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1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included in the Watts Water Technologies, Inc. (the Company) Consolidated Balance Sheet as of October 2, 2011, the Consolidated Statements of Operations for the third quarter and nine months ended October 2, 2011 and October 3, 2010, and the Consolidated Statements of Cash Flows for the nine months ended October 2, 2011 and October 3, 2010.
The balance sheet at December 31, 2010 has been derived from the audited consolidated financial statements at that date. The accounting policies followed by the Company are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. The financial statements included in this report should be read in conjunction with the consolidated financial statements and notes included in the Annual Report on Form 10-K for the year ended December 31, 2010. Operating results for the interim periods presented are not necessarily indicative of the results to be expected for the year ending December 31, 2011.
The Company operates on a 52-week fiscal year ending on December 31st. Any quarterly or nine-month data contained in this Quarterly Report on Form 10-Q generally reflects the results of operations for a 13-week or 39-week period, respectively.
Certain amounts in the year December 31, 2010, have been reclassified to permit comparison with the 2011 presentation. These reclassifications had no effect on reported results of operations or stockholders’ equity. |
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2. Accounting Policies
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Goodwill and Long-Lived Assets
The changes in the carrying amount of goodwill by geographic segment are as follows:
On April 29, 2011, the Company completed the acquisition of Danfoss Socla S.A.S. (Socla) and the related water controls business of certain other entities controlled by Danfoss A/S, in a share and asset purchase transaction. The aggregate consideration paid was EUR 120.0 million, less EUR 3.4 million in estimated working capital and related adjustments. The net consideration paid of EUR 116.6 million is subject to final working capital and related adjustments. The Company is accounting for the transaction as a business combination. The Company completed a preliminary purchase price allocation that resulted in the recognition of $74.3 million in goodwill and $41.9 million in intangible assets. Intangible assets consist primarily of customer relationships with estimated lives of 10 years and trade names with either 20-year lives or indefinite lives. See Note 12 for additional information regarding the Socla acquisition.
Goodwill and intangible assets not subject to amortization are tested for impairment at least annually or more frequently if events or circumstances indicate that it is “more likely than not” that goodwill might be impaired, such as a change in business conditions. The Company performs its annual impairment assessment of goodwill and intangible assets not subject to amortization in the fourth quarter of each year.
Intangible assets with estimable lives and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of intangible assets with estimable lives and other long-lived assets are measured by a comparison of the carrying amount of an asset or asset group to future net undiscounted pretax cash flows expected to be generated by the asset or asset group. If these comparisons indicate that an asset is not recoverable, the impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the related estimated fair value. Estimated fair value is based on either discounted future pretax operating cash flows or appraised values, depending on the nature of the asset. The Company determines the discount rate for this analysis based on the weighted average cost of capital based on the market and guideline public companies for the related business and does not allocate interest charges to the asset or asset group being measured. Significant management judgment is required to estimate future operating cash flows.
Intangible assets include the following:
During the nine months ended October 2, 2011, the Company recorded a $0.3 million impairment of a trade name in our European segment and subsequently reclassified the $2.1 million trade name value to amortizable intangibles.
Aggregate amortization expense for amortizable intangible assets for the third quarters of 2011 and 2010 was $4.2 million and $3.6 million, respectively, and for the nine-month periods of 2011 and 2010 was $13.5 million and $10.2 million, respectively. Additionally, future amortization expense for the next five years on amortizable intangible assets approximates $4.8 million for the remainder of 2011, $17.6 million for 2012, $16.2 million for 2013, $16.2 million for 2014 and $15.8 million for 2015. Amortization expense is provided on a straight-line basis over the estimated useful lives of the intangible assets. The weighted-average remaining life of total amortizable intangible assets is 12.0 years. Patents, customer relationships, technology and other amortizable intangibles have weighted-average remaining lives of 7.3 years, 7.5 years, 14.2 years and 21.9 years, respectively. Intangible assets not subject to amortization consist of certain trademarks and trade names.
