Table of Contents

 

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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

 

For the quarterly period ended June 29, 2014

 

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

 

04-2916536

(State or Other Jurisdiction of Incorporation or
Organization)

 

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

 

 

 

815 Chestnut Street, North Andover, MA

 

01845

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x   No o

 

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

 

Large accelerated filer  x

 

Accelerated filer  o

 

 

 

Non-accelerated filer  o

 

Smaller reporting company  o

(Do not check if a smaller reporting company)

 

 

 

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 issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at August 4, 2014

Class A Common Stock, $0.10 par value

 

28,589,504

 

 

 

Class B Common Stock, $0.10 par value

 

6,479,290

 

 

 



Table of Contents

 

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

 

INDEX

 

Part I. Financial Information

 

3

 

 

 

 

 

Item 1. Financial Statements

 

3

 

 

 

 

 

Consolidated Balance Sheets at June 29, 2014 and December 31, 2013 (unaudited)

 

3

 

 

 

 

 

Consolidated Statements of Operations for the Second Quarters and Six Months Ended June 29, 2014 and June 30, 2013 (unaudited)

 

4

 

 

 

 

 

Consolidated Statements of Comprehensive Income (Loss) for the Second Quarters and Six Months Ended June 29, 2014 and June 30, 2013 (unaudited)

 

5

 

 

 

 

 

Consolidated Statements of Cash Flows for the Six Months Ended June 29, 2014 and June 30, 2013 (unaudited)

 

6

 

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

 

7

 

 

 

 

 

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

 

20

 

 

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

32

 

 

 

 

 

Item 4. Controls and Procedures

 

33

 

 

 

 

Part II. Other Information

 

33

 

 

 

 

 

Item 1. Legal Proceedings

 

33

 

 

 

 

 

Item 1A. Risk Factors

 

33

 

 

 

 

 

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

 

34

 

 

 

 

 

Item 6. Exhibits

 

35

 

 

 

 

 

Signatures

 

36

 

 

 

 

 

Exhibit Index

 

37

 

2



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Amounts in millions, except share information)

(Unaudited)

 

 

 

June 29,

 

December 31,

 

 

 

2014

 

2013

 

ASSETS

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

 

$

244.3

 

$

267.9

 

Trade accounts receivable, less allowance for doubtful accounts of $10.2 million at June 29, 2014 and $9.7 million at December 31, 2013

 

234.9

 

212.9

 

Inventories, net:

 

 

 

 

 

Raw materials

 

115.2

 

111.3

 

Work in process

 

20.3

 

19.1

 

Finished goods

 

182.9

 

179.8

 

Total Inventories

 

318.4

 

310.2

 

Prepaid expenses and other assets

 

33.8

 

35.0

 

Deferred income taxes

 

28.4

 

29.8

 

Asset held for sale

 

1.3

 

1.3

 

Total Current Assets

 

861.1

 

857.1

 

PROPERTY, PLANT AND EQUIPMENT:

 

 

 

 

 

Property, plant and equipment, at cost

 

543.4

 

539.2

 

Accumulated depreciation

 

(331.1

)

(319.3

)

Property, plant and equipment, net

 

212.3

 

219.9

 

OTHER ASSETS:

 

 

 

 

 

Goodwill

 

511.5

 

514.8

 

Intangible assets, net

 

124.1

 

132.4

 

Deferred income taxes

 

4.8

 

3.8

 

Other, net

 

12.9

 

12.2

 

TOTAL ASSETS

 

$

1,726.7

 

$

1,740.2

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Accounts payable

 

$

133.1

 

$

145.6

 

Accrued expenses and other liabilities

 

134.9

 

135.2

 

Accrued compensation and benefits

 

43.6

 

43.9

 

Current portion of long-term debt

 

2.1

 

2.2

 

Total Current Liabilities

 

313.7

 

326.9

 

LONG-TERM DEBT, NET OF CURRENT PORTION

 

304.5

 

305.5

 

DEFERRED INCOME TAXES

 

44.0

 

45.9

 

OTHER NONCURRENT LIABILITIES

 

55.9

 

59.8

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

Preferred Stock, $0.10 par value; 5,000,000 shares authorized; no shares issued or outstanding

 

 

 

Class A Common Stock, $0.10 par value; 80,000,000 shares authorized; 1 vote per share; issued and outstanding 28,637,866 shares at June 29, 2014 and 28,824,779 shares at December 31, 2013

 

2.9

 

2.9

 

Class B Common Stock, $0.10 par value; 25,000,000 shares authorized; 10 votes per share; issued and outstanding, 6,479,290 shares at June 29, 2014 and 6,489,290 shares at December 31, 2013

 

0.6

 

0.6

 

Additional paid-in capital

 

483.8

 

473.5

 

Retained earnings

 

517.6

 

513.1

 

Accumulated other comprehensive income

 

3.7

 

12.0

 

Total Stockholders’ Equity

 

1,008.6

 

1,002.1

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

1,726.7

 

$

1,740.2

 

 

See accompanying notes to consolidated financial statements.

 

3



Table of Contents

 

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in millions, except per share information)

(Unaudited)

 

 

 

Second Quarter Ended

 

Six Months Ended

 

 

 

June 29,
2014

 

June 30,
2013

 

June 29,
2014

 

June 30,
 2013

 

Net sales

 

$

396.0

 

$

366.8

 

$

761.2

 

$

725.7

 

Cost of goods sold

 

257.0

 

234.0

 

488.9

 

464.0

 

GROSS PROFIT

 

139.0

 

132.8

 

272.3

 

261.7

 

Selling, general and administrative expenses

 

99.8

 

95.2

 

203.1

 

193.3

 

Restructuring and other charges, net

 

2.6

 

2.0

 

6.8

 

4.2

 

OPERATING INCOME

 

36.6

 

35.6

 

62.4

 

64.2

 

Other (income) expense:

 

 

 

 

 

 

 

 

 

Interest income

 

(0.2

)

(0.2

)

(0.3

)

(0.3

)

Interest expense

 

4.9

 

5.5

 

9.8

 

11.5

 

Other expense (income), net

 

(0.1

)

1.4

 

0.3

 

1.4

 

Total other expense

 

4.6

 

6.7

 

9.8

 

12.6

 

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

 

32.0

 

28.9

 

52.6

 

51.6

 

Provision for income taxes

 

10.7

 

10.0

 

17.2

 

16.4

 

NET INCOME FROM CONTINUING OPERATIONS

 

21.3

 

18.9

 

35.4

 

35.2

 

Loss from discontinued operations, net of tax

 

 

 

 

(0.2

)

NET INCOME

 

$

21.3

 

$

18.9

 

$

35.4

 

$

35.0

 

 

 

 

 

 

 

 

 

 

 

BASIC EPS

 

 

 

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.60

 

$

0.53

 

$

1.00

 

$

0.99

 

Discontinued operations

 

 

 

 

(0.01

)

NET INCOME

 

$

0.60

 

$

0.53

 

$

1.00

 

$

0.99

 

Weighted average number of shares

 

35.3

 

35.5

 

35.3

 

35.5

 

 

 

 

 

 

 

 

 

 

 

DILUTED EPS

 

 

 

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.60

 

$

0.53

 

$

1.00

 

$

0.99

 

Discontinued operations

 

 

 

 

(0.01

)

NET INCOME

 

$

0.60

 

$

0.53

 

$

1.00

 

$

0.98

 

Weighted average number of shares

 

35.4

 

35.6

 

35.4

 

35.6

 

 

 

 

 

 

 

 

 

 

 

Dividends per share

 

$

0.15

 

$

0.13

 

$

0.28

 

$

0.24

 

 

See accompanying notes to consolidated financial statements.

