
(5,222 |
) |
||
Net cash provided by financing activities |
|
137,538 |
|
19,873 |
|
||
Effect of exchange rate changes on cash and cash equivalents |
|
695 |
|
(519 |
) |
||
Net cash provided by (used in) operating activities of discontinued operations |
|
1,213 |
|
(172 |
) |
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INCREASE IN CASH AND CASH EQUIVALENTS |
|
63,606 |
|
323 |
|
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Cash and cash equivalents at beginning of period |
|
45,758 |
|
65,913 |
|
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CASH AND CASH EQUIVALENTS AT END OF PERIOD |
|
$ |
109,364 |
|
$ |
66,236 |
|
|
|
|
|
|
|
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NON CASH INVESTING AND FINANCING ACTIVITIES |
|
|
|
|
|
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Acquisition of businesses: |
|
|
|
|
|
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Fair value of assets acquired |
|
$ |
142,104 |
|
$ |
32,349 |
|
Cash paid, net of cash acquired |
|
82,014 |
|
28,178 |
|
||
Liabilities assumed |
|
$ |
60,090 |
|
$ |
4,171 |
|
|
|
|
|
|
|
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Acquisitions of fixed assets under capital lease |
|
$ |
15,957 |
|
$ |
|
|
Retirement of variable rate demand bonds with cash collateral |
|
$ |
8,900 |
|
$ |
|
|
|
|
|
|
|
|
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CASH PAID FOR |
|
|
|
|
|
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Interest |
|
$ |
7,832 |
|
$ |
3,680 |
|
Taxes |
|
$ |
19,394 |
|
$ |
16,421 |
|
See accompanying notes to consolidated financial statements.
6
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 Watts Water Technologies, Inc.s Consolidated Balance Sheet as of July 2, 2006, its Consolidated Statements of Operations for the second quarter and six months ended July 2, 2006 and the second quarter and six months ended July 3, 2005, and its Consolidated Statements of Cash Flows for the six months ended July 2, 2006 and the six months ended July 3, 2005.
The balance sheet at December 31, 2005 has been derived from the audited financial statements at that date. The accounting policies followed by the Company are described in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2005. The financial statements included in this report should be read in conjunction with the financial statements and notes included in the Annual Report on Form 10-K for the year ended December 31, 2005. Operating results for the interim period presented are not necessarily indicative of the results to be expected for the year ending December 31, 2006.
The Company operates on a 52-week fiscal year ending on December 31. Any second quarter ended data contained in this Report on Form 10-Q reflects the results of operations for the 13-week period ended on the Sunday nearest June 30 of the respective year.
Certain amounts in fiscal year 2005 have been reclassified to permit comparison with the 2006 presentation. These reclassifications had no effect on reported results of operations or stockholders equity.
2. Accounting Policies
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.
Goodwill and Long-Lived Assets
The changes in the carrying amount of goodwill by geographic segments from December 31, 2005 to July 2, 2006 are as follows:
|
|
North |
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Europe |
|
China |
|
Total |
|
||||
|
|
(in thousands) |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
||||
Carrying amount at the beginning of period |
|
$ |
193,597 |
|
$ |
97,438 |
|
$ |
5,601 |
|
$ |
296,636 |
|
Goodwill acquired during the period |
|
1,142 |
|
36,209 |
|
7,808 |
|
45,159 |
|
||||
Adjustments to goodwill during the period |
|
(322 |
) |
|
|
|
|
(322 |
) |
||||
Effect of change in exchange rates used for translation |
|
187 |
|
5,103 |
|
52 |
|
5,342 |
|
||||
Carrying amount at end of period |
|
$ |
194,604 |
|
$ |
138,750 |
|
$ |
13,461 |
|
$ |
346,815 |
|
Other intangible assets include the following and are presented in Other Assets: Other, net, in the July 2, 2006 Consolidated Balance Sheet:
|
|
Gross |
|
Accumulated |
|
||
|
|
(in thousands) |
|
||||
|
|
|
|
|
|
||
Patents |
|
$ |
9,659 |
|
$ |
(4,872 |
) |
Other |
|
72,378 |
|
(7,692 |
) |
||
Total amortizable intangibles |
|
82,037 |
|
(12,564 |
) |
||
Intangible assets not subject to amortization |
|
42,058 |
|
|
|
||
Total |
|
$ |
124,095 |
|
$ |
(12,564 |
) |
7
Aggregate amortization expense for amortized other intangible assets for the second quarters of 2006 and 2005 was $1,800,000 and $518,000, respectively, and for the six-month periods of 2006 and 2005 was $3,195,000 and $1,037,000, respectively. Additionally, future amortization expense on other intangible assets will be approximately $4,054,000 for the remainder of 2006, $7,738,000 for 2007, $7,495,000 for 2008, $6,792,000 for 2009 and $6,368,000 for 2010. Amortization expense is calculated on a straight-line basis over the estimated useful lives of the intangible assets. The weighted-average remaining life of total amortizable intangibles is 11.8 years. Patents and other amortizable intangibles have weighted-average remaining lives of 13.2 years and 11.7 years, respectively. Other amortizable intangibles primarily include customer relationships and non-compete agreements. Intangible assets not subject to amortization primarily include trademarks and unpatented technology.
Stock-Based Compensation
The Company maintains four stock incentive plans under which key employees and outside directors have been granted currently outstanding incentive stock options (ISOs) and nonqualified stock options (NSOs) to purchase the Companys Class A Common Stock. Only one plan, the 2004 Stock Incentive Plan, is currently available for the grant of new equity awards. Stock options granted under prior plans became exercisable over a five-year period at the rate of 20% per year and expire ten years after the date of grant. Under the 2004 Stock Incentive Plan, options become exercisable over a four -year period at the rate of 25% per year and expire ten years after the grant date. ISOs and NSOs granted under the plans may have exercise prices of not less than 100% and 50% of the fair market value of the common stock on the date of grant, respectively. The Companys current practice is to issue all options at fair market value on the grant date.
The Company has granted shares of restricted stock to its non-employee members of the Companys Board of Directors (and certain key employees) under the 2004 Stock Incentive Plan, which vest over three years. The restricted stock awards are amortized to expense on a straight-line basis over the vesting period.
The Company also has a Management Stock Purchase Plan that allows for the purchase of Restricted Stock Units (RSUs) by key employees of up to an aggregate of 1,000,000 shares of Class A Common Stock at 67% of the fair market value on the date of grant. RSUs vest annually over a three-year period from the date of grant.
A more detailed description of each of these stock and stock option plans can be found in Note 13 of Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2005.
Effective January 1, 2006, the Company adopted Financial Accounting Standards Board Statement No. 123R, Share-Based Payment(FAS 123R) utilizing the modified prospective method as described in FAS 123R. Under the modified prospective method, compensation cost is recognized for all share-based payments granted after the effective date and for all unvested awards granted prior to the effective date. In accordance with FAS 123R, prior period amounts were not restated. FAS 123R also requires the tax benefits associated with these share-based payments to be classified as financing activities in the Statements of Consolidated Cash Flows, rather than as operating cash flows as required under previous regulations. At July 2, 2006, the Company had three stock-based compensation plans with total unrecognized compensation costs related to unvested stock-based compensation arrangements of approximately $5,182,000 and a total weighted average remaining term of 2.3 years. For the second quarter and first six months of 2006, the Company recognized compensation costs related to stock-based programs of approximately $461,000 and $1,215,000, respectively, in selling, general and administrative expenses. The Company did not recognize any income tax benefits during the second quarter of 2006 for the compensation expense relating to its stock options. For the second quarter and six months ended July 2, 2006, the Company recorded approximately $121,000 and $232,000 of tax benefit for its other stock-based plans. The recognition of total stock-based compensation expense impacted both basic net income per common share and diluted net income per common share by $0.01 during the second quarter. For the six months ended July 2, 2006, the recognition of total stock-based compensation expense impacted both basic net income per common share and diluted net income per common share by $0.03.
Prior to the effective date, the stock-based compensation plans were accounted for under Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations. Pro-forma information regarding the impact of total stock-based compensation on net income and income per share for prior periods is required by FAS 123R.
