wts_Current_Folio_10Q

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

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

 

For the quarterly period ended July 2, 2017

 

or

 

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

 

For the transition period from              to             

 

Commission file number 001-11499

 

WATTS WATER TECHNOLOGIES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

 

Delaware

 

04-2916536

(State or Other Jurisdiction of Incorporation or
Organization)

 

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

 

 

 

815 Chestnut Street, North Andover, MA

 

01845

(Address of Principal Executive Offices)

 

(Zip Code)

 

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 ☒   No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ☒   No ☐

 

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

 

 

 

 

Large accelerated filer  ☒

 

Accelerated filer  ☐

 

 

 

Non-accelerated filer  ☐

 

Smaller reporting company  ☐

 

Emerging growth company  ☐

(Do not check if a smaller reporting company)

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

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

 

 

 

 

Class

 

Outstanding at August 1 , 2017

Class A Common Stock, $0.10 par value

 

27,809,237

 

 

 

Class B Common Stock, $0.10 par value

 

6,379,290

 

 

 

 

 

 


 

Table of Contents

 

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

 

INDEX

 

 

 

 

 

Part I. Financial Information 

    

3

 

 

 

 

Item 1. 

Financial Statements

 

3

 

 

 

 

 

Consolidated Balance Sheets at July 2, 2017 and December 31, 2016 (unaudited)

 

3

 

 

 

 

 

Consolidated Statements of Operations for the Second Quarters and Six Months Ended July 2, 2017 and July 3, 2016 (unaudited)

 

4

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the Second Quarters and Six Months Ended July 2, 2017 and July 3, 2016 (unaudited)

 

5

 

 

 

 

 

Consolidated Statements of Cash Flows for the Six Months Ended July 2, 2017 and July 3, 2016 (unaudited)

 

6

 

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

 

7

 

 

 

 

Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

23

 

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

 

33

 

 

 

 

Item 4. 

Controls and Procedures

 

34

 

 

 

 

Part II. Other Information 

 

35

 

 

 

 

Item 1. 

Legal Proceedings

 

35

 

 

 

 

Item 1A. 

Risk Factors

 

35

 

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

 

35

 

 

 

 

Item 6. 

Exhibits

 

36

 

 

 

 

Signatures 

 

37

 

 

 

 

Exhibit Index 

 

38

 

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Amounts in millions, except share information)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

July 2,

 

December 31,

 

 

    

2017

    

2016

 

ASSETS

 

 

    

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

217.5

 

$

338.4

 

Trade accounts receivable, less allowance for doubtful accounts of $15.1 million at July 2, 2017 and $14.2 million at December 31, 2016

 

 

245.5

 

 

198.0

 

Inventories, net

 

 

 

 

 

 

 

    Raw materials

 

 

81.5

 

 

81.5

 

    Work in process

 

 

16.6

 

 

13.7

 

    Finished goods

 

 

160.7

 

 

144.2

 

Total Inventories

 

 

258.8

 

 

239.4

 

Prepaid expenses and other assets

 

 

37.0

 

 

40.5

 

Assets held for sale

 

 

2.9

 

 

3.1

 

Total Current Assets

 

 

761.7

 

 

819.4

 

PROPERTY, PLANT AND EQUIPMENT

 

 

 

 

 

 

 

Property, plant and equipment, at cost

 

 

521.3

 

 

498.1

 

Accumulated depreciation

 

 

(329.7)

 

 

(308.4)

 

Property, plant and equipment, net

 

 

191.6

 

 

189.7

 

OTHER ASSETS:

 

 

 

 

 

 

 

Goodwill

 

 

544.7

 

 

532.7

 

Intangible assets, net

 

 

194.6

 

 

202.5

 

Deferred income taxes

 

 

2.7

 

 

3.0

 

Other, net

 

 

16.6

 

 

15.9

 

TOTAL ASSETS

 

$

1,711.9

 

$

1,763.2

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

 

Accounts payable

 

$

110.1

 

$

101.1

 

Accrued expenses and other liabilities

 

 

122.3

 

 

136.8

 

Accrued compensation and benefits

 

 

45.8

 

 

48.5

 

