Watts Water Technologies Inc: Form 10-Q for the period ended Sep 29, 2024

This Quarterly Report on Form 10-Q 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. The forward-looking statements included in this Quarterly Report on Form 10-Q, including without limitation statements regarding our business performance and strategy, including, without limitation, expected financial results, benefits from recent acquisitions, expected investments in capital expenditure, improvements in operating and free cash flow throughout and our ability to manage challenging macro-economic and softer market conditions, are only predictions and involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. 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” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2023, filed with the Securities and Exchange Commission. 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.

Overview

The following discussion and analysis is provided to increase the understanding of, and should be read in conjunction with, the accompanying unaudited consolidated financial statements and related notes. In this Quarterly Report on Form 10-Q, references to “the Company,” “Watts,” “we,” “us” or “our” refer to Watts Water Technologies, Inc. and its consolidated subsidiaries.

We are a leading supplier of solutions, systems and products that manage and conserve the flow of fluids and energy into, through and out of buildings in the commercial, industrial and residential markets in the Americas, Europe and Asia-Pacific, Middle East and Africa (“APMEA”). For 150 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 purify and conserve water. We earn revenue and income almost exclusively from the sale of our products. Our principal product and solution categories include:

• Residential & commercial flow control and protection—includes products and solutions typically sold into plumbing and hot water applications such as backflow preventers, water pressure regulators, temperature and pressure relief valves, thermostatic mixing valves, leak detection and protection products, commercial washroom solutions and emergency safety products and equipment. Many of our flow control and protection products are now smart and connected enabled, warning of leaks, floods, freezing temperatures and other hazards with alerts to Building Management Systems (“BMS”) and/or personal devices giving our customers greater insight into their water management and the ability to shut off the water supply to avoid waste and mitigate damage.
• Heating, ventilation and air conditioning (“HVAC”) & gas—includes commercial high-efficiency boilers, water heaters and heating solutions, hydronic and electric heating systems for under-floor radiant applications, custom heat and hot water solutions, hydronic pump groups for boiler manufacturers and alternative energy control packages, and flexible stainless steel connectors for natural and liquid propane gas in commercial food service and residential applications. Most of our HVAC products and solutions feature advanced controls enabling customers to easily connect to the BMS for better monitoring, control and operation.
• Drainage & water re-use—includes drainage products and engineered rain water harvesting solutions for commercial, industrial, marine and residential applications, including connected roof drain systems.
• Water quality—includes point-of-use and point-of-entry water filtration, monitoring, conditioning and scale prevention systems for commercial, marine and residential applications.

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”).

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 continue to make selective acquisitions, both in our core markets as well as in complementary markets; regulatory requirements relating to the quality and conservation of water and the safe use of water; increased demand for clean water; and continued enforcement of plumbing and building codes. Our acquisition strategy focuses on businesses that promote our key macro themes around safety and regulation, energy efficiency and water conservation. We target businesses that we believe 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, including smart and connected technologies, advanced production capabilities or complementary solution offerings. We have completed 14 acquisitions since 2014, and in the last year and a half, we have completed three strategic and complementary acquisitions that expanded our addressable market and that we believe will enable value creation through greater scale and growth opportunities.

We believe that sustainability guides every aspect of our business, including our product development strategy and design, and how we structure our operations. Our innovation strategy is focused on differentiated products and solutions that will provide greater opportunity to distinguish ourselves in the marketplace, while at the same time creating innovative products and smart solutions to protect, control, and conserve critical resources, and help our customers with their sustainability efforts through the use of our products. 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.

Over the past several years we have been building our smart and connected products foundation by expanding our internal capabilities and making strategic acquisitions. Our strategy is to deliver superior customer value through smart and connected products and intelligent water solutions. This strategy focuses on three dimensions: Connect, Control and Conserve. We are focused on introducing products that connect our customers with smart systems, manage systems for optimal performance, and conserve critical resources by increasing operability, efficiency and safety.

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. 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 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.