Such pro-forma information, determined as if the Company had accounted for its employee stock options and RSUs under the fair value method to measure stock-based compensation as required under the disclosure provisions of Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation (FAS 123) as amended by Financial Accounting Standards Board Statement No. 148 Accounting for Stock-Based Compensation Transition and Disclosure (FAS 148) during the second quarter and six months ended July 3, 2005, is illustrated in the following table:
8
|
|
Second Quarter Ended |
|
|
|
|
July 3, 2005 |
|
|
|
|
(amounts in thousands, except |
|
|
Net income, as reported |
|
$ |
13,913 |
|
Add: Stock-based employee compensation expense from the Management Stock Purchase Plan included in reported net income, net of tax |
|
158 |
|
|
Deduct: Stock-based employee compensation expense determined under the fair value method, net of tax: |
|
|
|
|
Restricted stock units (Management Stock Purchase Plan) |
|
(159 |
) |
|
Employee stock options |
|
(170 |
) |
|
Pro-forma net income |
|
$ |
13,742 |
|
|
|
|
|
|
Earnings per share: |
|
|
|
|
Basic-as reported |
|
$ |
.43 |
|
Basic-pro-forma |
|
$ |
.42 |
|
Diluted-as reported |
|
$ |
.42 |
|
Diluted-pro-forma |
|
$ |
.42 |
|
|
|
Six Months Ended |
|
|
|
|
July 3, 2005 |
|
|
|
|
(amounts in thousands, except |
|
|
Net income, as reported |
|
$ |
26,271 |
|
Add: Stock-based employee compensation expense from the Management Stock Purchase Plan included in reported net income, net of tax |
|
316 |
|
|
Deduct: Stock-based employee compensation expense determined under the fair value method, net of tax: |
|
|
|
|
Restricted stock units (Management Stock Purchase Plan) |
|
(318 |
) |
|
Employee stock options |
|
(340 |
) |
|
Pro-forma net income |
|
$ |
25,929 |
|
|
|
|
|
|
Earnings per share: |
|
|
|
|
Basic-as reported |
|
$ |
.81 |
|
Basic-pro-forma |
|
$ |
.80 |
|
Diluted-as reported |
|
$ |
.80 |
|
Diluted-pro-forma |
|
$ |
.79 |
|
The fair value of each option granted is estimated on the date of grant, using the Black-Scholes-Merton Model, based on the following weighted average assumptions for 2005:
|
Year Ended |
|
|
|
|
|
|
Expected life (years) |
|
5.8 |
|
Risk-free interest rate |
|
4.0 |
% |
Volatility |
|
36.2 |
% |
Dividend yield |
|
1.0 |
% |
There were no options granted in the first six months of 2006.
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 for the first six months of 2006 and 2005:
|
Six Months Ended |
|
|||
|
|
July 2, |
|
July 3, |
|
|
|
|
|
|
|
Expected life (years) |
|
3.0 |
|
3.0 |
|
Risk-free interest rate |
|
4.5 |
% |
3.4 |
% |
Volatility |
|
25.7 |
% |
26.0 |
% |
Dividend yield |
|
1.5 |
% |
1.4 |
% |
There were 87,125 and 120,036 shares issued under the Management Stock Purchase Plan in the first quarters of 2006 and 2005, respectively. There were no shares issued in the second quarters of 2006 or 2005.
9
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 option. The expected life (estimated period of time outstanding) of options and volatility were calculated using historical data. The expected dividend yield of stock is the Companys best estimate of the expected future dividend yield. The Company applied an estimated forfeiture rate of 15% for its stock options and 10% for its RSUs. These rates were calculated based upon historical activity and are an estimate of granted shares not expected to vest. If actual forfeitures differ from the expected rates, the Company may be required to make additional adjustments to compensation expense in future periods.
The above assumptions were used to determine the weighted average grant-date fair value of stock options of $11.54 in 2005. Also, the weighted average grant-date fair value of RSUs granted were $13.60 and $12.41 during the first six months of 2006 and 2005, respectively.
The Company distributed dividends of $0.09 and $0.18 per share for the second quarter and first six months of 2006, respectively, and $0.08 and $0.16 per share for the second quarter and first six months of 2005, respectively, on the Companys Class A Common Stock and Class B Common Stock.
2004 Stock Incentive Plan
For a description of the 2004 Stock Incentive Plans terms, see Note 13 to the Consolidated Financial Statements in the Companys Annual Report on Form 10-K for the year ended December 31, 2005.
No options were issued during the first six months of 2006 under the 2004 Stock Incentive Plan. At July 2, 2006, there were 1,039,193 options granted and outstanding to certain officers and key employees. No options were forfeited during the first six months of 2006. Total unrecognized compensation cost related to the unvested stock options was approximately $3,122,000 at July 2, 2006, and is being amortized on a straight-line basis over a five or four-year vesting period. For the second quarter and first six months of 2006, the Company recognized compensation cost of $143,000 and $605,000, respectively, in selling, general and administrative expenses.
A summary of the Companys incentive stock option activity and related information for the first six months of 2006 is shown in the following table:
|
|
As of July 2, 2006 |
|
||||||
|
|
Options |
|
Weighted |
|
Aggregate |
|
||
|
|
(options in thousands) |
|
||||||
Outstanding at beginning of period |
|
1,089 |
|
$ |
21.70 |
|
|
|
|
Granted |
|
|
|
|
|
|
|
||
Cancelled |
|
|
|
|
|
|
|
||
Exercised |
|
(50 |
) |
16.64 |
|
|
|
||
Outstanding at end of period |
|
1,039 |
|
$ |
21.95 |
|
$ |
11.60 |
|
Exercisable at end of period |
|
388 |
|
$ |
16.41 |
|
$ |
17.14 |
|
As of July 2, 2006, the aggregate intrinsic values of outstanding and exercisable options approximated $12,100,000 and $6,700,000, respectively, representing the total pre-tax intrinsic value, based on the Companys closing common stock price of $33.55 as of July 2, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. The total intrinsic value of options exercised for the first six months of 2006 was approximately $1,005,000. Upon exercise of options, the Company issues shares of Class A common stock.
The following table summarizes information about options outstanding at July 2, 2006:
|
|
Options Outstanding |
|
Options Exercisable |
|
||||||||
Range of Exercise Prices |
|
Number |
|
Weighted Average |
|
Weighted Average |
|
Number |
|
Weighted Average |
|
||
|
|
(options in thousands) |
|
||||||||||
$10.58 |
|
43 |
|
3.9 |
|
$ |
10.58 |
|
43 |
|
$ |
10.58 |
|
$11.75$12.44 |
|
43 |
|
3.7 |
|
12.00 |
|
43 |
|
12.00 |
|
||
$15.40$32.07 |
|
953 |
|
7.6 |
|
22.97 |
|
302 |
|
17.88 |
|
||
|
|
1,039 |
|
5.1 |
|
$ |
21.95 |
|
388 |
|
$ |
16.41 |
|
Additionally at July 2, 2006, there were 14,455 unvested shares of restricted stock outstanding that were granted to the non-employee members of the Companys Board of Directors and Chief Executive Officer of the Company. The Company issued 12,583 shares of restricted stock during the second quarter of 2006. At July 2, 2006, total unrecognized compensation cost related to unvested restricted stock was approximately $373,000, which is being amortized on a straight-line basis over the three-year vesting period. For the second quarter and six months ended July 2, 2006, the Company recognized compensation costs of $79,000 and $159,000,
10
respectively, in selling, general and administrative expenses. The aggregate intrinsic value of restricted stock granted and outstanding approximated $485,000 representing the total pre-tax intrinsic value based on the Companys closing common stock price of $33.55 as of July 2, 2006.
Management Stock Purchase Plan
For a description of the Management Stock Purchase Plan terms, see Note 13 to the Consolidated Financial Statements in the Companys Annual Report on Form 10-K for the year ended December 31, 2005.
There were 87,125 RSUs issued during the first six months of 2006 with an aggregate grant-date fair value approximating $1,185,000. At July 2, 2006, there were 353,799 RSUs granted and outstanding to certain officers and key employees. None were forfeited during the first six months of 2006. Total unrecognized compensation cost related to unvested RSUs was approximately $1,687,000 at July 2, 2006, and is being amortized on a straight-line basis over a three-year vesting period. For the second quarter and first six months of 2006 the Company recognized compensation cost of $239,000 and $451,000, respectively, in selling, general and administrative expenses.
A summary of the Companys RSUs activity and related information for the first six months of 2006 is shown in the following table:
|
As of July 2, 2006 |
|
|||||||
|
|
RSUs |
|
Weighted |
|
Aggregate |
|
||
|
|
(RSUs in thousands) |
|
||||||
Outstanding at beginning of period |
|
328 |
|
$ |
16.02 |
|
|
|
|
Granted |
|
87 |
|
23.34 |
|
|
|
||
Cancelled |
|
|
|
|
|
|
|
||
Settled |
|
(61 |
) |
10.44 |
|
|
|
||
Outstanding at end of period |
|
354 |
|
$ |
18.79 |
|
$ |
14.76 |
|
Vested at end of period |
|
155 |
|
$ |
15.29 |
|
$ |
18.26 |
|
As of July 2, 2006, the aggregate intrinsic values of outstanding and vested RSUs approximated $5,200,000 and $2,800,000, respectively, representing the total pre-tax intrinsic value, based on the Companys closing common stock price of $33.55 as of July 2, 2006, which would have been received by the RSUs holders had all RSUs settled as of that date. The total intrinsic value of RSUs settled for the first six months of 2006 was approximately $1,230,000. Upon settlement of RSUs, the Company issues shares of Class A common stock.