 

4



Table of Contents

 

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Amounts in millions)

(Unaudited)

 

 

 

Second Quarter Ended

 

Six Months Ended

 

 

 

June 29,
2014

 

June 30,
2013

 

June 29,
2014

 

June 30,
2013

 

Net income

 

$

21.3

 

$

18.9

 

$

35.4

 

$

35.0

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(4.3

)

7.5

 

(8.6

)

(12.4

)

Defined benefit pension plans:

 

 

 

 

 

 

 

 

 

Amortization of net losses included in net periodic pension cost

 

0.1

 

0.1

 

0.3

 

0.3

 

Other comprehensive income (loss), net of tax

 

(4.2

)

7.6

 

(8.3

)

(12.1

)

Comprehensive income

 

$

17.1

 

$

26.5

 

$

27.1

 

$

22.9

 

 

See accompanying notes to consolidated financial statements.

 

5



Table of Contents

 

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in millions)

(Unaudited)

 

 

 

Six Months Ended

 

 

 

June 29,
2014

 

June 30,
2013

 

OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

35.4

 

$

35.0

 

Less: Loss from discontinued operations, net of taxes

 

 

(0.2

)

Net income from continuing operations

 

35.4

 

35.2

 

Adjustments to reconcile net income from continuing operations to net cash provided by continuing operating activities:

 

 

 

 

 

Depreciation

 

16.6

 

16.9

 

Amortization of intangibles

 

7.4

 

7.4

 

Gain on disposal and impairment of goodwill, property, plant and equipment and other

 

 

(0.2

)

Stock-based compensation

 

3.4

 

3.9

 

Deferred income tax benefit

 

(1.3

)

(1.7

)

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

 

 

 

 

 

Accounts receivable

 

(23.2

)

(16.4

)

Inventories

 

(10.7

)

(17.3

)

Prepaid expenses and other assets

 

2.5

 

(3.7

)

Accounts payable, accrued expenses and other liabilities

 

(11.7

)

(2.3

)

Net cash provided by continuing operations

 

18.4

 

21.8

 

INVESTING ACTIVITIES

 

 

 

 

 

Additions to property, plant and equipment

 

(10.6

)

(18.0

)

Proceeds from the sale of property, plant and equipment

 

0.2

 

1.4

 

Proceeds from the sale of securities

 

 

2.1

 

Net cash used in investing activities

 

(10.4

)

(14.5

)

FINANCING ACTIVITIES

 

 

 

 

 

Payments of long-term debt

 

(0.9

)

(76.1

)

Payment of capital leases and other

 

(2.5

)

(3.2

)

Proceeds from share transactions under employee stock plans

 

4.7

 

3.9

 

Tax benefit of stock awards exercised

 

1.3

 

0.7

 

Payments to repurchase common stock

 

(20.0

)

(10.0

)

Debt issuance costs

 

(2.0

)

 

Dividends

 

(9.9

)

(8.5

)

Net cash used in financing activities

 

(29.3

)

(93.2

)

Effect of exchange rate changes on cash and cash equivalents

 

(2.3

)

(3.5

)

Net cash used in operating activities of discontinued operations

 

 

(0.6

)

DECREASE IN CASH AND CASH EQUIVALENTS

 

(23.6

)

(90.0

)

Cash and cash equivalents at beginning of year

 

267.9

 

271.3

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

 

$

244.3

 

$

181.3

 

 

 

 

 

 

 

NON-CASH INVESTING AND FINANCING ACTIVITIES

 

 

 

 

 

Acquisitions of fixed assets under financing agreement

 

$

 

$

0.4

 

Issuance of stock under management stock purchase plan

 

$

0.2

 

$

0.8

 

 

 

 

 

 

 

CASH PAID FOR:

 

 

 

 

 

Interest

 

$

9.5

 

$

11.7

 

Income taxes

 

$

15.5

 

$

17.7

 

 

See accompanying notes to consolidated financial statements.

 

6



Table of Contents

 

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

1.     Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included in the Watts Water Technologies, Inc. (the Company) Consolidated Balance Sheet as of June 29, 2014, the Consolidated Statements of Operations for the second quarters and six months ended June 29, 2014 and June 30, 2013, the Consolidated Statements of Comprehensive Income for the second quarters and six months ended June 29, 2014 and June 30, 2013, and the Consolidated Statements of Cash Flows for the six months ended June 29, 2014 and June 30, 2013.

 

The consolidated balance sheet at December 31, 2013 has been derived from the audited consolidated financial statements at that date. The accounting policies followed by the Company are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.  The financial statements included in this report should be read in conjunction with the consolidated financial statements and notes included in the Annual Report on Form 10-K for the year ended December 31, 2013. Operating results for the interim periods presented are not necessarily indicative of the results to be expected for the year ending December 31, 2014.

 

The Company operates on a 52-week fiscal year ending on December 31st.  Any quarterly data contained in this Quarterly Report on Form 10-Q generally reflect the results of operations for a 13-week period or 26-week period, respectively.

 

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 segment are as follows:

 

 

 

June 29, 2014

 

 

 

Gross Balance

 

Accumulated Impairment Losses

 

Net Goodwill

 

 

 

Balance
January 1,
2014

 

Acquired
During
the
Period

 

Foreign
Currency
Translation
and Other

 

Balance
June 29,
2014

 

Balance
January 1,
2014

 

Impairment
Loss
During the
Period

 

Balance
June 29,
2014

 

June 29,
2014

 

 

 

(in millions)

 

Americas

 

$

224.7

 

$

 

$

(0.1

)

$

224.6

 

$

(24.5

)

$

 

$

(24.5

)

$

200.1

 

Europe, Middle East and Africa (EMEA)

 

301.3

 

 

(2.8

)

298.5

 

 

 

 

298.5

 

Asia-Pacific

 

13.3

 

 

(0.4

)

12.9

 

 

 

 

12.9

 

Total

 

$

539.3

 

$

 

$

(3.3

)

$

536.0

 

$

(24.5

)

$

 

$

(24.5

)

$

511.5

 

 

 

 

June 30, 2013

 

 

 

Gross Balance

 

Accumulated Impairment Losses

 

Net Goodwill

 

 

 

Balance
January 1,
2013

 

Acquired
During the
Period

 

Foreign
Currency
Translation
and Other

 

Balance
June 30,
2013

 

Balance
January 1,
2013

 

Impairment
Loss During
the Period

 

Balance
June 30,
2013

 

June 30,
2013

 

 

 

(in millions)

 

Americas

 

$

225.6

 

$

 

$

(0.7

)

$

224.9

 

$

(24.2

)

$

 

$

(24.2

)

$

200.7

 

EMEA

 

289.7

 

 

(4.0

)

285.7

 

 

 

 

285.7

 

Asia-Pacific

 

12.9

 

 

 

12.9

 

 

 

 

12.9

 

Total

 

$

528.2

 

$

 

$

(4.7

)

$

523.5

 

$

(24.2

)

$

 

$

(24.2

)

$

499.3

 

 

7



Table of Contents

 

Goodwill and indefinite-lived intangible assets are tested for impairment at least annually or more frequently if events or circumstances indicate that it is “more likely than not” that they might be impaired, such as from a change in business conditions. The Company performs its annual goodwill and indefinite-lived intangible assets impairment assessment in the fourth quarter of each year.

 

Intangible assets with estimable lives and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of intangible assets with estimable lives and other long-lived assets are measured by a comparison of the carrying amount of an asset or asset group to future net undiscounted pretax cash flows expected to be generated by the asset or asset group. If these comparisons indicate that an asset is not recoverable based on the future net undiscounted pretax cash flows, the impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the related estimated fair value. Estimated fair value is based on either discounted future pretax operating cash flows or appraised values, depending on the nature of the asset. The Company determines the discount rate for this analysis based on the weighted average cost of capital based on the market and guideline public companies for the related business, and does not allocate interest charges to the asset or asset group being measured.  Judgment is required to estimate future operating cash flows.

