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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ýANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

Or

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

x                              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

or

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-11499001-11499

WATTS WATER TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

Delaware


(State or Other Jurisdiction of
Incorporation or Organization)

04-2916536


(I.R.S. Employer
Identification No.)

(State of incorporation)

(I.R.S. Employer Identification No.)


815 Chestnut Street, North Andover, MA

01845


(Address of principal executive offices)

Principal Executive Offices)



01845
(Zip Code)


Registrant's telephone number, including area code:(978) 688-1811

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class


Name of Each Exchange on Which Registered

Class A Common Stock, par value $0.10 per shareNew York Stock Exchange

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 ý    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 ý

Indicate by check mark whether the Registrantregistrant (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 Registrantregistrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes xý    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’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. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filerýAccelerated filero

Non-accelerated filero


Smaller reporting companyo

(Do not check if a smaller reporting company)

        Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes xo    No oý

Aggregate        As of June 29, 2007, the aggregate market value of the votingregistrant's common stock of the Registrant held by non-affiliates of the Registrantregistrant was approximately $1,170,291,367 based on June 27, 2004 was $671,448,689.the closing sale price as reported on the New York Stock Exchange.

As        Indicate the number of February 25, 2005, 25,075,840 shares outstanding of Class A Common Stock, $.10 par value, 7,343,880 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, 2008
Class A Common Stock, $0.10 par value per share29,272,927 shares
Class B Common Stock, $0.10 par value per share7,293,880 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 4, 2005,14, 2008, are incorporated by reference into Part III of this Annual Report on Form 10-K.







PART I


Item 1.    BUSINESSBUSINESS..

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, except as required by law, we undertake no obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.

In this annual report on Form 10-K, references to “the"the Company,” “Watts”, “we”, “us”" "Watts," "we," "us" or “our”"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 19th 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 of the people using it. The CompanyWatts Water Technologies, Inc. was incorporated in Delaware in 1985.1985 and became the parent Company of Watts 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.Europe with an emerging presence in China. Our primary objective is to grow earnings by increasing sales within existing markets, expanding into new markets, leveraging our distribution channels and customer base, making selected acquisitions, and reducing manufacturing costs.costs and advocating for the development and enforcement of industry standards.

        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 continuouslycontinually improving merchandising in both the do-it-yourself (DIY) and wholesale distribution channels. We alsocontinually target selected new product and geographic markets based on growth potential, and intendincluding our ability to continue to introduceleverage our existing distribution channels. Additionally, we continually leverage our distribution channels through the introduction of new products, appropriate for these new markets.as well as the integration of products of our acquired companies.

        We intend to continue to generate additional growth throughby targeting selected acquisitions, both in our core markets as well as in new complementary markets. Lastly, weWe have completed 31 acquisitions since divesting our industrial and oil and gas business in 1999, including one acquisition in 2007 and five acquisitions in 2006. 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 complementary 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, strong brand names, a new or improved technology or an expansion of the breadth of our Water by Watts offering.


        We are committed to reducing our manufacturing costs through a combination of expanding manufacturing in lower-cost countries and consolidating our diverse manufacturing operations in North America and Europe. We have acquired a number of manufacturing facilities in lower-cost regions such as China, Bulgaria and Tunisia. In 2007, we announced a global restructuring plan to reduce our manufacturing footprint in order to reduce our costs and to realize additional operating efficiencies.

Our products are sold to wholesale distributors, major DIY chains and original equipment manufacturers (OEMs). Most of our sales are for products that have been approved under regulatory standards incorporated into state and municipal plumbing, heating, building and fire protection codes in North America and Europe. We have consistently advocate foradvocated 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 facilitiesThese codes serve as a competitive barrier to entry by requiring that products sold in order to manufacture products in compliance with code requirements.select states meet stringent criteria.


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 Acquisitions

We have completed        On November 9, 2007, we acquired the following acquisitions sinceassets and business of Topway Global Inc. (Topway) located in Brea, California for approximately $18.4 million, of which $0.3 million of transaction costs remain to be paid. The preliminary allocations for goodwill and intangible assets are approximately $7.6 million and $8.2 million, respectively. The amount recorded as intangible assets is primarily for customer relationships with an estimated useful life of 10 years and trade names with indefinite lives. Topway manufactures a wide variety of water softeners, point of entry filter units, and point of use drinking water systems for residential, commercial and industrial applications. The purchase price allocation for Topway is preliminary pending the beginningfinal determination of 2005:the fair values of certain assumed assets and liabilities.

On January 5, 2005,August 14, 2006, we acquired 100% of the outstanding stock of HF Scientific, Inc.,Black Teknigas, Limited (Teknigas) located in Fort Myers, FloridaSt. Neots, United Kingdom for approximately $7.0$8.7 million, inwhich is net of cash plus $0.8acquired of approximately $0.3 million. The allocations for goodwill and intangible assets are approximately $3.6 million in assumed debt. HF Scientificand $4.5 million, respectively. The amount recorded as intangible assets is primarily for technology and customer relationships that have estimated useful lives ranging from 6 to 9 years and trade names with indefinite lives. Teknigas designs, develops and 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 Sea Tech, Inc. located in Wilmington, North Carolina for approximately $10.0 million in cash. Sea Tech provides cost effective solutions for fluidic connection needs. Sea Tech offers a wide range of standardgas control products and custom quick connect fittings, valvessystems for combustion, industrial, medical, laboratory and manifolds and pex tubing designed to address specific customer requirements.specialty gas.

We completed the following acquisitions during 2004:

On September 28, 2004, we increased our ownership percentage in Watts Stern Rubinetti, S.r.l. (Stern Rubinetti) located in Brescia, Italy from 51% to 85%. The price paid to the minority shareholders for this additional 34% was approximately $0.8 million in cash. We have a call option to acquire the remaining 15% from the minority shareholders for approximately $0.4 million, which became exercisable on January 1, 2005. We anticipate exercising this option in the second quarter of 2005. Stern Rubinetti is an Italian manufacturing company which produces brass components.

On May 21, 2004,June 7, 2006, we acquired 100% of the outstanding stock of McCoy Enterprises, Inc., which we subsequently renamed Orion Enterprises, Inc. (Orion),Kim Olofsson Safe Corporation AB (KimSafe) located in Kansas City, Kansas,Almhult, Sweden for approximately $27.9$5.8 million, in cash. Orion distributes its products underwhich is net of cash acquired of approximately $2.9 million. The allocations for goodwill and intangible assets are approximately $1.2 million and $4.1 million, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated useful lives of 5 years and trade names with indefinite lives. KimSafe manufactures electronic controls for heat pump, solar and pellet heaters, which provide the brand names of Orion, Flo Safe and Laboratory Enterprises. Orion’s product lines includes a complete line of acid resistant waste disposal products, double containment piping systems, as well as a line of high purity pipes, fittings and faucets.ability to heat water using renewable energy.

On April 16, 2004,June 2, 2006, we acquired 90%the assets and business of Calflex Manufacturing, Inc. (Calflex) located in Vernon, California and the stock of TEAM Precision Pipework, Ltd. (TEAM),Ningo Best Metal & Plastic Manufacturing, Ltd (Ningbo) located in Ammanford, West Wales, United Kingdom,Ningbo, China for an aggregate of approximately $6.3 million. The allocation for intangible assets is approximately $2.1 million. The amount recorded as intangible assets is primarily for customer relationships that have estimated useful lives of 12 years and trade names with indefinite lives. Calflex and Ningbo distribute and manufacture water connectors.


        On May 19, 2006, we acquired 100% of the outstanding stock of ATS Expansion Group (ATS) located in Sorgues, Grenoble and Hautvillers, France for approximately $17.2$62.1 million, inwhich is net of cash subjectacquired of approximately $5.7 million plus assumed debt of approximately $14.1 million. The allocations for goodwill and intangible assets are approximately $33.6 million and $25.6 million, respectively. The amount recorded as intangible assets is primarily for customer relationships with estimated useful lives of 6 years, patents with estimated useful lives from 6 to final adjustments, if any, as stipulated in the purchase12 years and sale agreement. TEAM custom designstrade names with indefinite lives. ATS' products include a broad range of fittings, valves and manufactures manipulated pipemanifolds for water, gas and hose tubing assemblies, which are utilized in the heating ventilationapplications and air conditioning markets. TEAM is a supplier to major OEM’s of air conditioning systems and several of the major European automotive air conditioning manufacturers.stainless steel flexible hoses.

On March 29, 2004,April 26, 2006, we acquired the 40% equity interestassets and business of Changsha Valve Works (Changsha) located in Taizhou Shida Plumbing Manufacturing Co., Ltd. (Shida) that had been held by our former joint venture partnerChangsha, China for approximately $3.0$9.2 million. The allocations for goodwill and intangible assets are approximately $5.7 million and $3.7 million, respectively. The amount recorded as intangible assets is primarily for non-compete agreements that have estimated useful lives of 10 years and customer order backlog with an estimated useful life of 1 year. Changsha 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 cash and the payment of $3.5 million in cash in connection with a know-how transfer and non-compete agreement. We now own 100% of Shida.China.

On January 5, 2004, we acquired substantially all of the assets of Flowmatic Systems, Inc. (Flowmatic) located in Dunnellon, Florida, for approximately $16.8 million in cash. Flowmatic designs and distributes a complete line of high quality reverse osmosis components and filtration equipment. Flowmatic’s product line includes stainless steel and plastic housings, filter cartridges, storage tanks, control valves, as well as complete reverse osmosis systems for residential and commercial applications.


Products

We believe that we have the broadest product linesrange of products in terms of design distinction, size and configuration withinin a majority of theour principal product lines we manufacture and market.lines. In 2007, water quality products accounted for approximately 18% of our total sales. Our principal product lines include:

·

    water quality products, including backflow preventers and check valves for preventing contamination of potable water caused by reverse flow within water supply lines and fire protection systems;

    ·systems and point-of-use water filtration and reverse osmosis systems for both commercial and residential applications;

    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 and hydraulic pump groups for gas boiler manufacturers.

    manufacturers and renewable energy applications, including solar and heat pump control packages;

    flexible stainless steel connectors for natural and liquid propane gas in commercial food service and residential applications; and

    large diameter butterfly valves for use in China's water infrastructure.

Customers and Markets

We sell our products to plumbing, heating and mechanical wholesale distributors, major DIY chains and OEMs.

        Wholesalers.Wholesalers.    Approximately 63%65% of our sales in 2004both 2007 and 20032006 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.DIY.    Approximately 18%15% and 19%16% of our sales in 20042007 and 2003,2006, respectively, were to DIY customers in North America.customers. 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


        OEMs.    Approximately 20% and successful merchandising efforts and the expansion of the market with the large national chains.

OEMs.   Approximately 19% and 18% of our sales in 20042007 and 2003,2006, respectively, were to OEMs in both North America and Europe.OEMs. 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 sales to OEMs in China are primarily to boiler and bath manufacturers, which include manufacturers of faucet and shower products.

        In 2007, no customer accounted for more than 10% of our total net sales. Our largest customer, The Home Depot, Inc.,top ten customers accounted for approximately $81.3$304.3 million, or 9.9%22%, of our total net sales in 20042007 and $74.8$282.3 million, or 10.7%23%, of our total net sales in 2003. Our top ten customers accounted for approximately $198.5 million, or 24.1%, of our total net sales in 2004 and $176.3 million, or 25.1%, of our total net sales in 2003.2006. Thousands of other customers comprisedconstituted the remaining 75.9%78% of our net sales in 20042007 and 74.9%77% of our net sales in 2003.2006.

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 plumbing and heating wholesalers. In addition, we sell products directly to certain large OEMs and private label accounts.

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.

Capital expenditures and depreciation and amortization for each of the last three years were as follows:

 

Years Ended December 31,

 

 Years Ended December 31,

 

2004

 

2003

 

2002

 

 2007
 2006
 2005

 

(in millions)

 

 (in millions)

Capital expenditures

 

$

21.0

 

$

20.0

 

$

19.6

 

 $37.8 $44.7 $18.6

Depreciation

 

$

28.1

 

$

21.3

 

$

22.3

 

 $28.9 $26.7 $23.5

        The Company's 2006 capital expenditures included approximately $18.0 million related to the purchase and subsequent sale-leaseback of a building in Italy.

Raw Materials

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 bronze, brass, cast iron, steel and crude oil. The price of copper has risen approximately 46% since December 31, 2003.certain raw materials, particularly copper. Bronze and brass are copper-based alloys. The spot price of copper based alloys. Sinceincreased approximately 41% from December 31, 2003, we have experienced cost increases in bronze and brass of approximately 48% and 39%, respectively. Since2005 to December 31, 2003, we have experienced cost increases in cast iron and steel of 10% and 16%, respectively. Additionally, due to the increase in crude oil, the costs of our certain plastic resins increased approximately 43% since December 31, 2003.2007. In response, to recent cost increases, we have implemented price increases for some of theour products whichthat have become more expensive to manufacture due to the increases in raw material costs. As a result of these priceDuring 2007 and 2006, cost increases we believe we have been successful in offsetting most, ifraw materials were not all, of thecompletely recovered by increased selling prices or other product cost increases.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 require 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 of Sanitary Engineers (A.S.S.E.), the University of Southern California Foundation for Cross-Connection Control (USC 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.). TheseMany of 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). Further, there are local regulatory standards 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 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 staff, 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 $9,942,000, $9,178,000$15.1 million, $12.7 million and $9,132,000$11.6 million for the years ended December 31, 2004, 20032007, 2006 and 2002,2005, 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. Due 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 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 $53.1approximately $119.1 million at February 18, 2005.15, 2008 and also was approximately $114.0 million at February 16, 2007. We do not believe that our backlog at any point in time is indicative of future operating results.

Employees

As of December 31, 2004,2007, our wholly ownedwholly-owned and majority ownedmajority-owned domestic and foreign operations employed approximately 5,7007,800 people. None of our employees in North America or China are covered by collective bargaining agreements. In some European countries our employees are subject to the traditional national collective bargaining agreements. We believe that our employee relations are good.


Available Information

We maintain a website with the addresswww.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 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 Stock Exchange on May 9, 2007 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 at least the past five years:


Name


Age


Position

Patrick S. O’Keefe

O'Keefe

52

55

Chief Executive Officer, President and Director


William C. McCartney


51


53



Chief Financial Officer Treasurer and Secretary

Treasurer


J. Dennis Cawte


54


57



Group Managing Director, Europe


Ernest E. Elliott


53


56



Executive Vice President of Wholesale Marketing

Paul A. Lacourciere


Michael P. Flanders



49


Corporate
Executive Vice President of Manufacturing

Operations, North America and Asia

Lynn A. McVay


Josh C. Fu


37


51



President, Asia


Gregory J. Michaud


46


Executive Vice President of Wholesale Sales

Human Resources

Jeffrey A. Polofsky


Taylor K. Robinson


46


44



Executive Vice President of Retail Sales and Marketing

Supply Chain Management


Lester J. Taufen


61


64



General Counsel, and Vice President of Legal Affairs

and Secretary


Douglas T. White


60


63



Group Vice President


Robert L. Ayers(1)(3)



62


Director

Richard J Carthcart(1)(3)


63


Director

Timothy P. Horne


66


69



Director


Ralph E. Jackson Jr.(1)(2)(3)


63


66



Director


Kenneth J. McAvoy

McAvoy(1)(3)


64


67



Director


John K. McGillicuddy(1)(2)(3)


61


64



Director


Gordon W. Moran(1)(2)Moran(2)(3)


66


69



Non-Executive Chairman of the Board and Director


Daniel J. Murphy, III(1)(2)(3)

III(2)


63


66



Director


(1)
Member of the Audit Committee



(2)
Member of the Compensation Committee



(3)
Member of the Nominating and Corporate Governance Committee

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 also held various senior management positions with Crane Co. from 1994 to 1997.


William C. McCartney joined 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.

J. Dennis Cawte joined 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, where his most recent position was the Managing Director Northern Europe, Middle East, Africa and India.

Ernest E. Elliott joined our Company in 1986 servingand has served in a variety of sales and marketing roles. He was appointed Vice President of Sales in 1991, andserved 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. Mr. Elliott temporarily assumed responsibilities of our former Chief Operating Officer and President of North American and Asian Operations in 1996.September 2007. Prior to joining our Company, he was Vice President of BTR Inc.’s's Valve Group, a diversified manufacturer of industrial and commercial valve products.

Michael P. FlandersPaul 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 1993-1995 and President from 1995-1997. In 1997 he was appointed Corporate Vice President of Manufacturing of our Company.

Lynn A. McVay joined our CompanyOctober 2007 as Executive Vice President of Wholesale SalesManufacturing Operations, North America and Asia. From August 2005 to July 2007, he served as President and Chief Operating Officer of Aavid Thermalloy, LLC, an international manufacturing company providing thermal management solutions to the computer and electronics industries. From July 2003 to April 2005, he was Vice President and General Manager of Waukesha Bearings Corporation, a manufacturer of hydrodynamic and active magnetic bearings and a subsidiary of Dover Corporation. From November 1998 to July 2003, he was General Manager of the LCN Division of Ingersoll-Rand Company Limited, which manufactured mechanical and electronic door control products.

Josh C. Fu joined our Company in March 2003.January 2008 as President, Asia. From January 2007 to December 2007, he served as President and Chief Executive Officer of Reradiant International Co. Ltd., a consulting firm focused on the energy and industrial goods industries. From August 2004 to December 2006, he served as President of the China operations of Flowserve Corporation, a global manufacturer of flow control equipment, including valves, pumps, and seals. From July 2003 to August 2004, he was Executive Vice President, Product Development and Merchandise Sourcing for Intercon Merchandise Sourcing, an importer of consumer goods from China. From 2000 to 2003, he held various senior management positions with the China operations of BP p.l.c., a worldwide petroleum and petrochemicals company.

Gregory J. Michaud joined our Company in April 2006 as Executive Vice President of Human Resources. Prior to joining our Company, he was theserved as Vice President, Human Resources of Salesthe Compact Equipment division of Ingersoll-Rand Company Limited, a diversified industrial company, from June 2003 through March 2006. He served as Vice President, Human Resources of the Productivity Solutions division of Ingersoll-Rand from January 2003 to June 2003 and Marketing for Little Giant Pump Company, a water pump manufacturing company and a wholly-owned subsidiaryas Director, Human Resources & Corporate Organizational Planning of Tecumseh Products Company,Ingersoll-Rand from 1997June 2000 to 2003.December 2002.

Taylor K. RobinsonJeffrey A. Polofsky joined our Company in October 1998September 2007 as the Vice President and General Manager of Anderson Barrows Metals Company. He was named Executive Vice President of Retail SalesSupply Chain Management. From January 2007 to August 2007, he owned and Marketing in January 2000. Prioroperated a consulting company named Global Supply Chain Solutions, which provided advice to joining our Company,international clients to improve their global supply chain methods and operations. From February 2004 to April 2006, he was employed at DesaChief Procurement Officer for H.J. Heinz Company, an international manufacturer and marketer of processed foods. From January 1999 to January 2004, he served in various positions for Honeywell International Inc., a manufacturerdiversified technology and manufacturing company, including Global Supply Chain Director, Aviation Aftermarket Services, Director of consumer hard goods, from 1988 to 1998.Global Sourcing, Aerospace Electronic Systems and Corporate Director of Global Commodity Management—Electronics.

Lester J. Taufen joined our Company in January 1999 as Associate Corporate Counsel. He was appointed General Counsel, and Vice President of Legal Affairs and Assistant Secretary in January 2000. 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. White joined our Company in September 2001 as Group Vice President. Prior to joining our Company he was employed by Honeywell International, Inc., a diversified technology and manufacturing company, as Vice President of Marketing—Consumer Products Group from 1998 to 2001.

Robert L. Ayers has served as a director of our Company since October 2006. He was Senior Vice President of ITT Industries and President of ITT Industries' Fluid Technology from October 1999 until September 2005. Mr. Ayers continued to be employed by ITT Industries from September 2005 until his retirement in September 2006, during which time he focused on special projects for the company. Mr. Ayers originally joined ITT Industries in 1998 as President of ITT Industries' Industrial Pump Group. Before joining ITT Industries, he was President of Sulzer Industrial USA and Chief Executive Officer of Sulzer Bingham, a pump manufacturer. He is a director of T-3 Energy Services, Inc.

Richard J. Cathcart has served as a director of our Company since October 2007. He was Vice Chairman and a member of the Board of Directors of Pentair, Inc. from February 2005 until his retirement in September 2007. Pentair is a diversified manufacturing company consisting of two operating segments: Water Technologies and Technical Products. He was appointed President and Chief Operating Officer of Pentair's Water Technologies Group in January 2001 and served in that capacity until his appointment as Vice Chairman in February 2005. He began his career at Pentair in March 1995 as Executive Vice President, Corporate Development, where he identified water as a strategic area of growth. In February 1996, he was named Executive Vice President and President of Pentair's Water Technologies Group. Prior to joining Pentair, he held several management and business development positions during his 20-year career with Honeywell International Inc. He is a director of Fluidra S.A.

Timothy P. Horne has served as a director of our Company since 1962. He became an employee of our Company in September 1959 and served as our President from 1976 to 1978, from 1994 to April 1997 and from October 1999 to August 2002. He served as 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 as an employee of our Company on December 31, 2002. Since his retirement, Mr. Hornehe has continued to serve our Company as a consultant.

Ralph E. Jackson, Jr. has served as a director of our Company since June 2004. He was employed byworked for Cooper Industries, Inc., a manufacturer of electrical products, from 1985 until his retirement in December 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 December 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.December 2003.

Kenneth J. McAvoy has served as a director of our Company since 1994. He was Controller of our Company from 1981 to 19861985 and Chief Financial Officer and Treasurer from 1986 to 1999. He also served the offices ofas 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.

John K. McGillicuddy has served as a director of our Company since May 2003. He 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 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 Directordirector 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.

Contingencies

James Jones Litigation

As previously disclosed, on        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 the Company. We formerly owned James Jones. The Relator filed under the 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”"defective" or “non-conforming”"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 and a Second Amended Complaint in December 2000, which brought the total number of plaintiffs to 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 the named cities have intervened, and attempts by four other named cities to intervene have been denied.

        In June 2002, the trial court excluded 47 cities from this December 2000 total of 161, but this exclusion was reversed by an August 30, 2006 California Court of Appeal ruling that is now final. This August 30, 2006 Court of Appeal ruling also reversed dismissals of Tyco International and Mueller Co., and this allowed the Relator to make a successful motion that removed the Armenta Case litigation from Judge Lichtman's court to the court of Judge Chaney, another complex litigation judge.

One of the allegations in the Second Amended Complaint and the Complaints-in-Intervention is that purchased non-conforming James Jones waterworks 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 and advertised ‘85'85 bronze alloy


(UNS (UNS No. C83600). This contention is based on the average difference of about 2% lead content between ‘81'81 bronze (6% to 8% lead) and ‘85'85 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. We believe the evidence and discovery available to date indicates that this is not the case.

In addition, ‘81'81 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”"lead free" under Section 1417 of the Federal Safe Drinking Water Act.

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. She 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’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 city of Los Angeles, by far the most significant city, for $7.3 million plus attorneys’attorneys' fees. Co-defendants contributed $2.0 million toward this settlement.


In August 2003, an additional settlement payment was made for $13$13.0 million ($1111.0 million from us and $2$2.0 million from James Jones), which settled the claims of the three Phase I cities (Santa Monica, San Francisco and East Bay Municipal Utility 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$13.0 million payment, we are obligated to pay the Relator’s attorney’sRelator's attorney's fees.

After the Phase I settlement, the courtCourt permitted the defendants to select five additional cities 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 then reached an agreement to settle the claims of the City of Santa Ana for a total of $45,000, an amount which approximates Santa Ana’sAna's purchases of James Jones products during the relevant period. The Santa Ana settlement was approved by the Court and then completed, andcompleted.

        On June 22, 2005, the trialCourt dismissed the claims of the remaining Phase II cities’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 unique, this ruling is significant for the claims of the remaining cities, and the Relator appealed. On June 29, 2007, the appellate court dismissed this appeal. However, this judgment can be appealed again at the conclusion of the entire case. The trial court has scheduled a trial on March 17, 2009 for six Phase III cities with three cities to be selected by each side. Litigation is presently scheduledinherently uncertain, and we are unable to predict the outcome of this case.

        On September 15, 2004, the Relator's attorneys filed a new common law fraud lawsuit in the California Superior Court for October 2005.the City of Banning and forty-six other cities and water districts against James Jones, Watts and Mueller Co. based on the same transactions alleged in the Armenta case. About forty-two of the plaintiffs in this new lawsuit are also plaintiffs in the Armenta case. The statute of limitations threshold issue is in the process of being resolved for these plaintiffs. Litigation is inherently uncertain, and we are unable to predict the outcome of this case.

We have a reserve of approximately $21$28.0 million with respect to the James Jones Litigation in our consolidated balance sheet as of December 31, 2004.2007. 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 Armenta 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 (the coverage case). James Jones filed a similar complaint, the cases were consolidated, and the trial court made summary adjudication rulings that Zurich must pay all reasonable defense costs incurred by us and James Jones in the Armenta case since April 23, 1998 as well as such future defense costs in the future until the end of the Armenta case. In JulyAugust 2004, the California Court of Appeal affirmed these rulings, and, on December 1, 2004, the California Supreme Court denied Zurich’sZurich's appeal of this decision. This denial permanently established Zurich’sZurich's obligation to pay Armenta defense costs for both us (about $13.8(approximately $16.6 million plus future costs) and James Jones (about $14.8(which we estimate to be $17.0 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        On November 22, 2002, the trial court madeentered a summary adjudication rulingorder that Zurich must indemnify and pay us and James Jones for amounts paid to settle with the City of Los Angeles. Zurich’sZurich's attempt to obtain appellate review of this order was denied, but Zurich will still be able to appeal this order at the end of the


coverage case. InOn August 6, 2004, the trial court made another summary adjudication ruling that Zurich must indemnify and pay Wattsus and James Jones for the $13$13.0 million paid to settle the claims of the Phase I cities described above. Zurich’sZurich'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 been makingnow made all of the payments required by these indemnity orders, weorders.

        On February 8, 2006, Zurich filed a motion to set aside as void the November 22, 2002 and August 6, 2004 summary adjudication indemnity payment orders. After this motion was denied, Zurich's appeal was also denied and the California Supreme Court denied Zurich's petition for review. We are currently unable to predict the finality of these indemnity payment orders since Zurich can also appeal them at the end of the coverage case. We have recorded reimbursed indemnity settlement amounts (but not reimbursed defense costs) as a liability pending court resolution of the indemnification matter as it relates to Zurich.

Zurich has asserted that all amounts (now approximately $47.5(which we estimate to be $56.0 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. However, managementWe believe the Armenta case should be viewed as one occurrence and counsel anticipatethe 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 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 appealed this ruling. On October 20, 2006, the United States Court of Appeals for the Seventh Circuit affirmed that an arbitration panel could decide which deductible agreements between Zurich and us would control Zurich's reimbursement claim for defense costs paid in the James Jones case. As a result of this development, we will ultimately prevail on this reimbursement issue with Zurich.recorded a pre-tax charge of $5.0 million to discontinued operations in 2006.

Based on management’smanagement's assessment, we do not believe that the ultimate outcome of the James Jones Litigation 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 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 Litigation.

Environmental Remediation

We have been named as a potentially responsible party (PRP) with respect to a limited number of identified contaminated sites, including a site in Babylon, New York.sites. The levels of contamination vary 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. WeAt December 31, 2007, we have a reserve of approximately $1.4 million (environmental accrual), which we estimate 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 matters will have a material adverse effect on our liquidity, financial condition or results of operations. Some of our environmental matters are inherently uncertain and there exists a possibility that we may ultimately incur losses from these matters in excess of the amount accrued. However, we cannot currently estimate the amount of any such additional losses.


Asbestos Litigation

We are defending approximately 161100 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 as a source of asbestos exposure. To date, we have been dismissed from each case when the scheduled trial date comes 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 us by North Carolina Hospitality Group, Inc. in the Circuit Court of Maryland, Prince George’s County. It alleges that certain commercial valve models contain a design defect that causes them to fail prematurely. On 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 year, and it is now being briefed in the appellate court. 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.

12




Item 2.   1A.    PROPERTIES.RISK FACTORS.

As of December 31, 2004, we maintained 50 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 28 manufacturing facilities located in North America, 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 our joint venture located in Tianjin, China, which is leased with a remaining term of approximately 20 years, the land on which our manufacturing facilities are located in Taizhou, China and Tianjin China, with remaining terms of 48 years and 47 years, respectively, and except for the following facilities, each of which is leased:

Type of Facility

Location

Lease Expiration

Manufacturing

Springfield, MO

2014

Manufacturing

Phoenix, AZ

2010

Manufacturing

Woodland, CA

2008

Manufacturing

Houston, TX

2009

Manufacturing

Santa Ana, CA

2008

Warehouse

Reno, NV

2009

Warehouse

Dallas, TX

2006

Warehouse

Alsip, IL

2008

Warehouse

Atlanta, GA

2005

Warehouse

Palmdale, CA

2006

Warehouse

Kansas City, KS

2005

Sales Office

Sacramento, CA

2009

Sales Office

Kennesaw, GA

2007

Sales Office

Des Plaines, IL

2005

Manufacturing

Rosieres, France

2015

Manufacturing

Monastir, Tunisia

2005

Manufacturing

Neuenburg am Rhein, Germany

2011

Sales/Distribution

Barcelona, Spain

2009

Sales/Distribution

Evesham, UK

2016

Sales/Distribution

Molndal, Sweden

2007

Sales/Distribution

Gliwice, Poland

(1

)

Sales/Distribution

Kiev, Ukraine

(1

)

Sales/Distribution

Moscow, Russia

(1

)

Sales/Distribution

Vilnius, Lithuania

(1

)

Sales/Distribution

Wingene, Belgium

(2

)

Sales/Distribution

Chartres, France

2006

Sales/Distribution

Calgary, Canada

2006

Sales/Distribution

Worcestershire, U.K.

2005


(1)          We operate in this facility pursuant to a month-to-month lease.

(2)          We operate in this facility pursuant to a lease with an indefinite term that may be terminated by either party upon six months notice.

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 2005 at these plants. This utilization is subject to change as a result of increases or decreases in sales.

Item 3.   LEGAL PROCEEDINGS.

Item 3(a).

We are from time to time involved in various legal and administrative procedures. See Part I, Item 1, “Business—Product Liability, Environmental and Other Litigation Matters.”

Item 3(b).

See Part I, Item 1, “Business—Product Liability, Environmental and Other Litigation Matters.”

Item 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

There were no matters submitted during the fourth quarter of the fiscal year covered by this Annual Report to a vote of security holders through solicitation of proxies or otherwise.

14




PART II

Item 5.   MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

The following table sets forth the high and low closing sales prices of our Class A Common Stock on the New York Stock Exchange during 2004 and 2003 and cash dividends paid per share.

 

 

2004

 

2003

 

 

 

High

 

Low

 

Dividend

 

High

 

Low

 

Dividend

 

First Quarter

 

$

24.10

 

$

21.42

 

 

$

0.07

 

 

$

16.75

 

$

13.53

 

 

$

0.06

 

 

Second Quarter

 

27.03

 

22.80

 

 

0.07

 

 

19.00

 

15.40

 

 

0.06

 

 

Third Quarter

 

27.00

 

24.63

 

 

0.07

 

 

19.55

 

17.27

 

 

0.06

 

 

Fourth Quarter

 

32.24

 

25.00

 

 

0.07

 

 

22.50

 

17.48

 

 

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 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 2004 and 2003 were $9,071,000 and $6,859,000, 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 25, 2005 was 131. The number of record holders of our Class B Common Stock as of February 25, 2005 was 8.


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
12/31/04(1)(2)(3)(7)

 

Year
Ended
12/31/03(3)(4)(7)

 

Year
Ended
12/31/02(5)

 

Year
Ended
12/31/01(6)

 

Year
Ended
12/31/00(7)

 

Selected Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 

$

824,558

 

 

 

$

701,859

 

 

$

615,526

 

$

548,940

 

$

516,100

 

Income from continuing operations

 

 

48,738

 

 

 

36,419

 

 

32,622

 

26,556

 

31,171

 

Loss from discontinued operations, net of taxes

 

 

(1,918

)

 

 

(3,057

)

 

 

 

(7,170

)

Net income

 

 

46,820

 

 

 

33,362

 

 

32,622

 

26,556

 

24,001

 

Total assets

 

 

924,248

 

 

 

840,918

 

 

635,472

 

520,470

 

482,025

 

Long-term debt, net of current portion

 

 

180,562

 

 

 

179,061

 

 

56,276

 

123,212

 

105,377

 

Income per share from continuing operations—diluted

 

 

1.49

 

 

 

1.32

 

 

1.21

 

0.99

 

1.17

 

Income (loss) per share from discontinued operations—diluted

 

 

(0.06

)

 

 

(0.11

)

 

 

 

(0.27

)

Net income per share—diluted

 

 

1.43

 

 

 

1.21

 

 

1.21

 

0.99

 

0.90

 

Cash dividends declared per common share

 

 

$

0.28

 

 

 

$

0.25

 

 

$

0.24

 

$

0.24

 

$

0.268

 


(1)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 a charge of $3,475,000 related to a contingent earn-out agreement and $724,000 of other income for various accrual adjustments and $462,000 recorded as an income tax benefit.

(2)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.

(3)In December 2004, we decided to divest our interest in our minority owned subsidiary, Jameco International, LLC (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 are the net of tax operating results of LLC of $54,000 of loss and $54,000 of income for the year ended December 31, 2004 and 2003, respectively.

(4)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.


(5)          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.

(6)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.

(7)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 2004, 2003 and 2000 relate to legal and settlement costs associated with the James Jones Litigation. The loss, net of taxes, consists of $1,125,000, $3,111,000 and $7,170,000 for the years ended December 31, 2004, 2003 and 2000, respectively.

17




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 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; and

·       systems for under-floor radiant applications and hydraulic pump groups for gas boiler manufacturers.

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. Non-residential and commercial construction starts have an impact on our levels of sales and earnings. In 2004, organic sales in North America increased in both our wholesale and DIY markets by approximately 10% over the prior year. Also in 2004, organic sales in Europe increased by approximately 4% 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. In 2004, our consolidated sales increased 17% over the prior year of which approximately 3% was primarily due to the euro appreciating against 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 eighteen 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 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 2004, sales from acquisitions contributed approximately 5% 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 bronze, brass, cast iron, steel and crude oil. The price of copper has risen approximately 46% since December 31, 2003. Bronze and brass are copper based alloys. Since December 31, 2003, we have experienced cost increases in bronze and brass of approximately 48% and 39%, respectively. Since December 31, 2003, we have experienced cost increases in cast iron and steel of 10% and 16%, respectively. Additionally, due to the increase in crude oil, the costs of our certain plastic resins increased approximately 43% since December 31, 2003.