The following table summarizes information about RSUs outstanding at July 2, 2006:
|
|
RSUs Outstanding |
|
RSUs Vested |
|
||||||||
Range of Purchase Prices |
|
Number |
|
Weighted Average |
|
Weighted Average |
|
Number |
|
Weighted Average |
|
||
|
|
(RSUs in thousands) |
|
||||||||||
$7.93$8.34 |
|
19 |
|
|
|
$ |
8.11 |
|
19 |
|
$ |
8.11 |
|
$9.36$9.54 |
|
5 |
|
|
|
9.47 |
|
5 |
|
9.47 |
|
||
$10.00$12.30 |
|
23 |
|
|
|
10.66 |
|
23 |
|
10.66 |
|
||
$15.50$23.34 |
|
307 |
|
1.6 |
|
20.22 |
|
108 |
|
17.84 |
|
||
|
|
354 |
|
1.6 |
|
$ |
18.79 |
|
155 |
|
$ |
15.29 |
|
Shipping and Handling
The Companys shipping costs included in selling, general and administrative expense were $9,217,000 and $6,594,000 for the second quarter of 2006 and 2005, respectively, and were $17,742,000 and $12,786,000 for the first six months of 2006 and 2005, respectively.
Research and development costs included in selling, general and administrative expense were $3,137,000 and $2,989,000 for the second quarters of 2006 and 2005, respectively, and were $6,309,000 and $5,908,000 for the first six months of 2006 and 2005, respectively.
New Accounting Standards
In July 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (FIN 48) which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, based on the technical merits. This interpretation also provides guidance on measurement, de-recognition, classification, interest and penalties, accounting in
11
interim periods, disclosure and transition. FIN 48 will become effective on fiscal years beginning after December 15, 2006. The Company is currently assessing the impact of FIN 48 on its consolidated financial statements.
In March 2006, the FASB issued Financial Accounting Standards Board Statement No. 156 Accounting for Servicing of Financial Assetsan amendment of FASB Statement No. 140 (FAS 156). FAS 156 amends FAS Statement No.140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. FAS 156 addresses the recognition and measurement of separately recognized servicing assets and liabilities and provides an approach to simplify efforts to obtain hedge-like (offset) accounting. The Company is required to adopt the provisions of FAS 156 as of January 1, 2007, although earlier adoption is permitted. The Company does not expect the impact of FAS 156 will be material to its consolidated financial statements.
In February 2006, the FASB issued Financial Accounting Standards Board Statement No. 155 Accounting for Certain Hybrid Financial Instrumentsan amendment of FASB Statements No. 133 and 140 (FAS 155). FAS 155 amends FAS 133, Accounting for Derivatives and Hedging Activities, and FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and allows an entity to remeasure at fair value a hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation from the host, if the holder irrevocably elects to account for the whole instrument on a fair value basis. Subsequent changes in the fair value of the instrument would be recognized in earnings. The Company is required to adopt the provision of FAS 155 as of January 1, 2007, although earlier adoption is permitted. The Company does not expect the impact of FAS 155 will be material to its consolidated financial statements.
In May 2005, the FASB issued Financial Accounting Standards Board Statement No. 154, Accounting Changes and Error Correction Replacement of APB Opinion No. 20 and FASB Statement No. 3 (FAS 154). FAS 154 replaces APB Opinion No. 20, Accounting Changes (APB 20), and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. APB 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. FAS 154 requires retrospective application to prior periods financial statements of changes in accounting principle. FAS 154 defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used. FAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. The Company applied the provisions of this statement in January 2006 and the impact was not material to its consolidated financial statements.
In December 2004, the FASB issued Financial Accounting Standards Board Statement No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions (FAS 153). The amendments made by FAS 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion No. 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. The statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The provisions of this statement were applied prospectively in January 2006 and the impact was not material to its consolidated financial statements.
In November 2004, the FASB issued Financial Accounting Standards Board Statement No. 151, Inventory Costs (FAS 151). FAS 151 amends the guidance in Accounting Research Bulletin No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for inventory costs. The provisions of this statement are effective for fiscal years beginning after June 15, 2005. The Company applied the provisions of this statement in January 2006 and the impact was not material to its consolidated financial statements.
12
3. Discontinued Operations
In September 1996, the Company divested its Municipal Water Group businesses, which included Henry Pratt, James Jones Company and Edward Barber and Company Ltd. Costs and expenses related to the Municipal Water Group for 2006 and 2005 primarily relate to legal and settlement costs associated with the James Jones Litigation, which is described in the Companys Annual Report on Form 10-K for the year ended December 31, 2005.
Condensed operating statements and balance sheets for discontinued operations are summarized below:
|
|
Second Quarter Ended |
|
||||
|
|
July 2, |
|
July 3, |
|
||
|
|
(in thousands) |
|
||||
Cost and expenses- Municipal Water Group |
|
$ |
(159 |
) |
$ |
(120 |
) |
Loss before income taxes |
|
(159 |
) |
(120 |
) |
||
Income tax benefit |
|
62 |
|
45 |
|
||
Loss from discontinued operations, net of taxes |
|
$ |
(97 |
) |
$ |
(75 |
) |
|
|
Six Months Ended |
|
||||
|
|
July 2, |
|
July 3, |
|
||
|
|
(in thousands) |
|
||||
Cost and expenses- Municipal Water Group |
|
$ |
(359 |
) |
$ |
(184 |
) |
Loss before income taxes |
|
(359 |
) |
(184 |
) |
||
Income tax benefit |
|
138 |
|
70 |
|
||
Loss from discontinued operations, net of taxes |
|
$ |
(221 |
) |
$ |
(114 |
) |
|
|
July 2, |
|
December 31, |
|
||
|
|
(in thousands) |
|
||||
Prepaid expenses and other assets |
|
$ |
108 |
|
$ |
2,511 |
|
Deferred income taxes |
|
7,947 |
|
7,044 |
|
||
Assets of discontinued operations |
|
$ |
8,055 |
|
$ |
9,555 |
|
Accrued expenses and other liabilities |
|
23,003 |
|
23,068 |
|
||
Liabilities of discontinued operations |
|
$ |
23,003 |
|
$ |
23,068 |
|
The assets and liabilities at July 2, 2006 and December 31, 2005 primarily relate to the reserves for the James Jones Litigation.
4. Derivative Instruments
The Company uses foreign currency forward exchange contracts as an economic hedge to reduce the impact of currency fluctuations on certain anticipated intercompany purchase transactions that are expected to occur within the year and certain other foreign currency transactions. Realized and unrealized gains and losses on the contracts are recognized in other income/expense. These contracts do not subject the Company to significant market risk from exchange movement because they offset gains and losses on the related foreign currency denominated transactions. At July 2, 2006, the fair value of the contracts was a loss of approximately $105,000.
The Company occasionally uses commodity futures contracts to fix the price on a certain portion of certain raw materials used in the manufacturing process. These contracts highly correlate to the actual purchases of the commodity and the contract values are reflected in the cost of the commodity as it is actually purchased. At July 2, 2006 and July 3, 2005 the Company had no commodity contracts.
5. Restructuring and Other Charges
The Company continues to implement a plan to consolidate several of its manufacturing plants in Europe. At the same time it is expanding its manufacturing capacity in China and other low cost areas of the world. In the second quarter of 2006, the Company recorded pre-tax income of approximately $5,669,000 compared to a pre-tax charge of $398,000 in the second quarter of 2005. Pre-tax costs of $7,000 and $302,000 were recorded in costs of goods sold in the second quarter of 2006 and 2005, respectively. Costs incurred for the second quarter of 2005 included accelerated depreciation for the closure of a U.S. manufacturing plant. The Company recorded income of $5,676,000 and a charge of $96,000 to restructuring and other charges in the second quarters of 2006 and 2005, respectively. In the second quarter of 2006, the Company recorded a gain of approximately $6,500,000 related to a building sale in Italy partially offset by costs of $824,000 primarily for severance costs related to the Companys European and Chinese restructuring plans. The costs incurred for the second quarter of 2005 are primarily for severance costs related to the Companys European restructuring plans.
For the first six months of 2006, the Company recorded pre-tax income of approximately $5,434,000 compared to a pre-tax charge of $1,172,000 for the first six months of 2005. Pre-tax costs of $7,000 and $714,000 were recorded in costs of goods sold in the first six months of 2006 and 2005, respectively. Costs incurred for the first six months of 2005 included accelerated depreciation for the
13
closure of a U.S. manufacturing plant. The Company recorded income of $5,441,000 and a charge of $458,000 to restructuring and other charges in the first six months of 2006 and 2005, respectively. In the first six months of 2006, the Company recorded a gain of approximately $6,500,000 related to the sale of a building in Italy, partially offset by costs of $1,059,000 primarily for severance costs related to the Companys European and Chinese restructuring plans. The costs incurred for the first six months of 2005 are primarily for severance costs related to Companys European restructuring plans.