 

Intangible assets include the following:

 

 

 

June 29, 2014

 

December 31, 2013

 

 

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

 

 

(in millions)

 

Patents

 

$

16.4

 

$

(12.9

)

$

3.5

 

$

16.6

 

$

(12.6

)

$

4.0

 

Customer relationships

 

132.6

 

(81.8

)

50.8

 

133.0

 

(76.4

)

56.6

 

Technology

 

26.8

 

(11.9

)

14.9

 

26.9

 

(10.9

)

16.0

 

Trade Names

 

13.6

 

(3.6

)

10.0

 

13.7

 

(3.0

)

10.7

 

Other

 

8.8

 

(5.7

)

3.1

 

8.8

 

(5.6

)

3.2

 

Total amortizable intangibles

 

198.2

 

(115.9

)

82.3

 

199.0

 

(108.5

)

90.5

 

Indefinite-lived intangible assets

 

41.8

 

 

41.8

 

41.9

 

 

41.9

 

Total

 

$

240.0

 

$

(115.9

)

$

124.1

 

$

240.9

 

$

(108.5

)

$

132.4

 

 

Aggregate amortization expense for amortizable intangible assets for both the second quarters of 2014 and 2013 was $3.7 million.  Additionally, future amortization expense for the next five years on amortizable intangible assets is expected to be approximately $7.4 million for the remainder of 2014, $14.6 million for 2015, $14.2 million for 2016, $13.8 million for 2017 and $9.7 million for 2018. Amortization expense is recorded on a straight-line basis over the estimated useful lives of the intangible assets. The weighted-average remaining life of total amortizable intangible assets is 8.1 years. Patents, customer relationships, technology, trade names and other amortizable intangibles have weighted-average remaining lives of 5.3 years, 5.1 years, 11.1 years, 10.5 years and 38.8 years, respectively. Indefinite-lived intangible assets primarily include trademarks and trade names.

 

Stock-Based Compensation

 

The Company maintains one stock incentive plan, the 2004 Stock Incentive Plan.  Under this plan, key employees have been granted nonqualified stock options to purchase the Company’s Class A common stock. Options typically become exercisable over a four-year period at the rate of 25% per year and expire ten years after the grant date. However, most options granted in 2014 become exercisable over a three-year period at the rate of one-third per year.  Options granted under the plans may have exercise prices of not less than 100% of the fair market value of the Class A common stock on the date of grant. The Company’s current practice is to grant all options at fair market value on the grant date. The Company issued 4,808 and 9,500 stock options during the first six months of 2014 and 2013, respectively.

 

The Company grants shares of restricted stock and deferred shares to key employees and stock awards to non-employee members of the Company’s Board of Directors under the 2004 Stock Incentive Plan.  Stock awards to non-employee members of the Company’s Board of Directors are fully vested upon grant.  Employees’ restricted stock awards and deferred shares typically vest over a three-year period at the rate of one-third per year, except that most restricted stock awards and deferred shares granted in 2014 vest over a two-year period at the rate of 50% per year. The restricted stock awards and deferred shares are amortized to expense on a straight-line basis over the vesting period. The Company issued 41,885 and 3,167 shares of restricted stock in the first six months of 2014 and 2013, respectively.

 

Beginning in 2014, the Company also granted performance stock units to key employees under the 2004 Stock Incentive Plan.  Performance stock units vest at the end of a three-year performance period.  Upon vesting, the number of shares of the Company’s Class A common stock awarded to each performance stock unit recipient will be determined based on the Company’s performance relative to certain performance goals set at the time the performance stock units were granted.  The performance goals for the 2014 performance stock units are based on the compound annual growth rate of the Company’s revenue over the three-year performance

 

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period and the Company’s return on invested capital (“ROIC”) for the third year of the performance period.  The performance period for the 2014 performance stock units is January 1, 2014 through December 31, 2016.  The 2014 performance stock units also provide an overall minimum ROIC threshold, which the Company must exceed in order for any shares of the Company’s Class A common stock to be earned. The number of shares of Class A common stock that may be earned by a performance stock unit recipient ranges from 0% to 200% of a target number of shares designated for each recipient at the time of grant.  The performance stock units are amortized to expense over the vesting period based on the Company’s performance relative to the performance goals.  If such goals are not met, no compensation expense is recognized and previously recognized compensation expense is reversed. The Company issued 20,069 shares of performance stock units in the second quarter of 2014 under the 2004 Stock Incentive Plan.

 

The Company has a Management Stock Purchase Plan that allows for the purchase of restricted stock units (RSUs) by key employees.  On an annual basis, key employees may elect to receive a portion of their annual incentive compensation in RSUs instead of cash.  Each RSU represents one share of Class A common stock and is purchased by the employee at 67% of the fair market value of the Company’s Class A common stock on the date of grant.  RSUs vest either annually over a three-year period from the grant date or upon the third anniversary of the grant date and receipt of the shares underlying RSUs is deferred for a minimum of three years or such greater number of years as is chosen by the employee.  An aggregate of 2,000,000 shares of Class A common stock may be issued under the Management Stock Purchase Plan. The Company granted 30,561 RSUs and 44,777 RSUs in the first six months of 2014 and 2013, respectively.

 

The fair value of each RSU 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:

 

 

 

2014

 

2013

 

Expected life (years)

 

3.0

 

3.0

 

Expected stock price volatility

 

31.2

%

34.1

%

Expected dividend yield

 

0.9

%

0.9

%

Risk-free interest rate

 

0.7

%

0.4

%

 

The above assumptions were used to determine the weighted average grant-date fair value of RSUs of $22.57 and $18.05 in 2014 and 2013, respectively.

 

A more detailed description of each of these plans can be found in Note 12 of Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

Shipping and Handling

 

The Company’s shipping and handling costs included in selling, general and administrative expenses were $15.8 million for the second quarters of 2014 and 2013, and were $30.5 million and $29.7 million for the first six months of 2014 and 2013, respectively.  The 2013 shipping and handling costs disclosed have been updated to include handling costs in order to be comparable with the current quarter.

 

Research and Development

 

Research and development costs included in selling, general and administrative expenses were $5.6 million and $5.5 million for the second quarters of 2014 and 2013, respectively, and were $11.9 million and $10.9 million for the first six months of 2014 and 2013, respectively.

 

Taxes, Other than Income Taxes

 

Taxes assessed by governmental authorities on sale transactions are recorded on a net basis and excluded from sales in the Company’s consolidated statements of operations.

 

Income Taxes

 

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

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New Accounting Standards

 

In June of 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-12, “Compensation — Stock Compensation: Accounting for Share Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period”. ASU 2014-12 clarifies that performance targets that could be achieved after the requisite period should be treated as performance conditions. Those performance conditions would not be reflected in estimating the grant date fair value of the award, but instead would be accounted for when the achievement of the performance condition becomes probable. ASU 2014-12 is effective in the first quarter of 2016 for public companies with calendar year ends, with early adoption permitted. The adoption of this guidance is not expected to have a material impact on the Company’s financial statements.

 

In May of 2014, FASB issued ASU 2014-09, “Revenue from Contracts with Customers”. ASU 2014-09 converges revenue recognition under U.S. GAAP and IFRS. For U.S. GAAP, the standard generally eliminates transaction and industry-specific revenue recognition guidance. This includes current guidance on long-term construction-type contracts, software arrangements, real estate sales, telecommunication arrangements, and franchise sales. Under the new standard, revenue is recognized based on a five-step model. ASU 2014-09 is effective in the first quarter of 2017 for public companies with calendar year ends, and early adoption is not permitted for public companies under U.S. GAAP. The Company is assessing the impact of this standard on the Company’s financial statements.