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 increases for some of the products which have become more expensive to manufacture due to the increases in raw material costs. As a result of these price increases we believe we have been successful in offsetting most, if not all, of the cost increases. 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.

Another 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 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 $21.0 million in 2004 and $20.0 million in 2003. 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 8, 2005, we declared a quarterly dividend of $0.08 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.

On January 5, 2005, we acquired HF Scientific, Inc. located in Fort Myers, Florida, in a stock purchase transaction, for approximately $7.0 million in cash plus $0.8 million in assumed debt. HF Scientific 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 Sea Tech, Inc. located in Wilmington, North Carolina in an asset purchase transaction, for approximately $10.0 million in cash. Sea Tech provides cost effective solutions for fluidic connection needs. Sea Tech offers a wide range of standard and custom quick connect fittings, valves and manifolds and pex tubing designed to address specific customer requirements.

In the fourth quarter of 2004, we planned to divest our interest in a minority owned subsidiary, Jameco International, LLC (LLC).  We recorded an impairment charge in discontinued operations to write down the investment to estimated fair value. Prior periods reflect LLC as discontinued operations. We expect to divest our interest in LLC in the first half of 2005.

Results of Operations

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 impacted 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. We estimate that we will record an additional after-tax charge of approximately $900,000, or ($0.03) per share, for the nine months ending October 2, 2005.

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
December 31, 2004

 

Year Ended
December 31, 2003

 

 

 

% Change to
Consolidated

 

 

 

Net Sales

 

% Sales

 

Net Sales

 

% Sales

 

Change

 

Net Sales

 

 

 

(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
As a % of Consolidated Net Sales

 

Change
As a % of Segment Net Sales

 

 

 

North
America

 

Europe

 

China

 

Total

 

North
America

 

Europe

 

China

 

Total

 

North
America

 

Europe

 

China

 

 

 

(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 wholesale market for 2004, excluding the sales from the acquisitions of Orion and Flowmatic, 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—Restructuring

 

 

(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 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.   Selling, general and administrative expense, or SG&A expense, for 2004 increased $37,428,000, or 22.1%, compared to 2003. The increase in SG&A expense 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 expense is primarily due to increased variable selling expense due to increased sales volume and costs incurred to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (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, as we expect these costs to move relative to our sales volume. 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 expense of $4,926,000.

Our SG&A expense as a percent 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

 

 

 

(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
America

 

Europe

 

China

 

Corp.

 

Total

 

North
America

 

Europe

 

China

 

Corp.

 

Total

 

North
America

 

Europe

 

China

 

Corp.

 

 

 

(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 increased gross profit in the wholesale market, benefits resulting from our completed manufacturing restructuring projects and outsourcing, partially offset by increased net SG&A expense. In 2004, we experienced raw material cost increases, which we have been able to recover by implementing price increases on some of our products. 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 expense. For 2004, we did not record any costs associated with our manufacturing restructuring plan compared to $906,000 for 2003. We expect to record and additional $625,000 in the first half of 2005 for approved costs associated with our manufacturing restructuring plan. 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.

23




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 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 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 83¤8% notes on December 1, 2003. On May 15, 2003, we refinanced our $75,000,000 83¤8% 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 variable rate from the revolving credit facility, which is three month EURIBOR plus 0.7%, for a fixed rate of 2.3%. For 2004, the EURIBOR rate has not fluctuated 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.

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 LLC.


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, 2003

 

Year Ended
December 31, 2002

 

 

 

% Change to
Consolidated

 

 

 

Net Sales

 

% Sales

 

Net Sales

 

% Sales

 

Change

 

Net Sales

 

 

 

(in thousands)

 

North America

 

 

$

472,518

 

 

 

67.3

%

 

$

450,233

 

 

73.1

%

 

$

22,285

 

 

3.6

%

 

Europe

 

 

210,614

 

 

 

30.0

 

 

145,629

 

 

23.7

 

 

64,985

 

 

10.6

 

 

China

 

 

18,727

 

 

 

2.7

 

 

19,664

 

 

3.2

 

 

(937

)

 

(0.2

)

 

Total

 

 

$

701,859

 

 

 

100

%

 

$

615,526

 

 

100

%

 

$

86,333

 

 

14.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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% and the appreciation of the Canadian dollar against the U.S. dollar, which accounted for $3,904,000, or 0.6%. 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. An 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.

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 (now a wholly-owned subsidiary), which we established on March 5, 2002, of approximately $2,636,000.

Gross Profit.   Gross profit for 2003 increased $31,145,000, or 14.9%, compared to 2002. This increase is primarily due to internal growth of $12,006,000, 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 and a reduction of restructuring and other charges of $2,103,000 in 2003 compared to 2002. Excluding the costs of restructuring for both periods, gross profits would have increased $29,042,000, or 13.7%. 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 $18,885,000, or 12.5%, 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 which accounted for $3,564,000 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.

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

 

 

$

64,375

 

 

$

55,313

 

$

9,062

 

Europe

 

 

22,592

 

 

13,608

 

8,984

 

China

 

 

(3,834

)

 

(625

)

(3,209

)

Corporate

 

 

(13,132

)

 

(10,767

)

(2,365

)

Total

 

 

$

70,001

 

 

$

57,529

 

$

12,472

 

The increase in operating income in North America in 2003 compared to 2002 is primarily due to internal growth of $6,753,000, a reduction of restructuring and other charges of $1,691,000 and the appreciation of the Canadian dollar against the U.S. dollar, which accounted for $618,000 of the increase. 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 customers 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.

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.

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 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.

Interest Expense.   Interest expense increased $3,416,000, or 39.3%, 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 $3,797,000, or 11.6%, to $36,419,000 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.

Loss From Discontinued Operations.   We recorded a charge net of tax to discontinued operations for 2003 of $3,057,000, 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. See Part I, Item 1, “Business—Product Liability, Environmental and other Litigation Matters”. In addition we 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. Additionally, losses from discontinued operations for 2003 include income of $54,000, or $0.00 per share, respectively, for the planned divesture of our interest in LLC.

Liquidity and Capital Resources

We generated $40,210,000 of cash from continuing operations from 2004. We experienced an increase in inventory in North America and China. The North America increase is primarily due to planned increases in finished goods as we set up additional distribution centers and a lengthened supply chain as we are producing more products abroad and increased sales volume. In addition, due to the cost increases in certain raw materials, our 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 a decrease in Europe. The North America increase is primarily due to increased sales volume and timing of certain cash receipts from certain large customers.

We used $111,379,000 of net cash for 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 have 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.

On September 23, 2004, we entered into an unsecured revolving credit facility with a syndicate of banks (the Revolving Credit Facility). The Revolving Credit Facility provides for multi-currency borrowings of up to $300,000,000, including stand-by letters of credit, and expires in September 2009. The Revolving Credit Facility is being used to support our acquisition program, working capital requirements and for general corporate purposes. As of December 31, 2004, long-term debt included $49,414,000 outstanding on the Revolving Credit Facility for euro-based borrowings and no amounts were outstanding for U.S. dollar borrowings. We had $218,445,000 of unused and potentially available revolving credit at December 31, 2004.

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 ..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.” As of December 31, 2004, the average interest rate for borrowings under the Revolving Credit Facility was approximately 2.8%. Effective September 23, 2004, we used funds from the Revolving Credit Facility to pay off the existing debt 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, 2004, 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 outstanding under our prior revolving credit facility. We swapped the variable rate from the Revolving Credit Facility that is three month EURIBOR plus 0.7% for a fixed rate of 2.3%. 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 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. Amounts recorded have been immaterial at December 31, 2004 and 2003.

We generated $6,553,000 of net cash from discontinued operations, net of the impact of deferred taxes, for 2004. We received $11,723,000 in cash for a contested reimbursement of a partial settlement including interest and $469,000 in cash for a contested reimbursement for settlement costs we incurred in the James Jones case. This cash has been recorded as a liability at December 31, 2004 because of the possibility that we may be required to reimburse the insurance company if it is ultimately successful with a future appeal. We also received $874,000 in cash for reimbursement of defense costs related to the James Jones case. We paid $2,094,000 for defense costs and $1,071,000 for indemnity costs we incurred in the James Jones case.


Working capital (defined as current assets less current liabilities) as of December 31, 2004 was $300,506,000 compared to $308,258,000 as of December 31, 2003. The ratio of current assets to current liabilities was 2.5 to 1 as of December 31, 2004 compared to 2.8 to 1 as of December 31, 2003. Cash and cash equivalents were $65,913,000 as of December 31, 2004 compared to $145,001,000 as of December 31, 2003. This decrease in cash was primarily due to cash paid for acquisitions, increased working capital requirements, increased investment securities and capital expenditures.

We had positive free cash flow of $12,283,000 (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, 2004 versus positive free cash flow of $27,179,000 in the comparable prior year period. This decrease in 2004 compared to 2003 was primarily due to increased inventories, increased accounts receivable and increased dividends partially offset by increases in accrued expenses. 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-bearing liabilities less cash and cash equivalents plus total stockholders equity, including minority interest) increased to 19.3% for 2004 from 9.3% for 2003. The increase resulted from a decrease in cash due to acquisitions and other working capital requirements in 2004. In 2003 we had additional cash due to the proceeds from our December 2003 stock offering.

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 provided by 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.

A reconciliation of free cash flow to net cash provided by continuing operations is provided below:

 

 

Years Ended December 31,

 

 

 

2004

 

2003

 

2002

 

 

 

(in thousands)

 

Net cash provided by continuing operations

 

 

$

40,210

 

 

$

52,303

 

$

51,425

 

Less: additions to property, plant, and equipment

 

 

(20,999

)

 

(20,030

)

(19,593

)

Plus: proceeds from the sale of property, plant, and equipment

 

 

2,143

 

 

1,765

 

3,194

 

Less: dividends

 

 

(9,071

)

 

(6,859

)

(6,490

)

Free cash flow

 

 

$

12,283

 

 

$

27,179

 

$

28,536

 

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,

 

 

 

2004

 

2003

 

 

 

(in thousands)

 

Current portion of long-term debt

 

$

4,981

 

$

11,689

 

Plus: long-term debt, net of current portion

 

180,562

 

179,061

 

Less: cash and cash equivalents

 

(65,913

)

(145,001

)

Net debt

 

$

119,630

 

$

45,749

 

A reconciliation of capitalization is provided below:

 

 

December 31,

 

 

 

2004

 

2003

 

 

 

(in thousands)

 

Net debt

 

 

$

119,630

 

 

$

45,749

 

Total stockholders’ equity

 

 

492,788

 

 

436,391

 

Plus: minority interest

 

 

7,515

 

 

9,767

 

Capitalization

 

 

$

619,933

 

 

$

491,907

 

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 next 12 months. However, we may have to consider external sources of financing for any large future acquisitions.

Our long-term contractual obligations as of December 31, 2004 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)

 

 

$

185,543

 

 

 

$

4,981

 

 

$

4,706

 

$

50,354

 

$

125,502

 

Operating lease obligations

 

 

21,208

 

 

 

3,466

 

 

5,770

 

4,319

 

7,653

 

Capital lease obligations(a)

 

 

1,404

 

 

 

672

 

 

671

 

61

 

 

Earn-out payout(b)

 

 

7,200

 

 

 

7,200

 

 

 

 

 

Pension contribution

 

 

1,700

 

 

 

1,700

 

 

 

 

 

Other(c)

 

 

11,271

 

 

 

11,157

 

 

114

 

 

 

Total

 

 

$

228,326

 

 

 

$

29,176

 

 

$

11,261

 

$

54,734

 

$

133,155

 


(a)          as recognized in the consolidated balance sheet

(b)includes $5,650,000 recognized in the consolidated balance sheet

(c)includes commodity and capital expenditure commitments at December 31, 2004

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 $42,570,000 as of December 31, 2004 and $29,880,000 as of December 31, 2003. 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 insurance coverage. These instruments may exist or expire without being drawn down therefore, they do not necessarily represent future cash flow obligations.

30




We own a 20% interest in Plumworld.co.uk Ltd, 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 annualized sales are approximately $11,000,000. We have a nominal investment of approximately $500 in Plumbworld and maintain a loan receivable in the amount of approximately $890,000 with 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 2004.

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 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, 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. We perform our annual test for indications of goodwill impairment on the last day of our fiscal October, which was October 24 for fiscal 2004.

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 determined by an independent valuation firm based on estimates and judgments regarding expectations of the success and life cycle of products and technology acquired.

It has been three years since adoption of FAS 142, and for all years 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. 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 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 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 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.

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 continuouslycontinually 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 aretypically do not currently party to anyenter into 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. TheDuring 2006 and continuing through 2007, the costs of many of these raw materials arewere at the highest levels that they have been in many years. We may continue to experience further cost increases of these materials. In 2006 and 2007, cost increases in raw materials were not completely recovered by increased selling prices or other product cost reductions. If we are not able to continue 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.

Down economic cycles, particularly reduced levels of residential 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 residential 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. The current conditions in the housing and debt markets have caused a reduction in residential and non-residential starts and renovation and remodeling. If these conditions continue or worsen in the future, our revenues and profits could decrease and could result in a material adverse effect on our financial condition and results of operations.

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 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. 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:

·

    inadequate internal controls over financial reporting and our ability to bring such controls into compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 in a timely manner;

    adverse short-term effects on our reported operating results;

    ·

    diversion of management’smanagement's attention;

    ·

    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.

Down economic cycles, particularly reduced levels        We maintain strict quality controls and procedures, including the testing of residentialraw materials and non-residential startssafety 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. We also cannot be certain that our suppliers will always eliminate latent defects in products we purchase from them. Accordingly, there is a risk that product defects will occur, which could require a product recall. Product recalls can be



expensive to implement and, remodeling,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 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 have an adverse effect onadversely affect our revenuesbusiness, financial condition and operating results.results of operations.

We face risks from product liability and other lawsuits, which may adversely affect our business.

We have experiencedbeen and expect to continue to experience fluctuations in revenues and operating results duebe subject to economic and business cycles. The businessesvarious 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 mostthe failure of our customers, particularly plumbingproducts. 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 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 residential 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. If these and other factors cause a material reduction in residential and non-residential and remodeling starts, our revenues and profits would decrease and result incould have a material adverse effect on our financial condition and results of operations.operations, liquidity and financial condition. 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 "Item 1. Business—Product Liability, Environmental and Other Litigation Matters."

Economic 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; and

    ·

    unexpected changes in regulatory requirements, which may be costly and require time to implement.


    Fluctuations in foreign exchange rates particularly the euro, could materially affect our reported results.

    We are exposed to fluctuations in foreign currencies, as a portion of our sales and certain portions of our costs, assets and liabilities are denominated in currencies other than U.S. dollars. Approximately 38.5%41.7% of our sales during the year ended December 31, 20042007 were from sales outside of the U.S. compared to 37.4%38.0% for the year ended December 31, 2003.2006. For the years ended December 31, 2004, 20032007 and 2002,2006, the appreciation of the euro against the U.S. dollar had a positive impact on sales of approximately $20.9 million, $31.1$34.1 million and $7.9$7.1 million, respectively. Additionally, our Canadian operations require significant amounts of U.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 and stated it would no longer tie the yuan to a fixed rate against the U.S. currency. The yuan was valued at 7.3 and 7.8 at December 31, 2007 and 2006, respectively. China also stated it will peg the yuan against numerous currencies, although it will keep the yuan in a tight band rather than letting it trade freely. The spot rate of the euro, Canadian dollar and yuan increased in value from December 31, 2006 to December 31, 2007 by approximately 12%, 16% and 6% respectively, against the U.S. dollar. If our share of revenue and purchases 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 risks in expanding our manufacturing operations and acquiring companies in China.

    As part of our strategy, we are shiftinghave shifted a portion of our manufacturing operations to China to reduce our production costs and to sell productproducts into the Chinese market. This shift will subjecthas subjected a greater portion of our operations to the risks of doing business in China. In addition, we have increased our participation in the Chinese water and power infrastructure markets with our acquisition of Changsha Valve Works. Changsha sells exclusively into the domestic Chinese marketplace. The increased 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 employees we may experience product quality issues. The Chinese central and local government authorities have a highhigher degree of control over our businessbusinesses in China than is customary in developed economiesmany of the countries in which we operate, and this makes the process of obtaining necessary regulatory approval in China inherently unpredictable. For instance, as announced in 2006, the local Chinese authorities in Tianjin, China informed us that property occupied by our TWT joint venture will be taken over by eminent domain by the end of the second quarter of 2008, and we have incurred significant costs in connection with the relocation of our operations there. 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.

    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,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. 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.operations.

    In addition, ourwe have an ongoing manufacturing restructuring plan, which we began in 2001, was initiatedprogram 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 expansionplant



    relocations 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,We have been named as a potentially responsible party or are otherwise conducting remedial activities with respect to a limited number of identified contaminated sites, including sites we currently own or operate. There can be no assurances that our ownership and operation of real property and our disposal of waste couldwill not lead to other 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 upclean-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—"Item 1. Business—Product Liability, Environmental and Other Litigation Matters."


    Third parties may infringe our intellectual property and we may expend 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 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 subject to various product liability claims or other lawsuits, including, among others that our products include inadequate or improper instructions for use or installation, or inadequate warnings concerning the effects of the failure of our products. In the event that we do not have adequate insurance or contractual indemnification, damages from these claims would have to be paid from our assets and could have a material adverse effect on our results of operations, liquidity and financial condition. In particular, if we settle or conclude litigation in a quarterly or annual reporting period, there could be a material impact on our operating results for that quarter or year. We, like other manufacturers and distributors of products designed to control and regulate fluids, face an inherent risk of exposure to product liability claims and other lawsuits in the event that the use of our products results in personal injury, property damage or business interruption to our customers. Although we maintain strict quality controls and procedures, including the testing of raw materials and safety testing of selected finished products, we cannot be certain that our products will be completely free from defect. In addition, in certain cases, we rely on third-party manufacturers for our products or components of our products. Although we have product liability and general insurance coverage, we cannot be certain that this insurance coverage will continue to be available to us at a reasonable cost, or, if available, will be adequate to cover any such liabilities. For more information, see Part I, Item 1, “Business—Product Liability, Environmental, and Other Litigation Matters.”

    The requirements of 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 and non-amortizable intangible assets, which would negatively impactaffect our operating results and financial condition.

    As of December 31, 2004,2007, we hadrecorded goodwill and non-amortizable intangible assets of $226.2$385.8 million or 24.5% of our total assets and 45.9% of our total stockholders’ equity.$52.2 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. 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 October 24, 2004,28, 2007, 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 $81.3$100.2 million, or 9.9%7%, of our total net sales for the year ended December 31, 2004,2007 and $74.8$122.7 million, or 10.7%10%, of our total net sales for year ended December 31, 2003.2006. 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 Home Depot and other customers. A significant reduction in orders from, or change in terms from Theof contracts with, Home Depot Inc.or other significant customers could have a material adverse effect on our future results of operations.

    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 or senior notes 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.

    Investments in auction rate certificates are subject to risks which may cause losses and affect the liquidity of these investments.

            At December 31, 2007, we had $39.0 million in investment securities. We have historically invested these amounts in auction rate certificates whose underlying investments are AAA rated municipal bonds. Our auction rate certificates are bought and sold at auction with reset dates of up to 35 days. Through February 25, 2008, we liquidated approximately $22.0 million of our auction rate certificates at par value and invested the proceeds into money market accounts. At February 25, 2008, we held approximately $17.0 million of auction rate certificates whose underlying investments are AAA rated municipal bonds.


            We have no current indications that the securities we hold may be impaired. However, volatility in the credit markets could affect our ability to liquidate these investments or cause the fair value of the securities to be impaired. If liquidity of the securities becomes prohibitive, we may be forced to hold the securities until maturity or until conditions improve, which could be as long as 33 years. Subsequent to December 31, 2007 through February 25, 2008, we experienced failed auctions on $6.6 million of our auction rate certificates. We do not have a present need to access these funds for operational purposes. The amounts associated with failed auctions will not be accessible until a successful auction occurs, a buyer is found outside of the auction process or the underlying securities have matured. As a result, we have classified the $17.0 million of auction rate certificates held as of February 25, 2008 as long-term assets in the our December 31, 2007 consolidated balance sheet. If the fair value of the securities deteriorates, we would be required to adjust the carrying value of the securities. The market risks associated with our auction rate certificates could adversely affect our results of operations, liquidity and financial condition.

    One of our stockholders can exercise substantial influence over our company.Company.

    As of January 31, 2005,February 1, 2008, Timothy P. Horne, a member of our board of directors, beneficially owned approximately 22.7%19.6% 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 99.0% of our outstanding shares of Class B Common Stock, which represents approximately 73.9%70.4% 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 allmost stockholder votes, and other stockholders will not be able to affect the outcome of any stockholder vote.such votes.

    Conversion and sale of a significant number of shares of our Class B Common Stock could adversely affect the market price of our Class A Common Stock.

    As of January 31, 2005February 1, 2008, there were outstanding 25,049,33829,680,122 shares of our Class A Common Stock and 7,343,8807,293,880 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, underUnder the terms of a registration rights agreement with respect to outstanding shares of our Class B Common Stock, the holders of our Class B Common Stock have rights with respect to the registration of the underlying Class A Common Stock. Under these registration rights, the holders of Class B Common Stock may require, on up to two occasions, that we register their shares for public resale. If 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. If all of the available registered shares are sold into the public market the trading price of our Class A Common Stock could decline.

    39




    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, 2005,February 1, 2008, our Class B Common Stock constituted 22.7%19.7% of our total outstanding common stock and 74.6%71.1% of the total outstanding voting power and thus is able to exercise a controlling influence over our business.


    Item 1B.    UNRESOLVED STAFF COMMENTS.

            None.



    Item 2.    PROPERTIES.

            As of December 31, 2007, we maintained approximately 78 facilities worldwide, including our corporate headquarters located in North Andover, Massachusetts. The remaining 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:

    North America:

    Location

    Principal Use
    Owned/Leased
    North Andover, MACorporate HeadquartersOwned
    Export, PAManufacturingOwned
    Franklin, NHManufacturing/DistributionOwned
    Burlington, ON, CanadaManufacturingOwned
    Kansas City, KSManufacturingOwned
    Fort Myers, FLManufacturingOwned
    St. Pauls, NCManufacturingOwned
    Spindale, NCManufacturing/DistributionOwned
    Chesnee, SCManufacturingOwned
    Palmdale, CAManufacturingOwned
    Dunnellon, FLWarehouseOwned
    San Antonio, TXWarehouseOwned
    Springfield, MOManufacturing/DistributionLeased
    Langley, BC, CanadaManufacturingLeased
    Santa Ana, CAManufacturingLeased
    Woodland, CAManufacturingLeased
    Houston, TXManufacturingLeased
    Wilmington, NCManufacturingLeased
    Brea, CAManufacturingLeased
    Phoenix, AZWarehouseLeased
    Chicago, ILDistribution CenterLeased
    Reno, NVDistribution CenterLeased
    Vernon, CADistribution CenterLeased
    Calgary, AB, CanadaDistribution CenterLeased

    Europe:

    Location

    Principal Use
    Owned/Leased
    Eerbeek, NetherlandsEuropean Headquarters/ManufacturingOwned
    Biassono, ItalyManufacturingOwned
    Brescia, ItalyManufacturingOwned
    Landau, GermanyManufacturingOwned
    Fresseneville, FranceManufacturingOwned
    Hautvillers, FranceManufacturingOwned
    Plovdiv, BulgariaManufacturingOwned
    Ammanford, United KingdomManufacturingOwned
    Rosières, FranceManufacturingLeased
    Monastir, TunisiaManufacturingLeased
    Gardolo, ItalyManufacturingLeased
    Sorgues, FranceManufacturingLeased
    Grenoble, FranceManufacturingLeased

    China:

    Location

    Principal Use
    Owned/Leased
    Tianjin Tanggu District, THMT, ChinaManufacturingOwned
    Taizhou, Yuhuan, ChinaManufacturingOwned
    Hunan, Changsha, ChinaManufacturingOwned
    Ningbo, Beilun, ChinaManufacturingOwned
    Tianjin Tanggu District, ChinaManufacturingLeased
    Ningbo, Beilun Port, ChinaDistribution CenterLeased

            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 plants in St. Pauls, North Carolina, Langley, BC, Canada and Gardolo, Italy, which are under-utilized. Management believes capacity utilization will continue to increase in 2008 at these plants, subject to unexpected changes in our sales volume.


    Item 3.    LEGAL PROCEEDINGS.

            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 on the New Accounting StandardsYork Stock Exchange during 2007 and 2006 and cash dividends paid per share.

     
     2007
     2006
     
     High
     Low
     Dividend
     High
     Low
     Dividend
    First Quarter $46.71 $35.05 $.10 $37.00 $29.55 $.09
    Second Quarter  41.34  36.10  .10  40.03  29.00  .09
    Third Quarter  39.96  30.40  .10  36.24  28.08  .09
    Fourth Quarter  33.09  25.40  .10  45.43  30.71  .09

            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 2007 and 2006 were $15.6 million and $12.4 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 as of February 22, 2008 was 172. The number of record holders of our Class B Common Stock as of February 22, 2008 was 7.

            Beginning in the second quarter of 2007, the Company satisfies the minimum withholding tax obligation due upon the vesting of shares of restricted stock and the conversion of restricted stock units into shares of Class A Common Stock by automatically withholding from the shares being issued a number of shares with an aggregate fair market value on the date of such vesting or conversion that would satisfy the withholding amount due.

            The following table includes information with respect to shares of the Company's Class A Common Stock withheld to satisfy withholding tax obligations during the quarter ended December 31, 2007.

     
     Issuer Purchases of Equity Securities
      
     
     (d) Maximum Number (or
    Approximate Dollar
    Value) of Shares (or
    Units) that May Yet Be
    Purchased Under the
    Plans or Programs

    Period

     (a) Total
    Number of
    Shares (or
    Units)
    Purchased

     (b) Average
    Price Paid per
    Share (or Unit)

     (c) Total Number of
    Shares (or Units)
    Purchased as Part of
    Publicly Announced
    Plans or Programs

    October 1, 2007 - October 28, 2007 70 $32.42  
    October 29, 2007 - November 25, 2007     
    November 26, 2007 - December 31, 2007     
      
     
     
     
    Total 70 $32.42  
      
     
     
     

            The following table includes information with respect to repurchases we made of our Class A Common Stock during the quarter ended December 31, 2007.

    Period

     (a) Total
    Number of
    Shares (or
    Units)
    Purchased(1)

     (b) Average
    Price Paid per
    Share (or Unit)

     (c) Total Number of
    Shares (or Units)
    Purchased as Part of
    Publicly Announced
    Plans or Programs(1)

     (d) Maximum Number (or
    Approximate Dollar
    Value) of Shares (or
    Units) that May Yet Be
    Purchased Under the
    Plans or Programs(1)

    October 1, 2007 - October 28, 2007     
    October 29, 2007 - November 25, 2007 176,330 $27.94 176,330 2,823,670
    November 26, 2007 - December 31, 2007 691,121 $29.00 691,121 2,132,549
      
     
     
     
    Total 867,451 $28.78 867,451 2,132,549
      
     
     
     

    (1)
    On November 9, 2007, we announced that our Board of Directors had authorized a stock repurchase program. Under the program, we may repurchase up to an aggregate of 3.0 million shares of our Class A Common Stock in open market purchases or in privately negotiated transactions.

    Performance Graph

            Set forth below is a line graph comparing the cumulative total shareholder return on our Class A Common Stock for the last five years with the cumulative return of companies on the Standard & Poor's 500 Stock Index and the Russell 2000 Index. We chose the Russell 2000 Index because it represents companies with a market capitalization similar to that of Watts. The graph assumes that the value of the investment in our Class A Common Stock and each index was $100 at December 31, 2002 and that all dividends were reinvested.

    COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
    Among Watts Water Technologies, Inc., The S&P 500 Index
    and The Russell 2000 Index


    *
    $100 invested on December 31, 2002 in stock or index, including reinvestment of dividends. Fiscal year ending December 31.

    Cumulative Total Return

     
     12/31/02
     12/31/03
     12/31/04
     12/31/05
     12/31/06
     12/31/07
    Watts Water Technologies, Inc 100.00 143.05 210.02 199.34 273.27 200.42
    S & P 500 100.00 128.68 142.69 149.70 173.34 182.87
    Russell 2000 100.00 147.25 174.24 182.18 215.64 212.26

    The above Performance Chart and related information shall not be deemed "soliciting material" or to be "filed" with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.



    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 millions, except per share and cash dividend information)

     
     Year Ended
    12/31/07(1)(7)

     Year Ended
    12/31/06(2)(7)

     Year Ended
    12/31/05(3)(4)(7)

     Year Ended
    12/31/04(5)(6)(7)

     Year Ended
    12/31/03(7)(8)

     
    Statement of operations data:                
    Net sales $1,382.3 $1,230.8 $924.3 $824.6 $701.9 
    Income from continuing operations  77.6  77.1  55.0  48.7  36.4 
    Loss from discontinued operations, net of taxes  (.2) (3.4) (.4) (1.9) (3.1)
    Net income  77.4  73.7  54.6  46.8  33.4 
    Income per share from continuing operations—diluted  1.99  2.29  1.67  1.49  1.32 
    Loss per share from discontinued operations—diluted  (.01) (.10) (.01) (.06) (.11)
    Net income per share—diluted  1.99  2.19  1.66  1.43  1.21 
    Cash dividends declared per common share $.40 $.36 $.32 $.28 $.25 
    Balance Sheet Data (at year end):                
    Total assets $1,729.3 $1,660.9 $1,101.0 $922.7 $840.9 
    Long-term debt, net of current portion $432.2 $441.7 $293.4 $180.6 $179.1 

    (1)
    For the year ended December 31, 2007, net income includes the following net pre-tax costs: change in estimate of workers compensation costs of $2.9 million, severance and product line discontinuance costs in North America of $0.4 million and $3.1 million, respectively; accelerated depreciation and asset write-downs, product line discontinuance costs and severance costs in China of $2.9 million, $0.7 million and $0.4 million, respectively, and minority interest income of $0.9 million. The after-tax cost of these items was $6.9 million.

    (2)
    For the year ended December 31, 2006, net income includes the following net pre-tax gain: gain on sales of buildings of $8.2 million, restructuring costs consisting primarily of European severance of $2.2 million and amortization of $0.4 million, other costs consisting of accelerated depreciation and severance in our Chinese joint venture of $4.7 million and minority interest income of $1.5 million. The after-tax gain of these items was $1.5 million.

    (3)
    For the year ended December 31, 2005, net income includes the following pre-tax costs: restructuring of $0.7 million and other costs consisting of accelerated depreciation and asset write-downs of $1.8 million. The after-tax cost of these items was $1.6 million.

    (4)
    For the year ended December 31, 2005, net income includes a net after-tax charge of $0.9 million for a selling, general and administrative expense charge of $1.5 million related to a contingent earn-out agreement.

    (5)
    For the year ended December 31, 2004, net income includes a net after-tax charge of $2.3 million for certain accrued expense adjustments, which are included in selling, general and administrative expense after-tax charges of $3.5 million related to a contingent earn-out agreement and $0.7 million for various accrual adjustments and $0.5 million recorded as an income tax benefit.

    (6)
    For the year ended December 31, 2004, net income includes the following pre-tax costs: restructuring of $0.1 million and other costs consisting of accelerated depreciation of $2.9 million. The after-tax cost of these items was $1.8 million.

    (7)
    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 $0.7 million for the year ended December 31, 2004. Also included in discontinued operations is the net of tax operating results of Jameco LLC of $0.1 million of loss and $0.1 million 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 Financial Accounting Standards Board (FASB) issued Financial Accounting Standards Board Statement No. 132 revisedMunicipal Water Group, for 2007, 2006, 2005, 2004 and 2003 “Employers’ Disclosures about Pensionsrelate to legal and Other Postretirement Benefits” (FAS 132R)settlement costs associated with the James Jones Litigation. The loss, net of taxes, consists of $0.2 million, $3.4 million, $0.4 million, $1.1 million and $3.1 million for the years ended December 31, 2007, 2006, 2005, 2004 and 2003, respectively.

    (8)
    For the year ended December 31, 2003, net income includes the following pre-tax costs: restructuring of $0.4 million; other costs consist of: inventory and other asset write-downs and accelerated depreciation of $0.5 million; and $0.8 million of other related charges. The after-tax cost of these items was $1.1 million.


    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 with an emerging presence in China. 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 and residential applications. We earn revenue and income almost exclusively from the sale of our products. Our principal product lines include:

      water quality products, including backflow preventers and check valves for preventing reverse flow within water lines and fire protection systems and point-of-use water filtration and reverse osmosis systems for both commercial and residential applications;

      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;

      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 renewable energy applications, including solar and heat pump control packages;

      flexible stainless steel connectors for natural and liquid propane gas in commercial food service and residential applications; and

      large diameter butterfly valves for use in China's water infrastructure.

            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). This standardInterest 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. All three of these activities have an impact on our levels of sales and earnings. 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 in new complementary markets, regulatory requirements relating to the quality and conservation of water, increased demand for clean water with continued enforcement of plumbing and building codes and a healthy economic environment. We have completed 31 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 conservation, water safety and water flow control and related complementary 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 2007 and 2006, sales from acquisitions contributed approximately 3.9% and 20.9%, to our total sales growth over the prior year.

            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 the product development, product testing capability and investment in plant and equipment needed to manufacture products in compliance with code requirements, represent 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 existing disclosure requirementscosts of certain raw materials, particularly copper. Bronze and brass are copper-based alloys. The spot price of copper increased approximately 41% from December 31, 2005 to December 31, 2007.

            A risk we face is our ability to deal effectively with increases in raw material costs. We manage this risk by requiring more details about pension plan assets, benefit obligations, cash flows, benefitmonitoring related market prices, working with our suppliers to achieve the maximum level of stability in their costs and related information. Companiespricing, seeking alternative supply sources when necessary, implementing cost reduction programs and passing increases in costs to our customers. Additionally from time to time we may use commodity futures contracts on a limited basis to manage this risk. 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.

            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 the product development, product testing capability and investment in plant and equipment needed to manufacture products in compliance with code requirements, represent 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 $37.8 million in 2007 and $44.7 million in 2006 (including approximately $18.0 million related to the purchase and subsequent sale-leaseback of a building in Italy).

    Recent Developments

            On February 5, 2008, we declared a quarterly dividend of eleven cents ($0.11) per share on each outstanding share of Class A Common Stock and Class B Common Stock. This is an increase of $0.01 per share compared to the dividend paid for the comparable period last year.