Global gross domestic product (“GDP”) remains positive and is generally a leading indicator for our repair and replacement business. New construction indicators are mixed, but are showing signs of weakening, particularly in multi-family housing, office, retail and recreation verticals. Light industrial, including data centers, is growing and institutional verticals remain steady. The European economy continued to show signs of weakening and geo-political risks have heightened. Elevated interest rates may impact new construction. We also continue to experience inflation across our labor and overhead costs. Despite these anticipated challenges and uncertainties, we continue to invest in our business, including new products, our smart and connected solutions and our growth and productivity initiatives. We remain focused on our customers’ needs and executing on our long-term strategy.

Financial Overview

Third quarter 2024 sales increased 7.8%, or $39.3 million, on a reported basis, and decreased 4.1%, or $20.4 million, on an organic basis, compared to the third quarter of 2023. The reported sales increase included acquired sales of 11.7%, or $58.8 million, all reported within the Americas segment, as well as net favorable impact of foreign exchange of 0.2%, or $0.9 million, compared to the third quarter of 2023. The 4.1% organic decline was driven by organic decline in the Americas of 2.7% and Europe of 11.5%, partially offset by 8.3% organic growth in APMEA compared to the third quarter of 2023 segment net sales. The organic decline was primarily driven by volume declines in the Americas and Europe, partially offset by favorable price realization and favorable volume in APMEA. Operating income of $93.2 million increased by $6.1 million, or 7.0%, in the third quarter of 2024 as compared to the third quarter of 2023. This increase, primarily driven by acquisitions of 13.7%, or $11.9 million, all reported within the Americas segment, as well as favorable price realization and productivity, more than offset inflation, incremental investments and restructuring charges and lower volume.

In discussing our results of operations, we refer to non-GAAP financial measures, including organic sales, organic selling, general and administrative expenses, and organic operating income, that exclude the impacts of acquisitions, divestitures and foreign exchange from year-over-year comparisons. Management believes reporting these non-GAAP financial measures provides useful information to investors, potential investors and others, because it allows for additional insight into underlying trends by providing growth on a consistent basis. We reconcile the change in these non-GAAP financial measures to our reported results below.

Recent Developments

On October 1, 2024, we publicly disclosed our intention for local management to begin consultations with the appropriate works council in regard to a project to close the foundry at our manufacturing facility in Hautvillers-Ouville, France and to relocate the facility’s other production activities primarily to our other facilities in France and other locations in Europe. We expect that the works council consultation process will last approximately three months, after which the local management team will present its proposal to our Board of Directors, who will make a determination whether to approve the restructuring plan. If our Board of Directors approves the restructuring plan, the charges expected to be incurred in connection with such plan are anticipated to be material.

On October 28, 2024, we declared a quarterly dividend of forty-three cents ($0.43) per share on each outstanding share of Class A common stock and Class B common stock payable on December 13, 2024 to stockholders of record on November 29, 2024.

On October 27, 2024, Shashank Patel, our Chief Financial Officer, provided notice of his intention to retire from the Company effective as of March 15, 2025. We have initiated a search for our next Chief Financial Officer, which will include both internal and external candidates. Mr. Patel will continue in his role as Chief Financial Officer until a successor is named and will assist with the transition of his responsibilities to his successor.

Results of Operations

Third Quarter ended September 29, 2024 Compared to Third Quarter Ended September 24, 2023

Net Sales. Our business is reported in three geographic segments: Americas, Europe and APMEA. Our net sales in each of these segments for each of the third quarters of 2024 and 2023 were as follows:

(dollars in millions)

The change in net sales was attributable to the following:

(dollars in millions)

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

(dollars in millions)

* Segment change as a % of segment net sales by channel and Total change as a % of consolidated net sales by channel.

Americas net sales increased $49.0 million, or 14.0%, for the third quarter of 2024 compared to the third quarter of 2023. The change in net sales was positively impacted by $58.8 million, or 16.8%, of acquired sales related to the Bradley and Josam acquisitions completed in the fourth quarter of 2023 and first quarter of 2024, respectively. Organic net sales decreased $9.4 million, or 2.7%, primarily in the wholesale channel from decreased sales across our core valve products partially related to safety stock reductions.