Current portion of long-term debt

 

 

37.9

 

 

139.1

 

Total Current Liabilities

 

 

316.1

 

 

425.5

 

LONG-TERM DEBT, NET OF CURRENT PORTION

 

 

510.4

 

 

511.3

 

DEFERRED INCOME TAXES

 

 

51.2

 

 

48.6

 

OTHER NONCURRENT LIABILITIES

 

 

37.0

 

 

41.5

 

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, 27,840,962 shares at July 2, 2017 and 27,831,013 shares at December 31, 2016

 

 

2.8

 

 

2.8

 

Class B common stock, $0.10 par value; 25,000,000 shares authorized; 10 votes per share; issued and outstanding, 6,379,290 shares at July 2, 2017 and December 31, 2016

 

 

0.6

 

 

0.6

 

Additional paid-in capital

 

 

543.7

 

 

535.2

 

Retained earnings

 

 

372.1

 

 

348.5

 

Accumulated other comprehensive loss

 

 

(122.0)

 

 

(150.8)

 

Total Stockholders’ Equity

 

 

797.2

 

 

736.3

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

1,711.9

 

$

1,763.2

 

See accompanying notes to consolidated financial statements.

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WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in millions, except per share information)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Second Quarter Ended

 

Six Months Ended

 

 

 

July 2,

 

July 3,

 

July 2,

 

July 3,

 

 

    

2017

    

2016

    

2017

    

2016

    

Net sales

 

$

378.5

 

$

371.1

 

$

725.7

 

$

715.3

 

Cost of goods sold

 

 

221.8

 

 

220.4

 

 

425.2

 

 

429.4

 

GROSS PROFIT

 

 

156.7

 

 

150.7

 

 

300.5

 

 

285.9

 

Selling, general and administrative expenses

 

 

110.2

 

 

110.5

 

 

217.8

 

 

213.1

 

Restructuring

 

 

1.7

 

 

3.2

 

 

2.2

 

 

4.6

 

Gain on disposition

 

 

 —

 

 

(8.7)

 

 

 —

 

 

(8.7)

 

OPERATING INCOME

 

 

44.8

 

 

45.7

 

 

80.5

 

 

76.9

 

Other expense (income):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

(0.2)

 

 

(0.3)

 

 

(0.4)

 

 

(0.5)

 

Interest expense

 

 

5.0

 

 

5.5

 

 

9.8

 

 

12.2

 

Other expense (income), net

 

 

0.2

 

 

(0.9)

 

 

0.5

 

 

(3.1)

 

Total other expense

 

 

5.0

 

 

4.3

 

 

9.9

 

 

8.6

 

INCOME BEFORE INCOME TAXES

 

 

39.8

 

 

41.4

 

 

70.6

 

 

68.3

 

Provision for income taxes

 

 

12.6

 

 

12.8

 

 

21.7

 

 

23.5

 

NET INCOME

 

$

27.2

 

$

28.6

 

$

48.9

 

$

44.8

 

Basic EPS

 

 

 

 

 

 

 

 

 

 

 

 

 

NET INCOME PER SHARE

 

$

0.79

 

$

0.83

 

$

1.42

 

$

1.30

 

Weighted average number of shares

 

 

34.5

 

 

34.5

 

 

34.5

 

 

34.4

 

Diluted EPS

 

 

 

 

 

 

 

 

 

 

 

 

 

NET INCOME PER SHARE

 

$

0.79

 

$

0.83

 

$

1.42

 

$

1.30

 

Weighted average number of shares

 

 

34.5

 

 

34.5

 

 

34.5

 

 

34.5

 

Dividends declared per share

 

$

0.19

 

$

0.18

 

$

0.37

 

$

0.35

 

 

See accompanying notes to consolidated financial statements.