            On December 3, 2007, we entered into an Equity Transfer Agreement (the "Agreement") with our joint venture partners to purchase the remaining 40% of the outstanding ownership interest in Tianjin Tanggu Watts Valve Company Limited ("TWT") that we did not already own. The purchase price will be requiredapproximately $5.2 million, payable after certain closing conditions are met, including the approval of the Agreement by the local Chinese authorities, which we expect will occur by the end of the second quarter of 2008. We expect to segregate planrecord approximately $3.7 million in goodwill for this acquisition.

            As part of this Agreement, the joint venture partners are obligated to reimburse approximately $2.0 million to TWT at the closing for relocation costs including lost land use rights. These costs were previously guaranteed by the joint venture partners as part of the original joint venture contract. TWT lost the future use of these land use rights when the local Chinese government decreed that the land where TWT's facility is located would be taken over by eminent domain. Since 2006, TWT has accelerated the amortization of the land use rights assets to coincide with the expected move. Further TWT has incurred and will incur relocation costs to move its operations. TWT had not previously recorded a receivable for this reimbursement amount, as collectibility of the amount under the original joint venture contract was not certain. The $2.0 million reimbursement will be recorded when the Agreement is finalized as an equity infusion by category, suchthe joint venture partners. The cost to move TWT's operations was included in the restructuring program announced in October 2007.


            On November 9, 2007, we acquired the assets and business of Topway Global, Inc. (Topway) located in Brea, California for approximately $18.4 million, of which $0.3 million of transaction costs remain to be paid. Topway manufactures a wide variety of water softeners, point of entry filter units, and point of use drinking water systems for residential, commercial and industrial applications.

            On November 9, 2007, we announced that our Board of Directors had authorized the repurchase of up to 3.0 million shares of our Class A Common Stock. As of February 22, 2008, we have repurchased 2.2 million shares of stock for a total cost of $63.2 million.

    Results of Operations

    Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

            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, 2007 and 2006 were as debt, equityfollows:

     
     Year Ended
    December 31, 2007

     Year Ended
    December 31, 2006

      
      
     
     
     Net Sales
     % Sales
     Net Sales
     % Sales
     Change
     Change to
    Consolidated
    Net Sales

     
     
     (Dollars in millions)

     
    North America $871.0 63.0%$821.3 66.7%$49.7 4.0%
    Europe  452.6 32.7  367.5 29.9  85.1 6.9 
    China  58.7 4.3  42.0 3.4  16.7 1.4 
      
     
     
     
     
     
     
    Total $1,382.3 100.0%$1,230.8 100.0%$151.5 12.3%
      
     
     
     
     
     
     

            The increase in net sales is attributable to the following:

     
      
      
      
      
     Change
    As a % of Consolidated
    Net Sales

     Change
    As a % of Segment
    Net Sales

     
     
     North America
     Europe
     China
     Total
     North America
     Europe
     China
     Total
     North America
     Europe
     China
     
     
     (Dollars in millions)

     
    Organic growth $41.0 $13.7 $8.5 $63.2 3.3%1.1%.7%5.1%5.0%3.7%20.3%
    Foreign exchange  3.9  34.1  2.4  40.4 .3 2.8 .2 3.3 .5 9.3 5.8 
    Acquisitions  4.8  37.3  5.8  47.9 .4 3.0 .5 3.9 .6 10.2 13.8 
      
     
     
     
     
     
     
     
     
     
     
     
    Total $49.7 $85.1 $16.7 $151.5 4.0%6.9%1.4%12.3%6.1%23.2%39.9%
      
     
     
     
     
     
     
     
     
     
     
     

            The organic growth in net sales in North America was primarily due to increased unit selling prices and real estate,increased unit sales of certain product lines into the wholesale market. Our sales into the wholesale market in 2007, excluding the sales from the acquisition of Calflex and Topway, grew by 7.7% compared to provide2006. This was primarily due to increased sales of our backflow products. Our sales into the North American DIY market in 2007 decreased by 4.4% compared to 2006 primarily due our discontinuing certain lower margin product lines, partially offset by price increases and new product rollouts.

            The acquired growth in net sales in North America was due to the inclusion of net sales of Calflex, acquired on June 2, 2006, and Topway, acquired on November 9, 2007.

            The organic sales growth in Europe was broad-based, especially in Eastern Europe and in the OEM market, which was partially offset by a weak German market. Our sales into the wholesale and OEM markets in 2007, excluding the sales from the acquisitions of ATS, Kimsafe and Teknigas, grew by 3.1% and 4.4%, respectively, compared to 2006.


            The acquired growth in net sales in Europe was due to the inclusion of the net sales of ATS, acquired on May 19, 2006, Kimsafe, acquired on June 7, 2006, and Teknigas, acquired on August 14, 2006.

            The organic sales growth in China was primarily due to increased export sales to Europe, increased sales into the domestic Chinese markets and the elimination of the one-month reporting lag in two of our Chinese entities.

            The acquired growth in net sales in China was due to the inclusion of net sales of Changsha, acquired on April 26, 2006.

            The increases in net sales due to foreign exchange in North America, Europe and China were primarily due to the appreciation of the Canadian dollar, euro and yuan, respectively, against the U.S. dollar. We cannot predict whether these currencies 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.

            Gross Profit.    Gross profit and gross profit as a percent of net sales (gross margin) for 2007 and 2006 were as follows:

     
     Year Ended
    December 31,

      
     
     
     Point Change
     
     
     2007
     2006
     
     
     (dollars in millions)

      
     
    Gross profit $461.6 $425.0   
    Gross margin  33.4% 34.5%(1.1%)

            Gross margin decreased in 2007 compared to 2006 primarily due to increased material costs, the write-off of inventory related to the discontinuance of certain product lines and an increase in our workers compensation reserve primarily due to a change in estimate. The North American margin for 2007 was affected by a charge related to our discontinuance of certain product lines and for cost increases for copper-based alloys and stainless steel products, which exceeded realized sales price increases for most of the year. The European margin remained relatively flat primarily due to higher margins contributed by price increases that were offset by increased material costs and a shift in sales to lower margin products primarily in the OEM market. Our China segment's gross margin decreased primarily due to higher material costs, underutilized capacity in certain locations primarily due to the relocation of our joint venture facility, a charge related to our discontinuance of certain product lines, value added tax increases and a shift in product mix.

            In 2007, we undertook a review of certain product lines and our overall manufacturing capacity. Based on that review, we initiated a global restructuring program that was approved by our Board of Directors on October 30, 2007. We also discontinued certain product lines. This program is expected ratesto include the shutdown of returnfive manufacturing facilities and the rightsizing of a sixth facility, including the relocation of our joint venture facility in China that was previously disclosed. The restructuring program and charges for certain product line discontinuances will include pre-tax charges totaling approximately $12.9 million. Charges are primarily for severance ($4.3 million), relocation costs ($2.8 million) and other informational disclosures. FAS 132(R) also requires companiesasset write-downs and expected net losses on asset disposals ($2.0 million) and will result in the elimination of approximately 330 positions worldwide. The pre-tax charge in 2007 of $4.3 million relates primarily to disclose various elementsproduct line discontinuances ($3.8 million). Total net after-tax charges for this program are expected to be approximately $9.4 million ($4.4 million non-cash), with costs being incurred through early 2010. We expect to spend approximately $13.4 million in capital expenditures to consolidate operations and will fund approximately $8.0 million of pensionthis amount through proceeds from the sale of buildings and postretirement benefit costs in interim-period financial statements for quarters beginning after December 15, 2003. We adoptedother assets being disposed of as part of the additional interim disclosure provisionsrestructuring program. Annual cash savings, net of FAS 132(R) effective January 1, 2004.

    On May 15, 2003, FASB issued Financial Accounting Standards Board Statement No. 150, “Accounting for Certain Financial Instruments with Characteristicstax, are estimated to be $4.5 million, which will be fully realized by the second half of Both Liabilities and Equity” (FAS 150). FAS 150 requires issuers2009.


            The following table presents the total estimated pre-tax charges to classify as liabilities (or assets in some circumstances) three classes of freestanding financial instruments that embody obligationsbe incurred for the issuer. Generally, FAS 150global restructuring program and product line discontinuances initiated in 2007 by our reportable segments:

    Reportable Segment

     (in millions)
    North America $5.7
    Europe  3.9
    China  3.3
      
    Total $12.9
      

            Selling, General and Administrative Expenses.    Selling, general and administrative expenses, or SG&A expenses, for 2007 increased $32.5 million, or 10.8%, compared to 2006. The increase in SG&A expenses is effective for financial instruments entered into or modified after May 31, 2003attributable to the following:

     
     (in millions)
     % Change
     
    Organic growth $13.1 4.4%
    Foreign exchange  7.9 2.6 
    Acquisitions  11.5 3.8 
      
     
     
    Total $32.5 10.8%
      
     
     

            The organic increase in SG&A expenses was primarily due to increased product liability costs, increased stock-based compensation costs and is otherwise effective atincreased variable selling expenses due to increased sales volumes partially offset by decreased incentive compensation costs. The increase in SG&A expenses from foreign exchange was primarily due to the beginningappreciation of the first interimeuro, Canadian dollar and the yuan against the U.S. dollar. The increase in SG&A expenses from acquisitions was due to the inclusion of Changsha, ATS, Calflex, Ningbo, Kimsafe, Teknigas and Topway. Total SG&A expenses, as a percentage of sales, was 24.1% in 2007 compared to 24.4% 2006.

            Restructuring and Other (Income) Charges.    In 2007, we recorded $3.2 million for asset write-downs, accelerated depreciation and severance in North America and China. In 2006, we recorded income of $5.7 million primarily due to a gain of approximately $8.2 million related to the sale of two buildings in Italy partially offset by a charge of $2.5 million primarily for severance costs related to our European restructuring programs.

            Operating Income.    Operating income by geographic segment for 2007 and 2006 was as follows:

     
     Years Ended
      
      
     
     
      
     % Change to
    Consolidated
    Operating
    Income

     
     
     December 31,
    2007

     December 31,
    2006

     Change
     
     
     (Dollars in millions)

     
    North America $93.3 $98.5 $(5.2)(4.0)%
    Europe  53.6  50.0  3.6 2.8 
    China  7.9  7.2  .7 .5 
    Corporate  (29.1) (25.2) (3.9)(3.0)
      
     
     
     
     
    Total $125.7 $130.5 $(4.8)(3.7)%
      
     
     
     
     

            The change in operating income is attributable to the following:

     
      
      
      
      
      
     Change
    As a % of Consolidated
    Operating Income

     Change
    As a % of Segment
    Operating Income

     
     
     North
    America

     Europe
     China
     Corp.
     Total
     North
    America

     Europe
     China
     Corp.
     Total
     North
    America

     Europe
     China
     Corp.
     
     
     (Dollars in millions)

     
    Organic growth $(1.3)$.9 $(1.5)$(3.9)$(5.8)(1.0)%.7%(1.3)%(3.0)%(4.6)%(1.4)%1.8%(20.8)%(15.5)%
    Foreign exchange  .9  4.0  .4    5.3 .7 3.1 .3  4.1 .9 8.0 5.5  
    Acquisitions  (1.3) 4.8  .8    4.3 (1.0)3.6 .7  3.3 (1.3)9.6 11.1  
    Restructuring/other  (3.5) (6.1) 1.0    (8.6)(2.7)(4.6).8  (6.5)(3.5)(12.2)13.9  
      
     
     
     
     
     
     
     
     
     
     
     
     
     
     
    Total $(5.2)$3.6 $.7 $(3.9)$(4.8)(4.0)%2.8%.5%(3.0)%(3.7)%(5.3)%7.2%9.7%(15.5)%
      
     
     
     
     
     
     
     
     
     
     
     
     
     
     

            The decrease in organic operating income in North America was primarily due to increased material costs partially offset by unit price increases, a net increase in our workers compensation reserve primarily due to a change in estimate and increased product liability costs, partially offset by decreased incentive compensation costs. In 2007, we recorded a charge of $3.1 million related to our discontinuance of certain product lines and $0.4 million for primarily for severance costs related to our global restructuring program.

            The acquired decrease is primarily due to the amortization of certain costs associated with the acquisition of Topway.

            Europe's organic growth in operating income is due to our ability to leverage SG&A expenses, increased selling prices partially offset by increased material costs and a shift in sales to lower margin products primarily in the OEM market. In 2007, we did not record any costs associated with restructuring compared to a gain of $6.0 million for the same period beginning after June 15, 2003.in 2006. We adoptedrecorded a gain of $8.2 million for the provisionsbuilding sales in Italy partially offset by $2.2 million of FAS 150 on July 1, 2003primarily severance costs.

            The acquired growth in Europe is due to the inclusion of the operating income from ATS, Kimsafe and Teknigas.

            The decrease in organic operating income in China was primarily attributable to decreased production levels at our wholly owned manufacturing plants. The acquired growth in China was due to the inclusion of the operating income of Changsha and Ningbo. In 2007, we recorded $3.3 million for existing financial instruments, allasset write-downs, accelerated depreciation and severance related to our global restructuring program and $0.7 million related to our discontinuance of which were entered into prior to June 30, 2003. We concluded that the adoptioncertain product lines. The elimination of FAS 150a one-month reporting lag in two of our Chinese entities did not have a material impact on itsChina's operating income.

            The decrease in organic operating income in Corporate was primarily attributable to increased stock-based compensation costs and legal costs, partially offset by decreased incentive compensation costs.

            The net increase in operating income from foreign exchange was primarily due to the appreciation of the euro, Canadian dollar and yuan against the U.S. dollar. We cannot predict whether these currencies 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.

            Interest Income.    Interest income increased $9.5 million, or 190.0%, in 2007 compared to 2006, primarily due to the investment of the net proceeds of approximately $219.0 million from the public offering of 5.75 million shares of our Class A Common Stock in November 2006.

            Interest Expense.    Interest expense increased $4.8 million, or 21.7%, in 2007 compared to 2006, primarily due to our April 27, 2006 issuance of $225.0 million 5.85% senior notes due in 2016 and an increase in the average variable rates charged on the revolving credit facility partially offset by decreased debt levels for acquisitions.


            Effective July 1, 2005, we entered into an interest rate swap for a notional amount of €25.0 million outstanding on our revolving credit facility. We swapped an adjustable rate of three month EURIBOR plus 0.6% for a fixed rate of 3.02%. We recorded a reduction to interest expense of approximately $0.7 million to recognize the fair value of the swap for 2006. The swap was terminated on October 3, 2006.

            Other (Income) Expense.    Other (income) expense increased $3.2 million, or 355.6% in 2007 compared to 2006, primarily due to currency movements and losses on forward currency contracts. Foreign currency losses were recorded in Europe, Canada and China in 2007, whereas foreign currency gains were recorded in 2006.

            Minority interest.    Minority interest increased $1.0 million, or 55.6%, for 2007 compared to 2006, primarily due to the credit recorded for the 40% liability of our joint venture partner's share in the recording of the $2.4 million TWT restructuring costs.

            Income Taxes.    Our effective tax rate for continuing operations decreased to 31.8% in 2007 from 33.6% in 2006. The decrease is primarily due to a one-time benefit associated with a refund of withholding taxes in Italy and in 2006 the recording of higher taxes on the sale of two buildings. This decrease is partially offset by the recording of a $3.2 million valuation allowance on the deferred tax assets of our 60% owned Chinese joint venture.

            Income From Continuing Operations.    Income from continuing operations in 2007 increased $0.5 million, or 0.6%, to $77.6 million, or $1.99 per common share, from $77.1 million, or $2.29 per common share, for 2006, in each case, on a diluted basis. Income from continuing operations for 2007 includes a tax refund of $1.9 million, or $0.05 per common share. Income from continuing operations for 2007 and 2006 included costs, net of tax, from our restructuring plan and product line discontinuances of $5.1 million, or $0.13 per common share, and included income, net of tax, of $1.5 million, or $0.04 per share, respectively. In 2006, the gains on the sales of our buildings in Italy resulted in an after-tax gain of $5.1 million, or $0.15 per share. The appreciation of the euro, Chinese yuan and Canadian dollar against the U.S. dollar resulted in a positive impact on income from continuing operations of $0.09 per common share for 2007 compared to the comparable period last year. We cannot predict whether the euro, Canadian dollar or yuan will appreciate or depreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net income.

            Additionally, in November 2006, the Company completed a public offering of 5.75 million shares of Class A Common Stock and received net proceeds of approximately $219.0 million. The interest earned on the net proceeds provided approximately $7.1 million in after-tax income in 2007. The issuance of an additional 5.75 million shares had a dilutive impact on earnings per share of $0.11 per share in 2007, after considering the interest income from the net proceeds.

            Loss From Discontinued Operations.    Loss from discontinued operations in 2007 and 2006 was $0.2 million, or $0.01 per common share, and $3.4 million, or $0.10 per common share, on a diluted basis for the comparable period. The losses for 2007 and 2006 were primarily attributable to increased deductible costs in 2006 and legal fees associated with the James Jones Litigation, as described in Part I, Item 1, "Business-Product Liability, Environmental and Other Litigation Matters." The 2007 loss was partially offset by reserve adjustments.


    Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

            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, 2006 and 2005 were as follows:

     
     Year Ended
    December 31, 2006

     Year Ended
    December 31, 2005

      
      
     
     
      
     Change to
    Consolidated
    Net Sales

     
     
     Net Sales
     % Sales
     Net Sales
     % Sales
     Change
     
     
     (Dollars in millions)

     
    North America $821.3 66.7%$629.9 68.2%$191.4 20.7%
    Europe  367.5 29.9  266.3 28.8  101.2 11.0 
    China  42.0 3.4  28.1 3.0  13.9 1.5 
      
     
     
     
     
     
     
    Total $1,230.8 100.0%$924.3 100.0%$306.5 33.2%
      
     
     
     
     
     
     

            The increase in net sales is attributable to the following:

     
      
      
      
      
     Change
    As a % of Consolidated
    Net Sales

     Change
    As a % of Segment
    Net Sales

     
     
     North
    America

     Europe
     China
     Total
     North
    America

     Europe
     China
     Total
     North
    America

     Europe
     China
     
     
     (Dollars in millions)

     
    Organic growth $54.0 $45.2 $3.0 $102.2 5.9%4.9%.3%11.1%8.6%17.0%10.6%
    Foreign exchange  3.5  7.1  .9  11.5 .3 .8 .1 1.2 .6 2.7 3.0 
    Acquisitions  133.9  48.9  10.0  192.8 14.5 5.3 1.1 20.9 21.2 18.3 35.9 
      
     
     
     
     
     
     
     
     
     
     
     
    Total $191.4 $101.2 $13.9 $306.5 20.7%11.0%1.5%33.2%30.4%38.0%49.5%
      
     
     
     
     
     
     
     
     
     
     
     

            The organic growth in net sales in North America was due to increased price and unit sales in certain product lines into both the wholesale and DIY markets. Our wholesale market in 2006, excluding the sales from the acquisitions of Alamo, Savard, Calflex, Flexflow, Core and Dormont, grew by 9.7% compared to 2005, primarily due to increased sales of water pressure regulators, relief valves and backflow preventer units, as well as in our plumbing and under-floor radiant heating product lines. Our sales into the North American DIY market in 2006 increased by 5.4% compared to 2005, primarily due to increased sales of fittings and supply lines and plumbing and under-floor radiant heating product lines partially offset by fewer new retail product introductions in 2006 than during 2005.

            The acquired growth in net sales in North America was due to the inclusion of net sales of Alamo, acquired on June 20, 2005, Savard, acquired on July 8, 2005, Flexflow, acquired on November 4, 2005, Core, acquired on December 2, 2005, Dormont, acquired on December 28, 2005, and Calflex acquired on June 2, 2006.

            The organic sales growth in Europe was broad-based with most markets and channels exhibiting improvement. Our sales into the wholesale and OEM markets in 2006, excluding the sales from the acquisitions of Electro Controls, Microflex, ATS, Kimsafe and Teknigas, grew by 18.5% and 16.4% respectively, compared to 2005.

            The acquired growth in net sales in Europe was due to the inclusion of the net sales of Electro Controls, acquired on May 11, 2005, Microflex, acquired on July 5, 2005, ATS, acquired on May 19, 2006, Kimsafe, acquired on June 7, 2006, and Teknigas, acquired on August 14, 2006.

            The organic sales growth in China was due to increased sales into the domestic and export markets, partially offset by decreased sales due to an approximately four- week work stoppage at our joint-venture facility in Tianjin. Additionally, the yuan strengthened against the U.S. dollar.

            The acquired growth in net sales in China was due to the inclusion of the net sales of Changsha, acquired on April 26, 2006, and Ningbo, acquired on June 2, 2006.


            The increases in net sales due to foreign exchange in North America, Europe and China were primarily due to the appreciation of the Canadian dollar, euro and yuan, respectively, against the U.S. dollar.

            Gross Profit.    Gross profit and gross margin for 2006 and 2005 were as follows:

     
     Year Ended
    December 31,

      
     
     
     Point
    Change

     
     
     2006
     2005
     
     
     (dollars in millions)

      
     
    Gross profit $425.0 $324.7   
    Gross margin  34.5% 35.1%(.6%)

            Gross margin for 2006 decreased slightly from 2005. Raw materials cost increases have been predominantly offset by increased sales prices with the exception of the North American retail market and certain markets in Europe. In particular, price increases have been difficult to pass along to customers in Germany. Margins have also been negatively affected by sales of lower margin products sold by Core and by European acquisition costs. North American gross margin percentage decreases were partially offset by a favorable sales mix toward higher margin wholesale sales.

            Margins were also negatively affected in 2006 by increased charges related to our manufacturing restructuring efforts. We recorded $4.7 million to cost of sales for primarily severance costs in 2006 as compared to $1.8 million in 2005 for accelerated depreciation and other costs.

            Selling, General and Administrative Expenses.    Selling, general and administrative expenses, or SG&A expenses, for 2006 increased $70.8 million, or 30.8%, compared to 2005. The increase in SG&A expenses is attributable to the following:

     
     (in millions)
     % Change
     
    Organic growth $24.6 10.7%
    Foreign exchange  2.1 .9 
    Acquisitions  44.1 19.2 
      
     
     
    Total $70.8 30.8%
      
     
     

            The organic increase in SG&A expenses was primarily due to increased variable selling expenses due to increased sales volumes, increased insurance costs, increased compensation costs and corporate administration costs including costs incurred for compliance with FAS 123R, partially offset by lower costs for complying with Section 404 of the Sarbanes-Oxley Act of 2002 (SOX) and lower earn-out costs related to a prior acquisition. The increase in SG&A expenses from foreign exchange was primarily due to the appreciation of the euro, Canadian dollar and yuan against the U.S. dollar. The increase in SG&A expenses from acquisitions was due to the inclusion of Electro Controls, Alamo, Microflex, Savard, Flexflow, Core, Dormont, Changsha, ATS, Calflex, Ningbo, Kimsafe and Teknigas.

            Restructuring and Other (Income) Charges.    Restructuring and other (income) charges for 2006 decreased $6.4 million primarily due to a gain of approximately $8.2 million related to the sale of two buildings in Italy partially offset by a charge of $2.5 million primarily for severance costs related to our European restructuring plans. During 2005, we recorded $0.7 million primarily for severance costs related to our European restructuring plans.


            Operating Income.    Operating income by geographic segment for 2006 and 2005 was as follows:

     
     Years Ended
      
      
     
     
      
     % Change to
    Consolidated
    Operating
    Income

     
     
     December 31,
    2006

     December 31,
    2005

     Change
     
     
     (Dollars in millions)

     
    North America $98.5 $79.1 $19.4 20.6%
    Europe  50.0  31.5  18.5 19.5 
    China  7.2  3.5  3.7 3.8 
    Corporate  (25.2) (19.5) (5.7)(5.9)
      
     
     
     
     
    Total $130.5 $94.6 $35.9 38.0%
      
     
     
     
     

            The change in operating income is attributable to the following:

     
      
      
      
      
      
     Change
    As a % of Consolidated
    Operating Income

     Change
    As a % of Segment
    Operating Income

     
     
     North
    America

     Europe
     China
     Corp.
     Total
     North
    America

     Europe
     China
     Corp.
     Total
     North
    America

     Europe
     China
     Corp.
     
     
     (Dollars in millions)

     
    Organic growth $6.4 $7.5 $6.8 $(5.7)$15.0 6.9%7.8%7.1%(5.9)%15.9%8.2%23.4%189.4%(28.5)%
    Foreign exchange  .8  .9  .3    2.0 .8 1.0 .3  2.1 1.0 3.0 8.3  
    Acquisitions  11.2  2.5  1.7    15.4 11.8 2.7 1.8  16.3 14.1 8.1 47.9  
    Restructuring/other  1.0  7.6  (5.1)   3.5 1.1 8.0 (5.4) 3.7 1.3 24.0 (143.1) 
      
     
     
     
     
     
     
     
     
     
     
     
     
     
     
    Total $19.4 $18.5 $3.7 $(5.7)$35.9 20.6%19.5%3.8%(5.9)%38.0%24.6%58.5%102.5%(28.5)%
      
     
     
     
     
     
     
     
     
     
     
     
     
     
     

            The organic growth in North America was primarily due to our increased gross profit from price increases and a favorable sales mix towards the wholesale market, benefits resulting from our completed manufacturing restructuring projects and product outsourcing, partially offset by increased net SG&A expense and inventory write-downs. In 2006, we did not record any costs associated with our manufacturing restructuring plan compared to costs of $1.0 million for 2005. The acquired growth was due to the inclusion of operating income from Alamo, Savard, Flexflow, Core, Dormont and Calflex.

            The organic growth in Europe was primarily due to increased gross profit from price and unit increases in the wholesale and OEM markets and benefits resulting from our completed manufacturing restructuring projects, partially offset by increased net SG&A expense. In 2006, we recorded a net gain of $6.0 million associated with our manufacturing restructuring plan compared to a charge of $1.5 million for 2005. We recorded a gain of $8.2 million for the building sales in Italy partially offset by $2.2 million primarily for severance costs. The acquired growth in Europe was due to the inclusion of the operating income from Electro Controls, Microflex, ATS, Kimsafe and Teknigas.

            The increase in organic growth in China was attributable to sales volume increase, favorable material purchases and improved manufacturing efficiencies associated with our wholly owned manufacturing plants, partially offset by increased net SG&A expense. The acquired growth in China was due to the inclusion of the operating income from Changsha and Ningbo. In 2006, we recorded $5.1 million of severance and accelerated depreciation costs associated with the planned move of our Chinese joint venture facility. We did not record any costs associated with our manufacturing restructuring plan in 2005.

            The decrease in organic operating income in Corporate was primarily attributable to incremental administration charges for variable compensation including costs incurred for compliance with FAS 123R, increased audit costs and increased pension costs, partially offset by lower costs incurred for SOX compliance.

            The net increase in operating income from foreign exchange was primarily due to the appreciation of the euro, Canadian dollar and yuan against the U.S. dollar.


            Interest Income.    Interest income increased $3.8 million, or 307.0%, for 2006 compared to 2005, primarily due to the investment of the residual proceeds from the private placement of $225.0 million 5.85% senior notes in April 2006 and the net proceeds from the public offering of 5.75 million shares of our Class A Common Stock in November 2006.

            Interest Expense.    Interest expense increased $11.7 million, or 113.9%, for 2006 compared to 2005, primarily due to interest expense associated with our $225.0 million 5.85% senior notes, increased debt levels for acquisitions made in 2005 and 2006, and an increase in the average variable rates charged on the revolving credit facility.

            Effective July 1, 2005, we entered into an interest rate swap for a notional amount of €25.0 million outstanding on our revolving credit facility. We swapped an adjustable rate of three month EURIBOR plus 0.6% for a fixed rate of 3.02%. We recorded a reduction to interest expense of approximately $0.7 million to recognize the fair value of the swap for 2006. The swap was terminated on October 3, 2006.

            Other (Income) Expense.    Other (income) expense increased $0.2 million, or 27.6%, for 2006 compared to 2005, primarily due to the gains on settlements of officers' life insurance policies.

            Minority interest.    Minority interest increased $2.1 million, or 622.3%, for 2006 compared to 2005, primarily due to the credit recorded for the 40% liability of our joint venture partner's share in the recording of the $5.1 million manufacturing restructuring costs.

            Income Taxes.    Our effective tax rate for continuing operations decreased to 33.6% in 2006 from 35.9% in 2005. The decrease is primarily due to higher earnings in our European and China segments. The shift in the mix of earnings to these segments causes our rate to decrease as these segments have lower effective tax rates than our worldwide average. The effect of the European earnings mix is partially offset by a higher effective tax from the gain on the sales of our Italian facilities. We were able to claim tax credits based on qualified fixed asset purchases in China that helped reduce the worldwide rate.

            Income From Continuing Operations.    Income from continuing operations for 2006 increased $22.1 million, or 40.1%, to $77.1 million, or $2.29 per common share, from $55.0 million, or $1.67 per common share, for 2005, in each case, on a diluted basis. Income from continuing operations for 2006 and 2005 includes income, net of tax, for our restructuring plan of $1.5 million, or $0.04 per share, and costs of $1.6 million, or ($0.05) per share, respectively. The gains on the sales of our buildings in Italy resulted in an after-tax gain of $5.1 million, or $0.15 per share. The appreciation of the Canadian dollar, euro and Chinese yuan against the U.S. dollar resulted in a positive impact on income from continuing operations of $1.3 million, or $0.04 per share, for 2006 compared to 2005.

            Loss From Discontinued Operations    We recorded a charge, net of tax, to discontinued operations for 2006 and 2005 of $3.4 million, or ($0.10) per common share, and $0.4 million, or ($0.01) per common share, respectively, in each case, on a diluted basis. In the third quarter of 2006, we recorded a pre-tax charge of $5.0 million due to a recent federal appellate court decision which affirmed that an arbitration panel could decide which deductible agreements between Watts and Zurich American Insurance Company (Zurich) would control Zurich's reimbursement claim for defense costs paid in the James Jones case. Other charges were primarily attributable to legal fees associated with the James Jones litigation, as described in Part I, Item 1. "Business-Product Liability, Environmental and Other Litigation Matters."

    Liquidity and Capital Resources

            We generated $91.7 million of cash from continuing operations in 2007. We experienced increases in inventory in North America and China. The increases were primarily due to increased raw material costs. There was also a decrease in accounts payable, accrued expenses and other liabilities, primarily in Europe and North America. In Europe, accounts payable declined in 2007 due to a decline in



    inventory. In North America, payments for cash compensation increased in 2007. Also, cash payments to cover income tax obligations were greater during 2007. Accounts receivable decreased in all three segments.

            We used $87.4 million of net cash for investing activities in 2007. We invested $37.8 million in capital equipment as part of our ongoing commitment to improve our manufacturing capabilities. We invested $27.5 million in investment grade auction rate securities. We used $18.1 million to fund the acquisitions of Topway. We paid $4.5 million for additional acquisition costs related to prior years acquisitions. We expect to invest approximately $35.0 in capital equipment in 2008.

            Recent distress in the markets has had an adverse impact on market activities including, among other things, volatility in security prices, diminished liquidity, rating downgrades of certain investments and declining valuations of others. We have assessed the implications of these factors on our current business and determined that there has not been a significant impact to our financial position, results of operations or liquidity during 2007.

            We used $66.5 million of net cash from financing activities in 2007. This was primarily due to payments of debt, payments for our stock repurchase program and dividend payments, partially offset by increased borrowings under our line of credit and tax benefits from the exercise of stock awards.

            In April 2006, we amended our revolving credit facility with a syndicate of banks to provide for multi-currency unsecured borrowings and stand-by letters of credit of up to $350.0 million and to extend the maturity date through April 2011. 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 our debt rating, depending on the applicable base rate and our bond rating. For 2007 the average interest rate under the revolving credit facility for euro-based borrowings was approximately 4.6%. There were no U.S. dollar borrowings at December 31, 2007. 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, 2007, we were in compliance with all covenants related to the revolving credit facility, had $234.4 million of unused and potentially available credit under the revolving credit facility and had $81.8 million of euro-based borrowings outstanding and $33.8 million for stand-by letters of credit outstanding on our revolving credit facility.

            We generated $0.1 million of net cash from discontinued operations in 2007. We paid approximately $0.5 million for defense costs and approximately $0.5 million for other legal costs we incurred in the James Jones Litigation. We also received $1.0 million for indemnity payments.

            Working capital (defined as current assets less current liabilities) as of December 31, 2007 was $667.0 million compared to $653.0 million as of December 31, 2006. This increase was primarily due to an increase in inventories and lower accounts payable, partially offset by an increase in accrued expenses. Cash and cash equivalents decreased to $290.3 million as of December 31, 2007 compared to $343.0 million as of December 31, 2006 primarily due to cash used to repurchase stock, fund capital expenditures and investments. The ratio of current assets to current liabilities was 3.3 to 1 as of December 31, 2007 compared to 3.2 to 1 as of December 31, 2006.

            We generated $83.0 million of cash from continuing operations for 2006. We experienced an increase in inventory and accounts receivable in North America, Europe and China. The increase in accounts receivable of $17.0 million was primarily due to increased sales volume and selling prices. The increase in inventory of $37.3 million was primarily due to increased cost of raw materials and planned increases in European safety stocks. The increase in inventory and accounts receivable was partially offset by increased accounts payable, accrued expenses and other liabilities of $29.5 million.

            We used $119.2 million of net cash for investing activities in 2006. We used $91.1 million to fund the acquisitions of Changsha, ATS, Calflex and Ningbo, Kimsafe and Teknigas, $1.9 million in



    additional costs related to 2005 acquisitions and $0.4 million to complete the planned increase of our ownership in Stern. We invested $11.8 million in investment grade auction rate securities and $44.7 million in capital equipment. Capital expenditures consisted of approximately $26.7 million for manufacturing machinery and equipment and approximately $18.0 million for the purchase of land and a building and for infrastructure improvements for a site in Italy. We subsequently entered into a sale-leaseback transaction with respect to the building. We received proceeds of $31.9 million, which primarily included $16.0 million related to the sale-leaseback in Italy and $13.4 million from the sales of two facilities in northern Italy. We also received proceeds from two buildings held for sale, totaling approximately $2.5 million during 2006.

            We generated $331.3 million of net cash from financing activities for 2006. On November 21, 2006, we completed a public offering of 5.75 million shares of newly issued Class A Common Stock at $40.00 per share. Net proceeds were approximately $218.6 million after taking into account underwriting discounts and expenses associated with the transaction. Additionally, we generated cash through the completion of our $225.0 million private placement of 5.85% notes in April 2006, increased borrowings under our line of credit for use in Europe and proceeds from the exercise of stock options, partially offset by payments of debt, dividend payments and debt issue costs.