6. Earnings per Share
The following tables set forth the reconciliation of the calculation of earnings per share:
|
|
For the Second Quarter Ended July 2, 2006 |
|
||||||
|
|
Income |
|
Shares |
|
Per Share |
|
||
|
|
(amounts in thousands, except share and |
|
||||||
Basic EPS |
|
|
|
|
|
|
|
||
Income from continuing operations |
|
$ |
22,543 |
|
32,653,524 |
|
$ |
.69 |
|
Loss from discontinued operations |
|
(97 |
) |
|
|
|
|
||
Net income |
|
$ |
22,446 |
|
|
|
$ |
.69 |
|
Effect of dilutive securities |
|
|
|
|
|
|
|
||
Common stock equivalents |
|
|
|
384,669 |
|
|
|
||
Diluted EPS |
|
|
|
|
|
|
|
||
Income from continuing operations |
|
$ |
22,543 |
|
|
|
$ |
.68 |
|
Loss from discontinued operations |
|
(97 |
) |
|
|
|
|
||
Net income |
|
$ |
22,446 |
|
33,038,193 |
|
$ |
.68 |
|
|
|
For the Second Quarter Ended July 3, 2005 |
|
||||||
|
|
Income |
|
Shares |
|
Per Share |
|
||
|
|
(amounts in thousands, except share and |
|
||||||
Basic EPS |
|
|
|
|
|
|
|
||
Income from continuing operations |
|
$ |
13,988 |
|
32,475,474 |
|
$ |
.43 |
|
Loss from discontinued operations |
|
(75 |
) |
|
|
|
|
||
Net income |
|
$ |
13,913 |
|
|
|
$ |
.43 |
|
Effect of dilutive securities |
|
|
|
|
|
|
|
||
Common stock equivalents |
|
|
|
601,866 |
|
|
|
||
Diluted EPS |
|
|
|
|
|
|
|
||
Income from continuing operations |
|
$ |
13,988 |
|
|
|
$ |
.42 |
|
Loss from discontinued operations |
|
(75 |
) |
|
|
|
|
||
Net income |
|
$ |
13,913 |
|
33,077,340 |
|
$ |
.42 |
|
|
|
For the Six Months Ended July 2, 2006 |
|
||||||
|
|
Income |
|
Shares |
|
Per Share |
|
||
|
|
(amounts in thousands, except share
and |
|
||||||
Basic EPS |
|
|
|
|
|
|
|
||
Income from continuing operations |
|
$ |
37,630 |
|
32,622,658 |
|
$ |
1.15 |
|
Loss from discontinued operations |
|
(221 |
) |
|
|
|
|
||
Net income |
|
$ |
37,409 |
|
|
|
$ |
1.15 |
|
Effect of dilutive securities |
|
|
|
|
|
|
|
||
Common stock equivalents |
|
|
|
392,151 |
|
|
|
||
Diluted EPS |
|
|
|
|
|
|
|
||
Income from continuing operations |
|
$ |
37,630 |
|
|
|
$ |
1.14 |
|
Loss from discontinued operations |
|
(221 |
) |
|
|
(.01 |
) |
||
Net income |
|
$ |
37,409 |
|
33,014,809 |
|
$ |
1.13 |
|
14
|
|
For the Six Months Ended July 3, 2005 |
|
||||||
|
|
Income |
|
Shares |
|
Per Share |
|
||
|
|
(amounts in thousands, except share and |
|
||||||
Basic EPS |
|
|
|
|
|
|
|
||
Income from continuing operations |
|
$ |
26,385 |
|
32,442,216 |
|
$ |
.81 |
|
Loss from discontinued operations |
|
(114 |
) |
|
|
|
|
||
Net income |
|
$ |
26,271 |
|
|
|
$ |
.81 |
|
Effect of dilutive securities |
|
|
|
|
|
|
|
||
Common stock equivalents |
|
|
|
589,560 |
|
|
|
||
Diluted EPS |
|
|
|
|
|
|
|
||
Income from continuing operations |
|
$ |
26,385 |
|
|
|
$ |
.80 |
|
Loss from discontinued operations |
|
(114 |
) |
|
|
|
|
||
Net income |
|
$ |
26,271 |
|
33,031,776 |
|
$ |
.80 |
|
7. Segment Information
Under the criteria set forth in Financial Accounting Standards Board Statement No.131 Disclosure about Segments of an Enterprise and Related Information, the Company operates in three geographic segments: North America, Europe, and China. Each of these segments is managed separately and has separate financial results that are reviewed by the Companys senior management. Sales by region are based upon location of the entity recording the sale. The accounting policies for each segment are the same as those described in the summary of significant accounting policies.
The following is a summary of our significant accounts and balances by segment, reconciled to our consolidated totals:
|
|
North |
|
Europe |
|
China |
|
Corporate (*) |
|
Consolidated |
|
|||||
|
|
(in thousands) |
|
|||||||||||||
As of and for the quarter ended July 2, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|||||
Net sales |
|
$ |
208,249 |
|
$ |
83,857 |
|
$ |
8,069 |
|
$ |
|
|
$ |
300,175 |
|
Operating income (loss) |
|
25,635 |
|
15,608 |
|
2,397 |
|
(5,404 |
) |
38,236 |
|
|||||
Capital expenditures |
|
3,048 |
|
19,111 |
|
532 |
|
|
|
22,691 |
|
|||||
Depreciation and amortization |
|
4,378 |
|
3,446 |
|
1,576 |
|
|
|
9,400 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
As of and for the quarter ended July 3, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|||||
Net sales |
|
$ |
157,116 |
|
$ |
63,636 |
|
$ |
7,431 |
|
$ |
|
|
$ |
228,183 |
|
Operating income (loss) |
|
20,254 |
|
7,952 |
|
572 |
|
(4,577 |
) |
24,201 |
|
|||||
Capital expenditures |
|
3,275 |
|
1,096 |
|
365 |
|
|
|
4,736 |
|
|||||
Depreciation and amortization |
|
3,284 |
|
1,905 |
|
1,039 |
|
|
|
6,228 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
As of and for the six months ended July 2, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|||||
Net sales |
|
$ |
404,815 |
|
$ |
156,116 |
|
$ |
14,194 |
|
$ |
|
|
$ |
575,125 |
|
Operating income (loss) |
|
48,037 |
|
25,178 |
|
3,412 |
|
(11,859 |
) |
64,768 |
|
|||||
Identifiable assets |
|
799,219 |
|
464,890 |
|
110,859 |
|
|
|
1,374,968 |
|
|||||
Long-lived assets |
|
98,979 |
|
86,307 |
|
30,208 |
|
|
|
215,494 |
|
|||||
Intangibles |
|
77,859 |
|
28,067 |
|
5,605 |
|
|
|
111,531 |
|
|||||
Capital expenditures |
|
6,436 |
|
22,292 |
|
1,064 |
|
|
|
29,792 |
|
|||||
Depreciation and amortization |
|
8,807 |
|
5,515 |
|
2,576 |
|
|
|
16,898 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
As of and for the six months ended July 3, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|||||
Net sales |
|
$ |
304,593 |
|
$ |
130,070 |
|
$ |
12,547 |
|
$ |
|
|
$ |
447,210 |
|
Operating income (loss) |
|
38,700 |
|
15,445 |
|
1,117 |
|
(9,751 |
) |
45,511 |
|
|||||
Identifiable assets |
|
535,406 |
|
315,302 |
|
90,127 |
|
|
|
940,835 |
|
|||||
Long-lived assets |
|
75,203 |
|
45,224 |
|
25,474 |
|
|
|
145,901 |
|
|||||
Intangibles |
|
31,428 |
|
8,886 |
|
2,656 |
|
|
|
42,970 |
|
|||||
Capital expenditures |
|
5,563 |
|
2,446 |
|
1,329 |
|
|
|
9,338 |
|
|||||
Depreciation and amortization |
|
6,612 |
|
4,231 |
|
2,383 |
|
|
|
13,226 |
|
The above operating segments are presented on a basis consistent with the presentation included in the Companys December 31, 2005 financial statements included in its Annual Report on Form 10-K.
15
*Corporate expenses are primarily for compensation expense, Sarbanes-Oxley compliance, professional fees, including legal and audit expenses, shareholder services and benefit administration costs. These costs are not allocated to the geographic segments as they are viewed as corporate functions that support all segments.
The North American segment consists of U.S. net sales of $193,857,000 and $145,930,000 for the second quarters of 2006 and 2005, respectively, and $376,763,000 and $282,535,000 for the six months of 2006 and 2005, respectively. The North American segment also consists of U.S. long-lived assets of $92,047,000 and $70,499,000 at July 2, 2006 and July 3, 2005, respectively.
Intersegment sales for the quarter ended July 2, 2006 for North America, Europe and China were $2,012,000, $673,000 and $18,162,000, respectively. Intersegment sales for the quarter ended July 3, 2005 for North America, Europe and China were $1,422,000, $1,578,000 and $12,456,000, respectively.
Intersegment sales for the six months ended July 2, 2006 for North America, Europe and China were $3,432,000, $1,230,000 and $32,388,000, respectively. Intersegment sales for the six months ended July 3, 2005 for North America, Europe and China were $2,531,000, $2,982,000 and $21,857,000, respectively.
