WATTS WATER TECHNOLOGIES INC - Annual Report: 2017 (Form 10-K)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10‑K

 

☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2017

 

Or

 

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001‑11499

 

WATTS WATER TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (978) 688‑1811

 

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

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well‑known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒  No ☐

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐  No ☒

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No ☐

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S‑K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10‑K or any amendment to this Form 10‑K. ☐ 

 

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

 

 

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 ☒

 

As of June 30, 2017, the aggregate market value of the registrant’s common stock held by non‑affiliates of the registrant was approximately $1,745,662,494 based on the closing sale price as reported on the New York Stock Exchange.

 

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

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Proxy Statement for its Annual Meeting of Stockholders to be held on May 16, 2018 are incorporated by reference into Part III of this Annual Report on Form 10‑K.

 

 

 

TABLE OF CONTENTS

 

 

 

PART I

 

Item 1.   BUSINESS.

 

This Annual Report on Form 10‑K contains statements that are not historical facts and are considered forward‑looking within the meaning of the Private Securities Litigation Reform Act of 1995. These forward‑looking statements contain projections of our future results of operations or our financial position or state other forward‑looking information. In some cases you can identify these forward‑looking statements by words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “should,” and “would” or similar words. You should not rely on forward‑looking statements because they involve known and unknown risks, uncertainties and other factors, some of which are beyond our control. These risks, uncertainties and other factors may cause our actual results, performance or achievements to differ materially from the anticipated future results, performance or achievements expressed or implied by the forward‑looking statements. Some of the factors that might cause these differences are described under Item 1A—“Risk Factors.” You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences. These forward‑looking statements were based on information, plans and estimates at the date of this report, and, except as required by law, we undertake no obligation to update any forward‑looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.

 

In this Annual Report on Form 10‑K, references to “the Company,” “Watts Water,” “we,” “us” or “our” refer to Watts Water Technologies, Inc. and its consolidated subsidiaries.

 

Overview

 

Watts Regulator Co. was founded by Joseph E. Watts in 1874 in Lawrence, Massachusetts. Watts Regulator Co. started as a small machine shop supplying parts to the New England textile mills of the 19th century and grew into a global manufacturer of products and systems focused on the control, conservation and quality of water and the comfort and safety of the people using it. Watts Water Technologies, Inc. was incorporated in Delaware in 1985 and became the parent company of Watts Regulator Co.

 

Our strategy is to be the preferred supplier of differentiated products and systems that manage and conserve the flow of fluids and energy into, through and out of buildings in the residential and commercial markets of the Americas, Europe, and Asia-Pacific, Middle East and Africa (“APMEA”). Within this framework, we focus upon three themes: safety & regulation, energy efficiency and water conservation. This strategy enables us to continue to increase our earnings via sales growth, both organic and inorganic, and the systematic reduction of manufacturing costs and operational expenses.

 

We intend to continue to expand organically by introducing new complementary products and solutions in existing markets, by enhancing our preferred brands, by promoting plumbing code development to drive the need for safety and water quality products and by continually improving merchandising in our wholesale distribution channels. We focus on selling solutions to our customers that integrate a variety of our product offerings. We target selected new product and geographic markets based on growth potential, including our ability to leverage our existing distribution channels. Additionally, we leverage our distribution channels through the introduction of new products, as well as the integration of products of our acquired companies.

 

We intend to continue to generate incremental growth by targeting selected acquisitions, both in our core markets as well as new complementary markets. We have completed 10 acquisitions in the last decade. Our acquisition strategy focuses on businesses that manufacture preferred brand name products that address our themes of safety & regulation, energy efficiency and water conservation in our primary or related complementary markets. We target businesses that will provide us with one or more of the following: an entry into new markets, an increase in shelf space with existing customers, strong brand names, a new or improved technology or an expansion of the breadth of our product and solution offerings.

 

We are committed to reducing our manufacturing and operating costs using Lean methodologies to drive improvement across all key processes, and consolidating our diverse manufacturing operations and distribution centers. We have a number of manufacturing facilities in lower‑cost regions. In recent years, we have announced global restructuring plans which reduced our manufacturing and distribution footprint in order to reduce our costs and to realize additional operating efficiencies.

 

Additionally, a majority of our manufacturing facilities are ISO 9000, 9001 or 9002 certified by the International Organization for Standardization.

 

Much of our sales are for products that have been approved under regulatory standards incorporated into state and municipal plumbing, heating, building and fire protection codes in the Americas, Europe, and certain countries within APMEA. We have consistently advocated for the development and enforcement of plumbing codes and are committed to providing products to meet these standards.

 

Our business is reported in three geographic segments: Americas, Europe and APMEA. The contributions of each segment to net sales, operating income and the presentation of certain other financial information by segment are reported in Note 17 of the Notes to Consolidated Financial Statements and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.

 

Products

 

We have a broad range of products in terms of design distinction, size and configuration. We classify our many products into four global product lines. These product lines are:

 

 

 

 

 

Commercial and Operational Excellence

 

We strive to invest in product innovation that meets the wants and needs of our customers. Our focus is on differentiated products that will provide greater opportunity to distinguish and defend ourselves in the market place. Conversely, we want to migrate away from commoditized products where we cannot add value. Our goal is to be a solutions provider, not merely a components supplier. We refer to this customer‑facing mindset as commercial excellence, and we are continually looking for strategic opportunities to invest or divest, where necessary, in order to meet those objectives. In conjunction with this customer‑centric focus, we continually review our operations to ensure we can efficiently and effectively produce and deliver products to customers. We call this aspect of our business operational excellence.

 

In 2015, our Board of Directors approved a program relating to the transformation of our Americas and APMEA businesses, and in 2017 we successfully completed this program.  The program involved the exit and discontinuation of low-margin, non-core product lines, enhancing our global sourcing capabilities and the reduction of the square footage of our Americas facilities. We eliminated approximately $165 million of our combined Americas and APMEA net sales of products that primarily sold through our do-it-yourself (DIY) distribution channel. We discontinued selling our remaining non-core product lines as of the end of the first quarter of 2016. As part of the exit of non-core product lines, we entered into an agreement to sell an operating subsidiary in China that was dedicated exclusively to the

manufacturing of products being discontinued. We completed that sale in the second quarter of 2016. The program also involved decreasing the square footage of our Americas facilities and reducing the Americas net operating footprint by approximately 30%. The footprint reduction was designed to improve the utilization of our remaining facilities, better leverage our cost structure, reduce working capital, and improve execution of customer delivery requirements. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion.

 

Customers and Markets

 

We sell our products to plumbing, heating and mechanical wholesale distributors and dealers, original equipment manufacturers (OEMs), specialty product distributors, and major DIY chains. In September 2015, as part of the first phase of our transformation of our Americas and APMEA business, we divested a substantial portion of our DIY business in the Americas, which reduced the significance of DIY as a distribution channel for our products in 2017 and 2016.

 

Wholesalers.  Approximately 63%, 57%, and 52% of our sales in 2017, 2016, and 2015, respectively, were to wholesale distributors for commercial and residential applications.

 

OEMs.  Approximately 16%, 21%, and 20% of our sales in 2017, 2016, and 2015, respectively, were to OEMs. In the Americas, our typical OEM customers are water heater manufacturers and equipment and water systems manufacturers needing flow control devices and other products. Our sales to OEMs in Europe are primarily to boiler manufacturers and radiant system manufacturers. Our sales to OEMs in APMEA are primarily to boiler, water heater and bath manufacturers, including manufacturers of faucet and shower products.

 

Specialty. Approximately 17% of our sales in 2017 and 18% of our sales in 2016 and 2015 were through our specialty channel. The specialty channel primarily includes sales related to high-efficiency boilers and water heaters, water filtration and conditioning products, specialty floor and tile products, and food service products.

 

DIY Chains.  Approximately 4% of our sales in 2017 and 2016, and 10% of our sales in 2015 were to DIY chains.

 

In 2017, 2016 and 2015, no customer accounted for more than 10% of our total net sales. Our top ten customers accounted for approximately $300.6 million, or 21%, of our total net sales in 2017; $275.2 million, or 20%, of our total net sales in 2016; and $345.6 million, or 24%, of our total net sales in 2015. Thousands of other customers constituted the balance of our net sales in each of those years.