Stock-Based Compensation and Chief Executive Officer Separation Costs
The Company maintains three stock incentive plans under which key employees and non-employee members of the Company’s Board of Directors have been granted incentive stock options (ISOs) and nonqualified stock options (NSOs) to purchase the Company’s Class A Common Stock. Only one plan, the 2004 Stock Incentive Plan, is currently available for the grant of new stock options, which are currently being granted only to employees. Stock options granted under prior plans became exercisable over a five-year period at the rate of 20% per year and expire ten years after the date of grant. Under the 2004 Stock Incentive Plan, options become exercisable over a four-year period at the rate of 25% per year and expire ten years after the grant date. ISOs and NSOs granted under the plans may have exercise prices of not less than 100% and 50% of the fair market value of the Class A Common Stock on the date of grant, respectively. The Company’s current practice is to grant all options at fair market value on the grant date. The Company issued 280,000 and 282,500 options to key employees under the 2004 Stock Incentive Plan in the third quarter and in the first nine months of 2011 and 2010, respectively.
The fair value of each share issued under the 2004 Stock Incentive Plan is estimated on the date of grant, using the Black-Scholes-Merton Model, based on the following weighted average assumptions:
The above assumptions were used to determine the weighted average grant-date fair value of stock options of $10.19 and $12.36 in 2011 and 2010, respectively.
The Company has also granted shares of restricted stock to key employees and stock awards to non-employee members of the Company’s Board of Directors under the 2004 Stock Incentive Plan, which vest either immediately, over a one-year period, or over a three-year period at the rate of one-third per year. The restricted stock awards are amortized to expense on a straight-line basis over the vesting period. The Company issued 107,786 and 104,975 shares of restricted stock under the 2004 Stock Incentive Plan in third quarters of 2011 and 2010, respectively. The Company issued 109,186 and 104,975 shares of restricted stock under the 2004 Stock Incentive Plan in the first nine months of 2011 and 2010, respectively.
The Company also has a Management Stock Purchase Plan that allows for the purchase of restricted stock units (RSUs) by key employees. On an annual basis, key employees may elect to receive a portion of their annual incentive compensation in RSUs instead of cash. Each RSU represents one share of Class A Common Stock and is purchased by the employee at 67% of the fair market value of the Company’s Class A Common Stock on the date of grant. RSUs vest annually over a three-year period from the grant date and receipt of the shares underlying RSUs is deferred for a minimum of three years or such greater number of years as is chosen by the employee. An aggregate of 2,000,000 shares of Class A Common Stock may be issued under the Management Stock Purchase Plan. The Company granted 96,454 RSUs and 158,473 RSUs in the first nine months of 2011 and 2010, respectively.
The fair value of each RSU issued under the Management Stock Purchase Plan is estimated on the date of grant, using the Black-Scholes-Merton Model, based on the following weighted average assumptions:
The above assumptions were used to determine the weighted average grant-date fair value of RSUs of $16.25 and $12.81 in 2011 and 2010, respectively.
A more detailed description of each of these stock and stock option plans can be found in Note 13 of Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.
On January 26, 2011, Patrick S. O’Keefe resigned from his positions of Chief Executive Officer, President and Director. The Company recorded a charge in the first quarter of 2011 of $6.3 million related to his separation agreement, consisting of $3.3 million in expected cash severance and a non-cash charge of $3.0 million for the modification of his stock options and restricted stock awards.
Shipping and Handling
The Company’s shipping costs included in selling, general and administrative expenses were $9.2 million and $8.6 million for the third quarters of 2011 and 2010, respectively, and were $28.4 million and $25.7 million for the first nine months of 2011 and 2010, respectively.
Research and Development
Research and development costs included in selling, general and administrative expenses were $5.3 million and $4.3 million for the third quarters of 2011 and 2010, respectively, and were $16.0 million and $14.0 million for the first nine months of 2011 and 2010, respectively.
Taxes, Other than Income Taxes
Taxes assessed by governmental authorities on sale transactions are recorded on a net basis and excluded from sales in the Company’s consolidated statements of operations.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
New Accounting Standards
In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-05, “Comprehensive Income.” This ASU intends to enhance comparability and transparency of other comprehensive income components. The guidance provides an option to present total comprehensive income, the components of net income and the components of other comprehensive income in a single continuous statement or two separate but consecutive statements. This ASU eliminates the option to present other comprehensive income components as part of the statement of changes in stockholders’ equity. The provisions of this ASU will be applied retrospectively for interim and annual periods beginning after December 15, 2011. Early application is permitted. The Company is currently evaluating the adoption of this new ASU, but does not expect the adoption to have a material impact on its consolidated financial statements.