On April 4, 2006, the Company sold an operating facility in Northern Italy to the local Italian government. The net selling price of the land and building approximated $9,200,000 resulting in a pre-tax gain of approximately $6,500,000 being recognized in the second quarter of 2006. Taxes associated with this gain of approximately $2,400,000 are due in installments over the next five years. The Company then used the proceeds from sale of this facility plus additional bank financing to purchase another site, which was owned by the same governmental agency. The purchase price for the new facility (land and building) approximated $16,300,000. Simultaneously, the Company entered into a 15-year sale and leaseback arrangement with a leasing company for the new facilitys building. The sale- leaseback transaction resulted in proceeds to the Company of approximately $16,000,000, partially used to repay the bank financing. There was no gain or loss recorded in connection with the sale-leaseback transaction.
8. Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) consist of the following:
|
|
Foreign |
|
Pension |
|
Accumulated Other |
|
|||
|
|
(in thousands) |
|
|||||||
|
|
|
|
|
|
|
|
|||
Balance December 31, 2005 |
|
$ |
13,090 |
|
$ |
(7,827 |
) |
$ |
5,263 |
|
Change in period |
|
4,611 |
|
|
|
4,611 |
|
|||
Balance April 2, 2006 |
|
17,701 |
|
(7,827 |
) |
9,874 |
|
|||
Change in period |
|
6,841 |
|
|
|
6,841 |
|
|||
Balance July 2, 2006 |
|
$ |
24,542 |
|
$ |
(7,827 |
) |
$ |
16,715 |
|
|
|
|
|
|
|
|
|
|||
Balance December 31, 2004 |
|
$ |
32,467 |
|
$ |
(5,849 |
) |
$ |
26,618 |
|
Change in period |
|
(6,885 |
) |
|
|
(6,885 |
) |
|||
Balance April 3, 2005 |
|
25,582 |
|
(5,849 |
) |
19,733 |
|
|||
Change in period |
|
(11,637 |
) |
|
|
(11,637 |
) |
|||
Balance July 3, 2005 |
|
$ |
13,945 |
|
$ |
(5,849 |
) |
$ |
8,096 |
|
16
Accumulated other comprehensive income (loss) in the consolidated balance sheets as of July 2, 2006 and July 3, 2005 consists primarily of cumulative translation adjustments and minimum pension liability adjustments. The Companys total comprehensive income was as follows:
|
|
Second Quarter Ended |
|
||||
|
|
July 2, |
|
July 3, |
|
||
|
|
(in thousands) |
|
||||
|
|
|
|
|
|
||
Net income |
|
$ |
22,446 |
|
$ |
13,913 |
|
Foreign currency translation adjustments and other |
|
6,841 |
|
(11,637 |
) |
||
Total comprehensive income |
|
$ |
29,287 |
|
$ |
2,276 |
|
|
|
Six Months Ended |
|
||||
|
|
July 2, |
|
July 3, |
|
||
|
|
(in thousands) |
|
||||
|
|
|
|
|
|
||
Net income |
|
$ |
37,409 |
|
$ |
26,271 |
|
Foreign currency translation adjustments and other |
|
11,452 |
|
(18,522 |
) |
||
Total comprehensive income |
|
$ |
48,861 |
|
$ |
7,749 |
|
9. Acquisitions
On June 7, 2006, a wholly owned subsidiary of the Company acquired 100% of the outstanding stock of Kim Olofsson Safe Corporation AB (KimSafe) located in Almhult, Sweden for approximately $5,700,000, which is net of cash acquired of approximately $2,900,000. The Company obtained a preliminary third-party valuation to allocate the purchase price consistent with the guidelines of Financial Accounting Standards Board Statement No. 141, Business Combinations (FAS 141). The preliminary allocations for goodwill and intangible assets are approximately $1,271,000 and $3,685,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated useful lives of 4 years and trade names with indefinite lives. KimSafe manufactures electronic controls for heat pump, solar and pellet heaters, which provide the ability to heat water using renewable energy.
On June 2, 2006, a wholly owned subsidiary of the Company acquired the assets and business of Calflex Manufacturing, Inc. (Calflex) located in Vernon, California and the stock of Ningbo Best Metal & Plastic Manufacturing Company, Ltd. (Ningbo) located in Ningbo, China for approximately $6,500,000. The Company obtained a preliminary third-party valuation to allocate the purchase price consistent with the guidelines of FAS 141. The preliminary allocation for goodwill is approximately $2,300,000. Calflex and Ningbo distribute and manufacture water connectors.
On May 19, 2006, a wholly owned subsidiary of the Company acquired 100% of the outstanding stock of ATS Expansion Group (ATS) located in Sorgues, Grenoble and Houtvillers, France for approximately $60,200,000, which is net of cash acquired of approximately $7,400,000 plus assumed debt of approximately $14,000,000. The Company will obtain a third-party valuation to allocate the purchase price consistent with the guidelines of FAS 141. Internal preliminary allocations for goodwill and intangible assets are approximately $34,938,000 and $11,861,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have weighted average estimated useful lives of 4.4 years and trade names with indefinite lives. ATS products include a broad range of fittings, valves and manifolds for water, gas and heating applications and stainless steel flexible hoses.
On April 26, 2006, a wholly owned subsidiary of the Company acquired the assets and business of Changsha Valve Works (Changsha) located in Changsha, China for approximately $8,500,000, of which approximately $600,000 remains to be paid subject to certain conditions being met. The Company obtained a preliminary third-party valuation to allocate the purchase price consistent with the guidelines of FAS 141. The preliminary allocations for goodwill and intangible assets are approximately $6,666,000 and $2,557,000, respectively. The amount recorded as intangible assets is primarily for non-compete agreements that have estimated useful lives of 10 years and customer order backlog with an estimated useful life of 1 year. Changsha is a leading manufacturer of large diameter hydraulic-actuated butterfly valves for thermo-power and hydro-power plants, water distribution projects and water works projects in China.
The purchase price allocations for the acquisitions noted above are preliminary pending the final determination of fair values of intangible assets and certain assumed assets and liabilities.
On April 5, 2006, a wholly owned subsidiary of the Company completed the planned increase of its ownership in Watts Stern Rubinetti, S.r.l. (Stern) from 85% to 100%. The price paid for this additional 15% interest was approximately $387,000.
17
10. Debt
On April 27, 2006, the Company completed a private placement of $225,000,000 of 5.85% senior unsecured notes due April 2016 (the 2006 Note Purchase Agreement). The 2006 Note Purchase Agreement includes operational and financial covenants, with which the Company is required to comply, including, among others, maintenance of certain financial ratios and restrictions on additional indebtedness, liens and dispositions. Events of default under the 2006 Note Purchase Agreement include failure to comply with its financial and operational covenants, as well as bankruptcy and other insolvency events. The Company may, at its option, upon notice to the noteholders, prepay at any time all or part of the Notes in an amount not less than $1 million by paying the principal amount plus a make-whole amount, which is dependent upon the yield of respective U.S. Treasury Securities. The Company used the net proceeds from the private placement to repay $147,000,000 outstanding under its revolving credit facility. The balance of the net proceeds will be used to finance future acquisitions and for general corporate purposes. As of July 2, 2006, the Company was in compliance with all covenants related to the 2006 Note Purchase Agreement. The payment of interest on the senior unsecured notes is due semi-annually on April 30th and October 30th of each year. Additionally, the Company amended its 2003 Note Purchase Agreement to reflect the existence of the subsidiary guarantors and to substantially conform certain provisions of the 2003 Note Purchase Agreement to the 2006 Note Purchase Agreement.
On April 27, 2006, the Company amended and restated its unsecured revolving credit facility with a syndicate of banks (as amended, the revolving credit facility). The revolving credit facility provides for multi-currency unsecured borrowings and stand-by letters of credit of up to $350,000,000 and expires in April 2011. Borrowings outstanding under the revolving credit facility bear interest at a fluctuating rate per annum equal to an applicable percentage equal to (i) in the case of Eurocurrency rate loans, the British Bankers Association LIBOR rate plus an applicable percentage of 0.60% which is determined by reference to the Companys consolidated leverage ratio and debt rating, or (ii) in the case of base rate loans and swing line loans, the higher of (a) the federal funds rate plus 0.5% and (b) the rate of interest in effect for such day as announced by Bank of America, N.A. as its prime rate. For first six months of 2006 the average interest rate under the revolving credit facility for euro-based borrowings was approximately 3.3%. The revolving credit facility includes operational and financial covenants customary for facilities of this type, including, among others, restrictions on additional indebtedness, liens and investments and maintenance of certain leverage ratios. As of July 2, 2006, the Company was in compliance with all covenants related to the revolving credit facility; had $215,207,000 of unused and potentially available credit under the revolving credit facility; had no U.S dollar denominated debt and $102,152,000 of euro-based borrowings outstanding on its revolving credit facility; and had $32,641,000 for stand-by letters of credit outstanding on its revolving credit facility.
Effective July 1, 2005, the Company entered into a three-year interest rate swap with a counter party for a notional amount of 25,000,000, which is outstanding under the revolving credit facility. The Company swapped three-month EURIBOR plus 0.6% for a fixed rate of 3.02%. At July 2, 2006, the fair value of the swap was approximately $793,000, which was recorded as a reduction of interest expense in the second quarter of 2006.
