QuickLinks-- Click here to rapidly navigate through this documentUNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended 12/31/01 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2003 | |
or | |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 0-14787
1-11499
WATTS INDUSTRIES,WATER TECHNOLOGIES, INC.
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(Exact
(Exact name of registrant as specified in its charter)
Delaware 04-2916536
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(State of incorporation) (I.R.S. Employer Identification No.)
815 Chestnut Street, North Andover, MA 01845
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (978) 688-1811
Securities registered pursuant to Section 12(b) of the Act: Class A Common
Stock, par value $.10 per share
Name of exchange on which registered: New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Delaware (State of incorporation) | 04-2916536 (I.R.S. Employer Identification No.) | |
815 Chestnut Street, North Andover, MA (Address of principal executive offices) | 01845 (Zip Code) | |
Registrant's telephone number, including area code:(978) 688-1811 | ||
Securities registered pursuant to Section 12(b) of the Act: Class A Common Stock, par value $.10 per share Name of exchange on which registered: New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act:None |
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes Xý No __o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]ý
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý Noo
Aggregate market value of the voting common stock of the Registrant held by non-affiliates of the Registrant on February 14, 2002June 30, 2003 was $289,132,253.$342,879,115.
As of February 14, 2002, 17,792,75429, 2004, 24,709,427 shares of Class A Common Stock, $.10 par value, 8,735,2247,471,700 shares of Class B Common Stock, $.10 par value, of the Registrant were outstanding.
Documents Incorporated by Reference
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Portions of the Registrant's Proxy Statement for its Annual Meeting of Stockholders to be held on April 23, 2002,May 5, 2004, are incorporated by reference into Part III of this Report.
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Item 1. BUSINESS.
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General
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Watts Industries, Inc., (the "Company") designs, manufactures
This annual report on Form 10-K contains statements which are not historical facts and sells an
extensive lineare considered forward-looking within the meaning of valvesthe Private Securities Litigation Reform Act of 1995. These forward-looking statements contain projections of our future results of operations, our financial position or state other forward-looking information. In some cases you can identify these statements by forward-looking words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "should," "will" and "would" or similar words. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other products forfactors, 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 water quality, water safety,
water flow control and water conservation markets. The Company is a leading
manufacturer and supplier of these products in both North America and Europe.
The Company's growth strategy emphasizes expanding brand preference with
customers, focusing on code development and enforcement, developing new valve
products and entering into new markets for specialized valves and related
products through diversification of its existing business, strategic
acquisitions in related business areas, both domestically and abroad, and
continued development of products and services foranticipated future results, performance or achievements expressed or implied by the home improvement,
do-it-yourself (DIY) retail market. Watts has focused on the valve industry
since its inception in 1874, when it was founded to design and produce steam
regulators for New England textile mills and power plants. The Company was
incorporated in Delaware in 1985.
The business description that follows describes the general developmentforward-looking statements. Some of the Company's water markets, which it has addressed primarily through the
plumbing and heating and water quality products business for fiscal 2001. The
Company's former industrial and oil and gas businesses were spun-off from the
Company on October 18, 1999 andfactors that might cause these differences are included as discontinued operations. Seedescribed under Item 7. "Management's7—"Management's Discussion and Analysis of Financial Condition and Results of Operations"Operations—Certain Factors Affecting Future Results." 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 we undertake no obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.
In this annual report on Form 10-K, references to "the Company," "we" or "us" refer to Watts Water Technologies, Inc. and its consolidated subsidiaries.
Overview
Watts Water Technologies, Inc. was founded by Joseph E. Watts in 1874 in Lawrence, Massachusetts, as Watts Regulator Co. The Company started as a small machine shop supplying parts to the New England textile mills of the 19th century and has grown into a global manufacturer of safety and flow control products for further information on these discontinued operations.
The Company'sthe residential and commercial plumbing, and heating and water quality markets. The Company was incorporated in Delaware in 1985 under the name Watts Industries, Inc. The Company's name was changed to Watts Water Technologies, Inc. in October 2003.
Our "Water by Watts" strategy is to be the leading provider of water quality, water conservation, water safety and water flow control products for the residential and commercial markets in North America and Europe. Our primary objective is to grow earnings by increasing sales within existing markets, expanding into new markets, making selected acquisitions and reducing manufacturing costs. We intend to continue to introduce products in existing markets by enhancing our preferred brands, developing new complementary products, promoting plumbing code development to drive sales of safety and water quality products and continuously improving merchandising in both the do-it-yourself (DIY) and wholesale distribution channels. We also target selected new markets based on growth potential and intend to continue to introduce new products appropriate for these new markets. We intend to continue to generate additional growth through selected acquisitions, both in our core markets as well as in new complementary markets. Lastly, we are committed to reducing our manufacturing costs through a combination of expanding manufacturing in lower-cost countries and consolidating our diverse manufacturing operations in North America and Europe.
Our products are sold to wholesale distributors, major DIY chains and original equipment manufacturers (OEMs). Most of our sales are for products that have been approved under regulatory standards incorporated into state and municipal plumbing, heating, building and fire protection codes in North America and Europe. We consistently advocate the development and enforcement of plumbing codes and are committed to providing products to meet these standards, particularly for safety and control valve products. We maintain quality control and testing procedures at each of our manufacturing facilities in order to manufacture products in compliance with code requirements.
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Additionally, a majority of our manufacturing facilities are ISO 9000, 9001 or 9002 certified by the International Organization for Standardization.
Our business is reported in three geographic segments: North America, Europe and China. The contributions of each segment to net sales, operating income and the presentation of certain other financial information by segment are reported in Note 17 of the Notes to Consolidated Financial Statements and in the Management's Discussion and Analysis included elsewhere in this report.
Recent Developments
On February 20, 2004, we entered into an agreement with Yuhuan County Cheng Guan Metal Hose Factory to acquire its 40% equity interest in our Taizhou Shida Plumbing Manufacturing Co., Ltd. (Shida) joint venture for an expected purchase price of $3.0 million, the assumption of approximately $6.0 million of debt and the payment of $3.5 million in connection with a three-year non-compete agreement. After the transaction, we will own 100% of Shida. The closing of the transaction is subject to the satisfaction of certain closing conditions and is expected to occur during the second quarter of 2004.
On January 5, 2004, we acquired substantially all of the assets of Flowmatic Systems, Inc. located in Dunnellon, Florida, for approximately $16.5 million in cash. Flowmatic designs and distributes a complete line of high quality reverse osmosis components and filtration equipment. Flowmatic's product line includes stainless steel and plastic housings, filter cartridges, storage tanks, control valves, as well as complete reverse osmosis systems for residential and commercial applications.
On December 15, 2003, we completed a public offering of 4.6 million shares of our Class A Common Stock resulting in net proceeds of approximately $82.5 million in cash.
In October 2003, we changed our name from Watts Industries, Inc. to Watts Water Technologies, Inc. to more accurately reflect our strategic focus on providing solutions to our customers' water based needs.
On July 30, 2003, we acquired Giuliani Anello S.r.l. located in Cento Bologna, Italy, for approximately $10.6 million in cash net of acquired cash of $1.4 million. Giuliani Anello manufactures and distributes valves and filters utilized in heating applications including strainer filters, solenoid valves, flow stop valves, stainless steel water filter elements and steam cleaning filters.
On May 15, 2003 we refinanced our $75.0 million 83/8% notes due December 1, 2003 through a private placement of $50.0 million 4.87% senior notes due May 15, 2010 and $75.0 million 5.47% senior notes due May 15, 2013.
On April 18, 2003, we acquired Martin Orgee U.K. Ltd. located in Kidderminster, West Midlands, United Kingdom for approximately $1.6 million in cash. Martin Orgee distributes a line of plumbing and heating products to the wholesale, commercial and OEM markets in the United Kingdom and Southern Ireland. Martin Orgee also assembles pumping systems for under-floor radiant heat applications.
Over the last 25 months, we have consolidated several of our manufacturing plants in North America and Europe and expanded our manufacturing capacity in lower cost countries such as China, Tunisia and Bulgaria. These manufacturing plant relocations and consolidations are an important part of our ongoing commitment to reduce production costs. We anticipate recording a pre-tax charge of approximately $6.0 million for additional manufacturing restructuring costs during 2004. These charges will be attributable to accelerated depreciation associated with the expected closure of one of our U.S. manufacturing plants and a reduction in estimated useful lives of manufacturing equipment due to the transfer of production to lower cost countries.
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Products
We believe that we have the broadest product lines include
temperaturein terms of design distinction, size and pressure safety relief valves; water pressure regulators;
configuration within a majority of the product lines we manufacture and market. Our principal product lines include:
Customers and Markets
We sell our products to plumbing, brass products
including shower valves and lavatory faucets. Powers' annualized sales prior to
the acquisition were approximately $20 million.
On February 12, 2002, the Board of Directors approved an establishment of
a 100% controlled brass and bronze valve manufacturing plant in Tianjin, China,
for an estimated cost of $9,000,000. The Board ratified on February 12, 2002,
the establishment of a 60% owned joint venture in the Shanghai provinces to
support some of the Company's retail-oriented products, such as flexible hose
connectors, plumbing fittings and under-the-sink products. The Company's
investment for 60% of this joint venture is estimated to be $7,800,000.
As previously announced, on October 18, 1999, the Company spun-off its
industrial and oil and gas businesses into a separate publicly traded company,
CIRCOR International, Inc. ("CIRCOR"). Under the terms of the spin-off
transaction, the Company distributed to shareholders a tax-free dividend of one
share of CIRCOR common stock for every two shares of Company common stock owned
as of the record date by that shareholder (the "Distribution"). The Company
continues to manufacture and distribute plumbing and heating and water quality
products through its three geographic business segments: North America, Europe,mechanical wholesale distributors, major DIY chains and Asia.
Sales
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The Company relies primarilyOEMs.
Wholesalers. Approximately 62% of our 2003 sales were to wholesale distributors for both commercial and residential applications. We rely on commissioned representative organizations,manufacturers' representatives, some of which maintain a consigned inventory of the Company'sour products, to market itsour product lines. These organizations, which
DIY. Approximately 20% of our 2003 sales were to DIY customers, primarily in North America. Our DIY customers demand less technical products, but are highly receptive to innovative designs and new product ideas. Our DIY sales over the past several years have increased as a result of our development of unique new products and successful merchandising efforts and the expansion of the market with the large national chains.
OEMs. Approximately 18% of our 2003 sales were to OEMs in both North America and Europe. In North America, our typical OEM customers are water heater manufacturers, equipment manufacturers needing flow control devices and water systems manufacturers needing backflow preventers. Our sales to OEMs in Europe are primarily to boiler manufacturers and radiant systems manufacturers.
Our largest customer, The Home Depot, Inc., accounted for approximately 69%$74.8 million, or 10.6%, of the Company'sour total net sales in fiscal 2001,2003. Our top ten customers accounted for approximately $176.3 million, or 25.0%, of our total net sales in 2003. Thousands of other customers comprised the remaining 75.0% of our net sales in 2003.
Marketing and Sales
We rely primarily on commissioned manufacturers' representatives, some of which maintain a consigned inventory of our products. These representatives sell primarily to plumbing and heating wholesalers. The Companywholesalers or service DIY store locations in North America. We also sellssell products for the residential construction and home repair and remodeling industries through DIY plumbing retailers, national catalog distribution companies, hardware stores, building material outlets and retail home center chains ("DIY Markets") and through the
Company'sour existing plumbing and heating wholesalers. In addition, the Company
sellswe sell products directly to certain large original equipment manufacturers
("OEM's")OEMs and private label accounts. The Company believes that sales to the
residential construction market may be subject to cyclical variations to a
greater extent than its other targeted markets; however, because the Company
sells into different geographic areas, to large and diverse customers, and has a
large replacement market, the potential adverse effects from cyclical variations
tend to be mitigated. No assurance can be given that the Company will be
protected from a broad downturn in the economy. Although no single customer
accounted for more than 10% of the Company's net sales in fiscal 2001, The Home
Depot accounted for approximately $54.5 million or 9.8% of the total net sales.
The second largest customer represents approximately 3.3% of the total net
sales. The top ten customers account for approximately 26% of the total net
sales; thousands of other customers comprise the remaining 74%.
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Manufacturing
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The Company has fully
We have integrated and highly automated manufacturing capabilities, including bronze and iron foundry,foundries, machining, plastic injection molding and assembly operations. The Company'sOur foundry operations include metal pouring systems, automatic core making, yellow brass forging and brass and bronze die castings. The Company'sOur machining operations feature computer-controlled machine tools, high-speed chucking machines with robotics and automatic screw machines for machining bronze, brass and steel components. The Company hasWe have invested heavily in recent years to expand itsour manufacturing base and to ensure the availability of the most efficient and productive equipment. The Company isWe are committed to maintaining itsour manufacturing equipment at a level consistent with current technology in order to maintain high levels of quality and manufacturing efficiencies. As part of this commitment, the
Company has spent a total of $62,110,000 on capital expenditures over the last
three and one half years. The Company has budgeted $18,700,000 for fiscal 2002
primarily for manufacturing machinery and equipment. The largest component of
this budget is the establishment of a 100% controlled brass and bronze valve
manufacturing plant in Tianjin, China, for an estimated cost of $9,000,000. See
Item 2. "Properties" below. The Company has substantially completed its
implementation of
We continue to implement an integrated enterprise-wide software system in its U.S. and
Canadianour North American locations with a focus on inventory management,management; production scheduling and electronic data interchange. This system has enabled the Companyus to provide better service to our customers, improve working capital management, lower transaction costs and improve e-commerce capabilities.
Capital expenditures were
$16,047,000, $14,238,000, $10,293,000 and $21,532,000 for fiscal 2001, 2000, six
months ended December 31, 1999 ("1999.5") and the twelve months ended June 30,
1999, respectively. Depreciationdepreciation and amortization for suchthe following periods were $23,675,000, $20,071,000, $9,225,000 and $17,456,000, respectively.
The Companyas follows:
Period | Capital Expenditures | Depreciation and Amortization | ||||
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Year ended December 31, 2003 | $ | 20.0 million | $ | 21.3 million | ||
Year ended December 31, 2002 | $ | 19.6 million | $ | 22.3 million | ||
Year ended December 31, 2001 | $ | 16.0 million | $ | 23.7 million |
Our capital expenditure budget for 2004 is committed to dramatically reducing the cost of its products
during the next two years by consolidating plants in North America and Europe,
while at the same time expanding manufacturing capacity in China beyond the
Company's cast iron manufacturing joint venture (TWT) in Tianjin, China, of
which the Company has a 60% controlling interest. Current projects include the
consolidation of Powers Process Controls into the New Hampshire Webster Valve
plant; consolidation of Fimet into the nearby plant in Biassono, Italy; and the
consolidation of the existing German distribution company into the operations of
Dumser Metallbau. In the fourth quarter of 2001, the Company recorded a
$5,831,000 pre-tax chargeapproximately $18.5 million, primarily for manufacturing restructuring costs, asset
write-downs,machinery and other related costs. In 2002, the Company anticipates an
additional $6,000,000 to $8,000,000 pre-tax charge as the Company continues to
implement this manufacturing restructuring plan.
equipment.
Raw Materials
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The five significant raw materials used in the Company'sour production processes are bronze ingot, brass rod, cast iron, steel and cast iron. While the Companyplastic. We historically hashave not experienced significant difficulties in obtaining these commodities in quantities sufficient for its operations, thereour operations. There have been significant changes in their prices. The Company'sthe costs of certain of these materials, including recent increases in the costs of bronze, brass, cast iron and steel. Our gross profit margins are adversely affected to the extent that the selling prices of itsour products do not increase proportionately with increases in the costs of bronze ingot, brass rod, and cast iron.these raw materials. Any significant unanticipated increase or decrease in the pricescosts of these commodities could materially affect the Company'sour results of operations. The
Company managesWe manage this risk by monitoring related market prices, working with itsour 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 itsour customers, to the maximum extent possible, when they occur. Additionally,In addition, on a limited basis, the Company useswe use commodity futures contracts to manage this risk. The CompanyWe did not purchase any commodity futurefutures contracts during fiscal 20012003. See "Management's Discussion and there were none outstanding at December 31,
2001. No assurances can be given that such factors will protect the Company from
future changes in the prices for such raw materials. See Item 7A. "QuantitativeAnalysis of Financial Condition and Results of Operations—Quantitative and Qualitative Disclosures About Market Risk." We have begun to implement some price increases in response to the recent increases in the cost of bronze, brass, cast iron and steel. At this point, it is too early to determine if these price increases will be successful in reducing or eliminating the impact of the increases in raw material costs.
Code Compliance
Products representing a majority of our sales are subject to regulatory standards and code enforcement which typically requires that these products meet stringent performance criteria. Standards are established by such industry test and certification organizations as the American Society of Mechanical Engineers (A.S.M.E.), the Canadian Standards Association (C.S.A.), the American Society
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of Sanitary Engineers (A.S.S.E.), the University of Southern California Foundation for Cross-Connection Control (USC FCC&HR), the International Association of Plumbing and Mechanical Officials (I.A.P.M.O.), Factory Mutual (F.M.), the National Sanitation Foundation (N.S.F.) and Underwriters Laboratory (U.L.). These standards are incorporated into state and municipal plumbing and heating, building and fire protection codes.
National regulatory standards in Europe vary by country. The major standards and/or guidelines which our products must meet are AFNOR (France), DVGW (Germany), UNI/ICIN (Italy), KIWA (Netherlands), SVGW (Switzerland), SITAC (Sweden) and WRAS (United Kingdom). Through the Committee for European Normalization (CEN) European applications and product standards will be adopted in each country and implemented in each certification system.
Together with our commissioned manufacturers' representatives, we have consistently advocated the development and enforcement of plumbing codes. We maintain stringent quality control and testing procedures at each of our manufacturing facilities in order to manufacture products in compliance with code requirements. We believe that significant product testing capability and investment in plant and equipment is needed to manufacture products in compliance with code requirements, which creates a barrier to entry for competitors. Additionally, a majority of our manufacturing facilities are ISO 9000, 9001 or 9002 certified by the International Organization for Standardization.
Product Development and Engineering
We maintain our own product development and design teams in North America, Europe and China that continuously enhance our existing products and develop new products. We maintain sophisticated product development and testing laboratories. Our efforts in this area have been particularly successful in the DIY market, which values innovation in product design.
Competition
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The domestic and international markets for valveswater safety and flow control devices are intensely competitive and includerequire us to compete against some companies possessing greater financial, marketing and other resources than the Company. Managementours. Our management considers product quality,
reputation,brand preference, engineering specifications, plumbing code requirements, price, effectiveness of distributiontechnological expertise, delivery times and breadth of product lineofferings to be the primary competitive factors. The Company believesWe believe that new product development and product engineering are also important to success in the valvewater industry and that the Company'sour position in the industry is attributable in significant part to itsour ability to develop new and innovative products quickly and to adapt and enhance existing products. During fiscal 2001, the Company
continuedWe continue to develop new and innovative products to enhance market position and isare continuing to implement manufacturing and 4
The CompanyWe cannot be certain that itsour efforts to develop new products will be successful or that itsour customers will accept itsour new products. The Company employs approximately 46 engineers and technicians,
excluding engineers working at TWT in Tianjin, China. Although the Company ownswe own certain patents and trademarks that it considerswe consider to be of importance, it doeswe do not believe that itsour business and competitiveness as a whole isare dependent on any one of itsour patents or trademarks or on patent or trademark protection generally.
The Company's financial information by geographic business segment is
contained in Note 17 of Notes to Consolidated Financial Statements incorporated
herein by reference. From time to time, the Company's results of operations may
be adversely affected by fluctuations in foreign exchange rates.
Backlog
Backlog was $25,076,000$40.0 million at February 8, 200220, 2004 and $27,265,000$42.7 million at February 9, 2001. The Company
does14, 2003. We do not believe that itsour backlog at any point in time is indicative of future operating results. The Company expects that available funds and funds provided
from the Company's operations are sufficient to meet anticipated capital
requirements. See Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations" below as it relates to the impact of
foreign exchange rates, capital requirements and financial information by
geographic segment.
Employees
As of December 31, 2001, the Company's2003, our domestic and foreign operations employed approximately 3,1673,700 people, plus 7321,400 employees at TWT in Tianjin,our joint ventures in China. There are noNone of our employees thatin North America are covered by collective bargaining agreements in North America.agreements. Our European employees are subject to the traditional national collective bargaining agreements. The Company believesWe believe that itsour employee relations are good.
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Available Information
We maintain a website with the addresswww.wattswater.com. The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. Other than an investor's own internet access charges, we make available free of charge through our website our Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we have electronically filed such material with, or furnished such material to, the Securities and Exchange Commission.
Executive Officers - ------------------
Information with respect toand Directors
Set forth below are the names of our executive officers and directors, their respective ages and positions with our Company and a brief summary of their business experience for the Company is set forth
below:
Name Position Age
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past five years:
Name | Age | Position | ||
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Patrick S. O'Keefe | 51 | Chief Executive Officer, President and Director | ||
William C. McCartney | 50 | Chief Financial Officer, Treasurer and Secretary | ||
Ernest E. Elliott | 52 | Executive Vice President of Wholesale Marketing | ||
Jeffrey A. Polofsky | 45 | Executive Vice President of Retail Sales and Marketing | ||
Lynn A. McVay | 36 | Executive Vice President of Wholesale Sales | ||
Paul A. Lacourciere | 48 | Corporate Vice President of Manufacturing | ||
J. Dennis Cawte | 53 | Group Managing Director Europe | ||
Lester J. Taufen | 60 | General Counsel and Vice President of Legal Affairs | ||
Douglas T. White | 59 | Group Vice President | ||
J. Timothy McCullough | 62 | Vice President of Human Resources | ||
Timothy P. Horne | 65 | Director | ||
Kenneth J. McAvoy(1)(2)(3) | 63 | Director | ||
Gordon W. Moran(1)(2)(3) | 65 | Non-Executive Chairman of the Board and Director | ||
Daniel J. Murphy, III(1)(2)(3) | 62 | Director | ||
Roger A. Young(1)(3) | 58 | Director | ||
John K. McGillicuddy(1)(3) | 60 | Director |
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Patrick S. O'Keefe joined our Company in August 2002. Prior to joining our Company, he served as President, Chief Executive Officer 63
President and Director William C. McCartneyof Industrial Distribution Group, a supplier of maintenance, repair, operating and production products, from 1999 to 2001. He was Chief FinancialExecutive Officer Treasurerof Zep Manufacturing, a unit of National Service Industries and Secretary 48
Michael O. Fifer Presidenta manufacturer of specialty chemicals throughout North American Operations 44
Robert T. McLaurin Corporate Vice President of Asian Operations 71
Lester J. Taufen General Counsel, Vice President of Legal Affairs 58America, Europe and Assistant Secretary
Timothy P. Horne joined the Company in September 1959 andAustralia, from 1997 to 1999. He has been a
Director since 1962. Mr. Horne served as the Company's President from 1976 to
1978,also held various senior management positions with Crane Co. from 1994 to April 1997 and again since October 1999. He has served as
Chief Executive Officer since 1978, and he became the Company's Chairman of the
Board in April 1986.
1997.
William C. McCartney joined theour Company in 1985 as Controller. He was appointed the Company'sour Vice President of Finance in 1994 and served as our Corporate Controller of the Company from April 1988 to December 1999. Mr.
McCartneyHe was appointed Chief Financial Officer, Treasurer and Secretary on January 1, 2000.
Michael O. Fifer
Ernest E. Elliott joined theour Company in May 19941986, serving in a variety of sales and marketing roles. He was appointed the
Company's Vice President of Corporate Development. He was appointedSales in 1991 and Executive Vice President of North American OperationsWholesale Sales and Marketing in October 1999.1996. Prior to joining theour Company, Mr.
Fiferhe was Associate DirectorVice President of Corporate Development with Dynatech Corp.,BTR Inc.'s Valve Group, a diversified high-tech manufacturer of industrial and commercial valve products.
Jeffrey A. Polofsky joined our Company in October 1998 as the Vice President and General Manager of Anderson Barrows Metals Company. He was named Executive Vice President of Retail Sales and Marketing in January 2000. Prior to joining our Company, he was employed at Desa International, a manufacturer of consumer hard goods, from 1988 to 1998.
Lynn A. McVay joined our Company as Executive Vice President of Wholesale Sales in March 2003. Prior to joining our Company, he was the Vice President of Sales and Marketing for Little Giant Pump Company, a water pump manufacturing company and a wholly-owned subsidiary of Tecumseh Products Company.
Paul A. Lacourciere joined our Company in 1986 as Vice President of New Hampshire operations in 1989. He also served our wholly-owned subsidiary Watts Regulator Co. as Vice President of Manufacturing from 1991 to April 1994.
Robert T. McLaurin1993; Executive Vice President from 1993-1995 and President from 1995-1997. In 1997 he was appointed Corporate Vice President of Asian
OperationsManufacturing of our Company.
J. Dennis Cawtejoined our Company in August 1994. He served as the Senior ViceOctober 2001 and was appointed Group Managing Director Europe. Prior to joining our Company, he was European President of ManufacturingPCC Valve and Controls, a division of Watts Regulator Co.Precision Castparts Corp., a manufacturer of components and castings to the aeronautical industry, from 19831999 to August 1994.2001. He joined Watts
Regulator Company as Vice Presidenthad also worked for Keystone Valve International, a manufacturer and distributor of Manufacturing in 1978.
industrial valves, for 20 years, his most recent position was the Director of Northern European Operations.
Lester J. Taufen joined theour Company in January 1999 as Associate Corporate Counsel. He was appointed General Counsel and Vice President of Legal Affairs, and Assistant Secretary in January 2000. Prior to joining theour Company, Mr.
Taufenhe was employed for 13 years at Elf Atochem North America, Inc., a chemical manufacturing company, serving as Senior Counsel.
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Douglas T. White joined our Company in September 2001 as Group Vice President. Prior to joining our Company he was employed by Honeywell International, Inc., a diversified technology and manufacturing company, as Vice President of Marketing—Consumer Products Group.
J. Timothy McCullough joined our Company as Director of Human Resources in May 1998. He was appointed Vice President of Human Resources in November 2003.
Timothy P. Horne has been a Director since 1962. He was employed by our Company since September 1959 and served as our President from 1976 to 1978, from 1994 to April 1997 and from October 1999 to August 2002. He served as Chief Executive Officer from 1978 to August 2002, and he served as Chairman of our Board of Directors from April 1986 to August 2002. He retired from our Company on December 31, 2002.
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Kenneth J. McAvoy was Controller of our Company from 1981 to 1986 and Chief Financial Officer and Treasurer from 1986 to 1999. He also served the offices of Vice President of Finance from 1984 to 1994; Executive Vice President of European Operations from 1994 to 1996; and Secretary from 1985 to 1999. He retired from our Company on December 31, 1999.
Gordon W. Moran has been the Chairman of Hollingsworth & Vose Company, a paper manufacturer, since 1997, and served as its President and Chief Executive Officer from 1983 to 1998.
Daniel J. Murphy, III has been the Chairman of Northmark Bank, a commercial bank, since August 1987. Prior to forming Northmark Bank in 1987, he was a Managing Director of Knightsbridge Partners, a venture capital firm, from January to August 1987, and President and a Director of Arltru Bancorporation, a bank holding company, and its wholly-owned subsidiary, Arlington Trust Company from 1980 to 1986.
Roger A. Young served as Chairman of the Board of Directors of Bay State Gas Company, a wholly-owned subsidiary of NiSource, Inc., from 1996 to 2003 and served on its Board from 1975 to 2003. He was elected President and Chief Operating Officer of Bay State Gas Company in 1981 and Chief Executive Officer in 1990, serving in such positions until 1999. He has also been a Director of NiSource, Inc. since 1999.
John K. McGillicuddy was employed by KPMG LLP, a public accounting firm, from June 1965 until his retirement in June 2000. He was elected into the Partnership at KPMG LLP in June 1975 where he served as Audit Partner, SEC Reviewing Partner, Partner-in-Charge of Professional Practice, Partner-in-Charge of College Recruiting and Partner-in-Charge of Staff Scheduling. He is a Director of Brooks Automation, Inc.
Product Liability, Environmental and Other Litigation Matters
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The Company is
We are subject to a variety of potential liabilities connected with itsour business operations, including potential liabilities and expenses associated with possible product defects or failures and compliance with environmental laws. The Company maintainsWe maintain product liability and other insurance coverage, which it believeswe believe to be generally in accordance with industry practices. Nonetheless, such insurance coverage may not be adequate to protect the Companyus fully against substantial damage claims, which may arise from product defects and failures.
Contingencies
James Jones Litigation
On
As previously disclosed, on June 25, 1997, Nora Armenta (the Relator) sued James Jones Company, Watts Industries,
Inc.,Water Technologies, Inc, which formerly owned James Jones, Mueller Co., and Tyco International (U.S.) Inc. in the California Superior Court for Los Angeles County with a
complaint that sought tens of millions of dollars in damages.County. By this complaint and an amended complaint filed on November 4, 1998 ("First(First Amended Complaint")Complaint), Armenta, a former employee of James Jones, sued on behalf of 34 municipalities as a qui tam plaintiff a Relator, under the California False Claims Act.Act (the Armenta case). Late in 1998, the Los Angeles Department of Water and Power ("LADWP")(LADWP) intervened. In December 2000, the court allowed the Relator to file a Second Amended Complaint, which added a number of new cities and water districts as plaintiffs and brought the total number of plaintiffs to 161. On June 3, 2002, the California Superior Court excluded 47 cities from this total of 161. The Relator was not able to obtain appellate modification of this order. To date, 1411 of the total number of plaintiffs have intervened.
The First Amended Complaint alleges that the Company'sour former subsidiary (James Jones Company) sold products that did not meet contractually specified standards used by the named municipalities for their water systems and falsely certified that such standards had been met. ArmentaThe Relator claims that these
9
municipalities were damaged by their purchase of these products and seeks treble damages, legal costs, attorneys' fees and civil penalties under the False Claims Act.
The LADWP's intervention, filed on December 9, 1998, adopted the First Amended Complaint and added claims for breach of contract, fraud and deceit, negligent misrepresentation and unjust enrichment. The LADWP also sought past and future reimbursement costs, punitive damages, contract difference in value damages, treble damages, civil penalties under the False Claims Act and costs of the suit.
One of the allegations in the First Amended Complaint's allegationsComplaint is the suggestion that because some of the purchased James Jones products are outwere made of specification'81 bronze (UNS No. C8440) and contain more lead than the `85specified '85 bronze specified,(UNS No. C83600), a risk to public health might exist. This contention is predicated on the average difference of about 2% lead content in `81'81 bronze (6% to 8% lead) and `85'85 bronze (4% to 6% lead) alloys and the assumption that this would mean increased consumable lead in public drinking water. TheWe believe the evidence and discovery available to date indicate that this is not the case.
In addition, bronze that does not contain more than 8% lead, like '81 bronze, is approved for municipal and home plumbing systems by municipalities and national and local codes, and the Federal Environmental Protection Agency defines metal for pipe fittings with no more than 8% lead as "lead free" under Section 1417 of the Federal Safe Drinking Water Act.
In June 2001, the Companywe and the other defendants reached a proposed settlement with the LADWP, one of the plaintiffs, which was approved by the California Superior Court on October 31, 2001 and by the Los Angeles City Council on December 14, 2001. On January 19, 2001,
In this case, the California False Claims
Act claims filed byRelator seeks three times an unspecified amount of actual damages and alleges that the municipalities have suffered hundreds of millions of dollars in damages. The Relator also seeks civil penalties of $10,000 for each false claim and alleges that defendants are responsible for tens of thousands of false claims. We settled with the City of Pomona were dismissed. The California CourtLos Angeles, by far the most significant city, for $5.7 million plus the Relator's statutory share and attorneys' fees. Co-defendants will contribute $2.0 million toward this settlement. In August 2003, an additional settlement payment was made for $13 million ($11 million from us and $2 million from the James Jones Company) which settled the claims of Appeal reversed this dismissal,the three Phase I cities (Santa Monica, San Francisco and East Bay Municipal Water District) chosen by the Relator as having the strongest claims to be tried first. This settlement payment included the Relator's statutory share, and the California Supreme Court declinedclaims of these three cities have been dismissed. In addition to review this reversal.$13 million payment, we are obligated to pay the Relator's attorney's fees.
After the Company's insurers had denied coveragePhase I settlement, the Court permitted the Company and the other defendants to select five additional cities (Contra Costa, Corona, Santa Ana, Santa Cruz and Vallejo) to serve as the plaintiffs in a second trial phase of the case. The Company and James Jones subsequently reached an agreement to settle the City of Santa Ana's claims for $45,000, and we are responsible for $38,000 of this settlement amount. Santa Ana has submitted this claim to the Court for approval in March 2004. The trial of the claims of the remaining Phase II cities is scheduled for September 2004.
We have a reserve of approximately $9.3 million with respect to the James Jones Litigation in our consolidated balance sheet as of December 31, 2003. We believe, on the basis of all available information, that this case,reserve is adequate to cover the Companyprobable and reasonably estimable losses resulting from the James Jones Litigation and the insurance coverage litigation with Zurich discussed below. We are currently unable to make an estimate of the range of any additional losses.
On February 14, 2001, we filed a complaint in the California Superior Court against itsour insurers for coverage.coverage of the claims in the Armenta case. The James Jones Company filed a similar complaint, the cases were consolidated, and on October 30, 2001 the California Superior Court ruledmade a summary adjudication ruling that Zurich American Insurance Company (Zurich) must pay all reasonable defense
10
costs incurred by the Companyus in the James JonesArmenta case since April 23, 1998 as well as the Company'sour future defense costs in this case until its final resolution. On October 24, 2002, the California Superior Court made another summary adjudication ruling that Zurich must indemnify and pay us for the amounts we must pay under our settlement agreement with the City of Los Angeles. Zurich has asserted that all amounts (both defense costs and indemnity amounts paid for settlements) paid by it to us are subject to reimbursement under Deductible Agreements between Zurich and us. However, management and counsel anticipate that we will ultimately prevail on reimbursement issues. Zurich appealed the orders requiring it to pay defense costs, the California Court of Appeal accepted that appeal, and it is contestingcurrently pending. Zurich also sought appellate review of the order that found coverage and required Zurich to indemnify us for the settlement with the City of Los Angeles. On March 26, 2003, the California Court of Appeal denied Zurich's petition for appellate review of this ruling. The Company isorder, but Zurich will still be able to appeal this order at the end of the case. We are currently unable to predict the outcomefinality of the litigation
relatingorder on indemnity for the Los Angeles settlement. We have recorded reimbursed indemnity settlement amounts (but not reimbursed defense costs) as a liability. We intend to insurance coverage.
6
Based on management's assessment, the Company doeswe do not believe that the ultimate outcome of the James Jones case will have a material adverse effect on itsour liquidity, financial condition or results of operations. While this assessment is based on all available information, litigation is inherently uncertain, and the actual liability to the Companyus to fully resolve this litigation cannot be predicted with any certainty. The Company intendscertainty and there exists a reasonable possibility that we may ultimately incur losses in the James Jones Litigation in excess of the amount accrued. We intend to continue to contest vigorously the James Jones case and its related litigation.
Environmental The New York Attorney General ("NYAG"), on behalf of the New York State
Department of Environmental Conservation ("NYSDEC"), has threatened litigation
against the Company and approximately fifteen (15) other Potentially Responsible
Parties ("PRPs") for the cost of closing, and controlling contamination from,
the Babylon Landfill in Babylon, New York. The Company agreed to enter a tolling
agreement with the NYAG to permit formation of a PRP groupRemediation
We have been named as a first step
toward establishing a negotiation process. The NYAG has produced only a record
of an interview in which a landfill employee stated that, before the Company had
acquired the Jameco company, Jameco had delivered waste to the site in its own
trucks. The Company knows of no other information connecting it or any
predecessor to this site.
On September 25, 2001, the United States Environmental Protection Agency
("EPA") issued a complaint and compliance order to the Watts Regulator Co., a
wholly owned subsidiary of the Company, under the Resource Conservation and
Recovery Act ("RCRA")potentially responsible party (PRP) with respect to a sand reclamation unit andlimited number of identified contaminated sites. The level of contamination varies significantly from site to site as do the sand it
generated at its Spindale, North Carolina facility. All requirementsrelated levels of this
complaint and compliance order have been resolved by a Consent Agreement and
Final Order filedremediation efforts. Environmental liabilities are recorded based on January 30, 2002,the most probable cost, if known, or on the estimated minimum cost of remediation. We accrue estimated environmental liabilities based on assumptions, which requires payment of a $100,000
civil penalty and submissions of a closure report for the reclamation unit and a
site assessment report for what became of the reclaimed sand which currently
appears to have been used in a manner acceptable to the EPA.