In September 2011, accounting guidance was issued by FASB in Accounting Standards Codification (ASC) Topic 350, “Intangibles — Goodwill and Other”. This guidance amends the requirements for goodwill impairment testing. The Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then performing the two-step impairment test is unnecessary. The Company intends to adopt this new standard effective with its annual goodwill impairment testing date of October 30, for the year ending December 31, 2011. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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3. Discontinued Operations
In the first quarter of 2010, the Company recorded an estimated reserve of $5.3 million in discontinued operations in connection with its investigation of potential violations of the Foreign Corrupt Practices Act (FCPA) at Watts Valve (Changsha) Co., Ltd. (CWV), a former indirect wholly-owned subsidiary of the Company in China (see Note 10). On October 13, 2011, the Company entered into a settlement with the Securities and Exchange Commission to resolve allegations concerning potential violations of the FCPA at CWV. Under the terms of the settlement, without admitting or denying the SEC’s allegations, the Company consented to entry of an administrative cease-and-desist order under the books and records and internal controls provisions of the FCPA. The Company has also agreed to pay to the SEC $3.6 million in disgorgement and prejudgment interest, and $200,000 in penalties. The Company anticipates that this settlement resolves all government investigations concerning CWV’s sales practices and potential FCPA violations. The Company recorded an estimated reserve of $5.3 million in the first quarter of 2010 and subsequently recorded a decrease of the reserve of $1.7 million in the second quarter of 2011, which reflects the final settlement. There were no material developments with respect to our environmental remediation proceedings during the first nine months ended October 2, 2011. See Note 3 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.
Condensed operating statements for discontinued operations are summarized below:
The carrying amounts of major classes of assets and liabilities associated with discontinued operations are as follows:
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4. Financial Instruments and Derivatives Instruments
The Company measures certain financial assets and liabilities at fair value on a recurring basis, including deferred compensation plan assets and related liability and contingent consideration. The fair values of these financial assets and liabilities were determined using the following inputs at October 2, 2011, December 31, 2010 and October 3, 2010:
(1) Included in other, net on the Company’s consolidated balance sheet. (2) Included in other noncurrent liabilities on the Company’s consolidated balance sheet.
The table below provides a summary of the changes in fair value of all financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the period December 31, 2010 to October 2, 2011.
The Level 3 contingent consideration obligation in connection with the Blue Ridge Atlantic Enterprises, Inc. (BRAE) acquisition was $2.2 million as of October 2, 2011 and $1.9 million as of December 31, 2010. The increase in fair value of this obligation of $0.3 million for the nine months ended October 2, 2011 was recorded in selling, general and administrative expenses. See Note 5 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, for a detailed description of the acquisition.
Short-term investment securities as of October 2, 2011 consists of a certificate of deposit with a remaining maturity of greater than three months at the date of purchase, for which the carrying amount is a reasonable estimate of fair value.
Cash equivalents consist of instruments with remaining maturities of three months or less at the date of purchase and consist primarily of money market funds and certificates of deposits, for which the carrying amount is a reasonable estimate of fair value.
The Company uses financial instruments from time to time to enhance its ability to manage risk, including foreign currency and commodity pricing exposures, which exist as part of its ongoing business operations. The use of derivatives exposes the Company to counterparty credit risk for nonperformance and to market risk related to changes in currency exchange rates and commodity prices. The Company manages its exposure to counterparty credit risk through careful due diligence and diversification of counterparties. The Company’s counterparties in derivative transactions are substantial commercial banks with significant experience using such derivative instruments. The impact of market risk on the fair value and cash flows of the Company’s derivative instruments is monitored and the Company restricts the use of derivative financial instruments to hedging activities. The Company does not enter into contracts for trading purposes nor does the Company enter into any contracts for speculative purposes. The use of derivative instruments is approved by senior management under written guidelines.