 

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements and Property, Plant, and Equipment: Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”. ASU 2014-08 will change the definition of discontinued operations and limit discontinued operations presentation to disposals of components representing a strategic shift that will have a major effect on the operations and financial results of the issuer. ASU 2014-08 is effective in the first quarter of 2015 for public companies with calendar year ends, with early adoption permitted. The adoption of this guidance is not expected to have a material impact on the Company’s financial statements.

 

3.     Discontinued Operations

 

On August 1, 2013, the Company completed the sale of all of the outstanding shares of an indirectly wholly-owned subsidiary, Watts Insulation GmbH (Austroflex), receiving net cash proceeds of $7.9 million.  The loss after tax on disposal of the business was approximately $2.2 million. The Company does not have a substantial continuing involvement in Austroflex’s operations and cash flows, therefore Austroflex’s results of operations have been presented as discontinued operations and all periods presented have been adjusted in the consolidated interim financial statements to reflect Austroflex’s results as discontinued operations. Austroflex’s pretax loss included in discontinued operations for the six months ended June 30, 2013 was $0.2 million. Austroflex’s revenues reported in discontinued operations were $4.5 million and $7.7 million for the three and six month periods ended June 30, 2013, respectively.

 

4.     Financial Instruments and Derivative Instruments

 

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including deferred compensation plan assets and related liability, and contingent consideration. There were no designated cash flow hedges as of June 29, 2014 and December 31, 2013.  The fair values of these certain financial assets and liabilities were determined using the following inputs at June 29, 2014 and December 31, 2013:

 

 

 

Fair Value Measurements at June 29, 2014 Using:

 

 

 

 

 

Quoted Prices in
Active
Markets for Identical
Assets

 

Significant Other
Observable
Inputs

 

Significant
Unobservable
Inputs

 

 

 

Total

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

Plan asset for deferred compensation(1)

 

$

4.2

 

$

4.2

 

$

 

$

 

Total assets

 

$

4.2

 

$

4.2

 

$

 

$

 

Liabilities

 

 

 

 

 

 

 

 

 

Plan liability for deferred compensation(2)

 

$

4.2

 

$

4.2

 

$

 

$

 

Contingent consideration(3)

 

2.2

 

 

 

2.2

 

Total liabilities

 

$

6.4

 

$

4.2

 

$

 

$

2.2

 

 

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Fair Value Measurements at December 31, 2013 Using:

 

 

 

 

 

Quoted Prices in
Active
Markets for Identical
Assets

 

Significant Other
Observable
Inputs

 

Significant
Unobservable
Inputs

 

 

 

Total

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

Plan asset for deferred compensation(1)

 

$

4.6

 

$

4.6

 

$

 

$

 

Total assets

 

$

4.6

 

$

4.6

 

$

 

$

 

Liabilities

 

 

 

 

 

 

 

 

 

Plan liability for deferred compensation(2)

 

$

4.6

 

$

4.6

 

$

 

$

 

Contingent consideration(3)

 

4.4

 

 

 

4.4

 

Total liabilities

 

$

9.0

 

$

4.6

 

$

 

$

4.4

 

 


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

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

(3)         Included on the Company’s consolidated balance sheet in accrued expenses and other liabilities as of June 29, 2014 and in other noncurrent liabilities and accrued expenses and other liabilities as of December 31, 2013.

 

The table below provides a summary of the changes in fair value of all financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the period December 31, 2013 to June 29, 2014.

 

 

 

Balance

 

Purchases,

 

Total realized and
unrealized (gains)
losses included in:

 

Balance

 

 

 

December 31,
2013

 

sales,
settlements, net

 

Net earnings
adjustments

 

Comprehensive
income

 

June 29,
2014

 

 

 

(in millions)

 

Contingent consideration

 

$

4.4

 

$

(2.2

)

$

 

$

 

$

2.2

 

 

On January 31, 2012, the Company completed the acquisition of tekmar Control Systems (tekmar) in a share purchase transaction. The initial purchase price paid was CAD $18.0 million, with post-closing adjustments related to working capital and an earnout based on the attainment of certain future earnings levels. A contingent liability of $5.1 million was recognized as the estimate of the acquisition date fair value of the contingent consideration. This liability was classified as Level 3 under the fair value hierarchy as it was based on the probability of achievement of a future performance metric as of the date of the acquisition, which was not observable in the market. The contingent liability was increased by $1.0 million during 2013 based on a revised estimate of the fair value of the contingent consideration. A portion of the contingent consideration was paid out during the first quarter of 2014 and the second quarter of 2013, in the amount of $2.2 million and $1.2 million, respectively, based on performance metrics achieved.  The earnout will be completed based on fiscal year 2014 earnings and final payment made in 2015.

 

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

 

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

 

The Company has exposure to a number of foreign currency rates, including the Canadian dollar, the euro, the Chinese yuan and the British pound sterling. To manage this risk, the Company has in the past used a layering methodology and entered into forward

 

11



Table of Contents

 

exchange contracts which hedged approximately 50% of the projected intercompany purchase transactions for the next twelve months. The Company presently does not have any open forward exchange contracts.

 

Fair Value

 

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

 

The fair values of the Company’s 5.85% senior notes due 2016, and 5.05% senior notes due 2020, are based on a discounted cash flow model using comparable industrial companies, the Company’s credit metrics, the Company’s size, as well as current market interest rates quoted in active markets and are classified within Level 2 of the valuation hierarchy.  The fair value of the Company’s variable rate debt approximates its carrying value. The carrying amount and the estimated fair market value of the Company’s long-term debt, including the current portion, are as follows:

 

 

 

June 29,

 

December 31,

 

 

 

2014

 

2013

 

 

 

(in millions)

 

Carrying amount

 

$

306.6

 

$

307.7

 

Estimated fair value

 

$

330.8

 

$

333.4

 

 

12



Table of Contents

 

5.     Restructuring and Other Charges, Net

 

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

 

2013 Actions

 

On July 30, 2013, the Board of Directors authorized a restructuring program with respect to the Company’s EMEA segment to reduce its European manufacturing footprint, improve organizational and operational efficiency and better align costs with expected revenues in response to changing market conditions. The restructuring program is expected to include a pre-tax charge to earnings totaling approximately $14.7 million, approximately $10.9 million of which is expected to be recorded through fiscal 2014 and the remainder recorded during fiscal 2015. Total expected pre-tax charges increased as of the second quarter of 2014 from $14.0 to $14.7 million due to additional expected severance costs. The total charge will include costs for severance benefits, relocation, site clean-up, professional fees and certain asset write-downs. The total net after-tax charge for the restructuring program is expected to be approximately $10.3 million. The restructuring program is expected to be completed by the end of the fourth quarter of fiscal 2015. Certain aspects of the restructuring program are subject to further analysis and determinations by local management and consultation and negotiation with various works councils. The net after-tax charge incurred in the second quarter and first six months of 2014 was $1.4 million and $1.7 million, respectively.

 

Other Actions

 

The Company also periodically initiates other actions which are not part of a major program.  In 2013 and 2014, the Company initiated restructuring activities in EMEA to relocate certain manufacturing activities and in EMEA and the Americas to reduce costs through a reduction-in-force.  There are no remaining expected costs relating to these actions.