            We generated $0.9 million of net cash by operations from discontinued operations in 2006. We also received approximately $2.8 million in cash for reimbursement of defense costs related to the James Jones Litigation. During 2006, we paid approximately $0.6 million for defense costs and approximately $0.5 million for indemnity costs we incurred in the James Jones Litigation.

            We generated $53.1 million of cash from continuing operations in 2005. We experienced an increase in accounts receivable in North America, Europe and China totaling $16.5 million. This increase is primarily due to increased sales volume. Additionally, we experienced an increase in inventories in North America, Europe and China totaling $20.3 million. 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 $14.3 million.

            We used $183.2 million of net cash for investing activities in 2005. We used $191.4 million to fund the acquisitions of Dormont, Core, Flexflow, Savard, Microflex, Alamo, Electro Controls, HF and Sea Tech. We also invested $18.6 million in capital equipment. We generated $26.6 million by the sale of investment securities.

            We generated $111.7 million 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 $3.8 million of debt owed to the former shareholders of Hunter Innovations.

            We used $1.1 million of net cash for discontinued operations in 2005. We received approximately $0.5 million 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 $2.1 million in cash for reimbursement of defense costs related to the James Jones case. During 2005, we paid approximately $2.5 million for defense costs, $0.6 million for legal costs and approximately $1.0 million for indemnity costs we incurred in the James Jones case.

            We had free cash flow of $54.5 million (a non-GAAP financial measure defined as net cash provided by continuing operations minus capital expenditures plus proceeds from sale of assets) during the year ended December 31, 2007 versus free cash flow of $70.2 million in 2006. This decrease in 2007 compared to 2006 was primarily due to the proceeds from the sale of property, plant and equipment in



    2006 partially offset by growth in cash generated by operations. 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-bearing liabilities less cash and cash equivalents plus total stockholders' equity) increased to 13.5% for 2007 from 11.4% for 2006. The increase resulted from an increase in net debt, partially offset by an increase in stockholders' equity.

            We had free cash flow of $70.2 million during the year ended December 31, 2006 versus free cash flow of $35.2 million in 2005. This increase in 2006 compared to 2005 was primarily due to growth in cash generated by operations, less net capital expenditures.

            We believe free cash flow to be an appropriate supplemental measure of our operating performance because it provides investors with a measure of our ability to generate cash, to repay debt and to fund acquisitions. We 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 provided by 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.

            A reconciliation of net cash provided by continuing operations to free cash flow is provided below:

     
     Years Ended December 31,
     
     
     2007
     2006
     2005
     
     
     (in millions)

     
    Net cash provided by continuing operations $91.7 $83.0 $53.1 
    Less: additions to property, plant, and equipment  (37.8) (44.7) (18.6)
    Plus: proceeds from the sale of property, plant, and equipment  .6  31.9  .7 
      
     
     
     
    Free cash flow $54.5 $70.2 $35.2 
      
     
     
     

            Our net debt to capitalization ratio is also a non-GAAP financial measure used by management. Management believes it to be an appropriate supplemental measure because it helps investors understand our ability to meet our financing needs and as a basis to evaluate our financial structure. 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,
     
     
     2007
     2006
     
     
     (in millions)

     
    Current portion of long-term debt $1.3 $7.5 
    Plus: long-term debt, net of current portion  432.2  441.7 
    Less: cash and cash equivalents  (290.3) (343.0)
      
     
     
    Net debt $143.2 $106.2 
      
     
     

            A reconciliation of capitalization is provided below:

     
     December 31,
     
     
     2007
     2006
     
     
     (in millions)

     
    Net debt $143.2 $106.2 
    Total stockholders' equity  915.5  826.6 
      
     
     
    Capitalization $1,058.7 $932.8 
      
     
     
    Net debt to capitalization ratio  13.5% 11.4%
      
     
     

            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 next 12 months. However, we may have to consider external sources of financing for any large future acquisitions.

            Our contractual obligations as of December 31, 2007 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 millions)

    Long-term debt obligations, including current maturities(a) $433.5 $1.3 $50.4 $81.8 $300.0
    Operating lease obligations  22.2  7.4  9.0  3.6  2.2
    Capital lease obligations(a)  16.7  1.4  2.8  2.8  9.7
    Pension contributions  9.4  .5  .2  .1  8.6
    Interest(b)  159.5  25.7  47.5  36.6  49.7
    Earnout payments(a)  3.8  3.8      
    Other(c)  23.0  20.7  .7  .9  .7
      
     
     
     
     
    Total $668.1 $60.8 $110.6 $125.8 $370.9
      
     
     
     
     

    (a)
    as recognized in the consolidated balance sheet

    (b)
    assumes the balance on the revolving credit facility remains at $81.8 million and the interest rate remains at approximately 5.4% for the presented periods

    (c)
    includes commodity, capital expenditure commitments and other benefits at December 31, 2007

            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 $45.0 million as of December 31, 2007 and $49.6 million as of December 31, 2006. 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. These instruments may exist or expire without being drawn down, therefore they do not necessarily represent future cash flow obligations.

            During the period January 1, 2008 to February 22, 2008, we repurchased 1.4 million shares of our Class A Common Stock for a total cost of $38.2 million. As of February 22, 2008, 0.8 million shares remain to be repurchased under the November 2007 stock repurchase program. Although we are under no obligation to repurchase these shares, we estimate that the total cost to repurchase the remaining 0.8 million shares would be approximately $20.0 million.

    Off-Balance Sheet Arrangements

            Except for operating lease commitments, we have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial



    condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

    Application of Critical Accounting Policies and Key Estimates

            The preparation of our consolidated financial statements.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. Except for the net increase in workers compensation reserves in the second quarter of 2007 primarily due to a change in estimate, there were no changes in accounting policies or significant changes in accounting estimates during 2007.

            We periodically discuss the development, selection and disclosure of the estimates with our 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 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 estimated reductions to revenue, made at the time of sale, for customer programs based on estimated purchase targets.

    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.

            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 creditworthiness 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 determined primarily 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 four 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

            Goodwill and intangible assets with indefinite lives are tested annually for impairment in accordance with the provisions of Financial Accounting Standards Board Statement No. 142 "Goodwill and Other Intangible Assets" (FAS 142). We use our judgment in assessing whether assets may have become impaired between annual impairment tests. We concluded that no impairment existed at October 28, 2007, the time of our latest annual review. We perform our annual test for indicators of goodwill and non-amortizable intangible assets impairment in the fourth quarter of our fiscal year or sooner if indicators of impairment exist.

            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. Because the liability is an estimate, the ultimate liability may be more or less than reported.

            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 determine the trend factors for product liability and workers' compensation liabilities based on consultation with outside actuaries.

            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 Part I, Item 1, "Business—Product Liability, Environmental and Other Litigation Matters." 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) and Financial Accounting Standards Board Statement No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)," (FAS 158). In applying FAS 87 and FAS 158, 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 these 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 variances 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.

    On November 29, 2004,January 1, 2007, we adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48). The purpose of FIN 48 is to increase the comparability in financial reporting of income taxes. FIN 48 requires that in order for a tax benefit to be booked in the income statement, the item in question must meet the more-likely-than-not (greater than 50% likelihood of being sustained upon examination by the taxing authorities) threshold. The adoption of FIN 48 did not have a material effect on our financial statements. No cumulative effect was booked through beginning retained earnings.

            As of the adoption date, we had gross unrecognized tax benefits of approximately $4.8 million, of which, approximately $4.2 million, if recognized, would affect the effective tax rate. The difference between the amount of unrecognized tax benefits and the amount that would affect the effective tax rate consists of the federal tax benefit of state income tax items. During 2007, we reduced our unrecognized tax benefits by approximately $0.6 million for a tax issue in Italy. As a result of the conclusion of state income tax audits, it is reasonably possible that the total amount of unrecognized tax benefits will change in the next twelve months. We estimate that it is reasonably possible that approximately $0.5 million of the currently remaining unrecognized tax benefit may be recognized by the end of 2008 as a result of the conclusion of the audits. Notwithstanding, we do not expect any further significant changes in the amounts of unrecognized tax benefits within the next twelve months.

            As of December 31, 2007, we had gross unrecognized tax benefits of approximately $3.7 million, of which approximately $3.2 million, if recognized, would affect the effective tax rate. The difference between the amount of unrecognized tax benefits and the amount that would impact the effective tax rate consists of the federal tax benefit of state income tax items.

    New Accounting Standards

            In December 2007, the FASB issued Financial Accounting Standards Board Statement (FAS) No. 151, “Inventory Costs”141 (R)," Business Combinations," (FAS 151).141R), which requires most identifiable assets, liabilities, non-controlling interests, and goodwill acquired in a business combination to be recorded at "full fair value." Under FAS 151 amends141R, all business combinations will be accounted for under the acquisition method. Significant changes, among others, from current guidance resulting from FAS 141R includes the requirement that contingent assets and liabilities and contingent consideration shall be recorded at estimated fair value as of the acquisition date, with any subsequent changes in Accounting Research Bulletinfair value charged or credited to earnings. Further, acquisition-related costs will be expensed rather than treated as part of the acquisition. FAS 141R is effective for periods beginning on or after December 15, 2008. We expect the adoption of FAS 141R will increase costs charged to operations.


            In December 2007, the FASB issued FAS No. 43, Chapter 4, “Inventory Pricing,”160, "Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB NO. 151," (FAS 160), which requires non-controlling interests (previously referred to clarifyas minority interest) to be treated as a separate component of equity, not as a liability as is current practice. FAS 160 applies to non-controlling interests and transactions with non-controlling interest holders in consolidated financial statements. FAS 160 is effective for periods beginning on or after December 15, 2008. We are currently evaluating the accountingeffect that FAS 160 will have on our consolidated financial statements.

            In February 2007, the FASB issued FAS No. 159, "The Fair Value Option for inventory costs. The provisions of this statement areFinancial Assets and Financial Liabilities—including an Amendment to FAS No. 115," (FAS 159), which permits entities to choose to measure many financial instruments and certain other items at fair value. FAS 159 is effective for financial statements issued for fiscal years beginning after JuneNovember 15, 2005, although early2007 and interim periods within those fiscal years. Earlier application is permitted.encouraged. We do not expect thatto measure our financial instruments at fair value and therefore we do not expect the adoption of FAS 159 to have a material impact of this statement will be material to theon our consolidated financial statements.

    On        In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements" (SAB 108), which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after November 15, 2006. The impact of SAB 108 was not material to our consolidated financial statements.

            In September 2006, the FASB issued FAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)" (FAS 158), which requires an employer to: (a) recognize in its statement of financial position an asset for a plan's overfunded status or a liability for a plan's underfunded status; (b) measure a plan's assets and its obligations that determine its funded status as of the end of the employer's fiscal year; and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes are reported in other comprehensive income. The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 16,15, 2006 for companies with publicly traded equity securities. The requirement to measure plan assets and benefit obligations as of the date of the employer's fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008, although earlier adoption is permitted. As a result of the requirement to recognize the funded status of our benefit plans as of December 31, 2006, we recorded an increase in our pension liability of approximately $8.3 million, a decrease of approximately $1.3 million in other assets: other, net and a decrease in accumulated other comprehensive income of approximately $5.8 million, net of tax. We have early-adopted the measurement date provisions of FAS 158 effective January 1, 2007. Our pension plans previously used a September 30 measurement date. All plans are now measured as of December 31, consistent with our fiscal year end. The non-cash effect of the adoption of the measurement date provisions of FAS 158 was not material and there was no effect on our results of operations.

            In September 2006, the FASB issued FAS No. 157, "Fair Value Measurements" (FAS 157), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. For financial assets and liabilities, FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. For non-financial assets and liabilities, FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. Earlier application is encouraged provided that the reporting company has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year. We do not expect the adoption of FAS 157 will have a material impact on our consolidated financial statements.


            In July 2006, the FASB issued Financial Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes." FIN 48 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, based on the technical merits. This interpretation also provides guidance on measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adopted the provisions of FIN 48 as of January 1, 2007 and the impact was not material to our consolidated financial statements.

            In March 2006, the FASB issued FAS No. 156, "Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140" (FAS 156). FAS 156 amends FAS Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," with respect to the accounting for separately recognized servicing assets and servicing liabilities. FAS 156 addresses the recognition and measurement of separately recognized servicing assets and liabilities and provides an approach to simplify efforts to obtain hedge-like (offset) accounting. We adopted FAS 156 as of January 1, 2007 and the impact was not material to our consolidated financial statements.

            In February 2006, the FASB issued FAS No. 155, "Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140" (FAS 155). FAS 155 amends FAS 133, "Accounting for Derivatives and Hedging Activities," and FAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," and allows an entity to remeasure at fair value a hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation from the host, if the holder irrevocably elects to account for the whole instrument on a fair value basis. Subsequent changes in the fair value of the instrument would be recognized in earnings. We adopted FAS 155 as of January 1, 2007 and the impact was not material to our consolidated financial statements.

            In May 2005, the FASB issued FAS No. 154, "Accounting Changes and Error Correction Replacement of APB Opinion No. 20 and FASB Statement No. 3" (FAS 154). FAS 154 replaces APB Opinion No. 20, "Accounting Changes" (APB 20), and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements," and changes the requirements for the accounting for and reporting of a change in accounting principle. APB 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. FAS 154 requires retrospective application to prior periods' financial statements of changes in accounting principle. FAS 154 defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used. FAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. The impact of FAS 154 was not material to our 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 (revised 2004), that requires companies to expense the value of employee stock options and similar awards. The statement is effective for public companies for interim and annual periods beginning after June 15, 2005, and applies to all outstanding and unvested SBP awards at a company’s adoption date. The impact of this statement on our results of operations is estimated to be approximately ($0.02) per share.

    On December 16, 2004, FASB issued Financial Accounting Standards Board StatementFAS No. 153, “Exchanges"Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions”Transactions" (FAS 153). The amendments 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 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 an 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 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The impact of FAS 153 was not material to our consolidated financial statements.


            In November 2004, the FASB issued FAS 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 shall be applied prospectively. We do not expect that theare effective for fiscal years beginning after June 15, 2005. The impact of this statement will beFAS 151 was not material to theour consolidated financial statements.


    Item 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

    We use derivative financial instruments primarily to reduce exposure to adverse fluctuations in foreign exchange rates, interest rates and 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 or the U.S. or Canadian dollar. We use foreign currency forward exchange contracts and options 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. TheFor 2007, the amounts recorded in other comprehensive income for the change in the fair value of thesuch contracts in our Canadian operations were immaterial for 2004 and 2003.was immaterial.

    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. Interest rate market risk for our interest rate swap was immaterial for 2004 and 2003. Information about our long-term debt including principal amounts and related interest rates appears in Notenote 11 of Notesnotes to Consolidated Financial Statements.consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2007.

    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 2004 or 2003.


    Item 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

    The index to financial statements is includedlisted in page 47section (a) (1) of "Part IV, Item 15. Exhibits and Financial Statement Schedules" of this Report.annual report are 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 applyapplies 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, ourthe Chief Executive Officer and Chief Financial Officer determinedconcluded that, as of December 31, 2004,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.forms and are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act are accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. There werewas no changeschange in our internal controlscontrol over financial reporting that occurred during the period covered by this reportquarter ended December 31, 2007, that havehas materially affected, or areis reasonably likely to materially affect, our internal controlscontrol over financial reporting. In connection with these rules, we will continue to review and document our disclosure controls and procedures, including our internal controlscontrol over financial reporting, and procedures for financial reporting. We may from time to time make changes in our controls and procedures aimed at enhancing their effectiveness and to ensure that our systems evolve with our businessbusiness.


    .


    Management’sManagement'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’sCompany'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’sCompany'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’sCompany'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 theour Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’sCompany's internal control over financial reporting as of December 31, 2004.2007. 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, 2004.2007.


    The audited consolidated financial statements of the Company include the results of Orion Enterprises,Topway Global Inc., which the Company acquired on May 21, 2004, TEAM Precision Pipework, Ltd., which the Company acquired on April 16, 2004, and Flowmatic Systems, Inc., which the Company acquired on January 5, 2004,November 9, 2007, but management’smanagement's assessment does not include an assessment of the internal control over financial reporting of these entities. None of these entities is significant (withinthis entity.

            The independent registered public accounting firm that audited the meaning of Rule 11-01(b) of Regulation S-X) to theCompany's consolidated financial statements ofincluded elsewhere in this Annual Report on Form 10-K has issued an attestation report on 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’sCompany's internal control over financial reporting and issued an attestation report.reporting. 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's internal control over financial reporting as of December 31, 2004,2007, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.Commission (COSO). Watts Water Technologies, Inc.’s's management is responsible for maintaining effective internal control over financial reporting, and for its assessment ofincluded in the effectiveness of internal control over financial reporting.accompanyingManagement's Annual Report on 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.’sCompany'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,assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control andbased on the assessed risk. Our audit also included 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’scompany'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’scompany'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’scompany'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, 2004, is fairly stated, in all material respects, based on criteria established inInternal 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, 2004,2007, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.Commission (COSO).

    Watts Water Technologies, Inc. acquired Orion Enterprises, Inc., TEAM Precision Pipework, Ltd., and Flowmatic Systems,Topway Global Inc. during 2004 (collectively the 2004 acquisitions)2007 (the 2007 acquisition). Management excluded from its assessment of internal control over financial reporting, the 2004 acquisitions2007 acquisition representing consolidated total assets of $80$19 million and consolidated revenues of $33$2 million included in the consolidated financial statements of Watts Water Technologies, Inc. as of and for the year ended December 31, 2004.2007. 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 2004 acquisitions.2007 acquisition.

    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, 20042007 and 2003,2006, 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, 2004,2007, and the



    related financial statement schedule, and our report dated March 14, 2005February 29, 2008 expressed an unqualified opinion on those consolidated financial statements.statements and financial statement schedule.

    Boston, MA

    March 14, 2005


    Boston, Massachusetts
    February 29, 2008


    Item 9B.    OTHER INFORMATION.

    None.


    44




    PART III


    Item 10.    DIRECTORS, AND EXECUTIVE OFFICERS OF THE REGISTRANT.AND CORPORATE GOVERNANCE.

    Directors

    The information appearing under the caption “Information as to Nominees for Director” in the Registrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 4, 2005 is incorporated herein by reference. With respect to Directors and Executive Officers, the information appearing under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Registrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 4, 2005 is incorporated herein by reference.

    Audit Committee

    The information appearing under the caption “Corporate Governance—Committees of the Board” in the Registrants Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 4, 2005 is incorporated herein by reference.

    Executive Officers

    Information with respect to the executive officers of the Company is set forth in Part I, Item 1 of this Report under the caption “Executive"Executive Officers and Directors.”

    CodeDirectors" and is incorporated herein by reference. The information provided under the captions "Information as to Nominees for Director," "Corporate Governance," and "Section 16(a) Beneficial Ownership Reporting Compliance" in our definitive Proxy Statement for our 2008 Annual Meeting of EthicsStockholders to be held on May 14, 2008 is incorporated herein by reference.

    We have adopted a Code of Business Conduct and Ethics applicable to all officers, employees and Board members. The Code of Business Conduct and Ethics is posted on our website, www.wattswater.com. In order to access this portionin the Investor Relations section of our website, click on the “Investors” tab. Thewww.wattswater.com. We will provide you with a print copy of our Code of Business Conduct and Ethics is located under the “Codefree of Conduct” caption.charge on written request to Lester J. Taufen, Secretary, Watts Water Technologies, Inc., 815 Chestnut Street, North Andover, MA 01845. Any amendments to, or waivers of, the Code of Business Conduct and Ethics which appliesapply 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.

            The information provided under the captions "Director Compensation," "Corporate Governance," "Compensation Discussion and Analysis," "Executive Compensation," "Compensation Committee Interlocks and Insider Participation," and "Compensation Committee Report" in our definitive Proxy Statement for our 2008 Annual Meeting of Stockholders to be held on May 14, 2008 is incorporated herein by reference.

            The "Compensation Committee Report" contained in our Proxy Statement shall not be deemed "soliciting material" or "filed" with the Securities and Exchange Commission or otherwise subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any filings under the Securities Act of 1933 or the Exchange Act, except to the extent we specifically request that such information be treated as soliciting material or specifically incorporate such information by reference into a document filed under the Securities Act or Exchange Act.


    Item 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

    The information appearing under the caption “Compensation Arrangements”"Principal Stockholders" in the Registrant’sRegistrant's Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 4, 200514, 2008 is incorporated herein by reference.

    Item 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

    The information appearing under the caption “Principal Stockholders” in the Registrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 4, 2005 is incorporated herein by reference.


    Securities Authorized for Issuance Under Equity Compensation Plans

    The following table givesprovides information as of December 31, 2007, about the shares of classClass A common stockCommon Stock that may be issued upon the exercise of stock options issued under the Company’sCompany's 2004 Stock Incentive Plan, 1986 Incentive Stock Option Plan, 1991 Directors’Directors' Non-Qualified Stock Option Plan, 1996 Stock Option Plan and 2003 Non-Employee Directors' Stock Option Plan and the settlement of restricted stock units granted



    under our Management Stock Purchase Plan as well as the number of shares remaining for future issuance under our 2004 Stock Incentive Plan and the 2003 Non-Employee Directors’Management Stock Option Plan, as of December 31, 2004.Purchase Plan.

     

     

    Equity Compensation Plan Information

     

    Plan category

     

     

     

    Number of securities to be
    issued upon exercise of
    outstanding options,
    warrants and rights

     

    Weighted Average exercise
    price of outstanding options,
    warrants and rights

     

    Number of securities remaining
    available for future issuance under
    equity compensation plan
    (excluding securities referenced in
    column (a))

     

     

     

    (a)

     

    (b)

     

    (c)

     

    Equity compensation plans approved by security holders

     

     

    1,267,041

    (1)

     

     

    $

    11.38

     

     

     

    3,116,645

    (2)

     

    Equity compensation plans not approved by security holders

     

     

    None

     

     

     

    None

     

     

     

    None

     

     

    Total

     

     

    1,267,041

    (1)

     

     

    $

    11.38

     

     

     

    3,116,645

    (2)

     

     
     Equity Compensation Plan Information
      
     
     
     Number of securities remaining
    available for future issuance under
    equity compensation plan
    (excluding securities reflected in
    column (a))
    (c)

     
    Plan Category

     Number of securities to be
    issued upon exercise of
    outstanding options,
    warrants and rights
    (a)

     Weighted-average exercise
    price of outstanding options,
    warrants and rights
    (b)

     
    Equity compensation plans approved by security holders 1,533,767(1)$24.64 3,078,132(2)
    Equity compensation plans not approved by security holders None  None None 
    Total 1,533,767(1)$24.64 3,078,132(2)

    (1)
    Represents 999,7201,168,233 outstanding options under the 1986 Incentive Stock Option Plan, 1991 Directors’Directors' Non-Qualified Stock Option Plan, 1996 Incentive Stock Option Plan, 2003 Non-Employee Directors’Directors' Stock Option Plan and the 2004 Stock Incentive Plan, and 267,321365,534 outstanding restricted stock units under the Management Stock Purchase Plan.



    (2)
    Includes 2,746,0002,074,517 shares available for future issuance under the 2004 Stock Incentive Plan, and 370,645 restricted stock units1,003,615 shares available for future issuance under the Management Stock Purchase Plan.



    Item 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

    The information appearingprovided under the caption “Compensation Arrangements—Certain Relationshipscaptions "Corporate Governance" and "Policies and Procedures for Related Transactions”Person Transactions" in the Registrant’sour definitive Proxy Statement relating to thefor our 2008 Annual Meeting of Stockholders to be held on May 4, 200514, 2008 is incorporated herein by reference.


    Item 14.    PRINCIPAL ACCOUNTINGACCOUNTANT FEES AND SERVICES.

    The information appearingprovided under the caption “Ratification"Ratification of Independent Auditors”Registered Public Accounting Firm" in the Registrant’sour definitive Proxy Statement relating to thefor our 2008 Annual Meeting of Stockholders to be held on May 4, 200514, 2008 is incorporated herein by reference.


    46




    PART IV

    Item 15.    EXHIBITS AND FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.SCHEDULES.

    (a)(1) Financial Statements

    The following financial statements are included in a separate section of this Report commencing on the page numbers specified below:

    (a)(2) Schedules

            

    All other 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.

    (a)(3) Exhibits

    Exhibit No.

    Description

    2.1

    Distribution Agreement dated as of October 1, 1999 between the Registrant and CIRCOR International, Inc. (14)

    3.1

    Restated Certificate of Incorporation, as amended (1)

    3.2

    Amended and Restated By-Laws, as amended (1)

    9.1

    The Amended and Restated George B. Horne Voting Trust Agreement—1997 dated as of September 14, 1999 (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 dated February 10, 2004 (17)

    10.4*

    1996 Stock Option Plan, dated October 15, 1996 (10), and First Amendment dated February 28, 2003 (3)


            

    10.5*

    1986 Incentive Stock Option Plan, as amended (17)

    10.6*

    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)

    10.7*

    Watts Industries, Inc. Pension Plan (amended and restated effective as of January 1, 1997) (3) and First Amendment dated October 25, 2002 (3)

    10.8

    Registration Rights Agreement dated July 25, 1986 (5)

    10.9*

    Executive Incentive Bonus Plan, as amended and restated (21)

    10.10

    Amended and Restated Stock Restriction Agreement dated October 30, 1991 (2), and Amendment dated August 26, 1997 (12)

    10.11*

    Watts Industries, Inc. 1991 Non-Employee Directors’ Nonqualified Stock Option Plan (6), and Amendment No. 1 (9)

    10.12*

    Watts Industries, Inc. 2003 Non-Employee Directors’ Stock Option Plan (3)

    10.13

    Letter of Credit issued by Fleet National Bank (as successor to BankBoston, N.A.) for the benefit of Zurich-American Insurance Company dated June 25, 1999, as amended January 22, 2001 (17)

    10.14

    Form of Stock Restriction Agreement for management stockholders (5)

    10.15

    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)

    10.16*

    Watts Water Technologies, Inc. Management Stock Purchase Plan, as amended and restated (21)

    10.17

    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)

    10.18

    Relocation Management Agreement between the Registrant and Cendant Mobility Services Corporation dated April 6, 2004 (18)

    10.19

    Note Purchase Agreement dated as of May 15, 2003 between the Registrant and the Purchasers namedThe exhibits listed 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)

    10.20

    Form of 4.87% Senior Note due May 15, 2010 (7)

    10.21

    Form of 5.47% Senior Note due May 15, 2013 (7)

    10.22*

    Watts Water Technologies, Inc. 2004 Stock Incentive Plan (17)

    10.23*

    Non-Employee Director Compensation Arrangements (21)

    10.24*

    Watts Water Technologies, Inc. Supplemental Employees Retirement Plan as Amended and Restated Effective May 4, 2004 (19)

    10.25*

    Form of Incentive Stock Option Agreement under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (20)


    10.26*

    Form of Non-Qualified Stock Option Agreement 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 Employees under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (20)

    10.29*

    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)Exhibit Index immediately preceding the exhibits are filed with the Securities and Exchange Commission on June 10, 2003.

    (2)          Incorporated by reference to the Registrant’s Form 8-K dated November 14, 1991.

    (3)          Incorporated by reference to the Registrant’sas part of this Annual Report on Form 10-K for the year ended December 31, 2002.

    (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.

    (7)          Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for quarter ended June 30, 2003.

    (8)          Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended June 30, 1995.

    (9)          Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended June 30, 1996.

    (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 Form 8-K dated September 4, 1996.

    (12)   Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended June 30, 1997.10-K.


    (13)   Incorporated by reference to notes to Consolidated Financial Statements, Note 2 of this Report.

    (14)
       Incorporated by reference to exhibit 2.1 to CIRCOR International, Inc. Amendment No. 1 to its registration statement on Form 10 filed on September 22, 1999. (File No. 000-26961).SIGNATURES

    (15)   Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended June 30, 1999.

    (16)   Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for quarter ended September 30, 2000.

    (17)   Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003.

    (18)   Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 28, 2004.

    (19)   Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 27, 2004.

    (20)   Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 26, 2004.

    (21)   Incorporated by reference to the Registrant’s Current Report on Form 8-K dated February 8, 2005.

    *                    Management contract or compensatory plan or arrangement.

    50




    SIGNATURES

    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:



    By:


    /s/S/ PATRICK S. O’KEEFEO'KEEFE


    Patrick S. O’Keefe

    O'Keefe
    Chief Executive Officer
    President and Director


    DATED: March 14, 2005

    February 29, 2008




            

    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/S/ PATRICK S. O’KEEFEO'KEEFE


    Patrick S. O'Keefe

    Chief Executive Officer,

    March 14, 2005

    Patrick S. O’Keefe


    President and Director

    February 29, 2008


    /s/S/ WILLIAM C. MCCARTNEY


    William C. McCartney



    Chief Financial Officer and Treasurer

    March 14, 2005

    William C. McCartney


    (Principal Financial and Accounting Officer), Secretary



    February 29, 2008


    /s/S/ TIMOTHY P. HORNE

    Director

    March 14, 2005


    Timothy P. Horne



    Director



    February 29, 2008


    /s/S/ ROBERT L. AYERS


    Robert L. Ayers


    Director


    February 29, 2008

    /S/ RICHARD J. CATHCART
    Richard J. Cathcart.


    Director


    February 29, 2008

    /S/ RALPH E. JACKSON, JR.

    Director

    March 14, 2005


    Ralph E. Jackson, Jr.



    Director



    February 29, 2008


    /s/S/ KENNETH J. MCAVOY

    Director

    March 14, 2005


    Kenneth J. McAvoy



    Director



    February 29, 2008



    /s/S/ JOHN K. MCGILLICUDDY

    Director

    March 14, 2005


    John K. McGillicuddy



    Director



    February 29, 2008


    /s/S/ GORDON W. MORAN


    Gordon W. Moran



    Chairman of the Board


    March 14, 2005


    February 29, 2008

    Gordon W. Moran


    /s/S/ DANIEL J. MURPHY, III

    Director

    March 14, 2005


    Daniel J. Murphy, III



    Director



    February 29, 2008

    51




    Report of Independent 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, 20042007 and 2003,2006, 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, 2004.2007. 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 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 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, 20042007 and 2003,2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004,2007, in conformity with U.S. generally accepted 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 discussed in Note 2 to the consolidated financial statements, Watts Water Technologies, Inc. adopted Statement of Financial Accounting Standard No. 123(R), "Share Based Payment" effective January 1, 2002,2006, utilizing the Company changed its methodmodified prospective application transition method.

            Also, as discussed in Note 2 to the consolidated financial statements, Watts Water Technologies, Inc. adopted the recognition and disclosure provisions of accounting for goodwill and other intangible assets based on the adoptionStatement of Financial Accounting StandardsStandard No. 142, “Goodwill158, "Employers' Accounting for Defined Benefit Pension and Other Intangible Assets.”Post Retirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)" effective December 31, 2006 and its measurement date provisions on January 1, 2007.

            Also, as discussed in Note 2 to the consolidated financial statements, Watts Water Technologies, Inc. adopted Financial Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" effective January 1, 2007.

    We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Watts Water Technologies, Inc.’s's internal control over financial reporting as of December 31, 2004,2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 14, 2004,February 29, 2008, expressed an unqualified opinion on management’s assessment of, and the effective operation of internal control over financial reporting.

    Boston, Massachusetts

    March 14, 2005

    52
    Boston, Massachusetts
    February 29, 2008





    Watts Water Technologies, Inc. and Subsidiaries

    Consolidated Statements of Operations


    (Amounts in thousands,millions, except per share information)

     

     

    Years Ended December 31,

     

     

     

    2004

     

    2003

     

    2002

     

    Net sales

     

    $

    824,558

     

    $

    701,859

     

    $

    615,526

     

    Cost of goods sold

     

    533,997

     

    461,994

     

    406,806

     

    GROSS PROFIT

     

    290,561

     

    239,865

     

    208,720

     

    Selling, general and administrative expenses

     

    206,866

     

    169,438

     

    150,553

     

    Restructuring and other charges

     

    95

     

    426

     

    638

     

    OPERATING INCOME

     

    83,600

     

    70,001

     

    57,529

     

    Other (income) expense:

     

     

     

     

     

     

     

    Interest income

     

    (1,135

    )

    (1,043

    )

    (992

    )

    Interest expense

     

    10,564

     

    12,108

     

    8,692

     

    Minority interest

     

    1,203

     

    (554

    )

    (117

    )

    Other

     

    296

     

    748

     

    (272

    )

     

     

    10,928

     

    11,259

     

    7,311

     

    INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

     

    72,672

     

    58,742

     

    50,218

     

    Provision for income taxes

     

    23,934

     

    22,323

     

    17,596

     

    INCOME FROM CONTINUING OPERATIONS

     

    48,738

     

    36,419

     

    32,622

     

    Loss from discontinued operations, net of taxes of $1,156 in 2004 and $1,914 in 2003

     

    (1,918

    )

    (3,057

    )

     

    NET INCOME

     

    $

    46,820

     

    $

    33,362

     

    $

    32,622

     

    Basic EPS

     

     

     

     

     

     

     

    Income (loss) per share:

     

     

     

     

     

     

     

    Continuing operations

     

    $

    1.51

     

    $

    1.33

     

    $

    1.22

     

    Discontinued operations

     

    (0.06

    )

    (0.11

    )

     

    NET INCOME

     

    $

    1.45

     

    $

    1.22

     

    $

    1.22

     

    Weighted average number of shares

     

    32,276

     

    27,455

     

    26,718

     

    Diluted EPS

     

     

     

     

     

     

     

    Income (loss) per share:

     

     

     

     

     

     

     

    Continuing operations

     

    $

    1.49

     

    $

    1.32

     

    $

    1.21

     

    Discontinued operations

     

    (0.06

    )

    (0.11

    )

     

    NET INCOME

     

    $

    1.43

     

    $

    1.21

     

    $

    1.21

     

    Weighted average number of shares

     

    32,719

     

    27,692

     

    27,056

     

    Dividends per share

     

    $

    0.28

     

    $

    0.25

     

    $

    0.24

     

     
     Years Ended December 31,
     
     
     2007
     2006
     2005
     
    Net sales $1,382.3 $1,230.8 $924.3 
    Cost of goods sold  920.7  805.8  599.6 
      
     
     
     
     GROSS PROFIT  461.6  425.0  324.7 
    Selling, general and administrative expenses  332.7  300.2  229.4 
    Restructuring and other (income) charges  3.2  (5.7) .7 
      
     
     
     
     OPERATING INCOME  125.7  130.5  94.6 
      
     
     
     
    Other (income) expense:          
     Interest income  (14.5) (5.0) (1.2)
     Interest expense  26.9  22.1  10.4 
     Minority interest  (2.8) (1.8) .3 
     Other  2.3�� (.9) (.7)
      
     
     
     
       11.9  14.4  8.8 
      
     
     
     
    INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES  113.8  116.1  85.8 
    Provision for income taxes  36.2  39.0  30.8 
      
     
     
     
     INCOME FROM CONTINUING OPERATIONS  77.6  77.1  55.0 
    Loss from discontinued operations, net of taxes of $0.2 in 2007, $2.1 in 2006 and $0.3 in 2005  (.2) (3.4) (.4)
      
     
     
     
     NET INCOME $77.4 $73.7 $54.6 
      
     
     
     
    Basic EPS          
    Income (loss) per share:          
     Continuing operations $2.01 $2.32 $1.69 
     Discontinued operations  (.01) (.10) (.01)
      
     
     
     
     NET INCOME $2.00 $2.21 $1.68 
      
     
     
     
    Weighted average number of shares  38.6  33.3  32.5 
      
     
     
     
    Diluted EPS          
    Income (loss) per share:          
     Continuing operations $1.99 $2.29 $1.67 
     Discontinued operations  (.01) (.10) (.01)
      
     
     
     
     NET INCOME $1.99 $2.19 $1.66 
      
     
     
     
    Weighted average number of shares  39.0  33.7  33.0 
      
     
     
     
    Dividends per share $.40 $.36 $.32 
      
     
     
     

    The accompanying notes are an integral part of these consolidated financial statements.


    53




    Watts Water Technologies, Inc. and Subsidiaries

    Consolidated Balance Sheets


    (Amounts in thousands,millions, except share information)

     

     

    December 31,

     

     

     

    2004

     

    2003

     

    ASSETS

     

     

     

     

     

    CURRENT ASSETS:

     

     

     

     

     

    Cash and cash equivalents

     

    $

    65,913

     

    $

    145,001

     

    Investment securities

     

    26,600

     

    4,000

     

    Trade accounts receivable, less allowance for doubtful accounts of $7,551 in 2004
    and $7,772 in 2003

     

    150,073

     

    135,170

     

    Inventories, net

     

    203,044

     

    154,121

     

    Prepaid expenses and other assets

     

    14,359

     

    10,355

     

    Deferred income taxes

     

    27,463

     

    23,889

     

    Assets of discontinued operations

     

    10,227

     

    10,358

     

    Total Current Assets

     

    497,679

     

    482,894

     

    PROPERTY, PLANT AND EQUIPMENT, NET

     

    150,689

     

    145,566

     

    OTHER ASSETS:

     

     

     

     

     

    Goodwill

     

    226,178

     

    184,901

     

    Other

     

    49,702

     

    27,557

     

    TOTAL ASSETS

     

    $

    924,248

     

    $

    840,918

     

    LIABILITIES AND STOCKHOLDERS’ EQUITY

     

     

     

     

     

    CURRENT LIABILITIES:

     

     

     

     

     

    Accounts payable

     

    $

    73,606

     

    $

    73,607

     

    Accrued expenses and other liabilities

     

    64,604

     

    54,843

     

    Accrued compensation and benefits

     

    29,679

     

    18,466

     

    Current portion of long-term debt

     

    4,981

     

    11,689

     

    Liabilities of discontinued operations

     

    24,303

     

    16,031

     

    Total Current Liabilities

     

    197,173

     

    174,636

     

    LONG-TERM DEBT, NET OF CURRENT PORTION

     

    180,562

     

    179,061

     

    DEFERRED INCOME TAXES

     

    19,578

     

    15,978

     

    OTHER NONCURRENT LIABILITIES

     

    26,632

     

    25,085

     

    MINORITY INTEREST

     

    7,515

     

    9,767

     

    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, 25,049,338 shares in 2004 and 24,459,121 shares in 2003

     

    2,505

     

    2,446

     

    Class B Common Stock, $.10 par value; 25,000,000 shares authorized; 10 votes per share; issued and outstanding, 7,343,880 shares in 2004 and 7,605,224 shares in 2003

     

    734

     

    761

     

    Additional paid-in capital

     

    140,172

     

    132,983

     

    Retained earnings

     

    324,145

     

    286,396

     

    Deferred compensation

     

    (1,386

    )

     

    Accumulated other comprehensive income

     

    26,618

     

    13,805

     

    Total Stockholders’ Equity

     

    492,788

     

    436,391

     

    TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

     

    $

    924,248

     

    $

    840,918

     

     
     December 31,
     
     2007
     2006
    ASSETS      
    CURRENT ASSETS:      
     Cash and cash equivalents $290.3 $343.0
     Short-term investment securities  22.0  11.8
     Trade accounts receivable, less allowance for doubtful accounts of $14.9 million in 2007 and $10.5 million in 2006  235.7  228.5
     Inventories, net  341.6  316.4
     Prepaid expenses and other assets  18.6  15.9
     Deferred income taxes  38.1  26.7
     Assets of discontinued operations  10.4  10.1
      
     
      Total Current Assets  956.7  952.4
    PROPERTY, PLANT AND EQUIPMENT, NET  223.7  206.2
    OTHER ASSETS:      
     Goodwill  385.8  356.1
     Long-term investment securities  17.0  
     Other, net  146.1  146.2
      
     
    TOTAL ASSETS $1,729.3 $1,660.9
      
     
    LIABILITIES AND STOCKHOLDERS' EQUITY      
    CURRENT LIABILITIES:      
     Accounts payable $108.0 $121.0
     Accrued expenses and other liabilities  113.6  100.4
     Accrued compensation and benefits  38.2  42.6
     Current portion of long-term debt  1.3  7.5
     Liabilities of discontinued operations  28.6  27.9
      
     
      Total Current Liabilities  289.7  299.4
    LONG-TERM DEBT, NET OF CURRENT PORTION  432.2  441.7
    DEFERRED INCOME TAXES  42.9  34.5
    OTHER NONCURRENT LIABILITIES  45.6  52.7
    MINORITY INTEREST  3.4  6.0
    STOCKHOLDERS' EQUITY:      
     Preferred Stock, $0.10 par value; 5,000,000 shares authorized; no shares issued or outstanding    
     Class A Common Stock, $0.10 par value; 80,000,000 shares authorized; 1 vote per share; issued and outstanding, 30,600,056 shares in 2007 and 31,239,111 shares in 2006  3.1  3.1
     Class B Common Stock, $0.10 par value; 25,000,000 shares authorized; 10 votes per share; issued and outstanding, 7,293,880 shares in 2007 and in 2006  .7  .7
     Additional paid-in capital  377.6  367.8
     Retained earnings  465.4  429.6
     Accumulated other comprehensive income  68.7  25.4
      
     
      Total Stockholders' Equity  915.5  826.6
      
     
    TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,729.3 $1,660.9
      
     

    The accompanying notes are an integral part of these consolidated financial statements.


    54




    Watts Water Technologies, Inc. and Subsidiaries

    Consolidated Statements of Stockholders’Stockholders' Equity


    (Amounts in thousands,millions, except share information)

     

     

    Class A
    Common Stock

     

    Class B
    Common Stock

     

    Additional
    Paid-In

     

    Retained

     

    Deferred

     

    Accumulated
    Other
    Comprehensive

     

    Total
    Stockholders’

     

     

     

    Shares

     

     Amount 

     

    Shares

     

    Amount

     

    Capital

     

    Earnings

     

    Compensation

     

    Income (loss)

     

    Equity

     

    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 and other

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    16,475

     

     

     

    16,475

     

     

    Pension plan additional minimum liability, net of tax of $2,444

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    (3,988

    )

     

     

    (3,988

    )

     

    Comprehensive income

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    45,109

     

     

    Shares of Class B Common Stock converted to Class A Common Stock

     

    550,000

     

     

    55

     

     

    (550,000

    )

     

    (55

    )

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Shares of Class A Common Stock issued upon the exercise of stock options

     

    501,646

     

     

    50

     

     

     

     

     

     

     

     

     

    6,297

     

     

     

     

     

     

     

     

     

     

     

     

     

    6,347

     

     

    Tax benefit for stock options exercised

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    855

     

     

     

     

     

     

     

     

     

     

     

     

     

    855

     

     

    Net change in restricted stock units

     

    35,327

     

     

    3

     

     

     

     

     

     

     

     

     

    798

     

     

     

     

     

     

     

     

     

     

     

     

     

    801

     

     

    Common Stock dividends

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    (6,490

    )

     

     

     

     

     

     

     

     

     

    (6,490

    )

     

    Balance at December 31, 2002

     

    18,863,482

     

     

    $

    1,886

     

     

    8,185,224

     

     

    $

    819

     

     

     

    $

    45,132

     

     

    $

    259,893

     

     

    $

     

     

     

    $

    (11,794

    )

     

     

    $

    295,936

     

     

    Comprehensive income:

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Net income

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    33,362

     

     

     

     

     

     

     

     

     

     

    33,362

     

     

    Cumulative translation adjustment and other

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    27,440

     

     

     

    27,440

     

     

    Pension plan additional minimum liability, net of tax of $1,205

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    (1,841

    )

     

     

    (1,841

    )

     

    Comprehensive income

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    58,961

     

     

    Shares of Class B Common Stock converted to Class A Common Stock

     

    580,000

     

     

    58

     

     

    (580,000

    )

     

    (58

    )

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Shares of Class A Common Stock issued upon the exercise of stock options

     

    301,011

     

     

    30

     

     

     

     

     

     

     

     

     

    4,029

     

     

     

     

     

     

     

     

     

     

     

     

     

    4,059

     

     

    Tax benefit for stock options exercised

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    423

     

     

     

     

     

     

     

     

     

     

     

     

     

    423

     

     

    Net change in restricted stock units

     

    114,628

     

     

    12

     

     

     

     

     

     

     

     

     

    1,333

     

     

     

     

     

     

     

     

     

     

     

     

     

    1,345

     

     

    Shares of Class A Common Stock issued in Stock Offering net of offering costs of $4,874

     

    4,600,000

     

     

    460

     

     

     

     

     

     

     

     

     

    82,066

     

     

     

     

     

     

     

     

     

     

     

     

     

    82,526

     

     

    Common Stock dividends

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    (6,859

    )

     

     

     

     

     

     

     

     

     

    (6,859

    )

     

    Balance at December 31, 2003

     

    24,459,121

     

     

    $

    2,446

     

     

    7,605,224

     

     

    $

    761

     

     

     

    $

    132,983

     

     

    $

    286,396

     

     

    $

     

     

     

    $

    13,805

     

     

     

    $

    436,391

     

     

    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

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     
     Class A
    Common Stock

     Class B
    Common Stock

      
      
      
      
     
     
      
      
     Accumulated
    Other
    Comprehensive
    Income (Loss)

      
     
     
     Additional
    Paid-In
    Capital

     Retained
    Earnings

     Total
    Stockholders'
    Equity

     
     
     Shares
     Amount
     Shares
     Amount
     
    Balance at December 31, 2004 25,049,338 $2.5 7,343,880 $.7 $138.8 $324.2 $26.7 $492.9 
     Comprehensive income:                       
      Net income               54.6     54.6 
      Cumulative translation adjustment and other                  (19.4) (19.4)
      Pension plan additional minimum liability, net of tax of ($1.2m)                  (2.0) (2.0)
                         
     
      Comprehensive income                     33.2 
                         
     
     Shares of Class A Common Stock issued upon the exercise of stock options 107,823         1.5        1.5 
     Tax benefit for stock options exercised            .9        .9 
     Issuance of shares of restricted Class A Common Stock 5,616                  
     Amortization of deferred compensation            .3        .3 
     Net change in restricted stock units 42,433         1.2        1.2 
     Common Stock dividends               (10.5)    (10.5)
      
     
     
     
     
     
     
     
     
    Balance at December 31, 2005 25,205,210 $2.5 7,343,880 $.7 $142.7 $368.3 $5.3 $519.5 
     Comprehensive income:                       
      Net income               73.7     73.7 
      Cumulative translation adjustment and other                  25.0  25.0 
      Pension plan additional liability, net of tax of $0.6 million                  .9  .9 
                         
     
      Comprehensive income                     99.6 
                         
     
     Initial impact upon adoption of FAS 158, net of tax of ($3.8m)                  (5.8) (5.8)
     Shares of Class A Common Stock issued upon the exercise of stock options 106,499         1.9        1.9 
     Tax benefit for stock options exercised            1.4        1.4 
     Stock-based compensation            3.0        3.0 
     Shares of Class B Common Stock converted to Class A Common Stock 50,000   (50,000)             
     Issuance of shares of restricted Class A Common Stock 59,008                  
     Net change in restricted stock units 68,394         .8        .8 
     Shares of Class A Common Stock issued in Stock Offering, net of offering costs of $11.4 million 5,750,000  .6       218.0        218.6 
     Common Stock dividends               (12.4)    (12.4)
      
     
     
     
     
     
     
     
     
    Balance at December 31, 2006 31,239,111 $3.1 7,293,880 $.7 $367.8 $429.6 $25.4 $826.6 
     Comprehensive income:                       
      Net income               77.4     77.4 
      Cumulative translation adjustment and other                  39.1  39.1 
      Pension plan gain arising during the year, net of tax of $3.0 million                  4.2  4.2 
                         
     
      Comprehensive income                     120.7 
                         
     
     Impact upon adoption of measurement date provisions of FAS158               (.8)    (.8)
     Shares of Class A Common Stock issued upon the exercise of stock options 66,658         1.1        1.1 
     Tax benefit for stock awards exercised            1.0        1.0 
     Stock-based compensation            6.0        6.0 
     Issuance of shares of restricted Class A Common Stock 58,726                  
     Net change in restricted stock units 109,977         1.7        1.7 
     Repurchase and retirement of Class A Common Stock (874,416)           (25.2)    (25.2)
     Common Stock dividends               (15.6)    (15.6)
      
     
     
     
     
     
     
     
     
    Balance at December 31, 2007 30,600,056 $3.1 7,293,880 $.7 $377.6 $465.4 $68.7 $915.5 
      
     
     
     
     
     
     
     
     

    The accompanying notes are an integral part of these consolidated financial statements.


    55




    Watts Water Technologies, Inc. and Subsidiaries

    Consolidated Statements of Cash Flows


    (Amounts in thousands)millions)

     

     

    Years Ended December 31,

     

     

     

    2004

     

    2003

     

    2002

     

    OPERATING ACTIVITIES

     

     

     

     

     

     

     

    Income from continuing operations

     

    $

    48,738

     

    $

    36,419

     

    $

    32,622

     

    Adjustments to reconcile net income from continuing operations to net cash  provided by continuing operating activities:

     

     

     

     

     

     

     

    Depreciation

     

    26,290

     

    20,502

     

    21,817

     

    Amortization

     

    1,761

     

    763

     

    477

     

    Other

     

    707

     

    1,065

     

    (235

    )

    Deferred income taxes (benefit)

     

    (5,735

    )

    (75

    )

    1,884

     

    Changes in operating assets and liabilities, net of effects from business acquisitions and divestures:

     

     

     

     

     

     

     

    Accounts receivable

     

    (5,745

    )

    1,858

     

    (13,762

    )

    Inventories

     

    (34,172

    )

    (7,176

    )

    (2,764

    )

    Prepaid expenses and other assets

     

    (2,179

    )

    (1,289

    )

    (3,405

    )

    Accounts payable, accrued expenses and other liabilities

     

    10,545

     

    236

     

    14,791

     

    Net cash provided by continuing operations

     

    40,210

     

    52,303

     

    51,425

     

    INVESTING ACTIVITIES

     

     

     

     

     

     

     

    Additions to property, plant and equipment

     

    (20,999

    )

    (20,030

    )

    (19,593

    )

    Proceeds from the sale of property, plant and equipment

     

    2,143

     

    1,765

     

    3,194

     

    Investments in securities

     

    (25,000

    )

    (4,000

    )

     

    Proceeds from sale of securities

     

    2,400

     

     

     

    Increase in other assets

     

    (1,470

    )

    (191

    )

    (1,189

    )

    Business acquisitions, net of cash acquired

     

    (68,453

    )

    (15,291

    )

    (26,233

    )

    Net cash used in investing activities

     

    (111,379

    )

    (37,747

    )

    (43,821

    )

    FINANCING ACTIVITIES

     

     

     

     

     

     

     

    Proceeds from long-term debt

     

    92,480

     

    219,736

     

    122,917

     

    Payments of long-term debt

     

    (104,693

    )

    (177,916

    )

    (137,513

    )

    Proceeds from exercise of stock options

     

    4,868

     

    5,404

     

    7,148

     

    Tax benefit of stock options exercised

     

    969

     

    423

     

    855

     

    Debt issue costs

     

    (1,079

    )

    (1,235

    )

     

    Proceeds from stock offering, net

     

     

    82,526

     

     

    Dividends

     

    (9,071

    )

    (6,859

    )

    (6,490

    )

    Net cash provided by (used in) financing activities

     

    (16,526

    )

    122,079

     

    (13,083

    )

    Effect of exchange rate changes on cash and cash equivalents

     

    2,054

     

    3,856

     

    2,281

     

    Net cash provided by (used in) discontinued operations

     

    6,553

     

    (6,463

    )

    2,174

     

    INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     

    (79,088

    )

    134,028

     

    (1,024

    )

    Cash and cash equivalents at beginning of year

     

    145,001

     

    10,973

     

    11,997

     

    CASH AND CASH EQUIVALENTS AT END OF YEAR

     

    $

    65,913

     

    $

    145,001

     

    $

    10,973

     

    NON CASH INVESTING AND FINANCING ACTIVITIES

     

     

     

     

     

     

     

    Acquisition of businesses

     

     

     

     

     

     

     

    Fair value of assets acquired

     

    $

    80,126

     

    $

    21,217

     

    $

    66,176

     

    Cash paid, net of cash acquired

     

    68,453

     

    15,291

     

    26,233

     

    Liabilities assumed

     

    $

    11,673

     

    $

    5,926

     

    $

    39,943

     

    CASH PAID FOR:

     

     

     

     

     

     

     

    Interest

     

    $

    9,815

     

    $

    13,499

     

    $

    10,084

     

    Taxes

     

    $

    33,000

     

    $

    17,700

     

    $

    16,400

     

     
     Years Ended December 31,
     
     
     2007
     2006
     2005
     
    OPERATING ACTIVITIES          
     Net income $77.4 $73.7 $54.6 
     Less: loss from discontinued operations  (.2) (3.4) (.4)
      
     
     
     
     Income from continuing operations  77.6  77.1  55.0 
     Adjustments to reconcile income from continuing operations to net cash provided by continuing operating activities:          
       Depreciation  28.9  26.7  23.5 
       Amortization  10.5  8.6  2.6 
       (Gain) loss on disposal and impairment of property, plant and equipment and other  2.0  (8.3) .6 
       Stock-based compensation  6.0  3.0   
       Deferred income tax benefit  (8.2) (2.1) (1.3)
       Changes in operating assets and liabilities, net of effects from business acquisitions and divestures:          
        Accounts receivable  6.5  (17.0) (16.5)
        Inventories  (8.1) (37.3) (20.3)
        Prepaid expenses and other assets  (1.2) 2.0  (4.1)
        Accounts payable, accrued expenses and other liabilities  (22.3) 30.3  13.6 
      
     
     
     
      Net cash provided by continuing operations  91.7  83.0  53.1 
      
     
     
     
    INVESTING ACTIVITIES          
     Additions to property, plant and equipment  (37.8) (44.7) (18.6)
     Proceeds from the sale of property, plant and equipment  .6  31.9  .7 
     Investments in securities  (27.5) (11.8)  
     Proceeds from sale of securities  .4    26.6 
     Increase in other assets  (.5) (1.2) (.5)
     Business acquisitions, net of cash acquired  (22.6) (93.4) (191.4)
      
     
     
     
      Net cash used in investing activities  (87.4) (119.2) (183.2)
      
     
     
     
    FINANCING ACTIVITIES          
     Proceeds from long-term debt  43.8  356.6  161.5 
     Payments of long-term debt  (71.5) (228.3) (42.0)
     Payment of capital leases  (1.7) (4.1)  
     Proceeds from share transactions under employee stock plans  1.1  1.9  1.8 
     Tax benefit of stock awards exercised  1.0  1.4  .9 
     Debt issue costs    (2.4)  
     Proceeds from stock offering, net    218.6   
     Payments to repurchase common stock  (23.6)    
     Dividends  (15.6) (12.4) (10.5)
      
     
     
     
      Net cash provided by (used in) financing activities  (66.5) 331.3  111.7 
      
     
     
     
    Effect of exchange rate changes on cash and cash equivalents  9.4  1.2  (.6)
    Net cash provided by (used in) operating activities of discontinued operations  .1  .9  (1.1)
      
     
     
     
    INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS  (52.7) 297.2  (20.1)
    Cash and cash equivalents at beginning of year  343.0  45.8  65.9 
      
     
     
     
    CASH AND CASH EQUIVALENTS AT END OF YEAR $290.3 $343.0 $45.8 
      
     
     
     
    NON CASH INVESTING AND FINANCING ACTIVITIES          
    Fair value of assets acquired and liabilities assumed from the acquisition of businesses $3.8 $4.0 $ 
      
     
     
     
    Acquisitions of property, plant and equipment under capital lease $1.4 $16.0 $ 
      
     
     
     
    Issuance of stock under management stock purchase plan $1.7 $.8 $1.2 
      
     
     
     
    Liability for shares repurchased $1.4 $ $ 
      
     
     
     
    Retirement of variable rate demand bonds with cash collateral $ $(8.9)$8.9 
      
     
     
     
    CASH PAID FOR:          
     Interest $27.1 $21.7 $9.5 
      
     
     
     
     Taxes $48.0 $35.3 $30.7 
      
     
     
     

    The accompanying notes are an integral part of these consolidated financial statements.


    56




    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements

    (1) Description of Business

    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, 20042007 and 2003 consist2006 consisted of auction rate certificates whose underlying investments arewere in AAA rated municipal bonds. The certificates are bought and sold at auction with reset dates of up to 35 days. The certificates are tradedwere purchased at par value, which approximates market value at December 31, 20042007 and 2003.2006. 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,


    Watts Water Technologies, Inc. and Subsidiaries
     Notes to Consolidated Financial Statements (Continued)

    concentration of receivables by customer, customer credit worthiness, current economic trends and changes in customer payment terms. The Company specifically analyzes individual accounts receivable and establishes specific reserves against financially troubled customers. In addition, factors


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (2) Accounting Policies (Continued)


    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 9.9%,10.0% and 10.7% and 10.2% of the Company’sCompany's total sales in 2004, 20032006 and 2002,2005, respectively, arewere to one company.customer. These sales arewere transacted within the North AmericanAmerica geographic segment. In 2007, no one customer accounted for 10.0% or more of the Company's total sales.

    Inventories

    Inventories are stated at the lower of cost (primarily(using primarily the 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. Goodwill and other intangible assets with indefinite useful lives are not amortized, but rather are tested annually for impairment. The test was performed as of October 24, 2004.28, 2007.

    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.Financial Accounting Standards Board Statement No. 142 "Goodwill and Other Intangible Assets" (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


    Watts Water Technologies, Inc. and Subsidiaries
     Notes to Consolidated Financial Statements (Continued)

    does not allocate interest charges to the asset or asset group being measured. Judgment is required to estimate discounted future operating cash flows.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (2) Accounting Policies (Continued)

    The changes in the carrying amount of goodwill are as follows:

     

    North
    America

     

    Europe

     

    China

     

    Total

     

     North
    America

     Europe
     China
     Total

     

    (in thousands)

     

     (in millions)

    Carrying amount at December 31, 2002

     

     

    $ 99,790

     

     

    $ 60,364

     

    $ 3,072

     

    $ 163,226

     

    Carrying amount at December 31, 2005 $193.6 $97.4 $5.6 $296.6

    Goodwill acquired during the period

     

     

     

     

    8,451

     

     

    8,451

     

      37.2 3.4 40.6

    Adjustments to goodwill during the period

     

     

    78

     

     

    (208

    )

     

    (130

    )

     5.3   5.3

    Effect of change in exchange rates used for translation

     

     

    149

     

     

    13,205

     

     

    13,354

     

      13.3 .3 13.6

    Carrying amount at December 31, 2003

     

     

    $ 100,017

     

     

    $ 81,812

     

    $ 3,072

     

    $ 184,901

     

     
     
     
     
    Carrying amount at December 31, 2006 $198.9 $147.9 $9.3 $356.1

    Goodwill acquired during the period

     

     

    23,309

     

     

    9,546

     

    1,450

     

    34,305

     

     7.6   7.6

    Adjustments to goodwill during the period

     

     

    153

     

     

     

     

    153

     

     3.8 1.1 2.4 7.3

    Effect of change in exchange rates used for translation

     

     

    60

     

     

    6,759

     

     

    6,819

     

     .7 13.4 .7 14.8

    Carrying amount at December 31, 2004

     

     

    $ 123,539

     

     

    $ 98,117

     

    $ 4,522

     

    $ 226,178

     

     
     
     
     
    Carrying amount at December 31, 2007 $211.0 $162.4 $12.4 $385.8
     
     
     
     

            The adjustments to North American goodwill during the year ended December 31, 2007 relate to an accrual of approximately $3.8 million in earn-out provisions. The adjustment to European goodwill during the year ended December 31, 2007 includes the finalization of the ATS Expansion Group purchase price allocation. ATS Expansion Group was acquired in May 2006. The adjustment to China goodwill during the year ended December 31, 2007 includes the finalization of the Changsha Valve Works purchase price allocation. Changsha Valve Works was acquired in April 2006.

            The adjustments to North American goodwill during the year ended December 31, 2006 relate to an accrual of approximately $4.0 million in earn-out provisions and in 2006 includes the finalization of the Dormont Manufacturing Company and Core Industries Inc. purchase price allocations. Dormont Manufacturing Company and Core Industries Inc. were acquired in December 2005.

    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,
     

     

    2004

     

    2003

     


     2007
     2006
     

     

    Gross
    Carrying
    Amount

     

    Accumulated
    Amortization

     

    Gross
    Carrying
    Amount

     

    Accumulated
    Amortization

     


     Gross
    Carrying
    Amount

     Accumulated
    Amortization

     Gross
    Carrying
    Amount

     Accumulated
    Amortization

     

     

    (in thousands)

     


     (in millions)

     

    Patents

     

    $ 8,913

     

     

    $ (4,288

    )

     

    $ 8,449

     

     

    $ (3,862

    )

     

    Patents $13.8 $(6.1)$13.2 $(5.3)
    Customer relationshipsCustomer relationships 70.0 (14.3) 65.3 (7.5)
    TechnologyTechnology 7.5 (2.3) 7.5 (1.2)

    Other

     

    17,051

     

     

    (2,634

    )

     

    3,377

     

     

    (1,245

    )

     

    Other 19.0 (5.8) 15.3 (4.0)

    Total amortizable intangibles

     

    25,964

     

     

    (6,922

    )

     

    11,826

     

     

    (5,107

    )

     

     
     
     
     
     
    Total amortizable intangible assets 110.3 (28.5) 101.3 (18.0)
     
     
     
     
     

    Intangible assets not subject to amortization

     

    19,775

     

     

     

     

    10,029

     

     

     

     

    Intangible assets not subject to amortization 52.2  50.5  

    Total

     

    $ 45,739

     

     

    $ (6,922

    )

     

    $ 21,855

     

     

    $ (5,107

    )

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     
     
     
     
     
    Total $162.5 $(28.5)$151.8 $(18.0)
     
     
     
     
     

            

    Aggregate amortization expense for amortized other intangible assets for the yearyears ended December 31, 2004, 20032007, 2006 and 20022005 was $1,761,000, $763,000$10.5 million, $8.6 million and $477,000,$2.6 million, respectively. Additionally, future amortization expense on otheramortizable intangible assets approximates $2,060,000 for 2005, $2,014,000 for 2006, $1,490,000 for 2007, $1,304,000$9.3 million for 2008, $9.0 million for 2009, $8.9 million for 2010, $8.3 million for 2011 and $1,272,000$6.9 million for 2009. 2012.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (2) Accounting Policies (Continued)

    Amortization expense is provided on a straight-line basesbasis over the estimated useful lives of the intangible assets. The weighted-average remaining life of total amortizable intangible assets which range from 3 to 50is 10.8 years.

    Patents, customer relationships, technology and other amortizable intangibles have weighted-average remaining lives of 9.2 years, 9.4 years, 6.4 years and 19.2 years, respectively. Intangible assets not subject to amortization primarily include trademarks and unpatented technology.


    Watts Water Technologies, Inc. and Subsidiaries
     Notes to Consolidated Financial Statements (Continued)

    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.

    Taxes, Other than Income Taxes

            Taxes assessed by governmental authorities on sale transactions are recorded on a net basis and excluded from sales, in the Company's consolidated statements of operations.

    Income Taxes

    Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

            On January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48). The purpose of FIN 48 is to increase the comparability in financial reporting of income taxes. FIN 48 requires that in order for a tax benefit to be booked in the income statement, the item in question must meet the more-likely-than-not (greater than 50% likelihood of being sustained upon examination by the taxing authorities) threshold. The adoption of FIN 48 did not have a material effect on the Company's financial statements. No cumulative effect was booked through beginning retained earnings.

            As of the adoption date, the Company had gross unrecognized tax benefits of approximately $4.8 million, of which approximately $4.2 million, if recognized, would affect the effective tax rate. The difference between the amount of unrecognized tax benefits and the amount that would impact the effective tax rate consists of the federal tax benefit of state income tax items. During 2007, the Company reduced its unrecognized tax benefits by approximately $0.6 million for a tax issue in Italy. As a result of the conclusion of state income tax audits, it is reasonably possible that the total amount of unrecognized tax benefits will change in the next twelve months. The Company estimates that it is reasonably possible that approximately $0.5 million of the currently remaining unrecognized tax benefit may be recognized by the end of 2008 as a result of the conclusion of the state income tax audits. Notwithstanding, the Company does not expect any further significant changes in the amounts of unrecognized tax benefits within the next twelve months.

            As of December 31, 2007, the Company had gross unrecognized tax benefits of approximately $3.7 million, of which approximately $3.2 million, if recognized, would affect the effective tax rate. The difference between the amount of unrecognized tax benefits and the amount that would impact the


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (2) Accounting Policies (Continued)


    effective tax rate consists of the federal tax benefit of state income tax items. A reconciliation of the beginning and ending amount of unrecognized tax benefits and a separate analysis of accrued interest related to the unrecognized tax benefits is as follows:

     
     (in millions)
     
    Balance as of January 1, 2007 $4.8 
    Increases related to prior year tax provisions  1.1 
    Decreases related to prior year tax provisions  (1.6)
    Increases related to current year tax positions  .2 
    Settlements  (.8)
      
     
    Balance as of December 31, 2007 $3.7 
      
     

            Accrued interest related to unrecognized tax benefits:

     
     (in millions)
    Balance as of January 1, 2007 $.6
    Increases  .4
    Decreases  
      
    Balance as of December 31, 2007 $1.0
      

            The Company was under audit by the Internal Revenue Service for the 2003 and 2004 tax years. The audit was completed in February 2008 and resulted in no significant adjustments. The Company conducts business in a variety of locations throughout the world resulting in tax filings in numerous domestic and foreign jurisdictions. The Company is subject to tax examinations regularly as part of the normal course of business. The Company's major jurisdictions are the U.S., Canada, China, Netherlands, U.K., Germany, Italy and France. With few exceptions the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for years before 2002.

            The Company accounts for interest and penalties related to uncertain tax positions as a component of income tax expense.

            Several tax years remain subject to examination by major jurisdictions. Years that remain open to examination with respect to U.S. federal taxes are 2005-2006. The Company is currently under audit by the Commonwealth of Massachusetts for 2001-2003. Upon conclusion of that audit, 2004-2006 will remain open. Years that remain open to examination in Canada are 2003-2006. Years that remain open to examination for major European countries include the United Kingdom 2002-2006, Germany 2005-2006, Italy 2002-2006, France 2005-2006 and the Netherlands 2002-2006.

    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


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (2) Accounting Policies (Continued)


    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.


    Watts Water Technologies, Inc.Stock-Based Compensation

            Effective January 1, 2006, the Company adopted Financial Accounting Standards Board Statement No. 123R, "Share-Based Payment" (FAS 123R) utilizing the "modified prospective" method as described in FAS 123R. Under the "modified prospective" method, compensation cost is recognized for all share-based payments granted after the effective date and Subsidiaries
     Notesfor all unvested awards granted prior to the effective date. In accordance with FAS 123R, prior period amounts were not restated. FAS 123R also requires the excess tax benefits associated with these share-based payments to be classified as financing activities in the Statements of Consolidated Financial Statements (Continued)
    Cash Flows, rather than as operating cash flows as required under previous regulations.

    Stock Based Compensation

            At December 31, 2007, the Company had three stock-based compensation plans with total unrecognized compensation costs related to unvested stock-based compensation arrangements of approximately $9.5 million and a total weighted average remaining term of 2.3 years. For 2007 and 2006, the Company recognized compensation costs related to stock-based programs of approximately $6.0 million and $3.0 million, respectively, in selling, general and administrative expenses. The Company accountsrecorded approximately $0.7 million and $0.4 million of tax benefit during 2007 and 2006, respectively, for the compensation expense relating to its stock based compensations in accordance withoptions. For 2007 and 2006, the Company recorded approximately $1.3 million and $0.6 million, respectively, of tax benefit for its other stock-based plans. For 2007 and 2006, the recognition of total stock-based compensation expense impacted both basic net income per common share and diluted net income per common share by $0.10 and $0.06, respectively.

            Prior to the effective date, the stock-based compensation plans were accounted for under Accounting Principles Board Opinion (APB) No. 25, “Accounting"Accounting for Stock Issued to Employees” (APB No. 25),Employees," and related interpretations. The Company records stock basedPro-forma information regarding the impact of total stock-based compensation expense associated with its Management Stock Purchase Plan due to the discount from market price. Stock-based compensation expense is amortized to expense on a straight-line basis over the vesting period. The following table illustrates the effect on reported net income and earningsincome per common share for prior periods is required by FAS 123R.