 

Marketing and Sales

 

For product sales in the Americas, we rely primarily on commissioned manufacturers’ representatives to market our product lines, some of which maintain a consigned inventory of our products. These representatives sell primarily to plumbing and heating wholesalers and contractors or supply DIY stores. Our specialty channel products in the Americas are sold through independent representatives, dealers and distributors. We also sell products directly to wholesalers, OEMs and private label accounts primarily in Europe and APMEA, and to a lesser extent in the Americas.

 

Manufacturing

 

We have integrated and automated manufacturing capabilities, including a state of the art lead-free foundry and a traditional brass and bronze foundry, machining, plastic extrusion and injection molding and assembly operations. Our foundry operations include metal pouring systems, automatic core making, and brass and bronze die‑castings. Our machining operations feature computer‑controlled machine tools, high‑speed chucking machines with robotics and automatic screw machines for machining bronze, brass and steel components. We have invested in recent years to expand our manufacturing capabilities and to adopt the most efficient and productive equipment. We are committed to maintaining our manufacturing equipment at a level consistent with current technology in order to maintain high levels of quality and manufacturing efficiencies. In 2017, we continued to invest in our systems and in our manufacturing and training facilities.

 

Capital expenditures and depreciation for each of the last three years were as follows:

 

 

Raw Materials

 

We require substantial amounts of raw materials to produce our products, including bronze, brass, cast iron, stainless steel, steel, plastic, and other materials used in our products. Substantially all of the raw materials we require are purchased from outside sources. The commodity markets have experienced volatility over the past several years, particularly with respect to copper and stainless steel. Bronze and brass are copper‑based alloys. The price of copper had steadily declined for a number of years until prices began to increase in the second half of 2016. Copper prices continued to increase in 2017, and we expect elevated commodity pricing will be maintained in 2018, particularly with respect to copper. Because we internationally source a significant amount of raw materials, several months of raw materials and work in process are moving through our supply chain at any point in time. We are not able to predict whether commodity costs, including copper and stainless steel, will significantly increase or decrease in the future. If commodity costs increase in the future and we are not able to reduce or eliminate the effect of the cost increases by reducing production costs or implementing price increases, our profit margins could decrease. If commodity costs were to decline, we may experience pressures from customers to reduce our selling prices. The timing of any price reductions and decreases in commodity costs may not align. As a result, our margins could be affected.

 

With limited exceptions, we have multiple suppliers for our commodities and other raw materials. We believe our relationships with our key suppliers are good and that an interruption in supply from any one supplier would not materially affect our ability to meet our immediate demands while another supplier is qualified. We regularly review our suppliers to evaluate their strengths. If a supplier is unable to meet our demands, we believe that in most cases our inventory of raw materials will allow for sufficient time to identify and obtain the necessary commodities and other raw materials from an alternate source. We believe that the nature of the commodities and other raw materials used in our business are such that multiple sources are generally available in the market.

 

Code Compliance

 

Products representing a majority of our sales are subject to regulatory standards and code enforcement, which typically require that these products meet stringent performance criteria. Standards in the Americas are established by such industry test and certification organizations as the American Society of Mechanical Engineers (ASME), the America Water Works Association (AWWA), the Canadian Standards Association (CSA), the American Society of Sanitary Engineering (ASSE), the American National Standards Institute—Leadership in Energy & Environmental Design (LEED), the University of Southern California Foundation for Cross‑Connection Control and Hydraulic Research (USC FCCC & HR), FM Global (FM), NSF International (NSF) and Underwriters Laboratories (UL), the National Board (NB), the Environmental Protection Agency (EPA), and the Californian Energy Commission (CEC). International standards are established by such organizations as the International Code Council (ICC), the International Association of Plumbing and Mechanical Officials (IAPMO). Many of these standards are incorporated into state and municipal plumbing and heating, building and fire protection codes.

 

National regulatory standards in Europe vary by country. The major standards and/or guidelines that our products must meet are AFNOR (France), DVGW (Germany), UNI/ICIM (Italy), KIWA (Netherlands), SVGW (Switzerland), SITAC (Sweden), WRAS (United Kingdom) and CEN (Denmark). Further, there are local regulatory standards requiring compliance as well.

 

Together with our commissioned manufacturers’ representatives, we have consistently advocated for the development and enforcement of plumbing codes. We maintain stringent quality control and testing procedures at each of our manufacturing facilities in order to manufacture products that comply with code requirements. We believe that product‑testing capability and investment in plant and equipment are needed to manufacture products that comply with code requirements. Our product-testing capabilities and dedicated investments are areas of strength for the Company. Additionally, a majority of our manufacturing facilities are ISO 9000, 9001 or 9002 certified by the International Organization for Standardization.

 

New Product Development and Engineering

 

We retain our own product development staff, design teams, and testing laboratories in the Americas, Europe and APMEA that work to enhance our existing products and develop new products. We maintain sophisticated product development and testing laboratories and are committed to investing more in this area. In 2015, we re-engineered our new product development process and rolled out a uniform global program. In 2016 and 2017, we continued to drive innovation to our markets, including the successful roll out of  IntelliStation™ and the AERCO Benchmark® Platinum boiler.  We continued to focus on our global program to leverage our electronics capabilities to drive our “connected” products strategy. Research and development costs included in selling, general, and administrative expense amounted to $29.0 million, $26.5 million and $23.5 million for the years ended December 31, 2017, 2016 and 2015, respectively.

 

Competition

 

The domestic and international markets for energy efficient products, water conservation devices, and products that address the safety & regulation for the flow of fluids, are intensely competitive and require us to compete against some companies possessing greater financial, marketing and other resources than ours. Due to the breadth of our product offerings, the number and identities of our competitors vary by product line and market. We consider quality, brand preference, delivery times, engineering specifications, plumbing code requirements, price, technological expertise, breadth of product offerings and integrated solutions offerings to be the primary competitive factors. We believe that new product development and product engineering are also important to success in the water industry and that our position in the industry is attributable in part to our ability to develop new and innovative products quickly and to adapt and enhance existing products. We continue to develop new and innovative products to enhance our market position and are continuing to implement manufacturing and design programs to reduce costs. We cannot be certain that our efforts to develop new products will be successful or that our customers will accept our new products. Although we own certain patents and trademarks that we consider to be of importance, we do not believe that our business and competitiveness as a whole are dependent on any one of our patents or trademarks or on patent or trademark protection generally.

 

Backlog

 

Backlog was approximately $86.3 million at January 28, 2018 and approximately $83.2 million at January 29, 2017. We do not believe that our backlog at any point in time is indicative of future operating results and we expect our entire current backlog to be converted to sales in 2018.

 

Employees

 

As of December 31, 2017, we employed approximately 4,800 people worldwide. With the exception of two subsidiaries, one in Canada and the other in New York, none of our employees in the Americas or APMEA are covered by collective bargaining agreements. In some European countries, our employees are subject to traditional national collective bargaining agreements. We believe that our employee relations are good.

 

Product Liability, Environmental and Other Litigation Matters

 

We are subject to a variety of potential liabilities connected with our business operations, including potential liabilities and expenses associated with possible product defects or failures and compliance with environmental laws. We maintain product liability and other insurance coverage, which we believe to be generally in accordance with industry practices. Nonetheless, such insurance coverage may not be adequate to protect us fully against substantial damage claims.

 

Contingencies

 

Connector Class Actions

 

In November and December 2014, Watts Water Technologies, Inc. and Watts Regulator Co. were named as defendants in three separate putative nationwide class action complaints (Meyers v. Watts Water Technologies, Inc., United States District Court for the Southern District of Ohio; Ponzo v. Watts Regulator Co., United States District Court for the District of Massachusetts; Sharp v. Watts Regulator Co., United States District Court for the District of Massachusetts) seeking to recover damages and other relief based on the alleged failure of water heater connectors. On June 26, 2015,

plaintiffs in the three actions filed a consolidated amended complaint, under the case captioned Ponzo v. Watts Regulator Co., in the United States District Court for the District of Massachusetts (hereinafter “Ponzo”). Watts Water Technologies was voluntarily dismissed from the Ponzo case. The complaint sought among other items, damages in an unspecified amount, replacement costs, injunctive relief, declaratory relief, and attorneys’ fees and costs. On August 7, 2015, the Company filed a motion to dismiss the complaint, which motion was mooted by the class settlements.