 

A summary of the pre-tax cost by restructuring program is as follows:

 

 

 

Second Quarter Ended

 

Six Months Ended

 

 

 

June 29,
2014

 

June 30,
2013

 

June 29,
2014

 

June 30,
2013

 

 

 

(in millions)

 

Restructuring costs:

 

 

 

 

 

 

 

 

 

2013 Actions

 

$

2.1

 

$

 

$

2.5

 

$

 

Other Actions

 

0.5

 

2.0

 

4.3

 

4.2

 

Total restructuring and other charges, net

 

$

2.6

 

$

2.0

 

$

6.8

 

$

4.2

 

 

The Company recorded pre-tax restructuring and other charges, net in its business segments as follows:

 

 

 

Second Quarter Ended

 

Six Months Ended

 

 

 

June 29,
2014

 

June 30,
2013

 

June 29,
2014

 

June 30,
2013

 

 

 

(in millions)

 

Americas

 

$

0.4

 

$

0.1

 

$

2.3

 

$

0.3

 

EMEA

 

2.2

 

1.9

 

3.7

 

3.9

 

Corporate

 

 

 

0.8

 

 

Total

 

$

2.6

 

$

2.0

 

$

6.8

 

$

4.2

 

 

Details of the Company’s 2013 European footprint program reserve, which for the six months ended June 29, 2014 relates only to severance, is as follows:

 

 

 

Six Months Ended

 

 

 

June 29, 2014

 

 

 

(in millions)

 

Balance at December 31, 2013

 

$

2.0

 

Net pre-tax restructuring charges

 

0.4

 

Utilization and foreign currency impact

 

(0.3

)

Balance at March 30, 2014

 

$

2.1

 

Net pre-tax restructuring charges

 

2.1

 

Utilization and foreign currency impact

 

(1.4

)

Balance at June 29, 2014

 

$

2.8

 

 

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Table of Contents

 

The following table summarizes total expected, incurred and remaining pre-tax costs for 2013 European footprint program actions by type, and all attributable to the EMEA reportable segment:

 

 

 

Severance

 

Legal and
consultancy

 

Asset
write-downs

 

Facility
exit

and other

 

Total

 

 

 

(in millions)

 

Expected costs

 

$

13.0

 

$

1.3

 

$

0.2

 

$

0.2

 

$

14.7

 

Costs incurred—2013

 

(4.1

)

 

 

 

(4.1

)

Costs incurred—first quarter 2014

 

(0.1

)

 

(0.2

)

(0.1

)

(0.4

)

Costs incurred—second quarter 2014

 

(2.0

)

(0.1

)

 

 

(2.1

)

Remaining costs at June 29, 2014

 

$

6.8

 

$

1.2

 

$

 

$

0.1

 

$

8.1

 

 

6.     Earnings per Share

 

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

 

 

 

For the Second Quarter Ended June 29, 2014

 

For the Second Quarter Ended June 30, 2013

 

 

 

Income
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Income
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

 

 

(amounts in millions, except per share amounts)

 

Basic EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

21.3

 

35.3

 

$

0.60

 

$

18.9

 

35.5

 

$

0.53

 

Effect of dilutive securities

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock equivalents

 

 

 

0.1

 

 

 

 

 

0.1

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

21.3

 

35.4

 

$

0.60

 

$

18.9

 

35.6

 

$

0.53

 

 

Options to purchase 0.3 million and 0.4 million shares of Class A common stock were outstanding during the second quarters of 2014 and 2013, respectively, but were not included in the computation of diluted EPS because to do so would be anti-dilutive.

 

 

 

For the First Six Months Ended June 29, 2014

 

For the First Six Months Ended June 30, 2013

 

 

 

Income
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Income
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

 

 

(amounts in millions, except per share amounts)

 

Basic EPS

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

35.4

 

35.3

 

$

1.00

 

$

35.2

 

35.5

 

$

0.99

 

Discontinued operations

 

 

 

 

 

(0.2

)

 

 

(0.01

)

Net income

 

$

35.4

 

 

 

$

1.00

 

$

35.0

 

 

 

$

0.99

 

Effect of dilutive securities

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock equivalents

 

 

 

0.1

 

 

 

 

 

0.1

 

 

 

Diluted EPS

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

35.4

 

 

 

$

1.00

 

$

35.2

 

 

 

$

0.99

 

Discontinued operations

 

 

 

 

 

(0.2

)

 

 

(0.01

)

Net income

 

$

35.4

 

35.4

 

$

1.00

 

$

35.0

 

35.6

 

$

0.98

 

 

Options to purchase 0.3 million and 0.4 million shares of Class A common stock were outstanding during each of the first six months of 2014 and 2013, respectively, but were not included in the computation of diluted EPS because to do so would be anti-dilutive.

 

On April 30, 2013, the Company’s Board of Directors authorized the repurchase of up to $90 million of the Company’s Class A common stock from time to time on the open market or in privately negotiated transactions.  The timing and number of any shares repurchased will be determined by the Company’s management based on its evaluation of market conditions.  Repurchases may also

 

14



Table of Contents

 

be made under a Rule 10b5-1 plan, which would permit shares to be repurchased when the Company might otherwise be precluded from doing so under insider trading laws.  The repurchase program may be suspended or discontinued at any time, subject to the terms of any Rule 10b5-1 plan the Company may enter into with respect to the repurchase program.  During the second quarter ended June 29, 2014, the Company repurchased approximately 186,000 shares of Class A common stock at a cost of approximately $10.6 million.  During the first six months of 2014, the Company repurchased approximately 347,000 shares of Class A common stock at a cost of approximately $20.0 million. During the quarter ended and six months ended June 30, 2013, the Company repurchased approximately 213,000 shares of Class A common stock at a cost of approximately $10.0 million.

 

7.     Segment Information

 

The Company operates in three geographic segments: Americas, EMEA, and Asia-Pacific. Each of these operating segments is managed separately and has separate financial results that are reviewed by the Company’s chief operating decision-maker. All intercompany sales transactions have been eliminated. 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.

 

As of January 1, 2014, the Company began allocating certain expenses to its three operating segments that had previously been recorded as Corporate expenses. These expenses primarily include stock compensation, legal expenses and audit expenses that are directly attributable to and benefit the three operating segments.  The 2013 results have been retrospectively revised for comparative purposes.

 

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

 

 

 

Second Quarter Ended

 

Six Months Ended

 

 

 

June 29,
2014

 

June 30,
2013

 

June 29,
2014

 

June 30,
2013

 

 

 

(in millions)

 

Net Sales

 

 

 

 

 

 

 

 

 

Americas

 

$

241.8

 

$

224.4

 

$

460.9

 

$

437.4

 

EMEA

 

143.9

 

134.1

 

283.0

 

273.3

 

Asia-Pacific

 

10.3

 

8.3

 

17.3

 

15.0

 

Consolidated net sales

 

$

396.0

 

$

366.8

 

$

761.2

 

$

725.7

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

 

 

 

 

 

 

 

 

Americas

 

$

29.0

 

$

30.7

 

$

51.6

 

$

52.8

 

EMEA

 

13.1

 

9.8

 

22.0

 

20.7

 

Asia-Pacific

 

2.1

 

2.4

 

3.0

 

5.3

 

Subtotal reportable segments

 

44.2

 

42.9

 

76.6

 

78.8

 

 

 

 

 

 

 

 

 

 

 

Corporate (*)

 

(7.6

)

(7.3

)

(14.2

)

(14.6

)

Consolidated operating income

 

36.6

 

35.6

 

62.4

 

64.2

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

0.2

 

0.2

 

0.3

 

0.3

 

Interest expense

 

(4.9

)

(5.5

)

(9.8

)

(11.5

)

Other income (expense), net

 

0.1

 

(1.4

)

(0.3

)

(1.4

)

Income from continuing operations before income taxes

 

$

32.0

 

$

28.9

 

$

52.6

 

$

51.6

 

Capital Expenditures

 

 

 

 

 

 

 

 

 

Americas

 

$

2.7

 

$

4.6

 

$

4.9

 

$

12.8

 

EMEA

 

2.6

 

2.1

 

5.1

 

4.3

 

Asia-Pacific

 

0.3

 

0.3

 

0.6

 

0.9

 

Consolidated capital expenditures

 

$

5.6

 

$

7.0

 

$

10.6

 

$

18.0

 

 

 

 

 

 

 

 

 

 

 