Europe net sales decreased $12.9 million, or 10.7%, for the third quarter of 2024 compared to the third quarter of 2023. The change in net sales was positively impacted by $0.9 million, or 0.8%, of foreign currency translation. Organic net sales decreased $13.8 million, or 11.5%, primarily due to lower volumes partially offset by favorable price realization. The decrease was primarily due to volume declines in the OEM channel which was impacted by reduced government energy incentives and the related heat pump destocking, as well as volume declines in wholesale plumbing product sales into France and Benelux, partially offset by an increase in sales of our drains products.

APMEA net sales increased $3.2 million, or 9.7%, for the third quarter of 2024 compared to the third quarter of 2023. The change in net sales was positively impacted by $0.4 million, or 1.4%, of foreign currency translation. Organic net sales increased $2.8 million, or 8.3%, primarily due to growth in China, New Zealand and the Middle East. China’s sales

growth was primarily from increased commercial valves within data centers.

The net increase in sales due to foreign exchange was mostly due to the favorable impact of the depreciation of the U.S. dollar against the euro and Chinese yuan, partially offset by appreciation of the U.S. dollar against the Canadian dollar in the third quarter of 2024. 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.

Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for the third quarters of 2024 and 2023 were as follows:

(dollars in millions)

Gross profit and gross margin increased primarily from higher price realization and productivity, partially offset by inflation, lower volume, and the dilutive impact of acquisitions on gross margin. Gross profit includes the impact of the Bradley and Josam acquisitions completed in the fourth quarter of 2023 and first quarter of 2024, respectively.

Selling, General and Administrative Expenses. Selling, general and administrative (“SG&A”) expenses increased $12.1 million, or 8.2%, in the third quarter of 2024 compared to the third quarter of 2023. The increase in SG&A expenses was attributable to the following:

(in millions)

The decrease in organic SG&A expenses was primarily due to $3.4 million from productivity initiatives, a net decrease in short-term and long-term compensation accruals of $1.5 million, decreased product liability and insurance costs of $1.1 million and decreased Corporate expenses of $4.0 million including lower acquisition-related costs, mostly offset by an increase in investments of $6.0 million, including in our smart and connected initiatives and other strategic initiatives and general inflation of $3.9 million compared to the third quarter of 2023. The increase in foreign exchange was mainly due to the depreciation of the U.S. dollar against the euro. The acquired SG&A costs related to the Bradley and Josam acquisitions in the Americas segment completed in the fourth quarter of 2023 and first quarter of 2024, respectively. The acquired SG&A costs include $0.9 million of acquisition-related costs and a $7.8 million gain on the settlement of Bradley’s frozen pension plan. Total SG&A expenses, as a percentage of net sales, were 29.2% in the third quarter of 2024 compared to 29.1% in the third quarter of 2023.

Restructuring. In the third quarter of 2024, we recorded a net restructuring charge of $4.9 million, which primarily related to immaterial actions in all regions including severance and other cost reductions. In the third quarter of 2023, we recorded a net restructuring charge of $0.4 million, which primarily related to an immaterial program approved in the Americas involving a planned facility exit and the related severance and other costs incurred.

Operating Income. Operating income (loss) by segment for the third quarters of 2024 and 2023 was as follows:

(dollars in millions)

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

(dollars in millions)

Operating income increased $6.1 million, or 7.0%, for the third quarter of 2024 compared to the third quarter of 2023. Operating income was positively impacted by $11.9 million, or 13.7%, from acquisitions as well as $0.1 million, or 0.1% of foreign currency translation. The decrease in organic operating income of $1.4 million, or 1.6%, was primarily due to inflation, incremental investments and lower volume, partially offset by higher price realization and productivity and lower organic SG&A expenses.

Interest Income. Interest income in the third quarter of 2024 decreased $0.2 million compared to the third quarter of 2023, primarily due to lower cash and cash equivalents balances.

Interest Expense. Interest expense in the third quarter of 2024 increased $2.4 million compared to the third quarter of 2023, primarily due to a higher principal balance of debt outstanding due to the acquisition of Bradley during the fourth quarter of 2023 and an increase in interest rates. Refer to Note 10 of the Notes to Consolidated Financial Statements for further details.

Other (Income) Expense, Net. Other (income) expense, net, was an income balance of $0.6 million in the third quarter of 2024 primarily due to an immaterial investment gain partially offset by unfavorable foreign currency translation, compared to an expense balance of $0.1 million in the third quarter of 2023.