 

In February 2015, Watts Regulator Co. was named as a defendant in a putative nationwide class action complaint (Klug v. Watts Water Technologies, Inc., et al., United States District Court for the District of Nebraska) seeking to recover damages and other relief based on the alleged failure of the Company’s Floodsafe connectors (hereinafter “Klug”). On June 26, 2015, the Company filed a partial motion to dismiss the complaint. In response, on July 17, 2015, plaintiff filed an amended complaint which added additional named plaintiffs and sought to correct deficiencies in the original complaint, Klug v. Watts Regulator Co., United States District Court for the District of Nebraska. The complaint seeks among other items, damages in an unspecified amount, injunctive relief, declaratory relief, and attorneys’ fees and costs. On July 31, 2015, the Company filed a partial motion to dismiss the complaint which was granted in part and denied in part on December 29, 2015. The Company answered the amended complaint on February 2, 2016.  No formal discovery was conducted.

 

The Company participated in mediation sessions of the Ponzo and Klug cases in December 2015 and January 2016. On February 16, 2016, the Company reached an agreement in principle to settle all claims. The proposed total settlement amount is $14 million, of which the Company is expected to pay approximately $4.1 million after insurance proceeds of up to $9.9 million. The parties executed final written settlement agreements in April 2016. Motions for preliminary approval of the settlements were submitted on May 4, 2016 before the District of Nebraska Federal Court. On December 7, 2016, the Court issued an order preliminarily approving the settlements. After a fairness hearing held on April 12, 2017, the Court entered Final Orders and Judgments approving the settlements on April 13, 2017. No appeals were filed and the settlements became final on May 15, 2017.

 

Environmental Remediation

 

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

 

Asbestos Litigation

 

We are defending approximately 355 lawsuits in different jurisdictions, alleging injury or death as a result of exposure to asbestos. The complaints in these cases typically name a large number of defendants and do not identify any of our particular products as a source of asbestos exposure. To date, discovery has failed to yield evidence of substantial exposure to any of our products and no judgments have been entered against us.

 

Other Litigation

 

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

 

Available Information

 

We maintain a website with the address www.wattswater.com. The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10‑K. Other than an investor’s own internet access charges, we make available free of charge through our website our Annual Report on Form 10‑K, quarterly reports on Form 10‑Q and current reports on Form 8‑K, and amendments to these reports, as soon as reasonably

practicable after we have electronically filed such material with, or furnished such material to, the Securities and Exchange Commission (SEC).

 

Executive Officers and Directors

 

Set forth below are the names of our executive officers and directors, their respective ages and positions with our Company and a brief summary of their business experience for at least the past five years:

 

 

 

 

Robert J. Pagano, Jr. has served as Chief Executive Officer, President and a director of our Company since May 2014. He also served as interim Chief Financial Officer from October 2014 to April 2015. Mr. Pagano previously served as Senior Vice President of ITT Corporation and President, ITT Industrial Process from April 2009 to May 2014. Mr. Pagano originally joined ITT in 1997 and served in several additional management roles during his career at ITT, including as Vice President Finance, Corporate Controller, and President of Industrial Products. ITT Corporation is a diversified manufacturer of highly engineered critical components and customized technology solutions for the energy, transportation and industrial markets. Prior to joining ITT, Mr. Pagano worked at KPMG LLP. Mr. Pagano is a Certified Public Accountant.  Mr. Pagano has also served as a member of the Board of Directors of Applied Industrial Technologies, Inc. since August 2017.  Applied Industrial Technologies is a distributor of bearings, power transmission products, fluid power components and other industrial supplies and provides engineering, design and systems integration for industrial and fluid power applications, as well as customized mechanical, fabricated rubber and fluid power shop services.

 

Todd A. Trapp has served as Chief Financial Officer since April 2015. Mr. Trapp previously served as Vice President of Financial Planning & Analysis of Honeywell International Inc. from August 2013 to April 2015. Mr. Trapp originally joined Honeywell in 2002 and served in several senior financial roles, including as Chief Financial Officer of the Airlines Business Unit from November 2010 to August 2013, Vice President of Business Analysis & Planning for Honeywell’s Aerospace Division from 2008 to November 2010, Director of Finance for the Transportation Systems Division from 2006 to 2008, Director of Business Analysis & Planning from 2005 to 2006, Investor Relations Manager from 2003 to 2005 and Senior Financial Analyst from 2002 to 2003. Honeywell is a Fortune 100 diversified technology and manufacturing leader, serving customers worldwide with aerospace products and services; control technologies for buildings, homes and industry; turbochargers; and performance materials. Prior to joining Honeywell, Mr. Trapp worked

as Assistant Treasurer at United Business Media Inc. and Manager of Treasury Services and Special Projects at Pearson Inc.

 

Jennifer L. Congdon has served as Chief Human Resources Officer since December 2016.  Ms. Congdon previously served as Vice President, Human Resources, Applied Water Systems and Business Transformation and Continuous Improvement with Xylem Inc. from August 2012 to December 2016.  Xylem is a global designer, manufacturer and equipment and service provider for water and wastewater applications.  From 2010 to August 2012, Ms. Congdon served as Vice President, Human Resources, Power Transmission for Rexnord Corporation.  Rexnord Corporation is a multi-industry manufacturer and marketer of highly engineered mechanical power transmission components and water management products.  From 2004 to 2010, Ms. Congdon held several human resources management positions of increasing responsibility with Honeywell International Inc.  Prior to joining Honeywell, Ms. Congdon was a Human Resources Manager with Cisco Systems, Inc. and worked as a human resources consultant.

 

Kenneth R. Lepage has served as General Counsel, Executive Vice President and Secretary of the Company since August 2008. He also served as Executive Vice President of Human Resources from December 2009 to October 2015. Mr. Lepage originally joined our Company in September 2003 as Assistant General Counsel and Assistant Secretary. Prior to joining our Company, he was a junior partner at the law firm of Hale and Dorr LLP (now Wilmer Cutler Pickering Hale and Dorr LLP).

 

Elie A. Melhem has served as President, Asia‑Pacific, Middle East & Africa since February 2016. Mr. Melhem originally joined our Company in July 2011 as President, Asia‑Pacific. Mr. Melhem was previously the Managing Director of China for Ariston Thermo Group, a global manufacturer of heating and hot water products, from 2008 to July 2011. Prior to joining Ariston, Mr. Melhem spent eleven years with ITT Industries in China where he held several management positions, including serving as President of ITT’s Residential and Commercial Water Group in China and President of ITT’s Water Technology Group in Asia.

 

Munish Nanda has served as President, Americas & Europe since February 2016. Mr. Nanda originally joined our Company in April 2015 as President, Americas. Mr. Nanda previously served as President of Control Technologies for ITT Corporation from April 2011 to March 2015. Mr. Nanda also served as Group Vice President of ITT Corporation’s Fluid and Motion Control Group from April 2008 to April 2011. ITT Corporation is a diversified manufacturer of highly engineered critical components and customized technology solutions for the energy, transportation and industrial markets. Prior to joining ITT Corporation, Mr. Nanda held several operating leadership and general management positions with Thermo Fisher Scientific Corporation and Honeywell International Inc.

 

Robert L. Ayers has served as a director of our Company since October 2006. He was Senior Vice President of ITT Industries and President of ITT Industries’ Fluid Technology from October 1999 until September 2005. Mr. Ayers continued to be employed by ITT Industries from September 2005 until his retirement in September 2006, during which time he focused on special projects for the company. Mr. Ayers joined ITT Industries in 1998 as President of ITT Industries’ Industrial Pump Group. Before joining ITT Industries, he was President of Sulzer Industrial USA and Chief Executive Officer of Sulzer Bingham, a pump manufacturer. Mr. Ayers served as a director of T‑3 Energy Services, Inc. from August 2007 to January 2011.

 

Christopher L. Conway has served as a director of our Company since June 2015. Mr. Conway was President, Chief Executive Officer and Chairman of the Board of CLARCOR Inc. from December 2011 until it was acquired in February 2017.  Mr. Conway is now retired. Mr. Conway originally joined CLARCOR in 2006 and served in several senior management roles prior to becoming President and Chief Executive Officer, including Chief Operating Officer, President of CLARCOR’s PECOFacet division, President of Facet USA, Inc., an affiliate of CLARCOR, and Vice President of Manufacturing of Baldwin Filters, Inc., another affiliate of CLARCOR.  CLARCOR was a diversified marketer and manufacturer of mobile, industrial and environmental filtration products sold in domestic and international markets.  Prior to joining CLARCOR, Mr. Conway served for two years as the Chief Operating Officer of Cortron Corporation, Inc., a manufacturing start-up based in Minneapolis, Minnesota.  Mr. Conway also served for seven years in various management positions at Pentair, Inc., an international provider of products, services, and solutions for its customers' diverse needs in water and other fluids, thermal management, and equipment protection.