Depreciation and Amortization

 

 

 

 

 

 

 

 

 

Americas

 

$

4.9

 

$

5.1

 

$

9.7

 

$

10.1

 

EMEA

 

6.8

 

6.4

 

13.4

 

12.9

 

Asia-Pacific

 

0.4

 

0.6

 

0.9

 

1.3

 

Consolidated depreciation and amortization

 

$

12.1

 

$

12.1

 

$

24.0

 

$

24.3

 

 

 

 

 

 

 

 

 

 

 

Identifiable Assets (at end of period)

 

 

 

 

 

 

 

 

 

Americas

 

 

 

 

 

$

768.2

 

$

743.0

 

EMEA

 

 

 

 

 

877.9

 

800.2

 

Asia-Pacific

 

 

 

 

 

80.6

 

80.1

 

Discontinued operations

 

 

 

 

 

 

12.5

 

Consolidated identifiable assets

 

 

 

 

 

$

1,726.7

 

$

1,635.8

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Americas

 

 

 

 

 

$

84.0

 

$

86.0

 

EMEA

 

 

 

 

 

114.7

 

119.5

 

Asia-Pacific

 

 

 

 

 

13.6

 

14.6

 

Consolidated property, plant and equipment, net

 

 

 

 

 

$

212.3

 

$

220.1

 

 


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

 

15



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Apart from the change noted above resulting from allocating certain expenses to its operating segments, the above operating segments are presented on a basis consistent with the presentation included in the Company’s December 31, 2013 consolidated financial statements included in its Annual Report on Form 10-K.

 

The U.S. property, plant and equipment of the Company’s Americas segment was $79.5 million and $81.0 million at June 29, 2014 and June 30, 2013, respectively.  The following includes U.S. net sales of the Company’s Americas segment:

 

 

 

Second Quarter Ended

 

Six Months Ended

 

 

 

June 29,
2014

 

June 30,
2013

 

June 29,
2014

 

June 30,
2013

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

U.S. net sales

 

$

222.1

 

$

201.6

 

$

423.7

 

$

394.4

 

 

The following includes intersegment sales for Americas, EMEA and Asia-Pacific:

 

 

 

Second Quarter Ended

 

Six Months Ended

 

 

 

June 29,
2014

 

June 30,
2013

 

June 29,
2014

 

June 30,
2013

 

 

 

(in millions)

 

Intersegment Sales

 

 

 

 

 

 

 

 

 

Americas

 

$

1.9

 

$

1.3

 

$

3.1

 

$

2.6

 

EMEA

 

3.8

 

2.4

 

7.4

 

5.1

 

Asia-Pacific

 

41.4

 

47.5

 

80.4

 

89.1

 

Intersegment sales

 

$

47.1

 

$

51.2

 

$

90.9

 

$

96.8

 

 

8.     Accumulated Other Comprehensive Income (Loss)

 

Accumulated other comprehensive income (loss) consists of the following:

 

 

 

Foreign
Currency
Translation

 

Pension
Adjustment

 

Accumulated Other
Comprehensive
Income (Loss)

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

Balance December 31, 2013

 

$

37.9

 

$

(25.9

)

$

12.0

 

Change in period

 

(4.3

)

0.2

 

(4.1

)

Balance March 30, 2014

 

$

33.6

 

$

(25.7

)

$

7.9

 

Change in period

 

(4.3

)

0.1

 

(4.2

)

Balance June 29, 2014

 

$

29.3

 

$

(25.6

)

$

3.7

 

 

 

 

 

 

 

 

 

Balance December 31, 2012

 

$

14.4

 

$

(25.2

)

$

(10.8

)

Change in period

 

(19.9

)

0.2

 

(19.7

)

Balance March 31, 2013

 

$

(5.5

)

$

(25.0

)

$

(30.5

)

Change in period

 

7.5

 

0.1

 

7.6

 

Balance June 30, 2013

 

$

2.0

 

$

(24.9

)

$

(22.9

)

 

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9.     Debt

 

On February 18, 2014, the Company terminated its prior credit agreement and entered into a new Credit Agreement (the Credit Agreement) among the Company, certain subsidiaries of the Company who become borrowers under the Credit Agreement, JPMorgan Chase Bank, N.A., as Administrative Agent, Swing Line Lender and Letter of Credit Issuer, and the other lenders referred to therein. The Credit Agreement provides for a $500 million, five-year, senior unsecured revolving credit facility which may be increased by an additional $500 million under certain circumstances and subject to the terms of the Credit Agreement. The Credit Agreement has a sublimit of up to $100 million in letters of credit. The Credit Agreement matures on February 18, 2019.

 

Borrowings outstanding under the Credit Agreement bear interest at a fluctuating rate per annum equal to an applicable percentage equal to (1) in the case of Eurocurrency rate loans, the British Bankers Association LIBOR rate plus an applicable percentage, ranging from 0.975% to 1.45%, determined by reference to the Company’s consolidated leverage ratio, or (2) in the case of base rate loans and swing line loans, the highest of (a) the federal funds rate plus 0.5%, (b) the rate of interest in effect for such day as announced by JPMorgan Chase Bank, N.A. as its “prime rate,” and (c) the British Bankers Association LIBOR rate plus 1.0%, plus an applicable percentage, ranging from 0.00% to 0.45%, determined by reference to the Company’s consolidated leverage ratio. In addition to paying interest under the Credit Agreement, the Company is also required to pay certain fees in connection with the credit facility, including, but not limited to, an unused facility fee and letter of credit fees.  Under the Credit Agreement, the Company is required to satisfy and maintain specified financial ratios and other financial condition tests.  The Company may repay loans outstanding under the Credit Agreement from time to time without premium or penalty, other than customary breakage costs, if any, and subject to the terms of the Credit Agreement. As of June 29, 2014, the Company was in compliance with all covenants related to the Credit Agreement and had $476.4 million of unused and available credit under the Credit Agreement and $23.6 million of stand-by letters of credit outstanding on the Credit Agreement. The Company did not have any borrowings outstanding under the Credit Agreement at June 29, 2014.

 

The Company is a party to several note agreements as further detailed in Note 10 of Notes to Consolidated Financial Statements of the Annual Report on Form 10-K for the year ended December 31, 2013.  These note agreements require the Company to maintain a fixed charge coverage ratio of consolidated EBITDA plus consolidated rent expense during the period to consolidated fixed charges.  Consolidated fixed charges are the sum of consolidated interest expense for the period and consolidated rent expense.  As of June 29, 2014, the Company was in compliance with all covenants regarding these note agreements.

 

10.  Contingencies and Environmental Remediation

 

Accrual and Disclosure Policy

 

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

 

The Company reviews its lawsuits and other legal proceedings on an ongoing basis and follows appropriate accounting guidance when making accrual and disclosure decisions.  The Company establishes accruals for matters when the Company assesses that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.  The Company does not establish accruals for such matters when the Company does not believe both that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.  The Company’s assessment of whether a loss is probable is based on its assessment of the ultimate outcome of the matter following all appeals.

 

Under the FASB issued ASC 450 “Contingencies”, an event is “reasonably possible” if “the chance of the future event or events occurring is more than remote but less than likely” and an event is “remote” if “the chance of the future event or events occurring is slight”.  Thus, references to the upper end of the range of reasonably possible loss for cases in which the Company is able to estimate a range of reasonably possible loss mean the upper end of the range of loss for cases for which the Company believes the risk of loss is more than slight.

 

There may continue to be exposure to loss in excess of any amount accrued.  When it is possible to estimate the reasonably possible loss or range of loss above the amount accrued for the matters disclosed, that estimate is aggregated and disclosed.  The Company

 

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records legal costs associated with its legal contingencies as incurred, except for legal costs associated with product liability claims which are included in the product liability accrual.