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WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Amounts in millions)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Second Quarter Ended

    

Six Months Ended

    

 

 

July 2,

 

July 3,

 

July 2,

 

July 3,

 

 

    

2017

    

2016

    

2017

    

2016

    

Net income

 

$

27.2

 

$

28.6

 

$

48.9

 

$

44.8

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

 

21.5

 

 

(12.2)

 

 

29.4

 

 

12.2

 

Reversal of foreign currency translation for sale of foreign entity, net of tax

 

 

 —

 

 

(6.9)

 

 

 —

 

 

(6.9)

 

Cash flow hedges, net of tax

 

 

(0.7)

 

 

(1.7)

 

 

(0.6)

 

 

(1.9)

 

Other comprehensive income (loss)

 

 

20.8

 

 

(20.8)

 

 

28.8

 

 

3.4

 

Comprehensive income

 

$

48.0

 

$

7.8

 

$

77.7

 

$

48.2

 

 

See accompanying notes to consolidated financial statements.

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WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in millions)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

July 2,

 

July 3,

 

 

    

2017

    

2016

    

OPERATING ACTIVITIES

 

 

 

 

 

 

 

Net income

 

$

48.9

 

$

44.8

 

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

 

 

 

 

 

 

 

Depreciation

 

 

14.6

 

 

14.7

 

Amortization of intangibles

 

 

11.1

 

 

10.2

 

Loss on disposal and impairment of property, plant and equipment and other

 

 

0.6

 

 

1.9

 

Gain on disposition

 

 

 —

 

 

(8.3)

 

Gain on acquisition

 

 

 —

 

 

(1.7)

 

Stock-based compensation

 

 

6.9

 

 

7.3

 

Deferred income tax

 

 

2.3

 

 

(0.4)

 

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

 

 

 

 

 

 

 

Accounts receivable

 

 

(41.5)

 

 

(30.6)

 

Inventories

 

 

(13.1)

 

 

(5.5)

 

Prepaid expenses and other assets

 

 

2.6

 

 

1.8

 

Accounts payable, accrued expenses and other liabilities

 

 

(23.4)

 

 

(26.4)

 

Net cash provided by operating activities

 

 

9.0

 

 

7.8

 

INVESTING ACTIVITIES

 

 

 

 

 

 

 

Additions to property, plant and equipment

 

 

(11.0)

 

 

(19.2)

 

Proceeds from the sale of property, plant and equipment

 

 

0.1

 

 

 —

 

Net proceeds from the sale of assets, and other

 

 

1.9

 

 

 

Business acquisitions, net of cash acquired

 

 

0.1

 

 

(2.1)

 

Net cash used in investing activities

 

 

(8.9)

 

 

(21.3)

 

FINANCING ACTIVITIES

 

 

 

 

 

 

 

Proceeds from long-term borrowings

 

 

20.0

 

 

530.0

 

Payments of long-term debt

 

 

(126.3)

 

 

(500.7)

 

Payment of capital leases and other

 

 

(4.3)

 

 

(1.1)

 

Proceeds from share transactions under employee stock plans

 

 

0.5

 

 

2.7

 

Tax benefit of stock awards exercised

 

 

 —

 

 

0.2

 

Payments to repurchase common stock

 

 

(9.0)

 

 

(17.6)

 

Debt issuance costs

 

 

 —

 

 

(2.1)

 

Dividends

 

 

(12.8)

 

 

(12.0)

 

Net cash used in financing activities

 

 

(131.9)

 

 

(0.6)

 

Effect of exchange rate changes on cash and cash equivalents

 

 

10.9

 

 

4.6

 

DECREASE IN CASH AND CASH EQUIVALENTS

 

 

(120.9)

 

 

(9.5)

 

Cash and cash equivalents at beginning of year

 

 

338.4

 

 

296.2

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

 

$

217.5

 

$

286.7

 

NON CASH INVESTING AND FINANCING ACTIVITIES

 

 

 

 

 

 

 

Acquisition of businesses:

 

 

 

 

 

 

 

Fair value of assets acquired

 

$

 —

 

$

5.7

 

Cash paid, net of cash acquired

 

 

 —

 

 

2.1

 

Gain on acquisition

 

 

 —

 

 

1.7

 

Liabilities assumed

 

$

 —

 

$

1.9

 

Issuance of stock under management stock purchase plan

 

$

1.0

 

$

0.7

 

CASH PAID FOR:

 

 

 

 

 

 

 

Interest

 

$

9.5

 

$

11.7

 

Income taxes

 

$

20.9

 

$

14.6

 

 

See accompanying notes to consolidated financial statements.