 

David A. Dunbar has served as a director of our Company since February 2017.  Mr. Dunbar has served as President, and Chief Executive Officer and a member of the Board of Directors of Standex International Corporation since January 2014, and as Chairman since October 2016.  Standex is a global, multi-industry manufacturer in five broad business

segments: Food Service Equipment Group, Engineering Technologies Group, Engraving Group, Electronics Group, and Hydraulics Group. Mr. Dunbar previously served as President of the valves and controls global business unit of Pentair Ltd. from October 2009 to December 2013.  The unit was initially owned by Tyco Flow Control and Tyco Flow Control and Pentair merged in 2012. Pentair is a global provider of products and services relating to energy, water, thermal management and equipment protection. Prior to his tenure at Pentair, Mr. Dunbar held a number of senior positions at Emerson Electric Co., including President of each of the following: Emerson Process Management Europe; Machinery Health Management; and Emerson Climate Technologies Refrigeration.

 

Jes Munk Hansen has served as a director of our Company since February 2017.  Mr. Hansen was Chief Executive Officer of LEDVANCE GmbH from July 2015 to December 2017.  LEDVANCE is the general lighting lamps business unit of OSRAM GmbH.  Mr. Hansen previously served as Chief Executive Officer of the classical lamps and ballast business unit of OSRAM from January 2015 to July 2015 and as Chief Executive Officer of OSRAM Americas and President of OSRAM Sylvania from October 2013 to January 2015.  OSRAM is a leading global lighting manufacturer. Prior to his tenure at OSRAM, Mr. Hansen served in several senior management roles with Grundfos from 2000 to October 2013, including as Chief Executive Officer and President of Grundfos North America from 2007 to October 2013. Grundfos is a leading global manufacturer of pumps as well as motors and electronics for monitoring and controlling pumps.

 

W. Craig Kissel has served as a director of our Company since November 2011. Mr. Kissel previously was employed by American Standard Companies Inc. from 1980 until his retirement in September, 2008. American Standard was a leading worldwide supplier of air conditioning and heating systems, vehicle control systems, and bathroom china and faucet‑ware. During his time at American Standard, Mr. Kissel served as President of Trane Commercial Systems from 2004 to June, 2008, President of WABCO Vehicle Control Systems from 1998 to 2003, President of the Trane North American Unitary Products Group from 1994 to 1997, Vice President of Trane Marketing of the North American Unitary Products Group from 1992 to 1994 and he held various other management positions at Trane from 1980 to 1991. From 2001 to 2008, Mr. Kissel served as Chairman of American Standard’s Corporate Ethics and Integrity Council, which was responsible for developing the company’s ethical business standards. Mr. Kissel also served in the U.S. Navy from 1973 to 1978. Mr. Kissel has served as a director of Chicago Bridge & Iron Company since May 2009. Chicago Bridge & Iron Company engineers and constructs some of the world’s largest energy infrastructure projects.

 

Joseph T. Noonan has served as a director of our Company since May 2013. Mr. Noonan has served as Chief Executive Officer of Homespun Design, Inc. since November 2013. Homespun Design is a start‑up phase online retailer of American‑made furniture and design founded by Mr. Noonan. Mr. Noonan previously worked as an independent digital strategy consultant from November 2012 to November 2013. Mr. Noonan was employed by Wayfair LLC from April 2008 to November 2012. During his time at Wayfair, Mr. Noonan served as Senior Director of Wayfair International from June 2011 to November 2012, Director of Category Management and Merchandising from February 2009 to June 2011 and Manager of Wayfair’s Business‑to‑Business Division from April 2008 to February 2009. Wayfair is an online retailer of home furnishings, décor and home improvement products. Prior to joining Wayfair, Mr. Noonan worked as a venture capitalist at Polaris Partners and as an investment banker at Cowen & Company.

 

Merilee Raines has served as a director of our Company since February 2011. Ms. Raines served as Chief Financial Officer of IDEXX Laboratories, Inc. from October 2003 until her retirement in May 2013. Prior to becoming Chief Financial Officer, Ms. Raines held several management positions with IDEXX Laboratories, including Corporate Vice President of Finance, Vice President and Treasurer of Finance, Director of Finance, and Controller. IDEXX Laboratories develops, manufactures and distributes diagnostic and information technology‑based products and services for companion animals, livestock, poultry, water quality and food safety, and human point‑of‑care diagnostics. Ms. Raines served as a member of the Board of Directors of Affymetrix, Inc., a provider of life science and molecular diagnostic products that enable analysis of biological systems at the gene, protein and cell level, from January 2015 until it was acquired in March 2016.  Ms. Raines is currently a member of the Board of Directors of Aratana Therapeutics, Inc., a pet therapeutics company focused on licensing, developing and commercializing biopharmaceutical products for companion animals.

 

Joseph W. Reitmeier has served as a director of our Company since February 2016. Mr. Reitmeier has served as Executive Vice President & Chief Financial Officer of Lennox International Inc. since July 2012. Mr. Reitmeier had served as Vice President of Finance for the LII Commercial business segment of Lennox International from 2007 to July 2012 and as Director of Internal Audit from 2005 to 2007. Lennox International is a leading global provider of climate control solutions and designs, manufactures and markets a broad range of products for the heating, ventilation, air

conditioning and refrigeration markets. Before joining Lennox International, Mr. Reitmeier held financial leadership roles at Cummins Inc. and PolyOne Corporation.

 

 

Item 1A.   RISK FACTORS.

 

Economic cycles, particularly those involving reduced levels of commercial and residential starts and remodeling, may have adverse effects on our revenues and operating results.

 

We have experienced and expect to continue to experience fluctuations in revenues and operating results due to economic and business cycles. The businesses of most of our customers, particularly plumbing and heating wholesalers and OEM manufacturers, are cyclical. Therefore, the level of our business activity has been cyclical, fluctuating with economic cycles. An economic downturn may also affect the financial stability of our customers, which could affect their ability to pay amounts owed to their vendors, including us. We also believe our level of business activity is influenced by commercial and residential starts and renovation and remodeling, which are, in turn, heavily influenced by interest rates, consumer debt levels, changes in disposable income, employment growth and consumer confidence. Credit market conditions may prevent commercial and residential builders or developers from obtaining the necessary capital to continue existing projects or to start new projects. This may result in the delay or cancellation of orders from our customers or potential customers and may adversely affect our revenues and our ability to manage inventory levels, collect customer receivables and maintain profitability. If economic conditions worsen in the future or if economic recovery were to dissipate, our revenues and profits could decrease or trigger additional goodwill, indefinite‑lived intangible assets, or long‑lived asset impairments and could have a material effect on our financial condition and results of operations.

 

We face intense competition and, if we are not able to respond to competition in our markets, our revenues and profits may decrease.

 

Competitive pressures in our markets could adversely affect our competitive position, leading to a possible loss of market share or a decrease in prices, either of which could result in decreased revenues and profits. We encounter intense competition in all areas of our business. Additionally, we believe our customers are attempting to reduce the number of vendors from which they purchase in order to reduce the size and diversity of their inventories and their transaction costs. To remain competitive, we will need to invest continually in manufacturing, product development, marketing, customer service and support and our distribution networks. We may not have sufficient resources to continue to make such investments and we may be unable to maintain our competitive position. In addition, we may have to reduce the prices of some of our products to stay competitive, potentially resulting in a reduction in the profit margin for, and inventory valuation of, these products. Some of our competitors are based in foreign countries and have cost structures and prices in foreign currencies. Accordingly, currency fluctuations could cause our U.S. dollar costed products to be less competitive than our competitors’ products costed in other currencies.

 

Changes in the costs of raw materials could reduce our profit margins. Reductions or interruptions in the supply of components or finished goods from international sources could adversely affect our ability to meet our customer delivery commitments.