 

As of June 29, 2014, the Company estimates that the aggregate amount of reasonably possible loss in excess of the amount accrued for its legal contingencies is approximately $10.3 million, pre-tax.  With respect to the estimate of reasonably possible loss, management has estimated the upper end of the range of reasonably possible loss based on (i) the amount of money damages claimed, where applicable, (ii) the allegations and factual development to date, (iii) available defenses based on the allegations, and/or (iv) other potentially liable parties.  This estimate is based upon currently available information and is subject to significant judgment and a variety of assumptions, and known and unknown uncertainties.  The matters underlying the estimate will change from time to time, and actual results may vary significantly from the current estimate.  In the event of an unfavorable outcome in one or more matters, the ultimate liability may be in excess of amounts currently accrued, if any, and may be material to the Company’s operating results or cash flows for a particular quarterly or annual period.  However, based on information currently known to it, management believes that the ultimate outcome of all matters, as they are resolved over time, is not likely to have a material adverse effect on the financial condition of the Company, though the outcome could be material to the Company’s operating results for any particular period depending, in part, upon the operating results for such period.

 

Trabakoolas et al., v, Watts Water Technologies, Inc., et al.,

 

On March 8, 2012, Watts Water Technologies, Inc., Watts Regulator Co., and Watts Plumbing Technologies Co., Ltd., among other companies, were named as defendants in a putative nationwide class action complaint filed in the U.S. District Court for the Northern District of California seeking to recover damages and other relief based on the alleged failure of toilet connectors. The complaint sought among other items, damages in an unspecified amount, replacement costs, injunctive relief, and attorneys’ fees and costs.

 

On December 12, 2013, the Company reached an agreement in principle to settle all claims. The total settlement amount is $23.0 million, of which the Company would be responsible for $14.0 million after insurance proceeds of $9.0 million. The settlement was subject to review by the Court at a preliminary approval hearing held on February 12, 2014. The Court granted preliminary approval on February 14, 2014. On July 18, 2014, the Court granted final approval of the class settlement at a fairness hearing, and issued a subsequent written order formalizing the approval on August 5, 2014.  The order will become final unless an appeal is taken within thirty days. The Company will vigorously contest any appeal that is taken. If the order becomes final without an appeal, the litigation will be terminated.

 

During the fourth quarter of 2013, the Company recorded a liability of $22.6 million related to the Trabakoolas matter, of which $12.7 million was included in current liabilities and $9.9 million in other noncurrent liabilities. In addition, a $9.0 million receivable was recorded in current assets related to insurance proceeds due under a separate settlement agreement if the class action settlement is approved and becomes final.  The liability was reduced by $1.3 million for notice and claims administrator payments made during the first half of 2014 and as of June 29, 2014, the remaining total liability was $21.3 million.

 

Product Liability

 

The Company is subject to a variety of potential liabilities in connection with product liability cases.  The Company maintains product liability and other insurance coverage, which the Company believes to be generally in accordance with industry practices.  For product liability cases in the U.S., management establishes its product liability accrual, which includes legal costs associated with accrued claims, by utilizing third-party actuarial valuations which incorporate historical trend factors and the Company’s specific claims experience derived from loss reports provided by third-party claims administrators.  Changes in the nature of claims, legal costs, or the actual settlement amounts could affect the adequacy of this estimate and require changes to the accrual. Because the liability is an estimate, the ultimate liability may be more or less than reported. In other countries, the Company maintains insurance coverage with relatively high deductible payments, as product liability claims tend to be smaller than those experienced in the U.S.

 

Environmental Remediation

 

The Company has been named as a potentially responsible party with respect to a limited number of identified contaminated sites.  The levels of contamination vary significantly from site to site as do the related levels of remediation efforts.  Environmental liabilities are recorded based on the most probable cost, if known, or on the estimated minimum cost of remediation.  Accruals are not discounted to their present value, unless the amount and timing of expenditures are fixed and reliably determinable.  The Company accrues estimated environmental liabilities based on assumptions, which are subject to a number of factors and uncertainties.  Circumstances that can affect the reliability and precision of these estimates include identification of additional sites, environmental regulations, level of cleanup required, technologies available, number and financial condition of other contributors to remediation and the time period over which remediation may occur.  The Company recognizes changes in estimates as new remediation requirements are defined or as new information becomes available. Environmental liabilities as of the second quarter ended 2014 and 2013 were not considered material.

 

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Table of Contents

 

Asbestos Litigation

 

The Company is defending 47 lawsuits in different jurisdictions, alleging injury or death as a result of exposure to asbestos.  The complaints in these cases typically name a large number of defendants and do not identify any particular Company products as a source of asbestos exposure.  To date, the Company has obtained a dismissal in every case before it has reached trial because discovery has failed to yield evidence of substantial exposure to any Company products.

 

Other Litigation

 

Other lawsuits and proceedings or claims, arising from the ordinary course of operations, are also pending or threatened against the Company.

 

11.  Defined Benefit Plans

 

For the majority of its U.S. employees, the Company sponsors a funded non-contributing defined benefit pension plan, the Watts Water Technologies, Inc. Pension Plan (the “Pension Plan”), and an unfunded non-contributing defined benefit pension plan, the Watts Water Technologies, Inc. Supplemental Employees Retirement Plan (the “SERP”).  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.  On October 31, 2011, the Company’s Board of Directors voted to cease accruals effective December 31, 2011 under both the Company’s Pension Plan and the SERP.  On April 28, 2014, the Company’s Board of Directors voted to terminate the Company’s Pension Plan and the SERP.

 

The Pension Plan was terminated effective July 31, 2014.  Distribution of plan assets pursuant to the termination will not be made until the plan termination satisfies the regulatory requirements prescribed by the Internal Revenue Service and the Pension Benefit Guaranty Corporation, which is expected to occur in late 2015.  The SERP was terminated effective May 15, 2014.  The Company will settle all liabilities under the SERP in accordance with Section 409A of the Internal Revenue Code by paying lump sums to plan participants at least twelve and no more than twenty four months following the termination date.  The Board of Directors authorized the Company to make such contributions to the Pension Plan and SERP as may be necessary to make the plans sufficient to settle all plan liabilities.

 

The components of net periodic benefit cost are as follows:

 

 

 

Second Quarter Ended

 

Six Months Ended

 

 

 

June 29,
2014

 

June 30,
2013

 

June 29,
2014

 

June 30,
2013

 

 

 

(in millions)

 

Service cost — administrative costs

 

$

0.1

 

$

0.1

 

$

0.3

 

$

0.2

 

Interest costs on benefits obligation

 

1.5

 

1.4

 

3.0

 

2.8

 

Expected return on assets

 

(1.5

)

(1.7

)

(3.0

)

(3.4

)

Net actuarial loss amortization

 

0.2

 

0.2

 

0.5

 

0.4

 

Net periodic benefit cost

 

$

0.3

 

$

 

$

0.8

 

$

 

 

The information related to the Company’s pension funds cash flow is as follows:

 

 

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

 

 

(in millions)

 

Employer contributions

 

$

0.4

 

$

0.4

 

 

The Company expects to contribute approximately $0.4 million to its pension plans for the remainder of 2014.

 

12.  Subsequent Events

 

Dividend Declared

 

On July 29, 2014, the Company declared a quarterly dividend of fifteen cents ($0.15) per share on each outstanding share of Class A common stock and Class B common stock payable on August 29, 2014 to stockholders of record at the close of business on August 18, 2014.

 

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Table of Contents

 

Item 2.  Management’s 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 calendar year ending on December 31.  Any quarterly data contained in this Quarterly Report on Form 10-Q generally reflect the results of operations for a 13-week period or 26-week period, respectively.