Income Taxes. Our effective income tax rate decreased slightly to 25.1% in the third quarter of 2024, from 25.3% in the third quarter of 2023. The Organization for Economic Co-operation and Development (“OECD”) has a framework for a 15% global minimum tax, commonly referred to as “Pillar Two” and certain aspects became effective January 1, 2024. We have assessed the 2024 forecasted annual impact of Pillar Two and it is not expected to be material to our consolidated financial statements.

Net Income. Net income was $69.1 million, or $2.06 per common share on a diluted basis, for the third quarter of 2024, compared to $65.8 million, or $1.96 per common share on a diluted basis, for the third quarter of 2023. Results for the third quarter of 2024 included an after-tax benefit of $5.8 million, or $0.17 per common share, for a gain on the settlement of the Bradley pension plan and $0.9 million, or $0.03 per common share, for other investment gains, partially offset by after-tax charges of $3.8 million, or $0.11 per common share, for restructuring and $1.9 million, or $0.06 per common share, for acquisition-related costs. Results for the third quarter of 2023 included after-tax charges of $2.3 million, or $0.07 per common share, for acquisition-related costs and $0.3 million, or $0.01 per common share, for restructuring.

Nine Months Ended September 29, 2024 Compared to Nine Months Ended September 24, 2023

Net Sales. Our net sales in each of the three geographic segments for the first nine months of 2024 and 2023 were as follows:

(dollars in millions)

The change in net sales was attributable to the following:

(dollars in millions)

The change in organic net sales by channel was attributable to the following:

(dollars in millions)

* Segment change as a % of segment net sales by channel and Total change as a % of consolidated net sales by channel.

Americas net sales increased $225.8 million, or 21.7%, for the first nine months of 2024 compared to the first nine months of 2023. The change in net sales was positively impacted by $183.7 million, or 17.6%, of acquired sales related to the Bradley and Josam acquisitions completed in the fourth quarter of 2023 and first quarter of 2024, respectively. Organic net sales increased $42.9 million, or 4.1%, primarily due to increased volume, partially from the benefit of additional shipping days in the first nine months of 2024 compared to the first nine months of 2023, and favorable price realization. The additional shipping days increased net sales by low single-digits. The organic net sales growth was primarily in the wholesale channel from increased sales across our core valve products and in the specialty channel from increased sales of our heating and hot water products.

Europe net sales decreased $39.4 million, or 10.3%, for the first nine months of 2024 compared to the first nine months of 2023. The change in net sales was positively impacted by $1.3 million, or 0.3%, of foreign currency translation. Organic net sales decreased $40.7 million, or 10.6%, primarily due to lower volumes despite the benefit of additional shipping days and favorable price realization. The additional shipping days increased net sales by low single-digits. The decrease was primarily due to volume declines in the OEM channel which was impacted by reduced government energy incentives in and the related heat pump destocking, as well as volume declines in wholesale plumbing product sales into France and Benelux, partially offset by an increase in sales of our drains products.

APMEA net sales increased $16.6 million, or 19.9%, for the first nine months of 2024 compared to the first nine months of 2023. The change in net sales was negatively impacted by $1.1 million, or 1.3%, of foreign currency translation, which was more than offset by $8.1 million, or 9.7%, of acquired sales related to the Enware acquisition completed in the second quarter of 2023. Organic net sales increased $9.6 million, or 11.5%, primarily due to volume growth from the benefit of additional shipping days in the first nine months of 2024 compared to the first nine months of 2023. The additional shipping days increased net sales by low-single-digits. The organic growth was primarily due to growth in all major countries in the segment.

The net decrease in sales due to foreign exchange was mostly due to the unfavorable impact of the appreciation of the U.S. dollar against the Chinese yuan and Canadian dollar, partially offset by the favorable impact of the depreciation of the U.S. dollar against the euro in the first nine months of 2024.