On December 28, 2005, the date of closing of the Dormont Manufacturing Company (Dormont) acquisition, Dormont had long-term debt outstanding of $8,900,000 in the form of two series of taxable variable rate demand bonds (1998 Series with $1,500,000 outstanding and the 2000 Series with $7,400,000 outstanding) which, due to the provisions of the trust agreements, could only be redeemed at dates subsequent to the closing. Each of these bonds was secured by a letter of credit from a bank, which maintained a security interest in the assets of Dormont. As a condition of the purchase and to gain the banks consent to the sale of Dormont to the Company, Dormonts former owners were required to establish a cash collateral account for the bonds in an amount equal to the potential obligation of Dormont to the bank under the letter of credit reimbursement agreements. The entire obligation under the bonds approximated $9,096,000, which represented the $8,900,000 in bond principal plus interest and related fees. At closing, a portion of the Dormont purchase price was placed in a cash collateral account as a guarantee of payment. The Company recorded this escrow deposit in prepaid expenses and other assets at December 31, 2005. The 1998 series bonds were repaid in full on January 17, 2006 and the 2000 series bonds were repaid in full on February 1, 2006 by the former owners using the cash collateral account.
11. Contingencies and Environmental Remediation
As disclosed in Part I, Item 1, Product Liability, Environmental and Other Litigation Matters of the Companys Annual Report on Form 10-K for the year ended December 31, 2005, the Company is a party to litigation described as the James Jones Litigation and is also engaged in certain environmental remediation. There have been no material developments with respect to the Companys contingencies and environmental remediation proceedings during the first six months ended July 2, 2006.
18
12. Employee Benefit Plans
The Company sponsors funded and unfunded defined benefit pension plans covering substantially all of its domestic employees. Benefits are based primarily on years of service and employees compensation. The funding policy of the Company for these plans is to contribute an annual amount that does not exceed the maximum amount that can be deducted for federal income tax purposes. The Company uses a September 30 measurement date for its plans.
The components of net periodic benefit cost are as follows:
|
|
Second Quarter Ended |
|
||||
|
|
July 2, |
|
July 3, |
|
||
|
|
(in thousands) |
|
||||
|
|
|
|
|
|
||
Service costbenefits earned |
|
$ |
887 |
|
$ |
715 |
|
Interest costs on benefits obligation |
|
945 |
|
838 |
|
||
Estimated return on assets |
|
(875 |
) |
(790 |
) |
||
Prior service cost amortization |
|
71 |
|
60 |
|
||
Net loss amortization |
|
303 |
|
215 |
|
||
Net periodic benefit cost |
|
$ |
1,331 |
|
$ |
1,038 |
|
|
|
Six Months Ended |
|
||||
|
|
July 2, |
|
July 3, |
|
||
|
|
(in thousands) |
|
||||
|
|
|
|
|
|
||
Service costbenefits earned |
|
$ |
1,774 |
|
$ |
1,430 |
|
Interest costs on benefits obligation |
|
1,890 |
|
1,676 |
|
||
Estimated return on assets |
|
(1,750 |
) |
(1,580 |
) |
||
Prior service cost amortization |
|
142 |
|
120 |
|
||
Net loss amortization |
|
606 |
|
430 |
|
||
Net periodic benefit cost |
|
$ |
2,662 |
|
$ |
2,076 |
|
Cash flows:
The information related to the Companys pension funds cash flow is as follows:
|
|
Six Months Ended |
|
||||
|
|
July 2, |
|
July 3, |
|
||
|
|
(in thousands) |
|
||||
|
|
|
|
|
|
||
Employer contributions |
|
$ |
3,162 |
|
$ |
1,758 |
|
19
Item 2. Managements Discussion And Analysis Of Financial Condition And Results Of Operations
Overview
The following discussion and analysis are provided to increase understanding of, and should be read in conjunction with, the accompanying unaudited consolidated financial statements and 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 operate on a 52-week fiscal year ending on December 31. Any second quarter ended data contained in this Report on Form 10-Q reflects the results of operations for the 13-week period ended on the Sunday nearest June 30 of the respective year.
We are a leading supplier of products for use in the water quality, water safety, water flow control and water conservation markets in North America and Europe. For over 130 years, we have designed and manufactured products that promote the comfort and safety of people and the quality and conservation of water used in commercial, residential and light industrial applications. We earn revenue and income almost exclusively from the sale of our products. Our principal product lines include:
· backflow preventers for preventing contamination of potable water caused by reverse flow within water supply lines and fire protection systems;
· a wide range of water pressure regulators for both commercial and residential applications;
· water supply and drainage products for commercial and residential applications;
· temperature and pressure relief valves for water heaters, boilers and associated systems;
· point-of-use water filtration and reverse osmosis systems for both commercial and residential applications;
· thermostatic mixing valves for tempering water in commercial and residential applications;
· systems for under-floor radiant applications and hydraulic pump groups for gas boiler manufacturers and renewable energy applications including solar heat pumps; and
· flexible stainless steel connectors for natural and liquid propane gas in commercial food service and residential applications.
Our business is reported in three geographic segments, North America, Europe and China. We distribute our products through three primary distribution channels, wholesale, do-it-yourself (DIY) and original equipment manufacturers (OEMs). Interest rates have an indirect effect on the demand for our products due to the effect such rates have on the number of new residential and commercial construction starts and remodeling projects. All three of these activities have an impact on our levels of sales and earnings. An additional factor that has had an effect on our sales is fluctuation in foreign currencies, as a portion of our sales and certain portions of our costs, assets and liabilities are denominated in currencies other than the U.S. dollar.
We believe that the factors relating to our future growth include our ability to continue to make selective acquisitions, both in our core markets as well as new complementary markets, regulatory requirements relating to the quality and conservation of water, increased demand for clean water and continued enforcement of plumbing and building codes and a healthy economic environment. We have completed over twenty-five acquisitions since divesting our industrial and oil and gas business in 1999. Our acquisition strategy focuses on businesses that manufacture preferred brand name products that address our themes of water quality, water safety, water conservation, water flow control and related complementary markets. We target businesses that will provide us with one or more of the following: an entry into new markets, an increase in shelf space with existing customers, a new or improved technology or an expansion of the breadth of our water quality, water conservation, water safety and water flow control products for the residential and commercial markets. In the first six months of 2006, sales from acquisitions contributed approximately 19.7% to our total sales growth over the comparable period of 2005.
Products representing a majority of our sales are subject to regulatory standards and code enforcement, which typically require that these products meet stringent performance criteria. Together with our commissioned manufacturers representatives, 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 the product development, product testing capability and investment in plant and equipment needed to manufacture products in compliance with code requirements, represent a barrier to entry for competitors. We believe there is an increasing demand among consumers for products to ensure water quality, which creates growth opportunities for our products.
We require substantial amounts of raw materials to produce our products, including bronze, brass, cast iron, steel and plastic, and substantially all of the raw materials we require are purchased from outside sources. We have experienced increases in the costs of certain raw materials, particularly copper. Bronze and brass are copper-based alloys. The spot price of copper has increased
20
approximately 123% from June 30, 2005 to June 30, 2006, including an increase of approximately 68% from December 31, 2005 to August 3, 2006.
A risk we face is our ability to deal effectively with increases in raw material costs. 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, implementing cost reduction programs and passing increases in costs to our customers, to the maximum extent possible, when they occur. Additionally, on a limited basis, we use commodity futures contracts to manage this risk, although we do not currently have any such contracts. We are not able to predict whether or for how long these cost increases will continue. If these cost increases continue and we are not able to reduce or eliminate the effect of the cost increases by reducing production costs or implementing price increases, our profit margins could decrease.
Another risk we face in all areas of our business is competition. We consider brand preference, engineering specifications, code requirements, price, technological expertise, delivery times and breadth of product offerings to be the primary competitive factors. As mentioned previously, we believe that the product development, product testing capability and investment in plant and equipment needed to manufacture products in compliance with code requirements, represent a barrier to entry for competitors. We are committed to maintaining our capital equipment at a level consistent with current technologies, and thus we expect to spend approximately $48,000,000 in 2006 (including approximately $18,000,000 related to the purchase and subsequent sale-leaseback of an Italian building). We are committed to expanding our manufacturing capacity in lower cost countries such as China, Tunisia and Bulgaria. Manufacturing plant relocations and consolidations are an important part of our ongoing commitment to reduce production costs. We anticipate the cash required to maintain our capital equipment will approximate depreciation expense for 2006.