 

We require substantial amounts of raw materials, including bronze, brass, cast iron, stainless steel and plastic, and substantially all of the raw materials we require are purchased from outside sources. The costs of raw materials may be subject to change due to, among other things, interruptions in production by suppliers and changes in exchange rates and worldwide price and demand levels. We typically do not enter into long‑term supply agreements. Our inability to obtain supplies of raw materials for our products at favorable costs could have a material adverse effect on our business, financial condition or results of operations by decreasing our profit margins. The commodity markets have experienced tremendous volatility over the past several years, particularly copper. Should commodity costs increase substantially, we may not be able to recover such costs, through selling price increases to our customers or other product cost reductions, which would have a negative effect on our financial results. If commodity costs decline, we may experience pressure from customers to reduce our selling prices. Additionally, we continue to purchase increased levels of components and finished goods from international sources. In limited cases, these components or finished goods are single‑sourced. The availability of components and finished goods from international sources could be adversely impacted by, among other things, interruptions in production by suppliers, suppliers’ allocations to other purchasers and new laws, tariffs, or regulations.

 

We are subject to risks associated with changing technology, manufacturing techniques, distribution channels and business continuity, which could place us at a competitive disadvantage.

 

The successful implementation of our business strategy requires us to continually evolve our existing products and introduce new products to meet customers’ needs in the industries we serve. Our products are characterized by stringent performance and specification requirements that mandate a high degree of manufacturing and engineering expertise. If we fail to meet these requirements, our business could be at risk. We believe that our customers rigorously evaluate their suppliers on the basis of a number of factors, including product quality, price competitiveness, technical and manufacturing expertise, development and product design capability, new product innovation, reliability and timeliness of delivery, operational flexibility, customer service and overall management. Our success will depend on our ability to continue to meet customers’ changing specifications with respect to these criteria. We cannot ensure that we will be able to address technological advances or introduce new products that may be necessary to remain competitive within our business. We cannot ensure that we can adequately protect any of our technological developments to produce a sustainable competitive advantage. Furthermore, we may be subject to business continuity risk in the event of an unexpected loss of a material facility or operation. We cannot ensure that we adequately protect against such loss.

 

Changes in regulations or standards could adversely affect our business.

 

Our products and business are subject to a wide variety of statutory, regulatory and industry standards and requirements. A significant change to regulatory requirements, whether federal, foreign, state or local, or to industry standards, could substantially increase manufacturing costs, impact the size and timing of demand for our products, or put us at a competitive disadvantage, any of which could harm our business and have a material adverse effect on our financial condition, results of operations and cash flow.

 

Implementation of our acquisition strategy may not be successful, which could affect our ability to increase our revenues or our profitability.

 

One of our strategies is to increase our revenues and profitability and expand our business through acquisitions that will provide us with complementary products and increase market share for our existing product lines. We cannot be certain that we will be able to identify, acquire or profitably manage additional companies or successfully integrate such additional companies without substantial costs, delays or other problems. Also, companies acquired recently and in the future may not achieve anticipated revenues, cost synergies, profitability or cash flows that justify our investment in them. We have faced increasing competition for acquisition candidates, which has resulted in significant increases in the purchase prices of many acquisition candidates. This competition, and the resulting purchase price increases, may limit the number of acquisition opportunities available to us, possibly leading to a decrease in the rate of growth of our revenues and profitability. In addition, acquisitions may involve a number of risks, including, but not limited to:

 

 

 

 

 

 

 

 

We are subject to risks related to product defects, which could result in product recalls and could subject us to warranty claims in excess of our warranty provisions or which are greater than anticipated due to the unenforceability of liability limitations.

 

We cannot be certain that our quality controls and procedures, including the testing of raw materials and safety testing of selected finished products, will reveal latent defects in our products or the materials from which they are made, which may not become apparent until after the products have been sold into the market. We also cannot be certain that our suppliers will always eliminate latent defects in products we purchase from them. Accordingly, there is a risk that product defects will occur, which could require a product recall. Product recalls can be expensive to implement and, if a product recall occurs during the product’s warranty period, we may be required to replace the defective product. In addition, a product recall may damage our relationship with our customers and we may lose market share with our customers. Our insurance policies may not cover the costs of a product recall.

 

Our standard warranties contain limits on damages and exclusions of liability for consequential damages and for misuse, improper installation, alteration, accident or mishandling while in the possession of someone other than us. We may incur additional operating expenses if our warranty provision does not reflect the actual cost of resolving issues related to defects in our products. If these additional expenses are significant, it could adversely affect our business, financial condition and results of operations.

 

We face risks from product liability and other lawsuits, which may adversely affect our business.

 

We have been and expect to continue to be subject to various product liability claims or other lawsuits, including, among others, that our products include inadequate or improper instructions for use or installation, inadequate warnings concerning the effects of the failure of our products, alleged manufacturing or design defects, or allegations that our products contained asbestos. If we do not have adequate insurance or contractual indemnification, damages from these claims would have to be paid from our assets and could have a material adverse effect on our results of operations, liquidity and financial condition. Like other manufacturers and distributors of products designed to control and regulate fluids and gases, we face an inherent risk of exposure to product liability claims and other lawsuits in the event that the use of our products results in personal injury, property damage or business interruption to our customers. We cannot be certain that our products will be completely free from defect. In addition, in certain cases, we rely on third‑party manufacturers for our products or components of our products. We cannot be certain that our insurance coverage will continue to be available to us at a reasonable cost, or, if available, will be adequate to cover any such liabilities. For more information, see “Item 1. Business—Product Liability, Environmental and Other Litigation Matters.”

 

Economic and other risks associated with international sales and operations could adversely affect our business and future operating results.

 

Since we sell and manufacture our products worldwide, our business is subject to risks associated with doing business internationally. Our business and future operating results could be harmed by a variety of factors, including:

 

 

 

 

 

 

 

 

 

 

Our ability to achieve savings through our restructuring and business transformation activities may be adversely affected by management’s ability to fully execute the plans as a result of local regulations, geo‑political risk or other factors within or beyond the control of management.

 

We have implemented a number of restructuring and business transformation activities, which include steps that we believe are necessary to enhance the value and performance of the Company, including reducing operating costs and increasing efficiencies throughout our manufacturing, sales and distribution footprint. Factors within or beyond the control of management may change the total estimated costs or the timing of when the savings will be achieved under the plans. Further, if we are not successful in completing the restructuring or business transformation activities timely or if additional or unanticipated issues such as labor disruptions, inability to retain key personnel during and after the transformation or higher exit costs arise, our expected cost savings may not be met and our operating results could be negatively affected. In addition, our restructuring and transformation activities may place substantial demands on our management, which could lead to diversion of management’s attention from other business priorities and result in a reduced customer focus.

 

Our operating results could be negatively affected by changes in tax rates, the adoption of new tax legislation, or exposure to additional tax liabilities.

 

As a global company, we are subject to taxation in numerous countries, states and other jurisdictions.  As a result, our effective rate is derived from a combination of applicable tax rates in the various places that we operate.  Our future taxes could be affected by numerous factors including changes in the mix of our profitability from country to country, the results of examinations and audits of our tax filings, adjustments to our uncertain tax positions, changes in accounting for income taxes and changes in tax laws.

 

In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain.  Significant judgment is required in determining our global provision for income taxes, deferred tax assets or liabilities, and in evaluating our tax positions.  Although we believe our estimates are reasonable, our tax filings are regularly under audit by tax authorities and the ultimate tax outcome may differ from the amounts recorded and may materially affect our financial results in the period or periods for which such determination is made.

 

The U.S. federal government enacted the Tax Cuts and Jobs Act (“2017 Tax Act”) on December 22, 2017.  The 2017 Tax Act has resulted in significant changes to the U.S. corporate income tax system.  These changes include lowering the corporate tax rate, implementing a territorial tax system, and imposing a one-time deemed repatriation toll tax on cumulative undistributed foreign earnings.

 

Due to the timing of the enactment and the complexity involved applying the provisions of the 2017 Tax Act, we made reasonable estimates of the effects and recorded provisional amounts in our financial statements as of December 31, 2017. As additional regulatory guidance is issued by the applicable taxing authorities, as accounting treatment is clarified, as we perform additional analysis on the application of the law, and as we refine estimates in calculating the effect, our final analysis, which will be recorded in the period completed, may be different from our current provisional amounts, which could materially affect our tax obligations and effective tax rate in the period or periods in which the adjustments are made.

 

We are currently a decentralized company, which presents certain risks.

 

We are currently a decentralized company, which sometimes places significant control and decision‑making powers in the hands of local management. This presents various risks such as the risk of being slower to identify or react to problems affecting a key business. Additionally, we are implementing in a phased approach a company‑wide initiative to standardize and upgrade our enterprise resource planning (ERP) systems. This initiative could be more challenging and costly to implement because divergent legacy systems currently exist. Further, if the ERP updates are not successful, we could incur substantial business interruption, including our ability to perform routine business transactions, which could have a material adverse effect on our financial results.