Certain of the Company's operations generate solid and hazardous wastes,
which are disposed of elsewhere by arrangement with the owners or operators of
disposal sites or with transporters of such waste. The Company's foundry and
other operations are subject to various federal, statea number of factors and local lawsuncertainties. Circumstances which can affect the reliability and precision of these estimates include identification of additional sites, environmental regulations, relatinglevel of cleanup required, technologies available, number and financial condition of other contributors to environmental quality. Compliance with these lawsremediation and regulations requires the Company to incur expenses and monitor its operations on
an ongoing basis. The Company cannot predict the effect of future requirements
on its capital expenditures, earnings or competitive position due to anytime period over which remediation may occur. We recognize changes in federal, stateestimates as new remediation requirements are defined or localas new information becomes available. We have a reserve of approximately $2.5 million, and we estimate that our accrued environmental laws, regulations or ordinances.
The Company is currently a partyremediation liabilities will likely be paid over the next five to or otherwise involved in various
administrative or legal proceedings under federal, state or local environmental
laws or regulations involving a limited number of sites.ten years. Based on the facts presentlycurrently known to it, the Company doesus, we do not believe that the ultimate outcome of these environmental proceedingsclaims will have a material adverse effect on itsour liquidity, financial condition or results of operations. Given
For several years, the natureNew York Attorney General (NYAG) has threatened to bring suit against approximately 16 PRPs, including Watts Water Technologies, Inc as successor to Jameco Industries, Inc., for incurred remediation costs and scopefor operation and maintenance costs that will be incurred in connection with the cleanup of a landfill site in Babylon, New York. The NYAG has identified recovery numbers between $19 million and $24 million, but it is too early to know what the final recovery number will be, what the final number of PRPs will be or what proportion of the Company's
manufacturing operations, there canfinal costs may be no assuranceallocated to us. In 2003, 139 PRPs were identified by our defense group, and they are in the process of being invited to join the PRPs identified so far by the NYAG. Based on the facts currently known to us, we do not believe that the ultimate outcome of the Babylon matter will have a material adverse effect on our liquidity, financial condition or results of operations.
11
Asbestos Litigation
We are a defendant in approximately 115 actions filed primarily, but not exclusively, in Mississippi and New Jersey state courts alleging injury or death as a result of exposure to asbestos. These filings typically name multiple defendants, and are filed on behalf of many plaintiffs. They do not identify any particular products of ours as a source of asbestos exposure. To date the Company has been dismissed from each case when the scheduled trial date comes near. Based on the facts currently known to us, we do not believe that the ultimate outcome of these claims will not
become subject to other environmental proceedings and liabilitieshave a material adverse effect on our liquidity, financial condition or results of operations.
Other Litigation
On or about March 26, 2003, a class action complaint was filed against the Company by North Carolina Hospitality Group, Inc. in the future
which may be materialCircuit Court of Maryland, Prince George's County. It alleges that certain commercial valve models contain a design defect that causes them to the Company. See Note 15fail prematurely. Our extensive investigation of the Notesevidence, including the physical evidence presented so far by the plaintiff, demonstrates that the allegations in the complaint are without merit, and we intend to defend this lawsuit vigorously. Based on the Consolidated Financial Statements.
Other Litigationfacts currently known to us, we do not believe that the ultimate outcome of this matter will have a material adverse effect on our liquidity, financial condition or results of operations.
Other lawsuits and proceedings or claims, arising from the ordinary course of operations, are also pending or threatened against the Company and its
subsidiaries.us. Based on the facts currently known to it, the Company doesus, we do not believe that the ultimate outcome of these other litigation matters will have a material adverse effect on itsour financial condition or results of operation. See
Note 15operations.
However, litigation is inherently uncertain, and we believe that there exists a reasonable possibility that we may ultimately incur losses in other litigation in excess of the Notes to the Consolidated Financial Statements.
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Item 2. PROPERTIES.
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The Company maintains 33
We maintain 45 facilities worldwide with itsour corporate headquarters located in North Andover, Massachusetts. TheOur manufacturing operations include fivefour casting foundries, two of which are located in the United States one in Europe and two at TWT in Tianjin, China, and it maintainsChina. Additionally, we maintain one yellow brass forging foundry located in Italy. Castings and forgings from these foundries and other components are machined and assembled into finished valves at 2025 manufacturing facilities located in the United States, Canada, Europe, China and China.Tunisia. Many of these facilities contain sales offices, warehouses, or warehousessales and distribution centers from which the Company shipswe ship finished goods to customers and commissioned representative organizations.manufacturers' representatives. All the Company'sour operating facilities and the related real estate are owned by the Company,us, except the buildings and land operated by one of our joint ventures located in Tianjin, People's Republic of China, which areis leased by TWT underwith a
lease agreement, the remaining term of which is approximately 2422 years, the Company'sland on which our manufacturing facility is located in Woodland, California,Taizhou, China with a remaining lease
term of 249 years and except for the Company's acquiredfollowing facilities, each of which is leased:
Type of Facility | Location | Lease Expiration | |||
---|---|---|---|---|---|
Manufacturing | Springfield, MO | 2004 | |||
Manufacturing | Phoenix, AZ | 2010 | |||
Manufacturing | Woodland, CA | 2008 | |||
Manufacturing | Sacramento, CA | 2005 | |||
Manufacturing | Santa Ana, CA | 2008 | |||
Warehouse | Reno, NV | 2005 | |||
Warehouse | Dallas, TX | 2006 | |||
Warehouse | Alsip, IL | 2008 | |||
Sales Office | Kennesaw, GA | 2007 | |||
Sales Office | Des Plaines, IL | 2008 | |||
Manufacturing | Rosieres, France | 2015 | |||
Manufacturing | Monastir, Tunisia | 2004 | |||
Manufacturing | Neuenburg am Rhein, Germany | 2004 | |||
Sales/Distribution | Barcelona, Spain | 2004 | |||
Sales/Distribution | Evesham, UK | 2016 | |||
Sales/Distribution | Molndal, Sweden | 2007 | |||
Sales/Distribution | Gliwice, Poland | (1 | ) | ||
Sales/Distribution | Vilnius, Lithuania | (1 | ) | ||
Sales/Distribution | Wingene, Belgium | (2 | ) | ||
Sales/Distribution | Chartres, France | 2004 | |||
Sales/Distribution | Calgary, Alberta, Canada | 2006 | |||
Sales/Distribution | Worcestershire, U.K. | 2005 |
Certain of the Company'sour facilities are subject to mortgages and collateral assignments under loan agreements with long-term lenders. In general, the Company believeswe believe that itsour properties, including machinery, tools and equipment, are in good condition, well maintained and adequate and suitable for their intended uses. The Company believesWe believe that theour manufacturing facilities are currently operating at a level that our management considers normal capacity.capacity, except for our two recently expanded plants in China which are under utilized. Management believes capacity utilization will be increasing in 2004 at these plants. This utilization is subject to change as a result of increases or decreases in sales.
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Item 3. LEGAL PROCEEDINGS.
------------------
Item 3(a). The Company is from time to time involved in various legal and
administrative procedures. See Part I, Item 1, "Product Liability,
Environmental and Other Litigation Matters".
Item 3(b). See Part I, Item 1, "Product Liability, Environmental and Other
Litigation Matters".
Item 3(a). | We are from time to time involved in various legal and administrative procedures. See Part I, Item 1, "Business��Product Liability, Environmental and Other Litigation Matters." | |
Item 3(b). | See Part I, Item 1, "Business—Product Liability, Environmental and Other Litigation Matters." |
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
----------------------------------------------------
There were no matters submitted during the fourth quarter of the fiscal year covered by this Annual Report to a vote of security holders through solicitation of proxies or otherwise.
8
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Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED -----------------------------------------------------
STOCKHOLDER MATTERS.
--------------------
Market Information
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The following tabulationtable sets forth the high and low sales prices of the
Company'sour Class A Common Stock on the New York Stock Exchange during fiscal
2001, fiscal 20002003 and fiscal 1999.52002 and cash dividends paid per share. The
prices of the Company's Class A Common Stock reported below were retroactively
adjusted to reflect the effect of the spin-off of CIRCOR on October 18, 1999. No
adjustments were made to the dividends reported.
| 2003 | 2002 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| High | Low | Dividend | High | Low | Dividend | ||||||||||||
First Quarter | $ | 16.75 | $ | 13.53 | $ | 0.06 | $ | 17.22 | $ | 13.82 | $ | 0.06 | ||||||
Second Quarter | 19.00 | 15.40 | 0.06 | 20.00 | 16.05 | 0.06 | ||||||||||||
Third Quarter | 19.55 | 17.27 | 0.06 | 20.12 | 15.82 | 0.06 | ||||||||||||
Fourth Quarter | 22.50 | 17.48 | 0.07 | 18.30 | 14.80 | 0.06 |
There is no established public trading market for theour Class B Common Stock,
of the Company, which is held exclusively by members of the Horne family and
management.family. The principal holders of such stock are subject to restrictions on transfer with respect to their shares. Each share of our Class B Common Stock (10 votes per share) of the Company is convertible into one share of Class A Common Stock (1 vote per share).
Aggregate common stock dividend payments for fiscal
2001, 20002003 and 1999.52002 were $6,422,000, $7,107,000$6,859,000 and $4,656,000,$6,490,000, respectively. While the Companywe presently intendsintend to continue to pay cash dividends, the payment of future cash dividends depends upon the Board of Directors' assessment of the Company'sour earnings, financial condition, capital requirements and other factors.
The number of record holders of the Company'sour Class A Common Stock as of February 14, 200229, 2004 was 141. The Company believes that the number of beneficial
shareholders of the Company's Class A Common Stock was approximately 3,000 as of
February 14, 2002.132. The number of record holders of the Company'sour Class B Common Stock as of February 14, 200219, 2004 was 9.
9
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Item 6. SELECTED FINANCIAL DATA.
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The selected financial data set forth below should be read in conjunction with the Company'sour consolidated financial statements, related Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included herein.
FIVE YEAR FINANCIAL SUMMARY 16 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS Overview We are a leading supplier of products for use in the water quality, water safety, water flow control and water conservation markets in both North America and Europe. For more than 125 years, we have designed and manufactured products that promote the comfort and safety of people and the quality and conservation for water used in commercial, residential and light industrial applications. We earn revenue and income almost exclusively from the sale of our products. Our principal product lines include: Our business is reported in three geographic segments, North America, Europe and China. We distribute our products through three primary distribution channels, wholesale, DIY and OEMs. Increases in Gross National Product (GNP) indicate a healthy economic environment which we believe positively impacts our results of operations. The economic factors that we believe have the most significant direct effect on the demand for our products are the number of new housing construction starts and non-residential, or commercial, construction starts. Interest rates have a significant indirect effect on the demand for our products due to the effect such rates have on the number of new residential and commercial construction starts and remodeling projects. An additional factor that has had a significant effect on our sales is fluctuations in foreign currencies, as a significant portion of our sales and certain portions of our costs, assets and liabilities are denominated in currencies other than the U.S. dollar. Approximately 37.2% of our sales during the year ended December 31, 2003 were from sales outside of the U.S. compared to 31.4% for the year ended December 31, 2002. We believe that the most significant factors relating to our future growth include our ability to continue to make selected acquisitions, both in our core markets as well as new complementary markets, regulatory requirements relating to the quality and conservation of water and increased demand for clean water and continued enforcement of plumbing and building codes. We have completed fourteen acquisitions since divesting our industrial and oil and gas business in 1999. Our acquisition strategy focuses on businesses that manufacture preferred brand name products that address our themes of water quality, water safety, water conservation and water flow control. We target businesses that will provide us with one or more of the following: an entry to new markets, an increase in shelf space with existing customers, a new or improved technology or an expansion of the breadth of our water quality, water conservation, water safety and water flow control products for the residential and commercial markets. Products representing a majority of our sales are subject to regulatory standards and code enforcement, which typically require that these products meet stringent performance criteria. Together with our commissioned manufacturers' representatives, we have consistently advocated the development and enforcement of such plumbing codes. We are focused on maintaining stringent quality control and 17 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 significant product development, product testing capability and investment in plant and equipment is needed to manufacture products in compliance with code requirements, which represents a significant barrier to entry for competitors. We believe there is an increasing demand among consumers for products to ensure water quality, which creates growth opportunities for our products. A significant risk we face is our ability to deal effectively with increases in raw material costs. We require substantial amounts of raw materials, including bronze, brass, cast iron, steel and plastic to produce our products and substantially all of the raw materials we require are purchased from outside sources. Recently, we have experienced increases in the costs of bronze, brass, cast iron and steel. If we are not able to reduce or eliminate the effect of these cost increases by reducing production costs or successfully implementing price increases, these increases in raw material costs could reduce our profit margins. Another significant risk we face in all areas of our business is competition. We consider brand preference, engineering specifications, plumbing code requirements, price, technological expertise, delivery times and breadth of product offerings to be the primary competitive factors. As mentioned previously, we believe that significant product development, product testing capability and investment in plant and equipment is needed to manufacture products in compliance with code requirements, which represents a significant barrier to entry for competitors. We are committed to maintaining our capital equipment at a level consistent with current technologies and we have invested $20.0 million in capital equipment in 2003 and we expect to invest approximately $18.5 million in 2004. We are also committed to expanding our manufacturing capacity in lower cost countries such as China, Tunisia and Bulgaria. These manufacturing plant relocations and consolidations are an important part of our ongoing commitment to reduce production costs. 2003 Highlights Highlights for the year ended December 31, 2003 include the following: 18 Recent Developments On February 20, 2004, we entered into an agreement with Yuhuan County Cheng Guan Metal Hose Factory to acquire its 40% equity interest in our Shida joint venture for an expected purchase price of $3.0 million, the assumption of approximately $6.0 million of debt and the payment of $3.5 million in connection with a three-year non-compete agreement. After the transaction, we will own 100% of Shida. The closing of the transaction is On January 5, 2004, we acquired substantially all of the assets of Flowmatic Systems, Inc. located in Dunnellon, Florida, for approximately $16.5 million in cash. Flowmatic designs and distributes a complete line of high quality reverse osmosis components and filtration equipment. Their product line includes stainless steel and plastic housings, filter cartridges, storage tanks, control valves, as well as complete reverse osmosis systems for residential and commercial applications. We continue to implement a plan to consolidate several of 19 manufacturing plants in Tunisia and Bulgaria. We expect to record an additional Results of Operations Year Ended December 31, Net Sales. Our business is reported in three geographic segments: North America, Europe and China. Our net sales in each of these segments for each of the The increase in net sales in North America in 2003 compared to 2002 is due to internal growth of $18,381,000, or 3.0%, the appreciation of the Canadian dollar against the U.S. dollar, which accounted for $3,904,000, or 0.6%, of the increase and the impact of the adoption of FIN 46R which accounted for $3,792,000, or 0.6%, of the increase. We cannot predict whether the Canadian dollar will continue to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales. The increase in the internal growth rate in North America is primarily due to increased unit sales into the DIY and wholesale markets. Our sales into the North American DIY market grew by 12.8% in 2003 over 2002 due to the increasing store count of our large customers, the successful introduction of new products and consistent and reliable delivery of our products. Our wholesale market grew by 2.1% in 2003 over 2002 due to increased sales of backflow preventors. A significant increase or decrease in interest rates or an increase or drop in the new housing construction market could have a positive or negative impact on our sales. Not included in either the DIY or wholesale market comparisons are fourth quarter sales of $3,792,000 from Jameco International LLC. In October 2003 we determined that our 49% minority interest in Jameco International, LLC qualified as a variable interest in a variable interest entity under FIN 46R and, as we are the primary beneficiary, should be consolidated into our North American results. Jameco International LLC's annual sales for the year ended 2003 were approximately $16,079,000. Since the adoption was effective October 1, 2003, we should continue to have this impact for the next three quarters as we continue to consolidate Jameco International LLC in accordance with FIN 46R. 20 The increase in net sales in Europe in 2003 compared to 2002 is primarily due to the appreciation of the euro against the U.S. dollar, which accounted for $31,107,000, or 5.1% of the increase, the inclusion of net sales of acquired companies of $21,313,000, or 3.5%, and internal growth of $12,565,000, or 2.0%. The foreign exchange growth is due to our average year to date euro rate increasing 20.6% over the average year to date rate for 2002. We cannot predict whether the euro will continue to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales. The acquired growth is due to the inclusion of the net sales of ADEV Electronic SA and E.K. Eminent A.B. both acquired on July 15, 2002, F&R Foerster and Rothman GmbH, acquired on July 29, 2002, Martin Orgee, acquired on April 18, 2003, and Giuliani Anello, acquired on July 30, 2003. We expect these recent acquisitions will have a positive impact on sales for the next two quarters. The internal growth in sales is primarily due to increased sales into the European OEM market. Inclusive of the acquisitions, and exclusive of the impact of foreign exchange, our sales into the European OEM market increased approximately $28,900,000, or 37.2%. The decrease in net sales in China in 2003 compared to 2002 is primarily due to an adjustment of $2,200,000 made in the second quarter of 2003 for previously recorded sales and increased sales rebates and returns recorded at our TWT joint venture in Tianjin. This was partially offset by the inclusion of net sales of our Shida joint venture, which we established on March 5, 2002, of approximately $2,636,000. Gross Profit. Gross profit for 2003 increased $31,941,000, or 15.3%, compared to 2002. This increase is primarily due to internal growth of $12,007,000, the change in foreign exchange rates, which accounted for $11,075,000 of the increase, the inclusion of gross profit from acquired companies of $5,961,000, a reduction of restructuring and other charges of $2,103,000 in 2003 compared to 2002, and the inclusion of the gross profit of Jameco International LLC of $795,000. Excluding the costs of restructuring for both periods, gross profits would have increased $29,838,000, or 14.1%. The internal growth is primarily due to the North American segment, which increased internal gross profits by $11,408,000. This increase is primarily due to improved manufacturing efficiencies and increased sales volume. The internal growth in gross profit was offset by a loss in our China segment of $3,873,000. This loss is due to start-up costs and under absorbed manufacturing costs due to a delay in production at our new wholly-owned manufacturing plant in China. We believe capacity utilization will be increasing in 2004 at this plant. It was also offset by inventory write-downs, increased sales rebates and returns and other net adjustments at our TWT joint venture located in Tianjin, China. Selling, General and Administrative Expenses. Selling, General and Administrative, or SG&A, expenses for 2003 increased $19,642,000, or 13.0%, compared to 2002. This increase is primarily due to an internal increase of $8,386,000, the change in foreign exchange rates, which accounted for $6,935,000 of the increase, and the inclusion of operating expenses of acquired companies and Jameco International LLC, which together accounted for $4,321,000 of the increase. The internal increase in SG&A expenses is primarily due to increased product liability expense, workers compensation expenses, professional fees, which include legal and audit expenses, pension costs and variable selling expenses due to increased sales volumes. Although there is an absolute increase in our SG&A expense over 2002, our SG&A expense as a percent of sales for 2003 decreased to 24.1% compared to 24.5% for 2002. 21 Operating Income. Operating income by geographic segment for each of the years ended December 31, 2003 and 2002 was as follows: The increase in operating income in North America in 2003 compared to 2002 is primarily due to internal growth of $6,754,000, a reduction of restructuring and other charges of $1,691,000, the appreciation of the Canadian dollar against the U.S. dollar, which accounted for $618,000 of the increase, and inclusion of income from Jameco International LLC of $38,000. The internal growth is due to our increased gross profit partially offset by increased SG&A expense. To the extent we are unable to recover raw material cost increases from our customer these cost increases would adversely affect our operating income. For 2003, we recorded $162,000 compared to $1,853,000 in 2002 for costs associated with our manufacturing restructuring plan. Excluding these costs, the operating income in North America would have been $64,576,000 for 2003 compared to $57,166,000 for 2002. We expect to record approximately $6,000,000 in 2004 for additional manufacturing restructuring expenses primarily attributable to accelerated depreciation associated with the anticipated closure of one of our U.S. manufacturing plants and a reduction in estimated useful lives of manufacturing equipment due to the transfer of production to lower cost countries. The increase in operating income in Europe in 2003 compared to 2002 is due to the euro appreciating against the U.S. dollar, which accounted for $3,522,000 of the increase, internal growth of $2,744,000, the inclusion of income from acquired companies of $1,932,000, and a reduction of restructuring and other charges of $786,000. We cannot predict whether the euro will continue to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our operating income. The internal operating profit is primarily due to the increased sales volume partially offset by increased SG&A expenses. We recorded $906,000 in 2003 compared to $1,692,000 in 2002 for costs associated with our manufacturing restructuring plan. Excluding these costs associated in both periods, operating income in Europe would have increased to $23,498,000 in 2003 from $15,300,000 in 2002. We do not anticipate recording any additional manufacturing restructuring costs in 2004 for our European operations. The increase in operating losses in China in 2003 compared to 2002 is due to an increase in internal operating losses of $3,512,000 partially offset by the inclusion of income from acquired companies of $465,000. In December 2003, we incurred a restructuring charge in our TWT facility of $162,000 for severance. The internal operating loss was due to inventory write-downs, increased sales rebates and returns and other net adjustments at our TWT joint venture and under absorbed manufacturing costs due to a delay in production and start up costs associated with our new wholly-owned manufacturing plant in China. Corporate expenses are primarily for compensation expense, professional fees, including legal and audit expenses and benefit administration costs. The increase in corporate expenses is primarily due to increased legal and audit expenses in 2003. 22 Interest Expense. Interest expense increased $3,422,000, or 39.4%, in 2003 compared to 2002, primarily due to the inclusion of the interest expense on the $125,000,000 senior notes issued on May 15, 2003. On December 1, 2003, we repaid our $75,000,000 83/8% notes and expect that interest expense will decrease as a result of this repayment. On September 1, 2001, we entered into an interest rate swap with respect to our $75,000,000 83/8% notes due December 2003. The swap converted the interest from fixed to floating. On August 5, 2002, we sold the swap and received $2,315,000 in cash. In the year ended December 31, 2003, we reduced interest expense by $1,420,000 by amortizing the adjustment to the fair value of the swap. In the year ended December 31, 2002, we reduced interest expense by $1,711,000 for the effectiveness of the swap. The amortization of the swap was completed upon repayment of the $75,000,000 83/8% notes. On July 1, 2003, we entered into an interest rate swap for a notional amount of 25,000,000 euros outstanding on our Revolving Credit Facility. We swapped the variable rate from the Revolving Credit Facility, which is three month EURIBOR plus 0.7%, for a fixed rate of 2.33%. The impact of swap was immaterial to the overall interest expense. Income Taxes. Our effective tax rate for continuing operations for 2003 increased to 38.0% from 35.0% for 2002. The increase is primarily due to losses in China, for which we have not received a tax benefit in accordance with FAS 109 and because certain of our Chinese entities are in a tax holiday. Income From Continuing Operations. Income from continuing operations for 2003 increased $3,851,000, or 11.8%, to $36,473,000 or $1.32 per common share, from $32,622,000 or $1.21 per common share, for 2002, in each case, on a diluted basis. The appreciation of the euro against the U.S. dollar resulted in a positive impact on income from continuing operations of $0.07 per share for the year ended December 31, 2003 compared to the prior year. We cannot predict whether the euro will continue to appreciate 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 income. Excluding the manufacturing restructuring costs incurred in both periods, income from continuing operations would have increased $2,383,000 or 6.8%. To supplement our consolidated financial statements presented in accordance with accounting principles generally accepted in the United States of America (GAAP) we sometimes use non-GAAP measures of net income, net income per share, income from continuing operations or income from continuing operations per share, and net cash provided by continuing operations that we believe are appropriate to enhance an overall understanding of our historical financial performance and future prospects. The non-GAAP results, which are adjusted to exclude certain costs, expenses, gains and losses from the comparable GAAP measures, are an indication of our baseline performance before gains, losses or other charges that are considered by management to be outside of our core operating results. These non-GAAP results are among the primary indicators management uses as a basis for evaluating our financial performance as well as for forecasting future periods. For these reasons, management believes these non-GAAP measures can be useful to investors, potential investors and 23 others. The presentation of this additional information is not meant to be considered in isolation or as a substitute for net income or income per share prepared in accordance with GAAP. Loss From Discontinued Operations. We recorded a charge net of tax to discontinued operations for 2003 of $3,111,000, or $0.11 per common share on a diluted basis. The charge is primarily attributable to legal expenses associated with the litigation involving the James Jones Company. We also recorded a charge in the second quarter of 2003 attributed to payments to be made to the selling shareholders of the James Jones Company pursuant to our original purchase agreement. See Part I, Item 1, "Business—Product Liability, Environmental and other Litigation Matters". Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 Net Sales. Net sales for the year ended December 31, 2002 increased $66,586,000, or 12.1%, to $615,526,000 compared to $548,940,000 for the same period in 2001. The increase in net sales was attributable to the following: The 24 We monitor our net sales in three Our net sales in each of these The increase in Gross Profit.Gross profit for the Selling, General and Restructuring and Other Charges. Restructuring and other charges for the year ended December 31, 2002 decreased $816,000, or 56.1%, to $638,000 compared to $1,454,000 for the same period in 2001. These costs are primarily for severance costs. The costs related to the year ended December 31, 2002 were for 24 employees, 12 of which have been terminated as of December 31, 2002, compared to the costs related to December 31, 2001 which were for 14 employees, all of which have been terminated as of December 31, 2002. Operating Income. Operating income for the year ended December 31, 2002 increased $7,246,000, or 14.4%, to $57,529,000 compared to $50,283,000 for the same period in 2001 due to increased gross profit and the cessation of goodwill amortization, partially offset by increased other selling, general and 25 administrative The increase in North America was due to increased gross profit, primarily due to the inclusion of operating results of acquired companies partially offset by increased premiums for product and general liability insurance. The increase in Europe was due to the Interest Expense. Interest expense for the Income Taxes. Our effective tax rate for continuing operations Income From Continuing Operations and Net Liquidity and Capital Resources We generated $49,990,000 of net 26 requirements of OEM customers in We used $37,045,000 of On January 29, 2003, we invested an We generated $128,050,000 of net cash in financing activities. On December 10, 2003, we completed a public offering of 4,600,000 shares of newly issued Class A Common Stock at $19.00 per share. Net proceeds were approximately $82,500,000, after taking into account underwriter discounts and expenses associated with the On May 15, 2003, we completed a private placement of $125,000,000 of senior unsecured notes consisting of $50,000,000 principal amount of 4.87% senior notes due 2010 and $75,000,000 principal amount of 5.47% senior notes due 2013. We used the net proceeds from the private placement to purchase restricted treasury securities for repayment of principal of, and interest on, our $75,000,000 principal amount of 83/8% notes due December Our revolving credit facility with a syndicate of banks 27 credit line utilized by our European subsidiaries and to allow us to use the proceeds from our December 2003 public offering for purposes other than the repayment of our credit facility. Outstanding indebtedness under the Revolving Credit Facility bears interest at Effective July 1, On November 4, 2003, we declared a quarterly dividend of $0.07 per share on our common stock. This was an increase of $0.01 per share over the dividends paid in each of the ten previous quarters. Dividends increased to We used $6,643,000 of net cash for discontinued operations. During the year ended December 31, 2003, we received $3,139,000 in cash as an indemnification payment for settlement costs we incurred in the James Jones case. This cash has been recorded as a liability at December 31, Working capital (defined as current assets less current liabilities) as of December 31, 2003 was $308,135,000 compared to $71,384,000 as of December 31, 2002. This increase is primarily We had positive free cash flow of $24,861,000 (defined as net cash provided by continuing operations minus capital 28 bearing liabilities less cash and cash equivalents plus total stockholders equity, including minority interest) to 8.8% for 2003 from 29.4% for 2002. We believe free cash flow to be an appropriate supplemental measure of the operating performance of our Company because it provides investors with a measure of our ability to repay debt A reconciliation of free cash flow to net cash provided by continuing operations is provided below: Our net debt to capitalization is not computed in accordance with GAAP. Management believes it to be an appropriate supplemental measure because it helps investors understand our ability to meet our financing needs. Our computation may not be comparable to other companies that may define debt to capitalization differently. A reconciliation of net debt is provided below: A reconciliation of capitalization is provided below: We anticipate that available funds from current operations, existing cash and 29 currently reviewing proposals from Our long-term contractual obligations as of We maintain letters of Critical Accounting Policies and Key Estimates The preparation of our consolidated financial statements in We have discussed the development, selection and disclosure of the estimates with the Audit Committee. Management believes the following critical accounting policies reflect its' more significant estimates and assumptions. Revenue recognition We recognize revenue when all of the following criteria are met: (1) we have entered into a binding agreement, (2) the product has shipped and title has passed, (3) the sales price to the customer is fixed or is determinable and (4) collectibility is reasonably assured. We recognize revenue based upon a determination that all criteria for revenue recognition have been met, which, based on the majority of our shipping terms, is considered to have occurred upon shipment of the finished product. Some shipping terms require the goods to be received by the customer before title passes. In those instances, revenues are not recognized until the customer has received the goods. We record estimated reductions to revenue for customer returns and allowances and for customer programs. Provisions for returns and allowances are made at the time of sale, derived from historical trends and form a portion of the 30 allowance for doubtful accounts. Customer programs, which are primarily annual volume incentive plans, allow customers to earn credit for attaining agreed upon purchase targets from us. We record customer programs as an adjustment to net sales. Allowance for doubtful accounts The allowance for doubtful accounts is established to represent our best estimate of the net realizable value of the outstanding accounts receivable. The development of our allowance for doubtful accounts varies by region but in general is based on a review of past due amounts, historical write-off experience, as well as aging trends affecting specific accounts and general operational factors affecting all accounts. In North America, management specifically analyzes individual accounts receivable and establishes specific reserves against financially troubled customers. In addition, factors are developed utilizing historical trends in bad debts, returns and allowances. The ratio of these factors to sales on a rolling twelve-month basis is applied to total outstanding receivables (net of accounts specifically identified) to establish a reserve. In Europe, management develops their bad debt allowance through an aging analysis of all their accounts, with analysis on the aging of specific delinquent accounts. In China, where payment terms are generally extended, we reserve all accounts receivable in excess of one year from the invoice date and specifically reserve for identified uncollectible accounts receivable less than one year old. We uniformly consider current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. We also aggressively monitor the credit worthiness of our largest customers, and periodically review customer credit limits to reduce risk. If circumstances relating to specific customers change or unanticipated changes occur in the general business environment, our estimates of the recoverability of receivables could be further adjusted. Inventory valuation Inventories are stated at the lower of cost or market with costs generally determined on a first-in first-out basis. We utilize both specific product identification and historical product demand as the basis for determining our excess or obsolete inventory reserve. We identify all inventories that exceed a range of one to three years in sales. This is determined by comparing the current inventory balance against unit sales for the trailing twelve months. New products added to inventory within the past twelve months are excluded from this analysis. A portion of our products contain recoverable materials, therefore the excess and obsolete reserve is established net of any recoverable amounts. Changes in market conditions, lower than expected customer demand or changes in technology or features could result in additional obsolete inventory that is not saleable and could require additional inventory reserve provisions. In certain countries, additional inventory reserves are maintained for potential losses experienced in the manufacturing process. The reserve is established based on the prior year's inventory losses adjusted for any change in the gross inventory balance. Goodwill and other intangibles We adopted Financial Accounting Standards Board Statement No. 142 "Goodwill and Other Intangible Assets" (FAS 142) on January 1, 2002, and as a result we no longer amortize goodwill. Goodwill and intangible assets with indefinite lives are tested annually for impairment in accordance with the provisions of FAS 142. We use judgment in assessing whether assets may have become impaired between annual impairment tests. Intangible assets such as purchased technology are generally recorded in connection with a business acquisition. In our larger, more complex acquisitions, the value assigned to intangible assets is 31 determined by an independent valuation firm based on estimates and judgments regarding expectations of the success and life cycle of products and technology acquired. This is the second year since adoption, and for both years we have had excess economic support for the carrying value of our goodwill and intangibles. While we believe that our estimates of future cash flows are reasonable, different assumptions regarding such factors as future sales volume, selling price changes, material cost changes, cost savings programs and capital expenditures could significantly affect our valuations. Other changes that may affect our valuations include, but are not limited to product acceptances and regulatory approval. If actual product acceptance differs significantly from the estimates, we may be required to record an impairment charge to write down the assets to their realizable value. A severe decline in market value could result in an unexpected impairment charge to goodwill, which could Product liability and workers compensation costs Because of retention requirements associated with Workers compensation liabilities in the U.S. are recognized for claims incurred (including claims incurred but not reported) and for changes in We maintain excess liability insurance with outside insurance carriers to Legal contingencies We are a defendant in numerous legal matters including those involving environmental law and product liability as discussed further in Note 15 of 32 cannot be predicted with any assurance of accuracy. Final settlement of these matters could possibly result in Pension benefits We We determine these assumptions based on consultation with outside actuaries and investment advisors. Any variance in the above assumptions could have a significant impact on future recognized pension costs, assets and liabilities. Income taxes We estimate and use our expected annual effective income tax rates to accrue income taxes. Effective tax rates are determined based on budgeted earnings before taxes including our best estimate of permanent items that will impact the effective rate for the year. Management periodically reviews these rates with outside tax advisors and changes are made if material discrepancies from expectations are identified. We recognize deferred taxes for the expected future consequences of events that have been reflected in the consolidated financial statements in accordance with the rules of Financial Accounting Standards Board Statement No. 109 "Accounting for Income Taxes" (FAS 109). Under FAS 109, deferred tax assets and liabilities are determined based on differences between the book values and tax bases of particular assets and liabilities, using tax rates in effect for the years in which the differences are expected to reverse. A valuation allowance is provided to offset any net deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. We consider estimated future taxable income and ongoing prudent tax planning strategies in assessing the need for a valuation allowance. 