Gross Profit. Gross profit and gross profit as a percent of net sales (gross margin) for the first nine months of 2024 and 2023 were as follows:

(dollars in millions)

Gross profit and gross margin increased primarily from higher price realization and productivity, partially offset by inflation, lower volume despite the additional shipping days, the dilutive impact of acquisitions on gross margin and the amortization of the fair value step-up adjustments for inventory purchased as part of the Bradley and Josam acquisitions. Gross profit includes the impact of the Bradley and Josam acquisitions completed in the fourth quarter of 2023 and first quarter of 2024, respectively.

Selling, General and Administrative Expenses. SG&A expenses increased $70.2 million, or 16.3%, in the first nine months of 2024 compared to the first nine months of 2023. The increase in SG&A expenses was attributable to the following:

(in millions)

The increase in organic SG&A expenses was primarily due to an increase in investments of $18.0 million, including in our smart and connected initiatives and other strategic initiatives, general inflation of $12.0 million and increased variable costs due to higher sales of $3.4 million. These increases were partially offset by $7.2 million from productivity initiatives, a net decrease in short-term and long-term compensation accruals of $5.9 million, $4.4 million gain on the sale of buildings, decreased acquisition-related expenses of $3.0 million, lower professional fees of $2.4 million and $1.5 million of restructuring savings compared to the first nine months of 2023. The decrease in foreign exchange was mainly due to the appreciation of the U.S. dollar against the Chinese yuan. The acquired SG&A costs related to the Bradley and Josam acquisitions in the Americas segment completed in the fourth quarter of 2023 and first quarter of 2024, respectively, as well as the Enware acquisition in the APMEA segment completed in the second quarter of 2023. The acquired SG&A costs include $4.1 million of acquisition-related costs and a $7.8 million gain on the settlement of Bradley’s frozen pension plan. Total SG&A expenses, as a percentage of sales, were 29.3% in the first nine months of 2024 compared to 28.6% in the first nine months of 2023.

Restructuring. In the first nine months of 2024, we recorded a net restructuring charge of $6.4 million, which primarily related to immaterial actions in all regions including severance, exit costs and other cost reductions. In the first nine months of 2023, we recorded a net restructuring charge of $1.7 million, which primarily related to immaterial actions in all regions related to severance and other cost reductions.

Operating Income. Operating income (loss) by segment for the first nine months of 2024 and 2023 was as follows:

(Dollars in millions)

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

(Dollars in millions)

Operating income increased $29.2 million, or 10.7%, for the first nine months of 2024 compared to the first nine months of 2023. Operating income was positively impacted by $18.1 million, or 6.7%, from acquisitions and negatively impacted by $0.1 million, or 0.2%, of foreign currency translation. The increase in organic operating income of $15.9 million, or 5.9%, was primarily due to higher price realization and productivity, partially offset by inflation, incremental investments and lower volume.

Interest Income. Interest income in the first nine months of 2024 increased $2.1 million compared to the first nine months of 2023, primarily due to higher interest rates earned on our cash and cash equivalents.

Interest Expense. Interest expense in the first nine months of 2024 increased $7.5 million compared to the first nine months of 2023, primarily due to a higher principal balance of debt outstanding due to the acquisition of Bradley during the fourth quarter of 2023 and an increase in interest rates. Refer to Note 10 of the Notes to Consolidated Financial Statements for further details.

Other Income, Net. Other income, net, in the first nine months of 2024 increased $1.0 million compared to the first nine months of 2023, primarily due to an immaterial investment gain partially offset by unfavorable foreign currency translation.

Income Taxes. Our effective income tax rate increased to 24.7% in the first nine months of 2024, from 24.2% in the first nine months of 2023, primarily due to 2023 including a reduction of foreign tax liabilities associated with the repatriation of funds and a higher tax benefit from the vesting of stock compensation awards. These impacts were slightly offset by a change in the geographical mix of income in 2024 compared to 2023.

Net Income. Net income was $223.6 million, or $6.67 per common share on a diluted basis, for the first nine months of 2024, compared to $206.4 million, or $6.15 per common share on a diluted basis, for the first nine months of 2023. Results for the first nine months of 2024 included after-tax charges of $9.9 million, or $0.30 per common share, for acquisition-related costs and $4.9 million, or $0.14 per common share, for restructuring, partially offset by an after-tax benefit of $5.8 million, or $0.17 per common share, for a gain on the settlement of the Bradley pension plan, $3.3 million, or $0.10 per common share, for gain on sale of assets and $0.9 million, or $0.03 per common share, for other investment gains. Results for the first nine months of 2023 include after-tax charges of $3.6 million, or $0.11 per common share, for acquisition-related costs and $1.2 million, or $0.04 per common share, for restructuring.