The Company has exposure to a number of foreign currency rates, including the Canadian dollar, the euro, the Chinese yuan and the British pound. To manage this risk, the Company generally uses a layering methodology whereby at the end of any quarter, the Company has generally entered into forward exchange contracts, which hedge approximately 50% of the projected intercompany purchase transactions for the next twelve months. The Company uses this strategy for purchases between Canada and the U.S., for purchases between the Euro zone and the U.S., and for purchases between the Euro zone and the United Kingdom. The average volume of contracts can vary but generally approximates $9 to $15 million in open contracts at the end of any given quarter. At October 2, 2011, the Company had contracts for purchases between Canada and the U.S. for notional amounts aggregating approximately $9.0 million to buy U.S. dollars. The Company accounts for the forward exchange contracts as an economic hedge and has not elected to use hedge accounting. Realized and unrealized gains and losses on the contracts are recognized in other (income) expense in the consolidated statements of operations. These contracts do not subject the Company to significant market risk from exchange movement because they offset gains and losses on the related foreign currency denominated transactions. The fair value of the foreign exchange contracts as of October 2, 2011 was not material.
Fair Value
The carrying amounts of cash and cash equivalents, short-term investments, trade receivables and trade payables approximate fair value because of the short maturity of these financial instruments.
The fair values of the Company’s 5.47% senior notes due 2013, 5.85% senior notes due 2016 and 5.05% senior notes due 2020, are based on a discounted cash flow model using like industrial companies, the Company’s credit metrics, the Company’s size, as well as current market demand. The fair value of the Company’s variable rate debt approximates its carrying value. The carrying amount and the estimated fair market value of the Company’s long-term debt, including the current portion, are as follows:
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5. Restructuring and Other Charges
The Company’s Board of Directors approves all major restructuring programs that involve the discontinuance of product lines or the shutdown of facilities. From time to time, the Company takes additional restructuring actions, including involuntary terminations that are not part of a major program. The Company accounts for these costs in the period that the individual employees are notified or the liability is incurred. These costs are included in restructuring and other charges in the Company’s consolidated statements of operations. The Company also includes as part of other charges, expenses associated with asset impairments. In 2011, the Board approved a restructuring program with respect to the Company’s operating facilities in Europe, which included the Company closure of a facility. The program is expected to include pre-tax costs of approximately $2.6 million, including costs for severance and shut down costs. The total net after-tax charge for this restructuring program is $1.8 million with costs being incurred through 2012. See Note 4 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, for a detailed description of the 2010 Europe and North America restructuring actions. Also, in 2011 the Board approved an integration program in association with the acquisition of Socla. The integration program was designed to eliminate certain redundancies with a total estimated pre-tax cost of $6.4 million with costs being incurred through 2012. In September 2011, the Company announced a plan of termination that would result in a reduction of approximately 10% of North American non-direct payroll costs. The Company recorded a charge of $1.1 million for severance in connection with the plan during the quarter ended October 2, 2011. The Company expects to pay all severance before the end of 2011.
A summary of the pre-tax cost by restructuring program is as follows:
The Company recorded net pre-tax restructuring and other charges in its business segments as follows:
The Company does not expect to incur additional costs related to the 2009 restructuring plan, as the project is substantially complete.
2011 Actions
Socla Actions
The following table summarizes the total expected, incurred and remaining pre-tax costs for the 2011 Socla integration program:
Details of the Company’s 2011 Socla integration program reserve for the first nine months of 2011 are as follows:
The Company expects to spend the remaining reserve by mid-2012.
The following table summarizes expected, incurred and remaining costs for 2011 Socla integration actions by type:
Europe Actions
The following table summarizes the total expected, incurred and remaining pre-tax costs for the 2011 Europe restructuring program:
Details of the Company’s 2011 Europe restructuring reserve for the first nine months of 2011 are as follows:
The following table summarizes expected, incurred and remaining costs for 2011 Europe restructuring actions by type:
2010 Actions
Europe Actions
The following table summarizes the total expected, incurred and remaining pre-tax costs for the 2010 Europe footprint consolidation-restructuring program:
Details of the Company’s 2010 Europe footprint consolidation-restructuring program reserve for the first nine months of 2011 are as follows:
The Company expects to spend the remaining reserve by mid-2012.
The following table summarizes expected, incurred and remaining costs for 2010 Europe footprint consolidation- restructuring actions by type:
The Company does not expect to incur additional costs related to the 2010 Europe footprint consolidation- restructuring plan, as the project is substantially complete.
North America Actions
The following table summarizes the total expected, incurred and remaining pre-tax costs for the 2010 North America footprint consolidation-restructuring program:
In September 2011, the Company revised its estimate from $3.3 million to $2.5 million on the North America footprint consolidation-restructuring program as the total costs to shut down and relocate equipment were lower than anticipated.