33 Certain Factors Affecting Future Results We face intense competition and, if we are not able to respond to competition in our markets, our revenues may decrease. Competitive pressures in our markets could adversely affect our competitive position, leading to a possible loss of market share or a decrease in prices, either of which could result in decreased revenues and profits. We encounter intense competition in all areas of our business. Additionally, customers for our products are attempting to reduce the number of vendors from which they purchase in order to reduce the size and diversity of their Reductions or interruptions in the supply of raw materials and increases in the costs of raw materials could reduce our profit margins and adversely impact our ability to meet our customer delivery commitments. We require substantial amounts of raw materials, including bronze, brass, cast iron, steel and plastic and substantially all of the raw materials we require are purchased from outside sources. The availability and costs of raw materials may be subject to curtailment or change due to, among other things, new laws or regulations, suppliers' allocations to other purchasers, interruptions in production by suppliers and changes in exchange rates and worldwide price and demand levels. We are not currently party to any long-term supply agreements. Our inability to obtain adequate supplies of raw materials for our products at favorable costs, or at all, could have a material adverse effect on our business, financial condition or results of operations by decreasing our profit margins and by hindering our ability to deliver products to our customers on a timely basis. Recently, we have experienced an increase in the costs of bronze, brass, cast iron, and steel. If we are not able to reduce or eliminate the effect of these cost increases through lowering other costs of production or successfully implementing price increases to our customers, such cost increases from our vendors could have a negative effect on our financial results. Implementation of our acquisition strategy may not be successful, which could affect our ability to increase our revenues or our profitability. One of our strategies is to increase our revenues and profitability and expand our markets through acquisitions that will provide us with complementary water-related products. We cannot 34 Down economic cycles, particularly reduced levels of housing starts and remodeling, could have an adverse effect on our revenues and operating results. We have experienced and expect to continue to Economic, political and other risks associated with international sales and operations could adversely affect our business and future operating results. Since we sell and manufacture our products worldwide, our business is subject to risks associated with doing business internationally. Our business and future operating results could be harmed by a variety of factors, including: Fluctuations in foreign exchange rates could materially affect our reported results. We are exposed to fluctuations in foreign currencies, as a significant portion of our sales and certain portions of our costs, assets and liabilities are denominated in currencies other than U.S. dollars. Approximately 37.2% of our sales during the year ended December 31, 2003 were from sales outside of the U.S. compared to 31.4% for the year ended December 31, 2002. For the year ended December 31, 2003, the appreciation of the euro against the U.S. dollar had a positive impact on sales 35 of approximately $31.1 million. For the year ended December 31, 2002, the appreciation of the euro against the U.S. dollar had a positive impact on sales of approximately $7.9 million. For the year ended December 31, 2001, the depreciation of the euro against the U.S. dollar had an adverse impact on sales of approximately $3.4 million. If our share of revenue in non-dollar denominated currencies continues to increase in future periods, exchange rate fluctuations will likely have a greater impact on our results of operations and financial condition. Further, the Chinese government may cease its utilization of a fixed rate of exchange of the Chinese RMB against the U.S. dollar which could adversely affect our current favorable cost structure for goods we source from our joint ventures, our wholly-owned subsidiary in China and our outside vendors. There are significant risks in expanding our manufacturing operations in China. As part of our strategy, we are shifting a significant portion of our manufacturing operations to China to reduce our production costs. Due to the outbreak of the SARS virus, some of these cost reduction efforts were delayed, and there can be no assurance that we will not experience additional delays. This shift will subject a greater portion of our operations to the risks of doing business in China. The Chinese legal system is relatively new and lacks transparency, which gives the Chinese central and local government authorities a higher degree of control over our business in China than is customary in developed economies and makes the process of obtaining necessary regulatory approval in China inherently unpredictable. In addition, the protection accorded our proprietary technology and know-how under the Chinese legal system is not as strong as in the United States and, as a result, we may lose valuable trade secrets and competitive advantage. Although the Chinese government has been pursuing economic reform and a policy of welcoming foreign investments for the past two decades, there can be no assurance that the Chinese government will not change its current policies in the future, making continued business operations in China difficult or unprofitable. To the extent we are not successful in implementing our manufacturing restructuring plan, our results of operations and financial condition could be adversely affected. Our manufacturing restructuring plan, which we began in 2001, was initiated to reduce our manufacturing costs. If our planned manufacturing plant consolidations in the United States and Europe and our production capability expansion in China are not successful, our results of operations and financial condition could be materially adversely affected. If we cannot continue operating our manufacturing facilities at current or higher utilization levels, our results of operations could be adversely affected. The equipment and management systems necessary for the operation of our manufacturing facilities may break-down, perform poorly or fail, resulting in fluctuations in our ability to manufacture our products and to achieve manufacturing efficiencies. We operate a number of manufacturing facilities, all of which are subject to this risk, and such fluctuations at any of these facilities could cause an increase in our production costs and a corresponding decrease in our profitability. For example, in 2001 one of our manufacturing facilities was shut down for a period of time as a result of a fire and we were required to source products from external vendors at substantially higher costs. We also have a vertically-integrated manufacturing process. Each segment is dependent upon the prior process and any breakdown in one segment will adversely affect all later components. Fluctuations in our production process may affect our ability to deliver products to our customers on a timely basis. Our inability to meet our delivery obligations could result in a loss of our customers and negatively impact our business, financial condition and results of operations. 36 If we experience delays in introducing new products or if our existing or new products do not achieve or maintain market acceptance and regulatory approvals, our revenues and our profitability may decrease. Our failure to develop new and innovative products or to custom design existing products could result in the loss of existing customers to competitors or the inability to attract new business, either of which may adversely affect our revenues. Our industry is characterized by: We believe our future success will depend, in part, on our ability to anticipate or adapt to these factors and to offer, on a timely basis, products that meet customer demands and the requirements of plumbing codes and/or regulatory agencies. The development of new or enhanced products is a complex and uncertain process requiring the anticipation of technological and market trends. We may experience design, manufacturing, marketing or other difficulties, such as an inability to attract a sufficient number of experienced engineers, that could delay or prevent our development, introduction, approval or marketing of new products or enhancements and result in unexpected expenses. Such difficulties could cause us to lose business from our customers and could adversely affect our competitive Environmental Our operations and properties are subject to extensive and increasingly stringent laws and regulations relating to environmental protection, including laws and regulations governing air emissions, water discharges, waste management and disposal and workplace safety. Such laws and regulations can impose substantial fines and sanctions for violations and require the installation of costly pollution control equipment or operational changes to limit pollution emissions and/or decrease the likelihood of accidental hazardous substance releases. We Under certain environmental laws, the current and We have 37 Third parties may infringe our We rely on a combination of patents, copyrights, trademarks, trade secrets, confidentiality provisions and licensing arrangements to establish and protect our proprietary rights. We may be required to spend significant resources to monitor and police our intellectual property rights. If we fail to successfully enforce our intellectual property rights, our competitive position could suffer, which could harm our operating results. We We face risks from product liability and other lawsuits, which may adversely affect our We may be subjected to various product liability claims or other lawsuits, including, among others that our products include inadequate or improper instructions for use or installation, or inadequate warnings concerning the effects of the failure of our products. In the event that we do not have adequate insurance or contractual indemnification, damages from these claims would have to be paid from our assets and could have a material adverse effect on our results of operations, liquidity and financial condition. In particular, if we settle or conclude litigation in a quarterly or annual reporting period, there could be a material impact on our operating results for that quarter or year. We, like other manufacturers and distributors of products designed to control and regulate fluids, face an inherent risk of exposure to product liability claims and other lawsuits in the event that the use of our products results in personal injury, property damage or business interruption to our customers. Although we maintain strict quality controls and procedures, including the testing of raw materials and safety testing of selected finished products, we cannot be certain that our products will be completely free from defect. In addition, in certain cases, we rely on third-party manufacturers for our products or components of our products. Although we have product liability and general insurance coverage, we cannot be certain that this insurance coverage will continue to be available to us at a reasonable cost, or, if available, will be adequate to cover any such liabilities. For more information, see Part I, Item 1, "Business—Product Liability, Environmental, and Other Litigation Matters." The requirements of FAS 142 may result in a write-off of all or a portion of our goodwill, which would negatively impact our operating results and financial condition. If we are required to take an impairment charge to our goodwill in connection with the requirements of FAS 142, our operating results may decrease and our financial condition may be harmed. As of December 31, 2003, we had goodwill of $184.9 million, or 22.1% of our total assets and 42.4% of our total stockholders' equity. Under FAS 142, goodwill and identifiable intangible assets that have indefinite useful lives are no longer amortized. In lieu of amortization, we were required to perform an initial impairment review of goodwill and are required to perform annual impairment reviews thereafter. We have concluded that no impairment existed at January 1, 2002, the time of adoption of FAS 142 and at October 26, 2003, the time of our annual review. We perform our annual test for indications of goodwill impairment in the fourth quarter of our fiscal year or sooner if indicators exist. The loss of a major customer could have an adverse effect on our results of operations. Our largest customer, The Home Depot, Inc., accounted for approximately $74.8 million, or 10.6%, of our total net sales for the year ended December 31, 2003, and $63.0 million, or 10.2%, of our total net sales for year ended December 31, 2002. Our customers generally are not obligated to purchase any minimum volume of products from us and are able to terminate their relationships with us at any time. A significant reduction in orders or change in terms from The Home Depot, Inc. could have a material adverse effect on our future results of operations. 38 Certain indebtedness may limit our ability to pay dividends, incur additional debt and make acquisitions and other investments. Our revolving credit facility and other senior indebtedness contain operational and financial covenants that restrict our ability to make distributions to stockholders, incur additional debt and make acquisitions and other investments unless we satisfy certain financial tests and comply with various financial ratios. If we do not maintain compliance with these covenants, our creditors could declare a default under our revolving credit facility and our indebtedness could be declared immediately due and payable. Our ability to comply with the provisions of our indebtedness may be affected by changes in economic or business conditions beyond our control. One As of February Shares of our Class A Common Stock eligible for public sale could adversely affect the market price of our Class A Common Stock. As of February 1, 2004 there were outstanding 24,607,425 shares of our Class A Common Stock and 7,471,700 shares of our Class B Common Stock. Shares of our Class B Common Stock may be converted into Class A Common Stock at any time on a one for one basis. All of the shares of Class A Common Stock are freely transferable without restriction or further registration under the federal securities laws, except for any shares held by our affiliates, sales of which will be limited by Rule 144 under the Securities Act. In addition, under the terms of a registration rights agreement with respect to outstanding shares of our class B common stock, the holders of our Class B Common Stock have rights with respect to the registration of the underlying Class A Common Stock. Under these registration rights, the holders of Class B Common Stock may require, on up to two occasions, that we register their shares for public resale. If Our Class A Common Stock has insignificant voting power. Our Class B Common Stock entitles its holders to ten votes for each share and our Class A Common Stock entitles its holders to one vote per share. As of January 31, 2004, our Class B Common Stock constituted 23.3% of our total outstanding common stock and 75.2% of the total outstanding voting power and thus is able to exercise a controlling influence over our business. 39 The trading price of our Class A Common Stock may be volatile. The trading price of our Class A Common Stock may be volatile and fluctuations in the trading price may result in substantial losses for investors. The trading price of our Class A Common Stock could Provisions in our charter documents and Delaware law may prevent or delay an acquisition of us, which could decrease the value of our Class A Common Stock. Our certificate of incorporation and bylaws and Delaware law contain provisions that could Delaware law also imposes restrictions on mergers and other business combinations between us and any New Accounting Standards In In 40 94-3, a liability for an exit cost was recognized at the date of In November 2002, the FASB issued Financial Accounting Standards Board Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that a liability be recorded in the guarantor's balance sheet upon issuance of certain guarantees. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a roll-forward of the entity's product warranty liabilities. FIN 45 required the application of the recognition provisions of FIN 45 prospectively to guarantees issued after December 31, 2002. We adopted the disclosure provisions of FIN 45 effective December 31, 2002. We do offer warranties on our products, but the returns under warranty have been immaterial. The warranty reserve is part of the sales returns and allowances, a component of our allowance for doubtful accounts. We adopted FIN 45 effective January 1, 2003 and its adoption was not material to our consolidated financial statements. In December 2002, the FASB issued Financial Accounting Standards Board Statement No. In December 2002, the In January 2003, the FASB issued Financial Accounting Standards Board Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46) which requires the consolidation of variable interest entities (VIE) by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 was effective for all new VIEs created or acquired after January 31, 2003. In October 2003, the FASB delayed the effective date for some VIEs that existed prior to February 1, 2003, provided the reporting entity had not "issued" financial statements reporting the VIE in accordance with Interpretation 46. FIN 46 was effective for the first interim or annual period ending after December 15, 41 security interest in the LLC's assets. The creditors have no recourse to the Company. The assets as of December 31, 2003 of $3,960,000 are We also maintain another variable interest in a VIE. In 2000 we entered into an agreement with Plumworld.co.uk Ltd in which we maintain a 20% interest in Plumbworld. Plumbworld is primarily an e-business that sells bathroom and sanitary appliances, as well as, plumbing and heating products, tools and plumbing consumables. Its annualized sales are approximately $7,100,000. We maintain a notional amount of approximately $500 investment in Plumbworld and maintain a loan receivable in the amount of approximately $850,000 with Plumbworld. We continue to account for our investment in Plumbworld using the equity method. In April 2003, the FASB issued Financial Accounting Standards Board Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" (FAS 149). FAS In May 2003, the FASB issued Financial Accounting Standards Board Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" (FAS 150). FAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. FAS 150 is effective for certain financial instruments entered into or modified after May 31, 2003. For unmodified financial instruments existing at May 31, 2003, FAS 150 is effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted FAS 150 apart from the deferral by FASB Staff Position 150-3 (FAS 150-3) of certain mandatorilly redeemable non controlling interests and its adoption was not material to the consolidated financial statements. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. We use derivative financial instruments primarily to reduce exposure to adverse fluctuations in foreign exchange rates, interest rates and 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 Our foreign subsidiaries transact most business, including certain intercompany transactions, in foreign currencies. Such transactions are principally purchases or sales of materials and are denominated in European currencies or the U.S. or Canadian dollar. 42 At December 31, We have historically had a very low exposure on the cost of our debt to changes in interest rates. Interest rate swaps are used to mitigate the impact of interest rate fluctuations on certain variable rate debt instruments and reduce interest expense on certain fixed rate instruments. Information about We purchase significant amounts of bronze ingot, brass rod, Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The index to financial statements is included in page Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING None. Item 9A. CONTROLS AND PROCEDURES. As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, 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 the design and operation 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 was required to apply its judgment in evaluating and implementing possible controls and procedures. The effectiveness of our disclosure controls and procedures is necessarily limited by the staff and other resources available to us and, although we have designed our disclosure controls and procedures to address the geographic diversity of our operations, this diversity inherently may limit the effectiveness of those controls and procedures. 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. There was no change in our internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. In connection with these rules, we will continue to review and document our disclosure controls and procedures, including our internal controls and procedures for 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. 43 Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Directors The information appearing under the caption "Information as to Nominees for Director" in the Registrant's Proxy Statement relating to the Annual Meeting of Stockholders to be held on Executive Officers Information with respect to the executive officers of the Company is set forth in Item 1 of this Report under the caption "Executive Code of Ethics We have adopted a Code of Business Conduct and Ethics applicable to all officers, employees and Board members. The Code of Business Conduct and Ethics is posted on our website, www.wattswater.com. In order to access this portion of our website, click on the "Investor Relations" tab. The Code of Business Conduct and Ethics is located under the "Corporate Governance" caption. Any amendments to, or waivers of, the Code of Business Conduct and Ethics which applies to our chief executive officer, chief financial officer, corporate controllers or any person performing similar functions will be disclosed on our website promptly following the date of such amendment or waiver. Item 11. EXECUTIVE COMPENSATION. The information appearing under the caption "Compensation Arrangements" in the Registrant's Proxy Statement relating to the Annual Meeting of Stockholders to be held on Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information appearing under the caption "Principal Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information appearing under the caption "Compensation Arrangements-Certain Relationships and Related Transactions" in the Registrant's Proxy Statement relating to the Annual Meeting of Stockholders to be held on Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. The information appearing under the caption "Ratification of Independent Auditors" in the Registrant's Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 5, 2004 is incorporated herein by reference. 44 Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a)(1) Financial Statements The following financial statements are included in a separate section of this Report commencing on the page numbers specified below: (a)(2) Schedules All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are included in the Notes to the Consolidated Financial Statements, or are not required under the related instructions or are inapplicable, and therefore have been omitted. (a)(3) Exhibits 45 46 47 (b) Reports on Form 8-K The following Current Reports on Form 8-K 48 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. 49 The Board of Directors and Stockholders We have audited the accompanying consolidated balance sheets of Watts We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Watts As discussed in Note 2 to the financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill and other intangible assets based on the adoption of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." Boston, Massachusetts 50 Watts Consolidated Statements of Operations (Amounts in thousands, except per share information) The accompanying notes are an integral part of these consolidated financial statements. 51 Watts The accompanying notes are an integral part of these consolidated financial statements. 52 Watts The accompanying notes are an integral part of these consolidated financial statements. 53 The accompanying notes are an integral part of these consolidated financial statements. 54 Notes to Consolidated Financial Statements (1) Description of Business Watts On October 15, 2003, the Company changed its name from Watts Industries, Inc. to Watts Water Technologies, Inc. to more accurately reflect its strategic focus on providing solutions to its customers' water based needs. (2) Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and its majority and wholly owned subsidiaries. Upon consolidation, all significant intercompany accounts and transactions are eliminated. Cash Equivalents Cash equivalents consist of highly liquid investments with maturities of three months or less at the date of original issuance. Allowance for Doubtful Accounts Allowance for doubtful accounts includes reserves for bad debts and sales returns and allowances. The Company analyzes the aging of accounts receivable, individual accounts receivable, historical bad debts, concentration of receivables by customer, customer credit worthiness, current economic trends and changes in customer payment terms. The Company specifically analyzes individual accounts receivable and establishes specific reserves against financially troubled customers. In addition, factors are developed in certain regions utilizing historical trends of sales and returns and allowances to derive a reserve for returns and allowances. Concentration of Credit The Company sells products to a diversified customer base and, therefore, has no significant concentrations of credit risk, except that approximately 10.6% and 10.2% of the Company's total sales in 2003 and 2002, respectively, are to one company. Inventories Inventories are stated at the lower of cost (first-in, first-out method) or market. Market value is determined by replacement cost or net realizable value. Historical experience is used as the basis for determining the reserve for excess or obsolete inventories. Goodwill and Other Intangible Assets Goodwill 55 Intangible Assets" (FAS 142). FAS 141 requires that the purchase method of Prior to Impairment of Goodwill and Long-Lived Assets Goodwill and intangible assets with indefinite lives are tested annually for impairment in accordance with the provisions of FAS 142. The Company's impairment review is based on a discounted cash flow approach at the reporting unit level that requires management judgment with respect to revenue and expense growth rates, changes in working capital and the selection and use of an appropriate discount rate. The Company uses its judgment in assessing whether assets may have become impaired between annual impairment tests. Indicators such as unexpected adverse business conditions, economic factors, unanticipated technological change or competitive activities, loss of key personnel and acts by governments and courts, may signal that an asset has become impaired. Intangible assets with estimable lives and other long-lived assets are reviewed for impairment whenever events of changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable in accordance with Financial Accounting Standards Board Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (FAS 144). Recoverability of intangible assets with estimable lives and other long-lived assets is 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 expected internal rate of return for the related business and does not allocate interest charges to the asset or asset group being measured. Judgment is required to estimate discounted future operating cash flows. 56 The following table adjusts net income in 2001 to reflect what it would have been if FAS 142 was adopted on January 1, 2001: The changes in the carrying amount of goodwill are as follows: Other intangible assets include the following and are presented in "Other Assets: "Other", in the Consolidated Balance Sheets: 57 Aggregate amortization expense for amortized other intangible assets for the year ended December 31, 2003, 2002 and 2001 was $763,000, $477,000 and $484,000, respectively. Additionally, future amortization expense on other intangible assets approximates $517,000 for 2004, $511,000 for 2005 and $472,000 for 2006 and 2007 and $448,000 for 2008. Property, Plant and Equipment Property, plant and equipment are recorded at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets, which range from 10 to 40 years for buildings and improvements and 3 to 15 years for machinery and equipment. 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. Foreign Currency Translation The financial statements of subsidiaries located outside the United States generally are measured using the local currency as the functional currency. Balance sheet accounts, including goodwill, of foreign subsidiaries are translated into United States dollars at Stock Based Compensation The Company accounts for 58 "Accounting for Stock-Based Compensation" (FAS 123) as amended by Financial Accounting Standards Board No. 148 "Accounting for Stock-Based Compensation Transition and Disclosure" (FAS 148). Net Income Per Common Share Basic net income per common share is calculated by dividing net income by the weighted average number of common shares outstanding. The calculation of diluted earnings per share assumes the conversion of all dilutive securities (see Note 13). Net income and number of shares used to compute net earnings per share,
(Amounts
(Amounts in thousands, except per share information)
Twelve(1) Twelve Six(2)(3) - - - - Twelve Months - - - -
Months Months Months Ended
Ended Ended Ended June 30,
12/31/01 12/31/00 12/31/99 Year
Ended
12/31/03(1)(4) Year
Ended
12/31/02(2) Year
Ended
12/31/01(3) Year
Ended
12/31/00(4) Six
Months
Ended
12/31/99(5)(6)(7) Year
Ended
6/30/99(4)(6)Selected Data Net sales $ 705,651 $ 615,526 $ 548,940 $ 516,100 $ 261,019 $ 477,869 Income from continuing operations 36,473 32,622 26,556 31,171 16,468 29,454 Income (loss) from discontinued operations, net of taxes (3,111 ) — — (7,170 ) (1,226 ) 6,502 Net income 33,362 32,622 26,556 24,001 15,242 35,956 Total assets 838,643 635,472 520,470 482,025 487,078 637,742 Long-term debt, net of current portion 179,061 56,276 123,212 105,377 123,991 118,916 Income per share from continuing operations—diluted 1.32 1.21 0.99 1.17 0.61 1.10 Income (loss) per share from discontinued operations—diluted (0.11 ) — — (0.27 ) (0.05 ) 0.24 Net income per share—diluted 1.21 1.21 0.99 0.90 0.56 1.34 Cash dividends declared per common share $ 0.25 $ 0.24 $ 0.24 $ 0.268 $ 0.175 $ 0.35 1998 1997
-------- -------- -------- ---- ---- ----
Selected Data
Net sales $548,940 $516,100 $261,019 $477,869 $444,735 $449,617
Income from continuing operations 26,556 31,171 16,468 29,454 28,123 26,515
Income/(loss) from discontinued
operations, net of taxes - (7,170) (1,226) 6,502 25,246 25,232
Net income 26,556 24,001 15,242 35,956 53,369 51,747
Total assets 520,470 482,025 487,078 637,742 552,896 526,366
Long-term debt, net of current portion 123,212 105,377 123,991 118,916 71,647 94,841
Income per share from continuing
operations-diluted 0.99 1.17 0.61 1.10 1.03 0.97
Income/(loss) per share from discontinued
operations - diluted - (0.27) (0.05) 0.24 0.92 0.92
Net income per share-diluted 0.99 0.90 0.56 1.34 1.95 1.89
Cash dividends declared per common share 0.24 0.268 0.175 0.35 0.33 0.295
1. Fiscal 2001 net income includes restructuring and other costs of $1,454,000$1,460,000 pre-tax inventory and other asset write-downs of $4,300,000
pre-tax and $77,000 pre-tax of other related charges, which totalor $861,000 net of taxtax.$3,593,000.
2. Onthe spin-off transaction, we distributed to our shareholders a tax-free dividend of one share of CIRCOR common stock for every two shares of our common stock owned as of the record date.14, 1999, the Company filed a Form 10-Q in which it reported its
decision to change itswe changed our fiscal year end from June 30 to a calendar year. As a result, the Company is reportingwe reported a six monthsix-month transition period ending December 31, 1999. See Note 2 of the Notes to the Consolidated Financial
Statements.
3. Fiscal 1999.5 net income includes an after-tax charge of $861,000 related
to restructuring costs.
-----------------------------------------------------------------------
OF OPERATIONS.
--------------
Recent Developments
- ------------------- (in millions) Foreign Exchange $ 35.0 5.7% Internal Growth 27.4 4.4% Acquisitions 23.9 3.9% Impact of FIN 46R 3.8 0.6% $ 90.1 14.6% implementingsubject to the satisfaction of certain closing conditions and is expected to occur during the second quarter of 2004.itsour manufacturing plants both in North America and Europe. At the same time it iswe are expanding itsour manufacturing capacity in China.China and other low cost areas of the world. The implementation of this manufacturing restructuring plan began during the fourth quarter of fiscal 2001 and is expected to be completed during fiscal 2002 to insure the quality of its
products and minimize any interruptionwill continue in the delivery of those products to its
customers.2004. The Companyprojects for which charges were recorded manufacturing restructuring plan costs of
$5,831,000 pre-tax in the fourth quarter of fiscal 2001 are essentially complete. During 2002, we decided to expand the scope of the manufacturing restructuring plan and is anticipating
recordingtransfer certain production to low cost$6,000,000$6.0 million in 2004 attributable to $8,000,000accelerated depreciation associated with the anticipated closure of one of our U.S. manufacturing plants and a reduction in estimated useful lives of manufacturing equipment due to the transfer of production to lower cost countries. The Company recorded pre-tax in 2002 as it continues
to implement the program.manufacturing restructuring and other costs of $1.7 million net of recoveries for 2003. The tax benefitsmanufacturing restructuring and other costs recorded consist primarily of theseverance costs, and asset write-downs will slightly exceedand accelerated depreciation. The severance costs, which have been recorded as restructuring, are for 48 employees in manufacturing and administration groups. We expect to make all of these severance payments during the cash outlayfirst quarter of 2004. Asset write-downs consist primarily of write-offs of inventory related to implementproduct lines that we have discontinued as part of this program, allowing the
Company to complete the restructuring without consuming any cash. The Company
estimates an annual pre-tax savingsplan and are recorded in cost of approximately $5,000,000 following the
completiongoods sold. Accelerated depreciation is based on shorter remaining estimated useful lives of the program.
On September 28, 2001, a wholly owned subsidiarycertain fixed assets and has been recorded in cost of the Company acquired
the assetsgoods sold. Other costs consist primarily of the Powers Process Controls Divisionremoval and shipping costs associated with relocation of Mark Controls Corporation,
a subsidiarymanufacturing equipment and have been recorded in cost of Crane Co. located in Skokie, Illinoisgoods sold and Mississauga,
10
Ontario, Canada for approximately $13 million in cash. The December 31, 2001
Consolidated Balance Sheet of the Company contains a purchase price allocation
of the Powers acquisition, consistent with the guidelines in SFAS 141 and
certain provisions of SFAS 142. Powers designs and manufactures thermostatic
mixing valves for personal safety and process control applications in commercial
and institutional facilities. It also manufactures control valves and commercial
plumbing brass products including shower valves and lavatory faucets. Powers'
annualized sales prior to the acquisition were approximately $20 million.
On June 13, 2001, a wholly owned subsidiary of the Company acquired
Premier Manufactured Systems, Inc., located in Phoenix, Arizona for
approximately $5 million in cash. Premier manufactures water filtration systems
for both residential and commercial applications and other filtration products
including under-the-counter ultraviolet filtrationhave been expensed as well as a variety of
sediment and carbon filters. Premier's annualized sales prior to the acquisition
were approximately $10 million.
On June 1, 2001, a wholly owned subsidiary of the Company acquired Fimet
S.r.l. (Fabbrica Italiana Manometri e Termometri) located in Milan, Italy and
its wholly owned subsidiary, MTB AD, which is located in Bulgaria for
approximately $6 million. The acquired business manufactures pressure and
temperature gauges for use in the HVAC market. Fimet's annualized sales prior to
the acquisition were approximately $9 million.
On January 5, 2001, the Company acquired Dumser Metallbau GmbH & Co. KG
located in Landau, Germany for approximately $20 million. The main products of
Dumser include brass, steel and stainless steel manifolds used as a prime
distribution device in hydronic heating systems. Dumser's annualized sales prior
to the acquisition were approximately $24 million. Dumser has a 51% controlling
share of Stern Rubinetti, which had annualized sales prior to the acquisition of
$4 million. Stern Rubinetti is an Italian manufacturing company producing brass
components located in Brescia, Italy.
incurred.
- ---------------------
Twelve Months20012003 Compared to - -------------------------------------------------
Twelve MonthsYear Ended December 31, 2000
- -------------------------------------2002twelve monthsyears ended December 31, 2001 increased
$32,840,000 (6.4%) to $548,940,000 compared to the same period in 2000.2003 and 2002 were as follows: Year Ended
December 31, Year Ended
December 31, 2003 % Sales 2002 % Sales Change % Change (in thousands) North America $ 476,310 67.5 % $ 450,233 73.1 % $ 26,077 4.2 % Europe 210,614 29.8 % 145,629 23.7 % 64,985 10.6 % China 18,727 2.7 % 19,664 3.2 % (937 ) (0.2 )% Total $ 705,651 100 % $ 615,526 100 % $ 90,125 14.6 % Years Ended December 31, 2003 2002 Change (in thousands) North America $ 64,414 $ 55,313 $ 9,101 Europe 22,592 13,608 8,984 China (3,834 ) (625 ) (3,209 ) Corporate (13,132 ) (10,767 ) (2,365 ) Total $ 70,040 $ 57,529 $ 12,511 Years Ended December 31, 2003 2002 2001 (in thousands, except per share information) Net income $ 33,362 $ 32,622 $ 26,556 Add back: loss from discontinued operations 3,111 — — Income from continuing operations 36,473 32,622 26,556 Add back: cost of restructuring and other charges 1,084 2,552 3,593 Add back: goodwill amortization — — 3,220 Adjusted income from continuing operations $ 37,557 $ 35,174 $ 33,369 Diluted earnings per share: Net income $ 1.21 $ 1.21 $ 0.99 Add back: discontinued operations 0.11 — — Continuing operations 1.32 1.21 0.99 Add back: cost of restructuring and other charges 0.04 0.09 0.13 Add back: goodwill amortization — — 0.12 Adjusted income from continuing operations $ 1.36 $ 1.30 $ 1.24
Internal Growth $(12,764) (2.4%)
Acquisitions 50,203 9.7%
Foreign Exchange (4,599) (0.9%)
-------- -----
Total Change $ 32,840 6.4%
======== ===== (in thousands) Internal Growth $ 11,773 2.1 % Acquisitions 47,080 8.6 % Foreign Exchange 7,733 1.4 % Total Change $ 66,586 12.1 % decreaseincrease in net sales from internal growth iswas primarily attributable to
decreased unit sales to North American and European plumbing and heating
wholesalers resulting from the continued weakness in the North American plumbing
market and the weakened European economy. These decreases were partially offset
by increased unit sales in the DIY market.market in North America. The growth in net sales from acquired businesses iswas due to the inclusion of the net sales from Powers Process Controls of Skokie, Illinois, acquired on September 28, 2001,2001; Premier Manufactured Systems of Phoenix, Arizona, acquired on June 13, 2001,2001; Fimet of Milan, Italy, acquired on June 1, 2001, Dumser Metallbau GmbH & Co., KG of Landau, Germany,2001; Shida, our joint venture, which we established on March 5, 2002; ADEV and Eminent, acquired on January 5, 2001, the business acquired from Chiles Power SupplyJuly 15, 2002; and Bask, LLC of Springfield, Missouri, now doing business as Watts Radiant,F&R acquired on August 30, 2000, and McCraney, Inc. of Santa Ana, California, doing
business as Spacemaker, acquired on May 12, 2000.July 29, 2002. The decreaseincrease in foreign exchange iswas due primarily to the euro devaluationappreciating against the U.S. dollar compared to the same period in 2000.
Watts monitors its2001.geographicalgeographic segments: North America, Europe and Asia.China. As outlined below, North America, Europe and AsiaChina accounted for 75.7%73.1%, 22.1%23.7% and 2.2%3.2% of net sales, respectively, in the twelve
months
11
20012002 compared to 77.6%75.7%, 20.0%22.1%, and 2.4%2.2%, respectively, in the twelve monthsyear ended in December 31, 2000. The Company's2001.groupsgeographic segments for the twelve monthsyears ended December 31, 20012002 and 20002001 were as follows:
12/31/01 12/31/00 Change
-------- -------- ------
North America $415,689 $400,384 $15,305
Europe 121,228 103,085 18,143
Asia 12,023 12,631 (608)
-------- -------- ------
Total $548,940 $516,100 $32,840
======== ======== ======= Years Ended
December 31, 2002 2001 Change (in thousands) North America $ 450,233 $ 415,689 $ 34,544 Europe 145,629 121,228 24,401 China 19,664 12,023 7,641 Total $ 615,526 $ 548,940 $ 66,586 North America's net sales isin North America was due to the inclusion of Powers Process Controls and Premier Manufactured Systems, Watts Radiant, and Spacemaker
acquisitions, as well as increased unit sales to the DIY market, partially
offset by decreased unit sales to plumbing and heating wholesalers.market. The increase in Europe's net sales isin Europe was due to the inclusion of Fimet, ADEV, Eminent and Dumser acquisitions, partially
offset by decreased unit sales to European plumbing and heating wholesalersF&R and the euro's devaluationappreciation of the euro against the U.S. dollar. The increase in net sales in China was primarily due to the inclusion of our Chen Guan joint venture.twelve monthsyear ended December 31, 2001 decreased
$1,772,000 (1.0%)2002 increased $25,188,000, or 13.7%, from the comparable prior year period and decreasedincreased as a percentage of net sales to 33.9% from 35.9% to 33.4%. The CompanyWe charged $2,907,000 and $4,253,000 of costs associated with itsour manufacturing restructuring plan to cost of sales.sales in 2002 and 2001, respectively. Excluding thesethe cost associated with the manufacturing restructuring costs, theplan in 2002 and 2001, gross profit would have increased $2,481,000$23,842,000, or 12.7%, and declinedwould have increased as a percentpercentage of sales from 35.9% to 34.2%.
This decreased percentage is primarily attributable to an unfavorable sales mix
caused by the decreasednet sales to plumbing34.4% from 34.2%.heating wholesalers as well as the
inclusion of the gross margin of acquired companies, which operate at a lower
gross margin than the remainder of the Company.
Selling, general and administrativeAdministrative Expenses. SG&A expenses increased $6,478,000 (5.2%)$18,758,000, or 14.2%, to $150,553,000 from $131,795,000 for the comparable prior year period to $131,795,000.period. This increase iswas attributable to the inclusion of the SG&A expenses of acquired companies, an increase in the cost of product and general liability insurance and administrative start-up costs associated with our new manufacturing plant in China. We adopted Financial Accounting Standards Board Statement No. 142 "Goodwill and Other Intangibles" (FAS142) on January 1, 2002, and accordingly did not record any goodwill amortization for 2002. We recorded goodwill amortization of $3,220,000 as part of our SG&A expenses for 2001.expensesexpenses. Operating income by segment for the years ended December 31, 2002 and 2001 was as follows: Years Ended
December 31, 2002 2001 Change (in thousands) North America $ 55,313 $ 47,294 $ 8,019 Europe 13,608 11,308 2,300 China (625 ) 1,365 (1,990 ) Corporate (10,767 ) (9,684 ) (1,083 ) Total $ 57,529 $ 50,283 $ 7,246 lower exchange rateinclusion of the operating results of acquired companies and the euro relative toappreciating against the U.S. dollar compared to the prior year. The decrease in China was primarily due to increased bad debt and reduced spending levels.
Restructuring and other chargeswarranty expense. Corporate expenses are primarily severancefor compensation expense, professional fees, including legal and relatedaudit expenses and benefit administration costs. The increase in corporate expenses was primarily due to increased legal and audit expenses and administrative start-up costs for 36 employees.
Operating incomeassociated with our new manufacturing plant in China.twelve monthsyear ended December 31, 20012002 decreased $9,704,000 (16.2%)$730,000, or 7.7%, to $50,283,000$8,692,000 compared to $9,422,000 for the same period in 2000 due to
reduced gross profit and manufacturing restructuring costs. The Company's
operating income by segment for the twelve months ended December 31, 2001, and
2000 were as follows:
12/31/01 12/30/00 Change
-------- -------- ------
North America $47,346 $55,661 $(8,315)
Europe 11,256 13,225 (1,969)
Asia 465 882 (417)
Corporate (8,784) (9,781) 997
-------- -------- ------
Total $50,283 $59,987 $(9,704)
======== ======== ======
The decrease in both North American and European operating income is due
to decreased unit sales to plumbing and heating wholesalers and manufacturing
restructuring plan costs. These decreases were partially offset by the operating
earnings of acquired companies.
Interest expense for the twelve months ended December 31, 2001 decreased
$475,000 (4.8%) compared to the same period in 2000, primarily due to lower interest rates on variable rate indebtedness despiteand capitalized construction period interest on our startup manufacturing plant in China, partially offset by the increased levels of debt incurred forto fund acquisitions. On September 1, 2001, the Companywe entered into an interest rate swap on itswith respect to our $75,000,000 8 3/8% notes.3/8% notes due December 2003. The swap tookconverted the interest from fixed to floatingfloating. On August 5, 2002, we sold the swap and received $2,315,000 in cash. Interest expense for the year ended December 31, 2002 had been reduced by $1,711,000 from the Company's interest expensebenefit of the swap while active and by $641,000
during 2001.
The Company'sthe amortization of the adjustment to the fair value subsequent to the sale of the swap.decreasedfor the year ended December 31, 2002, increased to 35.0% from 36.7% to 33.9%. for the comparable prior year period. The decrease isincrease was primarily due to statutory rate reductions
affecting incomea change in our earnings mix to jurisdictions with higher tax rates. Also in Canada and other tax planning opportunities. The2001, the costs for the manufacturing restructuring plan were recorded in tax jurisdictions with tax rates higher than the Company'sour effective rate, which loweredcaused the overall effective rate for fiscal 2001.
12
incomeIncome. Income from continuing operations for the twelve monthsyear ended December 31, 2001 decreased $4,615,000 (14.8%)2002 increased $6,066,000, or 22.8%, to $32,622,000, or $1.21 per common share compared to $26,556,000, or $0.99 per common share, compared to $1.17 per common share for the twelve monthsyear ended December 31, 20002001 on a diluted basis. On aof tax basis the manufacturing restructuring plan
costs accounted for $0.13 per share of this reduction.
For the twelve months ended December 31, 2000, discontinued operations
reported a net loss of $7,170,000 or $0.27 per share, on a diluted basis. The
Company did not record any costs associated with discontinuedcash from continuing operations for fiscal 2001.