 

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     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 July 2, 2017, the Consolidated Statements of Operations for the second quarters and six months ended July 2, 2017 and July 3, 2016, the Consolidated Statements of Comprehensive Income for the second quarters and six months ended July 2, 2017 and July 3, 2016, and the Consolidated Statements of Cash Flows for the six months  ended July 2, 2017 and July 3, 2016.

 

The consolidated balance sheet at December 31, 2016 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, 2016.  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, 2016. Operating results for the interim periods presented are not necessarily indicative of the results to be expected for the year ending December 31, 2017. Certain prior year amounts have been reclassified to conform to the current year presentation. Reclassifications did not have a material impact on previously reported results of operations, financial position or cash flows.

 

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

 

Estimates

 

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

 

2. Accounting Policies

 

The significant accounting policies used in preparation of these consolidated financial statements for the three and six months ended July 2, 2017 are consistent with those discussed in Note 2 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

 

Recently Adopted Accounting Standards

 

In January 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates the need to determine the fair value of individual assets and liabilities of a reporting unit to measure goodwill impairment. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value. The revised guidance will be applied prospectively and is effective for calendar year-end SEC filers in 2020. Early adoption is permitted for any impairment tests performed after January 1, 2017. The Company’s adoption of the new guidance effective January 1, 2017 did not have a material impact on the Company's financial statements.

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting.” ASU 2016‑09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as equity or liabilities, forfeitures, and classification on the statement of cash

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flows. The Company adopted this standard in the first quarter of 2017. The impact of the adoption of this standard resulted in the following:

 

The Company elected to account for forfeitures as they occur, rather than estimate expected forfeitures over the vesting period of the respective grant. This was adopted using a modified retrospective approach with a cumulative effect adjustment of $0.5 million to retained earnings as of January 1, 2017.

The Company no longer reclassifies the excess tax benefit from operating activities to financing activities in the Consolidated Statement of Cash Flows. This change has been applied prospectively in the Statement of Cash Flows. The Company had an excess tax benefit of $0.2 million in the six months ended July 3, 2016.

The Company no longer records windfall or shortfall tax benefits to additional paid-in capital and records these tax benefits directly to operations. This change has been applied prospectively as is required by the standard and therefore the comparative period has not been adjusted. This change may create volatility in the Company’s effective tax rate on a prospective basis.

 

In November 2015, the FASB issued ASU 2015-17, “Income Taxes: Balance Sheet Classification of Deferred Taxes.” ASU 2015-17 requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. ASU 2015-17 is effective for financial statements issued for annual periods beginning after December 15, 2016 and all interim periods thereafter. The Company adopted the provision of this ASU during the first quarter of 2017 and applied it retrospectively. As of December 31, 2016, the Company had $38.6 million of current deferred tax assets, $1.5 million of noncurrent deferred tax assets, and $85.7 million of noncurrent deferred tax liabilities. The adoption of this standard resulted in a reclassification of $38.6 million of current deferred tax assets to noncurrent deferred tax liabilities and a reclassification of $1.5 million of noncurrent deferred tax liabilities to noncurrent deferred tax assets. Therefore, the restated noncurrent deferred tax asset balance and noncurrent deferred tax liability balance as of December 31, 2016 was $3.0 million and $48.6 million, respectively. Adoption of this standard did not affect results of operations, retained earnings, or cash flows in the current or previous interim and annual reporting periods.

 

In July 2015, the FASB issued ASU 2015-11, “Inventory: Simplifying the Measurement of Inventory.” This new standard changes inventory measurement from lower of cost or market to lower of cost and net realizable value.  The standard eliminates the requirement to consider replacement cost or net realizable value less a normal profit margin when measuring inventory. ASU 2015-11 is effective in the first quarter of 2017 for public companies with calendar year ends, and should be applied prospectively with early adoption permitted. The adoption of this guidance did not have a material impact on the Company’s financial statements.

