Watts Water Technologies Reports Third Quarter Results for 2013

Watts Water Technologies, Inc. (NYSE: WTS) today announced results for the third quarter ended September 29, 2013. Net income from continuing operations per diluted share (EPS) for the third quarter of 2013 was $0.49. Adjusting for special items, third quarter 2013 adjusted EPS was $0.58, compared to third quarter 2012 adjusted EPS of $0.62. A summary of third quarter financial results is as follows:

All financial information and period-to-period references are on a continuing operations basis unless otherwise noted. Reconciliations to generally accepted accounting principles (GAAP) and non-GAAP reconciliations are provided in the attached financial tables.

Third Quarter Highlights:

• Third quarter 2013 sales increased 5.4% from the third quarter of 2012, driven by organic growth of 3.6% and benefits from foreign exchange of 1.8%. Organic sales growth in North America of 8.6% and Asia of 15.1% was partially offset by an organic sales reduction in Europe, Middle East and Africa (EMEA) of 4.2%.
• Organic sales growth rate in North America of 8.6% was more than three times the 2.8% first half 2013 growth rate, driven primarily by a 9.6% increase in wholesale end market sales.
• Adjusted operating margins decreased by 1.1 percentage points to 9.4% for the third quarter of 2013 as compared to the third quarter of 2012; operating margins on a GAAP basis decreased 1.1 percentage points to 8.1%, as compared to the third quarter of 2012.
• Adjusted operating margins declined by 2.1 percentage points in North America primarily due to a $3.5 million increase in the Company’s product liability cost and $2.4 million in manufacturing inefficiencies and logistics costs related to the lead free conversion, with an impact to EPS of $0.10. The increase in product liability cost is based on an updated actuarial analysis that incorporated a recent increase in reported claims.
• Adjusted operating margins expanded in Europe by 0.7 percentage points due primarily to production efficiencies and tight cost controls, despite a sales volume reduction.
• The Company repurchased approximately 189.1 thousand shares of Company stock during the third quarter, at a cost of $10 million, as part of the previously announced share repurchase program.
• The Company finalized the disposal of Watts Insulation GmbH (“Austroflex”), recording an after-tax loss on disposal of $2.2 million during the third quarter in discontinued operations. Austroflex operating results for the current and prior years have been reclassified to discontinued operations.
• Free cash flow was $46.5 million for the nine months ended September 29, 2013, as compared to $53.8 million for the nine months ended September 30, 2012; the decrease was primarily driven by an inventory increase and additional capital spending, both related to the Company’s investment in the lead free initiative.

North American sales increased $16.5 million, or 8.1%, to $220.5 million in the third quarter of 2013, compared to $204.0 million for the third quarter of 2012. This increase was primarily due to an organic sales increase of $17.5 million, or 8.6%, offset partially by unfavorable foreign exchange movements of $1.0 million associated with the weakening of the Canadian dollar against the U.S. dollar. Sales into the North American wholesale, OEM and DIY markets increased organically by 9.6%, 9.0% and 4.7% respectively, during the third quarter of 2013 as compared to the same period in 2012, primarily from increased sales in our residential and commercial flow control product lines.

EMEA sales increased $1.2 million, or 0.8%, to $142.7 million for the third quarter of 2013, compared to $141.5 million for the third quarter of 2012. This increase was primarily due to favorable foreign exchange movements associated with the strengthening of the Euro versus the U.S. dollar of $7.1 million, or 5.0%, partially offset by an organic sales decrease of $5.9 million, or (4.2%). Compared to 2012, OEM sales decreased organically by 9.1%, offset partially by a 0.9% increase in sales into the wholesale market. EMEA segment sales represented approximately 38.4% and 40.1% of total Company sales in the third quarters of 2013 and 2012, respectively.

Asia sales increased $1.3 million, or 17.8%, to $8.6 million for the third quarter of 2013, compared to $7.3 million for the third quarter of 2012. This increase was primarily due to an organic sales increase of $1.1 million, or 15.1%.

Adjusted operating income for the third quarter of 2013 decreased by $2.0 million, or 5.4%, to $34.9 million, as compared to the third quarter of 2012. North America adjusted operating margins decreased by 2.1 percentage points to 11.2% as product liability costs increased by $3.5 million and the segment incurred $2.4 million in manufacturing inefficiencies and logistics costs related to the lead free conversion. EMEA adjusted operating margins increased by 0.7 percentage points to 11.5% in the third quarter of 2013 as compared to the third quarter of 2012, as production efficiencies and stringent operating cost controls offset margin loss from the sales volume reduction.

During the third quarter of 2013, the Company spent approximately $10.0 million to repurchase its shares on the open market as part of the $90.0 million share repurchase program announced in April. The Company repurchased approximately 189.1 thousand shares during the quarter. Year to date, the Company has repurchased approximately 401.7 thousand shares, at a cost of approximately $20.0 million.

Consolidated sales for the first nine months of 2013 were $1.09 billion, an increase of $24.6 million, or 2.3%, compared to the first nine months of 2012. Organic sales were up 1.3%, with growth in North America and Asia being offset by a reduction in EMEA, and favorable foreign exchange movements also contributed to the increase in sales.

Free cash flow for the first nine months of 2013 decreased by $7.3 million, to $46.5 million, as compared to the first nine months of 2012. The decrease related primarily to the Company’s ongoing lead free investment. The Company increased lead free inventories in anticipation of customer transitions to lead free products and invested incremental capital in its lead free foundry.