Liquidity and Capital Resources

We generated $221.6 million of net cash provided by operating activities in the first nine months of 2024 compared to $200.9 million of net cash provided by operating activities in the first nine months of 2023. The increase in net cash provided by operating activities was primarily related to higher net income including contributions from our acquisitions.

We used $112.7 million of net cash for investing activities in the first nine months of 2024 compared to $31.1 million used in the first nine months of 2023. We used $96.3 million in cash for business acquisitions in our Americas segment in the first nine months of 2024 compared to $12.1 million for the immaterial acquisition in our APMEA segment in the first nine months of 2023, and $1.6 million less cash for net capital expenditures in the first nine months of 2024 compared to the first nine months of 2023. For the remainder of 2024, we expect to invest approximately $12 million in capital expenditures as part of our ongoing commitment to improve our operating capabilities.

We used $156.2 million of net cash for financing activities during the first nine months of 2024 primarily due to long-term debt repayments of $85.0 million, dividend payments of $41.1 million, tax withholding payments on vested stock awards of $12.8 million and payments of $13.0 million to repurchase approximately 66,000 shares of Class A common stock. In the first nine months of 2023, we used $113.8 million of net cash for financing activities primarily due to long-term debt repayments on our line of credit totaling $80.0 million (offset by proceeds from drawdowns of $30.0 million), tax withholding payments on vested stock awards of $15.8 million, dividend payments of $34.4 million and payments of $11.7 million to repurchase approximately 69,000 shares of Class A common stock.

On July 12, 2024, we entered into the Third Amended and Restated Credit Agreement by and among the Company, certain subsidiaries of the Company, the lenders and other parties from time to time parties thereto and JPMorgan Chase Bank, N.A., as administrative agent (the “Credit Agreement”). The Credit Agreement amends and restates the prior Second Amended and Restated Credit Agreement, dated as of March 30, 2021 (as amended by that certain Amendment No. 1 date August 2, 2022 and Amendment No. 2 dated December 12, 2023, the “Prior Credit Agreement”), that establishes our senior unsecured revolving credit facility of $800 million (the “Revolving Credit Facility”). The Credit Agreement also contains an expansion option of $400.0 million. Pursuant to the Credit Agreement, the maturity date of the Revolving Credit Facility is July 12, 2029, subject to extension under certain circumstances and subject to the terms of the Credit Agreement. The Credit Agreement provides for a maximum consolidated leverage ratio of 3.50 to 1.00 (or 4.00 to 1.00 during temporary step-ups following certain acquisitions) and the minimum consolidated interest ratio of 3.50 to 1.00.

The Revolving Credit Facility also includes sublimits of $100 million for letters of credit and $15 million for swing line loans. As of September 29, 2024, we had drawn down $215.0 million on this line of credit and had $12.9 million in letters of credit outstanding, which resulted in $572.1 million of unused and available credit under the Revolving Credit Facility as of such date. Borrowings outstanding under the Revolving Credit Facility bear interest at a fluctuating rate per annum equal to an applicable percentage defined as (i) in the case of Term Benchmark loans, the Term Benchmark rate plus an applicable percentage, ranging from 1.075% to 1.325%, or (ii) in the case of alternate base rate loans and swing line loans, interest (which at all times will not be less than 1.00%) at the greatest of (a) the Prime Rate in effect on such day, (b) the FRBNY Rate in effect on such day plus 0.50% and (c) the Term Benchmark rate plus 1.00% for a one month interest period, in each case, determined by reference to our consolidated leverage ratio. For the borrowings denominated in dollars, there is a fixed 10 basis point adjustment if the reference rate is Term SOFR. The weighted average interest rate on debt outstanding under the Revolving Credit Facility as of September 29, 2024 was 6.26%. The weighted average interest rate on debt outstanding inclusive of the interest rate swap discussed in Note 11 of the Notes to Consolidated Financial Statements and interest rates under the Revolving Credit Facility as of September 29, 2024 was 4.22%. In addition to paying interest under the Credit Agreement, we are also required to pay certain fees in connection with the Revolving Credit Facility, including, but not limited to, an unused facility fee and letter of credit fees. We 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 September 29, 2024, we were in compliance with all covenants related to the Credit Agreement.