 

Accounting Standards Updates

 

In January 2017, the FASB issued ASU 2017-01 “Business Combinations (Topic 805)-Clarifying the Definition of a Business”, which clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The standard introduces a screen for determining when assets acquired are not a business and clarifies that a business must include, at a minimum, an input and a substantive process that contribute to an output to be considered a business. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The adoption of this guidance is not expected to have a material impact on the Company’s financial statements. 

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers." ASU 2014-09 converges revenue recognition under U.S. GAAP and International Financial Reporting Standards ("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. The FASB issued ASU 2015-14 in August 2015 which deferred the effective date of ASU 2014-09 for public companies to periods beginning after December 15, 2017, with early adoption permitted. The Company is assessing the impact of the guidance on its revenues by reviewing its contract portfolio to identify potential differences that would result from applying the new standard to its current revenue arrangements, including evaluation of potential performance obligations and variable consideration. The Company has substantially completed its contract portfolio analysis, and is evaluating the impact, if any, on changes to the Company’s financial results, business processes, systems, and controls under this new guidance. The Company is expected to use the modified retrospective approach of adoption, with a cumulative adjustment to opening retained earnings in the period of adoption. The Company will adopt the new standard effective January 1, 2018.

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Shipping and Handling

 

Shipping and handling costs included in selling, general and administrative expense amounted to $13.0 million and $11.5 million for the second quarters of 2017 and 2016, respectively, and were $25.0 million and $22.9 million for the first six months of 2017 and 2016, respectively.

 

Research and Development

 

Research and development costs included in selling, general, and administrative expense amounted to $7.2 million and $6.4 million for the second quarters of 2017 and 2016, respectively, and was $14.3 million and $13.0 million for the first six months of 2017 and 2016, respectively. 

3. Acquisitions

 

PVI Industries, LLC

 

On November 2, 2016, the Company acquired 100% of the shares of PVI Riverside Holdings, Inc., the parent company of PVI Industries, LLC (“PVI”). The aggregate purchase price, including the final working capital adjustment, was approximately $79.1 million.

 

PVI is a leading manufacturer of commercial stainless steel water heating equipment, focused on the high capacity market in North America and is based in Fort Worth, Texas. PVI’s water heater product offering complements AERCO’s boiler products, allowing the Company to address customers’ heating and hot water requirements. 

 

The Company accounted for the transaction as a purchased business combination and the acquisition was funded partially with available cash and partially from borrowings under the Company’s Credit Agreement. During the second quarter of 2017 the Company finalized the purchase price allocation related to the purchase of PVI.  The acquisition resulted in the recognition of $41.1 million in goodwill and $31.0 million in intangible assets. The intangible assets acquired consist of customer relationships valued at $17.6 million, developed technology valued at $10.2 million, and the trade name valued at $3.2 million.  The goodwill is attributable to the workforce of PVI and the strategic platform adjacency that will allow Watts to extend its product offerings as a result of the acquisition.  Approximately $6.9 million of the goodwill is deductible for tax purposes.  The following table summarizes the value of the assets and liabilities acquired (in millions):

 

 

 

 

 

 

Accounts receivable

    

$

5.7

 

Inventory

 

 

12.7

 

Fixed assets

 

 

8.1

 

Other assets

 

 

2.8

 

Intangible assets

 

 

31.0

 

Goodwill

 

 

41.1

 

Accounts payable

 

 

(4.0)

 

Accrued expenses and other

 

 

(9.2)

 

Deferred tax liability

 

 

(9.1)

 

Purchase price

 

$

79.1

 

 

Apex

 

On November 30, 2015, the Company completed the acquisition of 80% of the outstanding shares of Apex Valves Limited (“Apex”). Apex specializes in the design and manufacturing of control valves for low and high pressure hot water and filtration systems. Apex also produces an extensive range of float and reservoir valves for the agricultural industry. The aggregate purchase price was approximately $20.4 million and the Company recorded a long-term liability of $5.5 million as the estimate of the acquisition date fair value on the contractual call option to purchase the remaining 20% within three years of closing. The Company acquired an additional 10% ownership in the first quarter of 2017 for approximately $2.9 million and now owns 90% of the outstanding shares of Apex. The Company maintains a long-term liability of approximately $3.0 million for the estimated fair value on the remaining 10% contractual call option. 