 

We are a leading supplier of products for use in the water quality, water safety, water flow control and water conservation markets in both the Americas and EMEA (Europe, Middle East and Africa), with a growing presence in Asia-Pacific. For 140 years, we have designed and manufactured products that promote comfort and safety of people and the quality and conservation of water used in commercial and residential applications. We earn revenue and income almost exclusively from the sale of our products. Our principal product lines are:

 

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

 

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

 

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

 

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

 

Our business is reported in three geographic segments: Americas, EMEA and Asia-Pacific. We distribute our products through three primary distribution channels: wholesale, do-it-yourself (DIY) and original equipment manufacturers (OEMs). Interest rates, the unemployment rate and credit availability 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 of these activities have an impact on our levels of sales and earnings. An additional factor that has an effect on our sales and operating income is fluctuation in foreign currency exchange rates, as approximately 44% of our sales in the second quarter ended June 29, 2014, and certain portions of our costs, assets and liabilities are denominated in currencies other than the U.S. dollar.

 

During the second quarter of 2014, sales increased $29.2 million as compared to the second quarter of 2013, primarily from an organic increase in sales of $23.7 million and a favorable foreign exchange movement of $5.5 million.  The foreign exchange impact was primarily due to the appreciation of the euro against the U.S. dollar, partially offset by the weakening of the Canadian dollar against the U.S. dollar.  Organic sales increased by 6.5% compared to last year’s comparable period, primarily from increased sales in the Americas.  Organic sales in the second quarter of 2014 increased in the Americas by $18.7 million, or 8.3%, an increase in EMEA of $3.1 million, or 2.3%, and an increase in Asia-Pacific by $1.9 million, or 22.9%.  Organic sales growth excludes the impacts of acquisitions, divestitures and foreign exchange from year-over-year comparisons.  We believe this provides investors with a more complete understanding of underlying sales trends by providing sales growth on a consistent basis.  Gross margin decreased in the second quarter of 2014 as compared to 2013 by 1.1 percentage points.  The decrease is due primarily to lower absorption, higher production costs and increased customer rebate expense in the Americas partially offset by production efficiencies, favorable material prices and cost containment in EMEA. Operating income of $36.6 million increased by 2.8% in the second quarter of 2014 as compared to the second quarter of 2013, driven primarily by cost control efforts in EMEA offset by increased selling, general and administrative expenses and restructuring costs.  Included in selling, general and administrative expenses for the quarter was $1.6 million of EMEA transformation deployment costs.

 

The EMEA transformation program began in the fourth quarter of 2013 and is designed to realign our European operating strategy from being country specific to pan European focused.  Under this initiative, we intend to (1) develop better sales capabilities through improved product management and enhanced product cross-selling efforts, (2) drive more efficient sourcing and logistics, and (3) enhance our focus on emerging market opportunities. We plan to align our legal and tax structure in accordance with our business structure and take advantage of favorable tax rates where possible. We expect this project to be ongoing through 2016. We incurred non-recurring deployment costs of approximately $1.6 million and $5.1 million in the three and six month periods ended June 29,

 

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Table of Contents

 

2014, respectively, and $6.3 million for the project to date. These non-recurring costs consist primarily of external consulting and IT related costs, and are exclusive of restructuring expense.  A more detailed description of this program can be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

We believe that the factors relating to our future growth include the demand for clean water around the world, a healthy economic environment regulatory requirements relating to the quality and conservation of water, continued enforcement of plumbing and building codes, our ability to grow organically in select attractive market segments and geographic regions and the successful completion of selective acquisitions.  Our acquisition strategy focuses on businesses that manufacture preferred brand name or specified products that address our themes of water quality, water conservation, water safety, water flow control, HVAC and related complementary markets and geographies. We target businesses that will provide us with one or more of the following: an entry into new markets and geographies, an increase in business 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 and HVAC products for the residential, commercial and light industrial markets.  We have completed 36 acquisitions since 1999.

 

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.

 

Historically, we have faced a risk relating to our ability to respond to raw material cost fluctuations. 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, purchasing forward commitments for raw materials, when available, implementing cost reduction programs and passing increases in costs to our customers in the form of price increases.

 

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, quality and breadth of product offerings to be the primary competitive factors. We believe that product development, product testing capability, breadth of product offerings and investment in plant and equipment needed to manufacture products in compliance with code requirements represent a competitive advantage for us. We expect to spend approximately $25 to $28 million during 2014 for purchases of capital equipment to continue to improve our manufacturing capabilities.

 

Recent Events

 

Dividend Declared

 

On July 29, 2014, we declared a quarterly dividend of fifteen cents ($0.15) per share on each outstanding share of Class A common stock and Class B common stock payable on August 29, 2014 to stockholders of record at the close of business on August 18, 2014.

 

Termination of Pension Plans

 

On April 28, 2014, our Board of Directors voted to terminate the Watts Water Technologies, Inc. Pension Plan (the “Pension Plan”) and the Watts Water Technologies, Inc. Supplemental Employees Retirement Plan (the “SERP”).  These terminations follow amendments to the Pension Plan and SERP to cease (or “freeze”) benefit accruals for eligible employees under those plans effective December 31, 2011.

 

The Pension Plan was terminated effective July 31, 2014.  Distribution of plan assets pursuant to the termination will not be made until the plan termination satisfies the regulatory requirements prescribed by the Internal Revenue Service and the Pension Benefit Guaranty Corporation, which is expected to occur in late 2015.  The SERP was terminated effective May 15, 2014.  We will settle all liabilities under the SERP in accordance with Section 409A of the Internal Revenue Code by paying lump sums to plan participants at least twelve and no more than twenty four months following the termination date.  The Board of Directors authorized us to make such contributions to the Pension Plan and SERP as may be necessary to make the plans sufficient to settle all plan liabilities.

 

Trabakoolas et al., v, Watts Water Technologies, Inc., et al.,

 

On March 8, 2012, Watts Water Technologies, Inc., Watts Regulator Co., and Watts Plumbing Technologies Co., Ltd., among other companies, were named as defendants in a putative nationwide class action complaint filed in the U.S. District Court for the Northern District of California seeking to recover damages and other relief based on the alleged failure of toilet connectors. The complaint seeks among other items, damages in an unspecified amount, replacement costs, injunctive relief, and attorneys’ fees and costs.

 

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On December 12, 2013, we reached an agreement in principle to settle all claims. The total settlement amount is $23.0 million, of which we would be responsible for $14.0 million after insurance proceeds of $9.0 million. The settlement was subject to review by the Court at a preliminary approval hearing held on February 12, 2014. The Court granted preliminary approval on February 14, 2014. On July 18, 2014, the Court granted final approval of the class settlement at a fairness hearing, and issued a subsequent written order formalizing the approval on August 5, 2014.  The order will become final unless an appeal is taken within thirty days.

 

Results of Operations

 

Second Quarter Ended June 29, 2014 Compared to Second Quarter Ended June 30, 2013

 

Net Sales.  Our business is reported in three geographic segments: Americas, EMEA and Asia-Pacific. Our net sales in each of these segments for each of the second quarters of 2014 and 2013 were as follows:

 

 

 

Second Quarter Ended
June 29, 2014

 

Second Quarter Ended
June 30, 2013

 

 

 

% Change to
Consolidated

 

 

 

Net Sales

 

% Sales

 

Net Sales

 

% Sales

 

Change

 

Net Sales

 

 

 

(dollars in millions)

 

Americas

 

$

241.8

 

61.1

%

$

224.4

 

61.2

%

$

17.4

 

4.7

%

EMEA

 

143.9

 

36.3

 

134.1

 

36.5

 

9.8

 

2.7

 

Asia-Pacific

 

10.3

 

2.6

 

8.3

 

2.3

 

2.0

 

0.6

 

Total

 

$

396.0

 

100.0

%

$

366.8

 

100.0

%

$

29.2

 

8.0

%

 

The change in net sales was attributable to the following: