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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended December 31, | ||
or | ||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 1-11499
001-11499
WATTS WATER TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware |
| |
(State or Other Jurisdiction of | (I.R.S. Employer | |
Incorporation or Organization) | Identification No.) | |
815 Chestnut Street, North Andover, MA |
| |
(Address of | (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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x
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 ýx 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'sRegistrant’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. ýo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated filer x Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ý Noo No x
AggregateAs of July 1, 2005, the aggregate market value of the votingregistrant’s common stock of the Registrant held by non-affiliates of the Registrantregistrant was $841,377,634 based on June 30, 2003 was $342,879,115.the closing sale price as reported on the New York Stock Exchange.
AsIndicate the number of February 29, 2004, 24,709,427 shares outstanding of Class A Common Stock, $.10 par value, 7,471,700 shares of Class B Common Stock, $.10 par value,each of the Registrant were outstanding.issuer’s classes of common stock, as of the latest practicable date.
Class | Outstanding at February 22, 2006 | |
Class A Common Stock, $0.10 par value per share | 25,270,700 shares | |
Class B Common Stock, $0.10 par value per share | 7,343,880 shares |
DOCUMENTS INCOPORATED BY REFERENCE
Documents Incorporated by Reference
Portions of the Registrant'sRegistrant’s Proxy Statement for its Annual Meeting of Stockholders to be held on May 5, 2004,4, 2006, are incorporated by reference into Part III of this Annual Report on Form 10-K.
This annual report on Form 10-K contains 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 contain projections of our future results of operations or our financial position or state other forward-looking information. In some cases you can identify these statements by forward-looking words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "should," "will"“anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “should,” “will” and "would"“would” or similar words. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond our control. These risks, uncertainties and other factors may cause our actual results, performance or achievements to differ materially from the anticipated future results, performance or achievements expressed or implied by the forward-looking statements. Some of the factors that might cause these differences are described under Item 7—"Management's Discussion and Analysis of Financial Condition and Results of Operations—Certain Factors Affecting Future Results."1A—“Risk Factors.” You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences. These forward-looking statements were based on information, plans and estimates at the date of this report, and 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“the Company," "we"” “Watts,” “we,” “us” or "us"“our” refer to Watts Water Technologies, Inc. and its consolidated subsidiaries.
Overview
Watts Water Technologies, Inc.Regulator Co. was founded by Joseph E. Watts in 1874 in Lawrence, Massachusetts, asMassachusetts. Watts Regulator Co. The Company started as a small machine shop supplying parts to the New England textile mills of the 19th19th century and has growngrew into a global manufacturer of products and systems focused on the control, conservation and quality of water and the comfort and safety and flow control products forof the residential and commercial plumbing, heating and water quality markets. The Companypeople using it. Watts Water Technologies, Inc. was incorporated in Delaware in 1985 underand became the nameparent Company of Watts Industries, Inc. The Company's name was changed to Watts Water Technologies, Inc. in October 2003.Regulator Co.
Our "Water“Water by Watts"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 wholesale and 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. For example, our recently acquired subsidiary, Dormont Manufacturing Company, provides flexible stainless steel connectors for natural and liquid propane gas and fluid conveyance applications to customers in the commercial foodservice, residential, and appliance original equipment manufacturers (OEMs) markets. Lastly, we are committed to reducing our manufacturing costs through a combination of expanding manufacturing in lower-costlower 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).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 for 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'sManagement’s Discussion and Analysis included elsewhere in this report.
Recent DevelopmentsAcquisitions
On February 20, 2004,December 28, 2005, we entered into an agreement with Yuhuan County Cheng Guan Metal Hose Factory to acquire its 40% equity interestacquired 100% of the stock of Dormont Manufacturing Company (Dormont) located in our Taizhou Shida Plumbing Manufacturing Co., Ltd. (Shida) joint ventureExport, Pennsylvania, for an expected purchase priceapproximately $94.9 million net of $3.0 million, the assumptioncash acquired of approximately $6.0$1.5 million. The preliminary allocations for goodwill and intangible assets are approximately $43.2 million and $35.9 million, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated 13-year lives and trade names with indefinite lives. Dormont provides flexible stainless steel connectors for natural and liquid propane gas. Dormont works with appliance OEM’s to provide internal component assemblies and private label gas connectors, which are sold under the OEM brand with the appliance in multiple leading retail chains. Dormont also supplies residential gas connectors through multiple trade channels and home improvement retailers. Dormont provides a core-plumbing product which is complimentary to our existing water product lines.
On December 2, 2005, we acquired 100% of debt and the paymentstock of $3.5Core Industries Inc. (Core) from SPX Corporation for approximately $45.0 million in connectioncash. Core consists of FEBCO, Mueller Steam Specialty and Polyjet Valves product lines. The preliminary allocations for goodwill and intangible assets are approximately $11.3 million and $14.5 million, respectively. The amount recorded as intangible assets is primarily for trade names with indefinite lives and customer relationships that have estimated 12-year lives. FEBCO is a manufacturer of backflow prevention valves and has a strong presence in both residential and commercial landscape irrigation. Mueller Steam Specialty allows us to expand into large diameter commercial strainers and check valves. Polyjet Valves offers a customized sleeve valve, which is used in severe service applications to provide precise flow and pressure control. We expect that this acquisition will allow us to offer a broader product line, improve operating efficiencies and provide better customer service.
On November 4, 2005, we acquired the assets of Flexflow Tubing LLP (Flexflow), located in Langley, British Columbia, Canada for approximately $6.2 million. The purchase agreement contains an earn-out provision to be calculated over a five-year period ending December 31, 2010. Earn-out payments under the purchase agreement, if any, will not exceed $4.3 million and will be treated as additional purchase price. Flexflow manufactures pex tubing for potable and non-potable applications. The preliminary allocations for goodwill and intangible assets are approximately $3.2 million and $0.9 million, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated 12-year lives. The acquisition of Flexflow is consistent with our strategy to increase our presence in the under floor radiant heating and potable water markets. This acquisition allows us to expand our presence in the market for flexible pex pipes for hot and cold-water transport.
On July 8, 2005, we acquired the water connector business of the Donald E. Savard Company (Savard) in an asset purchase transaction for approximately $3.7 million. The allocations for goodwill and intangible assets are approximately $1.4 million and $1.8 million, respectively. The amount recorded as intangible assets is primarily for trade names with indefinite lives and customer relationships that have 14-year lives. The acquisition of the water connector business of Savard is consistent with our theme of
water safety and control. This acquisition allows us to expand our presence in one of our leading product lines with a three-year non-compete agreement. Afterbrand name that is well known to the transaction,plumbing wholesale market.
On July 5, 2005, we will ownacquired 100% of Shida.the outstanding stock of Microflex N.V. (Microflex) located in Rotselaar, Belgium for approximately $14.9 million net of cash acquired of approximately $0.9 million. The closingallocations for goodwill and intangible assets are approximately $6.5 million and $5.3 million, respectively. The amount recorded as intangible assets is primarily for customer relationships that have 7-year lives and trade names that have indefinite lives. Microflex produces and distributes flexible, pre-insulated, pex pipes for hot and cold-water transport, as well as a range of accessory products including couplings, caps, and insulation kits in the HVAC and water protection markets.
On June 20, 2005, we acquired the water softener business of Alamo Water Refiners, Inc. (Alamo) located in San Antonio, Texas in an asset purchase transaction for approximately $5.1 million. The allocation for intangible assets is approximately $0.3 million and is primarily for the trade name with an indefinite life. There was no allocation to goodwill. The water softener products of Alamo are consistent with our theme of water quality and provide many synergistic opportunities when utilized in conjunction with our existing water filtration and water quality businesses. The acquisition of Alamo also expands our distribution presence into the southwestern U.S. markets.
On May 11, 2005, we acquired 100% of the transactionoutstanding stock of Electro Controls Ltd. (Electro Controls) located in Hounslow, United Kingdom for approximately $11.7 million net of cash acquired of approximately $5.0 million. The allocations for goodwill and intangible assets are approximately $5.8 million and $0.3 million, respectively. The amount recorded as intangible assets is subject toprimarily for trade names that have indefinite lives. Electro Controls designs and assembles a range of electrical controls for the satisfaction of certain closing conditions and is expected to occur duringHVAC market, with sales primarily in the second quarter of 2004.United Kingdom.
On January 5, 2004,2005, we acquired 100% of the outstanding stock of HF Scientific, Inc. (HF) located in Fort Myers, Florida for approximately $7.3 million in cash plus $0.8 million in assumed debt. The allocations for goodwill and intangible assets are approximately $4.2 million and $2.7 million, respectively. The amount recorded as intangible assets is primarily for customer relationships that have 15-year lives and trade names that have indefinite lives. HF manufactures and distributes a line of instrumentation equipment, test kits and chemical reagents used for monitoring water quality in a variety of applications.
On January 4, 2005, we acquired substantially all of the assets of Flowmatic Systems,Sea Tech, Inc. (Sea Tech) located in Dunnellon, Florida,Wilmington, North Carolina for approximately $16.5$10.1 million in cash. Flowmatic designsThe purchase agreement contains an earn-out provision to be calculated on a cumulative basis over a three-year period ending December 31, 2007. Payments under the agreement, if any, will not exceed $5,000,000 and distributeswill be treated as additional purchase price. The allocations for goodwill and intangible assets are approximately $6.5 million and $3.0 million, respectively. The amount recorded as intangible assets is primarily for customer relationships that have 15-year lives and trade names that have indefinite lives. Sea Tech provides cost-effective solutions for fluidic connection needs. Sea Tech offers a complete linewide range of high quality reverse osmosis componentsstandard 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 distributescustom quick connect fittings, valves and filters utilized in heating applications including strainer filters, solenoid valves, flow stop valves, stainless steel water filter elementsmanifolds and steam cleaning filters.pex tubing designed to address specific customer requirements.
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.Products
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 linesrange of products in terms of design distinction, size and configuration within a majority of the principal product lines we manufacture and market. Our principal product lines include:
·backflow preventers for preventing contamination of potable water caused by reverse flow within water supply lines and fire protection systems;
·a wide range of water pressure regulators for both commercial and residential applications;
·water supply and drainage products for commercial and residential applications;
·temperature and pressure relief valves for water heaters, boilers and associated systems;
·point-of-use water filtration and reverse osmosis systems for both commercial and residential applications;
·thermostatic mixing valves for tempering water in commercial and residential applications; and
· systems for under-floor radiant applications.
· flexible stainless steel connectors for natural and liquid propane gas in commercial food service and residential applications.
Customers and Markets
We sell our products to plumbing, heating and mechanical wholesale distributors, major DIY chains and OEMs.
Wholesalers.Approximately 62%64% and 63% of our 2003 sales in 2005 and 2004, respectively, were to wholesale distributors for both commercial and residential applications. We rely on commissioned manufacturers'manufacturers’ representatives, some of which maintain a consigned inventory of our products, to market our product lines.
DIY.Approximately 20%18% of our 2003 sales in both 2005 and 2004 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% and 19% of our 2003 sales in 2005 and 2004, respectively, 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., and its subsidiaries, accounted for approximately $74.8$98.5 million, or 10.6%10.7%, of our total net sales in 2003.2005 and $84.5 million, or 10.3 %, of our total net sales in 2004. Our top ten customers accounted for approximately $176.3$238.1 million, or 25.0%25.8%, of our total net sales in 2003.2005 and $201.7 million, or 24.5%, of our total net sales in 2004. Thousands of other customers comprisedconstituted the remaining 75.0%74.2% of our net sales in 2003.2005 and 75.5% of our net sales in 2004.
Marketing and Sales
We rely primarily on commissioned manufacturers'manufacturers’ representatives, some of which maintain a consigned inventory of our products. These representatives sell primarily to plumbing and heating wholesalers or service DIY store locations in North America. We also sell 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 and through our existing plumbing and heating wholesalers. In addition, we sell products directly to certain large OEMs and private label accounts.
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Manufacturing
We have integrated and automated manufacturing capabilities, including bronze and iron foundries, machining, plastic injection molding and assembly operations. Our foundry operations include metal pouring systems, automatic core making, yellow brass forging and brass and bronze die castings.die-castings. Our machining operations feature computer-controlled machine tools, high-speed chucking machines with robotics and automatic screw machines for machining bronze, brass and steel components. We have invested heavily in recent years to expand our manufacturing base and to ensure the availability of the most efficient and productive equipment. We are committed to maintaining our manufacturing equipment at a level consistent with current technology in order to maintain high levels of quality and manufacturing efficiencies.
We continue to implement an integrated enterprise-wide software system in our North American locations with a focus on inventory management; production scheduling and electronic data interchange. This system has enabled us to provide better service to our customers, improve working capital management, lower transaction costs and improve e-commerce capabilities.
Capital expenditures and depreciation and amortization for each of the following periodslast three years were as follows:
|
| Years Ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in millions) |
| |||||||
Capital expenditures |
| $ | 18.6 |
| $ | 21.0 |
| $ | 20.0 |
|
Depreciation |
| $ | 23.5 |
| $ | 26.3 |
| $ | 20.5 |
|
Our capital expenditure budget for 2004 is approximately $18.5 million, primarily for manufacturing machinery and equipment.
Raw Materials
The five significantWe require substantial amounts of raw materials used into produce our production processes areproducts, including bronze, ingot, brass, rod, cast iron, steel and plastic.plastic, and substantially all of the raw materials we require are purchased from outside sources. We historically have not experienced significant difficulties in obtaining these commodities in quantities sufficient for our operations. There have been significant changesincreases in the costs of certain of theseraw materials, including recent increasesparticularly copper. Bronze and brass are copper-based alloys. During 2005, the spot copper cost increased approximately 46.9%. Additionally, due to increased costs in crude oil, the costs of bronze, brass, cast iron and steel. Our gross profit margins are adversely affected to the extent that the selling prices of our products do not increase proportionately with increases in the costs of these raw materials. Any significant unanticipated increase or decrease in the costs of these commodities could materially affect our results of operations. We manage this risk by monitoring related market prices, working with our suppliers to achieve the maximum level of stability in their costs and related pricing, seeking alternative supply sources when necessary and passing increases in commodity costs to our customers, to the maximum extent possible, when they occur. In addition, on a limited basis,certain plastic resins we use commodity futures contracts to manage this risk. We did not purchase any commodity futures contractsincreased between 9.8% and 19.0% during 2003. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Quantitative and Qualitative Disclosures About Market Risk." We2005. In response, we have begun to implement someimplemented price increases in responsefor some of the products, which have become more expensive to the recent increases in the cost of bronze, brass, cast iron and steel. At this point, it is too earlymanufacture due to determine if these price increases will be successful in reducing or eliminating the impact of the increases in raw material costs. In 2005, cost increases in raw materials were not completely recovered by increased selling prices or other product cost reductions. We are not able to predict whether or for how long these cost increases will continue. If these cost increases continue and we are not able to reduce or eliminate the effect of the cost increases by reducing production costs or implementing price increases, our profit margins could decrease.
Code Compliance
Products representing a majority of our sales are subject to regulatory standards and code enforcement which typically requiresrequire 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)FCC), 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 productFurther, there are local regulatory standards will be adopted in each country and implemented in each certification system.requiring compliance as well.
Together with our commissioned manufacturers'manufacturers’ representatives, we have consistently advocated for the development and enforcement of plumbing codes. We maintain stringent quality control and testing procedures at each of our manufacturing facilities in order to manufacture products in compliance with
code requirements. We believe that significant product testingproduct-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.requirements. 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, and testing laboratories in North America, Europe and China that continuously work to 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. Research and development costs included in selling, general, and administrative expense amounted to $11.6 million, $9.9 million and $9.2 million for the years ended December 31, 2005, 2004 and 2003, respectively.
Competition
The domestic and international markets for water safety and flow control devices are intensely competitive and require us to compete against some companies possessing greater financial, marketing and other resources than ours. Our management considersDue to the breadth of our product offerings, the number and identities of our competitors vary by product line and market. 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. We believe that new product development and product engineering are also important to success in the water industry and that our position in the industry is attributable in significant part to our ability to develop new and innovative products quickly and to adapt and enhance existing products. We continue to develop new and innovative products to enhance market position and are continuing to implement manufacturing and design programs to reduce costs. We cannot be certain that our efforts to develop new products will be successful or that our customers will accept our new products. Although we own certain patents and trademarks that we consider to be of importance, we do not believe that our business and competitiveness as a whole are dependent on any one of our patents or trademarks or on patent or trademark protection generally.
Backlog
Backlog was $40.0$68.1 million at February 20, 2004 and $42.72006 compared to $46.9 million at February 14, 2003.18, 2005. We do not believe that our backlog at any point in time is indicative of future operating results.
Employees
As of December 31, 2003,2005, our wholly-owned and majority-owned domestic and foreign operations employed approximately 3,700 people, plus 1,400 employees in our joint ventures in China.7,300 people. None of our employees in North America or China are covered by collective bargaining agreements. OurIn some European countries our employees are subject to the traditional national collective bargaining agreements. We believe that our employee relations are good.
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Available Information
We maintain a website with the address www.wattswater.comwww.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'sinvestor’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.
Certifications
Our chief executive officer and chief financial officer have provided the certifications required by rule 13a-14(a) under the Securities and Exchange Act of 1934, copies of which are filed as exhibits to this Annual Report on Form 10-K. In addition, an annual chief executive officer certification was submitted by our chief executive officer to the New York Exchange on May 9, 2005 in accordance with the New York Stock Exchange listing requirements.
Executive Officers and Directors
Set forth below are the names of our executive officers and directors, their respective ages and positions with our Company and a brief summary of their business experience for the past five years:
Name |
| Age | Position | |||||||||
Patrick S. | 53 | Chief Executive Officer, President and Director | ||||||||||
William D. Martino | 59 | Chief Operating Officer and President of North American and Asian Operations | ||||||||||
William C. McCartney | 51 | Chief Financial Officer | ||||||||||
J. Dennis Cawte | 55 | Group Managing Director, Europe | ||||||||||
Ernest E. Elliott | 54 | Executive Vice President of | ||||||||||
Paul A. | 50 | Executive Vice President of | ||||||||||
Lynn A. McVay | 38 | Executive Vice President of | ||||||||||
Lester J. Taufen | 62 | General Counsel, | ||||||||||
Douglas T. White | 61 | Group Vice President | ||||||||||
Timothy P. Horne | 67 | Director | ||||||||||
Ralph E. Jackson Jr.(1)(2)(3) | 64 | Director | ||||||||||
Kenneth J. | 65 | Director | ||||||||||
John K. McGillicuddy(1)(2)(3) | 62 | Director | ||||||||||
Gordon W. Moran(1)(2)(3) | 67 | Non-Executive Chairman of the Board and Director | ||||||||||
Daniel J. Murphy, III(1)(2)(3) | 64 | Director | ||||||||||
(1)Member of the Audit Committee
(2)
(3)
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Patrick S. O'KeefeO’Keefe joined our Company in August 2002. Prior to joining our Company, he served as President, Chief Executive Officer and Director of Industrial Distribution Group, a supplier of maintenance, repair, operating and production products, from 1999 to 2001. He was Chief Executive Officer of Zep Manufacturing, a unit of National Service Industries and a manufacturer of specialty chemicals throughout North America, Europe and Australia, from 1997 to 1999. He has also held various senior management positions with Crane Co. from 1994 to 1997.
William D. Martino joined our Company in October 2005. Prior to joining our Company, he served as President of the Cooper Power Systems Division of Cooper Industries, a manufacturer of electrical enclosures, lighting and wiring devices used in hazardous locations, from 1994 through December 2004. He was Vice President, Operations of the Crouse Hinds Division of Cooper Industries from 1989 until 1994. He also served as president of the McEvoy-Willis Division of Smith International from 1981 to 1989 and held various positions with General Electric Company from 1972 to 1981.
William C. McCartneyjoined our Company in 1985 as Controller. He was appointed our Vice President of Finance in 1994 and served as our Corporate Controller from April 1988 to December 1999. He was appointed Chief Financial Officer and Treasurer andin 2000. He served as Secretary onof the Company from January 1, 2000.2000 to November 2005.
Ernest E. ElliottJ. Dennis Cawte joined our Company in 1986, serving in a variety of sales and marketing roles. He was appointed Vice President of Sales in 1991 and Executive Vice President of Wholesale Sales and Marketing in 1996. Prior to joining our Company, he was Vice President of BTR Inc.'s Valve Group, a diversified 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 1993; Executive Vice President from 1993-1995 and President from 1995-1997. In 1997 he was appointed Corporate Vice President of Manufacturing of our Company.
J. Dennis Cawtejoined our Company in October 2001 and was appointed Group Managing Director Europe. Prior to joining our Company, he was European President of PCC Valve and Controls, a division of Precision Castparts Corp., a manufacturer of components and castings to the aeronautical industry, from 1999 to 2001. He had also worked for approximately 20 years for Keystone Valve International, a manufacturer and distributor of industrial valves, for 20 years,where his most recent position was the Managing Director of Northern European Operations.Europe, Middle East, Africa and India.
Lester J. TaufenErnest E. Elliott joined our Company in January1986 and has served in a variety of sales and marketing roles. He was appointed Vice President of Sales in 1991, served as Executive Vice President of Wholesale Sales and Marketing from 1996 to March 2003, Executive Vice President of Wholesale Marketing from March 2003 to February 2006 and as Executive Vice President of Marketing since February 2006. Prior to joining our Company, he was Vice President of BTR Inc.’s Valve Group, a diversified manufacturer of industrial and commercial valve products.
Paul A. Lacourciere joined our Company in 1986. He became 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 1993, Executive Vice President from 1993 to 1995 and President from 1995 to 1997. He was appointed Corporate Vice President of Manufacturing of our Company in 1997 and Executive Vice President of Manufacturing in February 2006.
Lynn A. McVay joined our Company in March 2003 as Executive Vice President of Wholesale Sales. In October 2005, he was appointed President of the Retail Division and in February 2006 became Executive Vice President of Sales and President of the Retail Division. 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, from 1997 to 2003.
Lester J. Taufen joined our Company in 1999 as Associate Corporate Counsel. He was appointed General Counsel, and Vice President of Legal Affairs and Assistant Secretary in January 2000. He was appointed Secretary in November 2005. Prior to joining our Company, he was employed for 13 years at Elf Atochem North America, a chemical manufacturing company, serving as Senior Counsel.
Douglas T. Whitejoined 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.Group from 1998 to 2001.
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. Hornehas beenserved as a Directordirector of our Company since 1962. He was employed bybecame an employee of our Company since Septemberin 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 our 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 fromas an employee of our Company on December 31, 2002. Since his retirement, Mr. Horne has continued to serve our Company as a consultant.
Ralph E. Jackson, Jr. has served as a director of our Company since 2004. He was employed by Cooper Industries, Inc. from 1985 until his retirement in 2003. Prior to joining Cooper Industries, he worked for the Bussmann and Air Comfort divisions of McGraw-Edison from 1976 until McGraw-Edison was acquired by Cooper Industries in 1985. While with Cooper Industries, he served as Chief Operating Officer from 2000 to 2003, Executive Vice President, Electrical Operations from 1992 to 2000, and President, Bussmann Division from the time McGraw-Edison was acquired by Cooper Industries to 1992. He served as a member of the Board of Directors of Cooper Industries from 2000 to 2003, is currently a member of the Board of Trustees of Hope College and is a past Chairman of the National Electrical Manufacturers Association.
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Kenneth J. McAvoyhas served as a director of our Company since 1994. He 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. MoranJohn K. McGillicuddy 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 Chairmana director of Northmark Bank, a commercial bank,our Company 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 Directordirector of Brooks Automation, Inc.
Gordon W. Moran has served as a director of our Company since 1990. He 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 served as a director of our Company since 1986. He has been the Chairman of Northmark Bank, a commercial bank he founded, since 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.
Product Liability, Environmental and Other Litigation Matters
We are subject to a variety of potential liabilities connected with our business operations, including potential liabilities and expenses associated with possible product defects or failures and compliance with environmental laws. We maintain product liability and other insurance coverage, which we believe to be generally in accordance with industry practices. Nonetheless, such insurance coverage may not be adequate to protect us fully against substantial damage claims, which may arise from product defects and failures.claims.
Contingencies
James Jones Litigation
As previously disclosed, on June 25, 1997, Nora Armenta (the Relator) sued James Jones Company, Watts Water Technologies, Inc, which formerly owned James Jones, Mueller Co. and Tyco International (U.S.)filed a civil action in the California Superior Court for Los Angeles County. By this complaint and an amended complaint filed on November 4, 1998 (First Amended Complaint),County (the Armenta a former employee ofcase) against James Jones sued on behalf of 34 municipalities as aCompany (James Jones), Mueller Co., Tyco International (U.S.), and the Company. We formerly owned James Jones. The Relator filed under the qui tam plaintiff underprovision of the California state False Claims Act, (the Armenta case). LateCal. Govt. Code § 12650 et seq. (California False Claims Act) and generally alleged that James Jones and the other defendants violated this statute by delivering some “defective” or “non-conforming” waterworks parts to thirty-four municipal water systems in the State of California. The Relator filed a First Amended Complaint in November 1998 the Los Angeles Department of Water and Power (LADWP) intervened. In December 2000, the court allowed the Relator to file a Second Amended Complaint in December 2000, which added a number of new cities and water districts as plaintiffs and brought the total number of plaintiffs to 161. OnIn June, 3, 2002, the California Superior Courttrial court excluded 47 cities from this total of 161. The161, and
the Relator was not able to obtain appellate modification of this order.order, which can still be appealed at the end of the case. To date, 11 of the total number of plaintiffsnamed cities have intervened.intervened, and attempts by four other named cities to intervene have been denied.
The First Amended Complaint alleges that our 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. The Relator claims that these
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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 FirstSecond Amended Complaint and the Complaints-in-Intervention is the suggestion that because some of the purchased non-conforming James Jones productswaterworks parts may leach into public drinking water elevated amounts of lead that may create a public health risk because they were made out of '81‘81 bronze alloy (UNS No. C8440) and contain more lead than the specified '85and advertised ‘85 bronze alloy (UNS No. C83600), a risk to public health might exist.. This contention is predicatedbased on the average difference of about 2% lead content in '81between ‘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.water that could cause a public health concern. We believe the evidence and discovery available to date indicateindicates that this is not the case.
In addition, bronze that does not contain more than 8% lead, like '81‘81 bronze is approved forused extensively in municipal and home plumbing systems and is approved by municipalitiesmunicipal, local and national and local codes, and thecodes. The Federal Environmental Protection Agency also defines metal for pipe fittings with no more than 8% lead as "lead free"“lead free” under Section 1417 of the Federal Safe Drinking Water Act.
In June 2001, we 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.
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 RelatorShe also seeks civil penalties of $10,000 for each false claim and alleges that defendants are responsible for tens of thousands of false claims. Finally, the Relator requests an award of costs of this action, including attorneys’ fees.
In December 1998, the Los Angeles Department of Water and Power (LADWP) intervened in this case and filed a complaint. We settled with the Citycity of Los Angeles, by far the most significant city, for $5.7$7.3 million plus the Relator's statutory share and attorneys'attorneys’ fees. Co-defendants will contributecontributed $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)Jones), which settled the claims of the three Phase I cities (Santa Monica, San Francisco and East Bay Municipal WaterUtility District) chosen by the Relator as having the strongest claims to be tried first. This settlement payment included the Relator'sRelator’s statutory share, and the claims of these three cities have been dismissed. In addition to this $13 million payment, we are obligated to pay the Relator's attorney'sRelator’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. Contra Costa, Corona, Santa Ana, Santa Cruz and Vallejo were chosen. The Company and James Jones subsequentlythen reached an agreement to settle the claims of the City of Santa Ana's claimsAna for a total of $45,000, and we are responsible for $38,000an amount which approximates Santa Ana’s purchases of this settlement amount.James Jones products during the relevant period. The Santa Ana has submitted this claim tosettlement was approved by the Court for approval in March 2004. The trial ofand then completed.
On June 22, 2005, the Court dismissed the claims of the remaining Phase II cities (Contra Costa, Corona, Santa Cruz and Vallejo). The Court ruled that the Relator and these cities were required to show that the cities had received out of spec parts which were related to specific invoices and that this showing had not been made. Although each city’s claim is scheduledunique, this ruling is significant for the claims of the remaining cities, and the Relator has appealed. Litigation is inherently uncertain, and we are unable to predict the outcome of this appeal.
On September 2004.15, 2004, the Relator’s attorneys filed a new common law fraud lawsuit in the California Superior Court for the City of Banning and forty-five other cities and water districts against James Jones, Watts and Mueller Co. based on the same transactions alleged in the Armenta case. About thirty-four of the plaintiffs in this new lawsuit are also plaintiffs in the Armenta case. On January 4, 2006, the Court denied much of the defendants’ demurrer, which had been filed on claim-splitting and statute of
limitations grounds. Litigation is inherently uncertain, and we are unable to predict the outcome of this new lawsuit.
We have a reserve of approximately $9.3$21.0 million with respect to the James Jones Litigation in our consolidated balance sheet as of December 31, 2003.2005. We believe, on the basis of all available information, that this reserve is adequate to cover the probable and reasonably estimable losses resulting from the James Jones LitigationArmenta case and the insurance coverage litigation with Zurich American Insurance Company (Zurich) discussed below. We are currently unable to make an estimate of the range of any additional losses.
On February 14, 2001, after our insurers had denied coverage for the claims in the Armenta case, we filed a complaint for coverage against our insurers in the California Superior Court against our insurers for(the coverage of the claims in the Armenta case. Thecase). James Jones Company filed a similar complaint, the cases were consolidated, and on October 30, 2001 the California Superior Courttrial court made a summary adjudication rulingrulings that Zurich American Insurance Company (Zurich) must pay all reasonable defense
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costs incurred by us and James Jones in the Armenta case since April 23, 1998 as well as oursuch future defense costs inuntil the end of the Armenta case. In July 2004, the California Court of Appeal affirmed these rulings, and, on December 1, 2004, the California Supreme Court denied Zurich’s appeal of this case until its final resolution. On October 24,decision. This denial permanently established Zurich’s obligation to pay Armenta defense costs for both us (approximately $16.9 million plus future costs) and James Jones (which we estimate to be $17.3 million plus future costs), and Zurich is currently making payments of incurred Armenta defense costs. However, as noted below, Zurich asserts that the defense costs paid by it are subject to reimbursement.
In 2002, the California Superior Courttrial court made anothera summary adjudication ruling that Zurich must indemnify and pay us and James Jones for the amounts we must pay under our settlement agreementpaid to settle with the City of Los Angeles. Zurich has asserted that all amounts (both defense costs and indemnity amounts paid for settlements) paid by itZurich’s attempt 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 currently 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 forobtain appellate review of this order was denied, but Zurich will still be able to appeal this order at the end of the coverage case. WeIn 2004, the trial court made another summary adjudication ruling that Zurich must indemnify and pay us and James Jones for the $13 million paid to settle the claims of the Phase I cities described above. Zurich’s attempt to obtain appellate review of this ruling was denied on December 3, 2004 by the California Court of Appeal, but Zurich will still be able to appeal this order at the end of the coverage case. Although Zurich has now made most of the payments required by these indemnity orders, we are currently unable to predict the finality of these orders since Zurich can appeal them at the order on indemnity forend of the Los Angeles settlement.coverage case. We have recorded reimbursed indemnity settlement amounts (but not reimbursed defense costs) as a liability.liability pending court resolution of the indemnification matter as it relates to Zurich.
Zurich has asserted that all amounts (which we estimate to be $51 million for both defense costs and indemnity amounts paid for settlements) paid by it to us and James Jones are subject to reimbursement under Deductible Agreements related to the insurance policies between Zurich and Watts. If Zurich were to prevail on this argument, James Jones would have a possible indemnity claim against us for its exposure from the Armenta case. We intend to contest vigorouslybelieve the Armenta case should be viewed as one occurrence and the deductible amount should be $0.5 million per occurrence.
These reimbursement claims are subject to arbitration under the Watts/Zurich Deductible Agreements. Zurich claims its related litigation.reimbursement right for defense costs paid arises under six Deductible Agreements, and we contend that only two Deductible Agreements apply. We further contend that a final decision in California supports our position on the number of Deductible Agreements that should apply to defense costs. On January 31, 2006, the federal district court in Chicago, Illinois determined that there are disputes under all Deductible Agreements in effect during the period in which Zurich issued primary policies and that the arbitrator could decide which agreements would control reimbursement claims. We have appealed this ruling. Management and counsel anticipate that we will ultimately prevail on this reimbursement issue with Zurich.