 

 

 

 

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4. Goodwill & Intangibles

 

The Company operates in three geographic segments: Americas, Europe, and APMEA (Asia-Pacific, Middle East, and Africa). The changes in the carrying amount of goodwill by geographic segment are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

July 2, 2017

 

 

 

Gross Balance

 

Accumulated Impairment Losses

 

Net Goodwill

 

 

 

 

 

Acquired

 

Foreign

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance

 

During

 

Currency

 

Balance

 

Balance

 

Impairment

 

Balance

 

 

 

 

 

January 1,

 

the

 

Translation

 

July 2,

 

January 1,

 

Loss During

 

July 2,

 

July 2,

 

 

    

2017

    

Period (1)

    

and Other

    

2017

    

2017

    

the Period

    

2017

    

2017

 

 

 

(in millions)

 

Americas

 

$

434.7

 

 

2.0

 

 

0.3

 

 

437.0

 

$

(24.5)

 

 

 

 

(24.5)

 

 

412.5

 

Europe

 

 

234.9

 

 

 

 

8.8

 

 

243.7

 

 

(129.7)

 

 

 —

 

 

(129.7)

 

 

114.0

 

APMEA

 

 

30.2

 

 

 —

 

 

0.9

 

 

31.1

 

 

(12.9)

 

 

 

 

(12.9)

 

 

18.2

 

Total

 

$

699.8

 

 

2.0

 

 

10.0

 

 

711.8

 

$

(167.1)

 

 

 —

 

 

(167.1)

 

 

544.7

 

 

(1)Americas goodwill additions during the first half of 2017 includes purchase accounting adjustments related to the PVI acquisition discussed in Note 3 of the Notes to the Consolidated Financial Statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2016

 

 

 

Gross Balance

 

Accumulated Impairment Losses

 

Net Goodwill

 

 

 

 

 

Acquired

 

Foreign

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance

 

During

 

Currency

 

Balance

 

Balance

 

Impairment

 

Balance

 

 

 

 

 

January 1,

 

the

 

Translation

 

December 31,

 

January 1,

 

Loss During

 

December 31,

 

December 31,

 

 

    

2016

    

Period

    

and Other

    

2016

    

2016

    

the Period

    

2016

    

2016

 

 

 

(in millions)

 

Americas

 

$

391.2

 

 

43.3

 

 

0.2

 

 

434.7

 

$

(24.5)

 

 

 

 

(24.5)

 

 

410.2

 

Europe

 

 

238.6

 

 

 

 

(3.7)

 

 

234.9

 

 

(129.7)

 

 

 —

 

 

(129.7)

 

 

105.2

 

APMEA

 

 

26.3

 

 

3.7

 

 

0.2

 

 

30.2

 

 

(12.9)

 

 

 

 

(12.9)

 

 

17.3

 

Total

 

$

656.1

 

 

47.0

 

 

(3.3)

 

 

699.8

 

$

(167.1)

 

 

 —

 

 

(167.1)

 

 

532.7

 

 

 

 

 

Intangible assets include the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

July 2, 2017

 

December 31, 2016

 

 

 

Gross

 

 

 

 

Net

 

Gross

 

 

 

 

Net

 

 

 

Carrying

 

Accumulated

 

Carrying

 

Carrying

 

Accumulated

 

Carrying

 

 

    

Amount

    

Amortization

    

Amount

    

Amount

    

Amortization

    

Amount

 

 

 

(in millions)

 

Patents

 

$

16.1

 

$

(15.0)

 

$

1.1

 

$

16.1

 

$

(14.9)

 

$

1.2

 

Customer relationships

 

 

233.0

 

 

(125.3)

 

 

107.7

 

 

231.5

 

 

(117.3)

 

 

114.2

 

Technology

 

 

53.2

 

 

(21.2)

 

 

32.0

 

 

53.1

 

 

(19.2)

 

 

33.9

 

Trade names

 

 

25.4

 

 

(8.9)

 

 

16.5

 

 

25.1

 

 

(8.1)

 

 