            Such pro-forma information, determined as if the Company had appliedaccounted for its employee stock options and restricted stock units (RSUs) under 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 Statement No. 123, “Accounting"Accounting for Stock-Based CompensationCompensation" (FAS 123) as amended by Financial Accounting Standards Board Statement No. 148 “Accounting"Accounting for Stock-Based Compensation Transition


    Watts Water Technologies, Inc. and Disclosure”Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (2) Accounting Policies (Continued)

    and Disclosure" (FAS 148). during 2005, is illustrated in the following tables (Amounts in millions, except per share information):

     

     

    Years Ended December 31,

     

     

    2004

     

    2003

     

    2002

     

     

     

     

    (in thousands)

     

    Net income, as reported

     

     

    $ 46,820

     

     

    $ 33,362

     

    $ 32,622

     

    Add: Stock-based employee compensation expense from the Management Stock Purchase Plan included in reported net income, net of tax

     

     

    384

     

     

    202

     

    164

     

    Deduct: Stock-based employee expense determined under the fair value method, net of tax:

     

     

     

     

     

     

     

     

     

    Restricted stock units (Management Stock Purchase Plan)

     

     

    (381

    )

     

    (271

    )

    (220

    )

    Employee stock options

     

     

    (670

    )

     

    (575

    )

    (573

    )

    Proforma net income

     

     

    46,153

     

     

    $ 32,718

     

    $ 31,993

     

    Earnings per share:

     

     

     

     

     

     

     

     

     

    Basic—as reported

     

     

    $   1.45

     

     

    $   1.22

     

    $   1.22

     

    Basic—proforma

     

     

    1.43

     

     

    1.19

     

    1.20

     

    Dilutive—as reported

     

     

    1.43

     

     

    1.21

     

    1.21

     

    Dilutive—proforma

     

     

    $   1.42

     

     

    $   1.18

     

    $   1.19

     

     
     Year Ended
    December 31,
    2005

     
    Net income, as reported $54.6 
    Add: Stock-based employee compensation expense from the Management Stock Purchase Plan included in reported net income, net of tax  .5 
    Deduct: Stock-based employee expense determined under the fair value method, net of tax:    
     Restricted stock units (Management Stock Purchase Plan)  (.6)
     Employee stock options  (1.1)
      
     
    Pro forma net income $53.4 
      
     
    Earnings per share:    
     Basic—as reported $1.68 
     Basic—pro forma $1.64 
     Diluted—as reported $1.66 
     Diluted—pro forma $1.62 

    Net Income Per Common Share

    Basic net income per common share is calculated by dividing net income by the weighted average number of common shares outstanding. The calculation of diluted earningsincome per share assumes the conversion of all dilutive securities (see Note 13).


    Watts Water Technologies, Inc. and Subsidiaries
     Notes to Consolidated Financial Statements (Continued)

    Net income and number of shares used to compute net earningsincome per share, basic and assuming full dilution, are reconciled below:

     

    Years Ended December 31,

     

     Years Ended December 31,
     

     

    2004

     

    2003

     

    2002

     

     2007
     2006
     2005
     

     

    Net
    Income

     

    Shares

     

    Per
    Share
    Amount

     

    Net
    Income

     

    Shares

     

    Per
    Share
    Amount

     

    Net
    Income

     

    Shares

     

    Per
    Share
    Amount

     

     Net
    Income

     Shares
     Per
    Share
    Amount

     Net
    Income

     Shares
     Per
    Share
    Amount

     Net
    Income

     Shares
     Per
    Share
    Amount

     

     

    (Amounts in thousands, except per share information)

     

     (Amounts in millions, except per share information)

     

    Basic EPS

     

    $ 46,820

     

    32,276

     

     

    $ 1.45

     

     

    $ 33,362

     

    27,455

     

     

    $ 1.22

     

     

    32,622

     

    26,718

     

     

    $ 1.22

     

     

     $77.4 38.6 $2.00 $73.7 33.3 $2.21 $54.6 32.5 $1.68 

    Dilutive securities principally common stock options

     

     

    443

     

     

    0.02

     

     

     

    237

     

     

    0.01

     

     

     

    338

     

     

    0.01

     

     

       .4  (.01)  .4  (.02)  .5  (.02)
     
     
     
     
     
     
     
     
     
     

    Diluted EPS

     

    $ 46,820

     

    32,719

     

     

    $ 1.43

     

     

    $ 33,362

     

    27,692

     

     

    $ 1.21

     

     

    32,622

     

    27,056

     

     

    $ 1.21

     

     

     $77.4 39.0 $1.99 $73.7 33.7 $2.19 $54.6 33.0 $1.66 
     
     
     
     
     
     
     
     
     
     

            The computation of diluted net income per share for the year ended December 31, 2007 excludes the effect of the potential exercise of options to purchase approximately 0.5 million shares, because the exercise price of the option was greater than the average market price of the Class A Common Stock, as the effect would have been anti-dilutive.

            During the period January 1, 2008 to February 22, 2008, the Company repurchased approximately 1.4 million shares of its Class A Common Stock.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (2) Accounting Policies (Continued)

    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 ourthe 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 werewas 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 that does not qualify for which hedge accounting is not required because it is entered into to offset changes in the fair value of an underlying transaction which is required to be recognized in earnings (natural hedge). These instruments are reflected in the Consolidated Balance 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 2004


    Watts Water Technologies, Inc.2007 and Subsidiaries
     Notes to Consolidated Financial Statements (Continued)

    and 2003,2006, 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 anddid not qualify as a cash flow hedgeshedge under the criteria of FAS 133. FAS 133 requires that changes in fair value of derivatives that qualify as cash flow hedges be recognized in other comprehensive income while the ineffective portion of the derivative’s change in fair value be 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 2004 and 2003,2006, the Company used an interest rate swap as a means of hedging exposure to interest rate risks.risks (see Note 11). The Company’sCompany's interest rate swap was designated and qualifieddid not qualify as a cash flow hedge under the criteria of FAS 133. FAS 133 requires that changes in fair value of derivatives that qualify as cash flow hedges be recognized in other comprehensive income while the ineffective portion of the derivative’s change in fair value be recognized immediately in earnings.

    Shipping and Handling

    Shipping and handling costs included in selling, general and administrative expense amounted to $25,110,000, $22,111,000$39.1 million, $37.3 million and $20,900,000$28.1 million for the years ended December 31, 2004, 20032007, 2006 and 2002,2005, respectively.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (2) Accounting Policies (Continued)

    Research and Development

    Research and development costs included in selling, general, and administrative expense amounted to $9,942,000, $9,178,000$15.1 million, $12.7 million and $9,132,000$11.6 million for the years ended December 31, 2004, 20032007, 2006 and 2002,2005, 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".

    Basis of Presentation

    Certain amounts in years 2003for 2006 and 20022005 have been reclassified to permit comparison with the 20042007 presentation.

    63




    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)Estimates

    Estimates

    The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

    New Accounting Standards

    In December 2003,2007, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards Board Statement (FAS) No. 132 revised 2003, “Employers’ Disclosures about Pensions141 (R), "Business Combinations," (FAS 141R), which requires most identifiable assets, liabilities, non-controlling interests, and Other Postretirement Benefits” (FAS 132R). This standard increases the existing disclosure requirements by requiring more details about pension plan assets, benefit obligations, cash flows, benefit costs and related information. Companiesgoodwill acquired in a business combination to be recorded at "full fair value." Under FAS 141R, all business combinations will be requiredaccounted for under the acquisition method. Significant changes, among others, from current guidance resulting from FAS 141R includes the requirement that contingent assets and liabilities and contingent consideration shall be recorded at estimated fair value as of the acquisition date, with any subsequent changes in fair value charged or credited to segregate plan assets by category, suchearnings. Further, acquisition-related costs will be expensed rather than treated as debt, equity and real estate, and to provide certain expected ratespart of return and other informational disclosures.the acquisition. FAS 132(R) also requires companies to disclose various elements of pension and postretirement benefit costs in interim-period financial statements141R is effective for quartersperiods beginning on or after December 15, 2003.2008. The Company adoptedexpects the additional interim disclosure provisionsadoption of FAS 132(R) effective January 1, 2004.141R will increase costs charged to its operations.

    On May 15, 2003,        In December 2007, the FASB issued FAS No. 160, "Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB NO. 151," (FAS 160), which requires non-controlling interests (previously referred to as minority interest) to be treated as a separate component of equity, not as a liability as is current practice. FAS 160 applies to non-controlling interests and transactions with non-controlling interest holders in consolidated financial statements. FAS 160 is effective for


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (2) Accounting Standards Board StatementPolicies (Continued)


    periods beginning on or after December 15, 2008. The Company is currently evaluating the effect that FAS 160 will have on its consolidated financial statements.

            In February 2007, the FASB issued FAS No. 150, “Accounting159, "The Fair Value Option for Certain Financial Instruments with Characteristics of Both LiabilitiesAssets and Equity” (FAS150).Financial Liabilities—including an Amendment to FAS 150 requires issuersNo. 115," (FAS 159), which permits entities to classify as liabilities (or assets in some circumstances) three classes of freestandingchoose to measure many financial instruments that embody obligations for the issuer. Generally,and certain other items at fair value. FAS 150159 is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim periodstatements issued for fiscal years beginning after JuneNovember 15, 2003.2007 and interim periods within those fiscal years. Earlier application is encouraged. The Company adopted the provisions of FAS 150 on July 1, 2003 for existingdoes not expect to measure its financial instruments all of which were entered into prior to June 30, 2003. The Company concluded thatat fair value and therefore does not expect the adoption of FAS 150 did not159 to have a material impact on its consolidated financial statements.

    On November 29, 2004,        In September 2006, the FASB issued Financial Accounting Standards Board StatementFAS No. 151, “Inventory Costs”157, "Fair Value Measurements" (FAS 151).157), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. For financial assets and liabilities, FAS 151 amends the guidance in Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting157 is effective for inventory costs. The provisions of this statement are effectivefinancial statements issued for fiscal years beginning after JuneNovember 15, 2005, although early2007 and interim periods within those fiscal years. For nonfinancial assets and liabilities, FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. Earlier application is permitted.encouraged provided that the reporting company has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year. The Company does not expect thatthe adoption of FAS 157 will have a material impact on its consolidated financial statements.

            In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements" (SAB 108), which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after November 15, 2006. The Company adopted the provisions of SAB 108 for fiscal year 2006 and the impact of this statement will beSAB 108 was not material to theits consolidated financial statements.

    On        In September 2006, the FASB issued FAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)," (FAS 158), which requires an employer to: (a) recognize in its statement of financial position an asset for a plan's overfunded status or a liability for a plan's underfunded status; (b) measure a plan's assets and its obligations that determine its funded status as of the end of the employer's fiscal year; and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes are reported in other comprehensive income. The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 16,15, 2006 for companies with publicly traded equity securities. The requirement to measure plan assets and benefit obligations as of the date of the employer's fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008, although earlier adoption is permitted. As a result of the requirement to recognize the funded status of the Company benefit plans as of December 31, 2006, the Company recorded an increase in its pension liability of approximately $8.3 million, a decrease of approximately $1.3 million in other assets: other, net and a decrease in accumulated other comprehensive income of approximately $5.8 million, net of tax. The Company has early-adopted the measurement date provisions of FAS 158 effective January 1, 2007. The Company's pension plans previously used a September 30 measurement date. All plans are now measured as of December 31, consistent with the Company's fiscal year end.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (2) Accounting Policies (Continued)


    The non-cash effect of the adoption of the measurement date provisions of FAS 158 was not material and there was no effect on the Company's results of operations.

            In July 2006, the FASB issued Financial Interpretation No. 48, "Accounting for Uncertainty in Income Taxes," (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes." FIN 48 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, based on the technical merits. This interpretation also provides guidance on measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 was effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of FIN 48 for fiscal year 2007 and the impact was not material to its consolidated financial statements.

            In March 2006, the FASB issued FAS No. 156 "Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140," (FAS 156). FAS 156 amends FAS Statement No.140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," with respect to the accounting for separately recognized servicing assets and servicing liabilities. FAS 156 addresses the recognition and measurement of separately recognized servicing assets and liabilities and provides an approach to simplify efforts to obtain hedge-like (offset) accounting. The Company adopted the provisions of FAS 156 for fiscal year 2007 and the impact was not material to its consolidated financial statements.

            In February 2006, the FASB issued FAS No. 155 "Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140" (FAS 155). FAS 155 amends FAS 133, "Accounting for Derivatives and Hedging Activities," and FAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," and allows an entity to remeasure at fair value a hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation from the host, if the holder irrevocably elects to account for the whole instrument on a fair value basis. Subsequent changes in the fair value of the instrument would be recognized in earnings. The Company adopted the provisions of FAS 155 for fiscal year 2007 and the impact was not material to its consolidated financial statements.

            In May 2005, the FASB issued FAS No. 154, "Accounting Changes and Error Correction Replacement of APB Opinion No. 20 and FASB Statement No. 3" (FAS 154). FAS 154 replaces APB Opinion No. 20, "Accounting Changes" (APB 20), and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements," and changes the requirements for the accounting for and reporting of a change in accounting principle. APB 20 previously required that most voluntary changes in accounting principles be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. FAS 154 requires retrospective application to prior periods' financial statements of changes in accounting principle. FAS 154 defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used. FAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. The impact was not material to its 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 (revised 2004), that requires companies to expense the value of employee stock options and similar awards. The statement is effective for public companies for interim and annual periods beginning after June 15, 2005, and applies to all outstanding and unvested SBP awards at a company’s adoption date. The impact of this statement on the Company’s results of operations is expected to be approximately ($0.02) per share.

    On December 16, 2004, FASB issued Financial Accounting Standards Board StatementFAS No. 153, “Exchanges"Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions”Transactions" (FAS 153). The amendments made by FAS 153 are based on the principle that exchanges of nonmonetary assets should


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (2) Accounting Policies (Continued)


    be measured based on the fair value of the assets exchanged. Further, the


    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)

    amendments eliminate the narrow exception for nonmonetary 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 an 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 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 shall bewere applied prospectively.prospectively and the impact was not material to the Company's consolidated financial statements.

            In November 2004, the FASB issued FAS 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 Company does not expect the impactprovisions of this statement will beare effective for fiscal years beginning after June 15, 2005. The impact was not material to the Company's 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 2004 and 2003 relate to legal and settlement costs associated with the James Jones Litigation (see Note 15).

    The Company also recorded an expense for payments to be made to the selling shareholders of the James Jones Company pursuant to the Company’s original purchase agreement. For the year ended December 31, 2004 and 2003, the Company recorded a net of tax charge of $72,000 and $446,000, respectively.

    In the fourth quarter of 2004 the Company planned to divest its interest in its minority owned subsidiary Jameco International, LLC (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). The LLC was recorded in the North American segment. Management determined that the 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. The Company plans to divest its interest in the LLC in the first half of 2005. 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 the LLC. The 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 are summarized below:

     

     

    Years Ended December 31,

     

     

     

    2004

     

    2003

     

    2002

     

     

     

    (in thousands)

     

    Net sales—Jameco International, LLC

     

    $

    20,187

     

    $

    3,792

     

    $

     

    Costs and expenses

     

     

     

     

     

     

     

    Jameco International, LLC

     

    (20,231

    )

    (3,705

    )

     

    Municipal Water Group

     

    (1,828

    )

    (5,058

    )

     

    Loss on disposal of Jameco International, LLC

     

    (1,202

    )

     

     

    Loss before income taxes

     

    (3,074

    )

    (4,971

    )

     

    Income tax benefit

     

    1,156

     

    1,914

     

     

    Loss from discontinued operations, net of taxes

     

    $

    (1,918

    )

    $

    (3,057

    )

    $

     

     

     

     

     

     

     

     

     

     
     Years Ended December 31,
     
     
     2007
     2006
     2005
     
     
     (in millions)

     
    Costs and expenses—Municipal Water Group $(.4)$(5.5)$(.7)
      
     
     
     
    Loss before income taxes  (.4) (5.5) (.7)
    Income tax benefit  .2  2.1  .3 
      
     
     
     
    Loss from discontinued operations, net of taxes $(.2)$(3.4)$(.4)
      
     
     
     
     
     December 31,
     
     2007
     2006
     
     (in millions)

    Prepaid expenses and other assets $(.3)$.3
    Deferred income taxes  10.7  9.8
      
     
     Assets of discontinued operations $10.4 $10.1
      
     
    Accrued expenses and other liabilities $28.6 $27.9
      
     
     Liabilities of discontinued operations $28.6 $27.9
      
     

    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

            

     

     

    December 31,

     

     

     

    2004

     

    2003

     

     

     

    (in thousands)

     

    Prepaid expenses and other assets

     

    $

    2,561

     

    $

    7,110

     

    Deferred income taxes

     

    7,666

     

    3,248

     

    Assets of discontinued operations

     

    $

    10,227

     

    $

    10,358

     

    Accrued expenses and other liabilities

     

    24,303

     

    16,031

     

    Liabilities of discontinued operations

     

    $

    24,303

     

    $

    16,031

     

    The assets and liabilities for 20042007 and 2006 primarily relate to the reserves the James Jones Litigation. The 2003 amounts include the operating assets and liabilities of the LLC, as well as the reserves for the James Jones Litigation. Statements of Cash Flows amounts for 2007, 2006 and 2005 relate to operating activities.

    (4) Restructuring and Other (Income) Charges

            During 2007, the Company undertook a review of certain product lines and its overall manufacturing capacity. Based on that review, the Company initiated a global restructuring program that was approved by the Company's Board of Directors on October 30, 2007. The Company continuesis also discontinuing certain product lines. This program is expected to implementinclude the shutdown of five manufacturing facilities and the rightsizing of a plansixth facility, including the relocation of its joint venture facility in China that was previously disclosed. The restructuring program and charges for certain product line discontinuances will include pre-tax charges totaling approximately $12.9 million. Charges are primarily for severance ($4.3 million), relocation costs ($2.8 million) and other asset write-downs and expected net losses on asset disposals ($2.0 million) and will result in the elimination of approximately 330 positions worldwide. The product lines that were discontinued and accelerated depreciation resulted in a pre-tax charge of $4.3 million during 2007. Total net after-tax charges for this program are expected to be approximately $9.4 million ($4.4 million non-cash), with costs being incurred through early 2010. The Company expects to spend approximately $13.4 million in capital expenditures to consolidate severaloperations and will fund approximately $8.0 million of its manufacturing plants both in North America and Europe. Atthis amount through proceeds from the same time it is expanding its manufacturing capacity in Chinasale of buildings and other low cost areasassets being disposed of as part of the world.restructuring program. Annual cash savings, net of tax, are estimated to be $4.5 million, which will be fully realized by the second half of 2009.

            The following table presents the total estimated pre-tax charges to be incurred for the global restructuring program and product line discontinuances initiated in 2007 by the Company's reportable segments:

    Reportable Segment

     (in millions)
    North America $5.7
    Europe  3.9
    China  3.3
      
    Total $12.9
      

            For the year ended December 31, 2004,2007, the Company recorded an expensepre-tax charges of approximately $2,968,000 compared to other$7.5 million. Pre-tax costs of $1,655,000,$4.3 million recorded in costs of goods sold were primarily for product line discontinuances. Pre-tax costs of $3.2 million recorded in restructuring and other charges were primarily for asset write-downs related to the Company's wholly owned Chinese manufacturing plants, accelerated depreciation related to the Company's relocation of its 60% owned Chinese joint venture and severance costs in both China and North America. The Company also recognized income of $0.9 million in minority interest representing the 40% liability of its Chinese joint venture partner in the restructuring plan.

            For 2006, the Company recorded charges of $4.7 million in costs of goods sold primarily for manufacturing severance costs related to the Company's relocation plan for its 60% owned Chinese joint venture. The Company recorded income of $5.6 million to restructuring and other (income) charges which is primarily comprised of gains of approximately $8.2 million related to the sales of buildings in Italy, partially offset by charges of approximately $2.2 million for severance costs related to the Company's European restructuring plans and approximately $0.4 million for accelerated amortization related to the Company's Chinese restructuring plan. The Company also recognized income of $1.5 million in minority interest representing the 40% liability of its Chinese joint venture partner in the TWT restructuring plan.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (4) Restructuring and Other (Income) Charges (Continued)

            For 2005, Company recorded charges, net of recoveries, for the year ended December 31, 2003.of $2.5 million. The expenses incurred for 2004 were primarily for accelerated depreciation for both the planned closure of a U.S. manufacturing plant and a reduction in the estimated useful lives of certain manufacturing equipment, and for severance costs. The expenses, net of recoveries incurredand for 2003,European severance related charges and asset write-downs.

            With respect to the table below, restructuring costs consist primarily of accelerated depreciation, asset write-downs and severance costs. TheIn 2007 and 2005, severance costs are for 48 employeeswere recorded in manufacturingrestructuring and administration groups. The Company completed its severance payments during the first quarterother charges (income) and, in 2006, were recorded in cost of 2004. The expenses incurred for 2002 consist primarily of accelerated depreciation, asset write-downs and severance costs.

    goods sold. Asset write-downs consist primarily of write-offs of fixed assets and accelerated depreciation. Product line discontinuances consist of inventory write-offs 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 is primarily recorded in cost of goods sold. Other costs consist primarilyof gains on sales of buildings in 2006 and of removal and shipping costs associated with relocation of manufacturing equipment in 2007 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.


    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)
    2005.

    Details of the Company’sCompany's manufacturing restructuring planplans through December 31, 20042007 are as follows:

     

     

        Restructuring    

     

    Asset Write-downs

     

        Other Costs     

     

               Total           

     

     

     

    (in thousands)

    Balance as of December 31, 2001

     

     

    $

    762

     

     

    $

     

     

    $

     

     

    $

    762

     

    Provisions during 2002

     

     

    638

     

     

    2,491

     

     

    960

     

     

    4,089

     

    Utilized during 2002

     

     

    (981

    )

     

    (2,491

    )

     

    (960

    )

     

    (4,432

    )

    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

     

     

    $

     

     

    $

     

     

    $

     

     

    $

     

     
     Restructuring
     Asset
    Write-downs

     Product line
    discontinuance

     Other Costs
     Minority
    Interest

     Total
     
     
     (in millions)

     
    Balance as of December 31, 2004 $ $ $ $ $ $ 
    Provisions during 2005  .7  1.4    .4    2.5 
    Utilized during 2005  (.7) (1.4)   (.4)   (2.5)
      
     
     
     
     
     
     
    Balance as of December 31, 2005             
      
     
     
     
     
     
     
    Provisions during 2006  6.7  .5    (8.2) (1.5) (2.5)
    Utilized during 2006  (2.5) (.5)   8.2  1.5  6.7 
      
     
     
     
     
     
     
    Balance as of December 31, 2006  4.2          4.2 
      
     
     
     
     
     
     
    Provisions during 2007  .8  2.8  3.8  .1  (.9) 6.6 
    Utilized during 2007  (2.6) (2.8) (3.8) (.1) .9  (8.4)
      
     
     
     
     
     
     
    Balance as of December 31, 2007 $2.4 $ $ $ $ $2.4 
      
     
     
     
     
     
     

    (5) Business Acquisitions

    On September 28, 2004 a wholly-owned subsidiary        The following acquisition was accounted for by the purchase method of accounting and, accordingly, the Company completed the planned increase of its ownership in Watts Stern Rubinetti, S.r.l (Stern) from 51% to 85%. The price paid for this additional 34% was approximately $800,000. The Company has a call option to acquire the remaining 15% from the minority shareholders for approximately $400,000. The option became exercisable on January 1, 2005. The Company anticipates exercising this optionresults have been included in the second quarterCompany's consolidated results of 2005.operation since the date of acquisition.

    On May 21, 2004, a wholly-owned subsidiary ofNovember 9, 2007, the Company acquired 100%the assets and business of the outstanding stock of McCoy Enterprises,Topway Global Inc., which was subsequently renamed Orion Enterprises, Inc. (Orion), (Topway) located in Kansas City, Kansas,Brea, California for approximately $27,900,000 in cash. Orion distributes its products under the brand names$18.4 million, of Orion, Flo Safewhich $0.3 million of transaction costs remain to be paid. The preliminary allocations for goodwill and Laboratory Enterprises. The Company contracted for a third-party valuation to allocate the purchase price consistent with the guidelines of FAS 141. The allocation to goodwill wasintangible assets are approximately $18,100,000$7.6 million and approximately $4,300,000 was allocated to intangible assets. The amount recorded as intangibles assets was primarily for trademarks that have indefinite lives. Orion’s product lines include a complete line of acid resistant waste disposal products, double containment piping systems, as well as a line of high purity pipes, fittings and faucets.

    On April 16, 2004, a wholly-owned subsidiary of the Company acquired 90% of the stock of TEAM Precision Pipework, Ltd. (TEAM), located in Ammanford, West Wales, United Kingdom for approximately $17,200,000 in cash subject to final adjustments, if any, as stipulated in the purchase and sale agreement. The Company contracted for a third-party valuation to allocate the purchase price consistent with the guidelines of FAS 141. The allocation to goodwill was approximately $9,500,000 and approximately $9,500,000 was allocated to intangible assets.$8.2 million, respectively. The amount recorded as intangible assets wasis primarily for the valuationcustomer relationships with an estimated useful life of its customer base that is estimated to have10 years and trade names with indefinite lives. Topway manufactures a 12- year life. TEAM custom designs and manufactures manipulated pipe and hose tubing assemblies, which are utilized in the heating ventilation and air conditioning markets. TEAM is a supplier to major original equipment manufacturers of air conditioning systems and several of the major European automotive air conditioning manufacturers.

    On March 29, 2004, a wholly-owned subsidiary of the Company acquired the 40% equity interest in Taizhou Shida Plumbing Manufacturing Co., Ltd. (Shida), that had been held by the Company’s former joint venture partner for approximately $3,000,000 in cash and the payment of $3,500,000 in cash in


    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)

    connection with a know-how transfer and non-compete agreement. As of December 31, 2004 the Company had paid $5,750,000 in cash. The Company now owns 100% of Shida. Prior to the acquisition the joint venture declared a dividend of $1,250,000 and based on the 40% ownership, a $500,000 cash dividend was paid to its joint venture partner. The Company contracted for a third-party valuation to allocate the purchase price consistent with the guidelines of FAS 141. The preliminary allocation to goodwill was $1,450,000 and $2,050,000 was allocated to intangible assets. The amount recorded as intangible assets was primarily for the non-compete agreement that has a 3-year life. The Company had made prior investments in 2003 and 2002 totaling $8,000,000 in cash for its initial 60% interest. Shida is a manufacturer of awide variety of plumbing products sold both into the Chinese domestic marketwater softeners, point-of-entry filter units, and export markets.

    On January 5, 2004, a wholly-owned subsidiary of the Company acquired substantially all of the assets of Flowmatic Systems, Inc. (Flowmatic), located in Dunnellon, Florida, for approximately $16,800,000 in cash. The Company contracted for a third-party valuation to allocate the purchase price consistent with the guidelines of FAS 141. The allocation to goodwill was approximately $5,300,000 and approximately $5,600,000 was allocated to intangible assets. The amount recorded as intangible assets was primarily for trademarks that have indefinite lives. 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 osmosispoint-of-use drinking water systems for residential, commercial and commercialindustrial applications.

    On July 30, 2003, a wholly-owned subsidiary The purchase price allocation for Topway is preliminary pending the final determination of the Company acquired Giuliani Anello S.r.l. (Anello) located in Cento Bologna, Italy for approximately $10,600,000 in cash netfair values of acquired cash of $1,400,000. Giuliani Anello manufacturescertain assumed assets and distributes valves and filters utilized in heating applications including strainer filters, solenoid valves, flow stop valves, stainless steel water filter elements and steam cleaning filters.liabilities.

    On April 18, 2003, a wholly-owned subsidiary of the Company acquired Martin Orgee UK Ltd. (Martin Orgee) located in Kidderminster, West Midlands, United Kingdom for approximately $1,600,000 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.

    On July 29, 2002 a wholly-owned subsidiary of the Company acquired F&R Foerster and Rothmann GmbH (F&R) located in Neuenburg am Rhein, Germany, for approximately $2,300,000 in cash less assumed net debt of $800,000. F&R manufactures and distributes a line of gauges predominately to the French and German OEM markets.

    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.


    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)

    On May 9, 2002, a wholly-owned subsidiary of the Company acquired Hunter Innovations, Inc. (Hunter) 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 devices that represent a significant advance in technology. The improved product features that are important to the backflow prevention markets include lighter weight, more compact design, better flow characteristics, improved serviceability and multiple end-connection and shutoff valve options. On May 9, 2003, the Company made a scheduled payment of approximately $3,750,000 for the first installment on the interest bearing notes and on May 4, 2004, the Company made a scheduled payment of approximately $3,750,000 for the second installment on the interest bearing notes issued to the Hunter sellers.

    Certain current andacquisition agreements from 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. In 2007, the Company


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (5) Business Acquisitions (Continued)


    accrued approximately $3.8 million in earn-out provisions which were charged to goodwill and will be paid in 2008. In 2006, the Company accrued approximately $4.0 million in earn-out provisions which were charged to goodwill and paid in 2007. During 2005, the Company charged to operations approximately $1.5 million 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 reasonable doubt and therefore no liabilities have been established.

    The acquisitions above have beenAll future earn-outs payments, if any, will be accounted for utilizing theas additional purchase method of accounting. The pro-forma results, for each respective year, have not been displayed, as the combined results are not significant.price.

    (6) Accumulated Other Comprehensive Income (Loss)

    Other        Accumulated other comprehensive income (loss) consist of the following:

     

     

    Foreign
    Currency
    Translation

     

    Pension
    Adjustment

     

    Cash Flow
    Hedges

     

    Accumulated
    Other
    Comprehensive
    Income (Loss)

     

     

     

    (in thousands)

     

    Balance December 31, 2002

     

     

    $

    (7,806

    )

     

     

    $

    (3,988

    )

     

     

    $

     

     

     

    $

    (11,794

    )

     

    Change in period

     

     

    27,394

     

     

     

    (1,841

    )

     

     

    46

     

     

     

    25,599

     

     

    Balance December 31, 2003

     

     

    19,588

     

     

     

    (5,829

    )

     

     

    46

     

     

     

    13,805

     

     

    Change in period

     

     

    12,918

     

     

     

    (20

    )

     

     

    (85

    )

     

     

    12,813

     

     

    Balance December 31, 2004

     

     

    $

    32,506

     

     

     

    $

    (5,849

    )

     

     

    $

    (39

    )

     

     

    $

    26,618

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     
     Foreign
    Currency
    Translation
    and Other

     Defined Benefit
    Pension Plans

     Accumulated
    Other
    Comprehensive
    Income

     
     (in millions)

    Balance December 31, 2005 $13.1 $(7.8)$5.3
    Change in period  25.0  (4.9) 20.1
      
     
     
    Balance December 31, 2006  38.1  (12.7) 25.4
    Change in period  39.1  4.2  43.3
      
     
     
    Balance December 31, 2007 $77.2 $(8.5)$68.7
      
     
     

    (7) Inventories, net

    Inventories consist of the following:

     

    December 31,

     

     December 31,

     

    2004

     

    2003

     

     2007
     2006

     

    (in thousands)

     

     (in millions)

    Raw materials

     

    $

    53,942

     

    $

    41,998

     

     $108.9 $103.6

    Work in process

     

    28,020

     

    21,870

     

     45.7 39.6

    Finished goods

     

    121,082

     

    90,253

     

     187.0 173.2

     

    $

    203,044

     

    $

    154,121

     

     
     
     $341.6 $316.4
     
     

            

    Finished goods of $14,549,000$20.3 million and $13,191,000$18.3 million as of December 31, 20042007 and 2003,2006, 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,
     

     

    2004

     

    2003

     

     2007
     2006
     

     

    (in thousands)

     

     (in millions)

     

    Land

     

     

    $

    9,567

     

     

    $

    9,354

     

     $13.7 $12.5 

    Buildings and improvements

     

     

    84,876

     

     

    75,428

     

     132.6 124.3 

    Machinery and equipment

     

     

    222,274

     

     

    194,085

     

     270.5 247.4 

    Construction in progress

     

     

    4,938

     

     

    5,220

     

     20.6 7.7 

     

     

    321,655

     

     

    284,087

     

     
     
     

    Accumulated Depreciation

     

     

    (170,966

    )

     

    (138,521

    )

     

     

    $

    150,689

     

     

    $

    145,566

     

     437.4 391.9 
    Accumulated depreciation (213.7) (185.7)
     
     
     
     $223.7 $206.2 
     
     
     

    (9) Income Taxes

    The significant components of the Company’sCompany's deferred income tax liabilities and assets are as follows:

     

     

    December 31,

     

     

     

    2004

     

    2003

     

     

     

    (in thousands)

     

    Deferred income tax liabilities:

     

     

     

     

     

    Excess tax over book depreciation

     

    $

    14,101

     

    $

    16,447

     

    Intangibles

     

    10,458

     

    4,400

     

    Other

     

    4,920

     

    2,598

     

    Total deferred tax liabilities

     

    29,479

     

    23,445

     

    Deferred income tax assets:

     

     

     

     

     

    Accrued expenses

     

    15,199

     

    13,166

     

    Net operating loss carry-forward

     

    7,145

     

    4,384

     

    Inventory reserves

     

    4,825

     

    4,545

     

    Other

     

    11,033

     

    9,818

     

    Total deferred tax assets

     

    38,202

     

    31,913

     

    Less: valuation allowance

     

    (838

    )

    (557

    )

    Net deferred tax

     

    37,364

     

    31,356

     

    Net deferred tax assets

     

    $

    7,885

     

    $

    7,911

     

     
     December 31,
     
     
     2007
     2006
     
     
     (in millions)

     
    Deferred income tax liabilities:       
     Excess tax over book depreciation $15.3 $16.0 
     Intangibles  23.5  18.8 
     Other  12.4  11.1 
      
     
     
      Total deferred tax liabilities  51.2  45.9 
    Deferred income tax assets:       
     Accrued expenses  22.0  17.0 
     Net operating loss carry-forward  3.2  3.4 
     Inventory reserves  13.7  8.0 
     Other  10.7  9.7 
      
     
     
      Total deferred tax assets  49.6  38.1 
    Less: valuation allowance  (3.2)  
      
     
     
     Net deferred tax assets  46.4  38.1 
      
     
     
     Net deferred tax liabilities $(4.8)$(7.8)
      
     
     

            

    The provision for income taxes from continuing operations is based on the following pre-tax income:

     

     

    Years Ended December 31,

     

     

     

    2004

     

    2003

     

    2002

     

     

     

    (in thousands)

     

    Domestic

     

    $

    39,300

     

    $

    40,370

     

    $

    37,931

     

    Foreign

     

    33,372

     

    18,372

     

    12,287

     

     

     

    $

    72,672

     

    $

    58,742

     

    $

    50,218

     

     
     Years Ended December 31,
     
     2007
     2006
     2005
     
     (in millions)

    Domestic $47.6 $49.6 $46.4
    Foreign  66.2  66.5  39.4
      
     
     
      $113.8 $116.1 $85.8
      
     
     

    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (9) Income Taxes (Continued)

    The provision for income taxes from continuing operations consists of the following:

     

     

    Years Ended December 31,

     

     

     

    2004

     

    2003

     

    2002

     

     

     

    (in thousands)

     

    Current tax expense

     

     

     

     

     

     

     

    Federal

     

    $

    15,428

     

    $

    12,167

     

    $

    12,408

     

    Foreign

     

    10,380

     

    6,256

     

    4,241

     

    State

     

    3,318

     

    2,431

     

    2,139

     

     

     

    29,126

     

    20,854

     

    18,788

     

    Deferred tax expense (benefit)

     

     

     

     

     

     

     

    Federal

     

    (4,044

    )

    802

     

    (358

    )

    Foreign

     

    (331

    )

    509

     

    (630

    )

    State

     

    (817

    )

    158

     

    (204

    )

     

     

    (5,192

    )

    1,469

     

    (1,192

    )

     

     

    $

    23,934

     

    $

    22,323

     

    $

    17,596

     

     
     Years Ended December 31,
     
     
     2007
     2006
     2005
     
     
     (in millions)

     
    Current tax expense:          
     Federal $19.2 $18.0 $15.2 
     Foreign  20.4  20.5  14.0 
     State  4.8  4.1  3.5 
      
     
     
     
       44.4  42.6  32.7 
      
     
     
     
    Deferred tax expense (benefit):          
     Federal  (5.7) (1.7) (1.0)
     Foreign  (1.2) (1.5) (.7)
     State  (1.3) (.4) (.2)
      
     
     
     
       (8.2) (3.6) (1.9)
      
     
     
     
      $36.2 $39.0 $30.8 
      
     
     
     

            

    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,
     

     

    2004

     

    2003

     

    2002

     

     2007
     2006
     2005
     

     

    (in thousands)

     

     (in millions)

     

    Computed expected federal income expense

     

    $

    25,435

     

    $

    20,560

     

    $

    17,576

     

     $39.8 $40.6 $30.0 

    State income taxes, net of federal tax benefit

     

    1,626

     

    1,683

     

    1,257

     

     2.3 2.4 2.1 

    Foreign tax rate differential

     

    (1,632

    )

    335

     

    (862

    )

     (7.2) (4.4) (.5)

    Tax credits

     

    (1,041

    )

     

     

    Valuation allowance 3.2   

    Other, net

     

    (454

    )

    (255

    )

    (375

    )

     (1.9) .4 (.8)

     

    $

    23,934

     

    $

    22,323

     

    $

    17,596

     

     
     
     
     
     $36.2 $39.0 $30.8 
     
     
     
     

            

    At December 31, 20042007, the Company hadhas foreign net operating loss carryforwardscarry forwards of $19,700,000$16.9 million for income tax purposes. TheAll of the net operating losses relate toare foreign operations. $18,400,000losses. $7.0 million of the losses can be carried forward indefinitely and $1,300,000$4.8 million of the losses expires in 2008.2013 and $5.1 million of the losses expire in 2016. The net operating losses consist of $15,900,000$5.5 million related to German operations, $2,400,000$1.5 million to Austrian operations, $100,000 related$5.1 million to the Netherlands operations and $1,300,000$4.8 million related to Chinese operations.