Details of the Company’s 2010 North America footprint consolidation-restructuring program reserve for the first nine months of 2011 are as follows:
The Company expects to spend the remaining reserve by mid-2012.
The following table summarizes expected, incurred and remaining costs for the Company’s 2010 North America footprint consolidation-restructuring actions by type:
The third quarter charge for 2010 of $3.0 million consisted of approximately $1.9 million related to involuntary termination benefits, and $0.8 million for other costs associated with the 2010 actions. Additionally, the Company recorded $0.2 million related to involuntary termination benefits with the 2009 actions. The remaining costs of approximately $0.1 million related to involuntary termination benefits which were not part of a previously announced restructuring plan.
The first nine months charges for 2010 of $10.1 million consisted of approximately $5.2 million related to involuntary termination benefits, $1.3 million for accelerated depreciation for manufacturing operations, which was charged to cost of sales, and $1.8 million for other costs all associated with the 2010 actions. Additionally, the Company recorded $0.7 million related to involuntary termination benefits and $0.6 million for relocation expenses associated with the 2009 actions. The remaining costs of approximately $0.3 million related to involuntary termination benefits which were not part of a previously announced restructuring plan. Additionally, the Company recorded $0.2 million in the first nine months of 2010 for charges associated with impairments.
In addition, in 2010, the Company recorded a tax charge of approximately $1.5 million in connection with the expected sale of TWVC. The Company expects the sale of TWVC to be finalized in the fourth quarter of 2011, subject to final agreements with the buyer. The Company expects to receive net proceeds of approximately $5.5 million from the sale. The Company also expects to record a net gain of approximately $7.5 million after-tax, primarily to recognize the cumulative currency translation adjustment related to TWVC. Further, the Company will recognize a net gain of $3.3 million to reverse a tax provision upon completion of the sale. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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7. Segment Information
The Company operates in three geographic segments: North America, Europe, and China. Each of these segments is managed separately and has separate financial results that are reviewed by the Company’s chief operating decision-maker. All intercompany sales transactions have been eliminated. Sales by region are based upon location of the entity recording the sale. The accounting policies for each segment are the same as those described in the summary of significant accounting policies.
The following is a summary of the Company’s significant accounts and balances by segment, reconciled to the consolidated totals:
* Corporate expenses are primarily for administrative compensation expense, internal controls costs, professional fees, including legal and audit expenses, shareholder services and benefit administration costs. These costs are not allocated to the geographic segments as they are viewed as corporate functions that support all activities.
The above operating segments are presented on a basis consistent with the presentation included in the Company’s December 31, 2010 consolidated financial statements included in its Annual Report on Form 10-K.
The following includes U.S. net sales and U.S. property, plant and equipment of the Company’s North American segment:
The following includes intersegment sales for North America, Europe and China:
The North American segment and the China segment include $4.6 million and $6.4 million, respectively, in assets held for sale at October 2, 2011. The North American segment and the China segment includes $4.8 million and $6.1 million, respectively, in assets held for sale at October 3, 2010. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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8. Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) consists of the following:
Accumulated other comprehensive income (loss) in the consolidated balance sheets as of October 2, 2011 and October 3, 2010 consist primarily of cumulative translation adjustments and pension related prior service costs and net actuarial loss. The Company’s total comprehensive income (loss) was as follows:
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9. Debt
The Company’s credit agreement (the Credit Agreement) provides for a multi-currency $300.0 million, five-year, senior unsecured revolving credit facility which may be increased by an additional $150.0 million under certain circumstances and subject to the terms of the Credit Agreement. The Credit Agreement has a sublimit of up to $75.0 million in letters of credit.