17.0

 

Other

 

 

6.8

 

 

(6.0)

 

 

0.8

 

 

6.8

 

 

(5.9)

 

 

0.9

 

Total amortizable intangibles

 

 

334.5

 

 

(176.4)

 

 

158.1

 

 

332.6

 

 

(165.4)

 

 

167.2

 

Indefinite-lived intangible assets

 

 

36.5

 

 

 —

 

 

36.5

 

 

35.3

 

 

 —

 

 

35.3

 

 

 

$

371.0

 

$

(176.4)

 

$

194.6

 

$

367.9

 

$

(165.4)

 

$

202.5

 

 

Aggregate amortization expense for amortized intangible assets for the second quarter of 2017 and 2016 was $5.6 million and $5.1 million, respectively, and for the first six months of 2017 and 2016, was $11.1 million and $10.2 million, respectively.

 

 

5. Financial Instruments and Derivative Instruments

 

Fair Value

 

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

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Table of Contents

 

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

 

 

 

 

 

 

 

 

 

 

 

July 2,

 

December 31,

 

 

    

2017

    

2016

    

 

 

(in millions)

 

Carrying amount

 

$

551.2

 

$

653.6

 

Estimated fair value

 

$

553.9

 

$

658.3

 

 

Financial Instruments

 

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including deferred compensation plan assets and related liabilities, redeemable financial instruments, and derivatives. The fair values of these certain financial assets and liabilities were determined using the following inputs at July 2, 2017 and December 31, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurement at July 2, 2017 Using:

 

 

 

 

 

 

Quoted Prices in Active

 

Significant Other

 

Significant

 

 

 

 

 

 

Markets for Identical

 

Observable

 

Unobservable

 

 

 

 

 

 

Assets

 

Inputs

 

Inputs

 

 

    

Total

    

(Level 1)

    

(Level 2)

    

(Level 3)

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Plan asset for deferred compensation(1)

 

$

3.2

 

$

3.2

 

$

 —

 

$

 —

 

Interest rate swaps (1)

 

$

3.8

 

$

 —

 

$

3.8

 

$

 —

 

Total assets

 

$

7.0

 

$

3.2

 

$

3.8

 

$

 —

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Plan liability for deferred compensation(2)

 

$

3.2

 

$

3.2

 

$

 —

 

$

 —

 

Redeemable financial instrument(3)

 

$

3.0

 

$

 

$

 —

 

$

3.0

 

Total liabilities

 

$

6.2

 

$

3.2

 

$

 —

 

$

3.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at December 31, 2016 Using:

 

 

 

 

 

 

Quoted Prices in Active

 

Significant Other

 

Significant

 

 

 

 

 

 

Markets for Identical

 

Observable

 

Unobservable

 

 

    

 

 

 

Assets

 

Inputs

 

 Inputs

 

 

 

Total

    

(Level 1)

    

(Level 2)

    

(Level 3)

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Plan asset for deferred compensation(1)

 

$

3.0

 

$

3.0

 

$

 —

 

$

 —

 

Interest rate swaps (1)

 

$

4.6

 

$

 —

 

$

4.6

 

$

 

 

Total assets

 

$

7.6

 

$

3.0

 

$

4.6

 

$

 —

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Plan liability for deferred compensation(2)

 

$

3.0

 

$

3.0

 

$

 —

 

$

 —

 

Redeemable financial instrument(3)

 

 

5.8

 

 

 —

 

 

 —

 

 

5.8

 

Total liabilities

 

$

8.8

 

$

3.0

 

$

 —

 

$

5.8

 


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

 

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

 

(3)Included on the Company’s consolidated balance sheet in other noncurrent liabilities and relates to a mandatorily redeemable equity instrument as part of the Apex acquisition in 2015.