Based on management'smanagement’s assessment, we do not believe that the ultimate outcome of the James Jones caseLitigation will have a material adverse effect on our liquidity, financial condition or results of operations. While this assessment is based on all available information, litigation is inherently uncertain, the actual
liability to us to fully resolve this litigation fully cannot be predicted with any certainty 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 all aspects of the James Jones case and its related litigation.Litigation.
Environmental Remediation
We have been named as a potentially responsible party (PRP) with respect to a limited number of identified contaminated sites. The levellevels of contamination variesvary 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. We accrue estimated environmental liabilities 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. We recognize changes in estimates as new remediation requirements are defined or as new information becomes available. We have a reserve of approximately $2.5$1.5 million and(environmental accrual), which we estimate that our accrued environmental remediation liabilities will likely be paid for environmental remediation liabilities over the next five to ten years. Based on the facts currently known to us, we do not believe that the ultimate outcome of these claimsmatters will have a material adverse effect on our liquidity, financial condition or results of operations.
For several years, the New 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 Some of our environmental matters are inherently uncertain and for operation and maintenance coststhere exists a possibility that will be incurredwe may ultimately incur losses from these matters 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 proportionexcess of the final costs may be allocated to us. In 2003, 139 PRPs were identified by our defense group, and they are inamount accrued. However, we cannot currently estimate the processamount 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.any such additional losses.
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Asbestos Litigation
We are a defendant indefending approximately 115 actions121 cases 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 Watts products of ours as a source of asbestos exposure. To date, the Company haswe have been dismissed from each case when the scheduled trial date comes near.near or when discovery fails to yield any evidence of exposure to any of our products. Based on the facts currently known to us, we do not believe that the ultimate outcome of these claims will have 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 Companyus by North Carolina Hospitality Group, Inc. in the Circuit Court of Maryland, Prince George'sGeorge’s County. It alleges that certain commercial valve models contain a design defect that causes them to fail prematurely. Our extensive investigationOn June 7, 2004, the trial court issued an opinion and order that denied the plaintiff’s request for class certification. This ruling was appealed at the end of the evidence, including the physical evidence presented so far2004, and on January 17, 2006, this ruling was affirmed by the plaintiff, demonstrates that the allegations in the complaint are without merit, and we intend to defend this lawsuit vigorously.Maryland Court of Special Appeals. Based on the facts 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 us. Based on the facts currently known to us, we do not believe that the ultimate outcome of these other litigation matters will have a material adverse effect on our liquidity, financial condition or results of operations.
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 amount accrued.13
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Item 2. 1A.PROPERTIES.RISK FACTORS.
We maintain 45 facilities worldwide with our corporate headquarters located in North Andover, Massachusetts. Our manufacturing operations include four casting foundries, two of which are located in the United States and two in Tianjin, China. 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 25 manufacturing facilities located in the United States, Canada, Europe, China and Tunisia. Many of these facilities contain sales offices, warehouses, or sales and distribution centers from which we ship finished goods to customers and commissioned manufacturers' representatives. All our operating facilities and the related real estate are owned by us, except the buildings and land operated by one of our joint ventures located in Tianjin, China, which is leased with a remaining term of approximately 22 years, the land on which our manufacturing facility is located in Taizhou, China with a remaining term of 49 years and except for the following facilities, each of which is leased:
Certain of our facilities are subject to mortgages and collateral assignments under loan agreements with long-term lenders. In general, we believe that our properties, including machinery, tools and equipment, are in good condition, well maintained and adequate and suitable for their intended uses. We believe that our manufacturing facilities are currently operating at a level that our management considers normal 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 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.
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Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Market Information
The following table sets forth the high and low sales prices of our Class A Common Stock on the New York Stock Exchange during 2003 and 2002 and cash dividends paid per share.
| 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 our Class B Common Stock, which is held exclusively by members of the Horne family. The principal holders of such stock are subject to restrictions on transfer with respect to their shares. Each share of our Class B Common Stock (10 votes per share) is convertible into one share of Class A Common Stock (1 vote per share).
Aggregate common stock dividend payments for 2003 and 2002 were $6,859,000 and $6,490,000, respectively. While we presently intend to continue to pay cash dividends, the payment of future cash dividends depends upon the Board of Directors' assessment of our earnings, financial condition, capital requirements and other factors.
The number of record holders of our Class A Common Stock as of February 29, 2004 was 132. The number of record holders of our Class B Common Stock as of February 19, 2004 was 9.
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Item 6. SELECTED FINANCIAL DATA.
The selected financial data set forth below should be read in conjunction with our consolidated financial statements, related Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included herein.
FIVE YEAR FINANCIAL SUMMARY(Amounts in thousands, except per share information)
| 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 |
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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
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
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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:
| (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% | |||
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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 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. 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 our manufacturing plants in North America and Europe. At the same time we are expanding our manufacturing capacity in China and other low cost areas of the world. The implementation of this manufacturing restructuring plan began during the fourth quarter of 2001 and will continue in 2004. The projects for which charges were recorded in the fourth quarter of 2001 are essentially complete. During 2002, we decided to expand the scope of the manufacturing restructuring plan and transfer certain production to low cost
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manufacturing plants in Tunisia and Bulgaria. We expect to record an additional $6.0 million in 2004 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 Company recorded pre-tax manufacturing restructuring and other costs of $1.7 million net of recoveries for 2003. The manufacturing restructuring and other costs recorded consist primarily of severance costs, asset write-downs and 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 first quarter of 2004. Asset write-downs consist primarily of write-offs of inventory related to product lines that we have 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 and have been expensed as incurred.
Results of Operations
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
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 years ended December 31, 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 | % | ||||
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.
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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.
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Operating Income. Operating income by geographic segment for each of the years ended December 31, 2003 and 2002 was as follows:
| 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 | ||||
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.
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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
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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.
| 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 | ||||
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:
| (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 | % | ||
The increase in net sales from internal growth was primarily attributable to increased unit sales in the DIY market in North America. The growth in net sales from acquired businesses was due to the inclusion of the net sales from Powers Process Controls of Skokie, Illinois, acquired on September 28, 2001; Premier Manufactured Systems of Phoenix, Arizona, acquired on June 13, 2001; Fimet of Milan, Italy, acquired on June 1, 2001; Shida, our joint venture, which we established on March 5, 2002; ADEV and Eminent, acquired on July 15, 2002; and F&R acquired on July 29, 2002. The increase in foreign exchange was due primarily to the euro appreciating against the U.S. dollar compared to the same period in 2001.
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We monitor our net sales in three geographic segments: North America, Europe and China. As outlined below, North America, Europe and China accounted for 73.1%, 23.7% and 3.2% of net sales, respectively, in the year ended December 31, 2002 compared to 75.7%, 22.1%, and 2.2%, respectively, in the year ended in December 31, 2001.
Our net sales in each of these geographic segments for the years ended December 31, 2002 and 2001 were as follows:
| 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 | |||
The increase in net sales in North America was due to the inclusion of Powers Process Controls and Premier Manufactured Systems, as well as increased unit sales to the DIY market. The increase in net sales in Europe was due to the inclusion of Fimet, ADEV, Eminent and F&R and the appreciation 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.
Gross Profit. Gross profit for the year ended December 31, 2002 increased $25,188,000, or 13.7%, from the prior year and increased as a percentage of net sales to 33.9% from 33.4%. We charged $2,907,000 and $4,253,000 of costs associated with our manufacturing restructuring plan to cost of sales in 2002 and 2001, respectively. Excluding the cost associated with the manufacturing restructuring plan in 2002 and 2001, gross profit would have increased $23,842,000, or 12.7%, and would have increased as a percentage of net sales to 34.4% from 34.2%.
Selling, General and Administrative Expenses. SG&A expenses increased $18,758,000, or 14.2%, to $150,553,000 from $131,795,000 for the comparable prior year period. This increase was 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.
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
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administrative expenses. 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 | ||||
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 inclusion of the operating results of acquired companies and the euro appreciating against the U.S. dollar compared to the prior year. The decrease in China was primarily due to increased bad debt and warranty expense. Corporate expenses are primarily for compensation expense, professional fees, including legal and audit expenses and benefit administration costs. The increase in corporate expenses was primarily due to increased legal and audit expenses and administrative start-up costs associated with our new manufacturing plant in China.
Interest Expense. Interest expense for the year ended December 31, 2002 decreased $730,000, or 7.7%, to $8,692,000 compared to $9,422,000 for the same period in 2001, primarily due to lower interest rates on variable rate indebtedness and capitalized construction period interest on our startup manufacturing plant in China, partially offset by the increased levels of debt incurred to fund acquisitions. 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. Interest expense for the year ended December 31, 2002 had been reduced by $1,711,000 from the benefit of the swap while active and by the amortization of the adjustment to the fair value subsequent to the sale of the swap.
Income Taxes. Our effective tax rate for continuing operations for the year ended December 31, 2002, increased to 35.0% from 33.9% for the comparable prior year period. The increase was primarily due to a change in our earnings mix to jurisdictions with higher tax rates. Also in 2001, the costs for the manufacturing restructuring plan were recorded in tax jurisdictions with tax rates higher than our effective rate, which caused the overall effective rate for 2001 to be lower than would normally be expected. Excluding the impact of the after-tax manufacturing costs and goodwill amortization in both 2002 and 2001, the effective tax rate would have increased to 35.2% from 32.2%.
Income From Continuing Operations and Net Income. Income from continuing operations for the year ended December 31, 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, for the year ended December 31, 2001 on a diluted basis.
Liquidity and Capital Resources
We generated $49,990,000 of net cash from continuing operations for 2003. We experienced an increase in inventories in North America, Europe and China. The increase in inventory in North America is primarily due to planned increases in imported raw materials and finished goods to support our delivery capability as we extend our supply chain to lower cost regions, as well as an increase in inventory to support increased retail business. The increase in inventory in Europe is primarily due to increased safety stock growth to cover planned distribution relocations and to support the delivery
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requirements of OEM customers in Europe. The increase in inventory in China is the result of our wholly-owned manufacturing plant start-up operations. We had reductions in accounts receivable in Europe and China, partially offset by increased accounts receivable in North America. The increase in North America is due to increased sales volume. We funded $6,800,000 into our pension plans in the year ended December 31, 2003.
We used $37,045,000 of net cash for investing activities. We invested $20,035,000 in capital equipment for the year ended December 31, 2003. Capital expenditures were primarily for manufacturing machinery and equipment as part of our ongoing commitment to improve our manufacturing capabilities. The two largest components of this expenditure were for a building added to our Shida joint venture facility in Taizhou, China and for additional machinery and equipment for our wholly-owned manufacturing plant in Tianjin, China. We expect to invest approximately $18,500,000 in capital equipment in 2004.
On January 29, 2003, we invested an additional $3,040,000 in our Shida joint venture, bringing our total amount to approximately $8,040,000. This joint venture is owned 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 paid. 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 Giuliani Anello S.r.l.
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 transaction. We intend to use the net proceeds from the offering to fund potential acquisitions and for general corporate purposes.
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 1, 2003. On December 1, 2003 the principal of, and interest on, our $75,000,000 83/8% notes were paid with our restricted treasury securities. Additional net proceeds were used to repay approximately $32,000,000 outstanding under our Revolving Credit Facility. The balance of the net 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 November 15th of each year. The senior unsecured notes were issued by the Company and are subordinated to our revolving credit 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 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 notes include a prepayment provision which might require a make-whole payment to the note holders. Such payment is dependent upon the level of the respective treasuries. The notes include other customary terms and conditions, including events of default.
Our revolving credit facility with a syndicate of banks (as amended, 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 our acquisition program, working capital requirements 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 $2,000,000
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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 a rate determined by the type (currency) of loan plus an applicable margin determined by the Company's debt rating, depending on the applicable base rate and our bond rating. The average interest rate for borrowings under the Revolving Credit Facility was approximately 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. At December 31, 2003, we were in compliance with all covenants related to the Revolving Credit Facility.
Effective July 1, 2003, we entered into an interest rate swap for a notional amount of 25,000,000 euros outstanding under 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 term of the swap is 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 first 25,000,000 euros of our Revolving Credit Facility. We mark 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.
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 $6,859,000 in 2003 from $6,490,000 in 2002.
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, 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."
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 due to the net proceeds received from the $125,000,000 private placement and the stock offering that raised net cash of approximately $82,500,000. The ratio of current assets to current liabilities was 2.8 to 1 as of December 31, 2003 compared to 1.3 to 1 as of December 31, 2002. Cash and cash equivalents were $149,361,000 as of December 31, 2003 compared to $10,973,000 as of December 31, 2002. Our total debt increased to $192,312,000 as of December 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.
We had positive free cash flow of $24,861,000 (defined as net cash provided by continuing operations minus capital expenditures and dividends 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 and long term interest-
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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 and to fund acquisitions. Our computation may not be comparable to other companies that may 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.
A reconciliation of free cash flow to net cash provided by continuing operations is provided below:
| 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 | ||||
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:
| 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 | |||
A reconciliation of capitalization is provided below:
| 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 | ||
We anticipate that available funds from current operations, existing cash and other sources of liquidity will be sufficient to meet current operating requirements and anticipated capital expenditures for at least the next 12 months. However, we may have to consider external sources of financing for any large future acquisitions. Our current Revolving Credit Facility expires in February 2005. We are
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currently reviewing proposals from our syndicate of banks with the intention of structuring a new revolving line of credit.
Our long-term contractual obligations as of December 31, 2003 are presented in the 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 | |||||
We maintain letters of credit that guarantee our 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. 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 increase is primarily associated with insurance coverage. These instruments may exist or expire without being drawn down. Therefore, they do not necessarily represent future cash flow obligations.
Critical Accounting Policies and Key Estimates
The preparation of our consolidated financial statements in accordance with GAAP requires management to make judgments, assumptions and estimates that effect the amounts reported. A critical accounting estimate is an assumption about highly uncertain matters and could have a material effect on the consolidated financial statements if another, also reasonable, amount were used, or, a change in the estimate is reasonably likely from period to period. We base our assumptions on historical experience and on other estimates that we believe are reasonable 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.
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
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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
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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 have a material impact on the results of operations and financial position.
Product liability and workers compensation costs
Because of retention requirements associated with 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 well 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 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 the U.S. Changes in the nature of claims or the actual settlement amounts could affect the adequacy of this estimate and require changes to the provisions.
Workers compensation liabilities in the U.S. are recognized for claims incurred (including claims incurred but not reported) and for changes in the 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 claims experience. In other countries where workers compensation costs are applicable, we maintain insurance coverage with limited deductible payments. Because the liability is an estimate, the ultimate liability may be more or less than reported.
We maintain excess liability insurance with outside insurance carriers to minimize our risks related to catastrophic claims in excess of all self-insured positions. Any material change in the aforementioned factors could have an adverse impact on our operating results.
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 Notes 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 loss amount can be reasonably estimated, net of any applicable insurance proceeds. Estimates of potential outcomes of these contingencies are developed in consultation with outside counsel. While this assessment is based upon all available information, litigation is inherently uncertain and the actual liability to fully resolve this litigation
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cannot be predicted with any assurance of accuracy. Final settlement of these matters could possibly result in significant effects on our results of operations, cash flows and financial position.
Pension benefits
We account 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:
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.
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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 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 reduce the prices of some of our products to stay competitive, potentially resulting in a reduction in the profit margin for, and inventory valuation of, these products. Some of our competitors are based in foreign countries and have cost structures and prices in foreign currencies. Accordingly, currency fluctuations could cause our U.S. dollar-priced products to be less competitive than our competitors'competitors’ products which are priced in other currencies.
Reductions or interruptions in the supply of raw materials and increases in the costs of raw materials could reduce our profit margins and adversely impactaffect 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'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 theThe costs of bronze, brass, cast iron, and steel.many of these raw materials are at the highest levels that they have been in many years. We may continue to experience further cost increases of these materials. In 2005, cost increases in raw materials were not completely recovered by increased selling prices or other product cost reductions. 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 continue to have a negative effect on our financial results. Additionally, we continue to purchase increased levels of finished product from international sources. If there is an interruption in delivering these finished products to our domestic warehouses, this 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.products and increase market share for our existing product lines. We cannot be certain that we will be able to identify, acquire or profitably manage additional companies or successfully integrate such additional companies without substantial costs, delays or other problems. Also, companies acquired recently and in the future may not achieve 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. In particular, we expect that management will need to devote a significant amount of time and effort over the next twelve months to improve the operational results of our recently acquired subsidiary, Core Industries
Inc., including improvements in its profitability, customer satisfaction and revenue growth rate. If we are not successful in implementing these improvements, our financial results may be negatively affected. We have faced 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:
·adverse short-term effects on our reported operating results;
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· investigations of, or challenges to, acquisitions by competition authorities;
·loss of key personnel at acquired companies; and
·unanticipated management or operational problems or legal liabilities.
We are subject to risks related to product defects, which could result in product recalls and could subject us to warranty claims in excess of our warranty provisions or which are greater than anticipated due to the unenforceability of liability limitations.
We maintain strict quality controls and procedures, including the testing of raw materials and safety testing of selected finished products. However, we cannot be certain that our testing will reveal latent defects in our products or the materials from which they are made, which may not become apparent until after the products have been sold into the market. Accordingly, there is a risk that product defects will occur, which could require a product recall. Product recalls can be expensive to implement and, if a product recall occurs during the product’s warranty period, we may be required to replace the defective product. In addition, a product recall may damage our relationship with our customers and we may lose market share with our customers. Our insurance policies may not cover the costs of a product recall.
Our standard warranties contain limits on damages and exclusions of liability for consequential damages and for misuse, improper installation, alteration, accident or mishandling while in the possession of someone other than us. We record an accrual for estimated warranty costs at the time revenue is recognized. We may incur additional operating expenses if our warranty provision does not reflect the actual cost of resolving issues related to defects in our products. If these additional expenses are significant, it could adversely affect our business, financial condition and results of operations.
Down economic cycles, particularly reduced levels of housingresidential and non-residential starts and remodeling, could have an adverse effect on our revenues and operating results.
We have experienced and expect to continue to experience fluctuations in revenues and operating results due to economic and business cycles. The businesses of most of our customers, particularly plumbing and heating wholesalers and 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 housingresidential and non-residential starts and renovation and remodeling, which are, in turn, heavily influenced by interest rates, consumer debt levels, changes in disposable income, employment growth and consumer confidence. Prime interest rates have increased by 38.1% since December 31, 2004. If these and other factors cause a material reduction in housingresidential and non-residential and remodeling starts, our revenues and profits would decrease and result in a material adverse effect on our financial condition and results of operations.
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:
·trade protection measures and import or export licensing requirements, which could increase our costs of doing business internationally;
·potentially negative consequences from changes in tax laws, which could have an adverse impact on our profits;
·difficulty in staffing and managing widespread operations, which could reduce our productivity;
·costs of compliance with differing labor regulations, especially in connection with restructuring our overseas operations;
· natural disasters and public health emergencies;
·laws of some foreign countries, which may not protect our intellectual property rights to the same extent as the laws of the United States;
·unexpected changes in regulatory requirements, which may be costly and require significant time to implement; and
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%37.0% of our sales during the year ended December 31, 20032005 were from sales outside of the U.S. compared to 31.4%38.5% for the year ended December 31, 2002.2004. For the year ended December 31, 2003,2005, the appreciationdepreciation of the euro against the U.S. dollar had a positivenegative impact on sales
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of approximately $31.1$2.9 million. For the yearyears ended December 31, 2002,2004 and 2003, 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$20.9 million and $31.1 million, respectively. Additionally, our Canadian operations require significant amounts of the euroU.S. purchases for their operations. Instead of buying or manufacturing domestically, we currently have a favorable cost structure for goods we source from our joint venture, our wholly owned subsidiaries in China and our outside vendors. In 2005, China revalued its currency higher against the U.S. dollar had an adverse impact on sales of approximately $3.4 million.and stated it would no longer tie the yuan to a fixed rate against the U.S. currency. The yuan was revalued to 8.11 yuan per dollar from 8.28, or 2.1%. At December 31, 2005, the yuan was valued at 8.07. China also stated it will now peg the yuan against numerous currencies, although it will keep the yuan in a tight band rather than letting it trade freely. 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 and acquiring companies in China.
As part of our strategy, we are shifting a significant portion of our manufacturing operations to China to reduce our production costs. Duecosts and to sell product into 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.Chinese market. This shift will subject a greater portion of our operations to the risks of doing business in China. The Chinese legal system is relativelyincreased production levels in China require increased levels of working capital as we are rapidly increasing headcount and manufacturing equipment. If we are unable to quickly train these new and lacks transparency, which gives theemployees we may experience product quality issues. The Chinese central and local government authorities have a higher degree of control over our businessbusinesses in China than is customary in developed economiesmany of the countries in which we operate 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 We expect to increase our participation in the Chinese government has been pursuing economic reformwater and a policypower infrastructure markets with the consummation 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 resultsacquisition of operations and financial condition could be adversely affected.
Our manufacturing restructuring plan,Changsha Valve Works (Changsha), which we begansigned an agreement to acquire in 2001, was initiatedOctober 2005. The acquisition of Changsha remains subject to reduce our manufacturing costs. If our planned manufacturing plant consolidationsthe satisfaction of certain closing conditions by Changsha. Changsha sells exclusively into the domestic Chinese marketplace and deals 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.long-term contracts.
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 impactaffect our business, financial condition and results of operations..
36In addition, we have an ongoing manufacturing restructuring program to reduce our manufacturing costs. As we transition more of our operations overseas as a result of the manufacturing restructuring plan, we are transferring capacity utilization. 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 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:
·intense competition;
·changes in specifications required by our customers, plumbing codes and/or regulatory agencies;
·technically complex products; and
·constant improvement to existing products and introductions of new products.
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 position; in addition, added expenses could decrease the profitability associated with those products that do not gain market acceptance.
Environmental compliance costs and liabilities could increase our expenses or reduce our profitability.
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 also 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.
Under certain environmental laws, the current and past 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.
We have incurred, and expect to continue to incur, costs relating to these environmental 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 be 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—“Business—Product Liability, Environmental, and Other Litigation Matters."”
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Third parties may infringe our intellectual property and we may expend significant resources enforcing our rights or suffer competitive injury.
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 have been limited from selling products from time-to-time because of existing patents.
We face risks from product liability and other lawsuits, which may adversely affect our business.
We have been and may continue to be subjectedsubject 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 and gases, 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—“Business—Product Liability, Environmental, and Other Litigation Matters."”
The requirements of FASFinancial Accounting Standards Board Statement No. 142, “Goodwill and Other Intangible Assets” (FAS 142) may result in a write-off of all or a portion of our goodwill, which would negatively impactaffect our operating results and financial condition.
As of December 31, 2005, we recorded goodwill and non-amortizable intangible assets of $296.6 million and $40.6 million, respectively. If we are required to take an impairment charge to our goodwill or intangible assets 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 wereare required to perform an initialannual impairment review of both goodwill and are required to perform annual impairment reviews thereafter.non-amortizable intangible assets. We have concluded that no impairment existed at January 1, 2002,October 30, 2005, the time of adoption of FAS 142 and at October 26, 2003, the time of our latest annual review. We perform our annual test for indications of goodwill and non-amortizable intangible assets impairment in the fourth quarter of our fiscal year or sooner if indicators of impairment exist.
The loss of a major customer could have an adverse effect on our results of operations.
Our largest customer, The Home Depot, Inc., and its wholly owned subsidiaries, accounted for approximately $74.8$98.5 million, or 10.6%10.7%, of our total net sales for the year ended December 31, 2003,2005, and $63.0$84.5 million, or 10.2%10.3%, of our total net sales for year ended December 31, 2002.2004. Our customers generally are not obligated to purchase any minimum volume of products from us and are able to terminate their relationships with us at any time. In addition, increases in the prices of our products could result in a reduction in orders for our products from the Home Depot, Inc and other customers. A significant reduction in orders from, or change in terms fromof contracts with, The Home Depot, Inc. or other significant customers 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 of our stockholders can exercise substantial influence over our company.
As of February 1, 2004,2006, Timothy P. Horne, a member of our board of directors, beneficially owned approximately 23.8%22.6% of our outstanding shares of Class A Common Stock (assuming conversion of all shares of Class B Common Stock beneficially owned by Mr. Horne into Class A Common Stock) and approximately 96.8%99.0% of our outstanding shares of Class B Common Stock, which represents approximately 73.2%73.8% of the total outstanding voting power. As long as Mr. Horne controls shares representing at least a majority of the total voting power of our outstanding stock, Mr. Horne will be able to unilaterally determine the outcome of all stockholder votes and other stockholders will not be able to affect the outcome of any stockholder vote.
SharesConversion and sale of a significant number of shares of our Class AB Common Stock eligible for public sale could adversely affect the market price of our Class A Common Stock.
As of February 1, 20042006, there were outstanding 24,607,42525,205,210 shares of our Class A Common Stock and 7,471,7007,343,880 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 classClass B common stock,Common Stock, the holders of our Class B Common Stock have rights with respect to the registration of the underlying Class A Common Stock. Under these registration rights, the holders of Class B Common Stock may require, on up to two occasions, that we register their shares for public resale. If we are eligible to use Form S-3 or a similar short-form registration statement, the holders of Class B Common Stock may require that we register their shares for public resale up to two times per year. If we elect to register any shares of Class A Common Stock for any public offering, the holders of Class B Common Stock are entitled to include shares of Class A Common Stock into which such shares of Class B Common Stock may be converted in such registration. However, we may reduce the number of shares proposed to be registered in view of market conditions. We will pay all expenses in connection with any registration, other than underwriting discounts and commissions. 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.
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,February 1, 2006, our Class B Common Stock constituted 23.3%22.6% of our total outstanding common stock and 75.2%74.5% of the total outstanding voting power and thus is able to exercise a controlling influence over our business.
39
None.
20
As of December 31, 2005, we maintained approximately 75 facilities worldwide, including our corporate headquarters located in North Andover, Massachusetts. The trading priceremaining facilities consist of foundries, manufacturing facilities, warehouses, sales offices and distribution centers. The principal properties in each of our three geographic segments and their location, principal use and ownership status are set forth below:
Location | Principal Use | Owned/Leased | ||||
North Andover, MA | Corporate Headquarters | Owned | ||||
Export, PA | Manufacturing | Owned | ||||
Franklin, NH | Manufacturing | Owned | ||||
Burlington, ON, Canada | Manufacturing | Owned | ||||
Kansas City, KS | Manufacturing | Owned | ||||
Fort Myers, FL | Manufacturing | Owned | ||||
St. Pauls, NC | Manufacturing | Owned | ||||
Spindale, NC | Manufacturing | Owned | ||||
Chesnee, SC | Manufacturing | Owned | ||||
Palmdale, CA | Manufacturing | Owned | ||||
Dunnellon, FL | Warehouse | Owned | ||||
San Antonio, TX | Warehouse | Owned | ||||
Springfield, MO | Manufacturing | Leased | ||||
Langley, BC, Canada | Manufacturing | Leased | ||||
Santa Ana, CA | Manufacturing | Leased | ||||
Woodland, CA | Manufacturing | Leased | ||||
Houston TX | Manufacturing | Leased | ||||
Wilmington, NC | Manufacturing | Leased | ||||
Phoenix, AZ | Warehouse | Leased | ||||
Dallas, TX | Distribution Center | Leased | ||||
Chicago, IL | Distribution Center | Leased | ||||
Reno, NV | Distribution Center | Leased | ||||
Calgary, AB, Canada | Distribution Center | Leased |
Location | Principal Use | Owned/Leased | ||||
Eerbeek, Netherlands | European Headquarters | Owned | ||||
Biassono, Italy | Manufacturing | Owned | ||||
Caldero, Italy | Manufacturing | Owned | ||||
Brescia, Italy | Manufacturing | Owned | ||||
Lavis, Italy | Manufacturing | Owned | ||||
Landau, Germany | Manufacturing | Owned | ||||
Fresseneville, France | Manufacturing | Owned | ||||
Plovdiv, Bulgaria | Manufacturing | Owned | ||||
South Wales, United Kingdom | Manufacturing | Owned | ||||
Rosières, France | Manufacturing | Leased | ||||
Monastir, Tunisia | Manufacturing | Leased |
Location | Principal Use | Owned/Leased | ||||
Tianjin Tanggu District, China | Manufacturing | Owned | ||||
Tazhou, Yuhuan, China | Manufacturing | Owned | ||||
Tianjin Tanggu District, China | Manufacturing | Leased |
Certain of our facilities are subject to mortgages and collateral assignments under loan agreements with long-term lenders. In general, we believe that our properties, including machinery, tools and equipment, are in good condition, well maintained and adequate and suitable for their intended uses. We believe that our manufacturing facilities are currently operating at a level that our management considers normal capacity, except for our two expanded plants in China, which are under-utilized. Management believes capacity utilization will continue to increase in 2006 at these plants, subject to unexpected changes in our sales volume.
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,” which is incorporated herein by reference
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.
PART II
Item 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
The following table sets forth the high and low sales prices of our Class A Common Stock may be volatile.on the New York Stock Exchange during 2005 and 2004 and cash dividends paid per share.
|
| 2005 |
| 2004 |
| ||||||||||||||||||
|
| High |
| Low |
| Dividend |
| High |
| Low |
| Dividend |
| ||||||||||
First Quarter |
| $ | 34.87 |
| $ | 29.00 |
|
| $ | 0.08 |
|
| $ | 24.56 |
| $ | 21.36 |
|
| $ | 0.07 |
|
|
Second Quarter |
| 36.22 |
| 29.70 |
|
| 0.08 |
|
| 27.11 |
| 22.39 |
|
| 0.07 |
|
| ||||||
Third Quarter |
| 37.55 |
| 27.46 |
|
| 0.08 |
|
| 27.99 |
| 24.51 |
|
| 0.07 |
|
| ||||||
Fourth Quarter |
| 31.72 |
| 25.80 |
|
| 0.08 |
|
| 32.59 |
| 24.96 |
|
| 0.07 |
|
| ||||||
There is no established public trading market for our Class B Common Stock, which is held exclusively by members of the Horne family. The trading priceprincipal holders of such stock are subject to restrictions on transfer with respect to their shares. Each share of our Class B Common Stock (10 votes per share) is convertible into one share of Class A Common Stock (1 vote per share).
Aggregate common stock dividend payments for 2005 and 2004 were $10.5 million and $9.1 million, respectively. While we presently intend to continue to pay cash dividends, the payment of future cash dividends depends upon the Board of Directors’ assessment of our earnings, financial condition, capital requirements and other factors.
The number of record holders of our Class A Common Stock mayas of February 22, 2006 was 134. The number of record holders of our Class B Common Stock as of February 22, 2006 was 8.
23
Item 6.SELECTED FINANCIAL DATA.
The selected financial data set forth below should be volatileread in conjunction with our consolidated financial statements, related Notes thereto and fluctuations“Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein.
FIVE-YEAR FINANCIAL SUMMARY
(Amounts in thousands, except per share information)
|
| Year Ended |
| Year Ended |
| Year Ended |
| Year Ended |
| Year Ended |
| |||||||||||||||
Statement of operations data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net sales |
|
| $ | 924,346 |
|
|
| $ | 824,558 |
|
|
| $ | 701,859 |
|
|
| $ | 615,526 |
|
|
| $ | 548,940 |
|
|
Income from continuing operations |
|
| 55,020 |
|
|
| 48,738 |
|
|
| 36,419 |
|
|
| 32,622 |
|
|
| 26,556 |
|
| |||||
Loss from discontinued operations, net of taxes |
|
| (421 | ) |
|
| (1,918 | ) |
|
| (3,057 | ) |
|
| — |
|
|
| — |
|
| |||||
Net income |
|
| 54,599 |
|
|
| 46,820 |
|
|
| 33,362 |
|
|
| 32,622 |
|
|
| 26,556 |
|
| |||||
Income per share from continuing operations—diluted |
|
| 1.67 |
|
|
| 1.49 |
|
|
| 1.32 |
|
|
| 1.21 |
|
|
| 0.99 |
|
| |||||
Income (loss) per share from discontinued operations—diluted |
|
| (0.01 | ) |
|
| (0.06 | ) |
|
| (0.11 | ) |
|
| — |
|
|
| — |
|
| |||||
Net income per share—diluted |
|
| 1.66 |
|
|
| 1.43 |
|
|
| 1.21 |
|
|
| 1.21 |
|
|
| 0.99 |
|
| |||||
Cash dividends declared per common share |
|
| $ | 0.32 |
|
|
| $ | 0.28 |
|
|
| $ | 0.25 |
|
|
| $ | 0.24 |
|
|
| $ | 0.24 |
|
|
Balance Sheet Data (at year end): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Total assets |
|
| $ | 1,100,970 |
|
|
| $ | 922,680 |
|
|
| $ | 840,918 |
|
|
| $ | 635,472 |
|
|
| $ | 520,470 |
|
|
Long-term debt, net of current portion |
|
| $ | 293,350 |
|
|
| $ | 180,562 |
|
|
| $ | 179,061 |
|
|
| $ | 56,276 |
|
|
| $ | 123,212 |
|
|
(1) For the year ended December 31, 2005, net income includes the following pre-tax costs: restructuring of $729,000 and other costs consisting of accelerated depreciation and asset write downs of $1,816,000. The after tax cost of these items was $1,633,000.