Borrowings outstanding under the Credit Agreement bear interest at a fluctuating rate per annum equal to (i) in the case of Eurocurrency rate loans, the British Bankers Association LIBOR rate plus an applicable percentage, ranging from 1.70% to 2.30%, determined by reference to the Company’s consolidated leverage ratio plus, in the case of certain lenders, a mandatory cost calculated in accordance with the terms of the Credit Agreement, or (ii) in the case of base rate loans and swing line loans, the highest of (a) the federal funds rate plus 0.5%, (b) the rate of interest in effect for such day as announced by Bank of America, N.A. as its “prime rate,” and (c) the British Bankers Association LIBOR rate plus 1.0%, plus an applicable percentage, ranging from 0.70% to 1.30%, determined by reference to the Company’s consolidated leverage ratio. In addition to paying interest under the Credit Agreement, the Company is also required to pay certain fees in connection with the credit facility, including, but not limited to, a facility fee and letter of credit fees. Under the Credit Agreement, the Company is required to satisfy and maintain specified financial ratios and other financial condition tests. The Credit Agreement matures on June 18, 2015. The Company may repay loans outstanding under the Credit Agreement from time to time without premium or penalty, other than customary breakage costs, if any, and subject to the terms of the Credit Agreement. As of October 2, 2011, the Company was in compliance with all covenants related to the Credit Agreement and had $198.8 million of unused and available credit under the Credit Agreement and $34.6 million of stand-by letters of credit outstanding on the Credit Agreement. The Company had $66.6 million of euro-denominated borrowings outstanding under the Credit Agreement at October 2, 2011.
The Company is a party to several note agreements as further detailed in Note 11 of Notes to Consolidated Financial Statements of the Annual Report on Form 10-K for the year ended December 31, 2010. These note agreements require the Company to maintain a fixed charge coverage ratio of consolidated EBITDA plus consolidated rent expense during the period to consolidated fixed charges. Consolidated fixed charges are the sum of consolidated interest expense for the period and consolidated rent expense. As of October 2, 2011, the Company was in compliance with all covenants regarding these note agreements. |
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10. Contingencies and Environmental Remediation
As disclosed in Part I, Item 1, “Product Liability, Environmental and Other Litigation Matters” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, the Company was party to certain litigation, has conducted an investigation regarding information that employees of CWV made payments to employees of state-owned agencies and whether such payments may violate FCPA, and is engaged in certain environmental remediation. On October 13, 2011, the Company entered into a settlement with the Securities and Exchange Commission to resolve allegations concerning potential violations of the FCPA at CWV. Under the terms of the settlement, without admitting or denying the SEC’s allegations, the Company consented to entry of an administrative cease-and-desist order under the books and records and internal controls provisions of the FCPA. The Company has also agreed to pay to the SEC $3.6 million in disgorgement and prejudgment interest, and $200,000 in penalties. The Company anticipates that this settlement resolves all government investigations concerning CWV’s sales practices and potential FCPA violations. The Company recorded an estimated reserve of $5.3 million in the first quarter of 2010 and subsequently recorded a decrease of the reserve of $1.7 million in the second quarter of 2011, which reflects the final settlement amount. There were no material developments with respect to our environmental remediation proceedings or litigation during the first nine months ended October 2, 2011. |
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11. Employee Benefit Plans
The Company sponsors funded and unfunded defined benefit pension plans covering substantially all of its domestic employees. Benefits are based primarily on years of service and employees’ compensation. The funding policy of the Company for these plans is to contribute an annual amount that does not exceed the maximum amount that can be deducted for federal income tax purposes.
The components of net periodic benefit cost are as follows:
The information related to the Company’s pension funds cash flow is as follows:
The Company does not expect to make any additional contributions to its pension plan for the remainder of 2011. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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12. Acquisition
On April 29, 2011, the Company completed the acquisition of Danfoss Socla S.A.S. (Socla) and the related water controls business of certain other entities controlled by Danfoss A/S, in a share and asset purchase transaction. The aggregate consideration paid was EUR 120.0 million, less EUR 3.4 million in estimated working capital and related adjustments. The net purchase price of EUR 116.6 million was financed with cash on hand and euro-based borrowings under our Credit Agreement. The net purchase price, which is subject to final working capital and related adjustments, is equal to approximately $172.8 million based on the exchange rate of Euro to U.S. dollars as of April 29, 2011.
Socla is a manufacturer of water protection valves and flow control solutions for the water market and the heating, ventilation and air conditioning market. Its major product lines include backflow preventers, check valves and pressure reducing valves. Socla is based in France, and its products are distributed worldwide for commercial, residential, municipal and industrial use. Socla’s annual revenue for 2010 was approximately $130.0 million. Socla strengthens the Company’s European plumbing and flow control products and also adds to its HVAC products.