 

Our business and financial performance may be adversely affected by information technology and other business disruptions.

 

Our business may be impacted by disruptions, including information technology attacks or failures, threats to physical security, as well as damaging weather or other acts of nature, pandemics or other public health crises. Cyber security attacks, in particular, are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and corruption of data. Cyber security may also be breached due to employee error, malfeasance, system errors or vulnerabilities, including vulnerabilities of our vendors, suppliers, and their products. We have experienced cyber security attacks and may continue to experience them going forward, potentially with more frequency. Given the unpredictability of the timing, nature and scope of such disruptions, we could potentially be subject to production downtimes, operational delays, other detrimental impacts on our operations or ability to provide products to our customers, the compromising of confidential or otherwise protected information, misappropriation, destruction or corruption of data, security breaches, other manipulation or improper use of our systems or networks, financial losses from remedial actions, loss of business or potential liability, and/or damage to our reputation, any of which could have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.

 

The requirements to evaluate goodwill, indefinite‑lived intangible assets and long‑lived assets for impairment may result in a write‑off of all or a portion of our recorded amounts, which would negatively affect our operating results and financial condition.

 

As of December 31, 2017, our balance sheet included goodwill, indefinite‑lived intangible assets, amortizable intangible assets and property, plant and equipment of $550.5 million, $37.3 million, $147.9 million and $198.5 million, respectively. In lieu of amortization, we are required to perform an annual impairment review of both goodwill and indefinite‑lived intangible assets. In 2017 and 2016, none of our goodwill reporting units were impaired. In 2015, we recognized a pre‑tax non‑cash goodwill impairment charge of $129.7 million. The $129.7 million charge in 2015 related to an impairment within the Europe reporting unit and represented approximately 74% of the reporting unit’s goodwill balance. In 2017, none of our indefinite-lived tradenames were impaired. In performing our annual reviews in 2016 and 2015, we recognized pre‑tax non‑cash indefinite‑lived intangible asset impairment charges of approximately $0.4 million and $0.6 million, respectively. We are also required to perform an impairment review of our long‑lived assets if indicators of impairment exist. In 2017, 2016, and 2015, we recognized pre‑tax non‑cash charges of $1.0 million, $0.1 million, and $0.3 million, respectively.

 

There can be no assurances that future goodwill, indefinite‑lived intangible assets or other long‑lived asset impairments will not occur. We perform our annual test for indications of goodwill and indefinite‑lived intangible assets impairment in the fourth quarter of our fiscal year or sooner if indicators of impairment exist.

 

The loss or financial instability of major customers could have an adverse effect on our results of operations.

 

In 2017, our top ten customers accounted for approximately 21% of our total net sales with no one customer accounting for more than 10% of our total net sales. Our customers generally are not obligated to purchase any minimum volume of products from us and are able to terminate their relationships with us at any time. In addition, increases in the prices of our products could result in a reduction in orders from our customers. A significant reduction in orders from, or change in terms of contracts with, any significant customers could have a material adverse effect on our future results of operations.

 

Certain indebtedness may limit our ability to pay dividends, incur additional debt and make acquisitions and other investments.

 

Our revolving credit facility and other senior indebtedness contain operational and financial covenants that restrict our ability to make distributions to stockholders, incur additional debt and make acquisitions and other investments unless we satisfy certain financial tests and comply with various financial ratios. If we do not maintain compliance with these covenants, our creditors could declare a default under our revolving credit facility or senior notes and our indebtedness could be declared immediately due and payable. Our ability to comply with the provisions of our indebtedness may be affected by changes in economic or business conditions beyond our control. Further, one of our strategies is to increase our revenues and profitability and expand our business through acquisitions. We may require capital in excess of our available cash and the unused portion of our revolving credit facility to make large acquisitions, which we would generally obtain from access to the credit markets. There can be no assurance that if a large acquisition is identified that we would have access to sufficient capital to complete such acquisition. Should we require additional debt financing above our existing credit limit, we cannot be assured such financing would be available to us or available to us on reasonable economic terms.

 

One of our stockholders can exercise substantial influence over our Company.

 

As of January 28, 2018, Timothy P. Horne beneficially owned 6,329,290 shares of Class B common stock. Our Class B common stock entitles its holders to ten votes for each share and our Class A common stock entitles its holders to one vote per share. As of January 28, 2018, Timothy P. Horne beneficially owned approximately 18.6% of our outstanding shares of Class A common stock (assuming conversion of all shares of Class B common stock beneficially owned by Mr. Horne into Class A common stock) and approximately 99.2% of our outstanding shares of Class B common stock, which represents approximately 69.2% of the total outstanding voting power. As long as Mr. Horne controls shares representing at least a majority of the total voting power of our outstanding stock, Mr. Horne will be able to unilaterally determine the outcome of most stockholder votes, and other stockholders will not be able to affect the outcome of any such votes.

 

Conversion and sale of a significant number of shares of our Class B common stock could adversely affect the market price of our Class A common stock.

 

As of January 28, 2018, there were outstanding 27,690,781 shares of our Class A common stock and 6,379,290 shares of our Class B common stock. Shares of our Class B common stock may be converted into Class A common stock at any time on a one for one basis. Under the terms of a registration rights agreement with respect to outstanding shares of our Class B common stock, the holders of our Class B common stock have rights with respect to the registration of the underlying Class A common stock. Under these registration rights, the holders of Class B common stock may require, on up to two occasions that we register their shares for public resale. If we are eligible to use Form S‑3 or a similar short‑form registration statement, the holders of Class B common stock may require that we register their shares for public resale up to two times per year. If we elect to register any shares of Class A common stock for any public offering, the holders of Class B common stock are entitled to include shares of Class A common stock into which such shares of Class B common stock may be converted in such registration. However, we may reduce the number of shares proposed to be registered in view of market conditions. We will pay all expenses in connection with any registration, other than underwriting discounts and commissions. If all of the available registered shares are sold into the public market the trading price of our Class A common stock could decline.

 

Item 1B.  UNRESOLVED STAFF COMMENTS.

 

None.

 

Item 2.   PROPERTIES.

 

We maintain 31 principal manufacturing, warehouse and distribution centers worldwide, including our corporate headquarters located in North Andover, Massachusetts. Additionally, we maintain numerous sales offices and other smaller manufacturing facilities and warehouses. The principal properties in each of our three geographic segments and their location, principal use and ownership status are set forth below:

 

Americas:

 

 

Europe

 

 

Asia‑Pacific, Middle East, and Africa:

 

 

Certain of our facilities are subject to capital lease arrangements and collateral assignments under loan agreements with long‑term lenders. In general, we believe that our properties, including machinery, tools and equipment, are in good condition, well maintained and adequate and suitable for their intended uses.

 

Item 3.   LEGAL PROCEEDINGS.

 

We are from time to time involved in various legal and administrative proceedings. See Item 1. “Business—Product Liability, Environmental and Other Litigation Matters,” and Note 15 of the Notes to Consolidated Financial Statements, both of which are incorporated herein by reference.

 

Item 4.  MINE SAFETY DISCLOSURES.

 

Not applicable.

PART II

 

Item 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

The following table sets forth the high and low sales prices of our Class A common stock on the New York Stock Exchange during 2017 and 2016 and cash dividends declared per share.

 

 

There is no established public trading market for our Class B common stock, which is held by members of the Horne family. The principal holders of such stock are subject to restrictions on transfer with respect to their shares. Each share of our Class B common stock (10 votes per share) is convertible into one share of Class A common stock (1 vote per share).

 

On February 8, 2018, we declared a quarterly dividend of nineteen cents ($0.19) per share on each outstanding share of Class A common stock and Class B common stock.

 

Aggregate common stock dividend payments in 2017 were $25.9 million, which consisted of $21.1 million and $4.8 million for Class A shares and Class B shares, respectively. Aggregate common stock dividend payments in 2016 were $24.5 million, which consisted of $20.0 million and $4.5 million for Class A shares and Class B shares, respectively. While we presently intend to continue to pay comparable cash dividends, the payment of future cash dividends depends upon the Board of Directors’ assessment of our earnings, financial condition, capital requirements and other factors.

 

The number of record holders of our Class A common stock as of January 30, 2018 was 160. The number of record holders of our Class B common stock as of January 30, 2018 was 10.