            The Company hadhas a valuation allowance of $838,000 and $557,000 as of December 31, 2004 and 2003, respectively, against a portion of$3.2 million related to its deferred tax assets at its Chinese joint venture.

            The Company believes that it is more likely than not that it will be able to recover the net operating loss carryforwards. $18,400,000 of the net operating losses have indefinite lives, but the Company feels a limited valuation allowance is necessary due to the length of time it would take to earn the amounts needed to consume the net operating losses based on historical earnings of the operations involved.deferred tax assets.

            Undistributed earnings of the Company’sCompany's foreign subsidiaries amounted to approximately $144,200,000$251.6 million, $168.9 million and $163.1 million at December 31, 2004, $100,800,000 at December 31, 2003,2007, 2006 and $78,100,000 at December 31, 2002. 2005, respectively.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (9) Income Taxes (Continued)


    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


    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)

    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 $4,420,000$5.4 million would be payable upon remittance of all previously unremitted earnings at December 31, 2004.2007.

    The Company believes that it is more likely than not that it will be able to recover the deferred tax assets not subject to valuation allowance.

    The American Job Creation Act of 2004 (the AJCA) was signed into federal law on October 22, 2004. The AJCA contains 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 does not anticipate repatriating any dividends from our foreign affiliates under this provision.

    (10) Accrued Expenses and Other Liabilities

    Accrued expenses and other liabilities consist of the following:

     

    December 31,

     

     December 31,

     

    2004

     

    2003

     

     2007
     2006

     

    (in thousands)

     

     (in millions)

    Commissions and sales incentives payable

     

    $

    25,618

     

    $

    18,869

     

     $42.6 $37.0

    Accrued insurance

     

    13,751

     

    16,104

     

     26.1 15.0

    Pension liability

     

    4,880

     

    1,501

     

    Other

     

    17,255

     

    15,280

     

     38.5 39.3

    Income taxes payable

     

    3,100

     

    3,089

     

     6.4 9.1

     

    $

    64,604

     

    $

    54,843

     

     
     
     $113.6 $100.4
     
     

    (11) Financing Arrangements

            Long-term debt consists of the following:

     
     December 31,
     
     2007
     2006
     
     (in millions)

    5.85% notes due April 2016 $225.0 $225.0
    4.87% notes due May 2010  50.0  50.0
    5.47% notes due May 2013  75.0  75.0
    $350.0 million Revolving Credit Facility maturing in April 2011. Eurocurrency rate loans interest accruing at LIBOR or Euro LIBOR plus an applicable percentage (Euro LIBOR at 4.7% and 3.6% at December 31, 2007 and 2006, respectively) At December 31, 2007, $81.8 million was for euro based borrowings and there were no outstanding U.S. borrowings. At December 31, 2006, $91.1 million were for euro based borrowings and there were no outstanding U.S. borrowings  81.8  91.1
    Other—consists primarily of European borrowings (at interest rates ranging from 3.3% to 8.5%)  1.7  8.1
      
     
       433.5  449.2
    Less Current Maturities  1.3  7.5
      
     
      $432.2 $441.7
      
     

    72




    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (11) Financing Arrangements (Continued)

    Long-term debt consists of the following:

     

     

    December 31,

     

     

     

    2004

     

    2003

     

     

     

    (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 plus an applicable percentage (2.8% at December 31, 2004). At December 31, 2004, $49,414,000 was borrowed for euro based borrowings and there were no outstanding U.S. borrowings.

     

    49,414

     

     

    $150,000,000 revolving credit facility that was to expire in February 2005, amended to include a $75 million tranche for euro based borrowing. European loan interest accruing at a variable rate (2.8% at December 31, 2003). At December 31, 2003, $44,089,000 was borrowed for euro based borrowings and there were no outstanding U.S. borrowings.

     

     

    44,089

     

    Hunter Innovations notes with principal payable in three equal annual installments, accruing interest monthly, due May 2006 (annual interest rate of 3.9% and 2.7% at December 31, 2004 and 2003, respectively)

     

    7,500

     

    11,250

     

    Other—which in 2004 consists primarily of European borrowings and 2003 consists primarily of loans held by our Chinese joint ventures (at interest rates ranging from 2.7% to 11.3%)

     

    3,629

     

    10,411

     

     

     

    185,543

     

    190,750

     

    Less Current Maturities

     

    4,981

     

    11,689

     

     

     

    $

    180,562

     

    $

    179,061

     

    Principal payments during each of the next five years and thereafter are due as follows (in thousands)millions): 2005—$4,981; 2006—$4,226; 2007—$480; 2008—$367;1.3; 2009—$49,9870.2; 2010—$50.2; 2011—$81.8; 2012—$0 and thereafter—$125,502.300.0.

    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 $42,570,000$45.0 million as of December 31, 20042007 and $29,880,000$49.6 million as of December 31, 2003.2006. The Company’sCompany's letters of credit are primarily letters of credit associated with insurance coverage and to a lesser extent foreign purchases. The Company’sCompany'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.revolving credit facility. These instruments may exist or expire without being drawn down. Therefore, they do not necessarily represent future cash flow obligations.

    On September 23, 2004,April 27, 2006, the Company entered intocompleted a private placement of $225.0 million of 5.85% senior unsecured notes due April 2016 (the 2006 Note Purchase Agreement). The 2006 Note Purchase Agreement includes operational and financial covenants, with which the Company is required to comply, including, among others, maintenance of certain financial ratios and restrictions on additional indebtedness, liens and dispositions. Events of default under the 2006 Note Purchase Agreement include failure to comply with its financial and operational covenants, as well as bankruptcy and other insolvency events. The Company may, at its option, upon notice to the noteholders, prepay at any time all or part of the Notes in an amount not less than $1 million by paying the principal amount plus a make-whole amount, which is dependent upon the yield of respective U.S. Treasury Securities. The Company used the net proceeds from the private placement to repay $147.0 million outstanding under its revolving credit facility. The balance of the net proceeds will be used to finance future acquisitions and for general corporate purposes. As of December 31, 2007, the Company was in compliance with all covenants related to the 2006 Note Purchase Agreement. The payment of interest on the senior unsecured notes is due semi-annually on April 30th and October 30th of each year. Additionally, the Company amended its 2003 Note Purchase Agreement to reflect the existence of the subsidiary guarantors and to substantially conform certain provisions of the 2003 Note Purchase Agreement to the 2006 Note Purchase Agreement.

            On April 27, 2006, the Company amended and restated its unsecured revolving credit facility with a syndicate of banks (the Revolving Credit Facility)(as amended, the revolving credit facility). The Revolving Credit Facilityrevolving credit facility provides for multi-currency unsecured borrowings and stand-by letters of credit of up to $300,000,000$350.0 million and expires in September 2009.April 2011. Borrowings outstanding under the Revolving Credit Facilityrevolving credit facility bear interest at a fluctuating rate per annum forequal to an applicable percentage equal to (i) in the case of Eurocurrency rate loans, the British


    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)

    Bankers Association LIBOR rate plus an applicable percentage of up0.625%, which is determined by reference to 0.875% based on the Company’s currentCompany's 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 in effect for such day as announced by Bank of America, N.A. as its “prime"prime rate." For 20042007, the average interest rate for borrowings under the revolving credit facility for euro-based borrowings was approximately 2.8%4.6%. 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, 2004,2007, the Company was in compliance with all covenants related to the Revolving Credit Facility. The Companyrevolving credit facility; had $218,445,000$234.4 million of unused and potentially available credit under the Revolving Credit Facilityrevolving credit facility; had no U.S dollar denominated debt and $81.8 million of euro-based borrowings outstanding on its revolving credit facility; and had $33.8 million for stand-by letters of credit outstanding on its revolving credit facility.

            At the closing of the Dormont acquisition, Dormont had long-term debt outstanding of $8.9 million in the form of two series of taxable variable rate demand bonds (1998 Series with


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (11) Financing Arrangements (Continued)


    $1.5 million outstanding and the 2000 Series with $7.4 million 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 $9.1 million, which represents the $8.9 million in bond principal plus interest and 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 recorded this escrow deposit in prepaid expenses and other assets at December 31, 2004.2005. 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.

            Effective July 1, 2005, the Company entered into a three-year interest rate swap with a counter party for a notional amount of €25.0 million, which was outstanding under the revolving credit facility. The Company swapped three-month EURIBOR plus 0.6% for a fixed rate of 3.02%. The change in the fair value of the swap during 2006 approximated $0.7 million and was recorded as a reduction of interest expense in 2006. The swap was terminated on October 3, 2006.

    On May 15, 2003, the Company completed a private placement of $125,000,000$125.0 million of senior unsecured notes consisting of $50,000,000$50.0 million principal amount of 4.87% senior notes due 2010 and $75,000,000$75.0 million principal amount of 5.47% senior notes due 2013. The Company used the net proceeds from the private placement to purchase treasury securities to repay the $75,000,000 principal amount of 83¤8% Notes due December 2003. Additional net proceeds were used to repay approximately $32,000,000 outstanding under the previous 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 15th15th and November 15th15th of each year. The senior unsecured notes were issued by Watts Water Technologies, Inc. and arepari passu with the Revolving Credit Facility,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$150.0 million 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.

    Effective July 1, 2003, the Company entered into an interest rate swap for a notional amount of €25,000,000 outstanding on the prior revolving credit facility. The Company swapped the variable rate from the Revolving Credit Facility which is three month EURIBOR plus 0.7% for a fixed rate of 2.33%. The term of the swap is two years. The Company has designated the swap as a hedging instrument using the cash flow method. The swap hedges the cash flows associated with interest payments on the first €25,000,000 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, 2004 was $39,000.

    (12) Common Stock

    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, 2004,2007, the Company has reserved a total of 4,383,6864,611,899 of Class A Common Stock for issuance under its stock-based compensation plans and 7,343,8807,293,880 shares for conversion of Class B Common Stock to Class A Common Stock.

            In February 2007, the Company's Board of Directors adopted an amendment, which was subsequently approved by the Company's stockholders, to increase the number shares of Class A Common Stock available to be granted under the Company's Management Stock Purchase Plan from 1,000,000 shares to 2,000,000 shares.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (12) Common Stock (Continued)

            In November 2007, the Company announced that its Board of Directors had authorized a repurchase of up to 3,000,000 shares of its Class A Common Stock. As of December 31, 2007, the Company had repurchased 867,451 shares of stock for a total cost of $25.0 million.

    (13) Stock-Based Compensation

    There are four        The Company maintains three stock optionincentive plans under which key employees and outside directors have been granted currently outstanding incentive stock options (ISOs) and nonqualified stock options (NSOs) to purchase the Company’sCompany's Class A Common Stock. Only one plan, the 2004 Stock Incentive Plan, is currently available for the grant of new options. Theequity awards. Stock options had becomegranted under prior plans became exercisable over a five-year period at the rate of 20% per year and expire ten years after the date of grant. Under the 2004 Stock Incentive Plan, options become exercisable over a four yearfour-year period at the rate of 25% per year and expire ten years after the grant date. ISOs and NSOs granted under the plans may have exercise prices of not less than 100% and 50% of the fair market value of the common stockClass A Common Stock on the date of grant, respectively. The Company's current practice is to grant all options at fair market value on the grant date. At December 31, 2004, 4,383,6862007, 3,078,132 shares of Class A Common Stock were authorized for future grants of optionsnew equity awards under the Company’sCompany's stock optionincentive plans.

    The following is a summary of stock option activity and related information:

     

     

    Years Ended December 31,

     

     

     

    2004

     

    2003

     

    2002

     

     

     

    Options

     

    Weighted
    Average
    Exercise
    Price

     

    Options

     

    Weighted
    Average
    Exercise
    Price

     

    Options

     

    Weighted
    Average
    Exercise
    Price

     

     

     

    (Options in thousands)

     

    Outstanding at beginning of year

     

     

    1,015

     

     

     

    $

    14.90

     

     

     

    1,455

     

     

     

    $

    14.29

     

     

     

    1,757

     

     

     

    $

    13.31

     

     

    Granted

     

     

    254

     

     

     

    25.02

     

     

     

    248

     

     

     

    16.70

     

     

     

    273

     

     

     

    15.50

     

     

    Cancelled

     

     

    (11

    )

     

     

    16.10

     

     

     

    (387

    )

     

     

    13.35

     

     

     

    (73

    )

     

     

    11.75

     

     

    Exercised

     

     

    (258

    )

     

     

    14.24

     

     

     

    (301

    )

     

     

    14.98

     

     

     

    (502

    )

     

     

    11.88

     

     

    Outstanding at end of year

     

     

    1,000

     

     

     

    $

    17.82

     

     

     

    1,015

     

     

     

    $

    14.90

     

     

     

    1,455

     

     

     

    $

    14.29

     

     

    Exercisable at end of year

     

     

    392

     

     

     

    $

    14.29

     

     

     

    504

     

     

     

    $

    13.92

     

     

     

    858

     

     

     

    $

    14.11

     

     

    The following table summarizes information about options outstanding at December 31, 2004:

     

     

    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)

     

                   $10.58

     

     

    53

     

     

     

    5.0

     

     

     

    $

    10.58

     

     

     

    53

     

     

     

    $

    10.58

     

     

    $11.75—$14.05

     

     

    108

     

     

     

    5.1

     

     

     

    12.09

     

     

     

    96

     

     

     

    12.11

     

     

    $14.70—$25.02

     

     

    839

     

     

     

    8.0

     

     

     

    18.87

     

     

     

    243

     

     

     

    15.94

     

     

     

     

     

    1,000

     

     

     

    6.0

     

     

     

    $

    17.82

     

     

     

    392

     

     

     

    $

    14.29

     

     

    In 2004, the Company issued 32,133also grants shares of restricted stock to itskey employees and non-employee members of the Company's Board of Directors (includingunder the Company’s Chief Executive Officer) that2004 Stock Incentive Plan, which vest either immediately or over 3 years with a fair market price between $25.00 and $26.50three-year period at the rate of one-third per share amounting to approximately $805,000 of deferred compensation.year. 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 Unitsrestricted stock units (RSUs) to key employees. On an annual basis, key employees may elect to receive a portion of their annual incentive compensation in RSUs instead of cash. Each RSU provides the key employee with the right to purchase up to 1,000,000 sharesa share 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 grant date. An aggregate of 2,000,000 shares of Class A Common Stock may be issued under the Management Stock Purchase Plan.

      2004 Stock Incentive Plan

            At December 31, 2007, total unrecognized compensation cost related to the unvested stock options was approximately $4.4 million with a total weighted average remaining term of 2.6 years. For 2007 and 2006, the Company recognized compensation cost of $2.7 million and $1.4 million, respectively, in selling, general and administrative expenses.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    date(13) Stock-Based Compensation (Continued)

            The following is a summary of grant.stock option activity and related information:

     
     Years Ended December 31,
     
     2007
     2006
     2005
     
     Options
     Weighted
    Average
    Exercise
    Price

     Intrinsic
    Value

     Options
     Weighted
    Average
    Exercise
    Price

     Options
     Weighted
    Average
    Exercise
    Price

     
     (Options in thousands)

    Outstanding at beginning of year 1,140 $23.99    1,089 $21.70 1,000 $17.82
    Granted 189  33.36    164  35.20 310  31.66
    Cancelled/Forfeitures (94) 31.08    (7) 34.16 (113) 21.49
    Exercised (67) 17.17    (106) 17.61 (108) 14.26
      
           
        
       
    Outstanding at end of year 1,168 $25.32 $4.48 1,140 $23.99 1,089 $21.70
      
           
        
       
    Exercisable at end of year 705 $21.42 $8.38 566 $19.13 422 $16.05
      
           
        
       

            As of December 31, 2007, the aggregate intrinsic values of outstanding and exercisable options were approximately $5.2 million and $5.9 million, respectively, representing the total pre-tax intrinsic value, based on the Company's closing Class A Common Stock price of $29.80 as of December 31, 2007 which would have been received by the option holders had all option holders exercised their options as of that date. The difference betweentotal intrinsic value of options exercised for 2007 and 2006 was approximately $1.4 million and $2.2 million, respectively.

            Upon exercise of options, the RSU price andCompany issues shares of Class A Common Stock.

            The following table summarizes information about options outstanding at December 31, 2007:

     
     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)

    $10.56—$14.08 64 2.83 $11.17 64 $11.17
    $14.09—$17.60 370 4.92  16.53 333  16.43
    $24.64—$28.16 208 6.02  25.12 156  25.15
    $31.68—$35.20 526 8.25  33.28 152  32.86
      
          
       
      1,168 6.50 $25.32 705 $21.42
      
          
       

            The fair market value atof each option granted under the 2004 Stock Incentive Plan is estimated on the date of grant, using the Black-Scholes-Merton Model, based on the following weighted average assumptions:

     
     Years Ended December 31,
     
     
     2007
     2006
     2005
     
    Expected life (years) 5.8 5.8 5.8 
    Expected stock price volatility 37.2%35.9%36.2%
    Expected dividend yield 1.2%1.0%1.0%
    Risk-free interest rate 4.6%4.9%4.0%

    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (13) Stock-Based Compensation (Continued)

            The risk-free interest rate is amortizedbased upon the U.S. Treasury yield curve at the time of grant for the respective expected life of the option. The expected life (estimated period of time outstanding) of options and volatility were calculated using historical data. The expected dividend yield of stock is the Company's best estimate of the expected future dividend yield. The Company applied an estimated forfeiture rate of 15% for its stock options. These rates were calculated based upon historical activity and are an estimate of granted shares not expected to vest. If actual forfeitures differ from the expected rates, the Company may be required to make additional adjustments to compensation expense ratably overin future periods.

            The above assumptions were used to determine the vesting period.weighted average grant-date fair value of stock options of $12.75, $13.50 and $11.54 for the years ending December 31, 2007, 2006 and 2005, respectively.

            The following is a summary of unvested restricted stock activity and related information:

     
     Years Ended December 31,
     
     2007
     2006
     2005
     
     Shares
     Weighted
    Average
    Grant Date
    Fair Value

     Shares
     Weighted
    Average
    Grant Date
    Fair Value

     Shares
     Weighted
    Average
    Grant Date
    Fair Value

     
     (Shares in thousands)

    Unvested at beginning of year 73 $33.62 27 $26.51 32 $25.05
    Granted 74  33.21 60  35.27 6  32.05
    Forfeitures (15) 34.10 (1) 35.20   
    Vested (43) 31.85 (13) 26.09 (11) 25.05
      
        
        
       
    Unvested at end of year 89 $34.05 73 $33.62 27 $26.51
      
        
        
       

            The total fair value of shares vested during 2007, 2006 and 2005 was $1.4 million, $0.4 million and $0.3 million, respectively. At December 31, 2004, 267,3212007, total unrecognized compensation cost related to unvested restricted stock was approximately $2.9 million with a total weighted average remaining term of 2.1 years. For 2007 and 2006, the Company recognized compensation costs of $1.6 million and $0.6 million, respectively, in selling, general and administrative expenses. The Company applied an estimated forfeiture rate of 10% for restricted stock issued to key employees. The aggregate intrinsic value of restricted stock granted and outstanding approximated $2.7 million representing the total pre-tax intrinsic value based on the Company's closing Class A Common Stock price of $29.80 as of December 31, 2007.

      Management Stock Purchase Plan

            Total unrecognized compensation cost related to unvested RSUs were outstanding.was approximately $2.2 million at December 31, 2007 with a total weighted average remaining term of 1.9 years. For 2007 and 2006 the Company recognized compensation cost of $1.7 million and $1.0 million, respectively, in selling, general and administrative expenses. Dividends declared for RSUs, that are paid to individuals, that remain unpaid at December 31, 20042007 total approximately $35,000. Deferred compensation for the restricted stock and RSU plans at December 31, 2004 is anticipated to be expensed as follows: 2005 - -$721,000, 2006 -$553,000, and 2007 - $112,000.$0.2 million.


    The Company has elected to follow APB No. 25 and related interpretations in accounting for its stock-based compensation. In addition the Company provides proforma disclosure of stock-based compensation, as measured under the fair value requirements of FAS 123. These proforma disclosures, which are calculated for awards granted after June 30, 1995, are provided in Footnote 2 as required under FAS 148. The weighted average grant date fair value of options granted are $5.44, $4.48 and $4.43 for the years ending December 31, 2004, 2003 and 2002, respectively. Also, the weighted average grant date fair value of RSUs related to Management Stock Purchase Plan are $8.15, $6.55 and $5.48 for the years ending December 31, 2004, 2003 and 2002, respectively.

    The fair value of the Company’s stock-based awards to employees (used in reconciliation of Note 2) was estimated using a Black-Scholes option pricing model and the following assumptions:

     

     

    Years Ended December 31,

     

     

     

     2004 

     

     2003 

     

     2002 

     

    Expected life (years)

     

    5.0

     

    5.0

     

    5.0

     

    Expected stock price volatility

     

    20.3

    %

    28.3

    %

    33.2

    %

    Expected dividend yield

     

    1.1

    %

    1.4

    %

    1.6

    %

    Risk-free interest rate

     

    3.50

    %

    3.25

    %

    2.65

    %

    The fair value of the Company’s Management Stock Purchase Plan awards to employees (used in reconciliation of Note 2) was estimated using a Black-Scholes option pricing model and the following assumptions:

     

     

    Years Ended December 31,

     

     

     

     2004 

     

     2003 

     

     2002 

     

    Expected life (years)

     

    3.0

     

    3.0

     

    3.0

     

    Expected stock price volatility

     

    20.3

    %

    28.3

    %

    33.2

    %

    Expected dividend yield

     

    1.2

    %

    1.5

    %

    1.7

    %

    Risk-free interest rate

     

    2.25

    %

    5.63

    %

    2.65

    %

    76




    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (13) Stock-Based Compensation (Continued)

            A summary of the Company's RSUs activity and related information for 2007 is shown in the following table:

     
     Years Ended December 31,
     
     2007
     2006
     2005
     
     RSUs
     Weighted
    Average
    Purchase Price

     Intrinsic
    Value

     RSUs
     Weighted
    Average
    Purchase Price

     RSUs
     Weighted
    Average
    Purchase Price

     
     (RSUs in thousands)

    Outstanding at beginning of period 347 $19.00    328 $16.02 267 $12.27
    Granted 160  25.73    87  23.34 120  22.28
    Cancelled/Forfeitures (31) 25.03       (17) 9.93
    Settled (110) 15.62    (68) 10.20 (42) 16.50
      
           
        
       
    Outstanding at end of period 366 $22.45 $7.35 347 $19.00 328 $16.02
      
           
        
       
    Vested at end of period 141 $18.98 $10.82 148 $15.64 120 $11.56
      
           
        
       

            As of December 31, 2007, the aggregate intrinsic values of outstanding and vested RSUs were approximately $2.7 million and $1.5 million, respectively, representing the total pre-tax intrinsic value, based on the Company's closing Class A Common Stock price of $29.80 as of December 31, 2007 which would have been received by the RSUs holders had all RSUs settled as of that date. The total intrinsic value of RSUs settled for 2007 and 2006 was approximately $2.5 million and $1.4 million, respectively. Upon settlement of RSUs, the Company issues shares of Class A Common Stock.

            The following table summarizes information about RSUs outstanding at December 31, 2007:

     
     RSUs Outstanding
     RSUs Vested
    Range of Purchase Prices

     Number
    Outstanding

     Weighted Average
    Remaining Contractual
    Life (years)

     Weighted Average
    Purchase
    Price

     Number
    Vested

     Weighted Average
    Purchase
    Price

     
     (RSUs in thousands)

     $7.04—$10.56 35 3.2 $9.54 35 $9.54
    $14.08—$17.60 7 1.2  15.50 7  15.50
    $21.12—$24.64 188 .7  22.74 99  22.58
    $24.65—$28.16 136 2.2  25.73   
      
          
       
      366 1.5 $22.45 141 $18.98
      
          
       

            The fair value of each share issued under the Management Stock Purchase Plan is estimated on the date of grant, using the Black-Scholes-Merton Model, based on the following weighted average assumptions:

     
     Years Ended December 31,
     
     
     2007
     2006
     2005
     
    Expected life (years) 3.0 3.0 3.0 
    Expected stock price volatility 35.3%25.7%26.0%
    Expected dividend yield 1.0%1.5%1.4%
    Risk-free interest rate 4.8%4.5%3.4%

    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (13) Stock-Based Compensation (Continued)

            The risk-free interest rate is based upon the U.S. Treasury yield curve at the time of grant for the respective expected life of the RSU's. The expected life (estimated period of time outstanding) of RSU's and volatility were calculated using historical data. The expected dividend yield of stock is the Company's best estimate of the expected future dividend yield. The Company applied an estimated forfeiture rate of 10% for its RSUs. These rates were calculated based upon historical activity and are an estimate of granted shares not expected to vest. If actual forfeitures differ from the expected rates, the Company may be required to make additional adjustments to compensation expense in future periods.

            The above assumptions were used to determine the weighted average grant-date fair value of RSUs granted of $16.79, $13.60 and $12.41 during 2007, 2006 and 2005, respectively.

            The Company distributed dividends of $0.40 per share for 2007, $0.36 per share for 2006 and $0.32 per share for 2005 on the Company's Class A Common Stock and Class B Common Stock.

    (14) Employee Benefit Plans

    The Company sponsors funded and unfunded non-contributing defined benefit pension plans coveringthat together cover 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. TheBeginning in 2007, the Company uses a December 31 measurement date for its plans. Prior to 2007, the Company used a September 30 measurement date for its plans.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (14) Employee Benefit Plans (Continued)

    The funded status of the defined benefit plans and amounts recognized in the balance sheet are as follows:

     

    December 31,

     


     December 31,
     

     

    2004

     

    2003

     


     2007
     2006
     

     

    (in thousands)

     


     (in millions)

     

    Change in projected benefit obligation

     

     

     

     

     

    Change in projected benefit obligation     

    Balance at beginning of the year

     

    $

    51,741

     

    $

    41,961

     

    Balance at beginning of the year $72.6 $69.1 

    Service cost

     

    2,462

     

    2,021

     

    Service cost 3.8 3.5 

    Administration cost

     

    (297

    )

     

    Administration cost (.4) (.4)
    Plan changePlan change .1 .7 

    Interest cost

     

    3,054

     

    2,789

     

    Interest cost 4.3 3.8 

    Actuarial loss

     

    3,992

     

    6,550

     

    Amendments/curtailments

     

    193

     

    150

     

    Actuarial gainActuarial gain (6.0) (1.9)

    Benefits paid

     

    (1,920

    )

    (1,730

    )

    Benefits paid (2.3) (2.2)

    Balance at end of year

     

    $

    59,225

     

    $

    51,741

     

    One-time adjustment for measurement date changeOne-time adjustment for measurement date change 1.3  
     
     
     
    Balance at end of year $73.4 $72.6 
     
     
     

    Change in fair value of plan assets

     

     

     

     

     

    Change in fair value of plan assets     

    Balance at beginning of the year

     

    $

    32,189

     

    $

    25,535

     

    Balance at beginning of the year $42.6 $40.1 

    Actual gain on assets

     

    3,946

     

    4,611

     

    Actual gain on assets 3.6 1.9 

    Employer contributions

     

    3,103

     

    3,773

     

    Employer contributions 7.3 3.2 

    Administration cost

     

    (297

    )

     

    Administration cost (.4) (.4)

    Benefits paid

     

    (1,920

    )

    (1,730

    )

    Benefits paid (2.3) (2.2)

    Fair value of plan assets at end of the year

     

    $

    37,021

     

    $

    32,189

     

    Funded Status

     

    $

    (22,204

    )

    $

    (19,552

    )

    Unrecognized transition obligation

     

     

    (148

    )

    Unrecognized prior service costs

     

    1,462

     

    1,498

     

    Unrecognized net actuarial loss

     

    15,826

     

    13,681

     

    One-time adjustment for measurement date changeOne-time adjustment for measurement date change 8.0  
     
     
     
    Fair value of plan assets at end of the year $58.8 $42.6 
     
     
     

    Funded status at end of year

    Funded status at end of year

     

    $

    (14.6

    )

    $

    (30.0

    )

    Contributions after measurement date and on or before fiscal year end

     

    36

     

    3,020

     

    Contributions after measurement date and on or before fiscal year end  6.6 

    Net amount recognized

     

    $

    (4,880

    )

    $

    (1,501

    )

     

     

     

     

     

     
     
     
    Net amount recognized $(14.6)$(23.4)
     
     
     

            

    Amounts recognized in the statement of financial positionbalance sheet are as follows:

     

     

    December 31,

     

     

     

    2004

     

    2003

     

     

     

    (in thousands)

     

    Accrued benefit costs

     

    $

    (4,880

    )

    $

    (1,501

    )

    Minimum pension liability

     

    $

    (10,905

    )

    $

    (10,551

    )

    Intangible assets

     

    $

    1,462

     

    $

    1,073

     

     
     December 31,
     
     
     2007
     2006
     
     
     (in millions)

     
    Current liabilities $(.1)$(.1)
    Noncurrent liabilities  (14.5) (23.3)
      
     
     
    Net amount recognized $(14.6)$(23.4)
      
     
     

            Amounts recognized in accumulated other comprehensive income consist of:

     
     December 31,
     
     2007
     2006
     
     (in millions)

    Net actuarial loss $11.2 $19.0
    Prior service cost  1.8  1.7
      
     
    Net amount recognized $13.0 $20.7
      
     

    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (14) Employee Benefit Plans (Continued)

    Information for pension plans with an accumulated benefit obligation in excess of plan assets are as follows:

     

    December 31,

     

     December 31,

     

    2004

     

    2003

     

     2007
     2006

     

    (in thousands)

     

     (in millions)

    Projected benefit obligation

     

    $

    59,225

     

    $

    51,741

     

     $73.4 $72.6

    Accumulated benefit obligation

     

    $

    52,841

     

    $

    47,260

     

     $66.4 $64.3

    Fair value of plan assets

     

    $

    37,021

     

    $

    32,189

     

     $58.8 $42.6

            

    The components of net periodic benefit cost are as follows:

     

     

    Years Ended December 31,

     

     

     

    2004

     

    2003

     

    2002

     

     

     

    (in thousands)

     

    Service cost—benefits earned

     

    $

    2,462

     

    $

    2,021

     

    $

    1,512

     

    Interest costs on benefits obligation

     

    3,054

     

    2,789

     

    2,683

     

    Estimated return on assets

     

    (2,856

    )

    (2,281

    )

    (2,520

    )

    Transitional obligation amortization

     

    (148

    )

    (255

    )

    (255

    )

    Prior service cost amortization

     

    229

     

    219

     

    205

     

    Net loss amortization

     

    756

     

    521

     

     

    Net periodic benefit cost

     

    $

    3,497

     

    $

    3,014

     

    $

    1,625

     

     
     Years Ended December 31,
     
     
     2007
     2006
     2005
     
     
     (in millions)

     
    Service cost—benefits earned $3.8 $3.5 $2.9 
    Interest costs on benefits obligation  4.3  3.8  3.3 
    Expected return on assets  (4.4) (3.5) (3.2)
    Prior service cost amortization  .2  .3  .2 
    Net actuarial loss amortization  .9  1.2  .9 
    Curtailment charge  .2     
      
     
     
     
     Net periodic benefit cost $5.0 $5.3 $4.1 
      
     
     
     

            The estimated net actuarial loss and prior service cost for the defined benefit pension plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next year are $0.4 million and $0.2 million, respectively.