(2) For the year ended December 31, 2005, net income includes a net after-tax charge of $933,000 for a selling, general and administrative expense charge of $1,505,000 related to a contingent earn-out agreement.
(3) For the year ended December 31, 2004, net income includes a net after-tax charge of $2,289,000 for certain accrued expense adjustments, which includes in selling, general and administrative expense after-tax charges of $3,475,000 related to a contingent earn-out agreement and $724,000 for various accrual adjustments and $462,000 recorded as an income tax benefit.
(4) For the year ended December 31, 2004, net income includes the following pre-tax costs: restructuring of $95,000 and other costs consisting of accelerated depreciation of $2,873,000. The after tax cost of these items was $1,825,000.
(5) In December 2004, we decided to divest our interest in our minority owned subsidiary, Jameco International, LLC (Jameco LLC). We recorded in discontinued operation a net of tax impairment charge of $739,000 for the year ended December 31, 2004. Also included in discontinued operations is the net of tax operating results of Jameco LLC of $54,000 of loss and $54,000 of income for the year ended December 31, 2004 and 2003, respectively. In September 1996, we divested our 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 2005, 2004 and
2003 relate to legal and settlement costs associated with the James Jones Litigation. The loss, net of taxes, consists of $421,000, $1,125,000 and $3,111,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
(6) For the year ended December 31, 2003, net income includes the following pre-tax costs: restructuring of $426,000; other costs consist of: inventory and other asset write-downs and accelerated depreciation of $479,000; and $750,000 of other related charges. The after tax cost of these items was $1,084,000.
(7) For the year ended December 31, 2002, net income includes the following pre-tax costs: restructuring of $638,000; other costs consist of: inventory and other asset write-downs and accelerated depreciation of $2,491,000; and $960,000 of other related charges. The after-tax cost of these items was $2,552,000.
(8) For the year ended December 31, 2001, net income includes the following pre-tax costs: restructuring of $1,454,000; other costs consist of: inventory and other asset write-downs and accelerated depreciation of $4,300,000; and $77,000 of other related charges. The after-tax cost of these items was $3,593,000.
(9) For the year ended December 31, 2001, net income includes an after-tax charge for goodwill amortization expense of $3,220,000 as recorded prior to adoption of FAS 142.
Item 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Overview
We are a leading supplier of products for use in the tradingwater quality, water safety, water flow control and water conservation markets in both North America and Europe. For over 130 years, we have designed and manufactured products that promote the comfort and safety of people and the quality and conservation of 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:
· backflow preventers for preventing contamination of potable water caused by reverse flow within water supply lines and fire protection systems;
· a wide range of water pressure regulators for both commercial and residential applications;
· water supply and drainage products for commercial and residential applications;
· temperature and pressure relief valves for water heaters, boilers and associated systems;
· point-of-use water filtration and reverse osmosis systems for both commercial and residential applications;
· thermostatic mixing valves for tempering water in commercial and residential applications;
· systems for under-floor radiant applications and hydraulic pump groups for gas boiler manufacturers; and
· flexible stainless steel connectors for natural and liquid propane gas in commercial food service and residential applications.
Our business is reported in three geographic segments, North America, Europe and China. We distribute our products through three primary distribution channels, wholesale, do-it-yourself (DIY) and original equipment manufacturers (OEMs). Interest rates have an 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. Residential and commercial construction starts have an impact on our levels of sales and earnings. In 2005, organic segment sales in our North American wholesale and DIY markets combined increased by approximately 9.5% over the prior year. Also in 2005, organic segment sales in Europe increased by approximately 2.2% over the prior year despite a weak European economy. An additional factor that has had an effect on our sales is fluctuation in foreign currencies, as a portion of our sales and certain portions of our costs, assets and liabilities are denominated in currencies other than the U.S. dollar.
We believe that the factors relating to our future growth include our ability to continue to make selective acquisitions, both in our core markets as well as new complementary markets, regulatory requirements relating to the quality and conservation of water, increased demand for clean water and continued enforcement of plumbing and building codes and a healthy economic environment. We have completed twenty-five 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, water flow control and related complimentary markets. We target businesses that will provide us with one or more of the following: an entry into new markets, an increase in shelf space with existing customers, 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. In 2005, sales from acquisitions contributed approximately 4.9% to our total sales growth over the prior period.
Products representing a majority of our sales are subject to regulatory standards and code enforcement, which typically require that these products meet stringent performance criteria. Together with our commissioned manufacturers’ representatives, we have consistently advocated for the development and enforcement of such plumbing codes. We are focused on maintaining stringent quality control and testing procedures at each of our manufacturing facilities in order to manufacture products in compliance with code requirements and take advantage of the resulting demand for compliant products. We believe that product development, product testing capability and investment in plant and equipment is needed to manufacture products in compliance with code requirements, which represents a 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.
We require substantial amounts of raw materials to produce our products, including bronze, brass, cast iron, steel and plastic, and substantially all of the raw materials we require are purchased from outside sources. We have experienced increases in the costs of certain raw materials, particularly copper. Bronze and brass are copper-based alloys. During 2005, spot copper cost increased approximately 46.9%. Additionally, due to increases in the cost of crude oil, the costs of certain plastic resins we use increased approximately between 9.8% and 19.0% during 2005.
A risk we face is our ability to deal effectively with increases in raw material costs. We manage this risk by monitoring related market prices, working with our suppliers to achieve the maximum level of stability in their costs and related pricing, seeking alternative supply sources when necessary, implementing cost reduction programs and passing increases in costs to our customers, to the maximum extent possible, when they occur. Additionally, on a limited basis, we use commodity futures contracts to manage this risk, although we do not currently have any such contracts. In response to recent cost increases, we have implemented price may resultincreases for some of the products which have become more expensive to manufacture due to the increases in substantial lossesraw material costs. In 2005, cost increases in raw materials were not completely recovered by increased selling prices or other product cost reductions. We are not able to predict whether or for investors. The tradinghow long these cost increases will continue. If these cost increases continue and we are not able to reduce or eliminate the effect of the cost increases by reducing production costs or implementing price increases, our profit margins could decrease.
Another risk we face in all areas of our business is competition. We consider brand preference, engineering specifications, code requirements, price, technological expertise, delivery times and breadth of product offerings to be the primary competitive factors. As mentioned previously, we believe that product development, product testing capability and investment in plant and equipment is needed to manufacture products in compliance with code requirements, which represents a barrier to entry for competitors. We are committed to maintaining our capital equipment at a level consistent with current technologies, and thus we spent approximately $18.6 million in 2005 and $21.0 million in 2004. We are 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.
Recent Developments
On February 7, 2006, we declared a quarterly dividend of nine cents ($0.09) per share on the Company’s Class A Common Stock could declineand Class B Common Stock. This is an increase of $0.01 per share compared to the dividend paid for the comparable period last year.
27
Results of Operations
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Net Sales.Our business is reported in three geographic segments: North America, Europe and China. Our net sales in each of these segments for the years ended December 31, 2005 and 2004 were as follows:
|
| Year Ended |
| Year Ended |
|
|
| Change to |
| |||||||||||||
|
| Net Sales |
| % Sales |
| Net Sales |
| % Sales |
| Change |
| Net Sales |
| |||||||||
|
| (Dollars in thousands) |
| |||||||||||||||||||
North America |
| $ | 629,937 |
|
| 68.2 | % |
| $ | 545,139 |
|
| 66.1 | % |
| $ | 84,798 |
|
| 10.3 | % |
|
Europe |
| 266,346 |
|
| 28.8 |
|
| 253,234 |
|
| 30.7 |
|
| 13,112 |
|
| 1.6 |
|
| |||
China |
| 28,063 |
|
| 3.0 |
|
| 26,185 |
|
| 3.2 |
|
| 1,878 |
|
| 0.2 |
|
| |||
Total |
| $ | 924,346 |
|
| 100 | % |
| $ | 824,558 |
|
| 100 | % |
| $ | 99,788 |
|
| 12.1 | % |
|
The increase in net sales is attributable to the following:
Change | Change | ||||||||||||||||||||||
North | Europe | China | Total | North | Europe | China | Total | North | Europe | China | |||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||
Internal growth |
|
| $ | 51,796 |
|
| $ | 5,533 |
| $ | 1,529 |
| $ | 58,858 |
|
| 6.3 | % |
|
| 0.7 | % |
|
| 0.2 | % |
|
| 7.1 | % |
|
| 9.5 | % |
|
| 2.2 | % |
|
| 5.9 | % |
|
Foreign exchange |
|
| 3,112 |
|
| (2,857 | ) | 349 |
| 604 |
|
| 0.4 |
|
|
| (0.4 | ) |
|
| — |
|
|
| 0.1 |
|
|
| 0.6 |
|
|
| (1.1 | ) |
|
| 1.3 |
|
| ||||
Acquisitions |
|
| 29,890 |
|
| 10,436 |
| — |
| 40,326 |
|
| 3.6 |
|
|
| 1.3 |
|
|
| — |
|
|
| 4.9 |
|
|
| 5.5 |
|
|
| 4.1 |
|
|
| — |
|
| ||||
Total |
|
| $ | 84,798 |
|
| $ | 13,112 |
| $ | 1,878 |
| $ | 99,788 |
|
| 10.3 | % |
|
| 1.6 | % |
|
| 0.2 | % |
|
| 12.1 | % |
|
| 15.6 | % |
|
| 5.2 | % |
|
| 7.2 | % |
|
The internal growth in net sales in North America was broad-based in both our wholesale and DIY markets. Our wholesale market for 2005, excluding the sales from acquisitions, grew by 8.5% compared to 2004, primarily due to increased sales of backflow preventor units, as well as increased under-floor radiant heating product lines and increased unit selling prices in most of our product lines. Our sales into the North American DIY market for 2005 increased organically by 12.3% compared to 2004 primarily due to increased sales of fittings and supply lines and under-floor radiant heating products.
The increase in net sales due to foreign exchange in North America is due to the Canadian dollar appreciating against the U.S. dollar. We cannot predict whether the Canadian dollar will continue to appreciate against the U.S. dollar in future periods or fluctuatewhether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.
Acquired growth in responsenet sales in North America is due to the inclusion of net sales of Dormont, acquired on December 28, 2005, Core, acquired on December 2, 2005, Flexflow, acquired on November 4, 2005, Savard, acquired on July 8, 2005, Alamo, acquired on June 20, 2005, HF, acquired on January 5, 2005, Sea Tech, acquired on January 4, 2005, and Orion, acquired on May 21, 2004.
Internal growth in Europe net sales results from increased sales into the wholesale market as a result of gaining market share, particularly in Germany. Sales into the European OEM market were primarily flat compared to last year.
Net sales were negatively impacted by foreign exchange in Europe primarily from the depreciation of the euro against the U.S. dollar. We cannot predict whether the euro will continue to depreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.
Acquired growth in Europe net sales is due to the inclusion of the net sales of Microflex, which we acquired on July 5, 2005, Electro Controls, which we acquired on May 11, 2005, and TEAM, acquired on April 16, 2004.
The increase in net sales in China is primarily attributable to increased sales in both the Chinese domestic and export markets.
Gross Profit.Gross profit for 2005 increased $34,141,000, or 11.7%, compared to 2004. The increase in gross profit is attributable to the following:
|
| (in thousands) |
| % Change |
| |||||
Internal growth |
|
| $ | 16,079 |
|
|
| 5.5 | % |
|
Foreign exchange |
|
| 699 |
|
|
| 0.2 |
|
| |
Acquisitions |
|
| 16,306 |
|
|
| 5.6 |
|
| |
Other |
|
| 1,057 |
|
|
| 0.4 |
|
| |
Total |
|
| $ | 34,141 |
|
|
| 11.7 | % |
|
Internal margin growth was $6,891,000, $2,569,000 and $3,646,000 in North America, Europe and China, respectively. Internal growth resulted from increased sales volume in all regions. However, commodity costs, especially for copper-based products and oil, and a sales mix shift in North America and Europe, dampened margin growth. In 2005, we experienced raw material cost increases, which we were not able to fully recover through price increases on some of our products. North America experienced higher growth in lower-margin retail sales partially offset by a reclassification of product liability costs from cost of sales to selling, general and administrative expense. Europe’s OEM business was flat with an increase in lower margin wholesale product sales. Both regions benefited from completed manufacturing restructuring efforts. The China segment increased gross margin primarily due to increased sales volume in the domestic marketplace. The increase in gross margin from foreign exchange is primarily due to the appreciation of the Canadian dollar and the yuan against the U.S. dollar partially offset by a depreciation of the euro against the U.S. dollar. The increase in gross margin from acquisitions is due to the inclusion of gross profit from Dormont, Core, Flexflow, Savard, Microflex, Alamo, Electro Controls, HF, Sea Tech, Orion and TEAM.
Additionally, the increase in gross profit was due to decreased manufacturing restructuring and other costs. For 2005 we charged $1,816,000 of accelerated depreciation and other costs to cost of sales compared to $2,873,000 of accelerated depreciation and other costs for 2004. We anticipate recording a total of approximately $3,000,000 of manufacturing restructuring and other costs for 2006 in the North American and Europe segment.
Selling, General and Administrative Expenses.Selling, general and administrative expenses, or SG&A expenses, for 2005 increased $22,552,000, or 10.9%, compared to 2004. The increase in SG&A expenses is attributable to the following:
|
| (in thousands) |
| % Change |
| |||||
Internal growth |
|
| $ | 14,151 |
|
|
| 6.8 | % |
|
Foreign exchange |
|
| 391 |
|
|
| 0.2 |
|
| |
Acquisitions |
|
| 10,464 |
|
|
| 5.1 |
|
| |
Other |
|
| (2,454 | ) |
|
| (1.2 | ) |
| |
Total |
|
| $ | 22,552 |
|
|
| 10.9 | % |
|
Internal SG&A expenses increased primarily from higher variable selling expenses caused by increased sales volumes in North America and China, from due-diligence related charges, and from increased bad debt reserves. These cost increases were partially offset by lower costs for complying with
Section 404 of the Sarbanes-Oxley Act of 2002 (SOX). Additionally, we recorded $1,000,000 in reserve reductions in 2004 related to a varietyfavorable ruling in a legal matter. The increase in SG&A expenses from foreign exchange is primarily due to the appreciation of factors,the Canadian dollar and the yuan against the U.S. dollar partially offset by the depreciation of the euro against the U.S. dollar. The increase in SG&A expenses from acquisitions is due to the inclusion of Dormont, Core, Savard, Microflex, Alamo, Electro Controls, HF, Sea Tech, Orion and TEAM. Other includes costs of $2,454,000 for prior period corrections including an earn-out arrangement from a prior period acquisition that was accounted for as compensation expense. The earn-out arrangement was completed on August 31, 2005.
Operating Income.Operating income by geographic segment for 2005 and 2004 were as follows:
|
|
|
|
|
|
|
| % Change to |
| |||||||||
|
| Years Ended |
|
|
| Consolidated |
| |||||||||||
|
| December 31, |
| December 31, |
|
|
| Operating |
| |||||||||
|
| 2005 |
| 2004 |
| Change |
| Income |
| |||||||||
|
| (Dollars in thousands) |
| |||||||||||||||
North America |
|
| $ | 76,757 |
|
|
| $ | 68,558 |
|
| $ | 8,199 |
|
| 9.8 | % |
|
Europe |
|
| 31,528 |
|
|
| 31,597 |
|
| (69 | ) |
| (0.1 | ) |
| |||
China |
|
| 3,533 |
|
|
| 1,857 |
|
| 1,676 |
|
| 2.0 |
|
| |||
Corporate |
|
| (17,263 | ) |
|
| (18,412 | ) |
| 1,149 |
|
| 1.4 |
|
| |||
Total |
|
| $ | 94,555 |
|
|
| $ | 83,600 |
|
| $ | 10,955 |
|
| 13.1 | % |
|
The increase in operating income is attributable to the following:
Change | Change | ||||||||||||||||||||||||||||
As a % of Consolidated Operating Income | As a % of Segment Operating Income | ||||||||||||||||||||||||||||
North | North | North | |||||||||||||||||||||||||||
America | Europe | China | Corp. | Total | America | Europe | China | Corp. | Total | America | Europe | China | Corp. | ||||||||||||||||
(Dollars in thousands) |
Internal growth |
|
| $ | (467 | ) |
|
| $ | (1,100 | ) |
| $ | 1,622 |
| $ | 1,873 |
| $ | 1,928 |
|
| (0.6 | )% |
|
| (1.3 | )% |
|
| 1.9 | % |
|
| 2.3 | % |
|
| 2.3 | % |
|
| (0.7 | )% |
|
| (3.5 | )% |
|
| 87.4 | % |
|
| (10.2 | )% |
|
Foreign exchange |
|
| 658 |
|
|
| (404 | ) |
| 54 |
| — |
| 308 |
|
| 0.8 |
|
|
| (0.5 | ) |
|
| 0.1 |
|
|
| — |
|
|
| .4 |
|
|
| 1.0 |
|
|
| (1.3 | ) |
|
| 2.9 |
|
|
| — |
|
| |||||
Acquisitions |
|
| 2,867 |
|
|
| 2,975 |
|
| — |
| — |
| 5,842 |
|
| 3.4 |
|
|
| 3.6 |
|
|
| — |
|
|
| — |
|
|
| 7.0 |
|
|
| 4.2 |
|
|
| 9.4 |
|
|
| — |
|
|
| — |
|
| |||||
Other |
|
| 3,178 |
|
|
| — |
|
| — |
| (724 | ) | 2,454 |
|
| 3.8 |
|
|
| — |
|
|
| — |
|
|
| (0.9 | ) |
|
| 2.9 |
|
|
| 4.6 |
|
|
| — |
|
|
| — |
|
|
| 4.0 |
|
| |||||
Other—Restructuring |
|
| 1,963 |
|
|
| (1,540 | ) |
| — |
| — |
| 423 |
|
| 2.4 |
|
|
| (1.9 | ) |
|
| — |
|
|
| — |
|
|
| .5 |
|
|
| 2.9 |
|
|
| (4.9 | ) |
|
| — |
|
|
| — |
|
| |||||
Total |
|
| $ | 8,199 |
|
|
| $ | (69 | ) |
| $ | 1,676 |
| $ | 1,149 |
| $ | 10,955 |
|
| 9.8 | % |
|
| (0.1 | )% |
|
| 2.0 | % |
|
| 1.4 | % |
|
| 13.1 | % |
|
| 12.0 | % |
|
| (0.3 | )% |
|
| 90.3 | % |
|
| (6.2 | )% |
|
Internally our North American segment experienced a decrease in operating income primarily from increased commodity costs and increased SG&A expenses, partially offset by benefits resulting from our completed manufacturing restructuring projects and outsourcing. In 2005, we experienced raw material cost increases, which we were not able to fully recover through price increases on some of our products. For 2005, we recorded $1,005,000 for net costs associated with our manufacturing restructuring plan compared to $2,968,000 for 2004. The acquired growth is due to the inclusion of operating income from Dormont, Core, Savard, Alamo, HF, Sea Tech and Orion. Other represents costs accrued for an earn-out arrangement from a prior period acquisition. This earn-out arrangement was completed on August 31, 2005.
The increase in operating income due to foreign exchange in North America is due to the Canadian dollar appreciating against the U.S. dollar. 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.
Internally our European segment also experienced decrease in operating income. This was primarily due to a soft European economy, increased sales in lower margin wholesale products and increased SG&A expenses, offset by benefits resulting from our completed manufacturing restructuring projects and outsourcing. For 2005, we recorded $1,540,000 for costs associated with our manufacturing restructuring plan and we did not record any costs for 2004.
The decrease in Europe’s operating income from foreign exchange is primarily due to the depreciation of the euro against the U.S. dollar. We cannot predict whether the euro will continue to depreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our operating income.
The increase in internal growth in China of $1,622,000 is primarily attributable to increased capacity utilization and low cost sourcing to our domestic facilities offset by increased SG&A expenses primarily related to increased variable selling expenses due to increased sales volumes and increased bad debt reserves.
The increase in internal operating income in Corporate of $1,149,000 is primarily attributable to reductions in SOX and audit expenses partially offset by a $1,000,000 reserve reduction in the first quarter of 2004 due to a favorable ruling in a legal matter. Other consists of $724,000 of adjustments made in the fourth quarter of 2004 to correct errors for accrued expenses.
Interest Expense.Interest expense decreased $211,000, or 2.0%, for 2005 compared to 2004, primarily due to reduced debt levels in Europe. Debt levels increased in the U.S., but not limiteduntil December 2005, as a result of the fourth quarter acquisition activity.
Effective July 1, 2005, we entered into a three-year interest rate swap with a counter party for a notional amount of €25,000,000, which is outstanding under our Revolving Credit Facility. We swapped the three-month EURIBOR plus 0.6% for a fixed rate of 3.02%. The impact of the swap was immaterial to the overall interest expense.
We had previously entered into an interest rate swap for a notional amount of €25,000,000 outstanding on our prior revolving credit facility. We swapped the three-month EURIBOR plus 0.7%, for a fixed rate of 2.3%. The swap was terminated at June 30, 2005. The impact of the swap was immaterial to the overall interest expense.
Income Taxes.Our effective tax rate for continuing operations for 2005 increased to 35.9% from 32.9% for 2004. The increase is primarily due to the benefits realized in 2004 of approximately $800,000 for previously unrecognized deferred tax assets in China. In addition in 2004 we recorded multi-year refund claims relating to state tax credits; in 2005 those tax credits were realized for the current year only. This increase was partially offset by a decrease in our European tax rate for 2005 compared to 2004 due to earnings mix in Europe.
Income From Continuing Operations.Income from continuing operations for 2005 increased $6,282,000, or 12.9%, to $55,020,000, or $1.67 per common share, from $48,738,000, or $1.49 per common share, for 2004, in each case, on a diluted basis. Income from continuing operations for 2005 and 2004 includes net costs incurred for our manufacturing restructuring plan of $1,633,000, or ($0.05) per share and $1,825,000, or ($0.06) per share, respectively. Also included in income from continuing operations for 2004 is the net charge of $2,289,000, or ($0.07) per share for accounting corrections relating to certain accrued expenses.
Loss From Discontinued Operations We recorded a charge net of tax to discontinued operations for 2005 of $421,000, or ($0.01) per common share, and $1,918,000, or ($0.06) per common share, for 2004, in each case, on a diluted basis. Included in loss from discontinued operations for 2005 and 2004 are charges attributable to legal fees associated with the James Jones litigation and obligations to the former shareholders of the James Jones Company of $421,000, or ($0.01) per share and $1,125,000, or ($0.04) per share, respectively. See Part I, Item 1, “Business—Product Liability, Environmental and Other Litigation Matters.” Additionally, losses from discontinued operations for 2004 include an impairment charge and an operating loss totaling $793,000 or ($0.02) per share for the divesture of our interest in Jameco LLC.
31
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
During the fourth quarter of 2004, we identified and corrected errors related to certain accrued expenses. The after tax adjustments, which affected selling, general and administrative and tax expense, necessary to correct these errors amounted to $2,289,000, or ($0.07) per share. The portions of these adjustments that related to the year ended December 31, 2004 and the fourth quarter of 2004 were $1,520,000, or ($0.05) per share, and $411,000, or ($0.01) per share, respectively. The impact of the amount that related to prior periods was not material to any of the financial statements of prior periods, thus the amount related to prior periods was also recorded in the fourth quarter of 2004.
The following table illustrates the effects of the adjustments on earnings per share from continuing operations:
|
| Fourth Quarter Ended |
| Year Ended |
| ||||||
|
| December 31, 2004 |
| December 31, 2004 |
| ||||||
Adjustments: |
|
|
|
|
|
|
|
|
| ||
Related to 2004 |
|
| $ | (0.01 | ) |
|
| $ | (0.05 | ) |
|
Related to earlier periods |
|
| (0.06 | ) |
|
| (0.02 | ) |
| ||
|
|
| $ | (0.07 | ) |
|
| $ | (0.07 | ) |
|
Net Sales.Our business is reported in three geographic segments: North America, Europe and China. Our net sales in each of these segments for the years ended December 31, 2004 and 2003 were as follows:
|
| Year Ended |
| Year Ended |
|
|
| % Change to |
| |||||||||||||
|
| Net Sales |
| % Sales |
| Net Sales |
| % Sales |
| Change |
| Net Sales |
| |||||||||
|
| (Dollars in thousands) |
| |||||||||||||||||||
North America |
| $ | 545,139 |
|
| 66.1 | % |
| $ | 472,518 |
|
| 67.3 | % |
| $ | 72,621 |
|
| 10.3 | % |
|
Europe |
| 253,234 |
|
| 30.7 |
|
| 210,614 |
|
| 30.0 |
|
| 42,620 |
|
| 6.1 |
|
| |||
China |
| 26,185 |
|
| 3.2 |
|
| 18,727 |
|
| 2.7 |
|
| 7,458 |
|
| 1.1 |
|
| |||
Total |
| $ | 824,558 |
|
| 100 | % |
| $ | 701,859 |
|
| 100 | % |
| $ | 122,699 |
|
| 17.5 | % |
|
The increase in net sales is attributable to the following:
|
|
|
|
|
|
|
|
|
| Change |
| Change |
| ||||||||||||||||||||||||||||
|
| North |
| Europe |
| China |
| Total |
| North |
| Europe |
| China |
| Total |
| North |
| Europe |
| China |
| ||||||||||||||||||
|
| (Dollars in thousands) |
| ||||||||||||||||||||||||||||||||||||||
Internal growth |
| $ | 45,041 |
| $ | 8,822 |
| $ | 7,458 |
| $ | 61,321 |
|
| 6.4 | % |
|
| 1.3 | % |
|
| 1.1 | % |
|
| 8.8 | % |
|
| 9.6 | % |
|
| 4.2 | % |
|
| 39.8 | % |
|
Foreign exchange |
| 2,463 |
| 20,935 |
| — |
| 23,398 |
|
| 0.4 |
|
|
| 3.0 |
|
|
| — |
|
|
| 3.4 |
|
|
| 0.5 |
|
|
| 9.9 |
|
|
| — |
|
| ||||
Acquisitions |
| 25,117 |
| 12,863 |
| — |
| 37,980 |
|
| 3.5 |
|
|
| 1.8 |
|
|
| — |
|
|
| 5.3 |
|
|
| 5.3 |
|
|
| 6.1 |
|
|
| — |
|
| ||||
Total |
| $ | 72,621 |
| $ | 42,620 |
| $ | 7,458 |
| $ | 122,699 |
|
| 10.3 | % |
|
| 6.1 | % |
|
| 1.1 | % |
|
| 17.5 | % |
|
| 15.4 | % |
|
| 20.2 | % |
|
| 39.8 | % |
|
The internal growth in net sales in North America is due to increased price and unit sales into both the wholesale and DIY markets. Our sales into the wholesale market for 2004, excluding sales from acquisitions, grew by 10% compared to 2003, primarily due to increased sales of backflow preventor units, as well as in our plumbing and under-floor radiant heating product lines. Our sales into the North American DIY market for 2004 increased by 10% compared to 2003 primarily due to increased sales of our brass and tubular products.
The increase in net sales due to foreign exchange in North America is due to the Canadian dollar appreciating against the U.S. dollar. 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 acquired growth in net sales in North America is due to the inclusion of net sales of Flowmatic, acquired on January 5, 2004 and Orion, acquired on May 21, 2004.
The internal growth in net sales in Europe is primarily due to increased sales into the European OEM market and market share gains in the European wholesale markets.
The increase in net sales due to foreign exchange in Europe is primarily due to the appreciation of the euro against the U.S. dollar. 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 in net sales in Europe is due to the inclusion of the net sales of Martin Orgee, acquired on April 18, 2003, Anello, acquired on July 30, 2003, and TEAM, acquired on April 16, 2004.
The increase in net sales in China is primarily attributable to downward adjustments made in 2003 for previously recorded sales and increased sales rebates and returns recorded at our TWT joint venture located in Tianjin, China that did not repeat in 2004, and to internal growth primarily due to increased domestic shipments from our wholly-owned subsidiary located in Taizhou, China.
Gross Profit.Gross profit for 2004 increased $50,696,000, or 21.1%, compared to 2003. The increase in gross profit is attributable to the following:
|
| (in thousands) |
| % Change |
| |||||
Internal growth |
|
| $ | 31,628 |
|
|
| 13.2 | % |
|
Foreign exchange |
|
| 7,415 |
|
|
| 3.1 |
|
| |
Acquisitions |
|
| 13,722 |
|
|
| 5.7 |
|
| |
Other |
|
| (2,069 | ) |
|
| (0.9 | ) |
| |
Total |
|
| $ | 50,696 |
|
|
| 21.1 | % |
|
The internal growth is primarily due to a $21,449,000 increase in internal gross profit in the North American segment. This increase is primarily due to improved sales mix due to increased sales volume in the North American wholesale market, which typically generates higher gross margins than the North American retail market, and to benefits resulting from our completed manufacturing restructuring projects and outsourcing. The European segment increased internal gross profit by $3,972,000, primarily due to sales growth with European OEM and wholesale customers and to benefits resulting from our completed manufacturing restructuring projects. The China segment increased gross profit by $7,076,000, primarily due to inventory write-downs, increased sales rebates and returns and other net adjustments recorded in 2003 that did not repeat in 2004, and to increased sales volumes at WPT (formerly referred to as Shida) and improved manufacturing efficiencies at our wholly owned manufacturing plant in Tianjin in 2004. The increase in gross profit from foreign exchange is primarily due to the appreciation of the euro and Canadian dollar against the U.S. dollar. The increase in gross profit from acquisitions is due to the inclusion of gross profit from Orion, TEAM, Flowmatic, Martin Orgee and Anello. These factors contributed to an increased consolidated gross profit percent of 35.2% for 2004 compared to 34.2% in 2003.
The increase in gross profit was partially offset by increased manufacturing restructuring and other costs. For 2004 we charged $2,873,000 of accelerated depreciation to cost of sales compared to $804,000 of accelerated depreciation and other costs for 2003.
Selling, General and Administrative Expenses.SG&A expenses for 2004 increased $37,428,000, or 22.1%, compared to 2003. The increase in SG&A expenses is attributable to the following:
|
| (in thousands) |
| % Change |
| |||||
Internal growth |
|
| $ | 20,118 |
|
|
| 11.9 | % |
|
Foreign exchange |
|
| 4,573 |
|
|
| 2.7 |
|
| |
Acquisitions |
|
| 7,811 |
|
|
| 4.6 |
|
| |
Other |
|
| 4,926 |
|
|
| 2.9 |
|
| |
Total |
|
| $ | 37,428 |
|
|
| 22.1 | % |
|
The internal increase in SG&A expenses is primarily due to increased variable selling expense due to increased sales volume and costs incurred to comply with the requirements of SOX partially offset by a reserve reduction due to a favorable ruling in one of our legal cases. For 2004, commission expense and selling expense were approximately 4.2% and 11.5%, respectively, of sales. These expense percentages are consistent with 2003. For 2004, we recorded approximately $5,900,000 for SOX-related expenses.
As discussed previously, during the fourth quarter of 2004, we identified and corrected errors related to certain accrued expenses. The adjustments to net income necessary to correct these errors included a pre-tax charge to SG&A expenses of $4,926,000.
Our SG&A expenses as a percentage of sales for 2004 increased to 25.1% compared to 24.1% for 2003 primarily from SOX costs and the fourth quarter accrual adjustments.
Operating Income.Operating income by geographic segment for 2004 and 2003 were as follows:
|
|
|
|
|
|
|
| % Change to |
| |||||||||
|
| Years Ended |
|
|
| Consolidated |
| |||||||||||
|
| December 31, |
| December 31, |
|
|
| Operating |
| |||||||||
|
| 2004 |
| 2003 |
| Change |
| Income |
| |||||||||
|
| (Dollars in thousands) |
| |||||||||||||||
North America |
|
| $ | 68,558 |
|
|
| $ | 64,375 |
|
| $ | 4,183 |
|
| 6.0 | % |
|
Europe |
|
| 31,597 |
|
|
| 22,592 |
|
| 9,005 |
|
| 12.9 |
|
| |||
China |
|
| 1,857 |
|
|
| (3,834 | ) |
| 5,691 |
|
| 8.1 |
|
| |||
Corporate |
|
| (18,412 | ) |
|
| (13,132 | ) |
| (5,280 | ) |
| (7.6 | ) |
| |||
Total |
|
| $ | 83,600 |
|
|
| $ | 70,001 |
|
| $ | 13,599 |
|
| 19.4 | % |
|
The increase in operating income is attributable to the following:
Change | Change | ||||||||||||||||||||||||||||
As a % of Consolidated Operating Income | As a % of Segment Operating Income | ||||||||||||||||||||||||||||
North | Europe | China | Corp. | Total | North | Europe | China | Corp. | Total | North | Europe | China | Corp. | ||||||||||||||||
Dollars in thousands) | |||||||||||||||||||||||||||||
Internal growth |
| $ | 9,920 |
| $ | 2,065 |
| $ | 5,529 |
| $ | (6,004 | ) | $ | 11,510 |
|
| 14.2 | % |
|
| 3.0 | % |
|
| 7.9 | % |
|
| (8.6 | )% |
|
| 16.5 | % |
|
| 15.4 | % |
|
| 9.1 | % |
|
| 144.2 | % |
| (45.7 | )% |
Foreign exchange |
| 434 |
| 2,408 |
| — |
| — |
| 2,842 |
|
| 0.6 |
|
|
| 3.4 |
|
|
| — |
|
|
| — |
|
|
| 4.1 |
|
|
| 0.7 |
|
|
| 10.7 |
|
|
| — |
|
| — |
| |||||
Acquisitions |
| 2,285 |
| 3,626 |
| — |
| — |
| 5,911 |
|
| 3.3 |
|
|
| 5.2 |
|
|
| — |
|
|
| — |
|
|
| 8.4 |
|
|
| 3.6 |
|
|
| 16.1 |
|
|
| — |
|
| — |
| |||||
Other |
| (5,650 | ) | — |
| — |
| 724 |
| (4,926 | ) |
| (8.1 | ) |
|
| — |
|
|
| — |
|
|
| 1.0 |
|
|
| (7.1 | ) |
|
| (8.8 | ) |
|
| — |
|
|
| — |
|
| 5.5 |
| |||||
Other—Restructuring |
| (2,806 | ) | 906 |
| 162 |
| — |
| (1,738 | ) |
| (4.0 | ) |
|
| 1.3 |
|
|
| 0.2 |
|
|
| — |
|
|
| (2.5 | ) |
|
| (4.4 | ) |
|
| 4.0 |
|
|
| 4.2 |
|
| — |
| |||||
Total |
| $ | 4,183 |
| $ | 9,005 |
| $ | 5,691 |
| $ | (5,280 | ) | $ | 13,599 |
|
| 6.0 | % |
|
| 12.9 | % |
|
| 8.1 | % |
|
| (7.6 | )% |
|
| 19.4 | % |
|
| 6.5 | % |
|
| 39.9 | % |
|
| 148.4 | % |
| (40.2 | )% |
The internal growth in North America is primarily due to our failureincreased gross profit in the wholesale market, benefits resulting from our completed manufacturing restructuring projects and outsourcing, partially offset by increased net SG&A expenses. In 2004, we experienced raw material cost increases, which we were able to meet the performance estimates of securities analysts, changes in financial estimatesrecover by implementing price increases on some of our revenuesproducts. For 2004, we recorded $2,968,000 for costs associated with our manufacturing restructuring plan compared to $162,000 for 2003. We expect to record an additional $750,000 in the first half of 2005 for approved costs associated with our manufacturing restructuring plan. The acquired growth is due to the inclusion of operating income from Orion and Flowmatic. Other of $5,650,000 relates to compensation expense regarding the accrual adjustment.
The internal growth in Europe is primarily due to increased gross profit from the increased sales volume in the OEM and wholesale markets and to benefits resulting from our previous manufacturing restructuring projects, partially offset by increased SG&A expenses. For 2004, we did not record any costs associated with our manufacturing restructuring plan compared to $906,000 for 2003. The increase in operating income from foreign exchange is primarily due to the appreciation of the euro against the U.S. dollar. 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 acquired growth includes operating income from TEAM, Martin Orgee and Anello.
The increase in internal growth in China of $5,529,000 is attributable to inventory write-downs and other net adjustments recorded in 2003 that did not repeat in 2004, and to internal growth primarily due to increased sales volumes and improved manufacturing efficiencies associated with our manufacturing plant in Tianjin, which in 2003 was in a start-up phase.
The decrease in operating income in Corporate of $5,280,000 is primarily attributable to costs incurred for compliance with SOX. Other of $724,000 includes the adjustments to correct errors for accrued expenses.
Interest Expense.Interest expense decreased $1,544,000, or 12.8%, for 2004 compared to 2003, primarily due to overlapping interest charges on three separate senior note issues that were outstanding in 2003, while only two senior note issues remain outstanding in 2004, partially offset by the elimination of favorable amortization from our interest rate swap, increased indebtedness on our $125,000,000 senior notes and decreased indebtedness under our U.S. revolving credit facility. On September 1, 2001, we entered into an interest rate swap with respect to our $75,000,000 8.375% 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 2003, we reduced interest expense by $1,420,000 by amortizing the adjustment to the fair value of the swap. The amortization of the swap was completed upon repayment of the $75,000,000 8.375% notes on December 1, 2003. On May 15, 2003, we refinanced our $75,000,000 8.375% notes with proceeds from the issuance of $125,000,000 senior notes.
On July 1, 2003, we entered into an interest rate swap for a notional amount of €25,000,000 outstanding on our prior revolving credit facility. We swapped the three-month EURIBOR plus 0.7%, for a fixed rate of 2.3%. For 2004, the EURIBOR rate did not fluctuate materially and the impact of swap was immaterial to the overall interest expense.
Income Taxes.Our effective tax rate for continuing operations for 2004 decreased to 32.9% from 38.0% for 2003. The decrease is primarily due to improvements in the results of our Chinese operations that have allowed us to recognize the benefit of deferred tax assets and also have provided a favorable mix of earnings. We also recognized the benefit of a significant amount of state income tax credits in 2004. In addition, a credit of $462,000 was recorded for accounting corrections made in the fourth quarter of 2004 for an accrual that was related to prior years.
35
Income From Continuing Operations.Income from continuing operations for 2004 increased $12,319,000, or 33.8%, to $48,738,000, or $1.49 per common share, from $36,419,000, or $1.32 per common share, for 2003, in each case, on a diluted basis. The appreciation of the euro and the Canadian dollar against the U.S. dollar resulted in a positive impact on income from continuing operations of $0.05 per share for 2004 compared to 2003. We cannot predict whether the euro or 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 income. Income from continuing operations for 2004 and 2003 includes net costs incurred for our manufacturing restructuring plan of $1,825,000, or ($0.06) per share, and $1,084,000, or ($0.04) per share, respectively. Also included in income from continuing operations for 2004 is the net charge of $2,289,000, or ($0.07) per share, for accounting corrections relating to certain accrued expenses.
Loss From Discontinued Operations.We recorded a charge net of tax to discontinued operations for 2004 of $1,918,000, or ($0.06) per common share, and $3,057,000, or ($0.11) per common share, for 2003, in each case, on a diluted basis. Included in loss from discontinued operations for 2004 are charges attributable to legal fees associated with the James Jones litigation and obligations to the former shareholders of the James Jones Company of $1,125,000, or ($0.04) per share, compared to $3,111,000, or ($0.11) per share, for 2003. See Part I, Item 1, “Business—Product Liability, Environmental and Other Litigation Matters.” Additionally, losses from discontinued operations for 2004 and 2003 include an impairment charge and an operating loss totaling $793,000, or ($0.02) per share, and income of $54,000, or $0.00 per share, respectively, for the planned divesture of our interest in Jameco LLC.
Liquidity and Capital Resources
We generated $51,867,000 of cash from continuing operations in 2005. We experienced an increase in accounts receivable in North America, Europe and China totaling $16,546,000. This increase is primarily due to increased sales volume. Additionally, we experienced an increase in inventories in North America, Europe and China totaling $20,330,000. A portion of the overall increase in inventory is due to the increased costs of raw materials. The increase in inventory in Europe is primarily due to increased finished goods to support the delivery requirements of OEM customers in Europe and an increase in safety stocks during restructuring. North American and China inventories increased primarily due to the incremental volume of products being sourced from our extended China supply chain. The increase in inventory and accounts receivable was partially offset by increased accounts payable of approximately $14,257,000.
We used $183,203,000 of net cash for investing activities in 2005. We used $191,396,000 to fund the acquisitions of Dormont, Core, Flexflow, Savard, Microflex, Alamo, Electro Controls, HF and Sea Tech. We also invested $18,590,000 in capital equipment. Capital expenditures were primarily for manufacturing machinery and equipment as part of our ongoing commitment to improve our manufacturing capabilities. We expect to invest approximately $25,000,000 in capital equipment in 2006. We generated $26,600,000 by the sale of investment securities.
We generated $112,924,000 of net cash from financing activities in 2005 primarily from increased borrowings in the U.S. and Europe for acquisitions and proceeds from the exercise of stock options, offset by dividend payments and payments of debt. We paid $3,750,000 of debt owed to the former shareholders of Hunter Innovations, leaving a balance of $3,750,000 remaining to be paid in May 2006.
Our revolving credit facility with a syndicate of banks (the Revolving Credit Facility) provides for multi-currency unsecured borrowings and stand-by letters of credit of up to $300,000,000 and matures in September 2009. The Revolving Credit Facility is being used to support our acquisition program, working capital requirements and for general corporate purposes.
Outstanding indebtedness under the Revolving Credit Facility bears interest at a rate determined by the type of loan plus an applicable margin determined by the Company’s debt rating, depending on the
applicable base rate and our bond rating. For 2005 the average interest rate under the Revolving Credit Facility for U.S. dollar borrowings was approximately 5.0% and euro based borrowings was approximately 2.7%. We had approximately $100,096,000 of unused and potentially available revolving credit at December 31, 2005. At December 31, 2005, we had $127,000,000 for U.S dollar denominated debt and $40,263,000 for euro-based borrowings outstanding on our Revolving Credit Facility. Additionally, we had $32,641,000 outstanding for stand-by letters of credit on our Revolving Credit Facility at December 31, 2005. 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. At December 31, 2005, we were in compliance with all covenants related to the Revolving Credit Facility.
Effective July 1, 2005, we entered into a three-year interest rate swap with a counter party for a notional amount of €25,000,000, which is outstanding under our Revolving Credit Facility. We swapped the three-month EURIBOR plus 0.6% for a fixed rate of 3.02%. We have designated the swap as a hedge using the cash flow method. At December 31, 2005, the fair value of the swap was approximately $484,000.
We previously entered into an interest rate swap for a notional amount of €25,000,000 outstanding under our revolving credit facility that expired on June 30, 2005. The term of the swap was two years. We swapped the three-month EURIBOR plus 0.7% for a fixed rate of 2.3%. We designated the swap as a hedging instrument using the cash flow method.
We used $1,050,000 of net cash for discontinued operations. During 2005, we received approximately $548,000 in cash as a settlement payment for indemnification costs we incurred in the James Jones case. An offsetting liability has been recorded at December 31, 2005 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 approximately $2,100,000 in cash for reimbursement of defense costs related to the James Jones case. During 2005, we paid approximately $2,503,000 for defense costs, $550,000 for legal costs and approximately $1,021,000 for indemnity costs we incurred in the James Jones case.
Working capital (defined as current assets less current liabilities) as of December 31, 2005 was $305,092,000 compared to $303,374,000 as of December 31, 2004. The ratio of current assets to current liabilities was 2.4 to 1 as of December 31, 2005 compared to 2.6 to 1 as of December 31, 2004. Cash and cash equivalents were $45,758,000 as of December 31, 2005 compared to $65,913,000 as of December 31, 2004. This decrease in cash was primarily due to cash paid for acquisitions, increased working capital requirements and capital expenditures, offset by the sale of investment securities.
In May 2005, we filed a universal shelf registration statement on Form S-3 with the Securities and Exchange Commission, pursuant to which we registered $300,000,000 of an indeterminate amount of debt and/or buy/sell recommendationsequity securities. We expect that funds from any offerings would be used to finance acquisitions and working capital, repay or refinance debt and for other general corporate purposes. We generated $40,210,000 of cash from continuing operations in 2004. We experienced an increase in inventory in North America and China. The North America increase was primarily due to planned increases in finished goods as we set up additional distribution centers and a lengthened supply chain from producing more products abroad and increased sales volume. In addition, due to the cost increases in certain raw materials, the carrying value of our inventory in North America for 2004 has increased approximately $9,000,000 compared to 2003. Additionally, we experienced an increase in accounts receivable in North America partially offset by securities analysts, thea decrease in Europe. The North America increase was primarily due to increased sales volume and timing of announcementscertain cash receipts from certain large customers.
We used $111,379,000 of net cash from investing activities in 2004. We invested $20,999,000 in capital equipment. Capital expenditures were primarily for manufacturing machinery and equipment as part of our ongoing commitment to improve our manufacturing capabilities. We received $2,143,000 of proceeds primarily from a sale of one of our North American manufacturing facilities with respect to which we
entered into a sale and lease back arrangement. Our business acquisitions, net of cash acquired, consisted of cash purchases of $16,796,000 for the assets of Flowmatic, $5,750,000 for the 40% equity interest in Shida that had been held by our former joint venture partner, $17,247,000 for the TEAM acquisition, $27,873,000 for the Orion acquisition and $787,000 for an additional 34% investment in Watts Stern Rubinetti S.r.l. Additionally, our net investment in securities, primarily investment grade auction rate securities, increased to $26,600,000 in 2004 from $4,000,000 in 2003.
We used $16,526,000 of net cash from financing activities in 2004 primarily for dividend payments, debt repayment in China and $3,750,000 of debt paid to the former shareholders of Hunter Innovations partially offset by proceeds from stock option exercises.
We generated $52,303,000 of net cash from continuing operations in 2003. We experienced an increase in inventories in North America, Europe and China. The increase in inventory in North America was primarily due to planned increases in imported raw materials and finished goods to support our delivery capability as we extended our supply chain to lower cost regions, as well as an increase in inventory to support increased retail business. The increase in inventory in Europe was primarily due to increased safety stock growth to cover planned distribution relocations and to support the delivery requirements of OEM customers in Europe. The increase in inventory in China was the result of our wholly-owned manufacturing plant start-up operations. We had reductions in accounts receivable in Europe and China, partially offset by increased accounts receivable in North America. The increase in North America was due to increased sales volume. We funded $6,800,000 into our pension plans in the year ended December 31, 2003.
We used $37,747,000 of net cash for investing activities in 2003. We invested $20,030,000 in capital equipment for the year ended December 31, 2003. Capital expenditures were primarily for manufacturing machinery and equipment as part of our ongoing commitment to improve our manufacturing capabilities. The two largest components of this expenditure were for a building added to our Shida joint venture facility in Taizhou, China and for additional machinery and equipment for our wholly-owned manufacturing plant in Tianjin, China. On January 29, 2003, we invested an additional $3,040,000 in our Shida joint venture, bringing our total amount to approximately $8,040,000. This joint venture was owned 60% by us orand 40% by our competitors concerning significant product line developments, contracts or acquisitions or publicity regarding actual or potential results or performance, fluctuationChinese partner. 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 Giuliani Anello S.r.l.
We generated $122,079,000 of net cash from financing activities in our quarterly operating results caused by fluctuations in revenues and expenses, substantial sales2003. On December 10, 2003, we completed a public offering of our4,600,000 shares of newly issued Class A Common Stock by our existing shareholders, general stock market conditionsat $19.00 per share. Net proceeds were approximately $82,500,000, after taking into account underwriter discounts and other economic or external factors.
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 make it more difficult for a third party to acquire us without the consent of our board of directors. These provisions include those that:
Delaware law also imposes restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock.
New Accounting Standards
In August 2001, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards Board Statement No. 143, "Accounting for Asset Retirement Obligations" (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 obligationexpenses associated with the retirementtransaction. On May 6, 2003 we paid $3,750,000 of tangible long-lived assets that resultdebt owed to the former shareholders of Hunter Innovations, leaving a balance of $11,250,000 remaining to be paid.
We had free cash flow of $23,449,000 (defined as net cash provided by continuing operations minus capital expenditures and dividends plus proceeds from sale of assets) during the acquisition, construction, development and/or normal useyear ended December 31, 2005 versus free cash flow of $12,283,000 in 2004. This increase in 2005 compared to 2004 was primarily due to decreased growth in inventories partially offset by increased accounts receivable. 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 assets.sum of short and long term interest-bearing liabilities less cash and cash equivalents plus total stockholders’ equity, including minority interest) increased to 33.1% for 2005 from 19.3% for 2004. The company must also record a correspondingincrease resulted from an increase in debt to fund acquisitions and a decrease in cash due to other working capital requirements in 2005 and payments made for such acquisitions.
We had free cash flow of $12,283,000 during the carrying valueyear ended December 31, 2004 versus free cash flow of $27,179,000 in 2003. This decrease in 2004 compared to 2003 was primarily due to increased growth in
inventories, increased accounts receivable and increased dividends partially offset by increases in accrued expenses.
We believe free cash flow to be an appropriate supplemental measure 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. We have adopted FAS 143 effective January 1, 2003 and its adoption was not material to our consolidated financial statements.
In July 2002, the FASB issued Financial Accounting Standards Board Statement No. 146, "Accounting for Costs 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 a liability for a 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
40
94-3, a liability for an exit cost was recognized at the date of 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 146 effective January 1, 2003 and its adoption was not material to our 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. 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 componentperformance of our allowance for doubtful accounts. We adopted FIN 45 effective January 1, 2003Company because it provides investors with a measure of our ability to generate cash, to repay debt and its adoption wasto fund acquisitions. Our computation may not materialbe comparable to our consolidated financial statements.
In December 2002, the FASB issued Financial Accounting Standards Board Statement No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure" (FAS 148). FAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. FAS 148 also requiresother companies that disclosures of the pro 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 148 were effective for fiscal years ended after December 15, 2002. We are currently continuing to account for stock-based compensationmay define free cash flow differently. Free cash flow does not represent cash generated from operating activities in accordance with Accounting Principles Board Opinion No. 25 "Accounting for Stock IssuedGAAP. Therefore it should not be considered an alternative to Employees" (APB No. 25) and wenet cash provided the disclosures required by FAS 148.operations as an indication of our performance. Free cash flow should also not be considered an alternative to net cash provided by operations as defined by GAAP.
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 unitsA reconciliation of accounting, and, if separationnet cash provided by continuing operations to free cash flow is appropriate, how the arrangement consideration should be allocatedprovided below:
|
| Years Ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in thousands) |
| |||||||
Net cash provided by continuing operations |
| $ | 51,867 |
| $ | 40,210 |
| $ | 52,303 |
|
Less: additions to property, plant, and equipment |
| (18,590 | ) | (20,999 | ) | (20,030 | ) | |||
Plus: proceeds from the sale of property, plant, and equipment |
| 652 |
| 2,143 |
| 1,765 |
| |||
Less: dividends |
| (10,480 | ) | (9,071 | ) | (6,859 | ) | |||
Free cash flow |
| $ | 23,449 |
| $ | 12,283 |
| $ | 27,179 |
|
Our net debt to the identified accounting units. The provisions of EITF 00-21 are effective for revenue arrangements entered during fiscal periods beginning after June 15, 2003. We adopted EITF 00-21 effective July 1, 2003 and its adoption wascapitalization ratio is not material to our consolidated financial statements.
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 VIEcomputed in accordance with Interpretation 46. FIN 46 was effectiveGAAP. 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 net debt to capitalization differently.
A reconciliation of long-term debt (including current portion) to net debt and our net debt to capitalization ratio is provided below:
|
| December 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
Current portion of long-term debt |
| $ | 13,635 |
| $ | 4,981 |
|
Plus: long-term debt, net of current portion |
| 293,350 |
| 180,562 |
| ||
Less: cash and cash equivalents |
| (45,758 | ) | (65,913 | ) | ||
Net debt |
| $ | 261,227 |
| $ | 119,630 |
|
A reconciliation of capitalization is provided below:
|
| December 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
Net debt |
| $ | 261,227 |
| $ | 119,630 |
|
Total stockholders’ equity |
| 519,476 |
| 492,788 |
| ||
Plus: minority interest |
| 7,831 |
| 7,515 |
| ||
Capitalization |
| $ | 788,534 |
| $ | 619,933 |
|
Net debt to capitalization ratio |
| 33.1 | % | 19.3 | % |
We anticipate that available funds from current operations, existing cash, our Revolving Credit Facility and other sources of liquidity will be sufficient to meet current operating requirements and
anticipated capital expenditures for at least the first interim or annual period ending after December 15, 2003. In December 2003, the FASB issued a revisionnext 12 months. However, we may have 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 entitiesconsider external sources of financing 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 firstany large future acquisitions.
41
security interest in the LLC's assets. The creditors have no recourse to the Company. The assetsOur long-term contractual obligations as of December 31, 2003 of $3,960,0002005 are comprised 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 interestpresented in the assets offollowing table:
|
| Payment Due by Period |
| |||||||||||||||||||||
Contractual Obligations |
|
|
| Total |
| Less than |
| 1-3 years |
| 3-5 years |
| More than |
| |||||||||||
|
| (in thousands) |
| |||||||||||||||||||||
Long-term debt obligations, including current maturities(a) |
| $ | 306,985 |
|
| $ | 13,635 |
|
|
| $ | 680 |
|
| $ | 217,670 |
|
| $ | 75,000 |
|
| ||
Operating lease obligations |
| 23,315 |
|
| 4,322 |
|
|
| 6,743 |
|
| 3,875 |
|
| 8,375 |
|
| |||||||
Capital lease obligations(a) |
| 1,274 |
|
| 510 |
|
|
| 425 |
|
| 189 |
|
| 150 |
|
| |||||||
Pension contributions |
| 10,473 |
|
| 3,381 |
|
|
| 189 |
|
| 198 |
|
| 6,705 |
|
| |||||||
Other(b) |
| 17,611 |
|
| 14,819 |
|
|
| 1,554 |
|
| 1,102 |
|
| 136 |
|
| |||||||
Total |
| $ | 359,658 |
|
| $ | 36,667 |
|
|
| $ | 9,591 |
|
| $ | 223,034 |
|
| $ | 90,366 |
|
| ||
(a) as recognized in the LLC pertainingconsolidated balance sheet, includes $8,900,000 in bonds due in less than one year from the Dormont acquisition to our loan receivable of $2,230,680be settled by the former owners (see Note 11 to the Consolidated Financial Statements)
(b) includes acquisition related agreement, commodity and capital expenditure commitments at December 31, 2003, which eliminates2005
In November 2005, we signed a definitive agreement to acquire the assets and business of Changsha Valve Works located in consolidation as the resultChangsha, China. Changsha Valve Works is a leading manufacturer of large diameter hydraulic actuated butterfly valves for thermo-power and hydro-power plants, water distribution projects and water works projects in China. Consummation of the application of FIN 46R. Prioracquisition remains subject to the adoptionfulfillment of FIN 46R,certain closing conditions by Changsha Valve Works.
We have entered into a preliminary agreement where we accountedwill purchase a building located in Northern Italy from the local Italian government and, simultaneously, sell to the local Italian government one of our facilities in Northern Italy. This transaction is expected to be consummated in March 2006. The purchase price of the new building approximates $15,300,000. The selling price for our investmentexisting building approximates $9,100,000, with a book value of 49%approximately $2,800,000. It is management’s intention to finance the purchase of this new building under a sale and lease back arrangement, however, the specific terms and conditions of the financing have not yet been determined. Therefore, payments on the future financing have not been included in the LLC using the equity method.
We also maintain another variable interest inContractual Obligations schedule above. In a VIE. In 2000related transaction, we entered intohave an agreement to sell another building in Northern Italy to a private third party for approximately $3,700,000. We expect that this transaction will be consummated in the fourth quarter of 2006. The book value of this building approximates $2,500,000. These transactions are part of our strategy to consolidate our Italian manufacturing activities.
We maintain letters of credit that guarantee our performance or payment to third parties in accordance with Plumworld.co.uk Ltd in which we maintainspecified terms and conditions. Amounts outstanding for total letters of credit were approximately $48,651,000 as of December 31, 2005 and $42,570,000 as of December 31, 2004. Our letters of credit are primarily associated with insurance coverage and to a lesser extent foreign purchases and generally expire within one year of issuance. The increase is primarily associated with increased foreign purchases. These instruments may exist or expire without being drawn down, therefore they do not necessarily represent future cash flow obligations.
We own a 20% interest in Plumbworld.www.plumbworld.co.uk Limited (Plumbworld), a variable interest entity. Plumbworld is primarily an e-business that sells bathroom and sanitary appliances, as well as plumbing and heating products, tools and plumbing consumables. Its annualizedlatest fiscal year sales arewere approximately $7,100,000.
$11,600,000. We maintainhave a notional amountnominal investment of approximately $500 investment in Plumbworld and maintain a loan receivable in the amount of approximately $850,000$603,000 with Plumbworld. We have entered into an agreement with the majority shareholders of Plumbworld to exchange our 20% ownership interest for full receipt of our loan receivable. We expect to receive installment payments through September 2006, at which time we will relinquish our shares in Plumbworld. We continue to account for our investment in Plumbworld using the equity method.
Critical Accounting Policies and Key Estimates
The preparation of our consolidated financial statements in accordance with U.S. GAAP requires management to make judgments, assumptions and estimates that affect the amounts reported. A critical accounting estimate is an assumption about highly uncertain matters and could have a material effect on the consolidated financial statements if another, also reasonable, amount were used, or, a change in the estimate is reasonably likely from period to period. We base our assumptions on historical experience and on other estimates that we believe are reasonable under the circumstances. Actual results could differ significantly from these estimates. There were no changes in accounting policies or significant changes in accounting estimates during 2005.
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 April 2003,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 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. In China, management specifically analyzes individual accounts receivable and establishes specific reserves as needed. In addition, for waterworks customers, whose payment terms are generally extended, we reserve the majority of accounts receivable in excess of one year from the invoice date.
41
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 shrinkage 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. We perform our annual test for indications of goodwill impairment on the last day of our fiscal October, which was October 30 for fiscal 2005.
Intangible assets such as purchased technology are generally recorded in connection with a business acquisition. Values assigned to intangible assets are determined by an independent valuation firm based on estimates and judgments regarding expectations of the success and life cycle of products and technology acquired.
Since the adoption of FAS 142 our valuations have been greater than 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 have a material impact on the results of operations and financial position.
Product liability and workers compensation costs
Because of retention requirements associated with 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 loss reports provided by our third party administrators as well as developing internal historical trend factors based on our specific claims experience. Management utilizes the internal trend
factors that 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 the U.S. Changes in the nature of claims or the actual settlement amounts could affect the adequacy of this estimate and require changes to the provisions.
Workers compensation liabilities in the U.S. are recognized for claims incurred (including claims incurred but not reported) and for changes in the 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 claims experience. In other countries where workers compensation costs are applicable, we maintain insurance coverage with limited deductible payments. Because the liability is an estimate, the ultimate liability may be more or less than reported.
We maintain excess liability insurance with outside insurance carriers to minimize our risks related to catastrophic claims in excess of all self-insured positions. Any material change in the aforementioned factors could have an adverse impact on our operating results.
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 Notes 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 loss amount can be reasonably estimated, net of any applicable insurance proceeds. Estimates of potential outcomes of these contingencies are developed in consultation with outside counsel. While this assessment is based upon all available information, litigation is inherently uncertain and the actual liability to fully resolve this litigation cannot be predicted with any assurance of accuracy. Final settlement of these matters could possibly result in significant effects on our results of operations, cash flows and financial position.
Pension benefits
We account 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:
· Weighted average discount rate—this rate is used to estimate the current value of future benefits. This rate is adjusted based on movement in long-term interest rates.
· Expected long-term rate of return on assets—this rate is used to estimate future growth in investments and investment earnings. The expected return is based upon a combination of historical market performance and anticipated future returns for a portfolio reflecting the mix of equity, debt and other investments indicative of our plan assets.
· Rates of increase in compensation levels—this rate is used to estimate projected annual pay increases, which are used to determine the wage base used to project employees’ pension benefits at retirement.
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 affect 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.
New Accounting Standards
In November 2004, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards Board Statement No. 151, “Inventory Costs” (FAS 151). FAS 151 amends the guidance in Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for inventory costs. The provisions of this statement are effective for fiscal years beginning after June 15, 2005, although early application is permitted. We do not expect that the impact of this statement will be material to the consolidated financial statements.
In December 2004, the FASB issued its final standard on accounting for share-based payments (SBP), Financial Accounting Standards Board Statement No. 123R (FAS 123R) that requires companies to expense the value of employee stock options and similar awards. The statement applies to all outstanding and unvested SBP awards at a company’s adoption date. The Securities and Exchange Commission delayed implementation to fiscal years beginning after June 15, 2005. Therefore, we implemented FAS 123R effective January 1, 2006 using the modified prospective method, which requires recognizing expense for options over their remaining vesting period. The portion of these options’ fair value attributable to vested awards prior to the adoption is never recognized. The impact of this statement on our results of operations (based on equity instruments outstanding at December 31, 2005) for the fiscal year ending December 31, 2006 is expected to be approximately ($0.03) per share.
In December 2004, the FASB issued Financial Accounting Standards Board Statement No. 149, "Amendment153, “Exchanges of Statement 133 on Derivative Instruments and Hedging Activities"Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions” (FAS 149)153). The amendments made by 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 depending153 are based on the natureprinciple that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments to FAS 133, including oneeliminate the narrow exception for contracts entered intononmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion No. 29 required that the accounting for an exchange of a productive asset for a similar productive asset or modifiedan equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. The statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 30, 2003.15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The provisions of this statement are being applied prospectively as of January 2006.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47). FIN 47 is an interpretation of FASB Statement No. 143, “Accounting
for Asset Retirement Obligations” (FAS 143) and serves to clarify that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate such a liability. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. We adopted FAS 149 and its adoption wasconcluded that FIN 47 did not have a material to ourimpact on the consolidated financial statements.statements as of December 31, 2005.
In May 2003,2005, the FASB issued Financial Accounting Standards Board Statement No. 150, "Accounting for Certain154, “Accounting Changes and Error Corrections” (FAS 154), a replacement of APB Opinion No. 20, “Accounting Changes” and a replacement of FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Instruments with Characteristics of both Liabilities and Equity" (FAS 150)Statements”. FAS 150 establishes154 changes the accounting for, and reporting of, a change in accounting principle. The statement requires retrospective application to prior periods financial statements of voluntary changes in accounting principles and changes required by new accounting standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. FAS 150when the standard does not include specific transition provisions, unless it is impracticable to do so. The statement is effective for certain financial instruments entered into or modifiedaccounting changes and corrections of errors in fiscal years beginning after May 31, 2003. For unmodified financial instruments existing at May 31, 2003, FAS 150December 15, 2005. Earlier application is effective at the beginningpermitted for accounting changes and corrections of the first interim perioderrors during fiscal years 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.1, 2005.
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 costs of certain raw materials used in the manufacturing process. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all derivative positions are used to reduce risk by hedging underlying economic exposure. The derivatives we use are instruments with liquid markets.
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 RMB.yuan.
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, the yuan, or the U.S. or Canadian dollar. We use foreign currency forward exchange contracts to manage the risk related to intercompany purchases that occur during the course of a year and certain open foreign currency denominated commitments to sell products to third parties. In 2005 and 2004, the amounts recorded in other comprehensive income for the change in the fair value of such contracts was immaterial.
42
At December 31, 2003, we had no forward contracts to buy foreign currencies and no unrealized gains or losses.
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 our long-term debt including principal amounts and related interest rates appears in Note 11 of the Notes to the Consolidated Financial Statements included herein.in our Annual Report on Form 10-K for the year ended December 31, 2005.
We purchase significant amounts of bronze ingot, brass rod, cast iron, steel and plastic, which are utilized in manufacturing our many product lines. Our operating results can be adversely affected by changes in commodity prices if we are unable to pass on related price increases to our customers. We manage this risk by monitoring related market prices, working with our suppliers to achieve the maximum level of stability in their costs and related pricing, seeking alternative supply sources when necessary and passing increases in commodity costs to our customers, to the maximum extent possible, when they occur.
Additionally, on a limited basis, we use commodity futures contracts to manage this risk, but we did not use such contracts in 2003.2005 or 2004.
Item 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The index to financial statements is included in page 4552 of this Report.Report and incorporated herein by reference.
Item 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
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 also 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.operations. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission'sCommission’s rules and forms. There was no change in our internal control over financial reporting that occurred during the period covered by this reportquarter ended December 31, 2005, 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 forcontrol over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.
4346
Management’s Annual Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management, including the Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework.
Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2005.
The audited consolidated financial statements of the Company include the results of Dormont Manufacturing Company, which the Company acquired on December 28, 2005, Core Industries Inc., which the Company acquired on December 2, 2005, Flexflow Tubing LLP, which the Company acquired on November 4, 2005, the water connector business of the Donald E. Savard Company, which the Company acquired on July 8, 2005, Microflex N.V., which the Company acquired on July 5, 2005, the water softener business of Alamo Water Refiners, Inc, which the Company acquired on June 20, 2005, Electro Controls Ltd., which the Company acquired on May 11, 2005, HF Scientific, Inc., which the Company acquired on January 5, 2005 and Sea Tech, Inc., which the Company acquired on January 4, 2005, but management’s assessment does not include an assessment of the internal control over financial reporting of these entities. Under rule 1-02(w) of Regulation S-X, Dormont is considered significant to the consolidated financial statements of the Company. Additional disclosure about these acquisitions is set out under Part I, Item 1, “Business—Acquisitions.”
The Company’s independent auditors have audited management’s assessment of the Company’s internal control over financial reporting and issued an attestation report. That report appears immediately following this report.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Watts Water Technologies, Inc.:
We have audited management’s assessment, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting, that Watts Water Technologies, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Watts Water Technologies, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of Watts Water Technologies, Inc.’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Watts Water Technologies, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also, in our opinion, Watts Water Technologies, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Watts Water Technologies, Inc. acquired Dormont Manufacturing Company, Core Industries Inc., Flexflow Tubing LLP, the water connector business of the Donald E. Savard Company, Microflex N.V., the water softener business of Alamo Water Refiners, Inc, Electro Controls Ltd., HF Scientific, Inc. and Sea Tech, Inc. during 2005 (collectively the 2005 acquisitions). Management excluded from its assessment of internal control over financial reporting, the 2005 acquisitions representing consolidated total assets of
$238 million and consolidated revenues of $30 million included in the consolidated financial statements of Watts Water Technologies, Inc. as of and for the year ended December 31, 2005. Our audit of internal control over financial reporting of Watts Water Technologies, Inc. also excluded an evaluation of the internal control over financial reporting of the 2005 acquisitions.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Watts Water Technologies, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated March 1, 2006 expressed an unqualified opinion on those consolidated financial statements.
Boston, Massachusetts
March 1, 2006
None.
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Item 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.REGISTRANT.
Directors
The information appearing under the caption "Informationcaptions “Information as to Nominees for Director"Director” and “Legal Proceeding Involving Director” in the Registrant'sRegistrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 5, 20044, 2006 is incorporated herein by reference. With respect to Directors and Executive Officers, the information appearing under the caption "Section“Section 16(a) Beneficial Ownership Reporting Compliance"Compliance” in the Registrant'sRegistrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 5, 20044, 2006 is incorporated herein by reference.
Audit Committee and Director Nominations
The information appearing under the caption “Corporate Governance—Committees of the Board” in the Registrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 4, 2006 is incorporated herein by reference.
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“Executive Officers and Directors."Directors” and is incorporated herein by reference.
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. www.wattswater.com. In order to access this portion of our website, click on the "Investor Relations"“Investors” tab. The Code of Business Conduct and Ethics is located under the "Corporate Governance"“Code of Conduct” 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 controllerscontroller 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.COMPENSATION.
The information appearing under the caption "Compensation Arrangements"captions “Compensation Arrangements” and “Director Compensation” in the Registrant'sRegistrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 5, 20044, 2006 is incorporated herein by reference.
50
Item 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The information appearing under the caption "Principal Stockholders"“Principal Stockholders” in the Registrant'sRegistrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 5, 20044, 2006 is incorporated herein by reference.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table gives information about the shares of class A common stock that may be issued upon the exercise of options issued under the Company’s 2004 Stock Incentive Plan, 1991 Directors’ Non-Qualified Stock Option Plan, 1996 Stock Option Plan, the Management Stock Purchase Plan, and the 2003 Non-Employee Directors’ Stock Option Plan, as of December 31, 2005.
|
| Equity Compensation Plan Information |
| |||||||||||||
Plan category |
|
|
| Number of securities to be |
| Weighted-average exercise |
| Number of securities remaining |
| |||||||
|
| (a) |
| (b) |
| (c) |
| |||||||||
Equity compensation plans approved by security holders |
|
| 1,417,456 | (1) |
|
| $ | 20.39 |
|
|
| 2,735,609 | (2) |
| ||
Equity compensation plans not approved by security holders |
|
| None |
|
|
| None |
|
|
| None |
|
| |||
Total |
|
| 1,417,456 | (1) |
|
| $ | 20.39 |
|
|
| 2,735,609 | (2) |
| ||
(1) Represents 1,089,395 outstanding options under the 1991 Directors’ Non-Qualified Stock Option Plan, 1996 Incentive Stock Option Plan, 2003 Non-Employee Directors’ Stock Option Plan and 2004 Stock Incentive Plan, and 328,061 outstanding restricted stock units under the Management Stock Purchase Plan.
(2) Includes 2,485,000 shares available for future issuance under the 2004 Stock Incentive Plan, and 250,609 restricted stock units available for future issuance under the Management Stock Purchase Plan.
Item 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.TRANSACTIONS.
The information appearing under the caption "Compensation Arrangements-Certain“Compensation Arrangements—Certain Relationships and Related Transactions"Transactions” in the Registrant'sRegistrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 5, 20044, 2006 is incorporated herein by reference.
Item 14.PRINCIPAL ACCOUNTINGACCOUNTANT FEES AND SERVICES.
The information appearing under the caption "Ratification“Ratification of Independent Auditors"Auditors” in the Registrant'sRegistrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 5, 20044, 2006 is incorporated herein by reference.
4451
Item 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.SCHEDULES.
The following financial statements are included in a separate section of this Report commencing on the page numbers specified below:
Report of Independent | 54 | |
55 | ||
Consolidated Balance Sheets as of December 31, | 56 | |
57 | ||
58 | ||
59–90 |
(a)(2) Schedules
All other required 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.Statements.
45
46
52
47
(b) Reports on Form 8-KSIGNATURES
The following Current Reports on Form 8-K were filed by the Registrant during the quarter ended December 31, 2003:
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.
WATTS WATER TECHNOLOGIES, INC. | ||||
By: | /s/ PATRICK S. | |||
Patrick S. | ||||
Chief Executive Officer | ||||
DATED: March |
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.
Signature | Title | Date | ||||||||||||
/s/ PATRICK S. | Chief Executive Officer | March 1, 2006 | ||||||||||||
Patrick S. O’Keefe | President and Director | |||||||||||||
/s/ WILLIAM C. MCCARTNEY | Chief Financial Officer and Treasurer | March 1, 2006 | ||||||||||||
William C. McCartney | (Principal Financial and | |||||||||||||
/s/ TIMOTHY P. HORNE | Director | March 1, 2006 | ||||||||||||
Timothy P. Horne | ||||||||||||||
/s/ RALPH E. JACKSON, JR. | Director | March 1, 2006 | ||||||||||||
Ralph E. Jackson, Jr. | ||||||||||||||
/s/ KENNETH J. MCAVOY | Director | March 1, 2006 | ||||||||||||
Kenneth J. McAvoy | ||||||||||||||
/s/ JOHN K. MCGILLICUDDY | Director | March 1, 2006 | ||||||||||||
John K. McGillicuddy | ||||||||||||||
/s/ GORDON W. MORAN | Chairman of the Board | March | ||||||||||||
Gordon W. Moran | ||||||||||||||
/s/ | ||||||||||||||
Director | March 1, 2006 | |||||||||||||
Daniel J. Murphy, III | ||||||||||||||
49
53
Report of Independent Auditors' Report
Registered Public Accounting Firm
The Board of Directors and Stockholders
Watts Water Technologies, Inc.:
We have audited the accompanying consolidated balance sheets of Watts Water Technologies, Inc. and subsidiaries as of December 31, 20032005 and 2002,2004, and the related consolidated statements of operations, stockholders'stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2003.2005. In connection with our audits of the 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'sCompany’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with auditingthe standards generally accepted inof the United States of America.Public Company Accounting Oversight Board (United States). 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 Water Technologies, Inc. and subsidiaries as of December 31, 20032005 and 2002,2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003,2005, in conformity with accounting principlesU.S. generally accepted in the United States of America.accounting principles. 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.
As discussedWe also have audited, in Note 2 toaccordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Watts Water Technologies, Inc.’s internal control over financial statements, effective January 1, 2002, the Company changed its methodreporting as of accounting for goodwill and other intangible assetsDecember 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the adoptionCommittee of Financial Accounting Standards No. 142, "GoodwillSponsoring Organizations of the Treadway Commission (COSO) and Other Intangible Assets."our report dated March 1, 2006, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
Boston, MassachusettsFebruary 3, 2004,except as to the firstparagraph of Note 19,which is as ofFebruary 20, 2004.March 1, 2006
5054
Watts Water Technologies, Inc. and Subsidiaries
Consolidated Statements of Operations
(Amounts in thousands, except per share information)
| | Years Ended December 31, |
| Years Ended December 31, |
| ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2003 | 2002 | 2001 |
| 2005 |
| 2004 |
| 2003 |
| ||||||||||
Net sales | Net sales | $ | 705,651 | $ | 615,526 | $ | 548,940 |
| $ | 924,346 |
| $ | 824,558 |
| $ | 701,859 |
| ||||
Cost of goods sold | Cost of goods sold | 464,990 | 406,806 | 365,408 |
| 599,644 |
| 533,997 |
| 461,994 |
| ||||||||||
GROSS PROFIT | 240,661 | 208,720 | 183,532 | ||||||||||||||||||
GROSS PROFIT |
| 324,702 |
| 290,561 |
| 239,865 |
| ||||||||||||||
Selling, general and administrative expenses | Selling, general and administrative expenses | 170,195 | 150,553 | 131,795 |
| 229,418 |
| 206,866 |
| 169,438 |
| ||||||||||
Restructuring and other charges | Restructuring and other charges | 426 | 638 | 1,454 |
| 729 |
| 95 |
| 426 |
| ||||||||||
OPERATING INCOME |
| 94,555 |
| 83,600 |
| 70,001 |
| ||||||||||||||
Other (income) expense: |
|
|
|
|
|
|
| ||||||||||||||
Interest income |
| (1,232 | ) | (1,135 | ) | (1,043 | ) | ||||||||||||||
Interest expense |
| 10,353 |
| 10,564 |
| 12,108 |
| ||||||||||||||
Minority interest |
| 350 |
| 1,203 |
| (554 | ) | ||||||||||||||
Other |
| (727 | ) | 296 |
| 748 |
| ||||||||||||||
| 8,744 |
| 10,928 |
| 11,259 |
| |||||||||||||||
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 |
| 85,811 |
| 72,672 |
| 58,742 |
| ||||||||||||||
Provision for income taxes |
| 30,791 |
| 23,934 |
| 22,323 |
| ||||||||||||||
INCOME FROM CONTINUING OPERATIONS | INCOME FROM CONTINUING OPERATIONS |
| 55,020 |
| 48,738 |
| 36,419 |
| |||||||||||||
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 | |||||||||||||||
Loss from discontinued operations, net of taxes of $258 in 2005, $1,156 in 2004 and $1,914 in 2003 |
| (421 | ) | (1,918 | ) | (3,057 | ) | ||||||||||||||
NET INCOME |
| $ | 54,599 |
| $ | 46,820 |
| $ | 33,362 |
| |||||||||||
Basic EPS | Basic EPS |
|
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|
|
|
|
| |||||||||||||
Income (loss) per share: | Income (loss) per share: |
|
|
|
|
|
|
| |||||||||||||
Continuing operations | $ | 1.33 | $ | 1.22 | $ | 1.00 | |||||||||||||||
Discontinued operations | (0.11 | ) | — | — | |||||||||||||||||
NET INCOME | $ | 1.22 | $ | 1.22 | $ | 1.00 | |||||||||||||||
Continuing operations |
| $ | 1.69 |
| $ | 1.51 |
| $ | 1.33 |
| |||||||||||
Discontinued operations |
| (0.01 | ) | (0.06 | ) | (0.11 | ) | ||||||||||||||
NET INCOME |
| $ | 1.68 |
| $ | 1.45 |
| $ | 1.22 |
| |||||||||||
Weighted average number of shares | Weighted average number of shares | 27,455 | 26,718 | 26,497 |
| 32,489 |
| 32,276 |
| 27,455 |
| ||||||||||
Diluted EPS | Diluted EPS |
|
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|
|
|
| |||||||||||||
Income (loss) per share: | Income (loss) per share: |
|
|
|
|
|
|
| |||||||||||||
Continuing operations | $ | 1.32 | $ | 1.21 | $ | 0.99 | |||||||||||||||
Discontinued operations | (0.11 | ) | — | — | |||||||||||||||||
NET INCOME | $ | 1.21 | $ | 1.21 | $ | 0.99 | |||||||||||||||
Continuing operations |
| $ | 1.67 |
| $ | 1.49 |
| $ | 1.32 |
| |||||||||||
Discontinued operations |
| (0.01 | ) | (0.06 | ) | (0.11 | ) | ||||||||||||||
NET INCOME |
| $ | 1.66 |
| $ | 1.43 |
| $ | 1.21 |
| |||||||||||
Weighted average number of shares | Weighted average number of shares | 27,692 | 27,056 | 26,802 |
| 33,002 |
| 32,719 |
| 27,692 |
| ||||||||||
Dividends per share | $ | 0.25 | $ | 0.24 | $ | 0.24 | |||||||||||||||
Dividends per share |
| $ | 0.32 |
| $ | 0.28 |
| $ | 0.25 |
|
The accompanying notes are an integral part of these consolidated financial statements.
5155
Watts Water Technologies, Inc. and Subsidiaries
Consolidated Balance Sheets
(Amounts in thousands, except share information)
| | December 31, |
| December 31, |
| |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2003 | 2002 |
| 2005 |
| 2004 |
| ||||||||
ASSETS | ASSETS |
|
|
|
|
| ||||||||||
CURRENT 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 | ||||||||||||||
Cash and cash equivalents |
| $ | 45,758 |
| $ | 65,913 |
| |||||||||
Investment securities |
| — |
| 26,600 |
| |||||||||||
Trade accounts receivable, less allowance for doubtful accounts of |
| 177,364 |
| 150,073 |
| |||||||||||
Inventories, net |
| 242,837 |
| 205,049 |
| |||||||||||
Prepaid expenses and other assets |
| 25,361 |
| 10,786 |
| |||||||||||
Deferred income taxes |
| 27,540 |
| 27,463 |
| |||||||||||
Assets of discontinued operations |
| 9,555 |
| 10,227 |
| |||||||||||
Total Current Assets |
| 528,415 |
| 496,111 |
| |||||||||||
PROPERTY, PLANT AND EQUIPMENT, NET | PROPERTY, PLANT AND EQUIPMENT, NET | 145,711 | 134,376 |
| 164,999 |
| 150,689 |
| ||||||||
OTHER ASSETS: | OTHER ASSETS: |
|
|
|
|
| ||||||||||
Goodwill | 184,901 | 163,226 | ||||||||||||||
Other | 27,557 | 28,114 | ||||||||||||||
Goodwill |
| 296,636 |
| 226,178 |
| |||||||||||
Other, net |
| 110,920 |
| 49,702 |
| |||||||||||
TOTAL ASSETS | TOTAL ASSETS | $ | 838,643 | $ | 635,472 |
| $ | 1,100,970 |
| $ | 922,680 |
| ||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
| |||||||||||
CURRENT LIABILITIES: | 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 | ||||||||||||||
Accounts payable |
| $ | 91,053 |
| $ | 72,038 |
| |||||||||
Accrued expenses and other liabilities |
| 67,071 |
| 61,736 |
| |||||||||||
Accrued compensation and benefits |
| 28,496 |
| 29,679 |
| |||||||||||
Current portion of long-term debt |
| 13,635 |
| 4,981 |
| |||||||||||
Liabilities of discontinued operations |
| 23,068 |
| 24,303 |
| |||||||||||
Total Current Liabilities |
| 223,323 |
| 192,737 |
| |||||||||||
LONG-TERM DEBT, NET OF CURRENT PORTION | LONG-TERM DEBT, NET OF CURRENT PORTION | 179,061 | 56,276 |
| 293,350 |
| 180,562 |
| ||||||||
DEFERRED INCOME TAXES | DEFERRED INCOME TAXES | 15,978 | 15,011 |
| 24,803 |
| 19,578 |
| ||||||||
OTHER NONCURRENT LIABILITIES | OTHER NONCURRENT LIABILITIES | 25,588 | 19,743 |
| 32,187 |
| 29,500 |
| ||||||||
MINORITY INTEREST | MINORITY INTEREST | 9,286 | 10,134 |
| 7,831 |
| 7,515 |
| ||||||||
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 | ||||||||||||
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, 25,205,210 shares in 2005 and 25,049,338 shares in 2004 |
| 2,521 |
| 2,505 |
| |||||||||||
Class B Common Stock, $.10 par value; 25,000,000 shares authorized; 10 votes per share; issued and outstanding, 7,343,880 shares in 2005 and 2004 |
| 734 |
| 734 |
| |||||||||||
Additional paid-in capital |
| 144,284 |
| 140,172 |
| |||||||||||
Retained earnings |
| 368,264 |
| 324,145 |
| |||||||||||
Deferred compensation |
| (1,590 | ) | (1,386 | ) | |||||||||||
Accumulated other comprehensive income |
| 5,263 |
| 26,618 |
| |||||||||||
Total Stockholders’ Equity |
| 519,476 |
| 492,788 |
| |||||||||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |
| $ | 1,100,970 |
| $ | 922,680 |
|
The accompanying notes are an integral part of these consolidated financial statements.
5256
Watts Water Technologies, Inc. and Subsidiaries
Consolidated Statements of Stockholders'Stockholders’ Equity
(Amounts in thousands, except share information)
| 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 | Accumulated Other Comprehensive Income (loss) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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 | ) |
| Class A |
| Class B |
| Additional |
| Retained |
| Deferred |
| Accumulated |
| Total |
| ||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares |
| Amount |
| Shares |
| Amount |
| Capital |
| Earnings |
| Compensation |
| Income (Loss) |
| Equity |
| |||||||||||||||||||||||||||||||||||||||||||||||||||
Balance at December 31, 2002 | Balance at December 31, 2002 | 18,863,482 | $ | 1,886 | 8,185,224 | $ | 819 | $ | 45,132 | $ | 259,893 | $ | (11,794 | ) | $ | — | $ | 295,936 |
| 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 | ) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Comprehensive income: |
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| |||||||||||||||||||||||||||||||||||||
Net income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 33,362 |
|
|
|
|
|
|
|
|
|
|
| 33,362 |
|
| |||||||||||||||||||||||||||||||||||||
Cumulative translation adjustment and other |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 27,440 |
|
|
| 27,440 |
|
| |||||||||||||||||||||||||||||||||||||
Pension plan additional minimumliability, net of tax of $1,205 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1,841 | ) |
|
| (1,841 | ) |
| |||||||||||||||||||||||||||||||||||||
Comprehensive income |
|
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|
|
|
|
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|
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 58,961 |
|
| |||||||||||||||||||||||||||||||||||||
Shares of Class B Common Stock converted to Class A Common Stock |
| 580,000 |
|
| 58 |
|
| (580,000 | ) |
| (58 | ) |
|
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|
|
| |||||||||||||||||||||||||||||||||||||
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 issuedin 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 | Balance at December 31, 2003 | 24,459,121 | $ | 2,446 | 7,605,224 | $ | 761 | $ | 132,983 | $ | 286,396 | $ | 13,805 | $ | — | $ | 436,391 |
| 24,459,121 |
|
| $ | 2,446 |
|
| 7,605,224 |
|
| $ | 761 |
|
|
| $ | 132,983 |
|
|
| $ | 286,396 |
|
|
| $ | — |
|
|
| $ | 13,805 |
|
|
| $ | 436,391 |
|
| ||||||||||||
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||||||||||||||||||||
Net income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 46,820 |
|
|
|
|
|
|
|
|
|
|
| 46,820 |
|
| |||||||||||||||||||||||||||||||||||||
Cumulative translation adjustment and other |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 12,833 |
|
|
| 12,833 |
|
| |||||||||||||||||||||||||||||||||||||
Pension plan additional minimum liability, net of tax of ($54) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (20 | ) |
|
| (20 | ) |
| |||||||||||||||||||||||||||||||||||||
Comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 59,633 |
|
| |||||||||||||||||||||||||||||||||||||
Shares of Class B Common Stock converted to Class A Common Stock |
| 261,344 |
|
| 27 |
|
| (261,344 | ) |
| (27 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||||||||||||||||||||
Shares of Class A Common Stock issued upon the exercise of stock options |
| 258,247 |
|
| 25 |
|
|
|
|
|
|
|
|
| 3,794 |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 3,819 |
|
| |||||||||||||||||||||||||||||||||||||
Tax benefit for stock options exercised |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 969 |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 969 |
|
| |||||||||||||||||||||||||||||||||||||
Issuance of shares of restricted Class A Common Stock |
| 32,133 |
|
| 3 |
|
|
|
|
|
|
|
|
| 802 |
|
|
|
|
|
| (805 | ) |
|
|
|
|
|
| — |
|
| |||||||||||||||||||||||||||||||||||||
Amortization of deferred compensation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 157 |
|
|
|
|
|
|
| 157 |
|
| |||||||||||||||||||||||||||||||||||||
Net change in restricted stock units |
| 38,493 |
|
| 4 |
|
|
|
|
|
|
|
|
| 1,624 |
|
|
|
|
|
| (738 | ) |
|
|
|
|
|
| 890 |
|
| |||||||||||||||||||||||||||||||||||||
Common Stock dividends |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (9,071 | ) |
|
|
|
|
|
|
|
|
|
| (9,071 | ) |
| |||||||||||||||||||||||||||||||||||||
Balance at December 31, 2004 |
| 25,049,338 |
|
| $ | 2,505 |
|
| 7,343,880 |
|
| $ | 734 |
|
|
| $ | 140,172 |
|
|
| $ | 324,145 |
|
|
| $ | (1,386 | ) |
|
| $ | 26,618 |
|
|
| $ | 492,788 |
|
| |||||||||||||||||||||||||||||
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||||||||||||||||||
Net income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 54,599 |
|
|
|
|
|
|
|
|
|
|
| 54,599 |
|
| ||||||||||||||||||||||||||||||||||||
Cumulative translation adjustment and other |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (19,377 | ) |
|
| (19,377 | ) |
| ||||||||||||||||||||||||||||||||||||
Pension plan additional minimum liability, net of tax of ($1,203) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1,978 | ) |
|
| (1,978 | ) |
| ||||||||||||||||||||||||||||||||||||
Comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 33,244 |
|
| ||||||||||||||||||||||||||||||||||||
Shares of Class A Common Stock issued upon the exercise of stock options |
| 107,823 |
|
| 11 |
|
|
|
|
|
|
|
|
| 1,507 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 1,518 |
|
| ||||||||||||||||||||||||||||||||||||
Tax benefit for stock options exercised |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 875 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 875 |
|
| ||||||||||||||||||||||||||||||||||||
Issuance of shares of restricted Class A Common Stock |
| 5,616 |
|
| 1 |
|
|
|
|
|
|
|
|
| 149 |
|
|
|
|
|
|
| (150 | ) |
|
|
|
|
|
| — |
|
| ||||||||||||||||||||||||||||||||||||
Amortization of deferred compensation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 289 |
|
|
|
|
|
|
| 289 |
|
| ||||||||||||||||||||||||||||||||||||
Net change in restricted stock units |
| 42,433 |
|
| 4 |
|
|
|
|
|
|
|
|
| 1,581 |
|
|
|
|
|
|
| (343 | ) |
|
|
|
|
|
| 1,242 |
|
| ||||||||||||||||||||||||||||||||||||
Common Stock dividends |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (10,480 | ) |
|
|
|
|
|
|
|
|
|
| (10,480 | ) |
| ||||||||||||||||||||||||||||||||||||
Balance at December 31, 2005 |
| 25,205,210 |
|
| $ | 2,521 |
|
| 7,343,880 |
|
| $ | 734 |
|
|
| $ | 144,284 |
|
|
| $ | 368,264 |
|
|
| $ | (1,590 | ) |
|
| $ | 5,263 |
|
|
| $ | 519,476 |
|
|
The accompanying notes are an integral part of these consolidated financial statements.
53
Watts Water Technologies, Inc. and SubsidiariesConsolidated Statements of Cash Flows(Amounts in thousands)
| 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 | ||||||||
The accompanying notes are an integral part of these consolidated financial statements.
5457
Watts Water Technologies, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Amounts in thousands)
|
| Years Ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
OPERATING ACTIVITIES |
|
|
|
|
|
|
| |||
Income from continuing operations |
| $ | 55,020 |
| $ | 48,738 |
| $ | 36,419 |
|
Adjustments to reconcile net income from continuing operations to net cash provided by continuing operating activities: |
|
|
|
|
|
|
| |||
Depreciation |
| 23,542 |
| 26,290 |
| 20,502 |
| |||
Amortization |
| 2,576 |
| 1,761 |
| 763 |
| |||
Other |
| 572 |
| 707 |
| 1,065 |
| |||
Deferred income taxes (benefit) |
| (1,279 | ) | (5,735 | ) | (75 | ) | |||
Changes in operating assets and liabilities, net of effects frombusiness acquisitions and divestures: |
|
|
|
|
|
|
| |||
Accounts receivable |
| (16,546 | ) | (5,745 | ) | 1,858 |
| |||
Inventories |
| (20,330 | ) | (36,177 | ) | (7,176 | ) | |||
Prepaid expenses and other assets |
| (4,098 | ) | 1,394 |
| (1,289 | ) | |||
Accounts payable, accrued expenses and other liabilities |
| 12,410 |
| 8,977 |
| 236 |
| |||
Net cash provided by continuing operations |
| 51,867 |
| 40,210 |
| 52,303 |
| |||
INVESTING ACTIVITIES |
|
|
|
|
|
|
| |||
Additions to property, plant and equipment |
| (18,590 | ) | (20,999 | ) | (20,030 | ) | |||
Proceeds from the sale of property, plant and equipment |
| 652 |
| 2,143 |
| 1,765 |
| |||
Investments in securities |
| — |
| (25,000 | ) | (4,000 | ) | |||
Proceeds from sale of securities |
| 26,600 |
| 2,400 |
| — |
| |||
Increase in other assets |
| (469 | ) | (1,470 | ) | (191 | ) | |||
Business acquisitions, net of cash acquired |
| (191,396 | ) | (68,453 | ) | (15,291 | ) | |||
Net cash used in investing activities |
| (183,203 | ) | (111,379 | ) | (37,747 | ) | |||
FINANCING ACTIVITIES |
|
|
|
|
|
|
| |||
Proceeds from long-term debt |
| 161,476 |
| 92,480 |
| 219,736 |
| |||
Payments of long-term debt |
| (41,995 | ) | (104,693 | ) | (177,916 | ) | |||
Shares transactions under employee stock plans |
| 3,048 |
| 4,868 |
| 5,404 |
| |||
Tax benefit of stock options exercised |
| 875 |
| 969 |
| 423 |
| |||
Debt issue costs |
| — |
| (1,079 | ) | (1,235 | ) | |||
Proceeds from stock offering, net |
| — |
| — |
| 82,526 |
| |||
Dividends |
| (10,480 | ) | (9,071 | ) | (6,859 | ) | |||
Net cash provided by (used in) financing activities |
| 112,924 |
| (16,526 | ) | 122,079 |
| |||
Effect of exchange rate changes on cash and cash equivalents |
| (693 | ) | 2,054 |
| 3,856 |
| |||
Net cash provided by (used in) operating activities of discontinued operations (revised) |
| (1,050 | ) | 6,553 |
| (6,463 | ) | |||
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |
| (20,155 | ) | (79,088 | ) | 134,028 |
| |||
Cash and cash equivalents at beginning of year |
| 65,913 |
| 145,001 |
| 10,973 |
| |||
CASH AND CASH EQUIVALENTS AT END OF YEAR |
| $ | 45,758 |
| $ | 65,913 |
| $ | 145,001 |
|
NON CASH INVESTING AND FINANCING ACTIVITIES |
|
|
|
|
|
|
| |||
Acquisition of businesses |
|
|
|
|
|
|
| |||
Fair value of assets acquired |
| $ | 230,587 |
| $ | 80,126 |
| $ | 21,217 |
|
Cash paid, net of cash acquired |
| 191,396 |
| 68,453 |
| 15,291 |
| |||
Liabilities assumed |
| $ | 39,191 |
| $ | 11,673 |
| $ | 5,926 |
|
CASH PAID FOR: |
|
|
|
|
|
|
| |||
Interest |
| $ | 9,529 |
| $ | 9,815 |
| $ | 13,499 |
|
Taxes |
| $ | 30,698 |
| $ | 33,000 |
| $ | 17,700 |
|
The accompanying notes are an integral part of these consolidated financial statements.
58
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Watts Water Technologies, Inc. (the Company) designs, manufactures and sells an extensive line of water safety and flow control products primarily for the water quality, water safety, water flow control and water conservation markets located predominantly in North America, Europe, and China.
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.
Investment Securities
Investment securities at December 31, 2004 consisted of auction rate certificates whose underlying investments were in AAA rated municipal bonds. The certificates are bought and sold at auction with reset dates of up to 35 days. The certificates are traded at par value, which approximates market value at December 31, 2004. The Company classifies its debt securities as available for sale.
Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific-identification basis.
A decline in the market value of any available-for-sale security below cost that is deemed to be other-than-temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to year-end, and forecasted performance of the investee.
Premiums and discounts are amortized or accreted over the life of the related available-for-sale security as an adjustment to yield using the effective-interest method. Dividend and interest income are recognized when earned.
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
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
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%10.7%, 10.3% and 10.2%11.1% of the Company'sCompany’s total sales in 20032005, 2004 and 2002,2003, respectively, are to one company. These sales are transacted within the North America geographic segment.
Inventories
Inventories are stated at the lower of cost (first-in,(primarily 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 is recorded when the consideration 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 Other
55
Intangible Assets" (FAS 142). FAS 141 requires that the purchase method of accounting be used for all business combinations completed after June 30, 2001. FAS 142 requires that goodwillGoodwill and other intangible assets with indefinite useful lives no longer beare not amortized, but rather beare tested annually for impairment. The test was performed as of October 30, 2005.
Prior to the adoption of FAS 142, goodwill was amortized over 40 years using the straight-line method. Also, the Company previously assessed the recoverability of intangible assets by determining whether the intangible asset balance could be recovered through undiscounted cash flows of the acquired businesses. The amount of impairment, if any, was measured based on projected discounted future operating cash flows using a discount rate reflecting the Company's average cost of funds.
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'sCompany’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 ofor 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“Accounting for the Impairment or Disposal of Long-Lived Assets"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 2001Notes to reflect what it would have been if FAS 142 was adopted on January 1, 2001:Consolidated Financial Statements (Continued)
| 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 | |||
The changes in the carrying amount of goodwill are as follows:
| 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 | ||
|
| North |
| Europe |
| China |
| Total |
|
|
| (in thousands) |
| ||||||
Carrying amount at December 31, 2003 |
| $ 100,017 |
| $ 81,812 |
| $ 3,072 |
| $ 184,901 |
|
Goodwill acquired during the period |
| 23,309 |
| 9,546 |
| 1,450 |
| 34,305 |
|
Adjustments to goodwill during the period |
| 153 |
| — |
| — |
| 153 |
|
Effect of change in exchange rates used for translation |
| 60 |
| 6,759 |
| — |
| 6,819 |
|
Carrying amount at December 31, 2004 |
| $ 123,539 |
| $ 98,117 |
| $ 4,522 |
| $ 226,178 |
|
Goodwill acquired during the period |
| 69,712 |
| 12,295 |
| — |
| 82,007 |
|
Adjustments to goodwill during the period |
| 252 |
| (188 | ) | 939 |
| 1,003 |
|
Effect of change in exchange rates used for translation |
| 94 |
| (12,786 | ) | 140 |
| (12,552 | ) |
Carrying amount at December 31, 2005 |
| $ 193,597 |
| $ 97,438 |
| $ 5,601 |
| $ 296,636 |
|
Other intangible assets include the following and are presented in "Other“Other Assets: "Other"Other, net”, in the Consolidated Balance Sheets:
| | December 31, |
| December 31, |
| ||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2003 | 2002 |
| 2005 |
| 2004 |
| |||||||||||||||||||
| | Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization |
| Gross |
| Accumulated |
| Gross |
| Accumulated |
| |||||||||||||
| | (in thousands) |
| (in thousands) |
| ||||||||||||||||||||||
Patents | Patents | $ | 8,449 | $ | (3,862 | ) | $ | 8,353 | $ | (3,445 | ) |
| $ 9,264 |
|
| $ (4,669 | ) |
| $ 8,905 |
|
| $ (4,286 | ) |
| |||
Other | Other | 3,377 | (1,245 | ) | 4,888 | (917 | ) |
| 58,866 |
|
| (4,700 | ) |
| 17,959 |
|
| (2,636 | ) |
| |||||||
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 | ) | |||||||||||||||||
Total amortizable intangibles |
| 68,130 |
|
| (9,369 | ) |
| 26,864 |
|
| (6,922 | ) |
| ||||||||||||||
Intangible assets not subject to amortization |
| 40,582 |
|
| — |
|
| 18,875 |
|
| — |
|
| ||||||||||||||
Total |
| $ 108,712 |
|
| $ (9,369 | ) |
| $ 45,739 |
|
| $ (6,922 | ) |
|
57
Aggregate amortization expense for amortized other intangible assets for the year ended December 31, 2005, 2004 and 2003 2002was $2,576,000, $1,761,000 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$5,861,000 for 2006, $5,284,000 for 2007, $5,135,000 for 2008, $4,860,000 for 2009 and 2007$4,842,000 for 2010. Amortization expense is provided on a straight-line basis over the estimated useful lives of the intangible assets. The weighted-average remaining life of total amortizable intangibles is 10.1 years. Patents and $448,000 for 2008.other amortizable intangibles have weighted-average remaining lives of 11.5 years and 10.0 years, respectively. Intangible assets not subject to amortization primarily include trademarks and unpatented technology.
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
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
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 year-end exchange rates. Income and expense items are translated at weighted average exchange rates for each period. Net translation gains or losses are included in other comprehensive income, a separate component of stockholders'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.
Stock BasedStock-Based Compensation
The Company accounts for stock basedstock-based compensations in accordance with Accounting Principles Board Opinion No. 25, "Accounting“Accounting for Stock Issued to Employees"Employees” (APB No. 25), and related interpretations. The Company records stock basedstock-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,
58
"Accounting “Accounting for Stock-Based Compensation”" (FAS 123) as amended by Financial Accounting Standards Board No. 148, "Accounting“Accounting for Stock-Based Compensation Transition and Disclosure"Disclosure” (FAS 148).
| | Years Ended December 31, |
| Years Ended December 31, |
| |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2003 | 2002 | 2001 |
| 2005 |
| 2004 |
| 2003 |
| |||||||
| | (in thousands) |
| (in thousands) |
| |||||||||||||
Net income, as reported | Net income, as reported | $ | 33,362 | $ | 32,622 | $ | 26,556 |
| $ 54,599 |
| $ 46,820 |
| $ 33,362 |
| ||||
Add: Stock-based employee compensation expense from the Management Stock Purchase Plan included in reported net income, net of tax | Add: Stock-based employee compensation expense from the Management Stock Purchase Plan included in reported net income, net of tax | 131 | 164 | 184 |
| 531 |
| 384 |
| 202 |
| |||||||
Deduct: Stock-based employee expense determined under the fair value method, net of tax: | 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 | ||||||||||||
Restricted stock units (Management Stock Purchase Plan) |
| (560 | ) | (381 | ) | (271 | ) | |||||||||||
Employee stock options |
| (1,144 | ) | (670 | ) | (575 | ) | |||||||||||
Pro forma net income |
| $ 53,426 |
| $ 46,153 |
| $ 32,718 |
| |||||||||||
Earnings per share: | 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 | ||||||||||||
Basic—as reported |
| $ 1.68 |
| $ 1.45 |
| $ 1.22 |
| |||||||||||
Basic—pro forma |
| 1.64 |
| 1.43 |
| 1.19 |
| |||||||||||
Diluted—as reported |
| 1.66 |
| 1.43 |
| 1.21 |
| |||||||||||
Diluted—pro forma |
| $ 1.62 |
| $ 1.42 |
| $ 1.18 |
|
62
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
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, basic and assuming full dilution, are reconciled below:
| Years Ended December 31, |
| Years Ended December 31, |
| |||||||||||||||||||||||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 |
| 2005 |
| 2004 |
| 2003 |
| |||||||||||||||||||||||||||||||||||||||||||||
| Net Income | Shares | Per Share Amount | Net Income | Shares | Per Share Amount | Net Income | Shares | Per Share Amount |
| Net |
| Shares |
| Per |
| Net |
| Shares |
| Per |
| Net |
| Shares |
| Per |
| |||||||||||||||||||||||||||
| (Amounts in thousands, except per share information) |
| (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 |
| $ | 54,599 |
| 32,489 |
|
| $ | 1.68 |
|
| $ | 46,820 |
| 32,276 |
|
| $ | 1.45 |
|
| $ | 33,362 |
| 27,455 |
|
| $ | 1.22 |
|
| |||||||||
Dilutive securities principally common stock options | — | 237 | 0.01 | — | 338 | 0.01 | — | 305 | 0.01 |
| — |
| 513 |
|
| 0.02 |
|
| — |
| 443 |
|
| 0.02 |
|
| — |
| 237 |
|
| 0.01 |
|
| |||||||||||||||||||||
Diluted EPS | $ | 33,362 | 27,692 | $ | 1.21 | $ | 32,622 | 27,056 | $ | 1.21 | $ | 26,556 | 26,802 | $ | 0.99 |
| $ | 54,599 |
| 33,002 |
|
| $ | 1.66 |
|
| $ | 46,820 |
| 32,719 |
|
| $ | 1.43 |
|
| $ | 33,362 |
| 27,692 |
|
| $ | 1.21 |
|
| |||||||||
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, the 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 the Company'sCompany’s policies. The Company'sCompany’s hedging transactions include, but are not limited to, the use of various derivative financial and commodity instruments. As a matter of policy, the 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. The Company does not use derivative instruments for trading or speculative purposes.
Using qualifying criteria defined in Financial Accounting Standards Board Statement No. 133, "Accounting“Accounting for Derivative Instruments and Hedging Activities"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 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, the 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
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
are reflected in the Consolidated Balance Sheets 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 2003,2005 and 2004, the Company used foreign currency forward contracts as a means of hedging exposure to foreign currency risks. The Company'sCompany’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'sderivative’s change in fair value be recognized immediately in earnings.
Portions of the Company'sCompany’s outstanding debt are exposed to interest rate risks. The Company monitors its interest rate exposures on an ongoing basis to maximize the overall effectiveness of its interest rates. During 2003,2005 and 2004, the Company entered intoused an interest rate swap as a means of hedging exposure to interest rate risks (see Note 11). The Company's swap was designated as a cash flow hedge under the criteria of FAS 133.risks.
60
Shipping and Handling
Shipping and handling costs included in selling, general and administrative expense amounted to $22,111,000, $20,900,000$28,123,000, $25,110,000 and $21,002,000$22,111,000 for the years ended December 31, 2003, 20022005, 2004 and 2001,2003, respectively.
Research and Development
Research and development costs included in selling, general, and administrative expense amounted to $9,178,000, $9,132,000$11,576,000, $9,942,000 and $6,584,000$9,178,000 for the years ended December 31, 2003, 20022005, 2004 and 2001,2003, 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 collectability is reasonably assured. Provisions for estimated returns and allowances are made at the time of 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'sBoard’s Emerging Issues Task Force (EITF) Issue 00-14, "Accounting“Accounting for Certain Sales Incentives"(EITFIncentives” (EITF 00-14) and EITF Issue No 01-9, "Accounting“Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor's Products"Vendor’s Products”.
Advertising
The Company records advertising expense as incurred.
Basis of Presentation
Certain amounts in years 2002 and 2001for 2004 have been reclassified to permit comparison with the 20032005 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
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
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
In August 2001,November 2004, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards Board Statement No. 143, "Accounting151, “Inventory Costs” (FAS 151). FAS 151 amends the guidance in Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for Asset Retirement Obligations" (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/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.inventory costs. The provisions of FAS 143this statement 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.2005, although early application is permitted. The Company has adopted FAS 143 effective January 1, 2003 and its adoption wasdoes not expect that the impact of this statement will be material to the consolidated financial statements.
In July 2002,December 2004, the FASB issued its final standard on accounting for share-based payments (SBP), Financial Accounting Standards Board Statement No. 123R (FAS 123R) that requires companies to expense the value of employee stock options and similar awards. The statement applies to all outstanding and unvested SBP awards at a company’s adoption date. The Securities and Exchange Commission delayed implementation to fiscal years beginning after June 15, 2005. Therefore, the Company has implemented FAS 123R effective January 1, 2006 utilizing the modified prospective method, which requires recognizing expense for options over their remaining vesting period. The portion of these options’ fair value attributable to vested awards prior to the adoption is never recognized. The impact of this statement on the Company’s results of operations (based on equity instruments outstanding at December 31, 2005) for the fiscal year ending December 31, 2006 is expected to be approximately ($0.03) per share.
In December 2004, the FASB issued Financial Accounting Standards Board Statement No. 146, "Accounting153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Costs Associated with Exit or Disposal Activities"Nonmonetary Transactions” (FAS 146)153). The principal difference between this Statementamendments made by FAS 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and Emergency Issues Task Force (EITF) Issuereplace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion No. 94-3 "Liability Recognition29 required that the accounting 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 recognitionexchange of a liabilityproductive asset for a cost associated withsimilar productive asset or an exitequivalent interest in the same or disposal activity. This Statement requires that a liabilitysimilar productive asset should be based on the recorded amount of the asset relinquished. The statement is effective for a cost associated with an exit or disposal activity be recognized when the liabilitynonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is incurred. Under Issue 94-3, a liabilitypermitted for an exit cost was recognized atnonmonetary asset exchanges occurring in fiscal periods beginning after the date of an entity's commitment to an exit plan.issuance. The provisions of this statement areshall be applied prospectively in January 2006.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47). FIN 47 is an interpretation of FASB Statement No. 143, “Accounting for Asset Retirement Obligations” (FAS 143) and serves to clarify that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate such a liability. FIN 47 is effective for exit or disposal activities that are initiatedno later than the end of fiscal years ending after December 31, 2002.15, 2005. The Company adopted FAS 146 effective January 1, 2003 and its adoption wasconcluded that FIN 47 did not have a material toimpact on 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 Guaranteesstatements as 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.2005.
In December 2002,May 2005, the FASB issued Financial Accounting Standards Board Statement No. 148, "Accounting for Stock-Based Compensation, Transition154, “Accounting Changes and Disclosure" (FAS 148)Error Corrections”(FAS 154), a replacement of APB Opinion No. 20,
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
“Accounting Changes” and a replacement of FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”. FAS 148 provides alternative methods of transition for a voluntary change to154 changes the fair value based method of accounting for, stock-based employee compensation. FAS 148 alsoand reporting of, a change in accounting principle. The statement requires that disclosuresretrospective application to prior periods financial statements of voluntary changes in accounting principles and changes required by new accounting standards when the pro 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.standard does not include specific transition provisions, unless it is impracticable to do so. The additional disclosure requirements of FAS 148 werestatement is effective for accounting changes and corrections of errors in fiscal years endedbeginning after December 15, 2002. The Company currently continues to account2005. Earlier application is permitted for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25accounting changes and the Company 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 unitscorrections of accounting, and, if separation is appropriate, how the arrangement consideration should be allocated to the identified accounting units. The provisions of EITF 00-21 are effective for revenue arrangements enterederrors during fiscal periodsyears 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, 2003. 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. The Company adopted FIN 46R and as a result has 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 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 has a subordinated security interest in the assets 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 FIN 46R, the Company accounted for its investment of 49% in the LLC using the equity method.
The Company also maintains another variable interest in a VIE. In 2000 the Company entered into an agreement with Plumworld.co.uk Ltd in which the Company maintains 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. The Company maintains a notional amount of approximately $500 investment in Plumbworld and maintains a loan receivable in amount of approximately $850,000 with Plumbworld. The Company continues to account for its 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 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 businesses, which included Henry Pratt, James Jones Company and Edward Barber and Company Ltd. Costs and expenses related to the Municipal Water Group for 20032005 and 2004 relate to legal and settlement costs associated with the James Jones Litigation (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 toan expense for payments to be made to the selling shareholders of the James Jones Company pursuant to the Company'sCompany’s original purchase agreement. For the yearyears ended December 31, 2005, 2004 and 2003, the Company recorded a net of tax charge of $446,000.$91,000, $72,000 and $446,000, respectively.
In 2004 the Company divested its interest in its minority-owned subsidiary Jameco International, LLC (Jameco LLC) that had been previously consolidated as a result of Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities—Revised” (FIN 46R). Jameco LLC was recorded in the North American segment. Management determined that Jameco LLC did not have a long-term strategic fit with the Company and decided to divest its interest. As a result, the Company recorded an impairment charge net of tax of $739,000 to write down its investment to estimated fair value of $250,000. Additionally, for the years ended December 31, 2004 and 2003, the Company recorded a net loss of $54,000 and net income of $54,000, respectively, from the operations of Jameco LLC. Jameco LLC imports and sells vitreous china, imported faucets and faucet parts and imported bathroom accessories to the North American home improvement retail market.
Condensed operating statements and balance sheets for discontinued operations isare 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 | |||
|
| Years Ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in thousands) |
| |||||||
Net sales—Jameco International, LLC |
| $ | — |
| $ | 20,187 |
| $ | 3,792 |
|
Costs and expenses |
|
|
|
|
|
|
| |||
Jameco International, LLC |
| — |
| (20,231 | ) | (3,705 | ) | |||
Municipal Water Group |
| (679 | ) | (1,828 | ) | (5,058 | ) | |||
Loss on disposal of Jameco International, LLC |
| — |
| (1,202 | ) | — |
| |||
Loss before income taxes |
| (679 | ) | (3,074 | ) | (4,971 | ) | |||
Income tax benefit |
| 258 |
| 1,156 |
| 1,914 |
| |||
Loss from discontinued operations, net of taxes |
| $ | (421 | ) | $ | (1,918 | ) | $ | (3,057 | ) |
64
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
|
| December 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
Prepaid expenses and other assets |
| $ | 2,511 |
| $ | 2,561 |
|
Deferred income taxes |
| 7,044 |
| 7,666 |
| ||
Assets of discontinued operations |
| $ | 9,555 |
| $ | 10,227 |
|
Accrued expenses and other liabilities |
| 23,068 |
| 24,303 |
| ||
Liabilities of discontinued operations |
| $ | 23,068 |
| $ | 24,303 |
|
The assets and liabilities for 2005 and 2004 primarily relate to reserves for the James Jones Litigation. Statements of Cashflows for 2005, 2004 and 2003 primarily relate to operating activities.
(4) Restructuring and Other Charges
The Company continues 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 and other low cost areas of the world. The implementation of this manufacturing restructuring plan began during the fourth quarter of 2001. The projects for which charges were recorded in the fourth quarter of 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 essentially complete as of December 31, 2003. The Company recorded pre-tax manufacturing restructuring and other costs of $1,655,000,charges, net of recoveries, of $2,545,000, $2,968,000 and $1,655,000 for 2005, 2004 and 2003, respectively. The expenses incurred for 2005 were primarily for accelerated depreciation for both the year ended December 31, 2003. planned closure of a U.S. manufacturing plant and a reduction in the estimated useful lives of certain manufacturing equipment, net of recoveries and for European severance related charges and asset write-downs. The expenses incurred for 2004 were primarily for accelerated depreciation for both the planned closure of a U.S. manufacturing restructuringplant and other costs recorded consista reduction in the estimated useful lives of certain manufacturing equipment and for severance costs. The expenses incurred for 2003 were primarily of severance costs,for accelerated depreciation, asset write-downs and accelerated depreciation. The severance costs, which have been recorded as restructuring, are for 48 employees in manufacturing and administration groups. The Company expects to complete severance payments by the end of the first quarter of 2004. costs.
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 primarily recorded in cost of goods sold. Accelerated depreciation is based on shorter remaining estimated useful lives of certain fixed assets and has beenis primarily recorded in cost of goods sold. Other costs consist primarily of removal and shipping costs associated with relocation of manufacturing equipment and have been primarily recorded in cost of goods sold and have been expensed as incurred. Severance costs are recorded in restructuring and other charges.
Details of the Company'sCompany’s manufacturing restructuring plan through December 31, 20032005 are as follows:
| 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 | |||||||
|
| Restructuring |
| Asset Write-downs |
| Other Costs |
| Total |
| ||||||||||
|
| (in thousands) |
| ||||||||||||||||
Balance as of December 31, 2002 |
|
| $ | 419 |
|
|
| $ | — |
|
|
| $ | — |
|
| $ | 419 |
|
Provisions during 2003 |
|
| 426 |
|
|
| 479 |
|
|
| 750 |
|
| 1,655 |
| ||||
Utilized during 2003 |
|
| (804 | ) |
|
| (479 | ) |
|
| (750 | ) |
| (2,033 | ) | ||||
Balance as of December 31, 2003 |
|
| 41 |
|
|
| — |
|
|
| — |
|
| 41 |
| ||||
Provisions during 2004 |
|
| 95 |
|
|
| 2,873 |
|
|
| — |
|
| 2,968 |
| ||||
Utilized during 2004 |
|
| (136 | ) |
|
| (2,873 | ) |
|
| — |
|
| (3,009 | ) | ||||
Balance as of December 31, 2004 |
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| ||||
Provisions during 2005 |
|
| 729 |
|
|
| 1,360 |
|
|
| 456 |
|
| 2,545 |
| ||||
Utilized during 2005 |
|
| (729 | ) |
|
| (1,360 | ) |
|
| (456 | ) |
| (2,545 | ) | ||||
Balance as of December 31, 2005 |
|
| $ | — |
|
|
| $ | — |
|
|
| $ | — |
|
| $ | — |
|
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(5) Business Acquisitions
The following acquisitions were accounted for by the purchase method of accounting and, accordingly, their results have been included in the Company’s consolidated results of operation since their respective dates of acquisition.
On July 30, 2003,December 28, 2005, a wholly-owned subsidiary of the Company acquired Giuliani Anello S.r.l.100% of the stock of Dormont Manufacturing Company (Dormont) located in Cento Bologna, ItalyExport, Pennsylvania, for approximately $10,600,000 in cash$94,875,000, net of cash acquired cash of $1,400,000. Giuliani Anello manufacturesapproximately $1,505,000. The preliminary allocations for goodwill and distributes valvesintangible assets are approximately $43,227,000 and filters utilized in heating applications including strainer filters, solenoid valves, flow stop valves,$35,945,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated 13-year lives and trade names with indefinite lives. Dormont provides flexible stainless steel water filter elementsconnectors for natural and steam cleaning filters.liquid propane gas. Dormont works with appliance OEM’s to provide internal component assemblies and private label gas connectors, which are sold under the OEM brand with the appliance in multiple leading retail chains. Dormont also supplies residential gas connectors through multiple trade channels and home improvement retailers.
The following pro forma consolidated results of operations have been prepared as though the acquisition of Dormont had occurred at the beginning of the periods shown. The pro forma information, however, is not necessarily indicative of the results of operations that would have been achieved had the acquisition occurred at the beginning of the periods presented, nor is it necessarily indicative of future results.
|
| Years Ended December 31, |
| ||||||
(Unaudited) |
|
|
| 2005 |
| 2004 |
| ||
|
| (in thousands, except per |
| ||||||
Net sales |
| $ | 980,471 |
| $ | 877,017 |
| ||
Net income |
| $ | 56,389 |
| $ | 48,370 |
| ||
Earnings per share (basic) |
| $ | 1.74 |
| $ | 1.50 |
| ||
Earnings per share (diluted) |
| $ | 1.71 |
| $ | 1.48 |
| ||
On April 18, 2003,December 2, 2005, a wholly-owned subsidiary of the Company acquired Martin Orgee UK Ltd. located in Kidderminster, West Midlands, United Kingdom100% of the stock of Core Industries Inc. (Core) from SPX Corporation for approximately $1,600,000$45,000,000 in cash. Martin Orgee distributes a lineCore consists of plumbingFEBCO, Mueller Steam Specialty and heating products to the wholesale, commercialPolyjet Valves product lines. The preliminary allocations for goodwill and OEM markets in the United Kingdomintangible assets are approximately $11,272,000 and Southern Ireland. Martin Orgee also assembles pumping systems$14,528,000, respectively. The amount recorded as intangible assets is primarily for under-floor radiant heat applications.
On July 29, 2002 a wholly-owned subsidiary of the Company acquired F&R Foerstertrade names with indefinite lives 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 paid in cash 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 devicescustomer relationships 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,have estimated 12-year lives. FEBCO is a manufacturer of backflow prevention valves and has a variety of plumbing products soldstrong presence in both residential and commercial landscape irrigation. Mueller Steam Specialty allows us to expand into the Chinese domestic marketlarge diameter commercial strainer and export markets. Its product lines were contributedcheck valves. Polyjet Valves offers a customized sleeve valve, which is used in severe service applications to the joint ventureprovide precise flow 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. pressure control.
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,November 4, 2005, a wholly-owned subsidiary of the Company acquired the assets of the Powers Process Controls Division of Mark Controls Corporation, a subsidiary of Crane Co.Flexflow Tubing LLP (Flexflow), located in Skokie, Illinois and Mississauga, Ontario,Langley, British Columbia, Canada for approximately $13,000,000 in cash. Powers designs$6,200,000. The preliminary allocations for goodwill and intangible assets are approximately $3,180,000 and $868,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated 12-year lives. Flexflow manufactures thermostatic mixing valvespex tubing for personal safetypotable and process control applications in commercialnon-potable applications.
Watts Water Technologies, Inc. and institutional facilities. It also manufactures control valves and commercial plumbing brass products including shower valves and lavatory faucets.Subsidiaries
Notes to Consolidated Financial Statements (Continued)
On June 13, 2001,July 8, 2005, a wholly-owned subsidiary of the Company acquired Premier Manufactured Systems, Inc., locatedthe water connector business of the Donald E. Savard Company (Savard) in Phoenix, Arizonaan asset purchase transaction for approximately $5,000,000 in cash. Premier manufactures water filtration systems$3,680,000. The allocations for both residentialgoodwill and commercial applicationsintangible assets are approximately $1,350,000 and other filtration products including under-the-counter ultraviolet filtration$1,750,000, respectively. The amount recorded as well as a variety of sedimentintangible assets is primarily for trade names with indefinite lives and carbon filters.customer relationships that have 14-year lives.
On June 1, 2001,July 5, 2005, a wholly-owned subsidiary of the Company acquired Fimet S.r.l. (Fabbrica Italiana Manometri e Termometri)100% of the outstanding stock of Microflex N.V. (Microflex) located in Milan, Italy and its wholly-owned subsidiary, MTB AD, which is located in BulgariaRotselaar, Belgium for approximately $6,000,000.$14,900,000 net of cash acquired of approximately $875,000. The acquired business manufactures pressureallocations for goodwill and temperature gaugesintangible assets are approximately $6,507,000 and $5,315,000, respectively. The amount recorded as intangible assets is primarily for usecustomer relationships that have 7-year lives and trade names that have indefinite lives. Microflex produces and distributes flexible, pre-insulated, waterproof pex pipes for hot and cold water transport, as well as a range of accessory products including couplings, caps, and insulation kits in the HVAC market.and water protection markets.
On January 5, 2001,June 20, 2005, a wholly-owned subsidiary of the Company acquired Dumser Metallbau GmbH & Co. KGthe water softener business of Alamo Water Refiners, Inc. (Alamo) located in Landau, GermanySan Antonio, Texas in an asset purchase transaction for approximately $20,000,000$5,100,000. The allocation for intangible assets is approximately $285,000 and is primarily for the trade name with an indefinite life. There was no allocation to goodwill. The water softener products of Alamo are consistent with the Company’s theme of water quality and provide many synergistic opportunities when utilized in conjunction with its existing water filtration and water quality businesses.
On May 11, 2005, a wholly-owned subsidiary of the Company acquired 100% of the outstanding stock of Electro Controls Ltd. (Electro Controls) located in Hounslow, United Kingdom for approximately $11,737,000 net of cash acquired of approximately $5,014,000. The allocations for goodwill and intangible assets are approximately $5,788,000 and $315,000, respectively. The amount recorded as intangible assets is primarily for trade names that have indefinite lives. Electro Controls designs and assembles a range of electrical controls for the HVAC market, with sales primarily in the United Kingdom.
On January 5, 2005, a wholly-owned subsidiary of the Company acquired 100% of the outstanding stock of HF Scientific, Inc. (HF) located in Fort Myers, Florida for approximately $7,260,000 in cash plus $800,000 in assumed debt. The allocations for goodwill and intangible assets are approximately $4,178,000 and $2,660,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have 15-year lives and trade names that have indefinite lives. HF manufactures and distributes a line of instrumentation equipment, test kits and chemical reagents used for monitoring water quality in a variety of applications.
On January 4, 2005, a wholly-owned subsidiary of the Company acquired substantially all of the assets of Sea Tech, Inc. (Sea Tech) located in Wilmington, North Carolina for approximately $10,100,000 in cash. The main productsallocations for goodwill and intangible assets are approximately $6,505,000 and $3,033,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have 15-year lives and trade names that have indefinite lives. Sea Tech provides cost-effective solutions for fluidic connection needs. Sea Tech offers a wide range of Dumser include brass, steelstandard and stainless steelcustom quick connect fittings, valves and manifolds usedand pex tubing designed to address specific customer requirements.
69
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
Certain current and prior years acquisition agreements contain either an earn-out provision or a put feature on the remaining common stock not yet purchased by the Company. During 2005, the Company accrued approximately $1,500,000 in earn-out costs from a prior year acquisition, which were also paid in 2005. The calculations are typically based on a multiple of future gross margins or operating earnings as defined in the agreements. The amounts of contingent consideration are not determinable beyond a prime distribution device in hydronic heating systems. Dumser has a 51% controlling share of Stern Rubinetti. Stern Rubinetti is an Italian manufacturing company producing brass components located in Brescia, Italy.
66
The acquisitions abovereasonable doubt and therefore no liabilities have been established. All earn-outs payments, if any, will be accounted for utilizing theas additional purchase method of accounting. The pro-forma results have not been displayed, as the combined results are not significant.price.
(6) Accumulated Other Comprehensive Income (Loss)
Other comprehensive income (loss) consist of the following:
| Foreign Currency Translation | Pension Adjustment | Cash Flow Hedges | Accumulated Other Comprehensive Income (Loss) |
| Foreign |
| Pension |
| Accumulated |
| ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
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 | ||||||||||||||||||||||||
| (in thousands) |
| |||||||||||||||||||||||||||
Balance December 31, 2003 | $ | 19,588 | $ | (5,829 | ) | $ | 46 | $ | 13,805 |
|
| $ | 19,634 |
|
|
| $ | (5,829 | ) |
|
| $ | 13,805 |
|
| ||||
Change in period |
|
| 12,833 |
|
|
| (20 | ) |
|
| 12,813 |
|
| ||||||||||||||||
Balance December 31, 2004 |
|
| 32,467 |
|
|
| (5,849 | ) |
|
| 26,618 |
|
| ||||||||||||||||
Change in period |
|
| (19,377 | ) |
|
| (1,978 | ) |
|
| (21,355 | ) |
| ||||||||||||||||
Balance December 31, 2005 |
|
| $ | 13,090 |
|
|
| $ | (7,827 | ) |
|
| $ | 5,263 |
|
|
Inventories consist of the following:
| December 31, |
| December 31, |
| |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 |
| 2005 |
| 2004 |
| ||||||
| (in thousands) |
| (in thousands) |
| |||||||||
Raw materials | $ | 41,998 | $ | 40,591 |
| $ | 84,087 |
| $ | 61,250 |
| ||
Work in process | 24,348 | 17,289 |
| 23,201 |
| 28,020 |
| ||||||
Finished goods | 90,253 | 75,535 |
| 135,549 |
| 115,779 |
| ||||||
| $ | 242,837 |
| $ | 205,049 |
| |||||||
$ | 156,599 | $ | 133,415 | ||||||||||
Finished goods of $11,015,000$15,423,000 and $13,774,000$14,549,000 as of December 31, 20032005 and 2002,2004, respectively, were consigned.
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(8) Property, Plant and Equipment
Property, plant and equipment consists of the following:
| December 31, |
| December 31, |
| ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 |
| 2005 |
| 2004 |
| |||||||
| (in thousands) |
| (in thousands) |
| ||||||||||
Land | $ | 9,354 | $ | 8,980 |
| $ | 12,274 |
| $ | 9,567 |
| |||
Buildings and improvements | 75,428 | 64,935 |
| 99,217 |
| 84,876 |
| |||||||
Machinery and equipment | 194,248 | 166,684 |
| 210,695 |
| 222,274 |
| |||||||
Construction in progress | 5,220 | 8,334 |
| 6,626 |
| 4,938 |
| |||||||
| 328,812 |
| 321,655 |
| ||||||||||
284,250 | 248,933 | |||||||||||||
Accumulated Depreciation | (138,539 | ) | (114,557 | ) |
| (163,813 | ) | (170,966 | ) | |||||
| $ | 164,999 |
| $ | 150,689 |
| ||||||||
$ | 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, 2003 and 2002 and is 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 accordance with FAS 144 wrote down the asset to the estimated fair market value less costs to sell.
(9) Income Taxes
The significant components of the Company'sCompany’s deferred income tax liabilities and assets are as follows:
| | December 31, |
| December 31, |
| |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2003 | 2002 |
| 2005 |
| 2004 |
| ||||||||
| | (in thousands) |
| (in thousands) |
| |||||||||||
Deferred income tax liabilities: | 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 | ||||||||||||||
Excess tax over book depreciation |
| $ | 12,874 |
| $ | 14,101 |
| |||||||||
Intangibles |
| 10,522 |
| 10,458 |
| |||||||||||
Other |
| 10,654 |
| 4,920 |
| |||||||||||
Total deferred tax liabilities |
| 34,050 |
| 29,479 |
| |||||||||||
Deferred income tax assets: | 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 | ||||||||||||||
Accrued expenses |
| 13,641 |
| 15,199 |
| |||||||||||
Net operating loss carry-forward |
| 4,450 |
| 7,145 |
| |||||||||||
Inventory reserves |
| 7,707 |
| 4,825 |
| |||||||||||
Other |
| 10,989 |
| 11,033 |
| |||||||||||
Total deferred tax assets |
| 36,787 |
| 38,202 |
| |||||||||||
Less: valuation allowance | Less: valuation allowance | (557 | ) | (709 | ) |
| — |
| (838 | ) | ||||||
Net deferred tax | 31,019 | 27,708 | ||||||||||||||
Net deferred tax assets | $ | 7,574 | $ | 6,916 | ||||||||||||
Net deferred tax |
| 36,787 |
| 37,364 |
| |||||||||||
Net deferred tax assets |
| $ | 2,737 |
| $ | 7,885 |
|
The provision for income taxes from continuing operations is based on the following pre-tax income:
| Years Ended December 31, |
| Years Ended December 31, |
| |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 |
| 2005 |
| 2004 |
| 2003 |
| |||||||||
| (in thousands) |
| (in thousands) |
| |||||||||||||||
Domestic | $ | 40,457 | $ | 37,931 | $ | 30,152 |
| $ | 46,418 |
| $ | 39,300 |
| $ | 40,370 |
| |||
Foreign | 18,372 | 12,287 | 10,016 |
| 39,393 |
| 33,372 |
| 18,372 |
| |||||||||
| $ | 85,811 |
| $ | 72,672 |
| $ | 58,742 |
| ||||||||||
$ | 58,829 | $ | 50,218 | $ | 40,168 | ||||||||||||||
68
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
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 | ||||||
|
| Years Ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in thousands) |
| |||||||
Current tax expense: |
|
|
|
|
|
|
| |||
Federal |
| $ | 15,209 |
| $ | 15,428 |
| $ | 12,167 |
|
Foreign |
| 14,027 |
| 10,380 |
| 6,256 |
| |||
State |
| 3,484 |
| 3,318 |
| 2,431 |
| |||
|
| 32,720 |
| 29,126 |
| 20,854 |
| |||
Deferred tax expense (benefit): |
|
|
|
|
|
|
| |||
Federal |
| (963 | ) | (4,044 | ) | 802 |
| |||
Foreign |
| (747 | ) | (331 | ) | 509 |
| |||
State |
| (219 | ) | (817 | ) | 158 |
| |||
|
| (1,929 | ) | (5,192 | ) | 1,469 |
| |||
|
| $ | 30,791 |
| $ | 23,934 |
| $ | 22,323 |
|
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, |
| Years Ended December 31, |
| ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 |
| 2005 |
| 2004 |
| 2003 |
| ||||||||||
| (in thousands) |
| (in thousands) |
| ||||||||||||||||
Computed expected federal income expense | $ | 20,590 | $ | 17,576 | $ | 14,059 |
| $ | 30,033 |
| $ | 25,435 |
| $ | 20,560 |
| ||||
State income taxes, net of federal tax benefit | 1,686 | 1,257 | 1,074 |
| 2,122 |
| 1,626 |
| 1,683 |
| ||||||||||
Goodwill amortization | — | — | 751 | |||||||||||||||||
Foreign tax rate differential | 335 | (862 | ) | (1,025 | ) |
| (508 | ) | (1,632 | ) | 335 |
| ||||||||
Tax credits |
| — |
| (1,041 | ) | — |
| |||||||||||||
Other, net | (255 | ) | (375 | ) | (1,247 | ) |
| (856 | ) | (454 | ) | (255 | ) | |||||||
| $ | 30,791 |
| $ | 23,934 |
| $ | 22,323 |
| |||||||||||
$ | 22,356 | $ | 17,596 | $ | 13,612 | |||||||||||||||
At December 31, 2003,2005, the Company hadhas foreign net operating loss carryforwardscarry forwards of $11,500,000$13,300,000 for income tax purposes. All$12,500,000 of the net operating losses are foreign losses and can be carried forward indefinitely.indefinitely and $800,000 of the losses expire in 2008. The net operating losses relateconsist of $10,400,000 related to EuropeanGerman operations, $1,700,000 to Austrian operations, $400,000 related to Swedish operations and $800,000 related to Chinese operations.
The Company haddid not provide a valuation allowance of $557,000 and $709,000 as of December 31, 20032005 and 2002, respectively,provided $838,000 as of December 31, 2004, against a portion of the net operating loss carryforwards.carry forwards. The Company’s earnings related to its German operations have measurably improved; therefore the Company believes that a valuation allowance is primarily attributable to net operating losses generated in locations in which theno longer necessary.
The Company hasbelieves that it is more likely than not yet beenthat it will be able to determine with certaintyrecover the recoverability. deferred tax assets.
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
Undistributed earnings of the Company'sCompany’s foreign subsidiaries amounted to approximately $100,800,000$163,100,000 at December 31, 2003, $78,100,000 at December 31, 2002, and $55,500,000 at December 31, 2001.2005. 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 $3,900,000$2,140,000 would be payable upon remittance of all previously unremitted earnings at December 31, 2003.2005.
69
The American Job Creation Act of 2004 (the AJCA) was signed into federal law on October 22, 2004. The AJCA contain a one-time foreign dividend repatriation provision. This provision provides an 85% special deduction with respect to certain qualifying dividends from foreign subsidiaries for a limited period. The Company believes that it is more likely thandid not that it will be able to recover the deferred tax assets not subject to valuation allowance.repatriate any dividends from foreign affiliates under this provision.
(10) Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consist of the following:
| December 31, |
| December 31, |
| |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 |
| 2005 |
| 2004 |
| ||||||
| (in thousands) |
| (in thousands) |
| |||||||||
Commissions and sales incentives payable | $ | 18,869 | $ | 13,370 |
| $ | 30,807 |
| $ | 25,618 |
| ||
Accrued insurance | 16,104 | 14,168 |
| 11,836 |
| 13,751 |
| ||||||
Pension liability | 1,501 | 5,259 |
| 2,077 |
| 2,012 |
| ||||||
Other | 15,689 | 22,380 |
| 19,178 |
| 17,255 |
| ||||||
Income taxes payable | 3,089 | 1,860 |
| 3,173 |
| 3,100 |
| ||||||
| $ | 67,071 |
| $ | 61,736 |
| |||||||
$ | 55,252 | $ | 57,037 | ||||||||||
73
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
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 | |||
|
| December 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
4.87% notes due May 2010 |
| $ | 50,000 |
| $ | 50,000 |
|
5.47% notes due May 2013 |
| 75,000 |
| 75,000 |
| ||
$300,000,000 Revolving Credit Facility maturing in September 2009. Eurocurrency rate loans interest accruing at LIBOR or Euro LIBOR plus an applicable percentage (Euro LIBOR at 2.7% and 2.8% at December 31, 2005 and 2004, respectively) (LIBOR 5.0% at December 31, 2005) At December 31, 2005, $40,263,000 were for euro based borrowings and $127,000,000 were for U.S. borrowings. At December 31, 2004, $49,414,000 was for euro based borrowings and there were no outstanding U.S. borrowings. |
| 167,263 |
| 49,414 |
| ||
Hunter Innovations notes with principal payable in three equal annual installments, accruing interest monthly, due May 2006 (annual interest rate of 5.0% and 3.9% at December 31, 2005 and 2004, respectively) |
| 3,750 |
| 7,500 |
| ||
Variable rate demand bonds (4.3% at December 31, 2005) |
| 8,900 |
| — |
| ||
Other—consists primarily of European borrowings (at interest rates ranging from 2.7% to 11.3%) |
| 2,072 |
| 3,629 |
| ||
|
| 306,985 |
| 185,543 |
| ||
Less Current Maturities |
| 13,635 |
| 4,981 |
| ||
|
| $ | 293,350 |
| $ | 180,562 |
|
70
Principal payments during each of the next five years and thereafter are due as follows (in thousands): 2004—$13,251; 2005—$48,357; 2006—$4,194;13,635; 2007—$867;355; 2008—$244324; 2009—$167,500; 2010—$50,171 and thereafter—$125,399.75,000.
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 $48,651,000 as of December 31, 2005 and $42,570,000 as of December 31, 2004. The Company’s letters of credit are primarily associated with insurance coverage and to a lesser extent foreign purchases. The Company’s letters of credit generally expire within one year of issuance and are drawn down against the Revolving Credit Facility. The increase is primarily associated with insurance coverage. These instruments may exist or expire without being drawn down. Therefore, they do not necessarily represent future cash flow obligations.
At the closing of the Dormont acquisition, Dormont had long-term debt outstanding of $8,900,000 in the form of two series of taxable variable rate demand bonds (1998 Series with $1,500,000 outstanding and the 2000 Series with $7,400,000 outstanding) which, due to the provisions of the trust agreements, could only be redeemed at dates subsequent to the closing. Each of these bonds was secured by a letter of credit from a bank, which maintained a security interest in the assets of Dormont. As a condition of the purchase and to gain the bank’s consent to the sale of Dormont to the Company, Dormont’s former owners were required to establish a cash collateral account for the bonds in an amount equal to the potential obligation of Dormont to the bank under the letter of credit reimbursement agreements. The entire obligation under the bonds approximates $9,096,000, which represents the $8,900,000 in bond principal plus interest and
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
related fees. At closing, a portion of the Dormont purchase price was placed in a cash collateral account as a guarantee of payment. The Company has recorded this escrow deposit in prepaid expenses and other assets at December 31, 2005. The 1998 series bonds were repaid in full on January 17, 2006 and the 2000 series bonds were repaid in full on February 1, 2006 by the former owners using the cash collateral account.
On September 23, 2004, the Company entered into an unsecured revolving credit facility with a syndicate of banks (the Revolving Credit Facility). The Revolving Credit Facility provides for multi-currency unsecured borrowings and stand-by letters of credit of up to $300,000,000 and expires in September 2009. Borrowings outstanding under the Revolving Credit Facility bear interest at a fluctuating rate per annum for an applicable percentage equal to (i) in the case of Eurocurrency rate loans, the British Bankers Association LIBOR rate plus an applicable percentage, of up to 0.875% based on the Company’s current consolidated leverage ratio and debt rating, or (ii) in the case of base rate loans and swing line loans, the higher of (a) the federal funds rate plus 0.5% and (b) the annual rate of interest announced by Bank of America, N.A. as its “prime rate.” For 2005 the average interest rate under the Revolving Credit Facility for U.S. dollar borrowings was approximately 5.0% and euro based borrowings was approximately 2.7%. The Revolving Credit Facility replaced the unsecured revolving credit facility provided under the Revolving Credit Agreement dated February 28, 2002. The Revolving Credit Facility was used to pay off the debt that existed on the previous credit facility that was to expire in February 2005. 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, 2005, the Company was in compliance with all covenants related to the Revolving Credit Facility. The Company had $100,096,000 of unused and potentially available credit under the Revolving Credit Facility at December 31, 2005.
On May 15, 2003, 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 $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%8.375% Notes due December 2003. Additional net proceeds were used to repay approximately $32,000,000 outstanding under the Revolving Credit Facility.previous revolving credit facility. The balance of the net proceeds will bewas used for general corporate purposes. The payment of interest on the senior unsecured notes is due semi-annually on May 15th and November 15th of each year. The senior unsecured notes were issued by Watts Water Technologies, Inc. and are subordinated to pari passu with the 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'stockholders’ equity and (ii) debtpari passu or junior to the senior unsecured notes to the extent the Company maintains compliance with a 2.00 to 1.00 fixed charge coverage ratio. The notes include a prepayment provision which might require a make-whole payment to the note holders. Such payment is dependent upon the level of the respective treasuries. The notes include other customary terms and conditions, including events of default.
On February 28, 2002,Effective July 1, 2005, the Company entered into a revolving credit facilitythree-year interest rate swap with a syndicate of banks (as amended, the Revolving Credit Facility). 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 swapcounter party for a notional amount of €25,000,000, eurowhich is outstanding on ourunder the Revolving Credit Facility. The Company swapped the variable rate from the Revolving Credit Facility which is three monththree-month EURIBOR plus 0.7%0.6% for a fixed rate of 2.33%3.02%. The term of the swap is two years. The Company has designated the swap as a hedging instrumenthedge using the cash flow method. The swap hedgesAt December 31, 2005, 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$484,000.
75
Watts Water Technologies, Inc. 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 relatedSubsidiaries
Notes to the Revolving Credit Facility.Consolidated Financial Statements (Continued)
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 Company's letters of credit are primarily letters of credit associated with insurance coverage and 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, they do not necessarily represent future cash flow obligations.
(12) Common Stock
Since 1997, the Company's Board of Directors has authorized the repurchase of 4,380,200 shares of the Company's Common 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 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'sCompany’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. As of December 31, 2003,2005, the Company has reserved a total of 3,528,8254,153,065 of Class A Common Stock for issuance under its stock-based compensation plans and 7,605,2247,343,880 shares for conversion of Class B Common Stock to Class A Common Stock.
The Company maintainsThere are four stock option plans under which key employees and outside directors have been granted currently outstanding incentive stock options (ISOs) and nonqualified stock options (NSOs) options to purchase the Company'sCompany’s Class A Common Stock. Generally,Only one plan, the 2004 Stock Incentive Plan, is currently available for the grant of new options. The options, under the old plan, had become exercisable over a five yearfive-year period at the rate of 20% per year and expire ten years after the date of grant. Under the 2004 Stock Incentive Plan options become exercisable over a four-year period at the rate of 25% per year and expire ten years after the grant date. ISOs and NSOs granted under the plans 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, 2003, 3,528,8252005, 2,485,000 shares of Class A Common Stock were authorized for future grants of options under the Company'sCompany’s stock option plans.
The following is a summary of stock option activity and related information:
| Years Ended December 31, |
| Years Ended December 31, |
| |||||||||||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 |
| 2005 |
| 2004 |
| 2003 |
| |||||||||||||||||||||||||||||||||
| Options | Weighted Average Exercise Price | Options | Weighted Average Exercise Price | Options | Weighted Average Exercise Price |
| Options |
| Weighted |
| Options |
| Weighted |
| Options |
| Weighted |
| ||||||||||||||||||||||||
| (Options in thousands) |
| (Options in thousands) |
| |||||||||||||||||||||||||||||||||||||||
Outstanding at beginning of year | 1,455 | $ | 14.29 | 1,757 | $ | 13.31 | 1,714 | $ | 13.03 |
|
| 1,000 |
|
|
| $ | 17.82 |
|
|
| 1,015 |
|
|
| $ | 14.90 |
|
|
| 1,455 |
|
|
| $ | 14.29 |
|
| ||||||
Granted | 248 | 16.70 | 273 | 15.50 | 230 | 15.19 |
|
| 310 |
|
|
| 31.66 |
|
|
| 254 |
|
|
| 25.02 |
|
|
| 248 |
|
|
| 16.70 |
|
| ||||||||||||
Cancelled | (387 | ) | 13.35 | (73 | ) | 11.75 | (76 | ) | 13.89 |
|
| (113 | ) |
|
| 21.49 |
|
|
| (11 | ) |
|
| 16.10 |
|
|
| (387 | ) |
|
| 13.35 |
|
| |||||||||
Exercised | (301 | ) | 14.98 | (502 | ) | 11.88 | (111 | ) | 12.54 |
|
| (108 | ) |
|
| 14.26 |
|
|
| (258 | ) |
|
| 14.24 |
|
|
| (301 | ) |
|
| 14.98 |
|
| |||||||||
Outstanding at end of year | 1,015 | $ | 14.90 | 1,455 | $ | 14.29 | 1,757 | $ | 13.31 |
|
| 1,089 |
|
|
| $ | 21.70 |
|
|
| 1,000 |
|
|
| $ | 17.82 |
|
|
| 1,015 |
|
|
| $ | 14.90 |
|
| ||||||
Exercisable at end of year | 504 | $ | 13.92 | 858 | $ | 14.11 | 1,171 | $ | 13.20 |
|
| 422 |
|
|
| $ | 16.05 |
|
|
| 392 |
|
|
| $ | 14.29 |
|
|
| 504 |
|
|
| $ | 13.92 |
|
| ||||||
72
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
The following table summarizes information about options outstanding at December 31, 2003:2005:
| 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 | |||||||
|
| Options Outstanding |
| Options Exercisable |
| ||||||||||||||||||||
Range of Exercise Prices |
|
|
| Number |
| Weighted Average |
| Weighted Average |
| Number |
| Weighted Average |
| ||||||||||||
|
| (Options in thousands) |
| ||||||||||||||||||||||
$10.58 |
|
| 49 |
|
|
| 3.9 |
|
|
| $ | 10.58 |
|
|
| 49 |
|
|
| $ | 10.58 |
|
| ||
$11.75—$12.44 |
|
| 51 |
|
|
| 4.1 |
|
|
| 12.06 |
|
|
| 51 |
|
|
| 12.06 |
|
| ||||
$15.40—$32.07 |
|
| 989 |
|
|
| 7.9 |
|
|
| 22.78 |
|
|
| 322 |
|
|
| 17.52 |
|
| ||||
|
|
| 1,089 |
|
|
| 5.3 |
|
|
| $ | 21.70 |
|
|
| 422 |
|
|
| $ | 16.05 |
|
| ||
In 2005, the Company issued 5,616 shares of restricted stock to its Directors that vest over three years with a fair market price of $26.71 per share amounting to approximately $150,000 of deferred compensation. The restricted stock awards are amortized to expense on a straight-line basis over the vesting period.
In 2004, the Company issued 32,133 shares of restricted stock to its Directors (including the Company’s Chief Executive Officer) that vest over three years with a fair market price between $25.00 and $26.50 per share amounting to approximately $805,000 of deferred compensation. The restricted stock awards are amortized to expense on a straight-line basis over the vesting period.
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 Stock at 67% of the fair market value on the date of grant. RSUs vest annually over a three yearthree-year period from the date of grant. The difference between the RSU price and fair market value at the date of grant is amortized to compensation expense ratably over the vesting period. At December 31, 2003, 200,6922005, 328,061 RSUs were outstanding. Dividends declared for RSUs, that are paid to individuals, that remain unpaid at December 31, 20032005 total $62,172.approximately $162,000. Deferred compensation for the restricted stock and RSU plans at December 31, 2005 is anticipated to be expensed as follows: 2006 -$1,016,000 and 2007 -$574,000.
The Company has elected to follow APB No. 25 and related interpretations in accounting for its stock-based compensation. In addition the Company provides proformapro forma disclosure of stock-based compensation, as measured under the fair value requirements of FAS 123. These proformapro forma disclosures, which are calculated for awards granted after June 30, 1995, are provided in Footnote 2 as required under FAS 148. The weighted average grant date fair value of options granted are $4.48, $4.43$11.90, $9.01 and $6.74$5.94 for the years ending December 31, 2003, 20022005, 2004 and 2001,2003, respectively. Also, the weighted average grant date fair value of RSUs related to the Management Stock Purchase Plan are $6.55, $5.48$12.60, $8.41 and $7.30$5.39 for the years ending December 31, 2003, 20022005, 2004 and 2001,2003, respectively.
The fair value of the Company'sCompany’s stock-based awards to employees (used in reconciliation of Footnotein Note 2) was estimated using a Black-Scholes option pricing model and the following assumptions:
| Years Ended December 31, |
| Years Ended December 31, |
| ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 |
| 2005 |
| 2004 |
| 2003 |
| ||||
Expected life (years) | 5.0 | 5.0 | 5.0 |
| 5.8 |
| 5.0 |
| 5.0 |
| ||||
Expected stock price volatility | 28.3 | % | 33.2 | % | 52.4 | % |
| 36.2 | % | 20.3 | % | 28.3 | % | |
Expected dividend yield | 1.4 | % | 1.6 | % | 1.6 | % |
| 1.0 | % | 1.1 | % | 1.4 | % | |
Risk-free interest rate | 3.25 | % | 2.65 | % | 4.36 | % |
| 4.00 | % | 3.50 | % | 3.25 | % |
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
The fair value of the Company'sCompany’s Management Stock Purchase Plan awards to employees (used in reconciliation of Footnotein Note 2) was estimated using a Black-Scholes option pricing model and the following assumptions:
| Years Ended December 31, |
| Years Ended December 31, |
| ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 |
| 2005 |
| 2004 |
| 2003 |
| ||||
Expected life (years) | 3.0 | 3.0 | 3.0 |
| 3.0 |
| 3.0 |
| 3.0 |
| ||||
Expected stock price volatility | 28.3 | % | 33.2 | % | 52.4 | % |
| 26.0 | % | 20.3 | % | 28.3 | % | |
Expected dividend yield | 1.5 | % | 1.7 | % | 1.6 | % |
| 1.44 | % | 1.2 | % | 1.5 | % | |
Risk-free interest rate | 5.63 | % | 2.65 | % | 4.36 | % |
| 3.38 | % | 2.25 | % | 5.63 | % |
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'employees’ compensation. The funding policy of the Company for these plans is to contribute an annual amount that does not exceed the maximum amount that can be deducted for federal income tax purposes. The 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, |
| December 31, |
| ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2003 | 2002 |
| 2005 |
| 2004 |
| |||||||
| | (in thousands) |
| (in thousands) |
| ||||||||||
Change in projected benefit obligation | Change in projected benefit obligation |
|
|
|
|
| |||||||||
Balance at beginning of the year | Balance at beginning of the year | $ | 41,961 | $ | 36,038 |
| $ | 59,225 |
| $ | 51,741 |
| |||
Service cost | Service cost | 2,021 | 1,512 |
| 2,861 |
| 2,462 |
| |||||||
Administration cost |
| (299 | ) | (297 | ) | ||||||||||
Interest cost | Interest cost | 2,789 | 2,683 |
| 3,351 |
| 3,054 |
| |||||||
Actuarial loss | Actuarial loss | 6,550 | 3,495 |
| 5,934 |
| 3,992 |
| |||||||
Amendments/curtailments | Amendments/curtailments | 150 | 96 |
| 88 |
| 193 |
| |||||||
Benefits paid | Benefits paid | (1,730 | ) | (1,863 | ) |
| (2,046 | ) | (1,920 | ) | |||||
Balance at end of year | $ | 51,741 | $ | 41,961 | |||||||||||
Balance at end of year |
| $ | 69,114 |
| $ | 59,225 |
| ||||||||
Change in fair value of plan assets | Change in fair value of plan assets |
|
|
|
|
| |||||||||
Balance at beginning of the year | Balance at beginning of the year | $ | 25,535 | $ | 28,724 |
| $ | 37,021 |
| $ | 32,189 |
| |||
Actual gain (loss) on assets | 4,611 | (1,514 | ) | ||||||||||||
Actual gain on assets |
| 3,511 |
| 3,946 |
| ||||||||||
Employer contributions | Employer contributions | 3,773 | 188 |
| 1,822 |
| 3,103 |
| |||||||
Administration cost |
| (299 | ) | (297 | ) | ||||||||||
Benefits paid | Benefits paid | (1,730 | ) | (1,863 | ) |
| (2,046 | ) | (1,920 | ) | |||||
Fair value of plan assets at end of the year | Fair value of plan assets at end of the year | $ | 32,189 | $ | 25,535 |
| $ | 40,009 |
| $ | 37,021 |
| |||
Funded Status | Funded Status | $ | (19,552 | ) | $ | (16,426 | ) |
| $ | (29,105 | ) | $ | (22,204 | ) | |
Unrecognized transition obligation | (148 | ) | (403 | ) | |||||||||||
Unrecognized prior service costs | Unrecognized prior service costs | 1,498 | 1,567 |
| 1,310 |
| 1,462 |
| |||||||
Unrecognized net actuarial gain | 13,681 | 10,003 | |||||||||||||
Unrecognized net actuarial loss |
| 20,562 |
| 15,826 |
| ||||||||||
Contributions after measurement date and on or before fiscal year end | Contributions after measurement date and on or before fiscal year end | 3,020 | — |
| 29 |
| 36 |
| |||||||
Net amount recognized | $ | (1,501 | ) | $ | (5,259 | ) | |||||||||
Net amount recognized |
| $ | (7,204 | ) | $ | (4,880 | ) |
78
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
Amounts recognized in the statement of financial position are as follows:
| December 31, |
| December 31, |
| ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 |
| 2005 |
| 2004 |
| |||||||
| (in thousands) |
| (in thousands) |
| ||||||||||
Accrued benefit costs | $ | (1,501 | ) | $ | (5,259 | ) |
| $ | (7,204 | ) | $ | (4,880 | ) | |
Minimum pension liability | $ | (10,551 | ) | $ | (7,526 | ) |
| $ | (13,934 | ) | $ | (10,905 | ) | |
Intangible assets | $ | 1,073 | $ | 1,073 |
| $ | 1,310 |
| $ | 1,462 |
|
74
Information for pension plans with an accumulated benefit obligation in excess of plan assets are as follows:
| December 31, |
| December 31, |
| |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 |
| 2005 |
| 2004 |
| ||||||
| (in thousands) |
| (in thousands) |
| |||||||||
Projected benefit obligation | $ | 51,741 | $ | 41,961 |
| $ | 69,114 |
| $ | 59,225 |
| ||
Accumulated benefit obligation | $ | 47,260 | $ | 38,320 |
| $ | 61,175 |
| $ | 52,841 |
| ||
Fair value of plan assets | $ | 32,189 | $ | 25,535 |
| $ | 40,009 |
| $ | 37,021 |
|
The components of net periodic benefit cost are as follows:
| Years Ended December 31, |
| Years Ended December 31, |
| ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 |
| 2005 |
| 2004 |
| 2003 |
| ||||||||||
| (in thousands) |
| (in thousands) |
| ||||||||||||||||
Service cost—benefits earned | $ | 2,021 | $ | 1,512 | $ | 1,383 |
| $ | 2,861 |
| $ | 2,462 |
| $ | 2,021 |
| ||||
Interest costs on benefits obligation | 2,789 | 2,683 | 2,487 |
| 3,351 |
| 3,054 |
| 2,789 |
| ||||||||||
Estimated return on assets | (2,281 | ) | (2,520 | ) | (3,003 | ) |
| (3,174 | ) | (2,856 | ) | (2,281 | ) | |||||||
Transitional obligation/(asset) amortization | �� | (255 | ) | (255 | ) | (255 | ) | |||||||||||||
Transitional obligation amortization |
| — |
| (148 | ) | (255 | ) | |||||||||||||
Prior service cost amortization | 219 | 205 | 146 |
| 240 |
| 229 |
| 219 |
| ||||||||||
Net loss/(gain) amortization | 521 | — | (173 | ) | ||||||||||||||||
Net loss amortization |
| 862 |
| 756 |
| 521 |
| |||||||||||||
Net periodic benefit cost | $ | 3,014 | $ | 1,625 | $ | 585 |
| $ | 4,140 |
| $ | 3,497 |
| $ | 3,014 |
| ||||
Additional Information:
| December 31, | |||||
---|---|---|---|---|---|---|
| 2003 | 2002 | ||||
| (in thousands) | |||||
Increase in minimum liability included in other comprehensive income | $ | 3,046 | $ | 6,432 |
|
| December 31, |
| ||||||
|
| 2005 |
| 2004 |
| ||||
|
| (in thousands) |
| ||||||
Increase in minimum liability included in other comprehensive income, net of tax |
| $ | 1,978 |
|
| $ | 20 |
|
|
Assumptions:
Weighted-average assumptions used to determine benefit obligations:
| December 31, |
| December 31, |
| ||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 |
| 2005 |
| 2004 |
| |||
Discount rate | 6.00 | % | 6.75 | % |
| 5.50 | % | 5.75 | % | |
Rate of compensation increase | 4.00 | % | 4.00 | % |
| 4.00 | % | 4.00 | % |
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
Weighted-average assumptions used to determine net periodic benefit costs:
| December 31, |
| December 31, |
| ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 | 2001 |
| 2005 |
| 2004 |
| 2003 |
| ||||
Discount rate | 6.75 | % | 7.50 | % | 7.50 | % |
| 5.75 | % | 6.00 | % | 6.75 | % | |
Long-term rate of return on asset | 8.50 | % | 9.00 | % | 9.00 | % |
| 8.50 | % | 8.50 | % | 8.50 | % | |
Rate of compensation increase | 4.00 | % | 4.50 | % | 4.50 | % |
| 4.00 | % | 4.00 | % | 4.00 | % |
Discount rates are selected based upon rates of return at the measurement date utilizing benchmark pension discount rates currently available and expected to be available during the period to maturity of the pension benefits. 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'strust’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, |
|
| Plan Assets At |
| |||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Asset Category | ||||||||||||
2003 | 2002 |
|
|
| 2005 |
| 2004 |
| ||||
Equity securities | 74.8 | % | 52.8 | % | Equity securities |
| 66.0 | % | 71.2 | % | ||
Debt securities | 25.2 | % | 44.2 | % | Debt securities |
| 28.3 | % | 28.8 | % | ||
Real estate | — | % | — | % | ||||||||
Other/cash | — | % | 3.0 | % | ||||||||
Other | Other |
| 5.7 | % | — |
| ||||||
Total | 100.0 | % | 100.0 | % | Total |
| 100 | % | 100 | % | ||
The Company'sCompany’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.
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
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'sPlan’s aggregate bond position.
76
Cash flows:
The information related to the Company'sCompany’s pension funds cash flow is as follows:
| December 31, |
| December 31, |
| |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 |
| 2005 |
| 2004 |
| ||||||
| (in thousands) |
| (in thousands) |
| |||||||||
Employer Contributions | $ | 6,793 | $ | 188 |
| $ | 1,816 |
| $ | 117 |
| ||
Benefit Payments | $ | 1,730 | $ | 1,863 |
| $ | 2,046 |
| $ | 1,920 |
|
Contributions made in January 2006 approximated $3,100,000, other contributions expected to be made in 2006 approximate $120,000.
Expected benefit payments to be paid during 2004by the pension plans are approximately $105,000.as follows:
|
| (in thousands) |
| |||
During fiscal year ending December 31, 2006 |
|
| $ | 2,077 |
|
|
During fiscal year ending December 31, 2007 |
|
| $ | 2,162 |
|
|
During fiscal year ending December 31, 2008 |
|
| $ | 2,260 |
|
|
During fiscal year ending December 31, 2009 |
|
| $ | 2,454 |
|
|
During fiscal year ending December 31, 2010 |
|
| $ | 2,694 |
|
|
During fiscal year ending December 31, 2011 through |
|
| $ | 17,018 |
|
|
Additionally, substantially all of the Company'sCompany’s domestic employees are eligible to participate in acertain 401(k) savings plan.plans. Under this plan,these plans, the Company matches a specified percentage of employee contributions, subject to certain limitations. The Company'sCompany’s match expensescontributions (included in selling, general and administrative expense) for the years ended December 31, 2005, 2004, and 2003 2002,were $423,000, $421,000, and 2001 were $300,000, $330,000,respectively. Charges for European pension plans approximated $2,000,000, $1,900,000 and $324,000,$1,400,000 for the years ended December 31, 2005, 2004, and 2003, respectively. These costs relate to plans administered by certain European subsidiaries, with benefits calculated according to government requirements and paid out to employees upon retirement or change of employment.
81
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
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 services 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, 2002, and therefore the Supplemental Compensation period began on January 1, 2003. In accordance with Financial Accounting Standards Board Statement No. 106, "Employers“Employers Accounting for Post Retirement Benefits Other Than Pensions"Pensions”, the Company will accrue for the future post-retirement disability benefits over the period from January 1, 2003, to the time in which Mr. Horne becomes physically unable to perform his consulting services (the period in which the disability benefits are earned).
(15) Contingencies and Environmental Remediation
ContingenciesJames Jones Litigation
In April 1998, the Company became aware of a complaint (the Armenta case) that was filed byAs previously disclosed, on June 25, 1997, Nora Armenta (the Relator) filed a civil action in the California Superior Court for Los Angeles County (the Armenta case) against James Jones Company (James Jones), Mueller Co., Tyco International (U.S.), and Watts Industries, Inc., now Watts Water Technologies, Inc. (Watts). The Company formerly owned James Jones. The Relator filed under sealthe qui tam provision of the California state False Claims Act, Cal. Govt. Code § 12650 et seq. (California False Claims Act) and generally alleged that James Jones and the other defendants violated this statute by delivering some “defective” or “non-conforming” waterworks parts to thirty-four municipal water systems in the State of California alleging violations of the California False Claims Act.California. The complaint alleges thatRelator filed a former subsidiary of the Company (James Jones Company) sold products utilizedFirst Amended Complaint in municipal water systems that failed to meet contractually specified standardsNovember 1998 and falsely certified that such standards had been met. The complaint further alleges that the municipal entities have suffered damages as a result of defective products and seeks treble damages, reimbursement of legal costs and penalties. The original complaint has been amended, andSecond Amended Complaint in December 2000, which brought the total number of named plaintiffs isto 161. In June 2002, the trial court excluded 47 cities from this total of 161, and the Relator was not able to obtain appellate modification of this order, which can still be appealed at the end of the case. To date, 11 of whichthe named cities have intervened, and 47 of whichattempts by four other named cities to intervene have been ordered excluded from the case. In June 2001, the Company and other defendants reached a proposed settlement with the Los Angeles Department of Water and Power, onedenied.
One of the plaintiffsallegations in the Second Amended Complaint and the Complaints-in-Intervention is that purchased non-conforming James Jones case, which waswaterworks parts may leach into public drinking water elevated amounts of lead that may create a public health risk because they were made out of ‘81 bronze alloy (UNS No. C8440) and contain more lead than the specified and advertised ‘85 bronze alloy (UNS No. C83600). This contention is based on the average difference of about 2% lead content between ‘81 bronze (6% to 8% lead) and ‘85 bronze (4% to 6% lead) and the assumption that this would mean increased consumable lead in public drinking water that could cause a public health concern. The Company believes the evidence and discovery available to date indicate that this is not the case.
In addition, ‘81 bronze is used extensively in municipal and home plumbing systems and is approved by municipal, local and national codes. The Federal Environmental Protection Agency also defines metal for pipe fittings with no more than 8% lead as “lead free” under Section 1417 of the California Superior Court on October 31, 2001Federal Safe Drinking Water Act.
Watts Water Technologies, Inc. and by the Los Angeles City Council on December 14, 2001. The other plaintiffs remain, and the Company is vigorously contesting this matter.Subsidiaries
Notes to Consolidated Financial Statements (Continued)
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 RelatorShe 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 CompanyFinally, the Relator requests an award of costs of this action, including attorneys’ fees.
In December 1998, the Los Angeles Department of Water and Power (LADWP) intervened in this case and filed a complaint. We settled with the Citycity of Los Angeles, by far the most significant city, for $5.7 million$7,300,000 plus the Relator's statutory share and attorneys'attorneys’ fees. Co-defendants will contributecontributed $2.0 million toward this settlement.
In August 2003, an additional settlement payment was made for $13 million$13,000,000 ($11 million11,000,000 from the Company and $2 million$2,000,000 from the James Jones Company)Jones), which settled the claims of the three Phase I cities (Santa Monica, San Francisco and East Bay Municipal WaterUtility District) chosen by the Relator as having the strongest claims to be tried first. This settlement payment included the Relator'sRelator’s statutory share, and the claims of these three cities have been dismissed. In addition to this $13 million$13,000,000 payment, the Company is obligated to pay the Relator's attorney'sRelator’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 CompanyContra Costa, Corona, Santa Ana, Santa Cruz and Vallejo were chosen. Watts and James Jones subsequentlythen reached an agreement to settle the claims of the City of Santa Ana's claimsAna for a total of $45,000, andan amount which approximates Santa Ana’s purchases of James Jones products during the Company is responsible for $38,000 of this settlement amount.relevant period. The Santa Ana has submitted this claim tosettlement was approved by the Court for approval in March 2004. The trial ofand then completed.
On June 22, 2005, the Court dismissed the claims of the remaining Phase II cities (Contra Costa, Corona, Santa Cruz and Vallejo). The Court ruled that the Relator and these cities were required to show that the cities had received out of spec parts which were related to specific invoices and that this showing had not been made. Although each city’s claim is scheduledunique, this ruling is significant for the claims of the remaining cities, and the Relator has appealed. Litigation is inherently uncertain, and the Company is unable to predict the outcome of this appeal.
On September 2004.15, 2004, the Relator’s attorneys filed a new common law fraud lawsuit in the California Superior Court for the City of Banning and forty-five other cities and water districts against James Jones, Watts and Mueller Co. based on the same transactions alleged in the Armenta case. About thirty-four of the plaintiffs in this new lawsuit are also plaintiffs in the Armenta case. On January 4, 2006, the Court denied much of the Defendants’ demurrer, which had been filed on claim-splitting and statute of limitations grounds. Litigation is inherently uncertain, and the Company is unable to predict the outcome of this new lawsuit.
The Company has a reserve of approximately $9.3 million$21,000,000 with respect to the James Jones Litigation in itsour consolidated balance sheet as of December 31, 2003.2005. The Company believes, on the basis of all available information, that this reserve is adequate to cover itsthe probable and reasonably estimable losses resulting from the James Jones LitigationArmenta case and the insurance coverage litigation with Zurich American Insurance Company (Zurich) discussed below. The Company is currently unable to make an estimate of the range of any additional losses.
On February 14, 2001, after its insurers had denied coverage for the claims in the Armenta case, the Company filed a complaint for coverage against our insurers in the California Superior Court against its insurers for(the coverage of the claims in the Armenta case. Thecase). James Jones Company filed a similar complaint, the cases were consolidated, and on October 30, 2001 the California Superior Courttrial court made a summary adjudication rulingrulings that Zurich American Insurance Company (Zurich) must pay all reasonable defense costs incurred by the CompanyWatts
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
and James Jones in the Armenta case since April 23, 1998 as well as the Company'ssuch future defense costs inuntil the end of the Armenta case. In July 2004, the California Court of Appeal affirmed these rulings, and, on December 1, 2004, the California Supreme Court denied Zurich’s appeal of this case until its final resolution. On October 24,decision. This denial permanently established Zurich’s obligation to pay Armenta defense costs for both Watts (approximately $16,900,000 plus future costs) and James Jones (which is estimated to be $17,300,000 plus future costs), and Zurich is currently making payments of incurred Armenta defense costs. However, as noted below, Zurich asserts that the defense costs paid by it are subject to reimbursement.
In 2002, the California Superior Courttrial court made anothera summary adjudication ruling that Zurich must indemnify and pay the CompanyWatts and James Jones for the amounts the Company must pay under its settlement agreementpaid to settle with the City of Los Angeles. Zurich has asserted that all amounts (both defense costs and indemnity amounts paid for settlements) paid by itZurich’s attempt to the Company are subject to reimbursement 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 forobtain appellate review of this order was denied, but Zurich will still be able to appeal this order at the end of the coverage case. TheIn 2004, the trial court made another summary adjudication ruling that Zurich must indemnify and pay Watts and James Jones for the $13,000,000 paid to settle the claims of the Phase I cities described above. Zurich’s attempt to obtain appellate review of this ruling was denied on December 3, 2004 by the California Court of Appeal, but Zurich will still be able to appeal this order at the end of the coverage case. Although Zurich has now made most of the payments required by these indemnity orders, the Company is currently unable to predict the finality of these orders since Zurich can appeal them at the order on indemnity forend of the Los Angeles settlement.coverage case. The Company has recorded reimbursed indemnity settlement amounts (but not reimbursed defense costs) as a liability.liability pending court resolution of the indemnification matter as it relates to Zurich.
Zurich has asserted that all amounts (which is estimated to be $51,000,000 for both defense costs and indemnity amounts paid for settlements) paid by it to the Company and James Jones are subject to reimbursement under Deductible Agreements related to the insurance policies between Zurich and the Company. If Zurich were to prevail on this argument, James Jones would have a possible indemnity claim against the Company for its exposure from the Armenta case. The Company intends to contest vigorouslybelieves the Armenta case should be viewed as one occurrence and the deductible amount should be $500,000 per occurrence.
These reimbursement claims are subject to arbitration under the Watts/Zurich Deductible Agreements. Zurich claims its related litigation.reimbursement right for defense costs paid arises under six Deductible Agreements, and the Company contends that only two Deductible Agreements apply. The Company further contends that a final decision in California supports its position on the number of Deductible Agreements that should apply to defense costs. On January 31, 2006, the federal district court in Chicago, Illinois determined that there are disputes under all Deductible Agreements in effect during the period in which Zurich issued primary policies and that the arbitrator could decide which agreements would control reimbursement claims. The Company has appealed from this ruling. Management and counsel anticipate that the Company will ultimately prevail on this reimbursement issue with Zurich.
Based on management'smanagement’s assessment, the Company does not believe that the ultimate outcome of the James Jones case wouldLitigation will have a material adverse effect on its liquidity, financial condition or results
78
of 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 fully 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 all aspects of the James Jones caseLitigation.
Watts Water Technologies, Inc. and its related litigation.Subsidiaries
Notes to Consolidated Financial Statements (Continued)
Environmental Remediation
The Company has been named as a potentially responsible party (PRP) with respect to a limited number of identified contaminated sites. The levellevels of contamination variesvary 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 accruedCompany accrues 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$1,500,000 (environmental accrual), which the Company estimates that its accrued environmental remediation liabilities will likely be paid for environmental remediation liabilities over the next five to ten years. Based on the facts currently known to it, the Company does not believe that the ultimate outcome of these claimsmatters will have a material adverse effect on the Company'sits liquidity, financial condition or results of operations.
For several years, the New 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 for 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 Some of the final costs may be allocated to the Company. In 2003, 139 PRPs were identified by the Company's defense group,Company’s environmental matters are inherently uncertain, 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 there exists a possibility that the Company does not believe that the ultimate outcomemay ultimately incur losses from these matters in excess of the Babylon matter will have a material adverse effect onamount accrued. However, the Company's liquidity, financial condition or resultsCompany cannot currently estimate the amount of operations.any such additional losses.
Asbestos Litigation
The Company is a defendant indefending approximately 115 actions121 cases filed primarily, but not exclusively, in Mississippi and New Jersey state courts and 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 Watts products of the Company as a source of asbestos exposure. To date, the CompanyWatts has been dismissed from each case when the scheduled trial date comes near.near or when discovery fails to yield any evidence of exposure to any Watts product. Based 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'sits liquidity, financial condition or results of operations.
Other Litigation
On or about March 26, 2003, a class action complaincomplaint was filed against the CompanyWatts by North Carolina Hospitality Group, Inc. in the Circuit Court of Maryland, Prince George'sGeorge’s County. It alleges
79
that certain commercial valve models contain a design defect that causes them to fail prematurely. BasedOn June 7, 2004, the trial court issued an opinion and order that denied the plaintiff’s request for class certification. This ruling was appealed at the end of 2004, and, on the Company's extensive investigation of the evidence, including the physical evidence presented so farJanuary 17, 2006, this ruling was affirmed by the plaintiff, management believes that the allegations in the complaint are without merit, and the Company intends to defend this lawsuit vigorously.Maryland Court of Special Appeals. Based on the facts currently known to it, the Company does not believe that the ultimate outcome of these claimsthis matter will have a material adverse effect on the Company'sits 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.Company. Based on the facts currently known to it, the Company does not believe that the ultimate outcome of these other litigation matters will have a material adverse effect on its liquidity, financial condition or results of operation.operations.
However, litigation is inherently uncertain,85
Watts Water Technologies, Inc. and the Company believes that there exists a reasonable possibility that it may ultimately incur losses in other litigation in excess of the amount accrued.Subsidiaries
Notes to Consolidated Financial Statements (Continued)
Fair Value
The carrying amounts of cash and cash equivalents, investment securities, trade receivables and trade payables approximate fair value because of the short maturity of these financial instruments.
The fair value of the Company'sCompany’s 4.87% senior notes, due 2010 and 5.47% senior notes due 2013, is based on quoted market prices. The fair value of the Company'sCompany’s variable rate debt approximates its carrying value. The carrying amount and the estimated fair market value of the Company'sCompany’s long-term debt, including the current portion, are as follows:
| December 31, |
| December 31, |
| |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | 2002 |
| 2005 |
| 2004 |
| ||||||
| (in thousands) |
| (in thousands) |
| |||||||||
Carrying amount | $ | 192,312 | $ | 138,487 |
| $ | 306,985 |
| $ | 185,543 |
| ||
Estimated fair value | $ | 193,130 | $ | 142,162 |
| $ | 306,485 |
| $ | 186,606 |
|
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 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, 2003, 20022005, 2004 and 2001,2003, 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. There were no commodity contracts utilized for years ended December 31, 2003, 20022005, 2004 and 2001.2003.
Effective July 1, 2003,2005, the Company entered into ana three-year interest rate swap with a counter party for a notional amount of €25,000,000, eurowhich is outstanding onunder our Revolving Credit Facility. The Company swapped the variable rate
80
from the Revolving Credit Facility which is three monththree-month EURIBOR plus 0.7%0.6% for a fixed rate of 2.33%3.02%. The term of the swap is two years. The Company has designated the swap as a hedging instrumenthedge using the cash flow method. The swap hedgesAt December 31, 2005, 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 infair 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.approximately $484,000.
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
At December 31, 2001, the Company had an outstanding interest rate swap that converted 20,000,000 euro of the borrowings under variable rate euro Line of Credit to a fixed rate borrowings at 4.3%. This swap agreement expired in March 2002 and its value and its impact on the Company's results was not material at December 31, 2002.Leases
In September 2001, the Company entered an interest rate swap for its $75,000,000 83/8% notes. The Company swapped the fixed interest rate of 83/8% to floating LIBOR plus 3.74%. On August 5, 2002, the Company sold the swap and received $2,315,000 in cash. Based on the Company terminating this hedge transaction, 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 capital leases and non-cancelable operating leases as of December 31, 20032005 are as follows:
| Operating Leases | Capital Leases |
| Operating Leases |
| Capital Leases |
| ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2004 | $ | 1,992 | $ | 653 | |||||||||||||
2005 | 1,834 | 356 | |||||||||||||||
|
| (in thousands) |
| ||||||||||||||
2006 | 1,697 | 223 |
|
| $ | 4,322 |
|
|
| $ | 510 |
|
| ||||
2007 | 1,175 | 132 |
|
| 3,499 |
|
|
| 331 |
|
| ||||||
2008 | 1,187 | — |
|
| 3,244 |
|
|
| 94 |
|
| ||||||
2009 |
|
| 2,378 |
|
|
| 94 |
|
| ||||||||
2010 |
|
| 1,497 |
|
|
| 95 |
|
| ||||||||
Thereafter | 1,730 | — |
|
| 8,375 |
|
|
| 150 |
|
| ||||||
Total | $ | 9,615 | $ | 1,364 |
|
| $ | 23,315 |
|
|
| $ | 1,274 |
|
| ||
(17) Segment Information
Under the criteria set forth in Financial Accounting Standards Board No.131 "DisclosureNo. 131, “Disclosure about Segments of an Enterprise and Related Information",Information,” the Company operates in three geographic segments: North America, Europe, and China. Each of these segments sell similar products, is managed separately and has separate financial results that are reviewed by the Company'sCompany’s chief operating decision-maker. All intercompany transactions have been eliminated. Sales by region are based upon location of the entity recording the sale. The accounting policies for each segment are the same as those described in the summary of significant accounting policies (see Note 2).
81Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
The following is a summary of ourthe Company’s significant accounts and balances by segment, reconciled to ourits consolidated totals:
| North America | Europe | China | Corporate(*) | Consolidated |
| North |
| Europe |
| China |
| Corporate(*) |
| Consolidated |
| |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) |
| (in thousands) |
| |||||||||||||||||||||||||||||||
Year ended December 31, 2003 | |||||||||||||||||||||||||||||||||||
As of or for the year ended December 31, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Net sales | $ | 476,310 | $ | 210,614 | $ | 18,727 | $ | — | $ | 705,651 |
| $ | 629,937 |
| $ | 266,346 |
| $ | 28,063 |
|
| $ | — |
|
|
| $ | 924,346 |
|
| |||||
Operating income (loss) | 64,414 | 22,592 | (3,834 | ) | (13,132 | ) | 70,040 |
| 76,757 |
| 31,528 |
| 3,533 |
|
| (17,263 | ) |
|
| 94,555 |
|
| |||||||||||||
Identifiable assets | 509,010 | 266,849 | 62,784 | — | 838,643 |
| 717,424 |
| 288,783 |
| 94,763 |
|
| — |
|
|
| 1,100,970 |
|
| |||||||||||||||
Long-lived assets | 72,592 | 48,882 | 24,237 | — | 145,711 |
| 92,904 |
| 45,674 |
| 26,421 |
|
| — |
|
|
| 164,999 |
|
| |||||||||||||||
Capital expenditures | 6,500 | 4,832 | 8,703 | — | 20,035 |
| 9,502 |
| 6,082 |
| 3,006 |
|
| — |
|
|
| 18,590 |
|
| |||||||||||||||
Depreciation and amortization | 12,542 | 6,593 | 2,149 | — | 21,284 |
| 13,050 |
| 8,888 |
| 4,180 |
|
| — |
|
|
| 26,118 |
|
| |||||||||||||||
Year ended December 31, 2002 | |||||||||||||||||||||||||||||||||||
As of or for the year ended December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Net sales | $ | 450,233 | $ | 145,629 | $ | 19,664 | $ | — | $ | 615,526 |
| $ | 545,139 |
| $ | 253,234 |
| $ | 26,185 |
|
| $ | — |
|
|
| $ | 824,558 |
|
| |||||
Operating income (loss) | 55,313 | 13,608 | (625 | ) | (10,767 | ) | 57,529 |
| 68,558 |
| 31,597 |
| 1,857 |
|
| (18,412 | ) |
|
| 83,600 |
|
| |||||||||||||
Identifiable assets | 375,202 | 206,146 | 54,124 | — | 635,472 |
| 537,898 |
| 303,981 |
| 80,801 |
|
| — |
|
|
| 922,680 |
|
| |||||||||||||||
Long-lived assets | 78,333 | 40,295 | 15,748 | — | 134,376 |
| 72,019 |
| 52,276 |
| 26,394 |
|
| — |
|
|
| 150,689 |
|
| |||||||||||||||
Capital expenditures | 5,718 | 6,171 | 7,704 | — | 19,593 |
| 8,029 |
| 6,374 |
| 6,596 |
|
| — |
|
|
| 20,999 |
|
| |||||||||||||||
Depreciation and amortization | 14,731 | 6,370 | 1,193 | — | 22,294 |
| 14,961 |
| 8,870 |
| 4,220 |
|
| — |
|
|
| 28,051 |
|
| |||||||||||||||
Year ended December 31, 2001 | |||||||||||||||||||||||||||||||||||
As of or for the year ended December 31, 2003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Net sales | $ | 415,689 | $ | 121,228 | $ | 12,023 | $ | — | $ | 548,940 |
| $ | 472,518 |
| $ | 210,614 |
| $ | 18,727 |
|
| $ | — |
|
|
| $ | 701,859 |
|
| |||||
Operating income (loss) | 47,294 | 11,308 | 1,365 | (9,684 | ) | 50,283 |
| 64,375 |
| 22,592 |
| (3,834 | ) |
| (13,132 | ) |
|
| 70,001 |
|
| ||||||||||||||
Identifiable assets | 343,187 | 153,007 | 24,276 | — | 520,470 |
| 511,285 |
| 266,849 |
| 62,784 |
|
| — |
|
|
| 840,918 |
|
| |||||||||||||||
Long-lived assets | 86,409 | 36,495 | 5,702 | — | 128,606 |
| 72,447 |
| 48,882 |
| 24,237 |
|
| — |
|
|
| 145,566 |
|
| |||||||||||||||
Capital expenditures | 10,508 | 3,351 | 2,188 | — | 16,047 |
| 6,495 |
| 4,832 |
| 8,703 |
|
| — |
|
|
| 20,030 |
|
| |||||||||||||||
Depreciation and amortization | 16,109 | 6,820 | 746 | — | 23,675 |
| 12,523 |
| 6,593 |
| 2,149 |
|
| — |
|
|
| 21,265 |
|
|
* Corporate expenses are primarily for compensation expense, Sarbanes-Oxley compliance, professional fees, including legal and audit expenses, shareholder services and benefit administration costs. These costs are not allocated to the geographic segments as they are viewed as corporate functions that support all activities.
The North AmericanAmerica segment consists of U.S. net sales of $443,228,000, $422,703,000$582,279,000, $507,061,000 and $393,455,000439,436,000 for the years ended December 31, 2003, 20022005, 2004 and 2001,2003 respectively. The North American segment also consists of U.S. long-lived assets of $67,595,000, $73,907,000$86,099,000, $67,032,000 and $81,723,000$67,450,000 as of December 31, 2005, 2004 and 2003, respectively.
Intersegment sales for the yearsyear ended December 31, 2005 for North America, Europe and China were $4,847,000, $5,279,000 and $48,770,000, respectively. Intersegment sales for the year ended December 31, 2004 for North America, Europe and China were $6,040,000, $6,834,000 and $27,030,000, respectively. Intersegment sales for the year ended December 31, 2003 2002for North America, Europe and 2001,China were $4,180,000, $3,656,000 and $12,146,000, 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.
82
(18) Quarterly Financial Information (unaudited)
| 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 20, 2004, the Company entered into an agreement with 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 the payment of $3,500,000 in connection with a three-year non-compete agreement. After the transaction the Company 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, a wholly-owned subsidiary of the Company 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.
(18) Quarterly Financial Information (unaudited)
|
| First |
| Second |
| Third |
| Fourth |
| ||||||
|
| (in thousands, except per share information) |
| ||||||||||||
Year ended December 31, 2005 |
|
|
|
|
|
|
|
|
|
|
| ||||
Net sales |
| $ | 219,027 |
| $ | 228,183 |
| $ | 232,729 |
|
| $ | 244,407 |
|
|
Gross profit |
| 77,378 |
| 81,183 |
| 79,813 |
|
| 86,328 |
|
| ||||
Income from continuing operations |
| 12,397 |
| 13,988 |
| 13,439 |
|
| 15,196 |
|
| ||||
Net income |
| 12,358 |
| 13,913 |
| 13,368 |
|
| 14,960 |
|
| ||||
Per common share: |
|
|
|
|
|
|
|
|
|
|
| ||||
Basic |
|
|
|
|
|
|
|
|
|
|
| ||||
Income from continuing operations |
| 0.38 |
| 0.43 |
| 0.41 |
|
| 0.47 |
|
| ||||
Net income |
| 0.38 |
| 0.43 |
| 0.41 |
|
| 0.46 |
|
| ||||
Diluted |
|
|
|
|
|
|
|
|
|
|
| ||||
Income from continuing operations |
| 0.37 |
| 0.42 |
| 0.41 |
|
| 0.46 |
|
| ||||
Net income |
| 0.37 |
| 0.42 |
| 0.40 |
|
| 0.45 |
|
| ||||
Dividends per common share |
| 0.08 |
| 0.08 |
| 0.08 |
|
| 0.08 |
|
| ||||
Year ended December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
| ||||
Net sales |
| $ | 186,008 |
| $ | 206,954 |
| $ | 210,190 |
|
| $ | 221,406 |
|
|
Gross profit |
| 64,912 |
| 75,627 |
| 74,368 |
|
| 75,654 |
|
| ||||
Income from continuing operations |
| 10,995 |
| 14,059 |
| 13,835 |
|
| 9,849 |
|
| ||||
Net income |
| 11,001 |
| 13,953 |
| 13,705 |
|
| 8,161 |
|
| ||||
Per common share: |
|
|
|
|
|
|
|
|
|
|
| ||||
Basic |
|
|
|
|
|
|
|
|
|
|
| ||||
Income from continuing operations |
| 0.34 |
| 0.44 |
| 0.43 |
|
| 0.30 |
|
| ||||
Net income |
| 0.34 |
| 0.43 |
| 0.42 |
|
| 0.25 |
|
| ||||
Diluted |
|
|
|
|
|
|
|
|
|
|
| ||||
Income from continuing operations |
| 0.34 |
| 0.43 |
| 0.42 |
|
| 0.30 |
|
| ||||
Net income |
| 0.34 |
| 0.43 |
| 0.42 |
|
| 0.25 |
|
| ||||
Dividends per common share |
| 0.07 |
| 0.07 |
| 0.07 |
|
| 0.07 |
|
|
(1) During the fourth quarter of Cash Flows (Amounts2004, the Company identified and corrected errors related to certain accrued expenses. The adjustments to net income necessary to correct these errors amounted to $2,289,000, or ($0.07) per share. The portions of these adjustments that related to the year ended December 31, 2004 and the fourth quarter of 2004 were $1,520,000, or ($0.05) per share and $411,000, or ($0.01) per share, respectively. The impact of the amount that related to prior periods was not material to any of the financial statements of prior periods, thus the amount related to prior periods, including the first three quarters of 2004, was recorded in the fourth quarter of 2004.
Watts Water Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(19) Related Party Transactions
In 2004, an agreement was executed with a relocation firm to purchase and sell the home of the Company’s chief executive officer, who is also a member of the Company’s board of directors. The relocation firm purchased the home from the Company’s chief executive officer, on the Company’s behalf, at a price based on fair market appraisals obtained by the Company. Accordingly, the Company charged income from continuing operations for approximately $285,000 representing the difference between the original appraised value of the home and the final sale price to the third party.
The Company owns a 20% interest in www.plumbworld.co.uk Limited (Plumbworld), a variable interest entity. Plumbworld is primarily an e-business that sells bathroom and sanitary appliances, as well as plumbing and heating products, tools and plumbing consumables. Its latest fiscal year sales were approximately $11,600,000. The Company has a nominal investment of approximately $500 in Plumbworld and maintains a loan receivable in the amount of approximately $603,000 with Plumbworld. The Company has entered in to an agreement with the majority shareholders of Plumbworld to exchange its 20% ownership interest for full receipt of the loan receivable. The Company expects to receive installment payments on the loan receivable through September 2006, at which time it will relinquish it shares in Plumbworld. The Company continues to account for its investment in Plumbworld using the equity method.
The Company leases the land and buildings occupied by its Chinese joint venture from the joint venture partner. The lease is classified as an operating lease and extends for another 18 years. Total rental expense for 2005, 2004 and 2003 approximated $275,000 each year. Total lease costs over the remaining term of the lease will approximate $4,950,000.
(20) Subsequent Events
In February 7, 2006, the Company declared a quarterly dividend of nine cents ($0.09) per share on the Company’s Class A Common Stock and Class B Common Stock. This is an increase of $0.01 per share compared to the dividend paid for the comparable period last year.
90
Watts Water Technologies, Inc. and Subsidiaries
Schedule II—Valuation and Qualifying Accounts
For the Three Years Ended December 31:
|
| Balance At |
| Additions |
| Additions |
| Deductions |
| Balance At |
| ||||||||||||
Year Ended December 31, 2003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||
Allowance for doubtful accounts |
|
| $ | 7,322 |
|
|
| 2,373 |
|
|
| 60 |
|
|
| (1,983 | ) |
|
| $ | 7,772 |
|
|
Allowance for excess and obsolete inventories |
|
| $ | 13,201 |
|
|
| 3,558 |
|
|
| 172 |
|
|
| (2,686 | ) |
|
| $ | 14,245 |
|
|
Year Ended December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||
Allowance for doubtful accounts |
|
| $ | 7,772 |
|
|
| 2,100 |
|
|
| 337 |
|
|
| (2,658 | ) |
|
| $ | 7,551 |
|
|
Allowance for excess and obsolete inventories |
|
| $ | 14,245 |
|
|
| 7,325 |
|
|
| 289 |
|
|
| (5,660 | ) |
|
| $ | 16,199 |
|
|
Year Ended December 31, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||
Allowance for doubtful accounts |
|
| $ | 7,551 |
|
|
| 3,914 |
|
|
| 341 |
|
|
| (2,510 | ) |
|
| $ | 9,296 |
|
|
Allowance for excess and obsolete inventories |
|
| $ | 16,199 |
|
|
| 2,593 |
|
|
| 1,074 |
|
|
| (3,086 | ) |
|
| $ | 16,780 |
|
|
91
Exhibit No. | Description | |
2.1 | Stock Purchase Agreement dated as of December 8, 2005 by and among Watts Water Technologies, Inc., Watts Regulator Co., Evan J. Segal and Stacy A. Brovitz (14) | |
3.1 | Restated Certificate of Incorporation, as amended (22) | |
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 (15) | |
10.1* | Supplemental Compensation Agreement effective as of September 1, 1996 between the Registrant and Timothy P. Horne (9), Amendment No. 1, dated July 25, 2000 (16), 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 (23) | |
10.4* | 1996 Stock Option Plan, dated October 15, 1996 (10), and First Amendment dated February 28, 2003 (3) | |
10.5* | Watts Industries, Inc. Retirement Plan for Salaried Employees dated December 30, 1994, as amended and restated effective as of January 1, 1994 (8), Amendment No. 1 (9), Amendment No. 2 (9), Amendment No. 3 (9), Amendment No. 4 dated September 4, 1996 (12), Amendment No. 5 dated January 1, 1998 (15), Amendment No. 6 dated May 3, 1999 (15), and Amendment No. 7 dated June 7, 1999 (15) | |
10.6* | Watts Industries, Inc. Pension Plan (amended and restated effective as of January 1, 1997) (3) and First Amendment dated October 25, 2002 (3) | |
10.7 | Registration Rights Agreement dated July 25, 1986 (5) | |
10.8* | Executive Incentive Bonus Plan, as amended and restated (21) | |
10.9 | Amended and Restated Stock Restriction Agreement dated October 30, 1991 (2), and Amendment dated August 26, 1997 (12) | |
10.10* | Watts Industries, Inc. 1991 Non-Employee Directors’ Nonqualified Stock Option Plan (6), and Amendment No. 1 (9) | |
10.11* | Watts Industries, Inc. 2003 Non-Employee Directors’ Stock Option Plan (3) | |
10.12 | 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 (17) | |
10.13* | Form of Stock Restriction Agreement for management stockholders (5) | |
10.14 | Credit Agreement dated as of September 23, 2004 among Watts Water Technologies, Inc. and certain of its subsidiaries, Bank of America, N.A., JP Morgan Chase Bank, Wachovia Bank, National Association, Key Bank National Association, SunTrust Bank and certain other lenders (20) and Amendment No. 1 dated March 21, 2005 (24) | |
10.15* | Watts Water Technologies, Inc. Management Stock Purchase Plan, as amended and restated (21) | |
10.16 | 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 (11) |
10.17 | Relocation Management Agreement between the Registrant and Cendant Mobility Services Corporation dated April 6, 2004 (18) | |
10.18 | 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) | |
10.19 | Form of 4.87% Senior Note due May 15, 2010 (7) | |
10.20 | Form of 5.47% Senior Note due May 15, 2013 (7) | |
10.21* | Watts Water Technologies, Inc. 2004 Stock Incentive Plan (17) | |
10.22* | Non-Employee Director Compensation Arrangements (21) | |
10.23* | Watts Water Technologies, Inc. Supplemental Employees Retirement Plan as Amended and Restated Effective May 4, 2004 (19) | |
10.24* | Form of Incentive Stock Option Agreement under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (20) | |
10.25* | Form of Non-Qualified Stock Option Agreement under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (20) | |
10.26* | Form of Restricted Stock Award Agreement for Employees under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (20) | |
10.27* | Form of Restricted Stock Award Agreement for Employees under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (20) | |
10.28* | Form of Restricted Stock Award Agreement for Non-Employee Directors under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (20) | |
11 | Statement Regarding Computation of Earnings per Common Share (13) | |
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 1350 |
(1) Incorporated by reference to the Registrant’s Registration Statement on Form S-3 (No. 333-105989) filed with the Securities and Exchange Commission on June 10, 2003.
(2) Incorporated by reference to the Registrant’s Current Report Form 8-K dated November 14, 1991 (File No. 001-11499).
(3) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002 (File No. 001-11499).
(4) Incorporated by reference to the Registrant’s Form S-1 (No. 33-6515) dated June 17, 1986.
(5) Incorporated by reference to the Registrant’s Form S-1 (No. 33-6515) as part of the Second Amendment to such Form S-1 dated August 21, 1986.
(6) Incorporated by reference to Amendment No. 1 to the Registrant’s Annual Report on Form 10-K for year ended June 30, 1992 (File No. 001-11499).
(7) Incorporated by reference to the Registrant’s Current Report on Form 8-K dated May 15, 2003 (File No. 001-11499).
(8) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended June 30, 1995 (File No. 001-11499).
(9) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended June 30, 1996 (File No. 001-11499).
(10) Incorporated by reference to the Registrant’s Form S-8 (No. 333-32685) dated August 1, 1997.
(11) Incorporated by reference to the Registrant’s Current Report on Form 8-K dated September 4, 1996 (File No. 001- 11499).
(12) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended June 30, 1997(File No. 001- 11499).
(13) Incorporated by reference to notes to Consolidated Financial Statements, Note 2 of this Report.
(14) Incorporated by reference to the Registrant’s Current Report on Form 8-K dated December 28, 2005 (File No. 001-11499). The Registrant hereby agrees to furnish supplementally a copy of any omitted schedule or similar attachment to this agreement to the Securities and Exchange Commission upon its request.
(15) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended June 30, 1999 (File No. 001-11499).
(16) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for quarter ended September 30, 2000 (File No. 001-11499).
(17) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003 (File No. 001-11499).
(18) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 28, 2004 (File No. 001-11499).
(19) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 27, 2004 (File No. 001-11499).
(20) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 26, 2004 (File No. 001-11499).
(21) Incorporated by reference to the Registrant’s Current Report on Form 8-K dated February 8, 2005 (File No. 001-11499).
(22) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended July 3, 2005 (File No. 001-11499).
(23) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended October 2, 2005 (File No. 001-11499).
(24) Incorporated by reference to the Registrant’s Current Report on Form 8-K dated March 21, 2005 (File No. 001-11499).
* Management contract or compensatory plan or arrangement.
94