 

We satisfy the minimum withholding tax obligation due upon the vesting of shares of restricted stock and the conversion of restricted stock units into shares of Class A common stock by automatically withholding from the shares being issued a number of shares with an aggregate fair market value on the date of such vesting or conversion that would satisfy the withholding amount due.

 

The following table includes information with respect to shares of our Class A common stock withheld to satisfy withholding tax obligations during the quarter ended December 31, 2017.

 

 

The following table includes information with respect to repurchases of our Class A common stock during the three‑month period ended December 31, 2017 under our stock repurchase program.

 

 

Performance Graph

 

Set forth below is a line graph comparing the cumulative total shareholder return on our Class A common stock for the last five years with the cumulative return of companies on the Standard & Poor’s 500 Stock Index and the Russell 2000 Index. We chose the Russell 2000 Index because it represents companies with a market capitalization similar to that of

Watts Water. The graph assumes that the value of the investment in our Class A common stock and each index was $100 at December 31, 2012 and that all dividends were reinvested.

 

 

*$100 invested on 12/31/12 in stock or index, including reinvestment of dividends. Fiscal year ending December 31.

 

Cumulative Total Return

 

 

The above Performance Graph and related information shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.

 

Item 6.   SELECTED FINANCIAL DATA.

 

The selected financial data set forth below should be read in conjunction with our consolidated financial statements, related Notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein.

 

FIVE‑YEAR FINANCIAL SUMMARY

 

(Amounts in millions, except per share and cash dividend information)

 

 

 

 

 

 

 

Item 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

Overview

 

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

 

 

 

 

 

Our business is reported in three geographic segments: Americas, Europe, and APMEA. We distribute our products through four primary distribution channels: wholesale, original equipment manufacturers (OEMs), specialty, and do-it-yourself (DIY). In September 2015, we divested a substantial portion of our DIY business in the Americas, which reduced the significance of DIY as a distribution channel for our products in 2017 and 2016.

 

Prior to 2017, our Europe segment was formerly referred to as EMEA (Europe, Middle East, and Africa) and our APMEA segment was formerly referred to as Asia-Pacific. As of January 1, 2017, we began reporting the results of Watts Industries Middle East, an indirect, wholly owned subsidiary, within our APMEA segment to align with internal operating changes. These results had previously been reported within our former EMEA segment. This change does not affect our reportable segments but represents only a change in composition that better aligns with the structure of our internal organization. The 2016 and 2015 results by segment have been retrospectively revised for comparative purposes.

 

We believe that the factors relating to our future growth include continued product innovation that meets the needs of our customers and our end markets; our ability to make selective acquisitions, both in our core markets as well as in new complementary markets; regulatory requirements relating to the quality and conservation of water and the safe use of water; increased demand for clean water; continued enforcement of plumbing and building codes; and a healthy economic environment. We have completed 10 acquisitions in the last decade. Our acquisition strategy focuses on businesses that promote our key macro themes around safety & regulation, energy efficiency and water conservation. We target businesses that will provide us with one or more of the following: an entry into new markets and/or new geographies, improved channel access, unique and/or proprietary technologies, advanced production capabilities or complementary solution offerings.

Our innovation strategy is focused on differentiated products that provide greater opportunity to distinguish ourselves in the market place. Conversely, we want to migrate away from commoditized products where we cannot add value.  Our

goal is to be a solutions provider, not merely a components supplier. We continually look for strategic opportunities to invest in new products and markets or divest existing product lines where necessary in order to meet those objectives.

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

 

In 2017, we successfully completed our transformation programs and realized the benefits of our product portfolio rationalization, footprint optimization, and global sourcing initiatives, while simultaneously reinvesting in the business. We continued to drive commercial and operational excellence.  We completed the integration of PVI Industries, LLC (“PVI”) to our portfolio during the year. We continued to streamline our product portfolio across the regions as we focus on our core product lines and rationalize certain low-margin, non-core products. Our financial performance in 2017 was solid, driven by growth in the Americas and Europe segments and realization of our productivity and transformation savings.

 

The 2017 Tax Act has resulted in significant changes to the U.S. corporate income tax system and was enacted on December 22, 2017. These changes include a federal statutory rate reduction from 35% to 21% effective on January 1, 2018, the elimination or reduction of certain domestic deductions and credits, and limitations on the deductibility of interest expense and executive compensation. The 2017 Tax Act transitions international taxation from a worldwide system to a modified territorial system and includes base erosion prevention measures on non-U.S. earnings. The 2017 Tax Act also includes a one-time mandatory deemed repatriation tax on accumulated foreign subsidiaries' previously untaxed foreign earnings (“Toll Tax”).

Changes in tax rates and tax laws are accounted for in the period of enactment and deferred tax assets and liabilities are measured at the enacted tax rate. Therefore, during the year ended December 31, 2017, we recorded a charge totaling $25.1 million related to our current estimate of the provisions of the 2017 Tax Act, including an estimated $23.3 million expense under the Toll Tax. The Toll Tax will be paid over an eight-year period, starting in 2018, and will not accrue interest.  The provisions of the 2017 Tax Act allows us more flexibility in deploying our global cash resources as we continue to drive a balanced capital allocation strategy.  We expect that the 2017 Tax Act will have a positive effect on our income tax rate in 2018.

 

Overall, reported sales for 2017 increased 4.2%, or $58.3 million, primarily related to an increase in acquired sales of $47.0 million, or 3.3%, relating to the acquisitions of PVI and Watts Korea, an increase in organic sales of $7.0 million, or 0.5%, and an increase in sales due to foreign exchange of $7.8 million, or 0.7%.This increase was partially offset by a decrease in sales of $3.5 million related to product lines we divested by the first quarter of 2016 in the Americas segment as part of our Americas transformation program.  Compared to 2016, reported sales as a percentage of segment sales in the Americas and Europe increased by 5.6% and 2.1%, respectively, while reported sales in APMEA declined by 2.6%.  As a percentage of segment sales, organic sales in the Americas and Europe increased 0.8% and 0.6% respectively, while organic sales in APMEA declined by 4.6% compared to 2016. The increase in organic sales in the Americas was primarily driven by increased sales in our valve, HVAC, and drainage products, partially offset by declines in our tankless water heater and condensing boiler products. In Europe, the increase was primarily driven by our drains and electronics products, offset by a decline in our plumbing products due to the impact of product rationalization.  The decline in APMEA sales primarily related to the impact of product rationalization, partially offset by increased demand for our underfloor heating products and commercial valves and growth in Korea. Operating income of $162.3 million increased by $17.3 million, or 11.9% compared to 2016. This increase is driven by incremental transformation and productivity savings, lower transformation costs, the acquisition of PVI, and higher sales volume.

 

Organic sales is a non-GAAP measure that excludes the impacts of acquisitions, divestitures and foreign exchange from year-over-year comparisons. Divested sales includes the exit of our non-core products through sale and through the discontinuation of product lines. Management believes reporting organic sales growth provides useful information to investors, potential investors and others, because it allows for a more complete understanding of underlying sales trends by providing sales growth on a consistent basis. We reconcile the change in organic sales to our reported sales for each region within our results below.

 

In December 2017, we concluded our transformation program relating to our Americas and APMEA businesses, which primarily involved the exit and discontinuation of low-margin, non-core product lines, enhancing global sourcing capabilities and the reduction of the square footage of our Americas facilities. The transformation program was approved by our Board of Directors in 2015. Over the course of the program, we eliminated approximately $165 million of the combined Americas and APMEA net sales, primarily within our do-it-yourself (DIY) distribution channel. As part of the exit of non-core product lines, we entered into an agreement to sell an operating subsidiary in China that was dedicated exclusively to the manufacturing of products being discontinued. The sale was finalized in the second quarter of 2016, and we recognized a pre-tax gain of $8.7 million and received proceeds from the sale of $8.4 million.  The program also involved the consolidation of manufacturing facilities and distribution center network optimization, reducing the square footage of our Americas facilities net operating footprint by approximately 30%. The footprint focus of the program was designed to improve the utilization of our remaining facilities, better leverage our cost structure, reduce working capital, and improve execution of customer delivery requirements.

 

The total pre-tax cost for our transformation program related to our Americas and APMEA businesses was $59.8 million, including restructuring costs of $18.1 million, goodwill and intangible asset impairments of $13.5 million and other transformation and deployment costs of approximately $28.3 million. The other transformation and deployment costs included consulting and project management fees, inventory write-offs, and other associated costs. The program originally included estimated pre-tax charges totaling approximately $65 million. In the third quarter of 2017, the total expected costs of the planned actions were reduced to approximately $60 million, primarily related to reduced expected facility exit costs and reduced other transformation and deployment costs.  All costs associated with the Americas and APMEA transformation program were incurred as of December 31, 2017. Refer to Note 3 and Note 4 of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K for further details.