As of September 29, 2024, we held $303.9 million in cash and cash equivalents. Of this amount, $164.0 million of cash and cash equivalents were held by foreign subsidiaries. Our U.S. operations typically generate sufficient cash flows to meet our domestic obligations. However, if we did have to borrow to fund some or all of our expected cash outlays, we can do so at reasonable interest rates by utilizing the undrawn borrowings under our Revolving Credit Facility.

Subsequent to recording the Toll Tax as part of the Tax Cuts and Jobs Act of 2017, our intent, other than with respect to the one-time repatriation of foreign earnings in 2023, has been to permanently reinvest undistributed earnings of foreign subsidiaries, and we do not have any current plans to repatriate additional post-Toll Tax foreign earnings to fund operations in the United States. However, if amounts held by foreign subsidiaries were needed to fund operations in the United States, we could be required to accrue and pay taxes to repatriate these funds. Such charges may include potential state income taxes and other tax charges.

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

Non-GAAP Financial Measures

In accordance with the SEC’s Regulation G and Item 10(e) of Regulation S-K, the following provides definitions of the non-GAAP financial measures used by management. We believe that these measures enhance the overall understanding of underlying business results and trends. These non-GAAP measures are not intended to be considered by the user in place of the related GAAP financial measure, but rather as supplemental information to more fully understand our business results. These non-GAAP financial measures may not be the same as similar measures used by other companies due to possible differences in method and in the items or events being adjusted.

Organic net sales and organic net sales growth, organic SG&A expenses, and organic operating income, are non-GAAP measures that exclude the impacts of acquisitions, divestitures and foreign exchange from period-over-period comparisons. A reconciliation to the most closely related U.S. GAAP measure, net sales, SG&A and operating income, have been included in our discussion within “Results of Operations” above. Non-GAAP measures should be considered in addition to, and not as a replacement for or as a superior measure to U.S. GAAP measures. Management believes reporting these non-GAAP measures provide useful information to investors, potential investors and others, by facilitating easier comparisons of our performance with prior and future periods.

Free cash flow is a non-GAAP measure that does not represent cash provided by operating activities in accordance with U.S. GAAP. Therefore, it should not be considered an alternative to net cash provided by or used in operating activities as an indication of our performance. The cash conversion rate of free cash flow to net income is also a measure of our performance in cash flow generation. We believe free cash flow and cash flow conversion rate to be an appropriate supplemental measure of our operating performance because it provides investors with a measure of our ability to generate cash, repay debt, pay dividends, repurchase stock and fund acquisitions.

A reconciliation of net cash provided by operating activities to free cash flow and a calculation of our cash conversion rate is provided below:

(in millions)

Free cash flow improved in the first nine months of 2024 when compared to the first nine months of 2023 primarily driven by higher net income including contributions from our acquisitions.

Our net debt to capitalization ratio, a non-GAAP financial measure used by management, at September 29, 2024 was (5.8%) compared to (3.5%) at December 31, 2023. The change was driven by a decrease in net debt balance primarily due to decreased long-term debt and an increase in stockholders’ equity at September 29, 2024 compared to December 31, 2023 due to higher net income. Management believes the net debt to capitalization ratio is an appropriate supplemental measure because it helps investors understand our ability to meet our financing needs and serves as a basis to evaluate our financial structure. Our computation may not be comparable to other companies that may define their net debt to capitalization ratios differently.

A reconciliation of long-term debt (including current portion) to net debt and our net debt to capitalization ratio is provided below:

(in millions)

A reconciliation of capitalization is provided below:

(in millions)

Application of Critical Accounting Policies and Key Estimates

We believe that our critical accounting policies are those related to revenue recognition, inventory valuation, goodwill and other intangibles, product liability costs, legal contingencies and income taxes. We believe these accounting policies are particularly important to an understanding of our financial position and results of operations and require application of significant judgment by our management. In applying these policies, management uses its judgment in making certain assumptions and estimates. Our accounting policies are more fully described under the heading “Accounting Policies” in Note 2 of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K as filed with the SEC on February 21, 2024.