Results of Operations
- ---------------------
Twelve Months Ended December 31, 2000 Compared to
- -------------------------------------------------
Twelve Months Ended December 31, 1999
- -------------------------------------
Net sales for the twelve months ended December 31, 2000 increased
$6,444,000 (1.3%) to $516,100,000 compared to the same period in 1999. The2003. We experienced an increase in net sales is attributable to the following:
Internal Growth $ 7,456 1.5%
Acquisitions 15,030 2.9%
Foreign Exchange (16,042) (3.1%)
-------- -----
Total Change $ 6,444 1.3%
======== =====
The increaseinventories in net sales from internal growth is attributable to
increased unit shipments of North American and European plumbing and heating
valves. North American increases were offset by recent softness in the housing
market resulting from increased interest rates during 2000. The growth in net
sales from acquired companies is due to the inclusion of Watts Radiant,
Spacemaker and Cazzaniga S.p.A of Biassono, Italy which was acquired March 9,
1999. Excluding the acquired revenue of Cazzaniga and the impact of foreign
exchange, shipments of European plumbing and heating valves were 3.1% higher
than last year. The decrease in sales due to foreign exchange is principally due
to the devaluation of the euro, which depreciated almost 13% against the U.S.
dollar during the twelve month period ended December 31, 2000.
Watts monitors its net sales in three geographical segments: North America, Europe and Asia. As outlined below, North America, Europe and Asia
accounted for 77.6%, 20.0%, and 2.4% of net sales, respectively,China. The increase in the twelve
months ended December 31, 2000 compared to 76.1%, 21.3%, and 2.6%, respectively,
in the twelve months ended December 31, 1999. The Company's net sales in these
groups for the twelve months ended December 31, 2000 and 1999 were as follows:
12/31/00 12/31/99 Change
-------- -------- ------
North America $400,384 $388,049 $12,335
Europe 103,085 108,579 (5,494)
Asia 12,631 13,028 (397)
-------- -------- -------
Total $516,100 $509,656 $ 6,444
======== ======== =======
The increaseinventory in North America is primarily due to the Watts Radiantplanned increases in imported raw materials and Spacemaker acquisitions andfinished goods to a lesser extent fromsupport our delivery capability as we extend our supply chain to lower cost regions, as well as an increase in inventory to support increased unit sales.retail business. The decreaseincrease in Europe is due to the impact of the euro's devaluation against the
U.S. dollar. This was substantially offset by increased unit sales and the
inclusion of Cazzaniga. The decrease in Asia is primarily due to reduced demand
in the North American export market.
Gross profit for the twelve months ended December 31, 2000 decreased
$1,414,000 (0.8%), to $185,304,000 compared to the same period in 1999 and
decreased as a percentage of net sales from 36.6% to 35.9%. This percentage
reduction is attributable to price competition in certain markets the company
serves and additional production costs associated with new product introductions
in Europe. This was partially offset by the inclusion of acquired companies
currently operating at higher gross margins than the rest of the Company.
Selling, general and administrative expenses for the twelve months
decreased $3,666,000 (2.8%) to $125,317,000 compared to the same period in 1999.
This decrease is attributable to decreased corporate headquarters expenses
13
resulting from the CIRCOR spin-off, the euro's devaluation against the U.S.
dollar and reduced variable selling expenses. This was partially offset by the
inclusion of selling, general and administrative expenses of acquired companies.
Selling, general and administrative expenses for the twelve months decreased as
a percentage of sales from 25.3% in the twelve months ended December 31, 1999 to
24.3% in the twelve months ended December 31, 2000. This decreased percentage is
primarily due to decreased corporate headquarters expenses resulting from the
CIRCOR spin-off.
Operating income in the twelve months ended December 31, 2000 increased
$3,712,000 (6.6%) to $59,987,000 and increased as a percentage of sales to 11.6%
from 11.0% compared to the same period in 1999 due to increased net sales and
decreased selling, general and administrative expenses.
The Company's operating income by segment for the twelve months ended
December 31, 2000 and 1999 was as follows:
12/31/00 12/31/99 Change
-------- -------- ------
North America $55,661 $56,439 $ (778)
Europe 13,225 12,560 665
Asia 882 1,519 (637)
Corporate (9,781) (14,243) 4,462
------ ------- -----
Total $59,987 $56,275 $3,712
======= ======= ======
The decrease in North America is due to decreased unit prices in certain
markets. The increaseinventory in Europe is primarily due to increased net salessafety stock growth to cover planned distribution relocations and to support the Cazzaniga acquisition, substantially offset by the euro's devaluation against
the U.S. dollar. The decreasedeliveryAsia is due to decreased net sales. The
decrease in corporate is to due reduced headquarter expenses attributable to the
CIRCOR spin-off.
Interest expense increased $1,964,000 to $9,897,000 in the twelve months
ended December 31, 2000 compared to the same period in 1999, primarily due to
increased effective interest rates.
The Company's effective tax rate for continuing operations increased from
35.9% to 36.7% in the twelve months ended December 31, 2000 compared to the same
period in 1999. The increase is primarily attributable to a revised tax
structure required to execute the CIRCOR spin-off.
Net income from continuing operations for the twelve months ended December
31, 2000 increased $474,000 (1.5%) to $31,171,000 or $1.17 per common share
compared to $1.15 per common share for the twelve months ended December 31, 1999
on a diluted basis. The impact of foreign exchange, primarily due to the
devaluation of the euro against the U.S. dollar, decreased income approximately
$1,331,000 or $.05 per common share on a diluted basis in the period ended
December 31, 2000.
For the twelve months ended December 31, 2000, discontinued operations
reported a net loss of $7,170,000 or $0.27 per share, on a diluted basis. This
loss results from a charge recorded during the fiscal year representing the
Company's current estimate of the after tax impact of the cost to bring the
James Jones litigation to resolution. Additional details of the James Jones
litigation are provided in Part I, Item 1, Product Liability, Environmental and
Other Litigation Matters and in Note 15 of the Notes to the Consolidated
Financial Statements. For the twelve months ended December 31, 1999,
discontinued operations reported a net loss of $3,143,000 or $0.12 per share, on
a diluted basis. Results for the twelve months ended December 31, 1999 were
negatively impacted by after tax charges of $11,599,000 for spin-off related
costs, including professional fees, facility relocation costs and income tax
costs associated with the reorganizing of the Company's legal entity structure
in anticipation of the spin-off as well as legal fees associated with the James
Jones litigation. Excluding these charges, discontinued operations would have
had net income of $8,456,000 ($0.32 per share) for the twelve months ended
December 31, 1999. Additional details of the spin-off transaction are provided
in Note 3 of the Notes to the Consolidated Financial Statements.
14
Results of Operations
- ---------------------
Six Months Ended December 31, 1999 Compared to
- ----------------------------------------------
Six Months Ended December 31, 1998
- ----------------------------------
Net sales increased $31,869,000 (13.9%) to $261,019,000.Europe. The increase in net salesinventory in China is attributable to the following:
Internal Growth $20,234 8.8%
Acquisitions 17,061 7.4%
Foreign Exchange (5,426) (2.3%)
------- -----
Total Change $31,869 13.9%
======= =====
The increaseresult of our wholly-owned manufacturing plant start-up operations. We had reductions in net sales from internal growth is primarily attributable
to increased unit shipmentsaccounts receivable in the North American segment. The growth in net
sales from acquired companies is due to the inclusion of the net sales of
Cazzaniga S.p.A. of Biassono, Italy, which was acquired March 9, 1999. The
foreign exchange impact reflects the adverse affects of the euro's devaluation
against the U.S. dollar during the period. Excluding Cazzaniga, shipments in the
European plumbing and heating market were 9.2% higher than last year.
Watts monitors its net sales in three geographical segments: North
America, Europe and Asia. As outlined below,China, partially offset by increased accounts receivable in North America, Europe and Asia
accounted for 73.9%, 22.6%, and 3.5% of net sales, respectively, in the six
months ended December 31, 1999 compared to 77.2%, 19.0%, and 3.8%, respectively,
in the six months ended December 31, 1998. The Company's net sales in these
groups for the six months ended December 31, 1999 and 1998 were as follows:
12/31/99 12/31/98 Change
-------- -------- ------
North America $192,975 $176,918 $16,057
Europe 58,934 43,598 15,336
Asia 9,110 8,634 476
-------- -------- -------
Total $261,019 $229,150 $31,869
======== ======== =======America. The increase in North America is due to increased unit sales. The increasesales volume. We funded $6,800,000 into our pension plans in Europe is due to the Cazzaniga acquisition and increased unit sales, which
were partially offset by the devaluation of the euro against the U.S. dollar.
Gross profit increased $11,676,000 (14.0%) to $95,166,000 and remained
constant as a percentage of net sales at 36.4%. This increase is attributable to
increased net sales during the period.
During the periodyear ended December 31, 1999 the Company recorded a
restructuring charge2003.$1,460,000 before taxes. The charge was comprised of
severance costs of $1,299,000, contract termination costs of $134,000 and other
exit costs of $27,000. The Company consolidated certain Italian manufacturing
and warehouse facilities into the Cazzaniga facilitynet cash for investing activities. We invested $20,035,000 in Biassono, Italy. This
project, which included the termination of 29 employees, was completed during
fiscal 2000. Total program costs did not differ materially from the original
estimate.
Selling, general and administrative expenses increased $5,779,000 (9.9%)
to $64,148,000. This increase is primarily attributable to inclusion of the
selling, general and administrative expenses of Cazzaniga and increased variable
selling expenses, primarily commissions and freight costs.
Operating income in the six months ended December 31, 1999 increased
$4,437,000 (17.7%) to $29,558,000 due to the increased gross profit. Without the
restructuring charge, operating income would have increased by 23.5% and
increased as a percentage of sales from 11.0% to 11.9%.
15
The Company's operating income by segment for the six months ended December 31,
1999 and 1998 was as follows:
12/31/99 12/31/98 Change
-------- -------- ------
North America $27,793 $25,684 $2,109
Europe 7,252 5,682 1,570
Asia 731 822 (91)
Corporate (6,218) (7,067) 849
-------- -------- ------
Total $29,558 $25,121 $4,437
======== ======== ======
The increase in North America is due to increased net sales. The increase
in Europe is primarily due to increased net sales and the Cazzaniga acquisition,
which were partially offset by the restructuring charge.
Interest expense increased $1,783,000 in the six months ended December 31,
1999, primarily due to increased levels of debt associated with the acquisition
of Cazzaniga.
The Company's effective tax rate for continuing operations increased from
32.1% to 35.2%. The increase is attributable to acquired companies operating in
higher tax rate jurisdictions than the rest of the Company, tax planning
strategies favorably impacting fiscal 1998 only and a revised tax structure
required to effect the Distribution.
Net income from continuing operations for the six months ended December
31, 1999 increased $1,243,000 (8.2%) to $16,468,000 or $.61 per common share
compared to $.56 per common share for the six months ended December 31, 1998 on
a diluted basis. Net income from continuing operations exclusive of the
restructuring charge would have increased $2,104,000 to $17,329,000 or $.64 per
common share on a diluted basis. The impact of foreign exchange, primarily due
to the devaluation of the euro against the U.S. dollar, decreased net income
$.02 per common share on a diluted basis in the period ended December 31, 1999.
For the six months ended December 31, 1999, discontinued operations
generated a net loss of $1,226,000 ($0.05 per share), compared to net income of
$8,419,000 ($0.31 per share) for six months ended December 31, 1998. Results for
the six months ended December 31, 1999 were negatively impacted by an after tax
charge of $2,433,000 for spin-off related costs, including professional fees,
facility relocation costs and income tax costs associated with the reorganizing
of the Company's legal entity structure in anticipation of the spin-off.
Excluding this charge, discontinued operations would have had net income of
$1,207,000 ($0.05 per share) for the six months ended December 31, 1999. Net
sales for the discontinued operations for the three months ended September 30,
1999 were $76,957,000, a decrease of $3,699,000 (4.6%) from the comparable
period in 1998. The decrease in net sales is primarily attributable to lower
demand for oil and gas valve products. Declining prices, resulting from
increased competition; reduced manufacturing levels, resulting in lower
absorption of fixed manufacturing costs; and costs associated with the
integration of acquired companies negatively impacted operating profits during
the six months ended December 31, 1999. Additional details of the spin-off
transaction are provided in Note 3 of the Notes to the Consolidated Financial
Statements.
Results of Operations
- ---------------------
Twelve Months Ended June 30, 1999
- ---------------------------------
Net sales for the twelve months ended June 30, 1999 were $477,869,000.
Sales grew internally at a rate of 5.9% over the prior fiscal year, primarily
attributable to increased unit shipments in the North American market. In March
1999, the Company acquired Cazzaniga S.p.A. of Biassono, Italy. The inclusion of
the sales of Cazzaniga contributed $10,095,000 to overall net sales.
Net income from continuing operations was $29,454,000, while net income
from discontinued operations was $6,502,000capital equipment for the year ended June 30, 1999.
The results of discontinued operations for the year ended June 30, 1999 include
the net income from the industrial and oil and gas operations which were
negatively impacted by an after-tax charge of $6,166,000 for spin-off related
costs, including professional fees, facility relocation costs and income tax
costs associated with the reorganization of the Company's legal entity structure
in anticipation of this spin-off. The income from discontinued operations
contains an after-tax charge of $3,000,000 for legal expenses associated with
the litigation involving the James Jones Company. James Jones Company was a
subsidiary of the Company in the Municipal Water Works Division until September
1996 when it was sold to Tyco International, Ltd.
16
Liquidity and Capital Resources
- -------------------------------
During the twelve month period ended December 31, 2001, the Company
generated $51,237,000 in cash flow from continuing operations, which was
principally used to fund the purchase of $16,047,000 in capital equipment,
contribute to the funding of acquisitions, and to pay cash dividends to common
shareholders.2003. Capital expenditures were primarily for manufacturing machinery and equipment as part of the Company'sour ongoing commitment to continuously improve itsour manufacturing capabilities. The Company's capital expenditure budget for fiscal 2002 is $18,700,000.
Thetwo largest componentcomponents of this budget is the establishment ofexpenditure were for a 100% controlled
brassbuilding added to our Shida joint venture facility in Taizhou, China and bronze valvefor additional machinery and equipment for our wholly-owned manufacturing plant in Tianjin, China forChina. We expect to invest approximately $18,500,000 in capital equipment in 2004.estimated
cost of $9,000,000.
The Board ratified on February 12, 2002, the establishment of a 60% ownedadditional $3,040,000 in our Shida joint venture, in the Shanghai provincesbringing our total amount to support some of the Company's
retail-oriented products, such as flexible hose connectors, plumbing fittings
and under-the-sink products. The Company's investment for 60% of thisapproximately $8,040,000. This joint venture is estimatedowned 60% by us and 40% by our Chinese partner. On May 6, 2003 we paid $3,750,000 of debt owed to the former shareholders of Hunter Innovations, leaving a balance of $11,250,000 remaining to be $7,800,000.
The Company invested $42,977,000paid. In addition, on April 18, 2003, we paid approximately $1,600,000 to acquire Martin Orgee UK Limited, and on July 30, 2003, we paid approximately $10,600,000, which is net of cash acquired of $1,400,000, to acquire four
businesses duringGiuliani Anello S.r.l.twelve months endedtransaction. We intend to use the net proceeds from the offering to fund potential acquisitions and for general corporate purposes.31, 2001. These acquisitions1, 2003. On December 1, 2003 the principal of, and interest on, our $75,000,000 83/8% notes were Dumser Metallbau GmbH & Co. KG of Landau, Germany; Fimet S.r.l. of Milan,
Italy; Premier Manufactured Systems, Inc. of Phoenix, Arizona; and Powers
Process Controls of Skokie, Illinois and Mississauga, Ontario, Canada.paid with our restricted treasury securities. Additional net proceeds were used to repay approximately $32,000,000 outstanding under our Revolving Credit Facility. The purchase price of these acquisitions was primarily funded through the Company's
usebalance of the domesticnet proceeds will be used for general corporate purposes. The payment of interest on the senior unsecured notes is due semi-annually on May 15th and foreignNovember 15th of each year. The senior unsecured notes were issued by the Company and are subordinated to our revolving linescredit facility, which is at the subsidiary level. The senior unsecured notes allow us to have (i) debt senior to the new notes in an amount up to $150,000,000 plus 5% of credit.our stockholders' equity and (ii) debtpari passu or junior to the senior unsecured notes to the extent we maintain compliance with a 2.00 to 1.00 fixed charge coverage ratio. The Company's
consolidated long-term debt increased by $20,287,000notes include a prepayment provision which might require a make-whole payment to $126,905,000 at December
31, 2001 compared to $106,618,000 at December 31, 2000. The Company's operating
cash flow enabled it to pay a significant portionthe note holders. Such payment is dependent upon the level of the $42,977,000 invested in
acquired companies during 2001, reducing the userespective treasuries. The notes include other customary terms and conditions, including events of the Company's debt facility.
On February 27, 2002, the Company entered into a new Revolving Credit
Facilitydefault.(the "Revolving Credit Facility"), which
replaces(as amended, the Company's $100 million facility and its 39,350,000 euro facility.
The Revolving Credit FacilityFacility) provides for borrowings of up to $150 million,$150,000,000 which includes a $100 million$75,000,000 tranche for U.S. dollar borrowings and a $50
million tranche for euro baseeuro-based borrowings and matures in February 2005. Approximately $50 million of borrowings under the Revolving Credit Facility were
used to repay amounts outstanding under the prior facilities. The Revolving Credit Facility will beis being used to support the Company'sour acquisition program, working capital requirements of acquired companies, and for general corporate purposes. As of December 31, 2003, long-term debt included $44,089,000 outstanding on the Revolving Credit Facility for euro-based borrowings and no amounts were outstanding for U.S. dollar borrowings. This facility was amended during the fourth quarter of 2003 to permit us to enter into a guarantee of a $2,000,000onea rate determined by the type (currency) of three customary ratesloan plus aan applicable margin of 100 basis points,determined by the Company's debt rating, depending on the applicable base rate and the Company'sour bond rating. The average interest rate for February 2002borrowings under the Revolving Credit Facility was approximately 3%.2.8% at December 31, 2003. We have $105,911,000 of unused and available revolving credit at December 31, 2003. The Revolving Credit Facility includes operational and financial covenants customary for facilities of this type, including, among others, restrictions on additional indebtedness, liens and investments and maintenance of certain leverage ratios. As of February
27, 2002, the Company wasAt December 31, 2003, we were in compliance with all covenants related to the Revolving Credit Facility.
The Company's $5,000,000 industrial revenue bond is payable in September
2002. The Company intends to repay this debt by utilizing the Revolving Line of
Credit.
On September2001, the Company2003, we entered into an interest rate swap for its $75,000,000 8 3/8% notes due December 2003. The Companya notional amount of 25,000,000 euros outstanding under our Revolving Credit Facility. We swapped itsthe variable rate from the Revolving Credit Facility which is three month EURIBOR plus 0.7% for a fixed rate for a variable rate. The variable rate is floating LIBOR plus 3.74%of 2.33%. The term of the swap coincidesis two years. We have designated the swap as a hedging instrument using the cash flow method. The swap hedges the cash flows associated with interest payments on the termfirst 25,000,000 euros of our Revolving Credit Facility. We mark to market the changes in value of the notes.
Working capitalswap through other comprehensive income. Any ineffectiveness has been recorded in income. The fair value recorded in other comprehensive income as of December 31, 2001,2003 was $142,595,000 compared$46,000.$137,142,000$6,859,000 in 2003 from $6,490,000 in 2002.2000.2003 because of the possibility that we might have to reimburse the insurance company if it is ultimately successful with a future appeal. We also received $2,932,000 in cash for reimbursement of defense costs related to the James Jones case. We paid $2,283,000 for defense costs and $2,859,000 for indemnity costs we incurred in the James Jones case. Additionally, on September 2, 2003 we paid $11,000,000 relating to a settlement agreement in the James Jones case. See Part I, Item 1, "Business—Product Liability, Environmental and Other Litigation Matters."attributabledue to the inclusionnet proceeds received from the $125,000,000 private placement and the stock offering that raised net cash of working capital of acquired companies.approximately $82,500,000. The ratio of current assets to current liabilities was 2.32.8 to 1 atas of December 31, 20012003 compared to 2.21.3 to 1 atas of December 31, 2000.2002. Cash and cash equivalents were $11,997,000 at$149,361,000 as of December 31, 20012003 compared to $15,235,000 at$10,973,000 as of December 31, 2000. Debt2002. Our total debt increased to $192,312,000 as a
percentage of totalDecember 31, 2003 from $138,487,000 as of December 31, 2002 primarily due to the issuance of our $125,000,000 senior notes reduced by the repayment of our $75,000,000 principal amount of 83/8% notes due December 1, 2003.employed (short-termexpenditures and long-termdividends plus proceeds from sale of assets) during the year ended December 31, 2003 versus positive free cash flow of $28,536,000 in the comparable prior year period. This decrease in 2003 compared to 2002 was primarily due to increased inventories, pension funding of $6,800,000 and increased dividends partially offset by increases in accounts payable and reductions in accounts receivable. The effect of the free cash flow and proceeds from our stock offering has been to reduce our net debt to capitalization ratio (defined as short and long term interest-bearing liabilities less cash and cash equivalents as a percentage of the sum of short-termshort and long-termlong term interest-plus equity) was 33.7% at
December 31, 2001 comparedand to 31.4% at December 31, 2000.
17
The Company anticipatesfund acquisitions. Our computation may not be comparable to other companies that currentlymay define free cash flow differently. Free cash flow does not represent cash generated from operating activities in accordance with GAAP. Therefore it should not be considered an alternative to net cash flows from operating activities as an indication of our performance. Free cash flow should also not be considered an alternative to net cash flows from operating activities as defined by GAAP. Years Ended December 31, 2003 2002 2001 (in thousands) Net cash provided by continuing operations $ 49,990 $ 51,425 $ 51,237 Less: additions to property, plant, and equipment (20,035 ) (19,593 ) (16,047 ) Plus: proceeds from the sale of property, plant, and equipment 1,765 3,194 267 Less: dividends (6,859 ) (6,490 ) (6,422 ) Free cash flow $ 24,861 $ 28,536 $ 29,035 December 31, 2003 2002 (in thousands) Current portion of long-term debt $ 13,251 $ 82,211 Plus: long-term debt, net of current portion 179,061 56,276 Less: cash and cash equivalents (149,361 ) (10,973 ) Net debt $ 42,951 $ 127,514 December 31, 2003 2002 (in thousands) Net debt $ 42,951 $ 127,514 Total stockholders' equity 436,391 295,936 Plus: minority interest 9,286 10,134 Capitalization $ 488,628 $ 433,584 those funds
provided by the ongoing operationsother sources of liquidity will be sufficient to meet current operating requirements and anticipated capital expenditures for at least the next 2412 months. The CompanyHowever, we may have to consider external sources of financing for any large future acquisitions. Our current Revolving Credit Facility expires in February 2005. We aretime to time is involved in environmental proceedings and
other legal proceedings and incurs costs on an ongoing basis related to these
matters. The Company has not incurred material expenditures in fiscal 2001 in
connectionour syndicate of banks with anythe intention of these matters. See Part II, Item 1, Legal Proceedings.
Conversion To The Euro
- ----------------------
On January 1, 1999, 11structuring a new revolving line of the 15 member countriescredit.the European Union
adopted the euro as their common legal currency and established fixed conversion
rates between their existing sovereign currencies and the euro. The euro affects
the Company as the Company has manufacturing and distribution facilities in
several of the member countries and trades extensively across Europe. The
long-term competitive implications of the conversionDecember 31, 2003 are currently being
assessed by the Company; however, the Company has experienced a reductionpresented in the risks associated with foreign exchange. At this time, the Company has not
incurred any significant costs with the introduction and conversion to the euro.
The Company is currently able to make and receive payments in euro and has
converted its financial and information technology systems to use the euro,
where required, following table: Payments Due by Period Contractual Obligations Total Less than
1 year 1-3 years 3-5 years More than
5 years (in thousands) Long-term debt obligations, including current maturities(a) $ 192,312 $ 13,251 $ 52,551 $ 1,111 $ 125,399 Operating lease obligations 9,615 1,992 3,531 2,362 1,730 Capital lease obligations 1,364 653 579 132 — Total $ 203,291 $ 15,896 $ 56,661 $ 3,605 $ 127,129 its base currency.
Responsibility for Financial Statements
- ---------------------------------------
The Company is responsible for the objectivity and integrity of the
accompanying consolidated financial statements, which have been prepared in
conformity with accounting principles generally acceptedrecognized in the United Statesconsolidated balance sheetAmerica. The financial statements of necessity include the Company's estimates
and judgments relatingcredit that guarantee our performance or payment to matters not concluded by year end. Financial
information contained elsewhere in the Annual Report and Form 10-K is consistent
with that included in the financial statements.
The Company maintains a system of internal accounting controls. Although
there are inherent limitations to the effectiveness of any system of accounting
controls, the Company believes that its system provides reasonable, but not
absolute, assurance that its assets are safeguarded from unauthorized use or
disposition and that its accounting records are sufficiently reliable to permit
the preparation of financial statements that conform in all material respects
with accounting principles generally accepted in the United States.
KPMG LLP, independent auditors, are engaged to render an independent
opinion regarding the fair presentation in the financial statements of the
Company's financial condition and operating results. Their report appears on
page 31. Their examination was madethird parties in accordance with auditing standards
generally accepted in the United Statesspecified terms and conditions. Amounts outstanding were approximately $29,880,000 as of America and included a review of the
system of internal accounting controls to the extent they considered necessary
to determine the audit procedures required to support their opinion.
The Audit Committee of the Board of Directors is composed of four
non-employee directors. The Board has made a determination that the members of
the Audit Committee satisfy the requirements of the New York Stock Exchange as
to independence, financial literacy and experience, except that Mr. McAvoy is
not independent as defined in section 303.01(B)(3) of the listing requirements
of the New York Stock Exchange, because he was employed by the Company until December 31, 1999.2003 and $19,522,000 as of December 31, 2002. Our letters of credit are primarily letters of credit associated with insurance coverage and to a lesser extent foreign purchases. Our letters of credits generally expire within one year of issuance. The Committee meets periodically and privatelyincrease is primarily associated with the
independent auditors and financial officers of the Company, as it deems
necessary, to review the quality of the financial reporting of the Company and
the internal accounting controls. The Committee also reviews compliance with the
Company's policy regarding its relationship with the independent auditors. In
addition, the Committee is responsible for recommending the appointment of the
Company's independent auditors.
18
- ----------------------------------------------
Management considers the following accounting policies and key estimates
as being criticalreporting the financial position of the Company and its
results of operations:
o The proper application of revenue recognition criteriaaccordance with GAAP requires certainmanagement to make judgments, assumptions and estimates includingthat effect the assessment of credit
riskamounts reported. A critical accounting estimate is an assumption about highly uncertain matters and sales return rates. Management hascould have a material effect on the consolidated financial statements if another, also reasonable, amount were used, its best estimates
based on historic trends to establish these reserves.
o The valuation of inventory includes forecasted demand and
anticipated market pricing for its products.
o Contingencies and environmental remediation costs include estimates
for clean-up costs which could be paid over several years. Estimates
are based on management and legal counsel's best estimates of
ultimate liability.
o Product liability costs are estimated utilizing historic trends,
considering known insurance recoveries.
o In accounting for costs relating to the manufacturing restructuring
plan, certain estimates have been made in measuring the cost of the
plan and the impact on operations including the estimated timing of
facility closures.
Management believes that the estimates and assessments inherentor, a change in the application of these accounting policies have been appliedestimate is reasonably likely from period to period. We base our assumptions on ahistorical experience and on other estimates that we believe are reasonable basis.under the circumstances. Actual results could differ significantly from these estimates. Except as noted in product liability and pension benefits below, there were no changes in accounting policies or significant changes in accounting estimates during 2003. impact the financial position of the Company and its results of
operations.
Certain Factors Affecting Future Results
- ----------------------------------------
This report on form 10K includes forward-looking statements, which are not
historical facts and are considered forward-looking within the meaning of the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements reflect the Company's current views about future events and financial
performance. Forward-looking statements do not relate strictly to historical or
current facts and may be identified by their use of words like "plan",
"believe", "expect", "will", "anticipate", "estimate" and other words of similar
meaning. Investors should not rely on forward-looking statements because they
are subject to a variety of risks, uncertainties, and other factors that could
cause actual results to differ materially from our expectations, and we do not
undertake any duty to update forward-looking statements. Some important factors
that could cause our actual results to differ materially from those projected in
any such forward-looking statements are as follows:
Down Economic Cycles, Particularly Reduced Levels Of Housing Starts And
Remodeling, Have An Adverse Affect On Our Business And Revenues
The businesses of most of our customers, particularly plumbing and heating
wholesalers and home improvement retailers, are cyclical. Therefore, the level
of the Company's business activity has been cyclical, fluctuating with economic
cycles, in particular, with housing starts and remodeling levels. Housing starts
and remodeling are, in turn, heavily influenced by mortgage interest rates,
consumer debt levels, changes in disposable income, employment growth, consumer
confidence and, on a short term basis, weather conditions. There can be no
assurance that a downturn in these factors affecting housing starts and
remodeling will not occur, and if housing and remodeling starts are materially
reduced, it is likely such reduction would have a material adverse effectimpact on the Company due to reduced revenue.
Economic, Political And Other Risks Associated With International Sales And
Operations Could Adversely Affect Our Business
Since we sell our products worldwide, our business is subject to risksresults of operations and financial position.doing business internationally. Our sales outside North America,our insurance policies, we are generally self-insured for potential product liability claims and for workers' compensation costs associated with workplace accidents. For product liability cases in the U.S., management estimates expected settlement costs by utilizing stop loss reports provided by our third party administrators as a percentagewell as developing internal historical trend factors based on our specific claims experience. Prior to 2003, we used insurance carrier trend factors to determine our product liability reserves. However, we determined circumstances inherent in those trends were not necessarily indicative of our total sales, was 24.3%own circumstances regarding our claims. Management believes the internal trend factors will more accurately reflect final expected settlement costs. In other countries, we maintain insurance coverage with relatively high deductible payments, as product liability claims tend to be smaller than those experienced in 2001. Accordingly, our future
resultsthe U.S. Changes in the nature of claims or the actual settlement amounts could be harmed by a varietyaffect the adequacy of factors, including:
othis estimate and require changes to the provisions.foreign currency exchange rates
o changes inthe status of individual case reserves. At the time a workers' compensation claim is filed, a liability is estimated to settle the claim. The liability for workers' compensation claims is determined based on management's estimates of the nature and severity of the claims and based on analysis provided by third party administrators and by various state statutes and reserve requirements. We have developed our own trend factors based on our specific country's or region's political or economic
conditions, particularly in emerging markets
19
o trade protection measures and import or export licensing
requirements
o potentially negative consequences from changes in tax laws
o difficulty in staffing and managing widespread operations
o differing labor regulations
o differing protection of intellectual property
o unexpected changes in regulatory requirements
Reductionsclaims experience. In The Supply Of Raw Materials And Increases In The Prices Of Raw
Materials Could Adversely Affect Our Operating Results
We require substantial amounts of raw materials (bronze, brass, cast iron)
and substantially all raw materialsother countries where workers compensation costs are applicable, we require are purchased from outside
sources. The availability and prices of raw materialsmaintain insurance coverage with limited deductible payments. Because the liability is an estimate, the ultimate liability may be subjectmore or less than reported.curtailment or change dueminimize our risks related to among other things, new laws or regulations,
suppliers' allocations to other purchasers, interruptionscatastrophic claims in production by
suppliers, changes in exchange rates and worldwide price levels.excess of all self-insured positions. Any material change in the supply of, or price for, these raw materialsaforementioned factors could adversely affect our
operating results.
Fluctuations In Foreign Exchange Rates Could Materially Affect Our Reported
Results
Exchange rates between the United States dollar, in which our results are
and will be reported, and the local currency in the countries in which we
provide many of our services, may fluctuate from quarter to quarter. Since we
report our interim and annual results in United States dollars, we are subject
to the risk of currency fluctuations. When the dollar appreciates against the
applicable local currency in any reporting period, the actual earnings generated
by our services in that country are diminished in the conversion.
We are exposed to fluctuations in foreign currencies as a significant
portion of our revenue, and certain of our costs, assets and liabilities, are
denominated in currencies other than U.S. dollars. Approximately 24.3% of our
revenue during 2001 was from sales outside of North America. For the twelve
months ended December 31, 2001 the depreciation of the euro against the U.S.
dollar hadhave an adverse impact on revenueour operating results.$3,385,000, yetNotes to Consolidated Financial Statements. As required by Financial Accounting Standards Board Statement No. 5 "Accounting for Contingencies" (FAS 5), we determine whether an estimated loss from a loss contingency should be accrued by assessing whether a loss is deemed probable and the impact on
earnings was minimal. Our shareloss amount can be reasonably estimated, net of revenueany applicable insurance proceeds. Estimates of potential outcomes of these contingencies are developed in non-dollar denominated currencies
may continueconsultation with outside counsel. While this assessment is based upon all available information, litigation is inherently uncertain and the actual liability to increasefully resolve this litigationfuture periods. We can offer no assurance that
exchange rate fluctuations will not have a material adverse effectsignificant effects on our results of operations, cash flows and financial condition.position.Face Intense Competitionaccount for our pension plans in accordance with Financial Accounting Standards Board Statement No. 87 "Employers Accounting for Pensions" (FAS 87). In applying FAS 87, assumptions are made regarding the valuation of benefit obligations and the performance of plan assets. The primary assumptions are as follows:inventory.inventories and their transaction costs. To remain competitive, we will need to invest continuously in manufacturing, marketing, customer service and support and our distribution networks. We may not have sufficient resources to continue to make such investments and we may be unable to maintain our competitive position. In addition, we anticipate that we may have to adjustreduce the prices of some of our products to stay competitive, potentially resulting in a reduction in the profit margin for, and inventory valuation of, these products. Some of our competitors are based in foreign countries and impairment issues.have cost structures and prices in foreign currencies. Accordingly, currency fluctuations could cause our U.S. dollar-priced products to be less competitive than our competitors' products which are priced in other currencies.assure yoube certain that we will be able to identify, acquire or profitably manage additional companies or successfully integrate such additional companies without substantial costs, delays or other problems. Also, companies acquired recently and in the future may not achieve revenues, profitability or cash flows that justify our investment in them. We expect to spend significant time and effort in expanding our existing businesses and identifying, completing and integrating acquisitions. We have sufficient resourcesfaced increasing competition for acquisition candidates which have resulted in significant increases in the purchase prices of many acquisition candidates. This competition, and the resulting purchase price increases, may limit the number of acquisition opportunities available to us, possibly leading to a decrease in the rate of growth of our revenues and profitability. In addition, acquisitions may involve a number of special risks, including, but not limited to:make such investmentsexperience fluctuations in revenues and operating results due to economic and business cycles. The businesses of most of our customers, particularly plumbing and heating wholesalers and home improvement retailers, are cyclical. Therefore, the level of our business activity has been cyclical, fluctuating with economic cycles. We also believe our level of business activity is influenced by housing starts and renovation and remodeling, which are, in turn, heavily influenced by interest rates, consumer debt levels, changes in disposable income, employment growth and consumer confidence. If these and other factors cause a material reduction in housing and remodeling starts, our revenues and profits would decrease and result in a material adverse effect on our financial condition and results of operations.position.
position; in addition, added expenses could decrease the profitability associated with those products that do not gain market acceptance.Compliance Costs And Liabilities Could Adversely Affect Our
Financial Conditioncompliance costs and liabilities could increase our expenses or reduce our profitability.must
conformalso could be required to halt one or more portions of our operations until a violation is cured. We could also be liable for the costs of property damage or personal injury to others. Although we attempt to operate in compliance with these environmental laws, we may not succeed in this effort at all times. The costs of curing violations or resolving enforcement actions that might be initiated by government authorities could be substantial.propertiespast owners or operators of real property may be liable for the costs of cleaning up contamination, even if they did not know of or were not responsible for such contamination. These laws also impose liability on any person who arranges for the disposal or treatment of hazardous waste at any site. Therefore, our ownership and operation of real property and our disposal of waste could lead to liabilities under these laws, and adapt to regulatory
requirements in all countries as these requirements change.
20
experienced,incurred, and expect to continue to experience, operatingincur, costs relating to comply withthese environmental laws and regulations.matters. In addition, new laws and regulations, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination or the imposition of new clean up requirements could require us to incur additional costs or become the basis for new or increased liabilities that could have a material adverse effect onbe significant. Environmental litigation, enforcement and compliance are inherently uncertain and we may experience significant costs in connection with environmental matters. For more information, see Part I, Item 1, "Business—Product Liability, Environmental, and Other Litigation Matters."business,
financial conditionintellectual property and we may expend significant resources enforcing our rights or results of operations.
Third Parties May Infringe Our Intellectual Property, And We May Expend
Significant Resources Enforcing Our Rights Or Suffer Competitive Injury
Our success depends in part on our proprietary technology.suffer competitive injury.may be required to spend significant resources to monitor and police our
intellectual property rights.
If We Cannot Continue Operating Our Manufacturing Facilities At Current Or
Higher Levels, Our Results Of Operations Could Be Adversely Affected
We operate a number of manufacturing facilities for the production of our
products. The equipment and management systems necessary for such operations may
break down, perform poorly or fail, resulting in fluctuations in manufacturing
efficiencies. Such fluctuations may affect our ability to deliverhave been limited from selling products to
our customers on a timely basis which could have a material adverse effect on
our business, financial condition or results of operations.
To The Extent We Are Not Successful In Implementing Our Manufacturing
Restructuring Plan, It Could Have An Adverse Effect On Our Results Of Operations
And Financial Condition
We are reducing the number of manufacturing plants in the United States
and Europe. We are also expanding our production capability in China. We believe
this will reduce our product cost. If these plant consolidations and China
expansion plants are not successful, it could have a material adverse effect on
our results of operations and financial condition.
If We Experience Delays In Introducing New Products Or If Our Existing Or New
Products Do Not Achieve Or Maintain Market Acceptance, Our Revenues May Decrease
Our industry is characterized by:
o intense competition
o changes in end-user requirements
o technically complex products
o evolving product offerings and introductions
We believe our future success will depend, in part, on our ability to
anticipate or adapt to these factors and to offer, on a timely basis, products
that meet customer demands. Failure to develop new and innovative products or to
custom design existing products could result in the lossfrom time-to-time because of existing customers
to competitors or the inability to attract new business, either ofpatents.revenues.
Implementation Of Our Acquisition Strategy May Not Be Successful, Which Could
Affect Our Ability To Increase Our Revenues Or Reduce Our Profitability
One of our strategies is to increase our revenues and expand our markets
through acquisitions that will provide us with complementary water related
products. We expect to spend significant time and effort in expanding our
existing businesses and identifying, completing and integrating acquisitions. We
expect to face competition for acquisition candidates, which may limit the
number of acquisition opportunities available to us and may result in higher
acquisition
21
prices. We cannot be certain that we will be able to identify, acquire or
profitably manage additional companies or successfully integrate such additional
companies without substantial costs, delays or other problems. Also, there can
be no assurance that companies acquired in the future will achieve revenues,
profitability or cash flows that justify our investment in them. In addition,
acquisitions may involve a number of special risks, including:
o adverse short-term effects on our reported operating results
o diversion of management's attention
o loss of key personnel at acquired companies
o unanticipated management or operational problems or legal
liabilities
Some or all of the above special risks could have a material adverse
effect on our business, financial condition or results of operations.
If We Fail To Manufacture And Deliver High Quality Products, We May Lose
Customers
Product quality and performance are a priority for our customers. Our
products are used in control of temperature and pressure of water as well as
water quality and safety. These applications require products that meet
stringent performance and safety standards. If we fail to maintain and enforce
quality control and testing procedures, our products will not meet these
stringent performance and safety standards. Substandard products would seriously
harm our reputation resulting in both a loss of current customers to our
competitors and damage to our ability to attract new customers, which could have
a material adverse effect on our business, financial condition or results of
operations.
We Face Risks From Product Liability And Other Lawsuits, Which May Adversely
Affect Our Business
We, like other manufacturers and distributors of products designed to
control and regulate water, face an inherent risk of exposure to product
liability claims in the event that the use of our products results in personal
injury, property damage or business interruption to our customers.business.Of Our Shareholders Can Exercise Substantial Influence Over Our Companyof our stockholders can exercise substantial influence over our company.15, 2002,1, 2004, Timothy P. Horne, a member of our Chairman and Chief
Executiveboard of directors, beneficially owned 33.7%approximately 23.8% of our outstanding shares of Class A Common Stock (assuming conversion of all shares of Class B Common Stock beneficially owned by Mr. Horne into Class A Common Stock) and approximately 96.8% of our outstanding shares of Class B Common Stock, which represents 79.8%approximately 73.2% of the total outstanding voting power. As long as Mr. Horne controls shares representing at least a majority of the total voting power of the Company'sour outstanding stock, Mr. Horne will be able to unilaterally determine the outcome of all stockholder votes and other stockholders will not be able to affect the outcome of any stockholder vote.Mr. Horne werewe are eligible to selluse Form S-3 or a significant amountsimilar short-form registration statement, the holders of common stockClass B Common Stock may require that we register their shares for public resale up to two times per year. If we elect to register any shares of Class A Common Stock for any public offering, the holders of Class B Common Stock are entitled to include shares of Class A Common Stock into which such shares of Class B Common Stock may be converted in such registration. However, we may reduce the number of shares proposed to be registered in view of market conditions. We will pay all expenses in connection with any registration, other than underwriting discounts and commissions. Pursuant to the exercise of these registration rights, we have registered the resale of 1,200,000 shares of our Class A Common Stock on a Form S-3 shelf registration statement, of which 610,000 shares remained available for resale as of February 29, 2004. If all of the available registered shares are sold into the public market the trading price of our Class A Common Stock could decline.decline. See Part
III, Item 12, "Security Ownershipdecline or fluctuate in response to a variety of Certain Beneficial Owners and Management".
The foregoing list sets forth many,factors, including, but not all,limited to, our failure to meet the performance estimates of securities analysts, changes in financial estimates of our revenues and operating results and/or buy/sell recommendations by securities analysts, the factorstiming of announcements by us or our competitors concerning significant product line developments, contracts or acquisitions or publicity regarding actual or potential results or performance, fluctuation in our quarterly operating results caused by fluctuations in revenues and expenses, substantial sales of our Class A Common Stock by our existing shareholders, general stock market conditions and other economic or external factors.impact uponmake it more difficult for a third party to acquire us without the consent of our board of directors. These provisions include those that:achieve results described incall special meetings; andforward-looking
statements. Investors are cautioned not to place undue reliance on such
statements that speak only asholder of the date made. Investors also should understand
that it is not possible to predict15% or identify all such factors and that this
list should not be considered a complete statementmore of all potential risks and
uncertainties. Investors should also realize that if underlying assumptions
prove inaccurate or unknown risks or uncertainties materialize, actual results
could vary materially from our projections. We do not undertake any obligation
to update any forward-looking statements as a result of future events or
developments.
22
- ------------------------
During 2000, the Financial Accounting Standards Board's Emerging Issues
Task Force (EITF) added to its agenda various revenue recognition issues that
could impact the income statement classification of certain promotional
payments.May 2000, the EITF reached a consensus on Issue 00-14, "Accounting
for Certain Sales Incentives". EITF 00-14 addresses the recognition and income
statement classification of various sales incentives. Among its requirements,
the consensus will require the costs related to consumer coupons currently
classified as marketing costs to be classified as a reduction of revenue. The
impact of adopting this consensus is not expected to have a material impact on
our results of operations. The Company expects to implement the consensus in the
first quarter of 2002.
In April 2001, the EITF reached a consensus on Issue 00-25, "Vendor Income
Statement Characterization of Consideration to a Purchaser of the Vendor's
Products or Services". EITF 00-25 addresses the income statement classification
of consideration, other than that directly addressed in Issue 00-14, from a
vendor to a reseller, or another party that purchases the vendor's products.
Among its requirements, the consensus will require certain of our customer
promotional incentives currently classified as marketing costs to be classified
as a reduction of revenue. The consensus is effective for fiscal 2002. The
Company expects to implement the consensus in the first quarter of 2002.
In JulyAugust 2001, the Financial Accounting Standards Board ("FASB") issued
Financial Accounting Standards Board Statement No. 141, "Business Combinations"
("FAS 141") and Financial Accounting Standards Board Statement No. 142,
"Goodwill and Other Intangible Assets" ("FAS 142"). FAS 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. FAS 141 also specifies the criteria that intangible assets
acquired in a purchase method business combination must meet to be recognized
and reported apart from goodwill. FAS 142 requires that goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead be
tested for impairment, at least annually, in accordance with the provisions of
FAS 142. FAS 142 will also require that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with
Financial Accounting Standards Board Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of".
The provisions of FAS 141 were effective immediately, except with regard
to business combinations initiated prior to July 1, 2001. FAS 142 will be
effective as of January 1, 2002. Goodwill and other intangible assets determined
to have an indefinite useful life that are acquired in a purchase business
combination completed after June 30, 2001 will not be amortized, but will
continue to be evaluated for impairment in accordance with appropriate pre-FAS
142 accounting literature. Goodwill and other intangible assets acquired in
business combinations completed before July 1, 2001, will continue to be
amortized prior to the adoption of FAS 142. The Company is currently evaluating
the effect that the adoption of FAS 141 and FAS 142 will have on its results of
operations and its financial position.
In August 2001, the FASB(FASB) issued Financial Accounting Standards Board Statement No. 143, "Accounting for Asset Retirement Obligations" ("FAS 143")(FAS 143) which requires companies to record the fair value of an asset retirement obligation as a liability in the period it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and and/or normal use of the assets. The company must also record a corresponding increase in the carrying value of the related long-lived asset and depreciate that cost over the remaining useful life of the asset. The liability must be increased each period for the passage of time with the offset recorded as an operating expense. The liability must also be adjusted for changes in the estimated future cash flows underlying the initial fair value measurement. Companies must also recognize a gain or loss on the settlement of the liability. The provisions of FAS 143 are effective for fiscal years beginning after June 15, 2002. At the date of the adoption of FAS 143, companies are required to recognize a liability for all existing asset retirement obligations and the associated asset retirement costs. The Company is
currently evaluating the effect that the adoption ofWe have adopted FAS 143 will have on its
results of operationseffective January 1, 2003 and its adoption was not material to our consolidated financial position.
23
August 2001,July 2002, the FASB issued Financial Accounting Standards Board Statement No. 144,146, "Accounting for the ImpairmentCosts Associated with Exit or Disposal Activities" (FAS 146). The principal difference between this Statement and Emerging Issues Task Force (EITF) Issue No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit on Activity (including Certain Costs Incurred in a Restructuring)" (Issue 94-3) relates to its requirements for recognition of Long-Lived
Assets" ("FAS 144") which addresses the accounting and reportinga liability for the
impairmenta cost associated with an exit or disposal activity. This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issuelong-lived assets.an entity's commitment to an exit plan. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. We adopted FAS 144 supercedes146 effective January 1, 2003 and its adoption was not material to our consolidated financial statements.121,148, "Accounting for Stock-Based Compensation, Transition and Disclosure" (FAS 148). FAS 148 provides alternative methods of transition for a voluntary change to the Impairmentfair value based method of Long-Lived Assets andaccounting for Long-Lived Assets to be Disposed Of" ("stock-based employee compensation. FAS 121") but
retains many148 also requires that disclosures of the fundamental provisionspro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, FAS 148 requires disclosure of the pro forma effect in interim financial statements. The additional disclosure requirements of FAS 121. FAS 144 also supercedes
the accounting and reporting provisions of148 were effective for fiscal years ended after December 15, 2002. We are currently continuing to account for stock-based compensation in accordance with Accounting Principles Board Opinion No. 30, "Reporting25 "Accounting for Stock Issued to Employees" (APB No. 25) and we provided the Results of Operations - Reportingdisclosures required by FAS 148.Effects of Disposal
ofEITF issued EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." This consensus provides guidance in determining when a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" ("APB 30") for the disposal of a segment of a
business. However, FAS 144 retains the requirements of APB 30 to report
discontinued operations separately and extends that reporting requirement to
components of an entity that has either been disposed of or is classified as
held for sale. FAS 144 excludes goodwill and other intangibles that are not
amortized from its scope. For assets to be held and used, FAS 144 addresses how
cash flowsrevenue arrangement with multiple deliverables should be estimated to testdivided into separate units of accounting, and, if separation is appropriate, how the recoverability of an asset or group
of assets, clarifies how an impairment lossarrangement consideration should be allocated and creates a
requirement to use an expected present value technique to estimate fair value if
market prices are not available and uncertainties exist about the timing and
amount of future cash flows. For long-lived assets to be disposed of by sale,
FAS 144 establishes the criteria to be met to qualify for this classification,
defines the timing of when the related sale must be consummated, eliminates the
net realizable value measurement approach for segments of a business and certain
acquired assets in a business combination, and defines costs to sell the asset.identified accounting units. The provisions of FAS 144EITF 00-21 are effective for revenue arrangements entered during fiscal yearsperiods beginning after June 15, 2003. We adopted EITF 00-21 effective July 1, 2003 and its adoption was not material to our consolidated financial statements.20012003. In December 2003, the FASB issued a revision to FIN 46 (FIN 46R). Under the revised provisions, public entities are required to apply the guidance if the entity has interests in VIEs commonly referred to as special-purpose entities for periods ending after December 15, 2003. We adopted FIN 46R and as a result have consolidated Jameco International, LLC (the LLC) effective October 1, 2003 (the fourth quarter of fiscal 2003). The LLC imports and sells vitreous china, imported faucets and faucet parts and imported bathroom accessories to the North American home improvement retail market. Its annual sales for the twelve months ended December 31, 2003, were approximately $16,079,000. The LLC maintains a line of credit with a financial institution collateralized by a firstgenerallycomprised primarily of accounts receivable and inventory which we believe are collectable and saleable, respectively, within the normal course of business. We have a subordinated security interest in the assets of the LLC pertaining to be applied prospectively. The Company is
currently evaluatingour loan receivable of $2,230,680 at December 31, 2003, which eliminates in consolidation as the effect thatresult of the application of FIN 46R. Prior to the adoption of FIN 46R, we accounted for our investment of 49% in the LLC using the equity method.144 will have149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under FAS 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133). FAS 149 has multiple effective date provisions depending on its
resultsthe nature of operationsthe amendments to FAS 133, including one for contracts entered into or modified after June 30, 2003. We adopted FAS 149 and its adoption was not material to our consolidated financial position.
statements.
-----------------------------------------------------------
The Company usespricescosts of certain raw materials used in the manufacturing process. The Company
doesWe 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 the Company useswe use are instruments with liquid markets.
The Company'sremnimbi.
The Company'sRMB.The Company usesWe use foreign currency forward exchange contracts to manage the risk related to intercompany purchases that occur during the course of a fiscal year and certain open foreign currency denominated commitments to sell products to third parties.2001,
the Company2003, we had no forward contracts to buy foreign currencies and no unrealized gains or losses. See Note 16 of the Notes to the Consolidated Financial
Statements.
The Company hasthe Company'sour long-term debt including principal amounts and related interest rates appears in Note 11 of the Notes to the Consolidated Financial Statements included herein.
The Company purchasesand
cast iron, steel and plastic, which are utilized in manufacturing itsour many product lines. The
Company'sOur operating results can be adversely affected by changes in commodity prices if it iswe are unable to pass on related price increases to itsour customers. The
Company managesWe manage this risk by monitoring related market prices, working with itsour 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 itsour customers, to the maximum extent possible, when they occur. Additionally, on a limited basis, the Company useswe use commodity futures contracts to manage this risk. See Note 16 of the Notes to the Consolidated
Financial Statements.
24
--------------------------------------------2745 of this Report.-----------------------------------------------------------
AND FINANCIAL DISCLOSURE.
-------------------------
25
---------------------------------------------------
- ---------April 23, 2002May 5, 2004 is incorporated herein by reference. With respect to Directors and Executive Officers, the information appearing under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Registrant's Proxy Statement relating to the Annual Meeting of Stockholders to be held on April 23, 2002May 5, 2004 is incorporated herein by reference.
- ------------------Officers".
Officers and Directors."
-----------------------April 23, 2002May 5, 2004 is incorporated herein by reference.
--------------------------------------------------------------- and Management Stockholders" in the Registrant's Proxy Statement relating to the Annual Meeting of Stockholders to be held on April 23, 2002May 5, 2004 is incorporated herein by reference.
-----------------------------------------------April 23, 2002May 5, 2004 is incorporated herein by reference.
26
PART IV
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----------------------------------------------------------------
- ---------------------------
Report of Independent Auditors 31
Consolidated Statements of Operations for the twelve months
ended December 31, 2001, 2000 and 1999 (unaudited),
six months ended December 31, 1999 and 1998
(unaudited) and the twelve months ended June 30, 1999 32
Consolidated Balance Sheets as of December 31, 2001 and 2000 33
Consolidated Statements of Stockholders' Equity for the
twelve months ended December 31, 2001, 2000, the six
months ended December 31, 1999 and the twelve months
ended June 30, 1999 34-35
Consolidated Statements of Cash Flows for the twelve months
ended December 31, 2001, 2000 and 1999 (unaudited),
six months ended December 31, 1999, and the twelve
months ended June 30, 1999. 36
Notes to Consolidated Financial Statements 37-56Report of Independent Auditors 50
Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001
51
Consolidated Balance Sheets as of December 31, 2003 and 2002
52
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2003, 2002 and 2001
53
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001
54
Notes to Consolidated Financial Statements
55-83Schedule II—Valuation and Qualifying Accounts for the years ended December 31, 2003, 2002 and 2001 84
- ---------------
Exhibits 10.1-10.6, 10.8, 10.16, and 10.23 constitute all of the
management contracts and compensation plans and arrangements of the Company
required to be filed as exhibits to this Annual Report. Upon written request of
any stockholderExhibit No. Description
2.1
Distribution Agreement dated as of October 1, 1999 between the Registrant and CIRCOR International, Inc. (17)
3.1
Restated Certificate of Incorporation, as amended (1)
3.2
Amended and Restated By-Laws, as amended (1)
9.1
The Amended and Restated George B. Horne Voting Trust Agreement—1997 dated as of September 14, 1999 (18)
10.1*
Supplemental Compensation Agreement effective as of September 1, 1996 between the Registrant and Timothy P. Horne (11), Amendment No. 1, dated July 25, 2000 (19), and Amendment No. 2 dated October 23, 2002 (3)
10.2*
Deferred Compensation Agreement between the Registrant and Timothy P. Horne, as amended (4)
10.3*
Form of Indemnification Agreement between the Registrant and certain directors and officers of the Registrant dated February 10, 2004
10.4*
1996 Stock Option Plan, dated October 15, 1996 (12), and First Amendment dated February 28, 2003 (3)
10.5*
1986 Incentive Stock Option Plan, as amended
10.6*
Watts Industries, Inc. Retirement Plan for Salaried Employees dated December 30, 1994, as amended and restated effective as of January 1, 1994 (9), Amendment No. 1 (11), Amendment No. 2 (11), Amendment No. 3 (11), Amendment No. 4 dated September 4, 1996 (15), Amendment No. 5 dated January 1, 1998 (18), Amendment No. 6 dated May 3, 1999 (18), and Amendment No. 7 dated June 7, 1999 (18)
10.7*
Watts Industries, Inc. Pension Plan (amended and restated effective as of January 1, 1997) (3) and First Amendment dated October 25, 2002 (3)
10.8
Registration Rights Agreement dated July 25, 1986 (5)
10.9*
Executive Incentive Bonus Plan, as amended (9)
10.10
Amended and Restated Stock Restriction Agreement dated October 30, 1991 (2), and Amendment dated August 26, 1997 (15)
10.11*
Watts Industries, Inc. 1991 Non-Employee Directors' Nonqualified Stock Option Plan (6), and Amendment No. 1 (11)
10.12*
Watts Industries, Inc. 2003 Non-Employee Directors' Stock Option Plan (3)
10.13
Letter of Credit issued by Fleet National Bank (as successor to BankBoston, N.A.) for the benefit of Zurich-American Insurance Company dated June 25, 1999, as amended January 22, 2001
10.14
Form of Stock Restriction Agreement for management stockholders (5)
10.15
Letter of Credit issued by Fleet National Bank for the benefit of ACE Property and Casualty Insurance Company and Pacific Employers' Insurance Company dated January 23, 2002, as amended February 6, 2003
10.16
Revolving Credit Agreement dated as of February 28, 2002 among the Registrant, Watts Regulator Co., Watts Industries Europe B.V., the lenders listed therein and Fleet National Bank, as Administrative Agent (20), First Amendment dated March 28, 2003 (7), Second Amendment dated July 25, 2003 (8), and Third Amendment dated December 16, 2003
10.17*
Watts Industries, Inc. Management Stock Purchase Plan dated October 17, 1995 (10), Amendment No. 1 dated August 5, 1997 (15), Amendment No 2 dated November 1, 1999 (14), Amendment No. 3 dated March 1, 2001 (3)
10.18
Stock Purchase Agreement dated as of June 19, 1996 by and among Mueller Co., Tyco Valves Limited, Watts Investment Company, Tyco International Ltd. and the Registrant (13)
10.19
Guaranty dated as of February 28, 2002 among the Registrant, Watts Investment Company, Watts Spacemaker, Inc., Watts Distribution Company, Inc., Anderson-Barrows Metals Corporation, Watts Drainage Products, Inc., Webster Valve, Inc. and Jameco Industries, Inc. in favor of Fleet National Bank and the lenders under the Revolving Credit Agreement dated February 28, 2002 (20), and Ratification of Guaranty dated as of February 28, 2002 (7)
10.20
Form of Promissory Note dated as of May 9, 2002 issued by Watts Regulator Company and the Registrant as borrowers, to the former shareholders of Hunter Innovations, Inc. (21)
10.21
Note Purchase Agreement dated as of May 15, 2003 between the Registrant and the Purchasers named in Schedule A thereto relating to the Registrant's $50,000,000 4.87% Senior Notes, Series A, due May 15, 2010 and $75,000,000 5.47% Senior Notes, Series B, due May 15, 2013 (7)
10.22
Form of 4.87% Senior Note due May 15, 2010 (7)
10.23
Form of 5.47% Senior Note due May 15, 2013 (7)
10.24*
Watts Water Technologies, Inc. 2004 Stock Incentive Plan
11
Statement Regarding Computation of Earnings per Common Share (16)
21
Subsidiaries
23
Consent of KPMG LLP
31.1
Certification of Principal Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
31.2
Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
32.1
Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350
32.2
Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350Chief Financial Officer atRegistrant's Registration Statement on Form S-3 (No. 333-105989) filed with the Company's principal
executive office,Securities and Exchange Commission on June 10, 2003. Company will provide any of the Exhibits listed below.
27
Exhibit No. Description and Location
- -------------------------------------------
2.1 Distribution Agreement between Watts Industries, Inc. and CIRCOR
International, Inc. (20)
3.1 Restated Certificate of Incorporation, as amended. (12)
3.2 Amended and Restated By-Laws, as amended May 11, 1999. (1)
9.1 Horne Family Voting Trust Agreement-1991 dated as of October 31,
1991 (2), Amendments dated November 19, 1996 (18), February 24, 1997
(18), June 5, 1997 (18), August 26, 1997 (18), and October 17, 1997
(21), and an extension Amendment dated October 25, 2001.*
9.2 The Amended and Restated George B. Horne Voting Trust Agreement-1997
dated as of September 14, 1999. (22)
10.1 Employment Agreement effective as of September 1, 1996 between the
Registrant and Timothy P. Horne. (14)
10.2 Supplemental Compensation Agreement effective as of September 1,
1996 between the Registrant and Timothy P. Horne. (14), Amendment
No. 1, dated July 25, 2000 (23)
10.3 Deferred Compensation Agreement between the Registrant and Timothy
P. Horne, as amended. (4)
10.4 1996 Stock Option Plan, dated October 15, 1996. (15)
10.5 1989 Nonqualified Stock Option Plan. (3)
10.6 Watts Industries, Inc. Retirement Plan for Salaried Employees dated
December 30, 1994, as amended and restated effective as of January
1, 1994, (12), Amendment No. 1 (14), Amendment No. 2 (14), Amendment
No. 3 (14), Amendment No. 4 dated September 4, 1996. (18), Amendment
No. 5 dated January 1, 1998, Amendment No. 6 dated May 3, 1999 (22),
and Amendment No. 7 dated June 7, 1999. (22)
10.7 Registration Rights Agreement dated July 25, 1986. (5)
10.8 Executive Incentive Bonus Plan, as amended. (12)
10.9 Indenture dated as of December 1, 1991 between the Registrant and
The First National Bank of Boston, as Trustee, including form of
8-3/8% Note Due 2003. (8)
10.10 Loan Agreement and Mortgage among The Industrial Development
Authority of the State of New Hampshire, Watts Regulator Co. and
Arlington Trust Company dated August 1, 1985. (4)
10.11 Amendment Agreement relating to Watts Regulator Co. (Canaan and
Franklin, New Hampshire, facilities) financing dated December 31,
1985. (4)
10.12 Loan Agreement between The Rutherford County Industrial Facilities
and Pollution Control Financing Authority and Watts Regulator
Company dated September 1, 1994. (12)
10.13 Letter of Credit, Reimbursement and Guaranty Agreement dated
September 1, 1994 by and among the Registrant, Watts Regulator
Company and The First Union National Bank of North Carolina (12),
Amendment No. 1 (14), Amendment No. 2 dated October 1, 1996 (18),
and Amendment No. 3 dated October 18, 1999 (11).
10.14 Trust Indenture from The Rutherford County Industrial Facilities and
Pollution Control Financing Authority to The First National Bank of
Boston, as Trustee, dated September 1, 1994. (12)
10.15 Amended and Restated Stock Restriction Agreement dated October 30,
1991 (2), Amendment dated August 26, 1997. (18)
10.16 Watts Industries, Inc. 1991 Non-Employee Directors' Nonqualified
Stock Option Plan (7), Amendment No. 1. (14)
10.17 Letters of Credit relating to retrospective paid loss insurance
programs. (10)
10.18 Form of Stock Restriction Agreement for management stockholders. (5)
10.20 Loan Agreement dated September 1987 with, and related Mortgage to,
N.V. Sallandsche Bank. (6)
10.21 Agreement of the sale of shares of Intermes, S.p.A., RIAF Holding
A.G. and the participations in Multiscope Due S.R.L. dated November
6, 1992. (9)
10.22 Amended and Restated Revolving Credit Agreement dated March 27, 1998
between and among Watts Investment Company, certain financial
institutions, BankBoston N.A., as Administrative Agent, and the
Registrant, as Guarantor (17), and First Amendment to Amended and
Restated Revolving Credit Agreement dated October 18, 1999 (11).
10.23 Watts Industries, Inc. Management Stock Purchase Plan dated October
17, 1995 (13), Amendment No. 1 dated August 5, 1997. (18), Amendment
No 2, dated November 1, 1999
10.24 Stock Purchase Agreement dated as of June 19, 1996 by and among
Mueller Co., Tyco Valves Limited, Watts Investment Company, Tyco
International Ltd. and Watts Industries, Inc. (16)
11 Statement Regarding Computation of Earnings per Common Share. (19)
21 Subsidiaries. *
23 Consent of KPMG LLP. *
28
Incorporated By Reference To:
- -----------------------------
(1) Relevant exhibit to Registrant's Form 10-Q for quarter ended March 31,
1999.
(2) Relevant exhibit to Registrant's Form 8-K dated November 14, 1991. Relevant exhibitJune 30,
1989.
December 31, 2002. Relevant exhibit Relevant exhibit Relevant exhibit Registrant's Form S-1 (No. 33-27101) dated February
16, 1989.
(7) Relevant exhibit to Registrant's Amendment No. 1 to the Registrant's Annual Report on Form 10-K for year ended June 30, 1992.
(8) Relevant exhibit1992.
(9) Relevant exhibit1995.Registrant's Amendment No. 2 dated February 22, 1993
to Form 8-K dated November 6, 1992.
(10) Relevant exhibit to Registrant's Form 10-K for year ended June 30, 1993.
(11) Relevant exhibit to Registrant's Form 10-Q for quarter ended September 30,
1999.
(12) Relevant exhibit to Registrant's Form 10-K for year ended June 30, 1995.
(13) Relevant exhibit tothe Registrant's Form S-8 (No. 33-64627) dated November 29, 1995.
(14) Relevant exhibit
(15) Relevant exhibit
(16) Relevant exhibit
(17) Relevant exhibit10-Q10-K for quarteryear ended MarchDecember 31, 1998.
(18) Relevant exhibit2000.
(19) Notes
(20) Exhibit
(21) Relevant exhibit1998.
(22) Relevant exhibit1999.Form 10-K for year ended June 30, 1999.
(23) Relevant exhibit to Registrant'sQuarterly Report on Form 10-Q for quarter ended September 30, 2000.
* Filed as an exhibitthisthe Registrant's Quarterly Report withon Form 10-Q for the Securities and Exchange
Commission
quarter ended March 31, 2002.
- -------------------------
There were no reports filedforwere filed by the Registrant during the quarter endingended December 31, 2001.
29
WATTS INDUSTRIES, INC.
By: /s/ Timothy P. Horne
----------------------
Timothy P. Horne
Chairman of the Board,
Chief Executive Officer and President
DATED: March 14, 2002WATTS WATER TECHNOLOGIES, INC.
By:
/s/ PATRICK S. O'KEEFE
Patrick S. O'Keefe
Chief Executive Officer
President and Director
DATED: March 12, 2004Signature Title Date
--------- ----- ----
/s/ Timothy P. Horne /s/ PATRICK S. O'KEEFE
Patrick S. O'KeefeChief Executive Officer
President and DirectorMarch 12, 2004
/s/ WILLIAM C. MCCARTNEY
William C. McCartney
Chief Financial Officer and Treasurer
(Principal Financial and Accounting
Officer), Secretary
March 12, 2004
/s/ GORDON W. MORAN
Gordon W. Moran
Chairman of the Board
March 14, 2002
- --------------------- Chief Executive Officer,
12, 2004
/s/ TIMOTHY P. HORNE
Timothy P. Horne President (Principal Executive Officer)
and
Director
/s/ William C. McCartney Chief Financial Officer
March 14, 2002
- ------------------------- and Treasurer (Principal
William C. McCartney Financial and Accounting Officer),
Secretary
/s/ 12, 2004
/s/ KENNETH J. MCAVOY
Kenneth J. McAvoy
Director
March 14, 2002
- ----------------------
Kenneth12, 2004
/s/ DANIEL J. McAvoy
/s/ Gordon W. Moran Director March 14, 2002
- --------------------
Gordon W. Moran
/s/ MURPHY, III
Daniel J. Murphy, III
Director
March 14, 2002
- --------------------------
Daniel J. Murphy, III
/s/ 12, 2004
/s/ ROGER A. YOUNG
Roger A. Young
Director
March 14, 2002
- -------------------
Roger A. Young
12, 2004
/s/ JOHN K. MCGILLICUDDY
John K. McGillicuddy
Director
March 12, 2004
30
Watts Industries,Water Technologies, Inc.:Industries,Water Technologies, Inc. and subsidiaries as of December 31, 20012003 and 2000,2002, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years ended December 31, 2001 and 2000,in the six monththree-year period ended December 31, 1999 and2003. In connection with our audits of the fiscal year ended June 30, 1999.consolidated financial statements, we have also audited the financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.Industries,Water Technologies, Inc. and subsidiaries as of December 31, 20012003 and 2000,2002, and the results of their operations and their cash flows for each of the years ended December 31, 2001 and 2000,in the six monththree-year period ended December 31, 1999, and the fiscal year ended June 30,
19992003, in conformity with accounting principles generally accepted in the United States of America. /s/ KPMG LLP
Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
February 5, 2002
31
except as to the first
paragraph of Note 19,
which is as of
February 20, 2004.Industries,Water Technologies, Inc. and Subsidiaries
(Amounts
For the
-------For the Twelve Months Ended------- Six Months Ended
December 31, June 30, December 31,
2001 2000 1999 1999 1999 1998
-------- -------- -------- -------- -------- --------
(unaudited) (unaudited)
Net sales ..................................... $548,940 $516,100 $509,656 $477,869 $261,019 $229,150
Cost of goods sold ............................ 365,408 330,796 322,938 302,745 165,853 145,660
-------- -------- -------- -------- -------- --------
GROSS PROFIT ............................. 183,532 185,304 186,718 175,124 95,166 83,490
Selling, general and administrative expenses .. 131,795 125,317 128,983 123,286 64,148 58,369
Restructuring and other charges ............... 1,454 -- 1,460 -- 1,460 --
-------- -------- -------- -------- -------- --------
OPERATING INCOME ......................... 50,283 59,987 56,275 51,838 29,558 25,121
-------- -------- -------- -------- -------- --------
Other (income) expense:
Interest income .......................... (685) (827) (841) (923) (331) (413)
Interest expense ......................... 9,422 9,897 7,933 6,150 4,456 2,673
Other .................................... 1,378 1,705 1,276 1,688 22 434
-------- -------- -------- -------- -------- --------
10,115 10,775 8,368 6,915 4,147 2,694
-------- -------- -------- -------- -------- --------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES ...................... 40,168 49,212 47,907 44,923 25,411 22,427
Provision for income taxes .................... 13,612 18,041 17,210 15,469 8,943 7,202
-------- -------- -------- -------- -------- --------
INCOME FROM CONTINUING
OPERATIONS ............................... 26,556 31,171 30,697 29,454 16,468 15,225
Income (loss) from discontinued
operations, net of taxes ................. -- (7,170) (3,143) 6,502 (1,226) 8,419
-------- -------- -------- -------- -------- --------
NET INCOME ............................... $ 26,556 $ 24,001 $ 27,554 $ 35,956 $ 15,242 $ 23,644
======== ======== ======== ======== ======== ========
Basic EPS
Income (loss) per share:
Continuing operations .................... $ 1.00 $ 1.18 $ 1.16 $ 1.10 $ 0.62 $ 0.57
Discontinued operations .................. -- (0.27) (0.12) 0.24 (0.05) 0.31
-------- -------- -------- -------- -------- --------
NET INCOME ............................... $ 1.00 $ 0.91 $ 1.04 $ 1.34 $ 0.57 $ 0.88
======== ======== ======== ======== ======== ========
Weighted average number of shares ............. 26,497 26,409 26,498 26,736 26,453 26,935
======== ======== ======== ======== ======== ========
Diluted EPS
Income (loss) per share:
Continuing operations .................... $ 0.99 $ 1.17 $ 1.15 $ 1.10 $ 0.61 $ 0.56
Discontinued operations .................. -- (0.27) (0.12) 0.24 (0.05) 0.31
-------- -------- -------- -------- -------- --------
NET INCOME ............................... $ 0.99 $ 0.90 $ 1.03 $ 1.34 $ 0.56 $ 0.87
======== ======== ======== ======== ======== ========
Weighted average number of shares ............. 26,802 26,551 26,684 26,799 27,081 27,062
======== ======== ======== ======== ======== ========
Dividends per share ...................... $ 0.240 $ 0.268 $ 0.350 $ 0.350 $ 0.175 $ 0.175
======== ======== ======== ======== ======== ========
Years Ended December 31, 2003 2002 2001 Net sales $ 705,651 $ 615,526 $ 548,940 Cost of goods sold 464,990 406,806 365,408 GROSS PROFIT 240,661 208,720 183,532 Selling, general and administrative expenses 170,195 150,553 131,795 Restructuring and other charges 426 638 1,454 OPERATING INCOME 70,040 57,529 50,283 Other (income) expense: Interest income (1,021 ) (992 ) (685 ) Interest expense 12,114 8,692 9,422 Minority interest (463 ) (117 ) 198 Other 581 (272 ) 1,180 11,211 7,311 10,115 INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 58,829 50,218 40,168 Provision for income taxes 22,356 17,596 13,612 INCOME FROM CONTINUING OPERATIONS 36,473 32,622 26,556 Loss from discontinued operations, net of taxes of $1,947 (3,111 ) — — NET INCOME $ 33,362 $ 32,622 $ 26,556
Basic EPS
Income (loss) per share: Continuing operations $ 1.33 $ 1.22 $ 1.00 Discontinued operations (0.11 ) — — NET INCOME $ 1.22 $ 1.22 $ 1.00 Weighted average number of shares 27,455 26,718 26,497
Diluted EPS
Income (loss) per share: Continuing operations $ 1.32 $ 1.21 $ 0.99 Discontinued operations (0.11 ) — — NET INCOME $ 1.21 $ 1.21 $ 0.99 Weighted average number of shares 27,692 27,056 26,802
Dividends per share
$
0.25
$
0.24
$
0.24
32
Industries,Water Technologies, Inc. and Subsidiaries
Consolidated Balance Sheets
(Amounts
(Amounts in thousands, except share information)
December 31,
2001 2000
-------- --------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ........................................ $ 11,997 $ 15,235
Trade accounts receivable, less allowance for doubtful accounts
of $6,070 in 2001 and $6,614 in 2000 ......................... 95,498 97,718
Inventories ...................................................... 115,864 108,951
Prepaid expenses and other assets ................................ 7,436 6,850
Deferred income taxes ............................................ 25,329 20,486
-------- --------
Total Current Assets ......................................... 256,124 249,240
PROPERTY, PLANT AND EQUIPMENT, NET ......................................... 128,606 125,810
OTHER ASSETS:
Goodwill, net of accumulated amortization
of $17,885 in 2001 and $14,665 in 2000 ....................... 124,544 98,179
Other ............................................................ 11,196 8,796
-------- --------
TOTAL ASSETS ............................................................... $520,470 $482,025
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ................................................. $ 42,873 $ 39,569
Accrued expenses and other liabilities ........................... 55,930 59,088
Accrued compensation and benefits ................................ 11,033 12,200
Current portion of long-term debt ................................ 3,693 1,241
-------- --------
Total Current Liabilities .................................... 113,529 112,098
LONG-TERM DEBT, NET OF CURRENT PORTION ..................................... 123,212 105,377
DEFERRED INCOME TAXES ...................................................... 15,692 15,463
OTHER NONCURRENT LIABILITIES ............................................... 11,414 9,770
MINORITY INTEREST .......................................................... 7,309 6,775
STOCKHOLDERS' EQUITY:
Preferred Stock, $.10 par value; 5,000,000 shares
authorized; no shares issued or outstanding .................. -- --
Class A Common Stock, $.10 par value; 80,000,000 shares
authorized; 1 vote per share; issued and outstanding,
17,776,509 shares in 2001 and 17,225,965 shares in 2000 ...... 1,778 1,723
Class B Common Stock, $.10 par value; 25,000,000 shares
authorized; 10 votes per share; issued and outstanding,
8,735,224 shares in 2001 and 9,235,224 shares in 2000 ........ 874 924
Additional paid-in capital ....................................... 37,182 35,996
Retained earnings ................................................ 233,761 213,627
Accumulated Other Comprehensive Income ........................... (24,281) (19,728)
-------- --------
Total Stockholders' Equity ................................... 249,314 232,542
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................. $520,470 $482,025
======== ========
December 31, 2003 2002 ASSETS CURRENT ASSETS: Cash and cash equivalents $ 149,361 $ 10,973 Trade accounts receivable, less allowance for doubtful accounts of $7,772 in 2003 and $7,322 in 2002 136,064 123,504 Inventories, net 156,599 133,415 Prepaid expenses and other assets 8,500 8,818 Deferred income taxes 23,552 21,927 Assets held for sale 1,938 2,464 Assets of discontinued operations 4,460 8,655 Total Current Assets 480,474 309,756
PROPERTY, PLANT AND EQUIPMENT, NET
145,711
134,376
OTHER ASSETS:
Goodwill 184,901 163,226 Other 27,557 28,114 TOTAL ASSETS $ 838,643 $ 635,472
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES: Accounts payable $ 74,068 $ 64,704 Accrued expenses and other liabilities 55,252 57,037 Accrued compensation and benefits 18,466 15,514 Current portion of long-term debt 13,251 82,211 Liabilities of discontinued operations 11,302 18,906 Total Current Liabilities 172,339 238,372
LONG-TERM DEBT, NET OF CURRENT PORTION
179,061
56,276
DEFERRED INCOME TAXES 15,978 15,011 OTHER NONCURRENT LIABILITIES 25,588 19,743 MINORITY INTEREST 9,286 10,134
STOCKHOLDERS' EQUITY:
Preferred Stock, $.10 par value; 5,000,000 shares authorized; no shares issued or outstanding — — Class A Common Stock, $.10 par value; 80,000,000 shares authorized; 1 vote per share; issued and outstanding, 24,459,121 shares in 2003 and 18,863,482 shares in 2002 2,446 1,886 Class B Common Stock, $.10 par value; 25,000,000 shares authorized; 10 votes per share; issued and outstanding, 7,605,224 shares in 2003 and 8,185,224 shares in 2002 761 819 Additional paid-in capital 132,983 45,132 Retained earnings 286,396 259,893 Accumulated other comprehensive income (loss) 13,805 (11,794 ) Total Stockholders' Equity 436,391 295,936 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 838,643 $ 635,472
33
Industries,Water Technologies, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Amounts
(Amounts in thousands, except share information)
Class A Class B
Common Stock Common Stock Additional
------------------- -------------------- Paid-In
Shares Amount Shares Amount Capital
---------------------------------------------------------
Balance at June 30, 1998 ................................................ 16,859,027 $1,686 10,296,827 $1,030 $47,647
Comprehensive income
Net income .....................................................
Cumulative translation adjustment ..............................
Comprehensive income ....................................
Shares of Class B Common Stock converted to Class A Common Stock ... 11,580 1 (11,580) (1)
Shares of Class A Common Stock issued upon the exercise of
stock options .................................................. 3,700 1 60
Purchase of treasury stock, 615,000 shares @ cost
Retirement of treasury stock ....................................... (715,500) (72) (11,926)
Net change in restricted stock units ............................... 288
Common Stock dividends .............................................
---------------------------------------------------------
Balance at June 30, 1999 ................................................ 16,158,807 $1,616 10,285,247 $1,029 $36,069
Comprehensive income:
Net income .....................................................
Cumulative translation adjustment ..............................
Comprehensive income ....................................
Shares of Class B Common Stock converted to Class A Common Stock ... 800,000 80 (800,000) (80)
Shares of Class A Common Stock issued upon the exercise of
stock options .................................................. 29,700 3 511
Purchase of treasury stock, 100,000 shares @ cost ..................
Retirement of treasury stock ....................................... (100,000) (10) (1,295)
Net change in restricted stock units ............................... 45
Spin off of Industrial and Oil and Gas Group .......................
Common Stock dividends .............................................
---------------------------------------------------------
Balance at December 31, 1999 ............................................ 16,888,507 $1,689 9,485,247 $949 $35,330
Comprehensive income:
Net income .....................................................
Cumulative translation adjustment ..............................
Comprehensive income ....................................
Shares of Class B Common Stock converted to Class A Common Stock ... 250,023 25 (250,023) (25)
Shares of Class A Common Stock issued upon the exercise of
stock options .................................................. 39,609 4 309
Purchase of treasury stock, 10,000 shares @ cost ...................
Retirement of treasury stock ....................................... (10,000) (1) (104)
Net change in restricted stock units ............................... 57,826 6 461
Common Stock dividends .............................................
---------------------------------------------------------
Balance at December 31, 2000 ............................................ 17,225,965 $1,723 9,235,224 $924 $35,996
Comprehensive income:
Net income .....................................................
Cumulative translation adjustment ..............................
Comprehensive income ....................................
Shares of Class B Common Stock converted to Class A Common Stock ... 500,000 50 (500,000) (50)
Shares of Class A Common Stock issued upon the exercise of
stock options .................................................. 110,510 11 1,572
Purchase of treasury stock, 110,300 shares @ cost ..................
Retirement of treasury stock ....................................... (110,300) (11) (1,374)
Net change in restricted stock units ............................... 50,334 5 988
Common Stock dividends .............................................
---------------------------------------------------------
Balance at December 31, 2001 ............................................ 17,776,509 $1,778 8,735,224 $ 874 $37,182
=========================================================
Class A
Common Stock Class B
Common Stock Accumulated
Other
Comprehensive
Income (loss) Additional
Paid-In
Capital Retained
Earnings Treasury
Stock Total
Stockholders'
Equity Shares Amount Shares Amount Balance at December 31, 2000 17,225,965 $ 1,723 9,235,224 $ 924 $ 35,996 $ 213,627 $ (19,728 ) $ — $ 232,542 Comprehensive income: Net income 26,556 26,556 Cumulative translation adjustment (4,553 ) (4,553 ) Comprehensive income 22,003 Shares of Class B Common Stock converted to Class A Common Stock 500,000 50 (500,000 ) (50 ) Shares of Class A Common Stock issued upon the exercise of stock options 110,510 11 1,572 1,583 Purchase of treasury stock, 110,300 shares at cost (1,385 ) (1,385 ) Retirement of treasury stock (110,300 ) (11 ) (1,374 ) 1,385 Net change in restricted stock units 50,334 5 988 993 Common Stock dividends (6,422 ) (6,422 ) Balance at December 31, 2001 17,776,509 $ 1,778 8,735,224 $ 874 $ 37,182 $ 233,761 $ (24,281 ) $ — $ 249,314 Comprehensive income: Net income 32,622 32,622 Cumulative translation adjustment 16,475 16,475 Pension plan additional minimum liability, net of tax of $2,444 (3,988 ) (3,988 ) Comprehensive income 45,109 Shares of Class B Common Stock converted to Class A Common Stock 550,000 55 (550,000 ) (55 ) Shares of Class A Common Stock issued upon the exercise of stock options 501,646 50 6,297 6,347 Tax benefit for stock options
exercised 855 855 Net change in restricted stock units 35,327 3 798 801 Common Stock dividends (6,490 ) (6,490 ) Balance at December 31, 2002 18,863,482 $ 1,886 8,185,224 $ 819 $ 45,132 $ 259,893 $ (11,794 ) $ — $ 295,936 Comprehensive income: Net income 33,362 33,362 Cumulative translation adjustment and other 27,440 27,440 Pension plan additional minimum liability, net of tax of $1,205 (1,841 ) (1,841 ) Comprehensive income 58,961 Shares of Class B Common Stock converted to Class A Common Stock 580,000 58 (580,000 ) (58 ) Shares of Class A Common Stock issued upon the exercise of stock options 301,011 30 4,029 4,059 Tax benefit for stock options exercised 423 423 Net change in restricted stock units 114,628 12 1,333 1,345 Shares of Class A Common Stock issued in Stock Offering net of offering costs of $4,874 4,600,000 460 82,066 82,526 Common Stock dividends (6,859 ) (6,859 ) Balance at December 31, 2003 24,459,121 $ 2,446 7,605,224 $ 761 $ 132,983 $ 286,396 $ 13,805 $ — $ 436,391
34
Accumulated
Other Total
Retained Comprehensive Treasury Stockholders'
Earnings Income Stock Equity
--------------------------------------------------
Balance at June 30, 1998 ................................................ $337,565 $(11,330) $(2,583) $374,015
Comprehensive income
Net income ..................................................... 35,956 35,956
Cumulative translation adjustment .............................. (3,818) (3,818)
--------
Comprehensive income .................................... 32,138
--------
Shares of Class B Common Stock converted to Class A Common Stock ...
Shares of Class A Common Stock issued upon the exercise of
stock options .................................................. 61
Purchase of treasury stock, 615,000 shares @ cost (9,415) (9,415)
Retirement of treasury stock ....................................... 11,998
Net change in restricted stock units ............................... 288
Common Stock dividends ............................................. (9,432) (9,432)
--------------------------------------------------
Balance at June 30, 1999 ................................................ $364,089 $(15,148) $ -- $387,655
Comprehensive income:
Net income ..................................................... 15,242 15,242
Cumulative translation adjustment .............................. (51) (51)
--------
Comprehensive income .................................... 15,191
--------
Shares of Class B Common Stock converted to Class A Common Stock ...
Shares of Class A Common Stock issued upon the exercise of
stock options .................................................. 514
Purchase of treasury stock, 100,000 shares @ cost .................. (1,305) (1,305)
Retirement of treasury stock ....................................... 1,305
Net change in restricted stock units ............................... 45
Spin off of Industrial and Oil and Gas Group ....................... (177,942) (177,942)
Common Stock dividends ............................................. (4,656) (4,656)
--------------------------------------------------
Balance at December 31, 1999 ............................................ $196,733 $(15,199) $ -- $219,502
Comprehensive income:
Net income ..................................................... 24,001 24,001
Cumulative translation adjustment .............................. (4,529) (4,529)
--------
Comprehensive income .................................... 19,472
--------
Shares of Class B Common Stock converted to Class A Common Stock ...
Shares of Class A Common Stock issued upon the exercise of
stock options .................................................. 313
Purchase of treasury stock, 10,000 shares @ cost ................... (105) (105)
Retirement of treasury stock ....................................... 105
Net change in restricted stock units ............................... 467
Common Stock dividends ............................................. (7,107) (7,107)
--------------------------------------------------
Balance at December 31, 2000 ............................................ $213,627 $(19,728) $ -- $232,542
Comprehensive income:
Net income ..................................................... 26,556 26,556
Cumulative translation adjustment .............................. (4,553) (4,553)
--------
Comprehensive income .................................... 22,003
--------
Shares of Class B Common Stock converted to Class A Common Stock ...
Shares of Class A Common Stock issued upon the exercise of
stock options .................................................. 1,583
Purchase of treasury stock, 110,300 shares @ cost .................. (1,385) (1,385)
Retirement of treasury stock ....................................... 1,385
Net change in restricted stock units ............................... 993
Common Stock dividends ............................................. (6,422) (6,422)
--------------------------------------------------
Balance at December 31, 2001 ............................................ $233,761 $(24,281) $ -- $249,314
==================================================
35
Watts Industries,Water Technologies, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Amounts
(Amounts in thousands)
For the Six
-------For the Twelve Months Ended------- Months Ended
December 31, June 30, December 31,
2001 2000 1999 1999 1999
---- ---- ---- ---- ----
(unaudited)
OPERATING ACTIVITIES
Income from continuing operations ................................... $ 26,556 $ 31,171 $ 30,697 $ 29,454 $ 16,468
Adjustments to reconcile net income from continuing operations
to net cash provided by continuing operating activities:
Depreciation .................................................. 19,971 16,963 15,495 14,745 7,869
Amortization .................................................. 3,704 3,108 2,701 2,711 1,356
Deferred income taxes (benefit) ............................... (3,421) 1,380 (2,983) (2,823) 154
Loss/(Gain) on disposal of property, plant and equipment ...... 1,923 296 18 (19) 23
Equity in undistributed earnings/(loss) of affiliates ......... 6 (120) 747 712 (78)
Changes in operating assets and liabilities, net of effects
from business acquisitions and divestures:
Accounts receivable ...................................... 6,295 (5,544) (2,343) (876) (5,883)
Inventories .............................................. 4,213 3,648 (13,589) (532) (2,830)
Prepaid expenses and other assets ........................ (780) 5,529 (4,478) (1,050) (2,456)
Accounts payable, accrued expenses and
other liabilities ...................................... (7,230) 1,323 15,935 5,964 14,386
--------- -------- --------- -------- --------
Net cash provided by continuing operations ........................ 51,237 57,754 42,200 48,286 29,009
--------- -------- --------- -------- --------
INVESTING ACTIVITIES
Additions to property, plant and equipment .......................... (16,047) (14,238) (24,283) (21,532) (10,293)
Proceeds from sale of property, plant and equipment .............. 267 587 2,291 2,337 --
Decrease/(Increase) in other assets .............................. 508 (616) (617) (415) (862)
Business acquisitions, net of cash acquired ...................... (42,977) (9,982) (27,935) (28,422) --
--------- -------- --------- -------- --------
Net cash used in investing activities ........................ (58,249) (24,249) (50,544) (48,032) (11,155)
--------- -------- --------- -------- --------
FINANCING ACTIVITIES
Proceeds from long-term borrowings .................................. 124,992 71,000 112,453 81,121 59,089
Payments of long-term debt .......................................... (114,033) (92,430) (77,697) (47,138) (49,831)
Proceeds from exercise of stock options ............................. 2,576 780 556 61 556
Dividends ........................................................... (6,422) (7,107) (9,301) (9,358) (4,656)
Purchase and retirement of common stock ............................. (1,385) (105) (6,849) (9,415) (1,305)
--------- -------- --------- -------- --------
Net cash provided by/(used in) financing activities .............. 5,728 (27,862) 19,162 15,271 3,853
--------- -------- --------- -------- --------
Effect of exchange rate changes on cash and cash equivalents ............ (214) (496) 1,437 2,620 302
Net cash used in discontinued operations ................................ (1,740) (2,928) (13,852) (16,138) (21,767)
--------- -------- --------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ........................ (3,238) 2,219 (1,597) 2,007 242
Cash and cash equivalents at beginning of year .................... 15,235 13,016 14,613 10,767 12,774
--------- -------- --------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR ................................ $ 11,997 $ 15,235 $ 13,016 $ 12,774 $ 13,016
========= ======== ========= ======== ========
NON CASH INVESTING AND FINANCING ACTIVITIES
Acquisition of businesses
Fair value of assets acquired .................................... $ 64,951 $ 10,826 $ 61,303 $ 61,963 $ --
Cash paid, net of cash acquired .................................. 42,977 9,982 27,935 28,422 --
--------- -------- --------- -------- --------
Liabilities assumed .............................................. $ 21,974 $ 844 $ 33,368 $ 33,541 $ --
========= ======== ========= ======== ========
Years Ended December 31, 2003 2002 2001 OPERATING ACTIVITIES Income from continuing operations $ 36,473 $ 32,622 $ 26,556 Adjustments to reconcile net income from continuing operations to net cash provided by continuing operating activities: Depreciation 20,521 21,817 19,971 Amortization 763 477 3,704 Deferred income taxes (benefit) (75 ) 1,884 (3,421 ) Loss (gain) on disposal of property, plant and equipment 156 (134 ) 1,923 Assets held for sale 946 — — Equity in undistributed earnings (loss) of affiliates (37 ) (101 ) 6 Changes in operating assets and liabilities, net of effects from business acquisitions and divestures: Accounts receivable 2,180 (13,762 ) 6,295 Inventories (8,367 ) (2,764 ) 4,213 Prepaid expenses and other assets (2,556 ) (3,405 ) (780 ) Accounts payable, accrued expenses and other liabilities (14 ) 14,791 (7,230 ) Net cash provided by continuing operations 49,990 51,425 51,237 INVESTING ACTIVITIES Additions to property, plant and equipment (20,035 ) (19,593 ) (16,047 ) Proceeds from the sale of property, plant and equipment 1,765 3,194 267 Decrease (increase) in other assets (191 ) (1,189 ) 508 Business acquisitions, net of cash acquired (18,584 ) (26,233 ) (42,977 ) Net cash used in investing activities (37,045 ) (43,821 ) (58,249 ) FINANCING ACTIVITIES Proceeds from long-term borrowings 220,722 122,917 124,992 Payments of long-term debt (174,166 ) (137,513 ) (114,033 ) Proceeds from exercise of stock options 5,404 7,148 2,576 Tax benefit of stock options exercised 423 855 — Proceeds from stock offering, net 82,526 — — Dividends (6,859 ) (6,490 ) (6,422 ) Purchase and retirement of common stock — — (1,385 ) Net cash provided by (used in) financing activities 128,050 (13,083 ) 5,728 Effect of exchange rate changes on cash and cash equivalents 3,856 2,281 (214 ) Net cash provided by (used in) discontinued operations (6,463 ) 2,174 (1,740 ) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 138,388 (1,024 ) (3,238 ) Cash and cash equivalents at beginning of year 10,973 11,997 15,235 CASH AND CASH EQUIVALENTS AT END OF YEAR $ 149,361 $ 10,973 $ 11,997 NON CASH INVESTING AND FINANCING ACTIVITIES Acquisition of businesses Fair value of assets acquired $ 22,604 $ 66,176 $ 64,951 Cash paid, net of cash acquired 18,584 26,233 42,977 Liabilities assumed $ 4,020 $ 39,943 $ 21,974 CASH PAID FOR: Interest $ 13,499 $ 10,084 $ 10,416 Taxes $ 17,700 $ 16,400 $ 19,700
36
Watts Industries,Water Technologies, Inc. and SubsidiariesIndustries,Water Technologies, Inc. (the Company) designs, manufactures and sells an extensive line of valveswater safety and otherflow control products for the water quality, water safety, water flow control and water conservation markets located predominatelypredominantly in North America, Europe, and Asia.
China. The
financial statements of the Company reflect the industrial and oil and gas
businesses as discontinued operations for periods prior to a spin-off
transaction that was completed on October 18, 1999 (see Note 3).
Change in Fiscal Year
Effective July 1, 1999, the Company changed its fiscal year end from June
30 to December 31. Accordingly, the audited financial statements include
the results for the twelve month period ended December 31, 2001 ("fiscal
2001") and December 31, 2000 ("fiscal 2000"), the six month period ended
December 31, 1999 ("fiscal 1999.5"), and the fiscal year ended June 30,
1999 ("fiscal 1999"). In addition to the basic audited financial
statements and related notes, certain unaudited financial information for
the twelve month period ended December 31, 1999 and the six month period
ended December 31, 1998 have been presented to enhance comparability.
representsis recorded when the excess of cost overconsideration paid for acquisitions exceeds the fair value of net tangible and intangible assets acquired. In June 2001, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards Board Statement No. 141 "Business Combinations" (FAS 141) and Financial Accounting Standards Board Statement No. 142 "Goodwill and Otherbusinesses acquired. Goodwill relatedaccounting be used for all business combinations completed after June 30, 2001. FAS 142 requires that goodwill and other intangible assets with indefinite useful lives no longer be amortized, but rather be tested annually for impairment.acquisitions prior to July 1,
2001 isthe adoption of FAS 142, goodwill was amortized over 40 years using the straight-line method. Effective
July 1, 2001,Also, the Company adopted the provisions of Financial Accounting
Standards Board Statements No. 141 "Business Combinations," and certain
provisions of Statement No. 142 "Goodwill and Other Intangible Assets" as
required for goodwill and intangible assets resulting from business
combinations consummated after June 30, 2001. Goodwill relating to the
acquisition of Powers Process Controls is not being amortized as this
acquisition falls under certain provisions of FAS 142. The impact of the
adoption for the Powers acquisition was not material. The Company assessespreviously assessed the recoverability of intangible assets by determining whether the intangible asset balance cancould be recovered through undiscounted future
operating cash flows of the acquired businesses. The amount of impairment, if any, iswas measured based on projected discounted future operating cash flows using a discount rate reflecting the Company's average cost of funds. Years Ended December 31, 2003 2002 2001 (in thousands, except
per share information)Net income, as reported $ 33,362 $ 32,622 $ 26,556 Add back: goodwill amortization, net of tax — — 3,220 Adjusted net income $ 33,362 $ 32,622 $ 29,776 Basic earnings per share: Net income, as reported $ 1.22 $ 1.22 $ 1.00 Goodwill amortization — — 0.12 Adjusted net income $ 1.22 $ 1.22 $ 1.12 Diluted earnings per share: Net income, as reported $ 1.21 $ 1.21 $ 0.99 Goodwill amortization — — 0.12 Adjusted net income $ 1.21 $ 1.21 $ 1.11 December 31, 2003 2002 (in thousands) Carrying amount at the beginning of year $ 163,226 $ 124,544 Goodwill acquired during the year 8,451 30,662 Adjustments to goodwill during the period (130 ) — Effect of change in exchange rates used for translation 13,354 8,020 Carrying amount at end of year $ 184,901 $ 163,226 December 31, 2003 2002 Gross
Carrying
Amount Accumulated
Amortization Gross
Carrying
Amount Accumulated
Amortization (in thousands) Patents $ 8,449 $ (3,862 ) $ 8,353 $ (3,445 ) Other 3,377 (1,245 ) 4,888 (917 ) Total amortizable intangibles 11,826 (5,107 ) 13,241 (4,362 ) Intangible assets not subject to amortization. 10,029 — 10,256 — Total $ 21,855 $ (5,107 ) $ 23,497 $ (4,362 )
37
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
fiscal year endyear-end exchange rates. Operating accountsIncome and expense items are translated at weighted average exchange rates for each period. Net translation gains or losses are adjusted directly toincluded in other comprehensive income, a separate component of stockholders' equity. The Company does not provide for U.S. income taxes on foreign currency translation adjustments since it does not provide for such taxes on undistributed earnings of foreign subsidiaries. Gains and losses from foreign currency transactions of these subsidiaries are included in net earnings.
As allowed under Statement of Financial Accounting Standards (SFAS) No.
123, "Accounting for Stock-Based Compensation", theits stock-based employee compensation plansstock based compensations in accordance with the
provisions of APBAccounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25), and related interpretations. The Company records stock based compensation expense associated with its Management Stock Purchase Plan due to the discount from market price. Stock-based compensation expense is amortized to expense on a straight-line basis over the vesting period. The following table illustrates the effect on reported net income and earnings per common share if the Company had applied the fair value method to measure stock-based compensation, which is described more fully in Note 13 as required under the disclosure provisions of Financial Accounting Standards Board No. 123, Years Ended December 31, 2003 2002 2001 (in thousands) Net income, as reported $ 33,362 $ 32,622 $ 26,556
Add: Stock-based employee compensation expense from the Management Stock Purchase Plan included in reported net income, net of tax
131
164
184
Deduct: Stock-based employee expense determined under the fair value method, net of tax:
Restricted stock units (Management Stock Purchase Plan)
(271
)
(220
)
(192
) Employee stock options (575 ) (573 ) (551 ) Proforma net income $ 32,647 $ 31,993 $ 25,997 Earnings per share: Basic—as reported $ 1.22 $ 1.22 $ 1.00 Basic—proforma 1.19 1.20 0.98 Dilutive—as reported 1.21 1.21 0.99 Dilutive—proforma $ 1.18 $ 1.19 $ 0.97 from continuing operations, basic and assuming full dilution, are reconciled below:
Twelve Months Ended Twelve Months Ended Six Months Ended Twelve Months Ended
December 31, 2001 December 31, 2000 December 31, 1999 June 30, 1999
-------------------------- -------------------------- -------------------------- --------------------------
(Amounts in thousands, except per share information)
Income Income Income Income
from Per from Per from Per from Per
Continuing Share Continuing Share Continuing Share Continuing Share
Operations Shares Amount Operations Shares Amount Operations Shares Amount Operations Shares Amount
---------- ------ ------ ---------- ------ ------ ---------- ------ ------ ---------- ------ ------
Basic EPS $26,556 26,497 $1.00 $31,171 26,409 $1.18 $16,468 26,453 $0.62 $29,454 26,736 $1.10
Dilutive
securities
principally
common
stock options 305 0.01 142 0.01 628 0.01 63 --
------- ------ ----- ------- ------ ----- ------- ------ ----- ------- ------ -----
Diluted EPS $26,556 26,802 $0.99 $31,171 26,551 $1.17 $16,468 27,081 $0.61 $29,454 26,799 $1.10
======= ====== ===== ======= ====== ===== ======= ====== ===== ======= ====== =====
| Years Ended December 31, | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 | |||||||||||||||||||||
| Net Income | Shares | Per Share Amount | Net Income | Shares | Per Share Amount | Net Income | Shares | Per Share Amount | |||||||||||||||
| (Amounts in thousands, except per share information) | |||||||||||||||||||||||
Basic EPS | $ | 33,362 | 27,455 | $ | 1.22 | $ | 32,622 | 26,718 | $ | 1.22 | $ | 26,556 | 26,497 | $ | 1.00 | |||||||||
Dilutive securities principally common stock options | — | 237 | 0.01 | — | 338 | 0.01 | — | 305 | 0.01 | |||||||||||||||
Diluted EPS | $ | 33,362 | 27,692 | $ | 1.21 | $ | 32,622 | 27,056 | $ | 1.21 | $ | 26,556 | 26,802 | $ | 0.99 | |||||||||
Stock options to purchase 706,656 shares of common stock were outstanding at December 31, 2001, but were not included in the computation of diluted earnings per share because the options exercise price was greater than the average market price of the common shares and therefore, the effect would have been antidilutive. There were none outstanding at December 31, 2003 and 2002.
59
Derivative Financial Instruments
In the normal course of business, we managethe Company manages risks associated with commodity prices, foreign exchange rates and interest rates through a variety of strategies, including the use of hedging transactions, executed in accordance with ourthe Company's policies. OurThe Company's hedging transactions include, but are not limited to, the use of various derivative financial and commodity instruments. As a matter of policy, we dothe Company does not use derivative instruments unless there is an underlying exposure. Any change in the value of our derivative instruments would be substantially offset by an opposite change in the value of the underlying hedged items. We doThe Company does not use derivative instruments for trading or speculative purposes.
Using qualifying criteria defined in FASFinancial Accounting Standards Board Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities" (FAS 133), derivative instruments are designated and accounted for as either a hedge of a recognized asset or liability (fair value hedge) or a hedge of a forecasted transaction (cash flow hedge). For a fair value hedge, both the effective and ineffective portions of the change in fair value of the derivative instrument, along with an adjustment to the carrying amount of the hedged item for fair value changes attributable to the hedged risk, are recognized in earnings. For a cash flow hedge, changes in the fair value of the derivative instrument that are highly effective are deferred in accumulated other comprehensive income or loss until the underlying hedged item is recognized in earnings.
The ineffective portion of fair value changes on qualifying hedges is recognized in earnings immediately. If a fair value or cash flow hedge were to cease to qualify for hedge accounting or be terminated, it would continue to be carried on 38
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
the balance sheet at fair value until settled, but hedge accounting would be discontinued prospectively. If a forecasted transaction were no longer probable of occurring, amounts previously deferred in accumulated other comprehensive income would be recognized immediately in earnings. On occasion, wethe Company may enter into a derivative instrument for which hedge accounting is not required because it is entered into to offset changes in the fair value of an underlying transaction which is required to be recognized in earnings (natural hedge). These instruments are reflected in the Consolidated Balance SheetSheets at fair value with changes in fair value recognized in earnings.
Certain forecasted transactions, primarily intercompany sales between the United States and Canada, and assets are exposed to foreign currency risk. The Company monitors its foreign currency exposures on an ongoing basis to maximize the overall effectiveness of its foreign currency hedge positions. During fiscal year 2001,2003, the Company used foreign currency forward contracts as a means of hedging exposure to foreign currency risks. The Company's foreign currency forwards have been designated and qualify as cash flow hedges under the criteria of FAS 133. FAS 133 requires that changes in fair value of derivatives that qualify as cash flow hedges be recognized in other comprehensive income while the ineffective portion of the derivative's change in fair value be reorganizedrecognized immediately in earnings.
Portions of the Company's outstanding debt are exposed to interest rate risks. The net gainCompany monitors its interest rate exposures on these contracts
recorded in other comprehensive income duringan ongoing basis to maximize the year ended December 31,
2001overall effectiveness of its interest rates. During 2003, the Company entered into an interest rate swap as a means of hedging exposure to interest rate risks (see Note 11). The Company's swap was not material.
designated as a cash flow hedge under the criteria of FAS 133.
60
Shipping and Handling
Shipping and handling costs included in selling, general and administrative expense amounted to $21,002,000$22,111,000, $20,900,000 and $19,492,000$21,002,000 for the
fiscal years ended December 31, 2003, 2002 and 2001, respectively.
Research and 2000 respectively, $9,053,000Development
Research and development costs included in selling, general, and administrative expense amounted to $9,178,000, $9,132,000 and $6,584,000 for the six month periodyears ended December 31, 1999,2003, 2002 and $17,943,000 for the
fiscal year ended June 30, 1999.
2001, respectively.
Revenue Recognition
The Company recognizes revenue when all of the following criteria have been met: the Company has entered into a binding agreement, the product has been shipped and title passes, the sales price to the customer is fixed or is determinable, and the collectability of the
price is reasonably assured. Provisions for estimated returns and allowances are made at the time of sale.
sale, and are recorded as a reduction of sales and included in the allowance for doubtful accounts in the Consolidated Balance Sheets. The Company records provisions for sales incentives (primarily volume rebates), as an adjustment to net sales in accordance with the Financial Accounting Standards Board's Emerging Issues Task Force (EITF) Issue 00-14, "Accounting for Certain Sales Incentives"(EITF 00-14) and EITF Issue No 01-9, "Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor's Products".
Advertising
The Company records advertising expense as incurred.
Basis of Presentation
Certain amounts in fiscal years 2000, 1999.5,2002 and 19992001 have been reclassified to permit comparison with the 20012003 presentation.
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.
New Accounting Standards
The Company adopted Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities" (FAS 133),
as amended by FAS No. 137 and FAS No. 138, on January 1, 2001. FAS 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and
hedging activities. It requires the recognition of all derivative
instruments as assets or liabilities in the Company's balance sheet and
measurement of those instruments at fair value. The adoption of FAS 133 on
January 1,
In August 2001, did not have a material effect on the consolidated
financial statements.
During 2000, the Financial Accounting Standards Board's Emerging Issues
Task Force (EITF) added to its agenda various revenue recognition issues
that could impact the income statement classification of certain
promotional payments. In May 2000, the EITF reached a consensus on Issue
00-14, "Accounting for Certain Sales Incentives". EITF 00-14 addresses the
recognition and income statement classification of various sales
incentives. Among its requirements, the consensus will require the costs
related to consumer coupons currently classified as marketing costs to be
classified as a reduction of revenue. The impact of adopting this
consensus is not expected to have a material impact on our results of
operations. The Company will adopt the consensus in the first quarter of
fiscal 2002.
In January 2001, the EITF reached a consensus on Issue 00-22, "Accounting
for "Points" and Certain Other Time-Based or Volume-Based Sales Incentive
Offers, and Offers for Free Products or Services to Be Delivered in the
Future". Issue 00-22 requires that certain volume-based cash rebates to
customers currently recognized as marketing costs
39
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
be classified as a reduction of revenue. The consensus was effective for
the first quarter of 2001 and its adoption was not material to our
consolidated financial statements.
In April 2001, the EITF reached a consensus on Issue 00-25, "Vendor Income
Statement Characterization of Consideration to a Purchaser of the Vendor's
Products or Services". EITF 00-25 addresses the income statement
classification of consideration, other than that directly addressed in
Issue 00-14, from a vendor to a reseller, or another party that purchases
the vendor's products. Among its requirements, the consensus will require
certain of our customer promotional incentives currently classified as
marketing costs to be classified as a reduction of revenue. The Company
will adopt the consensus in the first quarter of fiscal 2002. The Company
is currently assessing the impact of adopting Issue 00-25, but anticipates
no material change to our consolidated financial statements.
In July 2001, the Financial Standards Accounting Board ("FASB") issued
Financial Accounting Standards Board Statement No. 141, "Business
Combinations" ("FAS 141") and Financial Accounting Standards Board
Statement No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"). FAS
141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. FAS 141 also
specifies the criteria that intangible assets acquired in a purchase
method business combination must meet to be recognized and reported apart
from goodwill. FAS 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead be tested for
impairment, at least annually, in accordance with the provisions of FAS
142. FAS 142 will also require that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with
Financial Accounting Standards Board Statement No. 121, "Accounting for
the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed
Of".
The provisions of FAS 141 are effective immediately, except with regard to
business combinations initiated prior to July 1, 2001. FAS 142 will be
effective as of January 1, 2002. Goodwill and other intangible assets
determined to have an indefinite useful life that are acquired in a
purchase business combination completed after June 30, 2001 will not be
amortized, but will continue to be evaluated for impairment in accordance
with appropriate pre-FAS 142 accounting literature. Goodwill and other
intangible assets acquired in business combinations completed before July
1, 2001, will continue to be amortized prior to the adoption of FAS 142.
The Company is currently evaluating the effect that the adoption of FAS
141 and FAS 142 will have on its results of operations and its financial
position.
In August 2001, the FASB(FASB) issued Financial Accounting Standards Board Statement No. 143, "Accounting for Asset Retirement Obligations" ("FAS
143")(FAS 143) which requires companies to record the fair value of an asset retirement obligation as a liability in the period it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and and/or normal use of the assets. The company must also record a corresponding increase in the carrying value of the related long-lived asset and depreciate that cost over the remaining useful life of the asset. The liability must be increased each period for the passage of time with the offset recorded as an operating expense. The liability must also be adjusted
61
for changes in the estimated future cash flows underlying the initial fair value measurement. Companies must also recognize a gain or loss on the settlement of the liability. The provisions of FAS 143 are effective for fiscal years beginning after June 15, 2002. At the date of the adoption of FAS 143, companies are required to recognize a liability for all existing asset retirement obligations and the associated asset retirement costs. The Company is currently evaluating the effect that the adoption ofhas adopted FAS 143 will have on its results of operationseffective January 1, 2003 and its adoption was not material to the consolidated financial position.statements.
In August 2001,July 2002, the FASB issued Financial Accounting Standards Board Statement No. 144,146, "Accounting for the ImpairmentCosts Associated with Exit or Disposal Activities" (FAS 146). The principal difference between this Statement and Emergency Issues Task Force (EITF) Issue No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) (Issue 94-3) relates to its requirements for recognition of Long-Lived Assets" ("FAS 144") which addresses the accounting and
reportinga liability for the impairmenta cost associated with an exit or disposal activity. This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of long-lived assets.an entity's commitment to an exit plan. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Company adopted FAS 144
supercedes146 effective January 1, 2003 and its adoption was not material to the consolidated financial statements.
In November 2002, the FASB issued Financial Accounting Standards Board Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that a liability be recorded in the guarantor's balance sheet upon issuance of certain guarantees. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a roll-forward of the entity's product warranty liabilities. FIN 45 required the application of the recognition provisions of FIN 45 prospectively to guarantees issued after December 31, 2002. The Company adopted the disclosure provisions of FIN 45 effective December 31, 2002. The Company does offer warranties for its products, but the returns under warranty have been immaterial. The warranty reserve is part of the sales returns and allowances reserve, a component of the Company's allowance for doubtful accounts. The Company adopted FIN 45 effective January 1, 2003 and its adoption was not material to the consolidated financial statements.
In December 2002, the FASB issued Financial Accounting Standards Board Statement No. 121,148, "Accounting for Stock-Based Compensation, Transition and Disclosure" (FAS 148). FAS 148 provides alternative methods of transition for a voluntary change to the Impairmentfair value based method of Long-Lived Assets andaccounting for Long-lived
Assets to be Disposed Of" ("stock-based employee compensation. FAS 121") but retains many148 also requires that disclosures of the fundamental
provisionspro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, FAS 148 requires disclosure of the pro forma effect in interim financial statements. The additional disclosure requirements of FAS 121. FAS 144 also supercedes the accounting and
reporting provisions of148 were effective for fiscal years ended after December 15, 2002. The Company currently continues to account for stock-based compensation in accordance with Accounting Principles Board Opinion No. 30,
"Reporting25 and the ResultsCompany provided the disclosures required by FAS 148.
In December 2002, the EITF issued EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." This consensus provides guidance in determining when a revenue arrangement with multiple deliverables should be divided into separate units of Operations - Reportingaccounting, and, if separation is appropriate, how the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" ("APB 30") for the disposal of a
segment of a business. However, FAS 144 retains the requirements of APB 30
to report discontinued operations separately and extends that reporting
requirement to components of an entity that has either been disposed of or
is classified as held for sale. FAS 144 excludes goodwill and other
intangibles that are not amortized from its scope. For assets to be held
and used, FAS 144 addresses how cash flows should
40
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
be estimated to test the recoverability of an asset or group of assets,
clarifies how an impairment lossarrangement consideration should be allocated and creates a
requirement to use an expected present value technique to estimate fair
value if market prices are not available and uncertainties exist about the timing and amount of future cash flows. For long-lived assets to be
disposed of by sale, FAS 144 establishes the criteria to be met to qualify
for this classification, defines the timing of when the related sale must
be consummated, eliminates the net realizable value measurement approach
for segments of a business and certain acquired assets in a business
combination, and defines costs to sell the asset.identified accounting units. The provisions of FAS
144EITF 00-21 are effective for revenue arrangements entered during fiscal yearsperiods beginning after June 15, 2003. The Company adopted EITF 00-21, effective July 1, 2003, and its adoption was not material to the consolidated financial statements.
62
In January 2003, the FASB issued Financial Accounting Standards Board Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46) which requires the consolidation of variable interest entities (VIE) by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 was effective for all new VIEs created or acquired after January 31, 2003. In October 2003, the FASB delayed the effective date for some VIEs that existed prior to February 1, 2003, provided the reporting entity had not "issued" financial statements reporting the VIE in accordance with Interpretation 46. FIN 46 was effective for the first interim or annual period ending after December 15, 2001 and2003. In December 2003, the FASB issued a revision to FIN 46 (FIN 46R). Under the revised provisions, public entities are generallyrequired to be applied prospectively.apply the guidance if the entity has interests in VIEs commonly referred to as special-purpose entities for periods ending after December 15, 2003. The Company will adopt FAS 144
in the firstadopted FIN 46R and as a result has consolidated Jameco International, LLC (the LLC) effective October 1, 2003 (the fourth quarter of fiscal 2002.2003). The LLC imports and sells vitreous china, imported faucets and faucet parts and imported bathroom accessories to the North American home improvement retail market. Its annual sales for the twelve months ended December 31, 2003, were approximately $16,079,000. The LLC maintains a line of credit with a financial institution collateralized by a first security interest in the LLC's assets. The creditors have no recourse to the Company. The assets as of December 31, 2003 of $3,960,000 are comprised primarily of accounts receivable and inventory which the Company believes are collectable and saleable, respectively, within the normal course of business. The Company is currently evaluatinghas a subordinated security interest in the effect thatassets of the LLC pertaining to its loan receivable of $2,230,680 at December 31, 2003, which eliminates in consolidation as the result of the application of FIN 46R. Prior to the adoption of FAS 144 will have on its results of
operations and its financial position.
(3) Discontinued Operations
On December 18, 1998,FIN 46R, the Company announcedaccounted for its intention to spin-off its
industrial and oil and gas businesses to its shareholders as an
independent publicly traded company.investment of 49% in the LLC using the equity method.
The spin-off was effected asCompany also maintains another variable interest in a tax-free distribution on October 18, 1999 ("Distribution Date"). Owners of
Watts common stock as of October 6, 1999 received one share of common
stock of CIRCOR International, Inc. ("CIRCOR"), the new company, for every
two shares of Watts class A or class B common stock held. Coincident with
the Distribution Date,VIE. In 2000 the Company received $96.0 millionentered into an agreement with Plumworld.co.uk Ltd in cash from
CIRCORwhich the Company maintains a 20% interest in Plumbworld. Plumbworld is primarily an e-business that sells bathroom and sanitary appliances, as repaymentwell as, plumbing and heating products, tools and plumbing consumables. Its annualized sales are approximately $7,100,000. The Company maintains a notional amount of intercompany loansapproximately $500 investment in Plumbworld and advances.maintains a loan receivable in amount of approximately $850,000 with Plumbworld. The historical operating results of CIRCOR throughCompany continues to account for its investment in Plumbworld using the distribution date
are shown, net of tax, as discontinued operations inequity method.
In April 2003, the consolidated
statements of operations. Included in the historical operating results of
the discontinued operations is an allocation of the Company's interest
expense based on an allocation of the Company's debt to discontinued
operations. Income taxes have been allocated to discontinued operations
based on their pre-tax income and calculated on a separate company basis
pursuant to the requirements of Statement ofFASB issued Financial Accounting Standards Board Statement No. 109.149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" (FAS 149). FAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under FAS 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133). FAS 149 has multiple effective date provisions depending on the nature of the amendments to FAS 133, including one for contracts entered into or modified after June 30, 2003. The Company adopted FAS 149 and its adoption was not material to the consolidated financial statements.
63
In May 2003, the FASB issued Financial Accounting Standards Board Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" (FAS 150). FAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. FAS 150 is effective for certain financial instruments entered into or modified after May 31, 2003. For unmodified financial instruments existing at May 31, 2003, FAS 150 is effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted FAS 150 apart from the deferral by FASB Staff Position 150-3 (FAS 150-3) of certain mandatorilly redeemable non controlling interests and its adoption was not material to the consolidated financial statements.
(3) Discontinued Operations
In September 1996, the Company divested its Municipal Water Group of businesses, which included Henry Pratt, James Jones Company and Edward Barber and Company Ltd. Costs and expenses related to the Municipal Water Group for fiscal 2000 and 19992003 relate to legal and settlement costs associated with the James Jones litigationLitigation (see Note 15). Specifically, in 2003, a settlement payment of $13,000,000, of which the Company paid $11,000,000, has been made to settle the claims of the three cities (Santa Monica, San Francisco and East Bay Municipal Water District) chosen by the Relator as having the strongest claims. This settlement, which was primarily expensed in prior years, and other legal fees, required the Company to record additional net of tax charges for the year ended December 31, 2003, of $2,665,000.
The Company also recorded a charge attributable to payments to be made to the selling shareholders of the James Jones Company pursuant to the Company's original purchase agreement. For the year ended December 31, 2003, the Company recorded a net of tax charge of $446,000.
Condensed operating statement data of thestatements and balance sheets for discontinued operations is summarized below:
| Years Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 | |||||||
| (in thousands) | |||||||||
Net sales | $ | — | $ | — | $ | — | ||||
Costs and expenses | ||||||||||
Municipal Water Group | (5,058 | ) | — | — | ||||||
Loss before income taxes | (5,058 | ) | — | — | ||||||
Income tax benefit | 1,947 | — | — | |||||||
Loss from discontinued operations, net of taxes | $ | (3,111 | ) | $ | — | $ | — | |||
| December 31, | ||||||
---|---|---|---|---|---|---|---|
| 2003 | 2002 | |||||
| (in thousands) | ||||||
Prepaid expenses and other assets | $ | 875 | $ | 1,914 | |||
Deferred income taxes | 3,585 | 6,741 | |||||
Assets of discontinued operations | $ | 4,460 | $ | 8,655 | |||
Accrued expenses and other liabilities | 11,302 | 18,906 | |||||
Liabilities of discontinued operations | $ | 11,302 | $ | 18,906 | |||
64
(4) Restructuring and Other Charges
The Company is implementingcontinues to implement a plan to consolidate several of its manufacturing plants both in North America and Europe. At the same time it is expanding its manufacturing capacity in China.China and other low cost areas of the world. The implementation of this manufacturing restructuring plan began during the fourth quarter of fiscal 2001 and is expected to be completed during fiscal
41
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2002 to insure the quality of its products and minimize any interruption
in its delivery of those products to its customers.2001. The Companyprojects for which charges were recorded
manufacturing restructuring plan costs of $5,831,000 pre-tax in the fourth quarter of fiscal 2001 are essentially complete. During 2002, the Company decided to expand the scope of the manufacturing restructuring plan and transfer certain production to low cost manufacturing plants in Tunisia and Bulgaria. The expanded plan is anticipating recording an additional
$6,000,000 to $8,000,000essentially complete as of December 31, 2003. The Company recorded pre-tax in 2002 as it continues to implementmanufacturing restructuring and other costs of $1,655,000, net of recoveries, for the program.year ended December 31, 2003. The manufacturing restructuring and other costs recorded in 2001 consist primarily of severance costs, asset write-downs and accelerated depreciation. The severance costs, which have been recorded as restructuring, are for approximately 3648 employees in manufacturing and administration groups, 35groups. The Company expects to complete severance payments by the end of whom have been terminated asthe first quarter of December 31,
2001.2004. Asset write-downs consist primarily of write-offs of inventory related to product lines that the Company has discontinued as part of this restructuring plan and are recorded in cost of goods sold. Accelerated depreciation is based on shorter remaining estimated useful lives of certain fixed assets and has been recorded in cost of goods sold. Other costs consist primarily of removal and shipping costs associated with relocation of manufacturing equipment and have been recorded in cost of goods sold. The tax
benefits of the costssold and asset write-downs will slightly exceed cash
outlays to implement this program, which would allow the Company to
complete the restructuring without consuming any cash. The Company
estimates an annual pre-tax savings of approximately $5,000,000 following
the completion of the program.have been expensed as incurred.
Details of the Company's manufacturing restructuring plan through December 31, 2003 are as follows:
Initial Utilized Remaining
Provision During 2001 Balance
--------- ----------- ---------
(in thousands)
Restructuring/Other $1,454 $ 692 $762
Asset Write-downs 4,300 4,300 --
Other exit costs 77 77 --
------ ------ ----
Total $5,831 $5,069 $762
====== ====== ====
In December 1999,
| Balance 12/31/01 | Provisions 2002 | Utilized 2002 | Balance 12/31/02 | Provisions 2003 | Utilized 2003 | Balance 12/31/03 | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) | ||||||||||||||||||||
Restructuring | $ | 762 | $ | 638 | $ | 981 | $ | 419 | $ | 426 | $ | 804 | $ | 41 | |||||||
Asset write-downs | — | 2,491 | 2,491 | — | 479 | 479 | — | ||||||||||||||
Other costs | — | 960 | 960 | — | 750 | 750 | — | ||||||||||||||
Total | $ | 762 | $ | 4,089 | $ | 4,432 | $ | 419 | $ | 1,655 | $ | 2,033 | $ | 41 | |||||||
(5) Business Acquisitions
On July 30, 2003, a wholly-owned subsidiary of the Company announcedacquired Giuliani Anello S.r.l. located in Cento Bologna, Italy for approximately $10,600,000 in cash net of acquired cash of $1,400,000. Giuliani Anello manufactures and distributes valves and filters utilized in heating applications including strainer filters, solenoid valves, flow stop valves, stainless steel water filter elements and steam cleaning filters.
On April 18, 2003, a restructuringwholly-owned subsidiary of its operations
in Italy to consolidate the warehousing and manufacturing operations. In
connection with this restructuring, the Company recordedacquired Martin Orgee UK Ltd. located in Kidderminster, West Midlands, United Kingdom for approximately $1,600,000 in cash. Martin Orgee distributes a pre-tax chargeline of $1,460,000. This restructuring programplumbing and heating products to the wholesale, commercial and OEM markets in the United Kingdom and Southern Ireland. Martin Orgee also assembles pumping systems for under-floor radiant heat applications.
On July 29, 2002 a wholly-owned subsidiary of the Company acquired F&R Foerster and Rothmann GmbH (F&R) located in Neuenburg am Rhein, Germany, for approximately $2,300,000 in cash less assumed net debt of $800,000. F&R manufactures and distributes a line of gauges predominately to the French and German OEM markets.
65
On July 15, 2002, a wholly-owned subsidiary of the Company acquired ADEV Electronic SA (ADEV) located in Rosieres, France and its closely affiliated distributor, E.K. Eminent A.B. (Eminent) located in Gothenburg, Sweden for approximately $12,900,000 in cash less assumed net debt of $3,500,000. ADEV also has a low cost manufacturing facility located in Tunisia. ADEV manufactures and distributes electronic systems predominantly to the OEM market. Their product lines include thermostats and controls for heating, ventilation and air conditioning, control systems for hydronic and electric floor warming systems, and controls for other residential applications. Eminent distributes electronic controls, mechanical thermostats and other electric control related products throughout the European Nordic countries.
On May 9, 2002, a wholly-owned subsidiary of the Company acquired Hunter Innovations of Sacramento, California for $25,000,000, of which approximately $10,000,000 was completedpaid in fiscal 2000.
(5) Business Acquisitionscash at the closing and the balance in interest bearing notes, payable in equal annual installments through 2006. Hunter Innovations was founded in 1995 and has developed a line of large backflow prevention devices that represent a significant advance in technology. The improved product features that are important to the backflow prevention markets include lighter weight, more compact design, better flow characteristics, improved serviceability and multiple end-connection and shutoff valve options. On May 9, 2003, the Company made an additional payment of approximately $3,750,000 for the first installment on the interest bearing notes.
In March 5, 2002, the Company entered into a joint venture with the Yuhuan County Cheng Guan Metal Hose Factory (Cheng Guan) located in Taizhou, Zhejiang Province of the People's Republic of China. Cheng Guan, is a manufacturer of a variety of plumbing products sold both into the Chinese domestic market and export markets. Its product lines were contributed to the joint venture and include hose, hose connectors, multi-layer tubing and stainless steel braided hose. The joint venture is owned 60% by the Company and 40% by its Chinese partner. On January 29, 2003, the Company made an additional payment of $3,000,000 associated with the Cheng Guan joint venture bringing the aggregate cash investment to $8,000,000 for the 60% interest.
On September 28, 2001, a wholly ownedwholly-owned subsidiary of the Company acquired the assets of the Powers Process Controls Division of Mark Controls Corporation, a subsidiary of Crane Co. located in Skokie, Illinois and Mississauga, Ontario, Canada for approximately $13 million$13,000,000 in cash. The
December 31, 2001 Consolidated Balance Sheet of the Company contains a
purchase price allocation of the Powers acquisition, consistent with the
guidelines of FAS 141 and certain provisions of FAS 142. Powers designs and manufactures thermostatic mixing valves for personal safety and process control applications in commercial and institutional facilities. It also manufactures control valves and commercial plumbing brass products including shower valves and lavatory faucets. Powers' annualized sales
prior to the acquisition were approximately $20 million.
On June 13, 2001, a wholly ownedwholly-owned subsidiary of the Company acquired Premier Manufactured Systems, Inc., located in Phoenix, Arizona for approximately $5 million$5,000,000 in cash. Premier manufactures water filtration systems for both residential and commercial applications and other filtration products including under-the-counter ultraviolet filtration as well as a variety of Sedimentsediment and Carboncarbon filters. Premier's annualized
sales prior to the acquisition were approximately $10 million.
On June 1, 2001, a wholly ownedwholly-owned subsidiary of the Company acquired Fimet S.r.l. (Fabbrica Italiana Manometri e Termometri) located in Milan, Italy and its wholly-owned subsidiary, MTB AD, which is located in Bulgaria for approximately $6 million.$6,000,000. The acquired business manufactures pressure and temperature gauges for use in the HVAC market. Fimet's annualized sales
prior to the acquisition were approximately $9 million.
On January 5, 2001, a wholly-owned subsidiary of the Company acquired Dumser Metallbau GmbH & Co. KG located in Landau, Germany for approximately $20 million.$20,000,000 in cash. The main products of Dumser include brass, steel and stainless steel manifolds used as a prime distribution device in hydronic heating systems. Dumser's
annualized sales prior to the acquisition were approximately $24 million.
Dumser has a 51% controlling share of Stern Rubinetti, which had
annualized sales prior to the acquisition of $4 million.Rubinetti. Stern Rubinetti is an Italian manufacturing company producing brass components located in Brescia, Italy.
42
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
66
The acquisitions above have been accounted for utilizing the purchase method of accounting. The pro-forma results have not been displayed, as the combined results are not significant.
(6) Allowance for Doubtful Trade Accounts Receivable
Activity inOther Comprehensive Income (Loss)
Other comprehensive income (loss) consist of the allowance for doubtful trade accounts receivable is as
follows:
| Foreign Currency Translation | Pension Adjustment | Cash Flow Hedges | Accumulated Other Comprehensive Income (Loss) | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Balance December 31, 2001 | $ | (24,281 | ) | $ | — | $ | — | $ | (24,281 | ) | |||
Change in period | 16,475 | (3,988 | ) | — | 12,487 | ||||||||
Balance December 31, 2002 | (7,806 | ) | (3,988 | ) | — | (11,794 | ) | ||||||
Change in period | 27,394 | (1,841 | ) | 46 | 25,599 | ||||||||
Balance December 31, 2003 | $ | 19,588 | $ | (5,829 | ) | $ | 46 | $ | 13,805 | ||||
(7) Inventories
Inventories consist of the following:
| December 31, | |||||
---|---|---|---|---|---|---|
| 2003 | 2002 | ||||
| (in thousands) | |||||
Raw materials | $ | 41,998 | $ | 40,591 | ||
Work in process | 24,348 | 17,289 | ||||
Finished goods | 90,253 | 75,535 | ||||
$ | 156,599 | $ | 133,415 | |||
Finished goods of $11,015,000 and $13,774,000 as of December 31, December 31,
2001 2000
------------ ------------
(in thousands)
Raw materials $ 34,276 $ 35,483
Work in process 13,032 16,390
Finished goods 68,556 57,078
-------- --------
$115,864 $108,951
======== ========
2003 and 2002, respectively, were consigned.
(8) Property, Plant and Equipment
Property, plant and equipment consists of the following:
| December 31, | ||||||
---|---|---|---|---|---|---|---|
| 2003 | 2002 | |||||
| (in thousands) | ||||||
Land | $ | 9,354 | $ | 8,980 | |||
Buildings and improvements | 75,428 | 64,935 | |||||
Machinery and equipment | 194,248 | 166,684 | |||||
Construction in progress | 5,220 | 8,334 | |||||
284,250 | 248,933 | ||||||
Accumulated Depreciation | (138,539 | ) | (114,557 | ) | |||
$ | 145,711 | $ | 134,376 | ||||
67
The Company also maintains assets held for sale of $1,938,000 and $2,464,000 as of December 31, 2003 and 2002, respectively. These amounts are primarily for the Company's former distribution center for the German market that was closed during 2002 due to the Company's manufacturing restructuring plan. In accordance with FAS 144, the Company has classified this asset as an "Assets held for Sale" in the Consolidated Balance Sheets as of December 31, 2001 2000
------------ ------------
(in thousands)
Land $ 8,890 $ 8,297
Buildings2003 and improvements 61,045 55,779
Machinery2002 and equipment 142,615 131,642
Constructionis carrying the asset at the estimated fair market value less costs to sell. The Company has kept this asset held for sale beyond one year as it is still actively marketing the building. During 2003, the Company reduced the asking price and in progress 5,685 6,774
-------- --------
218,235 202,492
Accumulated Depreciation (89,629) (76,682)
-------- --------
$128,606 $125,810
======== ========
43
Watts Industries, Inc. and Subsidiaries
Notesaccordance with FAS 144 wrote down the asset to Consolidated Financial Statements (continued)
the estimated fair market value less costs to sell.
(9) Income Taxes
The significant components of the Company's deferred income tax liabilities and assets are as follows:
December 31, December 31,
2001 2000
------------ ------------
(in thousands)
Deferred income tax liabilities:
Excess tax over book depreciation $12,945 $12,216
Other 2,747 3,247
------- -------
Deferred income tax liabilities 15,692 15,463
------- -------
Deferred income tax assets:
Accrued expenses 12,185 11,433
Net operating loss carryforward 3,298 4,102
Inventory 3,613 1,688
Restructuring 1,553 --
Other 5,329 4,017
------- -------
Deferred income tax assets 25,978 21,240
Valuation allowance (649) (754)
------- -------
Deferred income tax assets, net
of valuation allowance 25,329 20,486
------- -------
Net deferred income tax asset $ 9,637 $ 5,023
======= =======
| December 31, | ||||||||
---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | |||||||
| (in thousands) | ||||||||
Deferred income tax liabilities: | |||||||||
Excess tax over book depreciation | $ | 16,447 | $ | 13,806 | |||||
Intangibles | 4,400 | 4,496 | |||||||
Other | 2,598 | 2,490 | |||||||
Total deferred tax liabilities | 23,445 | 20,792 | |||||||
Deferred income tax assets: | |||||||||
Accrued expenses | 13,166 | 12,189 | |||||||
Net operating loss carry-forward | 4,384 | 4,664 | |||||||
Inventory reserves | 4,545 | 4,056 | |||||||
Other | 9,481 | 7,508 | |||||||
Total deferred tax assets | 31,576 | 28,417 | |||||||
Less: valuation allowance | (557 | ) | (709 | ) | |||||
Net deferred tax | 31,019 | 27,708 | |||||||
Net deferred tax assets | $ | 7,574 | $ | 6,916 | |||||
The provision for income taxes from continuing operations is based on the following pre-tax income:
Twelve Months Twelve Months Six Months Twelve Months
Ended Ended Ended Ended
December 31, December 31, December 31, June 30,
2001 2000 1999 1999
------------- ------------- ------------ -------------
(in thousands)
Domestic $30,152 $35,565 $18,424 $33,787
Foreign 10,016 13,647 6,987 11,136
------- ------- ------- -------
$40,168 $49,212 $25,411 $44,923
======= ======= ======= =======
44
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
| Years Ended December 31, | ||||||||
---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 | ||||||
| (in thousands) | ||||||||
Domestic | $ | 40,457 | $ | 37,931 | $ | 30,152 | |||
Foreign | 18,372 | 12,287 | 10,016 | ||||||
$ | 58,829 | $ | 50,218 | $ | 40,168 | ||||
68
The provision for income taxes from continuing operations consists of the following:
| Years Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 | ||||||||
| (in thousands) | ||||||||||
Current tax expense | |||||||||||
Federal | $ | 12,195 | $ | 12,408 | $ | 11,411 | |||||
Foreign | 6,256 | 4,241 | 4,238 | ||||||||
State | 2,436 | 2,139 | 2,125 | ||||||||
20,887 | 18,788 | 17,774 | |||||||||
Deferred tax expense (benefit) | |||||||||||
Federal | 802 | (358 | ) | (2,096 | ) | ||||||
Foreign | 509 | (630 | ) | (1,593 | ) | ||||||
State | 158 | (204 | ) | (473 | ) | ||||||
1,469 | (1,192 | ) | (4,162 | ) | |||||||
$ | 22,356 | $ | 17,596 | $ | 13,612 | ||||||
Actual income taxes reported from continuing operations are different than would have been computed by applying the federal statutory tax rate to income from continuing operations before income taxes. The reasons for this difference are as follows:
| Years Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 | |||||||
| (in thousands) | |||||||||
Computed expected federal income expense | $ | 20,590 | $ | 17,576 | $ | 14,059 | ||||
State income taxes, net of federal tax benefit | 1,686 | 1,257 | 1,074 | |||||||
Goodwill amortization | — | — | 751 | |||||||
Foreign tax rate differential | 335 | (862 | ) | (1,025 | ) | |||||
Other, net | (255 | ) | (375 | ) | (1,247 | ) | ||||
$ | 22,356 | $ | 17,596 | $ | 13,612 | |||||
At December 31, 2001,2003, the Company had foreign net operating loss carry-forwardscarryforwards of $8.8 million$11,500,000 for income tax purposes. Approximately $8.7
millionAll of the foreign net operating losses are foreign losses and can be carried forward indefinitely,indefinitely. The net operating losses relate to European operations. The Company had a valuation allowance of $557,000 and $709,000 as of December 31, 2003 and 2002, respectively, against a portion of the net operating loss carryforwards. The valuation allowance is primarily attributable to net operating losses generated in locations in which the Company has not yet been able to determine with certainty the remainder expiring in fiscal years 2002 and 2003.recoverability. Undistributed earnings of the Company's foreign subsidiaries amounted to approximately $55 million$100,800,000 at December 31, 2001, and $57 million2003, $78,100,000 at December 31, 2000, $43 million2002, and $45 million$55,500,000 at December 31, 1999 and
June 30, 1999, respectively.2001. Those earnings are considered to be indefinitely reinvested, and, accordingly, no provision for U.S. federal and state income taxes has been recorded thereon. Upon distribution of those earnings, in the form of dividends or otherwise, the Company will be subject to withholding taxes payable to the various foreign countries. Determination of the amount of U.S. income tax liability that would be incurred is not practicable because of the complexities associated with its hypothetical calculation; however, unrecognized foreign tax credits would be available to reduce some portion of any U.S. income tax liability. Withholding taxes of approximately $3.6 million$3,900,000 would be payable upon remittance of all previously unremitted earnings at December 31, 2001.
45
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Management2003.
69
The Company believes that it is more likely than not that it will be able to recover the deferred tax assets net ofnot subject to valuation allowance, will be realized.
The Company made income tax payments of $19.7 million for the fiscal year
ended December 31, 2001, $18.4 million for the fiscal year ended December
31, 2000, $11.2 million and $24.8 million in fiscal years ended December
31, 1999 and June 30, 1999, respectively.
allowance.
(10) Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consist of the following:
December 31, December 31,
2001 2000
------------ ------------
(in thousands)
Commissions and sales incentives payable $12,214 $11,261
Accrued insurance 12,415 11,434
Net Pension Liability 4,162 3,668
Other 18,919 18,549
Income Taxes Payable 1,766 5,217
Accrued legal/settlement 6,454 8,959
------- -------
$55,930 $59,088
======= =======
46
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
| December 31, | |||||
---|---|---|---|---|---|---|
| 2003 | 2002 | ||||
| (in thousands) | |||||
Commissions and sales incentives payable | $ | 18,869 | $ | 13,370 | ||
Accrued insurance | 16,104 | 14,168 | ||||
Pension liability | 1,501 | 5,259 | ||||
Other | 15,689 | 22,380 | ||||
Income taxes payable | 3,089 | 1,860 | ||||
$ | 55,252 | $ | 57,037 | |||
(11) Financing Arrangements
Long-term debt consists of the following:
| December 31, | |||||
---|---|---|---|---|---|---|
| 2002 | 2001 | ||||
| (in thousands) | |||||
83/8% notes due December 2003 | $ | — | $ | 75,000 | ||
4.87% notes due May 2010 | 50,000 | — | ||||
5.47% notes due May 2013 | 75,000 | — | ||||
Hunter Innovations notes with principal payable in three equal annual installments, accruing interest monthly, due May 2006 (annual interest rate of 2.70% and 4.11% at December 31, 2003 and 2002, respectively) | 11,250 | 15,000 | ||||
$150 million revolving credit facility maturing in February 2005, amended to include a $75 million tranche for euro based borrowing. U.S. loan interest accruing at a variable rate (4.25% at December 31, 2002) of either Eurocurrency rate loans at a LIBOR rate plus the applicable margin with respect to eurocurrency rate loans in effect for that period, or the U.S. base rate, which is the higher of the "prime rate" or (0.5%) above the Federal Funds Effective Rate. European loan interest accruing at a variable rate (2.83% at December 31, 2003 and 3.84% at December 31, 2002) of either eurocurrency rate loans at a EURIBOR rate plus the applicable margin with respect to eurocurrency rate loans in effect for that period, or the euro base rate plus the greater of 1.0% and the applicable margin with respect to euro base rate loans in effect for that period. At December 2003, $44,089,000 was borrowed for euro based borrowings and there were no outstanding U.S. borrowings. At December 2002, of the $41,649,000, $6,000,000 was borrowed under the U.S. tranche and $35,649,000 was borrowed for euro based borrowings | 44,089 | 41,649 | ||||
Other—which consists primarily of loans held by our Chinese joint ventures (at interest rates ranging from 3.00% to 11.28%) | 11,973 | 6,838 | ||||
192,312 | 138,487 | |||||
Less Current Maturities | 13,251 | 82,211 | ||||
$ | 179,061 | $ | 56,276 | |||
70
Principal payments during each of the next five fiscal years and thereafter are due as follows (in thousands): 2002 - $37,532;2004—$13,251; 2005—$48,357; 2006—$4,194; 2007—$867; 2008—$244 and thereafter—$125,399.
On May 15, 2003, - $83,817; 2004 - $3,427,
2005 - $426,the Company completed a private placement of $125,000,000 of senior unsecured notes consisting of $50,000,000 principal amount of 4.87% senior notes due 2010 and 2006 - $404. Interest paid$75,000,000 principal amount of 5.47% senior notes due 2013. The Company used the net proceeds from the private placement to purchase treasury securities to repay the $75,000,000 principal amount of 83/8% Notes due December 2003. Additional net proceeds were used to repay approximately $32,000,000 outstanding under the Revolving Credit Facility. The balance of the net proceeds will be used for all periods presented ingeneral corporate purposes. The payment of interest on the accompanying consolidated financial statements approximates interest
expense.
47
Industries,Water Technologies, Inc. and Subsidiaries
Notesare subordinated to Consolidated Financial Statements (continued)
Lettersthe Revolving Credit Facility, which is at the subsidiary level. The senior unsecured notes allow the Company to have (i) debt senior to the new notes in an amount up to $150,000,000 plus 5% of stockholders' equity and (ii) debt
On February 28, 2002, the Company entered into a revolving credit facility with a syndicate of banks (as amended, the Revolving Credit are purchased guarantees that ensureFacility). The Revolving Credit Facility provides for borrowings of up to $150,000,000, which includes a $75,000,000 tranche for euro-based borrowings, and matures in February 2005. The Revolving Credit Facility is being used to support the Company's acquisition program, working capital requirements and for general corporate purposes.
Effective July 1, 2003, the Company entered into an interest rate swap for a notional amount of 25,000,000 euro outstanding on our Revolving Credit Facility. The Company swapped the variable rate from the Revolving Credit Facility which is three month EURIBOR plus 0.7% for a fixed rate of 2.33%. The term of the swap is two years. The Company has designated the swap as a hedging instrument using the cash flow method. The swap hedges the cash flows associated with interest payments on the first 25,000,000 euro of the Revolving Credit Facility. The Company marks to market the changes in value of the swap through other comprehensive income. Any ineffectiveness has been recorded in income. The fair value of the swap recorded in other comprehensive income as of December 31, 2003 was $46,000.
Outstanding indebtedness under the Revolving Credit Facility bears interest at a rate determined by the type (currency) of loan plus an applicable margin determined by the Company's debt rating. The average interest rate for borrowings under the Revolving Credit Facility was approximately 2.8% at December 31, 2003. The Revolving Credit Facility includes operational and financial covenants customary for facilities of this type, including, among others, restrictions on additional indebtedness, liens and investments and maintenance of certain leverage ratios. As of December 31, 2003, The Company was in compliance with all covenants related to the Revolving Credit Facility.
The Company maintains letters of credit that guarantee its performance or payment to third parties in accordance with specified terms and conditions. Amounts outstanding were approximately $29,880,000 as of December 31, 2003 and $19,522,000 as of December 31, 2002. The following table presents the Company's Lettersletters of Credit for amounts committed but not drawn-downcredit are primarily letters of credit associated with insurance coverage and the amounts drawn-down
on such instruments.to a lesser extent foreign purchases. The Company's letters of credit generally expire within one year of issuance. The increase is
71
primarily associated with insurance coverage. These instruments may exist or expire without being drawn down. Therefore, the amounts committed but not drawn-down,they do not necessarily represent future cash flows.
(12) Common Stock
Since fiscal 1997, the Company's Board of Directors has authorized the repurchase of 4,380,200 shares of the Company's common stockCommon Stock in the open market and through private purchases. Since the inception of this repurchase program, 3,716,000 shares of the Company's common stockCommon Stock have been repurchased and retired.
The Class A Common Stock and Class B Common Stock have equal dividend and liquidation rights. Each share of the Company's Class A Common Stock is entitled to one vote on all matters submitted to stockholders and each share of Class B Common Stock is entitled to ten votes on all such matters. Shares of Class B Common Stock are convertible into shares of Class A Common Stock, on a one-to-one basis, at the option of the holder. TheAs of December 31, 2003, the Company has reserved a total of 5,799,987 shares3,528,825 of Class A Common Stock for issuance under its stock-based compensation plans and 8,735,2247,605,224 shares for conversion of Class B Common Stock to Class A Common Stock.
48
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(13) Stock-Based Compensation
The Company has severalmaintains four stock option plans under which key employees and outside directors have been granted incentive (ISOs) and nonqualified (NSOs) options to purchase the Company's Class A common stock.Common Stock. Generally, options become exercisable over a five year period at the rate of 20% per year and expire ten years after the date of grant. ISOs and NSOs granted under the plans have exercise prices of not less than 100% and 50% of the fair market value of the common stock on the date of grant, respectively. At December 31, 2001, 3,042,7232003, 3,528,825 shares of Class A common stockCommon Stock were authorized for future grants of options under the Company's stock option plans.
The following is a summary of stock option activity and related information:
| Years Ended December 31, | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 | ||||||||||||
| Options | Weighted Average Exercise Price | Options | Weighted Average Exercise Price | Options | Weighted Average Exercise Price | |||||||||
| (Options in thousands) | ||||||||||||||
Outstanding at beginning of year | 1,455 | $ | 14.29 | 1,757 | $ | 13.31 | 1,714 | $ | 13.03 | ||||||
Granted | 248 | 16.70 | 273 | 15.50 | 230 | 15.19 | |||||||||
Cancelled | (387 | ) | 13.35 | (73 | ) | 11.75 | (76 | ) | 13.89 | ||||||
Exercised | (301 | ) | 14.98 | (502 | ) | 11.88 | (111 | ) | 12.54 | ||||||
Outstanding at end of year | 1,015 | $ | 14.90 | 1,455 | $ | 14.29 | 1,757 | $ | 13.31 | ||||||
Exercisable at end of year | 504 | $ | 13.92 | 858 | $ | 14.11 | 1,171 | $ | 13.20 | ||||||
72
The following table summarizes information about options outstanding at December 31, 2001:
| Options Outstanding | Options Exercisable | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Range of Exercise Prices | Number Outstanding | Weighted Average Remaining Contractual Life (years) | Weighted Average Exercise Price | Number Exercisable | Weighted Average Exercise Price | ||||||||
| (Options in thousands) | ||||||||||||
$ | 9.20—$10.59 | 90 | 5.2 | $ | 10.58 | 90 | $ | 10.58 | |||||
$ | 10.72—$14.05 | 153 | 6.7 | 12.08 | 111 | 12.10 | |||||||
$ | 14.29—$17.50 | 772 | 7.0 | 16.05 | 303 | 15.57 | |||||||
1,015 | 6.3 | $ | 14.90 | 504 | $ | 13.92 | |||||||
The Company also has a Management Stock Purchase Plan that allows for the granting of Restricted Stock Units (RSUs) to key employees to purchase up to 1,000,000 shares of Class A common stockCommon Stock at 67% of the fair market value on
49
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued) the date of grant. RSUs vest annually over a three year period from the date of grant. The difference between the RSU price and fair market value at the date of awardgrant is amortized to compensation expense ratably over the vesting period. At December 31, 2001, 229,5432003, 200,692 RSUs were outstanding. Dividends declared for RSUs that remain unpaid at December 31, 20012003 total $62,900.
Pro forma information regarding net income$62,172.
The Company has elected to follow APB No. 25 and net income per share is
required by SFAS No. 123related interpretations in accounting for its stock-based compensation. In addition the Company provides proforma disclosure of stock-based compensation, as measured under the fair value requirements of FAS 123. These proforma disclosures, which are calculated for awards granted after June 30, 1995, are provided in Footnote 2 as if the
Company had accounted for its stock-based awards to employeesrequired under the
fair value method of SFAS 123.FAS 148. The weighted average grant date fair value of options granted are $2.78$4.48, $4.43 and $2.02 at$6.74 for the years ending December 31, 2003, 2002 and 2001, respectively. Also, the weighted average grant date fair value of RSUs related to Management Stock Purchase Plan are $6.55, $5.48 and 2000,
respectively, and $3.04 and $2.47 at$7.30 for the years ending December 31, 19992003, 2002 and June 30, 1999,2001, respectively.
The fair value of the Company's stock-based awards to employees (used in reconciliation of Footnote 2) was estimated using a Black-Scholes option pricing model and the following assumptions:
| Years Ended December 31, | ||||||
---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 | ||||
Expected life (years) | 5.0 | 5.0 | 5.0 | ||||
Expected stock price volatility | 28.3 | % | 33.2 | % | 52.4 | % | |
Expected dividend yield | 1.4 | % | 1.6 | % | 1.6 | % | |
Risk-free interest rate | 3.25 | % | 2.65 | % | 4.36 | % |
The fair value of the Company's pro forma information is as follows:
| Years Ended December 31, | ||||||
---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 | ||||
Expected life (years) | 3.0 | 3.0 | 3.0 | ||||
Expected stock price volatility | 28.3 | % | 33.2 | % | 52.4 | % | |
Expected dividend yield | 1.5 | % | 1.7 | % | 1.6 | % | |
Risk-free interest rate | 5.63 | % | 2.65 | % | 4.36 | % |
73
(14) 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 annuallyan annual amount that does not exceed the maximum amount that can be deducted for federal income tax purposes. The Company uses a September 30 measurement date for its plans.
The funded status of the defined benefit plans and amounts recognized in the balance sheet are as follows:
| December 31, | |||||||
---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | ||||||
| (in thousands) | |||||||
Change in projected benefit obligation | ||||||||
Balance at beginning of the year | $ | 41,961 | $ | 36,038 | ||||
Service cost | 2,021 | 1,512 | ||||||
Interest cost | 2,789 | 2,683 | ||||||
Actuarial loss | 6,550 | 3,495 | ||||||
Amendments/curtailments | 150 | 96 | ||||||
Benefits paid | (1,730 | ) | (1,863 | ) | ||||
Balance at end of year | $ | 51,741 | $ | 41,961 | ||||
Change in fair value of plan assets | ||||||||
Balance at beginning of the year | $ | 25,535 | $ | 28,724 | ||||
Actual gain (loss) on assets | 4,611 | (1,514 | ) | |||||
Employer contributions | 3,773 | 188 | ||||||
Benefits paid | (1,730 | ) | (1,863 | ) | ||||
Fair value of plan assets at end of the year | $ | 32,189 | $ | 25,535 | ||||
Funded Status | $ | (19,552 | ) | $ | (16,426 | ) | ||
Unrecognized transition obligation | (148 | ) | (403 | ) | ||||
Unrecognized prior service costs | 1,498 | 1,567 | ||||||
Unrecognized net actuarial gain | 13,681 | 10,003 | ||||||
Contributions after measurement date and on or before fiscal year end | 3,020 | — | ||||||
Net amount recognized | $ | (1,501 | ) | $ | (5,259 | ) | ||
Amounts recognized in the statement of financial position are as follows:
| December 31, | ||||||
---|---|---|---|---|---|---|---|
| 2003 | 2002 | |||||
| (in thousands) | ||||||
Accrued benefit costs | $ | (1,501 | ) | $ | (5,259 | ) | |
Minimum pension liability | $ | (10,551 | ) | $ | (7,526 | ) | |
Intangible assets | $ | 1,073 | $ | 1,073 |
74
Information for pension plans with an accumulated benefit obligation in excess of plan assets are as follows:
| December 31, | |||||
---|---|---|---|---|---|---|
| 2003 | 2002 | ||||
| (in thousands) | |||||
Projected benefit obligation | $ | 51,741 | $ | 41,961 | ||
Accumulated benefit obligation | $ | 47,260 | $ | 38,320 | ||
Fair value of plan assets | $ | 32,189 | $ | 25,535 |
The components of net periodic benefit cost are as follows:
| Years Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 | |||||||
| (in thousands) | |||||||||
Service cost—benefits earned | $ | 2,021 | $ | 1,512 | $ | 1,383 | ||||
Interest costs on benefits obligation | 2,789 | 2,683 | 2,487 | |||||||
Estimated return on assets | (2,281 | ) | (2,520 | ) | (3,003 | ) | ||||
Transitional obligation/(asset) amortization | �� | (255 | ) | (255 | ) | (255 | ) | |||
Prior service cost amortization | 219 | 205 | 146 | |||||||
Net loss/(gain) amortization | 521 | — | (173 | ) | ||||||
Net periodic benefit cost | $ | 3,014 | $ | 1,625 | $ | 585 | ||||
Additional Information:
| December 31, | |||||
---|---|---|---|---|---|---|
| 2003 | 2002 | ||||
| (in thousands) | |||||
Increase in minimum liability included in other comprehensive income | $ | 3,046 | $ | 6,432 |
Assumptions:
Weighted-average assumptions used to determine benefit obligations:
| December 31, | ||||
---|---|---|---|---|---|
| 2003 | 2002 | |||
Discount rate | 6.00 | % | 6.75 | % | |
Rate of compensation increase | 4.00 | % | 4.00 | % |
Weighted-average assumptions used to determine net periodic benefit costs:
| December 31, | ||||||
---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 | ||||
Discount rate | 6.75 | % | 7.50 | % | 7.50 | % | |
Long-term rate of return on asset | 8.50 | % | 9.00 | % | 9.00 | % | |
Rate of compensation increase | 4.00 | % | 4.50 | % | 4.50 | % |
In selecting the expected long-term rate of return on assets, the Company considers the average rate of earnings expected on the funds invested or to be invested to provide for the benefits of this
75
plan. This includes considering the trust's asset allocation and the expected returns likely to be earned over the life of the plan. This basis is consistent with the prior year.
Plan assets:
The weighted average asset allocations by asset category is as follows:
| Plan Assets At December 31, | ||||
---|---|---|---|---|---|
Asset Category | |||||
2003 | 2002 | ||||
Equity securities | 74.8 | % | 52.8 | % | |
Debt securities | 25.2 | % | 44.2 | % | |
Real estate | — | % | — | % | |
Other/cash | — | % | 3.0 | % | |
Total | 100.0 | % | 100.0 | % | |
The Company's written Retirement Plan Investment Policy sets forth the investment policy, objectives and constraints of the Watts Water Technologies, Inc. Pension Plan. This Retirement Plan Investment Policy, set forth by the Pension Plan Committee, defines general investment principles and directs investment management policy, addressing preservation of capital, risk aversion and adherence to investment discipline. Investment managers are to make a reasonable effort to control risk and are evaluated quarterly against commonly accepted benchmarks to ensure that the risk assumed is commensurate with the given investment style and objectives.
The portfolio is designed to achieve a balanced return of current income and modest growth of capital, while achieving returns in excess of the rate of inflation over the investment horizon in order to preserve purchasing power of Plan assets. All Plan assets are required to be invested in liquid securities. Derivative investments will not be allowed.
Prohibited investments include, but are not limited to the following: commodities and futures contracts, private placements, options, limited partnerships, venture-capital investments, real estate properties, interest-only (IO), principal-only (PO), and residual tranche CMOs, and Watts Water Technologies, Inc. stock.
Prohibited transactions include, but are not limited to the following: short selling and margin transactions.
Allowable assets include: cash equivalents, fixed income securities, equity securities, mutual funds, and GICs.
Specific guidelines regarding allocation of assets are as follows: equities shall comprise between 25% and 75% of the total portfolio, while fixed income shall comprise between 30% and 65%. Investment performance is monitored on a regular basis and investments are re-allocated to stay within specific guidelines. An equity/fixed income allocation of 55%/45% is preferred. The securities of any one company or government agency should not exceed 10% of the total fund, and no more than 20% of the total fund should be invested in any one industry. Individual treasury securities may represent 50% of the total fund, while the total allocation to treasury bonds and notes may represent up to 100% of the Plan's aggregate bond position.
76
Cash flows:
The information related to the Company's pension funds cash flow is as follows:
| December 31, | |||||
---|---|---|---|---|---|---|
| 2003 | 2002 | ||||
| (in thousands) | |||||
Employer Contributions | $ | 6,793 | $ | 188 | ||
Benefit Payments | $ | 1,730 | $ | 1,863 |
Contributions expected to be paid during 2004 are approximately $105,000.
Additionally, substantially all of the Company's domestic employees are eligible to participate in a 401(k) savings plan. Under this plan, the Company matches a specified percentage of employee contributions, subject to certain limitations. The Company's match expenseexpenses for the years ended December 31, 2003, 2002, and 2001 were $300,000, $330,000, and 2000,$324,000, respectively.
The Company entered into a Supplemental Compensation Agreement (the Agreement) with Timothy P. Horne on September 1, 1996. Per the Agreement, upon ceasing to be an employee of the Company, Mr. Horne must make himself available, as requested by the Board, to work a minimum of 300 but not more than 500 hours per year as a consultant in return for certain annual compensation as long he is physically able to do so. If Mr. Horne complies with the consulting provisions of the agreement above, he shall receive supplemental compensation on an annual basis of $400,000 per year in exchange for the six months endedservices performed, as long as he is physically able to do so. In the event of physical disability, subsequent to commencing consulting services for the Company, Mr. Horne will continue to receive $400,000 annually. The payment for consulting services provided by Mr. Horne will be expensed as incurred by the Company. Mr. Horne retired effective December 31, 1999,2002, and therefore the Supplemental Compensation period began on January 1, 2003. In accordance with Financial Accounting Standards Board Statement No. 106, "Employers Accounting for Post Retirement Benefits Other Than Pensions", the Company will accrue for the twelve
months ended June 30, 1999, were $324,000, $225,000, $200,000 and
$310,000, respectively.
50
Watts Industries, Inc. and Subsidiaries
Notesfuture post-retirement disability benefits over the period from January 1, 2003, to Consolidated Financial Statements (continued)
The components of the pension planstime in which Mr. Horne becomes physically unable to perform his consulting services (the period in which the disability benefits are as follows:
Twelve Months Twelve Months Twelve Months Twelve Months
Ended Ended Ended Ended
December 31, December 31, December 31, June 30,
2001 2000 1999 1999
------------- ------------- ------------- -------------
(in thousands)
Components of net benefit expense
Service cost - benefits earned $ 1,383 $ 1,314 $ 631 $ 1,485
Interest costs on benefits obligation 2,487 2,371 1,131 2,220
Estimated return on assets (3,003) (2,931) (1,358) (2,686)
------- ------- ------- -------
867 754 404 1,019
Net amortization /deferral (282) (271) 78 215
------- ------- ------- -------
Total benefit expense $ 585 $ 483 $ 482 $ 1,234
======= ======= ======= =======
The funded status of the defined benefit plan and amounts recognized in
the balance sheet are as follows:
December 31, December 31,
2001 2000
------------ ------------
(in thousands)
Change in projected benefit obligation
Balance at beginning of period $31,803 $30,088
Service cost 1,382 1,314
Interest cost 2,487 2,371
Actuarial (gain)/loss 1,182 (1,068)
Amendments/curtailments 631 181
Benefits paid (1,447) (1,083)
------- -------
Balance at end of period 36,038 31,803
======= =======
Change in fair value of plan assets
Balance at beginning of period 33,943 33,228
Actual return/(loss) on assets (4,010) 1,376
Employer contributions 238 422
Benefits paid (1,447) (1,083)
------- -------
Fair value of plan assets at end of period 28,724 33,943
======= =======
Plan assets in excess of (less than)
benefit obligation (7,315) 2,141
Unrecognized transition obligation (657) (911)
Unrecognized prior service costs 1,677 1,192
Unrecognized net actuarial gain/(loss) 2,474 (5,895)
------- -------
Net accrued benefit costs $(3,821) $(3,473)
======= =======
Accrued benefit liability (476) (443)
Intangible asset 476 443
The weighted average assumptions used in determining the obligations of
pension benefit plans are shown below:
December 31, December 31, December 31, June 30,
2001 2000 1999 1999
------------ ------------ ------------ --------
Discount rate 7.50% 8.00% 7.75% 7.00%
Expected return on plan assets 9.00% 9.00% 9.00% 9.00%
Rate of compensation increase 4.50% 5.00% 5.00% 5.00%
51
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
earned).
(15) Contingencies and Environmental Remediation
Contingencies
In April 1998, the Company became aware of a complaint (the Armenta case) that was filed by Nora Armenta (the Relator) under seal in the State of California alleging violations of the California False Claims Act. The complaint alleges that a former subsidiary of the Company (James Jones Company) sold products utilized in municipal water systems that failed to meet contractually specified standards and falsely certified that such standards had been met. The complaint further alleges that the municipal entities have suffered tens
of millions of dollars in damages as a result of defective products and seeks treble damages, reimbursement of legal costs and penalties. DuringThe original complaint has been amended, and the quarter ended December 31, 2000,total number of named plaintiffs is 161, 11 of which have intervened and 47 of which have been ordered excluded from the case. In June 2001, the Company made an offer to
settle all of the claims ofand other defendants reached a proposed settlement with the Los Angeles Department of Water and Power, one of the plaintiffs in the James Jones case, (Los Angeles Department of Water and Power, ex
rel. Nora Amenta v. James Jones Company, et al). This offerwhich was approved by the California Superior Court on October 31, 2001 and by the Los Angeles City Council on December 14, 2001. The other plaintiffs remain, and the Company is vigorously contesting this matter.
77
In this case, the Relator seeks three times an unspecified amount of actual damages and alleges that the municipalities have suffered hundreds of millions of dollars in damages. The Relator also seeks civil penalties of $10,000 for each false claim and alleges that defendants are responsible for tens of thousands of false claims. The Company settled with the City of Los Angeles, by far the most significant city, for $5.7 million plus the Relator's statutory share and attorneys' fees. Co-defendants will contribute $2.0 million toward this settlement. In August 2003, an additional settlement payment was made for $13 million ($11 million from the Company and $2 million from the James Jones Company) which settled the claims of the three Phase I cities (Santa Monica, San Francisco and East Bay Municipal Water District) chosen by the Relator as having the strongest claims to be tried first. This settlement payment included the Relator's statutory share, and the claims of these three cities have been dismissed. In addition to this $13 million payment, the Company is obligated to pay the Relator's attorney's fees.
After the Phase I settlement, the Court permitted the Company and the other defendants to select five additional cities (Contra Costa, Corona, Santa Ana, Santa Cruz and Vallejo) to serve as the plaintiffs in a second trial phase of the case. The Company and James Jones subsequently reached an agreement to settle the City of Santa Ana's claims for $45,000, and the Company is responsible for $38,000 of this settlement amount. Santa Ana has submitted this claim to the Court for approval in March 2004. The trial of the claims of the remaining Phase II cities is scheduled for September 2004.
The Company has a reserve of approximately $9.3 million with respect to the James Jones Litigation in its consolidated balance sheet as of December 31, 2003. The Company believes, on the basis of all available information, that this reserve is adequate to cover its probable and reasonably estimable losses resulting from the James Jones Litigation and the insurance coverage litigation with Zurich discussed below. The Company is currently pursuing insurance coverage for this case with its carriers. As a result
of these developments and management's current assessment of the case, the
Company recorded a charge of $7,170,000 after tax in the quarter ended
December 31, 2000, which represents the Company's currentunable to make an estimate of the cost to bringrange of any additional losses.
On February 14, 2001, the entire case to resolution. This charge is reported as
loss from discontinued operations. While this charge representsCompany filed a complaint in the after
tax impactCalifornia Superior Court against its insurers for coverage of the claims in the Armenta case. The James Jones Company filed a similar complaint, the cases were consolidated, and on October 30, 2001 the California Superior Court made a summary adjudication ruling that Zurich American Insurance Company (Zurich) must pay all reasonable defense costs incurred by the Company in the Armenta case since April 23, 1998 as well as the Company's current estimate based onfuture defense costs in this case until its final resolution. On October 24, 2002, the California Superior Court made another summary adjudication ruling that Zurich must indemnify and pay the Company for the amounts the Company must pay under its settlement agreement with the City of Los Angeles. Zurich has asserted that all available
information, litigation is inherently uncertainamounts (both defense costs and the actual liabilityindemnity amounts paid for settlements) paid by it to the Company are subject to fully resolve the litigation could be materially higher
than this estimate.
Other lawsuits and proceedings or claims, arising from the ordinary course
of operations, are also pending or threatened againstreimbursement under Deductible Agreements between the Company and Zurich. However, management and counsel anticipate that the Company will ultimately prevail on reimbursement issues. Zurich appealed the orders requiring it to pay defense costs, the California Court of Appeal accepted that appeal, and it is currently pending. Zurich also sought appellate review of the order that found coverage and required Zurich to indemnify the Company for the settlement with the City of Los Angeles. On March 26, 2003, the California Court of Appeal denied Zurich's petition for appellate review of this order, but Zurich will still be able to appeal this order at the end of the case. The Company is currently unable to predict the finality of the order on indemnity for the Los Angeles settlement. The Company has recorded reimbursed indemnity settlement amounts (but not reimbursed defense costs) as a liability. The Company intends to contest vigorously the Armenta case and its subsidiaries.related litigation.
Based on the facts currently known to it,management's assessment, the Company does not believe that the ultimate outcome of these other litigation matters
willthe James Jones case would have a material adverse effect on its liquidity, financial condition or results
78
of operation.
operations. While this assessment is based on all available information, litigation is inherently uncertain, the actual liability to the Company to fully resolve this litigation cannot be predicted with any certainty and there exists a reasonable possibility that the Company may ultimately incur losses in the James Jones Litigation in excess of the amount accrued. The Company intends to continue to contest vigorously the James Jones case and its related litigation.
Environmental Remediation
The Company has been named as a potentially responsible party (PRP) with respect to a limited number of identified contaminated sites. The level of contamination varies significantly from site to site as do the related levels of remediation efforts. Environmental liabilities are recorded based on the most probable cost, if known, or on the estimated minimum cost of remediation. The Company's accrued estimated environmental liabilities are based on assumptions, which are subject to a number of factors and uncertainties. Circumstances which can affect the reliability and precision of these estimates include identification of additional sites, environmental regulations, level of cleanup required, technologies available, number and financial condition of other contributors to remediation and the time period over which remediation may occur. The Company recognizes changes in estimates as new remediation requirements are defined or as new information becomes available. The Company has a reserve of approximately $2.5 million and estimates that its accrued environmental remediation liabilities will likely be paid over the next five to ten years. TheBased on the facts currently known to it, the Company does not believe that the ultimate outcome of these claims will have a material adverse effect on the Company's liquidity, financial condition or results of operations.
For several years, the New York Attorney General ("NYAG"), on behalf of the New York State
Department of Environmental Conservation ("NYSDEC"),(NYAG) has threatened litigationto bring suit against approximately 16 PRPs, including Watts Water Technologies, Inc as successor to Jameco Industries, Inc., for incurred remediation costs and for operation and maintenance costs that will be incurred in connection with the Company and approximately fifteen (15) other
Potentially Responsible Parties ("PRPs") for the costcleanup of closing, and
controlling contamination from, the Babylon Landfilla landfill site in Babylon, New York. The NYAG has identified recovery numbers between $19 million and $24 million, but it is too early to know what the final recovery number will be, what the final number of PRPs will be or what proportion of the final costs may be allocated to the Company. In 2003, 139 PRPs were identified by the Company's defense group, and they are in the process of being invited to join the PRPs identified so far by the NYAG. Based on the facts currently known to it, the Company agreed to enterdoes not believe that the ultimate outcome of the Babylon matter will have a tolling agreement withmaterial adverse effect on the NYAG to permit
formationCompany's liquidity, financial condition or results of operations.
Asbestos Litigation
The Company is a PRP groupdefendant in approximately 115 actions filed primarily, but not exclusively, in Mississippi and New Jersey state courts and alleging injury or death as a first step toward establishing a negotiation
process. The NYAG has produced only a recordresult of an interview in which a
landfill employee stated that, before the Company had acquired the Jameco
company, Jameco had delivered wasteexposure to the site in its own trucks. The
Company knowsasbestos. These filings typically name multiple defendants, and are filed on behalf of no other information connecting it ormany plaintiffs. They do not identify any predecessor to
this site.
On September 25, 2001, the United States Environmental Protection Agency
("EPA") issued a complaint and compliance order to the Watts Regulator
Co., a wholly owned subsidiaryparticular products of the Company underas a source of asbestos exposure. To date the Resource
Conservation and Recovery Act ("RCRA") with respectCompany has been dismissed from each case when the scheduled trial date comes near. Based on the facts currently known to it, the Company does not believe that the ultimate outcome of these claims will have a sand reclamation
unitmaterial adverse effect on the Company's liquidity, financial condition or results of operations.
Other Litigation
On or about March 26, 2003, a class action complain was filed against the Company by North Carolina Hospitality Group, Inc. in the Circuit Court of Maryland, Prince George's County. It alleges
79
that certain commercial valve models contain a design defect that causes them to fail prematurely. Based on the Company's extensive investigation of the evidence, including the physical evidence presented so far by the plaintiff, management believes that the allegations in the complaint are without merit, and the sandCompany intends to defend this lawsuit vigorously. Based on the facts currently known to it, generated atthe Company does not believe that the ultimate outcome of these claims will have a material adverse effect on the Company's liquidity, financial condition or results of operations.
Other lawsuits and proceedings or claims, arising from the ordinary course of operations, are also pending or threatened against the Company and its Spindale, North Carolina facility.
All requirementssubsidiaries. Based on the facts currently known to it, the Company does not believe that the ultimate outcome of this complaintthese matters will have a material adverse effect on its financial condition or results of operation.
However, litigation is inherently uncertain, and compliance order have been resolved
bythe Company believes that there exists a Consent Agreement and Final Order filed on January 30, 2002, which
requires payment of a $100,000 civil penalty and submissions of a closure
report for the reclamation unit and a site assessment report for what
becamereasonable possibility that it may ultimately incur losses in other litigation in excess of the reclaimed sand which currently appears to have been used in
a manner acceptable to the EPA.
52
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
amount accrued.
(16) Financial Instruments
Fair Value
The carrying amounts of cash and cash equivalents, trade receivables and trade payables approximate fair value because of the short maturity of these financial instruments.
The fair value of the Company's 8-3/8%4.87% senior notes, due December 2003,2010 and 5.47% senior notes due 2013, is based on quoted market prices. 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:
December 31, December 31,
2001 2000
------------ ------------
(in thousands)
Carrying amount $126,905 $106,618
Estimated fair value $131,990 $109,768
| December 31, | |||||
---|---|---|---|---|---|---|
| 2003 | 2002 | ||||
| (in thousands) | |||||
Carrying amount | $ | 192,312 | $ | 138,487 | ||
Estimated fair value | $ | 193,130 | $ | 142,162 |
Derivative Instruments
The Company uses foreign currency forward exchange contracts to reduce the impact of currency fluctuations on certain anticipated intercompany purchase transactions that are expected to occur within the fiscal year and certain other foreign currency transactions. Related gains and losses are recognized in other income/expense when the contracts expire, which is generally in the same period as the underlying foreign currency denominated transaction. 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. At December 31, 20012003, 2002 and 2000,2001, the Company had no outstanding forward contracts to buy foreign currencies.
The Company uses commodity futures contracts to fix the price on a certain portion of certain raw materials used in the manufacturing process. These contracts highly correlate to the actual purchases of the commodity and the contract values are reflected in the cost of the commodity as it is actually purchased. At June 30, 1999, the Company had outstanding
contracts with a notional value of $3.5 million and a fair value of $0.2
million. In December 1999, these contacts were sold and the Company
realized a gain of approximately $0.5 million. This gain was deferred at
December 31, 1999 and was off-set against the costs of January and
February 2000 raw material purchases, hedged in the original transaction.
There were no commodity contracts outstanding atutilized for years ended December 31, 20012003, 2002 and 2000.2001.
Effective July 1, 2003, the Company entered into an interest rate swap for a notional amount of 25,000,000 euro outstanding on our Revolving Credit Facility. The Company swapped the variable rate
80
from the Revolving Credit Facility which is three month EURIBOR plus 0.7% for a fixed rate of 2.33%. The term of the swap is two years. The Company designated the swap as a hedging instrument using the cash flow method. The swap hedges the cash flows associated with interest payments on the first 25,000,000 euro of our Revolving Credit Facility. The Company marks to market the changes in value of the swap through other comprehensive income. Any ineffectiveness has been recorded in income. The fair value recorded in other comprehensive income as of December 31, 2003 was $46,000.
At December 31, 2001, the Company had an outstanding interest rate swap that converted 20 million20,000,000 euro of the borrowings under variable rate euro Line of Credit to a fixed rate borrowings at 4.3%. This swap agreement expiresexpired in March 2002 and its value and its impact on the Company's results was not material at December 31, 2001.2002.
In September 2001, the Company entered an interest rate swap for its $75
million$75,000,000 83/8% notes. The Company swapped the fixed interest rate of 8 3/8%3/8% to floating LIBOR plus 3.74%. ThisOn August 5, 2002, the Company sold the swap qualifies forand received $2,315,000 in cash. Based on the Company terminating this hedge accountingtransaction, the adjustment to the fair value was amortized, over the term of the Notes which matured December 1, 2003.
Leases
The Company leases certain manufacturing facilities, sales offices, warehouses, and equipment. Generally the leases carry renewal provisions and require the Company to pay maintenance costs. Future minimum lease payments under FAS 133. The swap reduced interest expense by $641,000 during the year
endedcapital leases and non-cancelable operating leases as of December 31, 2001. This swap expires in December 2003 and has a fair
value of $1,091,000 at December 31, 2001.
53
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
are as follows:
| Operating Leases | Capital Leases | ||||
---|---|---|---|---|---|---|
2004 | $ | 1,992 | $ | 653 | ||
2005 | 1,834 | 356 | ||||
2006 | 1,697 | 223 | ||||
2007 | 1,175 | 132 | ||||
2008 | 1,187 | — | ||||
Thereafter | 1,730 | — | ||||
Total | $ | 9,615 | $ | 1,364 | ||
(17) Segment Information
The following table presents certain operating segment information:
North
America Europe Asia Corporate Consolidated
------- ------ ---- --------- ------------
(in thousands)
Twelve Months Ended December 31, 2001
Net sales $415,689 $121,228 $12,023 $ -- $548,940
Operating income 47,346 11,256 465 (8,784) 50,283
Identifiable assets 343,187 153,007 24,276 -- 520,470
Capital expenditures 10,508 3,351 2,188 -- 16,047
Depreciation and amortization 16,109 6,820 746 -- 23,675
Twelve Months Ended December 31, 2000
Net sales $400,384 $103,085 $12,631 $ -- $516,100
Operating income 55,661 13,225 882 (9,781) 59,987
Identifiable assets 332,621 125,213 24,191 -- 482,025
Capital expenditures 11,466 2,558 214 -- 14,238
Depreciation and amortization 14,229 5,185 657 -- 20,071
Six Months Ended December 31, 1999
Net sales $192,975 $ 58,934 $ 9,110 $ -- $261,019
Operating income 27,793 7,252 731 (6,218) 29,558
Identifiable assets 327,431 136,246 23,401 -- 487,078
Capital expenditures 8,764 1,396 133 -- 10,293
Depreciation and amortization 6,373 2,537 315 -- 9,225
Twelve Months Ended June 30, 1999
Net sales $372,220 $ 92,631 $13,018 $ -- $477,869
Operating income 54,094 11,228 1,608 (15,092) 51,838
Identifiable assets 481,648 133,720 22,374 -- 637,742
Capital expenditures 17,987 3,471 74 -- 21,532
Depreciation and amortization 12,851 3,921 684 -- 17,456
Under the criteria set forth in Financial Accounting Standards Board No.131 "Disclosure about Segments of an Enterprise and Related Information", the Company operates in three geographic segments: North America, Europe, and China. Each operating segmentof these segments is individually managed separately and has separate financial results that are reviewed by the Company's chief operating decision-maker. 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 (see Note 2).
81
The following is a summary of our significant accounts and balances by segment, reconciled to our consolidated totals:
| North America | Europe | China | Corporate(*) | Consolidated | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) | ||||||||||||||
Year ended December 31, 2003 | |||||||||||||||
Net sales | $ | 476,310 | $ | 210,614 | $ | 18,727 | $ | — | $ | 705,651 | |||||
Operating income (loss) | 64,414 | 22,592 | (3,834 | ) | (13,132 | ) | 70,040 | ||||||||
Identifiable assets | 509,010 | 266,849 | 62,784 | — | 838,643 | ||||||||||
Long-lived assets | 72,592 | 48,882 | 24,237 | — | 145,711 | ||||||||||
Capital expenditures | 6,500 | 4,832 | 8,703 | — | 20,035 | ||||||||||
Depreciation and amortization | 12,542 | 6,593 | 2,149 | — | 21,284 | ||||||||||
Year ended December 31, 2002 | |||||||||||||||
Net sales | $ | 450,233 | $ | 145,629 | $ | 19,664 | $ | — | $ | 615,526 | |||||
Operating income (loss) | 55,313 | 13,608 | (625 | ) | (10,767 | ) | 57,529 | ||||||||
Identifiable assets | 375,202 | 206,146 | 54,124 | — | 635,472 | ||||||||||
Long-lived assets | 78,333 | 40,295 | 15,748 | — | 134,376 | ||||||||||
Capital expenditures | 5,718 | 6,171 | 7,704 | — | 19,593 | ||||||||||
Depreciation and amortization | 14,731 | 6,370 | 1,193 | — | 22,294 | ||||||||||
Year ended December 31, 2001 | |||||||||||||||
Net sales | $ | 415,689 | $ | 121,228 | $ | 12,023 | $ | — | $ | 548,940 | |||||
Operating income (loss) | 47,294 | 11,308 | 1,365 | (9,684 | ) | 50,283 | |||||||||
Identifiable assets | 343,187 | 153,007 | 24,276 | — | 520,470 | ||||||||||
Long-lived assets | 86,409 | 36,495 | 5,702 | — | 128,606 | ||||||||||
Capital expenditures | 10,508 | 3,351 | 2,188 | — | 16,047 | ||||||||||
Depreciation and amortization | 16,109 | 6,820 | 746 | — | 23,675 |
* Corporate expenses are primarily for compensation expense, professional fees, including legal and audit expenses 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 North American segment consists of U.S. net sales of $443,228,000, $422,703,000 and $393,455,000 for the years ended December 31, 2003, 2002 and 2001, respectively. The North American segment also consists of long-lived assets of $67,595,000, $73,907,000 and $81,723,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
Goodwill amounts to $184,901,000 of which $100,017,000 is reported in the North American segment, $81,812,000 is reported in the European segment, and $3,072,000 is reported in the Chinese segment as of December 31, 2003.
All intercompany transactions have been eliminated, and intersegment revenues are not significant.
54
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
82
(18) Quarterly Financial Information (unaudited)
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands, except per share information)
Twelve months ended December 31, 2001:
Net sales $135,925 $135,562 $138,009 $139,444
Gross profit 46,664 46,349 46,943 43,576
Net income from continuing operations 7,273 7,035 7,809 4,439
Net income 7,273 7,035 7,809 4,439
Per common share:
Basic
Income from continuing operations 0.27 0.27 0.29 0.17
Net income 0.27 0.27 0.29 0.17
Diluted
Income from continuing operations 0.27 0.26 0.29 0.17
Net income 0.27 0.26 0.29 0.17
Dividends per common share .0600 .0600 .0600 .0600
Twelve months ended December 31, 2000:
Net sales $131,651 $131,184 $125,656 $127,609
Gross profit 47,374 47,229 45,856 44,845
Net income from continuing operations 7,940 8,027 7,670 7,534
Net income 7,940 8,027 7,670 364
Per common share:
Basic
Income from continuing operations .30 .30 .29 .28
Net income .30 .30 .29 .01
Diluted
Income from continuing operations .30 .30 .29 .28
Net income .30 .30 .29 .01
Dividends per common share .0875 .0600 .0600 .0600
Six months ended December 31, 1999:
Net sales $131,375 $129,644
Gross profit 47,940 47,226
Net income from continuing operations 9,042 7,426
Net income 8,297 6,945
Per common share:
Basic
Income from continuing operations .34 .28
Net income .31 .26
Diluted
Income from continuing operations .34 .28
Net income .31 .26
Dividends per common share .0875 .0875
Twelve months ended June 30, 1999:
Net sales $114,007 $115,225 $117,855 $130,782
Gross profit 41,824 41,748 42,771 48,781
Net income from continuing operations 7,893 7,332 6,905 7,324
Net income 12,388 11,256 6,905 5,407
Per common share:
Basic
Income from continuing operations .29 .27 .26 .27
Net income .46 .42 .26 .20
Diluted
Income from continuing operations .29 .27 .26 .27
Net income .46 .42 .26 .20
Dividends per common share .0875 .0875 .0875 .0875
55
Watts Industries, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands, except per share information) | ||||||||||||
Year ended December 31, 2003 | |||||||||||||
Net sales | $ | 165,692 | $ | 173,512 | $ | 175,509 | $ | 190,938 | |||||
Gross profit | 55,764 | 58,565 | 59,373 | 66,959 | |||||||||
Income from continuing operations | 8,936 | 8,680 | 9,019 | 9,838 | |||||||||
Net income | 6,610 | 8,106 | 8,905 | 9,741 | |||||||||
Per common share: | |||||||||||||
Basic | |||||||||||||
Income from continuing operations | 0.33 | 0.32 | 0.33 | 0.35 | |||||||||
Net income | 0.24 | 0.30 | 0.33 | 0.35 | |||||||||
Diluted | |||||||||||||
Income from continuing operations | 0.33 | 0.32 | 0.33 | 0.34 | |||||||||
Net income | 0.24 | 0.30 | 0.32 | 0.34 | |||||||||
Dividends per common share | 0.06 | 0.06 | 0.06 | 0.07 | |||||||||
Year ended December 31, 2002 | |||||||||||||
Net sales | $ | 143,320 | $ | 151,505 | $ | 159,811 | $ | 160,890 | |||||
Gross profit | 49,479 | 52,232 | 53,507 | 53,502 | |||||||||
Income from continuing operations | 8,056 | 8,633 | 8,773 | 7,160 | |||||||||
Net income | 8,056 | 8,633 | 8,773 | 7,160 | |||||||||
Per common share: | |||||||||||||
Basic | |||||||||||||
Income from continuing operations | 0.30 | 0.32 | 0.33 | 0.27 | |||||||||
Net income | 0.30 | 0.32 | 0.33 | 0.27 | |||||||||
Diluted | |||||||||||||
Income from continuing operations | 0.30 | 0.32 | 0.32 | 0.26 | |||||||||
Net income | 0.30 | 0.32 | 0.32 | 0.26 | |||||||||
Dividends per common share | 0.06 | 0.06 | 0.06 | 0.06 |
(19) Subsequent Events
On February 5, 200220, 2004, the Company signedentered into an agreement with the Yuhuan County Cheng Guan Metal Hose Factory to acquire its 40% equity interest in its Taizhou Shida Plumbing Manufacturing Co., Ltd. (Shida) joint venture for an expected purchase price of $3,000,000, the assumption of approximately $6,000,000 of debt and Yuhuan Shida Pipe Product Company, Ltd.
to establishthe payment of $3,500,000 in connection with a joint venture. Thethree-year non-compete agreement. After the transaction the Company will invest $7.8 million and
receive a 60% shareown 100% of Shida. The closing of the joint venture. The joint venture will
manufacture flexible hosetransaction is subject to the satisfaction of certain closing conditions and connectors. Theis expected to occur during the second quarter of 2004.
On January 5, 2004, a wholly-owned subsidiary of the Company is awaiting
government approval, which it anticipates it will receive on or about
March 1, 2002.
56
acquired substantially all of the assets of Flowmatic Systems, Inc. located in Dunnellon, Florida, for approximately $16,500,000 in cash. Flowmatic designs and distributes a complete line of high quality reverse osmosis components and filtration equipment. Their product line includes stainless steel and plastic housings, filter cartridges, storage tanks, control valves, as well as complete reverse osmosis systems for residential and commercial applications.