Recent Developments
The local Chinese government has informed us that property owned by Tianjin Tanggu Watts Valve Co. Ltd. (TWT), our 60% owned joint venture in Tianjin China, will be taken over by eminent domain by December 31, 2007. We have therefore established a plan to relocate and rationalize those operations. Presently we anticipate spending approximately $3,000,000 in the second half of 2006 to begin construction of a new building, for the purchase of equipment and for near-term employee severance costs. Building and equipment costs are anticipated to be $1,500,000, which are included in our expected capital equipment forecast. We anticipate that we will take a charge of approximately $1,900,000, of which $400,000 will be a non-cash charge, in the second half of 2006, for severance costs and for accelerated depreciation on existing assets. Presently, total building, equipment and severance expenditures are estimated at approximately $9,200,000, of which approximately $5,400,000 are building and equipment costs and $3,800,000 will be for severance and moving costs. All but approximately $700,000 of severance costs is expected to be spent by the end of 2007. In addition, we anticipate that in total, we will accelerate depreciation on existing property plant and equipment by $1,300,000. Other charges, if any, for further accelerated depreciation or asset write-downs, will be taken as they become evident during the relocation process. The Chinese government is expected to partially compensate us for the move, but the exact reimbursement amount is yet to be determined.
In June 2006, we notified the employees of TWT of the Chinese governments decision to take over the facility by eminent domain and of our plans to relocate TWTs operations. In response, the employees of TWT commenced an unauthorized strike and demanded, among other things, certain severance benefits in connection with the shut down of the facility. Ultimately, the Company and our joint venture partner were able to negotiate an agreement with representatives of the employees and the employees of TWT returned to work. The work stoppage at TWT lasted approximately 4 weeks. The work stoppage has not had, and is not expected to have, a material impact on the availability of the Companys products for sale. The work stoppage is expected to have a minor impact on the pre-tax profit of our China segment for the third quarter of 2006 of less than $500,000.
We have entered into an agreement to sell land and a building in Italy for approximately $3,900,000. We will recognize a gain on sale of approximately $1,200,000 in the fourth quarter of 2006 when we expect to consummate this sale.
Acquisitions
On June 7, 2006, we acquired 100% of the outstanding stock of Kim Olofsson Safe Corporation AB (KimSafe) located in Almhult, Sweden for approximately $5,700,000, which is net of cash acquired of approximately $2,900,000. We obtained a preliminary third-party valuation to allocate the purchase price consistent with the guidelines of Financial Accounting Standards Board Statement No. 141, Business Combinations (FAS 141). The preliminary allocations for goodwill and intangible assets are approximately $1,271,000 and $3,685,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated useful lives of 4 years and trade names with indefinite lives. KimSafe manufactures electronic controls for heat pump, solar and pellet heaters, which provide the ability to heat water using renewable energy.
On June 2, 2006, we acquired the assets and business of Calflex Manufacturing, Inc. (Calflex) located in Vernon, California and the stock of Ningo Best Metal & Plastic Manufacturing, Ltd (Ningbo) located in Ningbo, China for approximately $6,500,000. We obtained a preliminary third-party valuation to allocate the purchase price consistent with the guidelines of FAS 141. The preliminary allocation for goodwill is approximately $2,300,000. Calflex and Ningbo distribute and manufacture water connectors.
On May 19, 2006, we acquired 100% of the outstanding stock of ATS Expansion Group (ATS) located in Sorgues, Grenoble and Houtvillers, France for approximately $60,200,000which is net of cash acquired of approximately $7,400,000 plus assumed debt of approximately $14,000,000. We will obtain a preliminary third-party valuation to allocate the purchase price consistent with the guidelines of FAS 141. Internal preliminary allocations for goodwill and intangible assets are approximately $34,938,000 and $11,861,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have weighted average estimated useful lives of 4.4 years and trade names with indefinite lives. ATS products include a broad range of fittings, valves and manifolds for water, gas and heating applications and stainless steel flexible hoses.
On April 26, 2006, we acquired the assets and business of Changsha Valve Works (Changsha) located in Changsha, China for approximately $8,500,000 of which approximately $600,000 remains to be paid subject to certain conditions being met. We obtained a preliminary third-party valuation to allocate the purchase price consistent with the guidelines of FAS 141. The preliminary allocations for goodwill and intangible assets are approximately $6,666,000 and $2,557,000, respectively. The amount recorded as intangible assets is primarily for non-compete agreements that have estimated useful lives of 10 years and customer order backlog with an
21
estimated useful life of 1 year. Changsha is a leading manufacturer of large diameter hydraulic-actuated butterfly valves for thermo-power and hydro-power plants, water distribution projects and water works projects in China.
The purchase price allocations for the acquisitions noted above are preliminary pending the final determination of fair values of intangible assets and certain assumed assets and liabilities.
On April 5, 2006, we completed the planned increase of our ownership in Watts Stern Rubinetti, S.r.l. (Stern) from 85% to 100%. The price paid for this additional 15% interest was approximately $378,000.
On December 28, 2005, we acquired 100% of the stock of Dormont Manufacturing Company (Dormont) located in Export, Pennsylvania, for approximately $95,379,000 net of cash acquired of approximately $1,506,000. The preliminary allocations for goodwill and intangible assets are approximately $38,652,000 and $38,600,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated 13-year lives and trade names with indefinite lives. Dormont provides flexible stainless steel connectors for natural and liquid propane gas. Dormont works with appliance OEMs to provide internal component assemblies and private label gas connectors, which are sold under the OEM brand with the appliance in multiple leading retail chains. Dormont also supplies residential gas connectors through multiple trade channels and home improvement retailers. Dormont provides a core-plumbing product, which is complementary to our existing water product lines.
On December 2, 2005, we acquired 100% of the stock of Core Industries Inc. (Core) from SPX Corporation for approximately $45,749,000 in cash. Core consists of FEBCO, Mueller Steam Specialty and Polyjet Valves product lines. The preliminary allocations for goodwill and intangible assets are approximately $15,506,000 and $8,320,000, respectively. The amount recorded as intangible assets is primarily for trade names with indefinite lives and customer relationships that have estimated 12-year lives. FEBCO is a manufacturer of backflow prevention valves and has a strong presence in both residential and commercial landscape irrigation. Mueller Steam Specialty allows us to expand into large diameter commercial strainers and check valves. Polyjet Valves offers a customized sleeve valve, which is used in severe service applications to provide precise flow and pressure control. We expect that this acquisition will allow us to offer a broader product line, improve operating efficiencies and provide better customer service.
On November 4, 2005, we acquired the assets of Flexflow Tubing LLP (Flexflow), located in Langley, British Columbia, Canada for approximately $6,220,000. The purchase agreement contains an earn-out provision to be calculated over a five-year period ending December 31, 2010. Earn-out payments under the purchase agreement, if any, will not exceed $4,300,000 and will be treated as additional purchase price. Flexflow manufactures pex tubing for potable and non-potable applications. The allocations for goodwill and intangible assets are approximately $3,195,000 and $868,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated 12-year lives. The acquisition of Flexflow is consistent with our strategy to increase our presence in the under floor radiant heating and potable water markets. This acquisition allows us to expand our presence in the market for flexible pex pipes for hot and cold-water transport.
On July 8, 2005, we acquired the water connector business of the Donald E. Savard Company (Savard) in an asset purchase transaction for approximately $3,680,000. The allocations for goodwill and intangible assets are approximately $1,350,000 and $1,750,000, respectively. The amount recorded as intangible assets is primarily for trade names with indefinite lives and customer relationships that have 14-year lives. The acquisition of the water connector business of Savard is consistent with our theme of water safety and control. This acquisition allows us to expand our presence in one of our leading product lines with a brand name that is well known to the plumbing wholesale market.
On July 5, 2005, we acquired 100% of the outstanding stock of Microflex N.V. (Microflex) located in Rotselaar, Belgium for approximately $14,900,000 net of cash acquired of approximately $875,000. The allocations for goodwill and intangible assets are approximately $6,507,000 and $5,315,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have 7-year lives and trade names that have indefinite lives. Microflex produces and distributes flexible, pre-insulated, pex pipes for hot and cold-water transport, as well as a range of accessory products including couplings, caps, and insulation kits to the HVAC and water protection markets.
On June 20, 2005, we acquired the water softener business of Alamo Water Refiners, Inc. (Alamo) located in San Antonio, Texas in an asset purchase transaction for approximately $5,100,000. The allocation for intangible assets is approximately $285,000 and is primarily for the trade name with an indefinite life. There was no allocation to goodwill. The water softener products of Alamo are consistent with our theme of water quality and provide many synergistic opportunities when utilized in conjunction with our existing water filtration and water quality businesses. The acquisition of Alamo also expands our distribution presence into the southwestern U.S. markets.
On May 11, 2005, we acquired 100% of the outstanding stock of Electro Controls Ltd. (Electro Controls) located in Hounslow, United Kingdom for approximately $11,737,000 net of cash acquired of approximately $5,014,000. The allocations for goodwill and intangible assets are approximately $5,788,000 and $315,000, respectively. The amount recorded as intangible assets is primarily for trade names that have indefinite lives. Electro Controls designs and assembles a range of electrical controls for the HVAC market, with sales primarily in the United Kingdom.
On January 5, 2005, we acquired 100% of the outstanding stock of HF Scientific, Inc. (HF) located in Fort Myers, Florida for approximately $7,260,000 in cash plus $800,000 in assumed debt. The allocations for goodwill and intangible assets are
22
approximately $4,178,000 and $2,660,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have 15-year lives and trade names that have indefinite lives. HF manufactures and distributes a line of instrumentation equipment, test kits and chemical reagents used for monitoring water quality in a variety of applications.