We use derivative financial instruments primarily to reduce exposure to adverse fluctuations in foreign exchange rates, interest rates and costs of certain raw materials used in the manufacturing process. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all derivative positions are used to reduce risk by hedging underlying economic exposure. The derivatives we use are instruments with liquid markets. See Note 11 of Notes to the Consolidated Financial Statements for further details.

Our consolidated earnings, which are reported in United States dollars, are subject to translation risks due to changes in foreign currency exchange rates. This risk is concentrated in the exchange rate between the U.S. dollar and the euro; the U.S. dollar and the Canadian dollar; and the U.S. dollar and the Chinese yuan.

Our non-U.S. subsidiaries transact most business, including certain intercompany transactions, in foreign currencies. Such transactions are principally purchases or sales of materials and are denominated in European currencies, the Chinese yuan or the U.S. or Canadian dollar. We use foreign currency forward exchange contracts from time to time to manage the risk related to intercompany loans, intercompany purchases and intercompany sales that occur during the course of a year, and certain open foreign currency denominated commitments to sell products to third parties. We have entered into forward exchange contracts which hedge approximately 80% to 85% of the forecasted intercompany purchases between one of our Canadian subsidiaries and our U.S. operating subsidiaries for the next twelve months. We record the effective portion of the designated foreign currency hedge contracts in other comprehensive income (loss) until inventory turns and is sold to a third-party. Once the third-party transaction associated with the hedged forecasted transaction occurs, the effective portion of any related gain or loss on the designated foreign currency hedge is reclassified into cost of goods sold within earnings. The fair value of the Company’s designated foreign hedge contracts outstanding as of September 29, 2024 was a liability of less than $0.1 million.

Under the Credit Agreement, our earnings and cash flows are exposed to fluctuations in interest payments related to our floating rate debt. In order to manage our exposure, we entered into an interest rate swap on March 30, 2021. Under the interest rate swap agreement, we received the one-month USD-LIBOR subject to a 0.00% floor and paid a fixed rate of 1.02975% on a notional amount of $100.0 million. On August 2, 2022, we amended the interest rate swap to replace LIBOR as a reference rate for borrowings with Term SOFR. Under the amended interest rate swap agreement, we receive the one-month Term SOFR subject to a -0.1 percent floor and pay a fixed rate of 0.942% on a notional amount of $100.0 million. We entered into an additional interest rate swap on October 23, 2023, as part of the acquisition of Bradley. Under the interest rate swap agreement, we receive the one-month Term SOFR subject to a -0.1% floor and pay a fixed rate of 4.844% on a notional amount of $100.0 million. Both swaps mature on March 30, 2026. Information about our long-term debt facility and related interest rates appears in Note 10 of the Consolidated Financial Statements.

We purchase significant amounts of bronze ingot, brass rod, cast iron, stainless steel and plastic, which are utilized in manufacturing our many product lines. Our operating results can be adversely affected by changes in commodity prices if we are unable to pass on related price increases to our customers. We manage this risk by monitoring related market prices, working with our suppliers to achieve the maximum level of stability in their costs and related pricing, seeking alternative supply sources when necessary and passing increases in commodity costs to our customers, to the maximum extent possible, when they occur.

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended, or Exchange Act, as of the end of the period covered by this report, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily applies its judgment in evaluating and implementing possible controls and procedures. The effectiveness of our disclosure controls and procedures is also necessarily limited by the staff and other resources available to us and the geographic diversity of our operations. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act are accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There was no change in our internal control over financial reporting that occurred during the third quarter ended September 29, 2024, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. We are currently in the process of integrating the Bradley operations, control processes and information systems into our systems and control environment. We believe that we have taken the necessary steps to monitor and maintain appropriate internal controls over financial reporting during this integration. We will continue to review and document our disclosure controls and procedures, including our internal control over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.

There have been no material changes to the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2023.