The Company is accounting for the transaction as a business combination. The Company completed a preliminary purchase price allocation that resulted in the recognition of $74.3 million in goodwill and $41.9 million in intangible assets. Intangible assets consist primarily of customer relationships with estimated lives of 10 years and trade names with either 20-year lives or indefinite lives. The goodwill is attributable to the workforce of Socla and the synergies that are expected to arise as a result of the acquisition. The goodwill is not expected to be deductible for tax purposes. The following table summarizes the preliminary value of the assets and liabilities acquired (in millions):
The purchase price allocation for the acquisition noted above is preliminary pending the final valuations of fair values of intangible assets and certain assumed assets and liabilities and the resolution of the final purchase price, including working capital and related adjustments.
The consolidated statement of operations includes the results of Socla since the acquisition date and includes $63.2 million of revenues and $1.0 million of operating losses, which includes non-recurring acquisition accounting charges of $5.4 million and restructuring charges of $2.8 million. During the nine months ended October 2, 2011, due diligence costs of $1.1 million were included in selling, general and administrative costs.
Supplemental pro-forma information (unaudited)
Had the Company completed the acquisition of Socla at the beginning of 2010, net sales, net income from continuing operations and earnings per share from continuing operations would have been as follows:
Net income from continuing operations for the quarter ended October 3, 2010 was adjusted to include $0.5 million of net interest expense related to the financing and $0.6 million of net amortization expense resulting from the estimated allocation of purchase price to amortizable intangible assets. Net income from continuing operations for the nine months ended October 2, 2011 and October 3, 2010 was adjusted to include $0.7 million and $1.6 million, respectively, of net interest expense related to the financing and $0.8 million and $1.8 million, respectively, of net amortization expense resulting from the estimated allocation of purchase price to amortizable intangible assets. Net income from continuing operations for the quarter and nine months ended October 2, 2011 was also adjusted to exclude $1.2 million and $4.7 million, respectively, of net non-recurring acquisition-related charges and third-party costs. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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13. Subsequent Events
Dividend Declared
On October 31, 2011, the Company declared a quarterly dividend of eleven cents ($0.11) per share on each outstanding share of Class A Common Stock and Class B Common Stock payable on December 2, 2011 to stockholders of record at the close of business on November 21, 2011.
New Director
On October 31, 2011, the Company announced that its Board of Directors elected W. Craig Kissel to serve as a member of the Company’s Board of Directors until the Company’s 2012 Annual Meeting of Stockholders or until his successor has been duly elected and qualified. Mr. Kissel was also appointed by the Board to serve as a member of each of the Compensation Committee and the Nominating and Corporate Governance Committee of the Board of Directors.
Pension Plans Freeze
On October 31, 2011, the Company’s Board of Directors voted to cease accruals effective December 31, 2011 under both the Company’s Pension Plan and Supplemental Employees Retirement Plan. The Company expects to record a curtailment charge of approximately $1.4 million in the fourth quarter of 2011 in connection with this action. The Board also voted to enhance the Company’s existing 401(k) Savings Plan. |
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| The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. |
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Goodwill and intangible assets not subject to amortization are tested for impairment at least annually or more frequently if events or circumstances indicate that it is “more likely than not” that goodwill might be impaired, such as a change in business conditions. The Company performs its annual impairment assessment of goodwill and intangible assets not subject to amortization in the fourth quarter of each year.
Intangible assets with estimable lives and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of intangible assets with estimable lives and other long-lived assets are measured by a comparison of the carrying amount of an asset or asset group to future net undiscounted pretax cash flows expected to be generated by the asset or asset group. If these comparisons indicate that an asset is not recoverable, the impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the related estimated fair value. Estimated fair value is based on either discounted future pretax operating cash flows or appraised values, depending on the nature of the asset. The Company determines the discount rate for this analysis based on the weighted average cost of capital based on the market and guideline public companies for the related business and does not allocate interest charges to the asset or asset group being measured. Significant management judgment is required to estimate future operating cash flows. |
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| Taxes assessed by governmental authorities on sale transactions are recorded on a net basis and excluded from sales in the Company’s consolidated statements of operations. |
| Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. |
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(1) Included in other, net on the Company’s consolidated balance sheet. (2) Included in other noncurrent liabilities on the Company’s consolidated balance sheet.
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* Corporate expenses are primarily for administrative compensation expense, internal controls costs, professional fees, including legal and audit expenses, shareholder services and benefit administration costs. These costs are not allocated to the geographic segments as they are viewed as corporate functions that support all activities. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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