David J. Coghlan, Chief Executive Officer, commented, “Our organic growth in the North American wholesale, OEM and DIY markets was solid during the third quarter due to continued expansion in new residential construction, a stable repair and replace end market and the continuing transition by our customers to lead free products. Notably, North America results were impacted by two items. We increased our product liability reserve based on an updated actuarial analysis that incorporated a recent increase in reported claims. Additionally, North America’s gross margins were negatively impacted by incremental costs related to the lead free conversion, primarily from the lead free alloy production process and incremental transportation costs to expedite parts and components for both leaded and lead free products. In EMEA, we were pleased with the segment’s expanded adjusted operating margins for the third quarter despite the decline in sales. The rate of the sales decline in EMEA has tapered from the first half of this year, and the team delivered productivity and cost savings initiatives during the quarter to offset the impact of volume loss. We expect EMEA will continue to execute on its restructuring program that we announced in July. In Asia, the 15.1% organic sales growth was driven principally by residential plumbing and heating product sales. During the quarter we gained sales momentum in the North American wholesale, OEM and DIY channels. We also believe that some of our key markets, like the commercial market in North America and our core European markets, may be turning the corner and could provide more upside as we head into the new year.”

In this press release we refer to non-GAAP financial measures (including adjusted operating income, adjusted operating margins, adjusted net income, adjusted earnings per share, free cash flow, net debt to capitalization ratio and the cash conversion rate of free cash flow to net income) and provide a reconciliation of those non-GAAP financial measures to the corresponding financial measures contained in our consolidated financial statements prepared in accordance with GAAP. We believe that these financial measures are appropriate to enhance an overall understanding of our historical financial performance and future prospects. Adjusted operating income, adjusted operating margins, adjusted net income and adjusted earnings per share eliminate certain expenses incurred in the periods presented that relate primarily to our global restructuring programs, goodwill and other long-lived asset impairment charges, significant legal and customs settlements, CFO retention costs, acquisition accounting costs, and other costs and related tax benefits. Management then utilizes these adjusted financial measures to assess the run-rate of the Company’s continuing operations against those of comparable periods without the distortion of those factors. Free cash flow and the net debt to capitalization ratio, which are adjusted to exclude certain cash inflows and outlays, and include only certain balance sheet accounts from the comparable GAAP measures, are an indication of our performance in cash flow generation and also provide an indication of the Company's relative balance sheet leverage to other industrial manufacturing companies. The cash conversion rate of free cash flow to net income is also a measure of our performance in cash flow generation. These non-GAAP financial measures are among the primary indicators management uses as a basis for evaluating our cash flow generation and our capitalization structure. In addition, free cash flow is used as a criterion to measure and pay certain compensation-based incentives. For these reasons, management believes these non-GAAP financial measures can be useful to investors, potential investors and others. The Company’s non-GAAP financial measures may not be comparable to similarly titled measures reported by other companies. The presentation of this additional information is not meant to be considered in isolation or as a substitute for financial measures prepared in accordance with GAAP.

Watts Water Technologies, Inc. will hold a live web cast of its conference call to discuss third quarter results for 2013 on Wednesday, October 30, 2013, at 9:00 a.m. Eastern Time. This press release and the live web cast can be accessed by visiting the Investor Relations section of the Company's website at www.wattswater.com. Following the web cast, an archived version of the call will be available at the same address until October 30, 2014.

Watts Water Technologies, Inc., through its subsidiaries, is a world leader in the manufacture of innovative products to control the efficiency, safety, and quality of water within residential, commercial, and institutional applications. Watts’ expertise in a wide variety of water technologies enables Watts to be a comprehensive supplier to the water industry.

This Press Release includes 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 reflect Watts Water Technologies’ current views about future results of operations and other forward-looking information. In some cases you can identify these statements by forward-looking 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 Watts’ actual results may differ materially from those indicated by these forward-looking statements as a result of a number of important factors. These factors include, but are not limited to, the following: the effectiveness of our operational excellence initiatives and cost recovery actions; the current economic and financial condition, which can affect levels of housing starts and remodeling, affecting the markets where the Company’s products are sold, manufactured, or marketed; shortages in and pricing of raw materials and supplies; difficulties in converting lead free products; loss of market share through competition; introduction of competing products by other companies; pressure on prices from competitors, suppliers, and/or customers; changes in variable interest rates on Company borrowings; identification and disclosure of material weaknesses in our internal control over financial reporting; failure to expand our markets through acquisitions; failure or delay in developing new products; lack of acceptance of new products; failure to manufacture products that meet required performance and safety standards; foreign exchange rate fluctuations; cyclicality of industries, such as plumbing and heating wholesalers and home improvement retailers, in which the Company markets certain of its products; environmental compliance costs; product liability costs; the results and timing of the Company’s manufacturing restructuring plan; changes in the status of current litigation; and other risks and uncertainties discussed under the heading “Item 1A. Risk Factors” and in Note 14 of the Notes to the Consolidated Financial Statements in the Watts Water Technologies, Inc. Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities Exchange Commission and other reports Watts files from time to time with the Securities and Exchange Commission. Watts does not intend to, and undertakes no duty to, update the information contained in this Press Release, except as required by law.