 

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Table of Contents

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, 2016 to July 2, 2017.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total realized and unrealized

 

 

 

 

 

 

Balance

 

 

 

 

 

 

(gains) losses included in:

 

Balance

 

 

 

December 31,

 

 

 

 

 

 

Net earnings

 

Comprehensive

 

July 2,

 

 

    

2016

    

Settlements

    

Purchases

    

adjustments

    

income

    

2017

 

 

 

(in millions)

 

Redeemable financial instrument

 

$

5.8

 

 

(2.9)

 

$

 —

 

 

 —

 

$

0.1

 

$

3.0

 

 

In connection with the acquisition of Apex, a liability of $5.5 million was recognized on November 30, 2015 as the estimate of the acquisition date fair value of the mandatorily redeemable equity instrument. The Company acquired an additional 10% ownership in the first quarter of 2017 for approximately $2.9 million and now owns 90% of Apex outstanding shares. The remaining liability is classified as Level 3 under the fair value hierarchy as it is based on the commitment to purchase the remaining 10% of Apex shares within the next year, which is not observable in the market.

 

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

 

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

Interest Rate Swaps

On February 12, 2016, the Company entered into a Credit Agreement (the “Credit Agreement”) pursuant to which it received a funding commitment under a Term Loan of $300 million, of which the entire $300 million has been drawn on, and a Revolving Commitment (“Revolver”) of $500 million, of which $177.0 million has been drawn as of July 2, 2017.  Both facilities mature on February 12, 2021.  For each facility, the Company can choose either an Adjusted LIBOR or Alternative Base Rate (“ABR”). Upon intended election of Adjusted LIBOR as the interest rate, the Term Loan has quarterly interest payments that began in May 2016, quarterly principal repayments that commenced on March 31, 2017, with a balloon payment of principal on maturity date. The Revolver has quarterly interest payments that began in July 2016.

 

Accordingly, the Company’s earnings and cash flows are exposed to interest rate risk from changes in Adjusted LIBOR. In order to manage the Company’s exposure to changes in cash flows attributable to fluctuations in LIBOR-indexed interest payments related to the Company’s floating rate debt, the Company entered into two interest rate swaps. For each interest rate swap, the Company receives the three-month USD-LIBOR subject to a 0% floor, and pays a fixed rate of 1.31375% on a notional amount of $225.0 million. The swaps mature on February 12, 2021.  The Company formally documents the hedge relationships at hedge inception to ensure that its interest rate swaps qualify for hedge accounting. On a quarterly basis, the Company assesses whether the interest rate swaps are highly effective in offsetting changes in the cash flow of the hedged item. The Company does not hold or issue interest rate swaps for trading purposes. The swaps are designated as cash flow hedges. For the three and six months ended July 2, 2017, a loss of $0.8 million and  $0.6 million, respectively, was recorded in Accumulated Other Comprehensive Income to recognize the effective portion of the fair value of interest rate swaps that qualify as a cash flow hedge. For the three and six months ended July 3, 2016, a loss of $1.7 million and 1.9 million, respectively, was recorded in Accumulated Other Comprehensive Income to recognize the effective portion of the fair value of interest rate swaps that qualify as a cash flow hedge.

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Non-Designated Cash Flow Hedge

The Company’s foreign subsidiaries transact most business, including certain intercompany transactions, in foreign currencies. Such transactions are principally purchases or sales of materials and are denominated in European currencies or the U.S. or Canadian dollar. The Company uses foreign currency forward exchange contracts from time to time to manage the risk related to intercompany loans, intercompany purchases that occur during the course of a year, and certain open foreign currency denominated commitments to sell products to third parties.  These forward exchange contracts are not designated as cash flow or fair value hedges. The Company entered into one forward contract in the fourth quarter of 2016 and one forward contract in the first quarter of 2017 to manage the foreign currency rate exposure between the Hong Kong Dollar and the euro regarding two intercompany loans. These forward contracts are marked-to-market with changes in the fair value recorded to earnings. The Company recognized a loss of $1.3 million and $2.1 million for the three and six months ended July 2, 2017, respectively, related to the forward exchange contracts.

 

 

6. Restructuring and Other Charges, Net

 

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

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Second Quarter Ended

 

Six Months Ended

 

 

 

July 2,

 

July 3,

 

July 2,

 

July 3,

 

 

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

(in millions)

 

Restructuring costs:

 

 

 

 

 

 

 

 

 

 

 

 

 

2015 Actions

 

$

1.6

 

$

0.8