On January 4, 2005, we acquired substantially all of the assets of Sea Tech, Inc. (Sea Tech) located in Wilmington, North Carolina for approximately $10,100,000 in cash. The purchase agreement contains an earn-out provision to be calculated on a cumulative basis over a three-year period ending December 31, 2007. Payments under the agreement, if any, will not exceed $5,000,000 and will be treated as additional purchase price. The allocations for goodwill and intangible assets are approximately $6,505,000 and $3,033,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have 15-year lives and trade names that have indefinite lives. Sea Tech provides cost-effective solutions for fluidic connection needs. Sea Tech offers a wide range of standard and custom quick connect fittings, valves and manifolds and pex tubing designed to address specific customer requirements.
Results of Operations
Second Quarter Ended July 2, 2006 Compared to Second Quarter Ended July 3, 2005
Net Sales. Our business is reported in three geographic segments: North America, Europe and China. Our net sales in each of these segments for each of the second quarters ended 2006 and 2005 were as follows:
|
|
Second Quarter Ended |
|
Second Quarter Ended |
|
|
|
% Change to |
|
|||||||
|
|
Net Sales |
|
% Sales |
|
Net Sales |
|
% Sales |
|
Change |
|
Net Sales |
|
|||
|
|
(dollars in thousands) |
|
|||||||||||||
North America |
|
$ |
208,249 |
|
69.4 |
% |
$ |
157,116 |
|
68.9 |
% |
$ |
51,133 |
|
22.4 |
% |
Europe |
|
83,857 |
|
27.9 |
|
63,636 |
|
27.9 |
|
20,221 |
|
8.9 |
|
|||
China |
|
8,069 |
|
2.7 |
|
7,431 |
|
3.2 |
|
638 |
|
.3 |
|
|||
Total |
|
$ |
300,175 |
|
100 |
% |
$ |
228,183 |
|
100 |
% |
$ |
71,992 |
|
31.6 |
% |
The increase in net sales is attributable to the following:
|
|
|
|
|
|
|
|
|
|
Change |
|
Change |
|
||||||||||||||
|
|
North |
|
Europe |
|
China |
|
Total |
|
North |
|
Europe |
|
China |
|
Total |
|
North |
|
Europe |
|
China |
|
||||
|
|
(dollars in thousands) |
|
||||||||||||||||||||||||
Internal growth |
|
$ |
9,511 |
|
$ |
8,947 |
|
$ |
(222 |
) |
$ |
18,236 |
|
4.2 |
% |
3.9 |
% |
(.1 |
)% |
8.0 |
% |
6.1 |
% |
14.1 |
% |
(3.0 |
)% |
Foreign exchange |
|
1,455 |
|
1,119 |
|
236 |
|
2,810 |
|
.6 |
|
.5 |
|
.1 |
|
1.2 |
|
.9 |
|
1.7 |
|
3.2 |
|
||||
Acquisitions |
|
40,167 |
|
10,155 |
|
624 |
|
50,946 |
|
17.6 |
|
4.5 |
|
.3 |
|
22.4 |
|
25.6 |
|
16.0 |
|
8.4 |
|
||||
Total |
|
$ |
51,133 |
|
$ |
20,221 |
|
$ |
638 |
|
$ |
71,992 |
|
22.4 |
% |
8.9 |
% |
.3 |
% |
31.6 |
% |
32.6 |
% |
31.8 |
% |
8.6 |
% |
The internal growth in net sales in North America was primarily due to increased sales prices and increased unit sales in certain product lines into both the wholesale and DIY markets. Our wholesale market in the second quarter of 2006, excluding the sales from the acquisitions of Alamo, Savard, Flexflow, Core, Dormont and Calflex, grew by 6.5% compared to the second quarter of 2005. This was primarily due to increased sales of our plumbing and heating and backflow products. Our sales into the North American DIY market in the second quarter of 2006 increased by 4.9% compared to the second quarter of 2005 primarily due to increased sales of under-floor radiant heating product lines.
The increase in net sales due to foreign exchange in North America was due to the Canadian dollar appreciating against the U.S. dollar. We cannot predict whether the Canadian dollar will continue to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.
The acquired growth in net sales in North America was due to the inclusion of net sales of Alamo, acquired on June 20, 2005, Savard, acquired on July 8, 2005, Flexflow, acquired on November 4, 2005, Core, acquired on December 2, 2005, Dormont, acquired on December 28, 2005 and Calflex acquired on June 2, 2006.
The internal sales growth in Europe was broad based with most markets and channels exhibiting improvement. Our sales into the wholesale and OEM markets in the second quarter of 2006, excluding the sales from the acquisitions of Electro Controls, Microflex, ATS and Kimsafe, grew by 16.3% and 12.7%, respectively, compared to the second quarter of 2005.
The increase in net sales due to foreign exchange in Europe was primarily due to the appreciation of the euro against the U.S. dollar. We cannot predict whether the euro will continue to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.
The acquired growth in net sales in Europe was due to the inclusion of the net sales of Electro Controls, acquired on May 11, 2005, Microflex, acquired on July 5, 2005, ATS, acquired on May 19, 2006 and Kimsafe, acquired on June 7, 2006.
The decrease in internal growth in net sales in China was due to disruptions from recent changes made in our domestic Chinese sales channels, along with heightened competition in the Chinese waterworks marketplace.
23
The increase in net sales due to foreign exchange in China was primarily due to the appreciation of the yuan against the U.S. dollar. We cannot predict whether the yuan will continue to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.
The acquired growth in net sales in China was due to the inclusion of the net sales of Changsha, acquired on April 26, 2006. The operating results of the acquisition of Ningbo will be recorded in the third quarter of 2006.
Gross Profit. Gross profit for the second quarter of 2006 increased $25,176,000, or 31.0%, compared to the second quarter of 2005. The increase in gross profit was attributable to the following:
|
|
(in thousands) |
|
% Change |
|
|
|
|
|
|
|
|
|
Internal growth |
|
$ |
6,853 |
|
8.4 |
% |
Foreign exchange |
|
1,161 |
|
1.4 |
|
|
Acquisitions |
|
16,867 |
|
20.8 |
|
|
Restructuring |
|
295 |
|
.4 |
|
|
Total |
|
$ |
25,176 |
|
31.0 |
% |
All three segments contributed to the internal growth in gross profit. The North American segment increased $3,448,000 due to an improved sales mix and increased unit sales into the wholesale market partially offset by inventory write-downs to certain product lines. The European segment increased $2,237,000 primarily due to increased sales of products to wholesalers. Our China segment increased $1,399,000 primarily due to increased production levels and cost reductions. The increase in gross profit from foreign exchange was primarily due to the appreciation of the Canadian dollar and the euro against the U.S. dollar. The increase in gross profit from acquisitions is due to the inclusion of gross profit from Electro Controls, Alamo, Microflex, Savard, Flexflow, Core, Dormont, Changsha, ATS, Calflex and Kimsafe.
The increase in gross profit includes decreased manufacturing restructuring and other costs. In the second quarter of 2006, we recorded $7,000 to cost of sales as compared to $302,000 in the second quarter of 2005 for accelerated depreciation and other costs.
Selling, General and Administrative Expenses. Selling, General and Administrative, or SG&A expenses, for the second quarter of 2006 increased $16,913,000, or 29.7%, compared to the second quarter of 2005. The increase in SG&A expenses was attributable to the following:
|
|
(in thousands) |
|
% Change |
|
|
|
|
|
|
|
|
|
Internal growth |
|
$ |
5,117 |
|
9.0 |
% |
Foreign exchange |
|
588 |
|
1.0 |
|
|
Acquisitions |
|
11,208 |
|
19.7 |
|
|
Total |
|
$ |
16,913 |
|
29.7 |
% |
The internal increase in SG&A expenses was primarily due to increased variable selling expenses due to increased sales volumes and increased insurance costs, partially offset by lower earn-out costs related to a prior acquisition and lower costs for complying with Section 404 of the Sarbanes-Oxley Act of 2002 (SOX). The increase in SG&A expenses from foreign exchange was primarily due to the appreciation of the Canadian dollar and the euro against the U.S. dollar. The increase in SG&A expenses from acquisitions was due to the inclusion of Electro Controls, Alamo, Microflex, Savard, Flexflow, Core, Dormont, Changsha, ATS, Calflex and Kimsafe.
Restructuring and other charges. Restructuring and other charges for the second quarter of 2006 decreased $5,772,000 primarily due to a gain of approximately $6,500,000 related to the sale of a building in Italy. This gain was partially offset by charges of $824,000 primarily for severance costs related to our European and Chinese restructuring plans. In second quarter 2005, we recorded a $96,000 charge primarily for severance costs related to our European restructuring plans.
24
Operating Income. Operating income by geographic segment for each of the second quarters ended 2006 and 2005 was as follows:
|
|
Second Quarter Ended |