 

Acquisitions and Disposals

 

On November 2, 2016, we acquired 100% of the shares of PVI Riverside Holdings, Inc., the parent company of 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 us to address customers’ heating and hot water requirements.

 

On February 26, 2016, we acquired an additional 50% of the outstanding shares of Watts Korea for an aggregate purchase price of approximately $4 million. Prior to February 26, 2016, the Company held a 40% interest in Watts Korea, which operated as a joint venture. We acquired the remaining 10% ownership in the fourth quarter of 2016 and now own 100% of Watts Korea.  Watts Korea strengthens our strategic vision to expand solutions sales into the Korean market. We accounted for the transaction as a step acquisition within a business combination. We recognized a $1.7 million pre-tax gain on the previously held 40% ownership interest in the first quarter of 2016.

 

On September 22, 2015, we signed an agreement to sell an operating subsidiary in China that was dedicated to the production of non-core products. The sale was finalized in the second quarter of 2016, and we received total proceeds of approximately $8.4 million from the sale as of the fourth quarter of 2016. We recognized a pre-tax gain of $8.7 million, which includes a non-cash accumulated currency translation adjustment of $7.3 million. The net after-tax gain was approximately $8.3 million.

 

On November 30, 2015, we acquired 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 we 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. Apex manufactures high‑end valves for the New Zealand market that we believe could be introduced in the China market and other countries in South East Asia. We acquired an additional 10% ownership in the first quarter of 2017 for approximately $2.9 million and now own 90% of the outstanding shares of Apex. We maintain a current liability of approximately $2.9 million for the estimated fair value on the remaining 10% contractual call option, which is expected to be exercised in 2018.

 

Recent Developments

 

On February 8, 2018, we declared a quarterly dividend of nineteen cents ($0.19) per share on each outstanding share of Class A common stock and Class B common stock payable on March 16, 2018 to stockholders of record on March 2, 2018.

 

Results of Operations

 

Year Ended December 31, 2017 Compared to Year Ended December 31, 2016

 

Net Sales.  Our business is reported in three geographic segments: Americas, Europe and APMEA. Our net sales in each of these segments for the years ended December 31, 2017 and December 31, 2016 were as follows:

 

 

The change in net sales was attributable to the following:

 

 

The change in organic net sales as a percentage of consolidated net sales and of segment net sales in the Americas excludes divested sales for both periods presented.

 

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

 

 

The organic sales increase of $7.0 million was partially muted by the $15.1 million impact of our ongoing product rationalization efforts across our regions, as we continue to focus on our core product lines. The product rationalization mainly affected our DIY and OEM channels.

 

Organic net sales in the Americas increased $7.4 million mainly from growth in the wholesale channel, driven by valve, HVAC, and drainage products. This increase was partially offset by declines in the specialty channels, where we experienced weakness in our tankless water heater and condensing boiler products.  There was also a decrease in the DIY channel due to the product rationalization discussed above.

 

Organic net sales in Europe increased $2.5 million primarily due to growth in the wholesale channel from increased sales of our drains products. This increase was also due to higher demand for our electronics products in Germany. These increases were partially offset by product rationalization and reduced demand for our HVAC products in Italy.

 

Organic net sales in APMEA decreased $2.9 million driven primarily by the impact of product rationalization. This decrease was offset partly by higher demand in China for our residential underfloor heating products and commercial valves products, as well as growth in South Korea from an expanded product offering.

 

The net increase in sales due to foreign exchange was primarily due to the appreciation of the euro and the Canadian dollar against the U.S. dollar in 2017. We cannot predict whether foreign currencies will appreciate or depreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.

 

The decrease in total net sales due to divested products of $3.5 million relates to the discontinuation of product lines we divested by the end of the first quarter of 2016 in the Americas segment as part of our Americas transformation program.

 

The increase in net sales from acquisitions in the Americas and APMEA segments are related to the fourth quarter 2016 acquisition of PVI and the first quarter 2016 acquisition of Watts Korea, respectively.

 

Gross Profit.  Gross profit and gross profit as a percent of net sales (gross margin) for 2017 and 2016 were as follows:

 

 

The increase in gross margin percentage is attributable to increased volume, manufacturing productivity, changes to our product mix, and incremental savings from our transformation and restructuring programs primarily within the Americas and Europe.

 

Selling, General and Administrative Expenses.  Selling, general and administrative, or SG&A, expenses increased $8.2 million, or 1.9%, in 2017 compared to 2016. The increase in SG&A expenses was attributable to the following:

 

 

SG&A expenses increased primarily as a result of our 2016 acquisitions of PVI and Watts Korea, as well as increases in foreign exchange primarily from the appreciation of the euro and the Canadian dollar against the U.S. dollar compared to 2016. Organically SG&A expenses decreased $7.3 million compared to 2016, primarily related to a decline in product liability costs of $9.4 million, lower transformation costs of $8.1 million as we completed our transformation program in 2017, and lower property tax and other tax charges of $1.1 million. The decline in product liability costs was primarily due to the resolution of the class action lawsuits related to certain legacy claims for undifferentiated products which we have exited, and the associated reduction in reported claims. The organic decrease was partially offset by $8.2 million for investments in strategic initiatives, which includes $2.5 million in research and development costs, and$4.2 million of higher distribution and freight costs.  Total SG&A expenses, as a percentage of sales, were 29.7% in 2017 compared to 30.3% in 2016.

 

Restructuring. In 2017, we recorded a net charge of $6.8 million, primarily for the transformation of our Americas business, involuntary terminations and other costs incurred as part of our restructuring initiatives, as compared to a net charge of $4.7 million in 2016. For a more detailed description of our current restructuring plans, see Note 3 of Notes to Consolidated Financial Statements in this Annual Report Form 10-K. 

 

Goodwill and Other Long‑Lived Asset Impairment Charges.  In 2017, we recorded an impairment of $1.0 million, primarily related to a technology asset in the Americas operating segment. In 2016, we recorded impairment charges of $0.5 million, primarily related to an indefinite lived tradename in the Europe operating segment. See Note 6 of Notes to Consolidated Financial Statements in this Annual Report on Form 10‑K for additional information regarding these impairments.

 

Gain on disposition. In the second quarter of 2016, we recorded a pre-tax gain of $8.7 million related to the sale of a China subsidiary that was dedicated to the production of non-core products and part of the transformation of our Americas and APMEA businesses. The pre-tax gain included a non-cash accumulated currency translation adjustment of $7.3 million.

 

Operating Income (Loss).  Operating income (loss) by geographic segment for 2017 and 2016 was as follows:

 

 

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

 

 

The increase in consolidated operating income was primarily driven by increased volume and gross margin improvements in the Americas, as well as savings from our restructuring initiatives in Europe. The increase in operating income was also driven by reduced transformation costs compared to 2016 in the Americas and APMEA as our transformation program was completed in 2017.  Contributing to the increase in consolidated operating income was $2.9 million from the acquisition of PVI. Included in operating income in 2016 was an $8.7 million gain on a disposition of a China subsidiary.

 

Interest Expense.  Interest expense decreased $3.5 million, or 15.5%, in 2017 from 2016 as we repaid over $150 million in outstanding debt during 2017. Further, our weighted average interest rate decreased marginally year to year as we retired higher cost private placement debt in the middle of 2016 and replaced with lower cost revolver debt and we replaced certain U.S. based revolver debt with lower cost euro denominated debt in late 2016. Refer to Note 11 of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K for further details.

 

Other expense (income), net.    Other expense (income), net, decreased $5.5 million to a net expense balance of $1.1 million in 2017 as compared to a net other income balance of ($4.4) million in 2016. Included in other income in 2016 was a $1.7 million non-cash gain recognized on the acquisition of Watts Korea. The remaining decrease is primarily due to net foreign currency transaction losses in 2017.

 

Income Taxes.    Our effective income tax rate changed to 48.9% in 2017, from 34.1% in 2016. The tax rate increased primarily due to the impact of the 2017 Tax Act, which was enacted on December 22, 2017, and has resulted in significant changes to the U.S. corporate income tax system.  These changes include lowering the corporate tax rate from