    Additional Information:

     

     

    December 31,

     

     

     

    2004

     

    2003

     

     

     

    (in thousands)

     

    Increase in minimum liability included in other comprehensive
    income

     

    $

    34

     

    $

    3,046

     

    Assumptions:

    Weighted-average assumptions used to determine benefit obligations:

     

    December 31,

     

     

      2004  

     

      2003  

     

     2007
     2006
     

    Discount rate

     

     

    5.75

    %

     

     

    6.00

    %

     

     6.50%5.875%

    Rate of compensation increase

     

     

    4.00

    %

     

     

    4.00

    %

     

     4.00%4.00%

            

    Weighted-average assumptions used to determine net periodic benefit costs:

     

    December 31,

     

     

      2004  

     

      2003  

     

      2002  

     

     2007
     2006
     2005
     

    Discount rate

     

     

    6.00

    %

     

     

    6.75

    %

     

     

    7.50

    %

     

     5.875%5.50%5.75%

    Long-term rate of return on asset

     

     

    8.50

    %

     

     

    8.50

    %

     

     

    9.00

    %

     

    Long-term rate of return on assets 8.50%8.50%8.50%

    Rate of compensation increase

     

     

    4.00

    %

     

     

    4.00

    %

     

     

    4.50

    %

     

     4.00%4.00%4.00%

            

    Discount rates are selected based upon rates of return at the measurement date utilizing a bond matching approach to match the expected benefit cash flows. 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 plan. This


    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)

    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.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (14) Employee Benefit Plans (Continued)

      Plan assets:

    The weighted average asset allocations by asset category is as follows:

     

    Plan Assets At
    December 31,

     

    Asset Category

     

     

     

    2004

     

    2003

     

     2007
     2006
     

    Equity securities

    Equity securities

     

    71.2

    %

    74.8

    %

     64.9%64.4%

    Debt securities

    Debt securities

     

    28.8

    %

    25.2

    %

     29.8 30.0 
    Other 5.3 5.6 
     
     
     

    Total

    Total

     

    100.0

    %

    100.0

    %

     100.0%100.0%

     

     

     

     

     

     
     
     

            

    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.

    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.


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (14) Employee Benefit Plans (Continued)

      Cash flows:

    The information related to the Company’sCompany's pension funds cash flow is as follows:

     

    December 31,

     

     December 31,

     

    2004

     

    2003

     

     2007
     2006

     

    (in thousands)

     

     (in millions)

    Employer Contributions

     

    $

    117

     

    $

    6,793

     

     $7.3 $9.8

    Benefit Payments

     

    $

    1,920

     

    $

    1,730

     

     $2.3 $2.2

            

    ContributionsNo contributions are expected to be made during 2005 approximate $1,700,000.in 2008.

    Expected benefit payments to be paid by the pension plans are as follows:

     

     

    (in thousands)

     

    During fiscal year ending December 31, 2005

     

     

    $

    1,990

     

     

    During fiscal year ending December 31, 2006

     

     

    $

    2,041

     

     

    During fiscal year ending December 31, 2007

     

     

    $

    2,089

     

     

    During fiscal year ending December 31, 2008

     

     

    $

    2,191

     

     

    During fiscal year ending December 31, 2009

     

     

    $

    2,369

     

     

    During fiscal year ending December 31, 2010 through December 31, 2014

     

     

    $

    14,978

     

     

     
     (in millions)
    During fiscal year ending December 31, 2008 $2.6
    During fiscal year ending December 31, 2009 $2.8
    During fiscal year ending December 31, 2010 $3.0
    During fiscal year ending December 31, 2011 $3.2
    During fiscal year ending December 31, 2012 $3.5
    During fiscal year ending December 31, 2013 through December 31, 2017 $24.0

            

    Additionally, substantially all of the Company’sCompany's domestic employees are eligible to participate in certain 401(k) savings plans. Under these plans, the Company matches a specified percentage of employee contributions, subject to certain limitations. The Company’sCompany's match contributions (included in selling, general and administrative expense) for the years ended December 31, 2004, 2003,2007, 2006, and 20022005 were $421,000, $300,000,$0.6 million, $0.6 million, and $330,000,$0.4 million, respectively. Charges for European pension plans approximated $3.0 million, $1.9 million and $2.0 million for the years ended December 31, 2007, 2006, and 2005, 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.

    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 as 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, subject to cost of living increases each 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).


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (15) Contingencies and Environmental Remediation

    James Jones Litigation

    As previously disclosed, on        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


    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)

    (James (James Jones), Mueller Co., Tyco International (U.S.), and Watts Industries, Inc., now Watts Water Technologies, Inc. (Watts).the Company. The Company formerly owned James Jones. The Relator filed under the 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”"defective" or “non-conforming”"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 and a Second Amended Complaint in December 2000, which brought the total number of plaintiffs to 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 the named cities have intervened and attempts by four other named cities to intervene have been denied.

            In June 2002, the trial court excluded 47 cities from this December 2000 total of 161, but this exclusion was reversed by an August 30, 2006 California Court of Appeal ruling that is now final. This August 30, 2006, Court of Appeal ruling also reversed dismissals of Tyco International and Mueller Co. and this allowed the Relator to make a successful motion that removed the Armenta Case litigation from Judge Lichtman's court to the court of Judge Chaney, another complex litigation judge.

    One of the allegations in the Second Amended Complaint and the Complaints-in-Intervention is that purchased non-conforming James Jones waterworks 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 and advertised ‘85'85 bronze alloy (UNS No. C83600). This contention is based on the average difference of about 2% lead content between ‘81'81 bronze (6% to 8% lead) and ‘85'85 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 indicateindicates that this is not the case.

    In addition, ‘81'81 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”"lead free" under Section 1417 of the Federal Safe Drinking Water Act.

    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. She 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’attorneys' fees.

    In December 1998, the Los Angeles Department of Water and Power (LADWP) intervened in this case and filed a complaint. WeThe Company settled with the city of Los Angeles, by far the most significant city, for $7,300,000$7.3 million plus attorneys’attorneys' fees. Co-defendants contributed $2.0 million toward this settlement.

    In August 2003, an additional settlement payment was made for $13,000,000$13.0 million ($11,000,00011.0 million from the Company and $2,000,000$2.0 million from James Jones), which settled the claims of the three Phase I cities (Santa Monica, San Francisco and East Bay Municipal Utility District) chosen by the Relator as having the strongest claims to be tried first. This settlement payment included the Relator’sRelator's statutory share,


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (15) Contingencies and Environmental Remediation (Continued)


    and the claims of these three cities have been dismissed. In addition to this $13,000,000$13.0 million payment, the Company is obligated to pay the Relator’s attorney’sRelator's attorney's fees.

    After the Phase I settlement, the courtCourt permitted the defendants to select five additional cities to serve as the plaintiffs in a second trial phase of the case. Contra Costa, Corona, Santa Ana, Santa Cruz and Vallejo were chosen. WattsThe Company and James Jones then reached an agreement to settle the claims of the City of Santa Ana for a total of $45,000, an amount which approximates Santa Ana’sAna's purchases of James Jones products during the relevant period. The Santa Ana settlement was approved by the Court and then completed, andcompleted.

            On June 22, 2005, the trialCourt dismissed the claims of the remaining Phase II cities’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 unique, this ruling is significant for the claims of the remaining cities, and the Relator appealed. However, this judgment can be appealed again at the conclusion of the entire case. The trial court has scheduled a trial on March 17, 2009 for six Phase III cities with three cities to be selected by each side. Litigation is presently scheduledinherently uncertain, and the Company is unable to predict the outcome of this case.

            On September 15, 2004, the Relator's attorneys filed a new common law fraud lawsuit in the California Superior Court for October 2005.


    the City of Banning and forty-six other cities and water districts against James Jones, Watts Water Technologies, Inc. and Subsidiaries
    NotesMueller Co. based on the same transactions alleged in the Armenta case. About forty-two of the plaintiffs in this new lawsuit are also plaintiffs in the Armenta case. The statute of limitations threshold issue is in the process of being resolved for these plaintiffs. Litigation is inherently uncertain, and the Company is unable to Consolidated Financial Statements (Continued)
    predict the outcome of this case.

    The Company has a reserve of approximately $21,000,000$28.0 million with respect to the James Jones Litigation in our consolidated balance sheet as of December 31, 2004.2007. The Company believes, on the basis of all available information, that this reserve is adequate to cover the probable and reasonably estimable losses resulting from the Armenta 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 itsthe Company's insurers had denied coverage for the claims in the Armenta case, the Companyit filed a complaint for coverage against ourits insurers in the California Superior Court (the coverage case). James Jones filed a similar complaint, the cases were consolidated, and the trial court made summary adjudication rulings that Zurich must pay all reasonable defense costs incurred by Wattsthe Company and James Jones in the Armenta case since April 23, 1998 as well as such future defense costs in the future until the end of the Armenta case. In JulyAugust 2004, the California Court of Appeal affirmed these rulings, and, on December 1, 2004, the California Supreme Court denied Zurich’sZurich's appeal of this decision. This denial permanently established Zurich’sZurich's obligation to pay Armenta defense costs for both Watts (about $13,800,000the Company (approximately $16.6 million plus future costs) and James Jones (about $14,800,000(which the Company estimates to be $17.0 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        On November 22, 2002, the trial court madeentered a summary adjudication rulingorder that Zurich must indemnify and pay Wattsthe Company and James Jones for amounts paid to settle with the City of Los Angeles. Zurich’sZurich's attempt to obtain appellate review of this order was denied, but Zurich will still be able to appeal this order at the end of the coverage case. InOn August 6, 2004, the trial court made


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (15) Contingencies and Environmental Remediation (Continued)


    another summary adjudication ruling that Zurich must indemnify and pay Wattsus and James Jones for the $13,000,000$13.0 million paid to settle the claims of the Phase I cities described above. Zurich’sZurich'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 been makingnow made all of the payments required by these indemnity orders,orders.

            On February 8, 2006, Zurich filed a motion to set aside as void the November 22, 2002 and August 6, 2004 summary adjudication indemnity payment orders. After this motion was denied, Zurich's appeal was also denied and the California Supreme Court denied Zurich's petition for review. The Company is currently unable to predict the finality of these indemnity payment orders since Zurich can also appeal them at the end of the coverage case. We haveThe Company has recorded reimbursed indemnity settlement amounts (but not reimbursed defense costs) as a liability pending court resolution of the indemnification matter as it relates to Zurich.

    Zurich has asserted that all amounts (now approximately $47,500,000(which the Company estimates to be $56.0 million for both defense costs and indemnity amounts paid for settlements) paid by it to Wattsthe Company 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 Wattsthe Company for its exposure from the Armenta case. However, managementThe Company believes the Armenta case should be viewed as one occurrence and counsel anticipatethe 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 reimbursement right for defense costs paid arises under six Deductible Agreements, and the Company contend that Watts will ultimately prevailonly two Deductible Agreements apply. The Company 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. The Company appealed this ruling. On October 20, 2006, the United States Court of Appeals for the Seventh Circuit affirmed that an arbitration panel could decide which deductible agreements between Zurich and the Company would control Zurich's reimbursement issue with Zurich.claim for defense costs paid in the James Jones case. As a result of this development, the Company recorded a pre-tax charge of $5.0 million to discontinued operations in 2006.

    Based on management’smanagement's assessment, the Company does not believe that the ultimate outcome of the James Jones Litigation will have a material adverse effect on ourits liquidity, financial condition or results of operations. While this assessment is based on all available information, litigation is inherently uncertain, the actual liability to the Company to 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 Litigation.


    Watts Water Technologies, Inc. and 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, including a site in Babylon, New York.sites. The levels of contamination vary 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 accrues


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (15) Contingencies and Environmental Remediation (Continued)


    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. The Company recognizes changes in estimates as new remediation requirements are defined or as new information becomes available. TheAt December 31, 2007, the Company has a reserve of approximately $1,400,000$1.4 million (environmental accrual), which the Companyit estimates 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 matters will have a material adverse effect on its liquidity, financial condition or results of operations. Some of the Company’sits environmental matters are inherently uncertain and it there exists a possibility that the Companyit may ultimately incur losses from these matters in excess of the amount accrued. However, the Company cannot currently estimate the amount of any such additional losses.

    Asbestos Litigation

    The Company is defending approximately 161100 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 as a source of asbestos exposure. To date, Wattsthe Company has been dismissed from each case when the scheduled trial date comes near or when discovery fails to yield any evidence of exposure to any Watts product.of its products. 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 its liquidity, financial condition or results of operations.

    Other Litigation

    On or about March 26, 2003, a class action complaint was filed against Watts by North Carolina Hospitality Group, Inc. in the Circuit Court of Maryland, Prince George’s County. It alleges that certain commercial valve models contain a design defect that causes them to fail prematurely. On 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 year, and it is now being briefed in the appellate court. Based on the facts currently known to it, the Company does not believe that the ultimate outcome of this matter will have a material adverse effect on its 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. 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 operations.


    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)

    (16) Financial Instruments

    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 and 5.85% senior notes due 2016 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,

     

    2004

     

    2003

     

     2007
     2006

     

    (in thousands)

     

     (in millions)

    Carrying amount

     

    $

    185,543

     

    $

    190,750

     

     $433.5 $449.2

    Estimated fair value

     

    $

    186,606

     

    $

    191,568

     

     $424.9 $447.5

    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (16) Financial Instruments (Continued)

    Derivative Instruments

    The Company uses foreign currency forward exchange contracts as an economic hedge to reduce the impact of currency fluctuations on certain anticipated intercompany purchase transactions that are expected to occur withinduring the yearnext twelve months and certain other foreign currency transactions. RelatedRealized and unrealized gains and losses on the contracts are recognized in other income/expense when the contracts expire, which is generally in the same period as the underlying foreign currency denominated transaction.expense. 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, 2004, 20032007 and 2002,2006, the fair value of the contracts approximated $0.1 million and $0.2 million, respectively. At December 31, 2005, the Company had no outstanding forward contracts to buy foreign currencies.

    The Company occasionally 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 the years ended December 31, 2004, 20032007, 2006 and 2002.2005.

    Effective July 1, 2003, the Company entered into an interest rate swap for a notional amount of Leases25,000,000 outstanding on its Revolving Credit Facility. The Company swapped the variable rate from the Revolving Credit Facility which is three month EURIBOR plus 0.7% for a fixed rate of 2.33%. The term of the swap is two years. The Company 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 of our Revolving Credit Facility. The Company marks to market the changes in value of the swap through other comprehensive income. Any ineffectiveness has been recorded in income. The fair value recorded in other comprehensive income as of December 31, 2004 was $39,000.

    At December 31, 2001, the Company had an outstanding interest rate swap that converted 20,000,000 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.

    84




    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)

    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, 20042007 are as follows:

     

     

    Operating Leases

     

    Capital Leases

     

     

     

    (in thousands)

     

    2005

     

     

    $       3,466

     

     

     

    $         672

     

     

    2006

     

     

    3,126

     

     

     

    464

     

     

    2007

     

     

    2,644

     

     

     

    207

     

     

    2008

     

     

    2,489

     

     

     

    57

     

     

    2009

     

     

    1,830

     

     

     

    4

     

     

    Thereafter

     

     

    7,653

     

     

     

     

     

    Total

     

     

    $ 21,208

     

     

     

    $ 1,404

     

     

     
     Capital Leases
     Operating Leases
     
     (in millions)

    2008 $1.8 $7.4
    2009  1.8  5.5
    2010  1.8  3.5
    2011  1.8  2.2
    2012  1.6  1.4
    Thereafter  11.4  2.2
      
     
     Total $20.2 $22.2
         
    Less amount representing interest (at rates ranging from 4.2% to 8.7%)  (3.5)  
      
       
    Present value of net minimum capital lease payments  16.7   
    Less current installments of obligations under capital leases  (1.4)  
      
       
     Obligations under capital leases, excluding installments $15.3   
      
       

    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (16) Financial Instruments (Continued)

            Carrying amounts of assets under capital lease include:

     
     December 31,
     
     
     2007
     2006
     
     
     (in millions)

     
    Buildings $18.6 $18.3 
    Machinery and equipment  8.9  3.1 
      
     
     
       27.5  21.4 
    Less accumulated depreciation  (4.0) (2.9)
      
     
     
      $23.5 $18.5 
      
     
     

    (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 sales transactions have been eliminated. Sales by region are based upon location of the entity recording the sale. The accounting policies for each segment are the same as those described in the summary of significant accounting policies (see Note 2).


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (17) Segment Information (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

     

     

     

    (in thousands)

     

    Year ended December 31, 2004

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Net sales

     

    $ 545,139

     

    $ 253,234

     

    $ 26,185

     

     

    $         —

     

     

     

    $ 824,558

     

     

    Operating income (loss)

     

    68,558

     

    31,597

     

    1,857

     

     

    (18,412

    )

     

     

    83,600

     

     

    Identifiable assets

     

    539,466

     

    303,981

     

    80,801

     

     

     

     

     

    924,248

     

     

    Long-lived assets

     

    72,019

     

    52,276

     

    26,394

     

     

     

     

     

    150,689

     

     

    Capital expenditures

     

    8,029

     

    6,374

     

    6,596

     

     

     

     

     

    20,999

     

     

    Depreciation and amortization

     

    14,961

     

    8,870

     

    4,220

     

     

     

     

     

    28,051

     

     

    Year ended December 31, 2003

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Net sales

     

    $ 472,518

     

    $ 210,614

     

    $ 18,727

     

     

    $         —

     

     

     

    $ 701,859

     

     

    Operating income (loss)

     

    64,375

     

    22,592

     

    (3,834

    )

     

    (13,132

    )

     

     

    70,001

     

     

    Identifiable assets

     

    511,285

     

    266,849

     

    62,784

     

     

     

     

     

    840,918

     

     

    Long-lived assets

     

    72,447

     

    48,882

     

    24,237

     

     

     

     

     

    145,566

     

     

    Capital expenditures

     

    6,495

     

    4,832

     

    8,703

     

     

     

     

     

    20,030

     

     

    Depreciation and amortization

     

    12,523

     

    6,593

     

    2,149

     

     

     

     

     

    21,265

     

     

    Year ended December 31, 2002

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Net sales

     

    $ 450,233

     

    $ 145,629

     

    $ 19,664

     

     

    $         —

     

     

     

    $ 615,526

     

     

    Operating income (loss)

     

    55,313

     

    13,608

     

    (625

    )

     

    (10,767

    )

     

     

    57,529

     

     

    Identifiable assets

     

    375,202

     

    206,146

     

    54,124

     

     

     

     

     

    635,472

     

     

    Long-lived assets

     

    78,333

     

    40,295

     

    15,748

     

     

     

     

     

    134,376

     

     

    Capital expenditures

     

    5,718

     

    6,171

     

    7,704

     

     

     

     

     

    19,593

     

     

    Depreciation and amortization

     

    14,731

     

    6,370

     

    1,193

     

     

     

     

     

    22,294

     

     

     
     December 31,
     
     
     2007
     2006
     2005
     
     
     (in millions)

     
    Net Sales          
     North America $871.0 $821.3 $629.9 
     Europe  452.6  367.5  266.3 
     China  58.7  42.0  28.1 
      
     
     
     
      Consolidated net sales $1,382.3 $1,230.8 $924.3 
      
     
     
     
    Operating income (loss)          
     North America $93.3 $98.5 $79.1 
     Europe  53.6  50.0  31.5 
     China  7.9  7.2  3.5 
      
     
     
     
      Subtotal reportable segments  154.8 $155.7 $114.1 
     Corporate(*)  (29.1) (25.2) (19.5)
      
     
     
     
      Consolidated operating income  125.7  130.5  94.6 
      Interest income  14.5  5.0  1.2 
      Interest expense  (26.9) (22.1) (10.4)
      Minority interest  2.8  1.8  (.3)
      Other  (2.3) .9  .7 
      
     
     
     
     Income from continuing operations before income taxes $113.8 $116.1 $85.8 
      
     
     
     
    Identifiable Assets          
     North America $1,066.0 $1,046.8 $717.4 
     Europe  531.6  493.4  288.8 
     China  131.7  120.7  94.8 
      
     
     
     
      Consolidated identifiable assets $1,729.3 $1,660.9 $1,101.0 
      
     
     
     
    Long-Lived Assets          
     North America $100.2 $99.7 $92.9 
     Europe  88.5  78.4  45.7 
     China  35.0  28.1  26.4 
      
     
     
     
      Consolidated long-lived assets $223.7 $206.2 $165.0 
      
     
     
     
    Capital Expenditures          
     North America $13.9 $14.6 $9.5 
     Europe  12.6  27.5  6.1 
     China  11.3  2.6  3.0 
      
     
     
     
      Consolidated capital expenditures $37.8 $44.7 $18.6 
      
     
     
     
    Depreciation and Amortization          
     North America $17.8 $17.1 $13.0 
     Europe  15.7  13.0  8.9 
     China  5.9  5.2  4.2 
      
     
     
     
      Consolidated depreciation and amortization $39.4 $35.3 $26.1 
      
     
     
     

    *
    Corporate expenses are primarily for compensation expense, Sarbanes-Oxley compliance, compensation expense, 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.

    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (17) Segment Information (Continued)

    The North AmericanAmerica segment consists of U.S. net sales of $507,061,000, $439,436,000$805.5 million, $762.7 million and $422,703,000$582.3 million for the years ended December 31, 2004, 20032007, 2006 and 2002,2005, respectively. The North American segment also consists of U.S. long-lived assets of $67,032,000, $67,450,000$92.7 million, $93.1 million and $73,907,000$86.1 million as of December 31, 2007, 2006 and 2005, respectively.

            Intersegment sales for the yearsyear ended December 31, 2004, 20032007 for North America, Europe and 2002,China were $6.6 million, $6.0 million and $137.1 million, respectively. Intersegment sales for the year ended December 31, 2006 for North America, Europe and China were $6.9 million, $3.0 million and $82.3 million, respectively. Intersegment sales for the year ended December 31, 2005 for North America, Europe and China were $4.8 million, $5.3 million and $48.8 million, respectively.

    All intercompany transactions have been eliminated, and intersegment revenues are not significant.


    Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)

    (18) Quarterly Financial Information (unaudited)

     

    First
    Quarter

     

    Second
    Quarter

     

    Third
    Quarter

     

    Fourth
     Quarter(1) 

     


     First
    Quarter

     Second
    Quarter

     Third
    Quarter

     Fourth
    Quarter

     

    (in thousands, except per share information)

     


     (in millions, except per share information)

    Year ended December 31, 2004

     

     

     

     

     

     

     

     

     

     

     

    Year ended December 31, 2007Year ended December 31, 2007        

    Net sales

     

    $ 186,008

     

    $ 206,954

     

    $ 210,190

     

     

    $ 221,406

     

     

    Net sales $346.1 $350.4 $340.5 $345.3

    Gross profit

     

    64,912

     

    75,627

     

    74,368

     

     

    75,654

     

     

    Gross profit 114.7 114.6 110.4 121.9

    Income from continuing operations

     

    10,995

     

    14,059

     

    13,835

     

     

    9,849

     

     

    Income from continuing operations 20.0 17.7 18.2 21.7

    Net income

     

    11,001

     

    13,953

     

    13,705

     

     

    8,161

     

     

    Net income 20.0 17.8 18.1 21.5

    Per common share:

     

     

     

     

     

     

     

     

     

     

     

    Per common share:        

    Basic

     

     

     

     

     

     

     

     

     

     

     

    Basic        

    Income from continuing operations

     

    0.34

     

    0.44

     

    0.43

     

     

    0.30

     

     

    Net income

     

    0.34

     

    0.43

     

    0.42

     

     

    0.25

     

     

    Income from continuing operations .52 .46 .47 .56
    Net income .52 .46 .47 .56

    Diluted

     

     

     

     

     

     

     

     

     

     

     

    Diluted        

    Income from continuing operations

     

    0.34

     

    0.43

     

    0.42

     

     

    0.30

     

     

    Net income

     

    0.34

     

    0.43

     

    0.42

     

     

    0.25

     

     

    Income from continuing operations .51 .45 .47 .56
    Net income .51 .46 .46 .55

    Dividends per common share

     

    0.07

     

    0.07

     

    0.07

     

     

    0.07

     

     

    Dividends per common share .10 .10 .10 .10

    Year ended December 31, 2003

     

     

     

     

     

     

     

     

     

     

     

    Year ended December 31, 2006Year ended December 31, 2006        

    Net sales

     

    $ 165,692

     

    $ 173,512

     

    $ 175,509

     

     

    $ 187,146

     

     

    Net sales $275.0 $300.2 $325.1 $330.5

    Gross profit

     

    55,764

     

    58,565

     

    59,373

     

     

    66,163

     

     

    Gross profit 95.8 106.4 111.9 110.9

    Income from continuing operations

     

    8,936

     

    8,680

     

    9,019

     

     

    9,784

     

     

    Income from continuing operations 15.1 22.5 21.3 18.1

    Net income

     

    6,610

     

    8,106

     

    8,905

     

     

    9,741

     

     

    Net income 15.0 22.4 18.2 18.1

    Per common share:

     

     

     

     

     

     

     

     

     

     

     

    Per common share:        

    Basic

     

     

     

     

     

     

     

     

     

     

     

    Basic        

    Income from continuing operations

     

    0.33

     

    0.32

     

    0.33

     

     

    0.35

     

     

    Net income

     

    0.24

     

    0.30

     

    0.33

     

     

    0.35

     

     

    Income from continuing operations .46 .69 .65 .52
    Net income .46 .69 .56 .52

    Diluted

     

     

     

     

     

     

     

     

     

     

     

    Diluted        

    Income from continuing operations

     

    0.33

     

    0.32

     

    0.33

     

     

    0.34

     

     

    Net income

     

    0.24

     

    0.30

     

    0.32

     

     

    0.34

     

     

    Income from continuing operations .46 .68 .65 .51
    Net income .46 .68 .55 .51

    Dividends per common share

     

    0.06

     

    0.06

     

    0.06

     

     

    0.07

     

     

    Dividends per common share .09 .09 .09 .09


    (1)   During the fourth quarter of 2004, 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.

    (19) Related Party Transactions

    In the second quarter of 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. An agreement to


    Company's 60% owned Chinese joint venture Tianjin Tanggu Watts Water Technologies, Inc. and Subsidiaries
    Notes to Consolidated Financial Statements (Continued)

    sell the home to a third party was executed during the third quarter. Accordingly, theValve 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 Plumworld.co.uk Ltd, 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 annualized sales are approximately $10,980,000. The Company has a notional investment of approximately $500 in Plumbworld and maintains a loan receivable in the amount of approximately $890,000 with Plumbworld. As of December 31, 2004, the Company continues to account for its investment in Plumbworld using the equity method.

    The CompanyLimited (TWT) leases the land and buildings occupied by its Chinese joint venture from the joint venture partner.partner in Tianjin China. The lease is classified as an operating lease and extends over another 20 years.lease. Total rental expense for 2004, 20032007, 2006, and 20022005 approximated $267,000 each year. Total lease costs


    Watts Water Technologies, Inc. and Subsidiaries

    Notes to Consolidated Financial Statements (Continued)

    (19) Related Party Transactions (Continued)


    $0.3 million. During 2006, the local Chinese government informed the Company that the property leased by TWT would be taken over by eminent domain by the end of the second quarter of 2008. The Company has therefore established a plan to relocate and rationalize those operations (see note 4).

            On December 3, 2007, the Company entered into an Equity Transfer Agreement (the Agreement) with its joint venture partners to purchase the remaining term40% of the leaseoutstanding ownership interest in TWT that it did not already own. The purchase price will approximate $5,300,000.be approximately $5.2 million, payable after certain closing conditions are met, including the approval of the Agreement by the local Chinese authorities, which the Company expects will occur by the end of the second quarter of 2008. The Company expects to record approximately $3.7 million in goodwill for this acquisition.

    (20) Subsequent Events

    On February 8, 2005,5, 2008, the Company declared a quarterly dividend of $0.08eleven cents ($0.11) per share on the Company’seach outstanding share of 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.

    On        From January 5, 2005,1, 2008 through February 25, 2008, the Company acquired 100%liquidated approximately $22.0 million of the outstanding stock of HF Scientific, Inc., located in Fort Myers, Florida for approximately $7,000,000 in cash plus $800,000 in assumed debt. HF Scientific manufacturesCompany's auction rate certificates at par value 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,invested the proceeds into money market accounts. At February 25, 2008, the Company acquired substantially allheld approximately $17.0 million of auction rate certificates whose underlying investments are AAA rated municipal bonds. The Company has no current indications that the securities its holds may be impaired. However, volatility in the credit markets could impact the Company's ability to liquidate these investments or cause the fair value of the securities to be impaired. If liquidity of the securities becomes prohibitive, the Company may be forced to hold the securities until maturity or until conditions improve which could be as long as 33 years. Subsequent to December 31, 2007 through February 25, 2008, the Company experienced failed auctions on $6.6 million of its auction rate certificates. The Company does not have a present need to access these funds for operational purposes. The amounts associated with failed auctions will not be accessible until a successful auction occurs, a buyer is found outside of the auction process or the underlying securities have matured. As a result, the Company has classified the $17.0 million of auction rate certificates held as of February 25, 2008 as long-term assets of Sea Tech, Inc. located in Wilmington, North Carolina for approximately $10,000,000 in cash. Sea Tech provides cost effective solutions for fluidic connection needs. Sea Tech offers a wide range of standard and custom quick connect fittings, valves and manifolds and pex tubing designed to address specific customer requirements.the Company's December 31, 2007 consolidated balance sheet.


    88




    Watts Water Technologies, Inc. and Subsidiaries

    Schedule II—Valuation and Qualifying Accounts


    (Amounts in thousands)millions)

    For the Three Years Ended December 31:

     

    Balance At
    Beginning of
    Period

     

    Additions
    Charged To
    Expense

     

    Additions
    Charged To
    Other Accounts

     

    Deductions

     

    Balance At
    End of
    Period

     

     Balance At
    Beginning of
    Period

     Additions
    Charged To
    Expense

     Additions
    Charged To
    Other Accounts

     Deductions
     Balance At
    End of
    Period

    Year Ended December 31, 2002

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Year Ended December 31, 2005          

    Allowance for doubtful accounts

     

     

    $ 6,070

     

     

     

    1,225

     

     

     

    167

     

     

     

    (140

    )

     

     

    $ 7,322

     

     

     $7.6 3.9 .3 (2.5)$9.3

    Allowance for excess and obsolete inventories

     

     

    $ 11,147

     

     

     

    4,481

     

     

     

    470

     

     

     

    (2,897

    )

     

     

    $ 13,201

     

     

     $16.2 2.6 1.1 (2.3)$17.6

    Year Ended December 31, 2003

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Year Ended December 31, 2006          

    Allowance for doubtful accounts

     

     

    $ 7,322

     

     

     

    2,373

     

     

     

    60

     

     

     

    (1,983

    )

     

     

    $ 7,772

     

     

     $9.3 3.5 .3 (2.6)$10.5

    Allowance for excess and obsolete inventories

     

     

    $ 13,201

     

     

     

    3,558

     

     

     

    172

     

     

     

    (2,686

    )

     

     

    $ 14,245

     

     

     $17.6 9.1 1.0 (7.2)$20.5

    Year Ended December 31, 2004

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Year Ended December 31, 2007          

    Allowance for doubtful accounts

     

     

    $ 7,772

     

     

     

    2,100

     

     

     

    337

     

     

     

    (2,658

    )

     

     

    $ 7,551

     

     

     $10.5 5.4 1.2 (2.2)$14.9

    Allowance for excess and obsolete inventories

     

     

    $ 14,245

     

     

     

    7,325

     

     

     

    289

     

     

     

    (5,660

    )

     

     

    $ 16,199

     

     

     $20.5 9.1 2.0 (7.2)$24.4

    89
    EXHIBIT INDEX

    Exhibit No.

    Description
    3.1Restated Certificate of Incorporation, as amended (14)
    3.2Amended and Restated By-Laws, as amended (1)
    9.1The 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*Form of Indemnification Agreement between the Registrant and certain directors and officers of the Registrant (18)
    10.3*1996 Stock Option Plan, dated October 15, 1996 (10), and First Amendment dated February 28, 2003 (3)
    10.4*Watts Water Technologies, Inc. Pension Plan (amended and restated effective as of January 1, 2006) and First Amendment effective as of January 1, 2008
    10.5Registration Rights Agreement dated July 25, 1986 (5)
    10.6*Executive Incentive Bonus Plan, as amended and restated (8)
    10.7Amended and Restated Stock Restriction Agreement dated October 30, 1991 (2), and Amendment dated August 26, 1997 (12)
    10.8*Watts Industries, Inc. 1991 Non-Employee Directors' Nonqualified Stock Option Plan (6), and Amendment No. 1 (9)
    10.9*Watts Industries, Inc. 2003 Non-Employee Directors' Stock Option Plan (3)
    10.10Letter 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)
    10.11*Watts Water Technologies, Inc. Management Stock Purchase Plan (Amended and Restated as of January 1, 2005), as amended (20)
    10.12Stock 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)
    10.13Note 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)
    10.14Form of 4.87% Senior Note due May 15, 2010 (7)
    10.15Form of 5.47% Senior Note due May 15, 2013 (7)
    10.16*Watts Water Technologies, Inc. 2004 Stock Incentive Plan, as amended (20)
    10.17*Non-Employee Director Compensation Arrangements (1)
    10.18*Watts Water Technologies, Inc. Supplemental Employees Retirement Plan as Amended and Restated Effective May 4, 2004, First Amendment effective March 1, 2005 and Second Amendment effective January 1, 2008
    10.19*Form of Incentive Stock Option Agreement under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (19)
    10.20*Form of Non-Qualified Stock Option Agreement under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (20)
    10.21*Form of Restricted Stock Award Agreement for Employees under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (Incremental Vesting) (20)
    10.22*Form of Restricted Stock Award Agreement for Employees under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (Cliff Vesting) (19)
    10.23*Form of Restricted Stock Award Agreement for Non-Employee Directors under the Watts Water Technologies, Inc. 2004 Stock Incentive Plan (19)
    10.24Note Purchase Agreement, dated as of April 27, 2006, between the Registrant and the Purchasers named in Schedule A thereto relating to the Registrant's $225,000,000 5.85% Senior Notes due April 30, 2016 (4)
    10.25Form of 5.85% Senior Note due April 30, 2016 (4)

    10.26Subsidiary Guaranty, dated as of April 27, 2006, in connection with the Registrant's 5.85% Senior Notes due April 30, 2016 executed by the subsidiary guarantors party thereto, including the form of Joinder to Subsidiary Guaranty (4)
    10.27First Amendment, dated as of April 27, 2006, to Note Purchase Agreement dated as of May 15, 2003 among the Registrant and the purchasers named therein (4)
    10.28Amended and Restated Credit Agreement, dated as of April 27, 2006, among the Registrant, certain subsidiaries of the Registrant as Borrowers, Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer and the other lenders referred to therein (4)
    10.29Amended and Restated Guaranty, dated as of April 27, 2006, by the Registrant, the Subsidiaries of the Registrant set forth therein and Watts Industries Europe B.V., in favor of Bank of America, N.A. (4)
    10.30*Resignation Agreement dated October 16, 2007 between the Registrant and William D. Martino (18)
    11Statement Regarding Computation of Earnings per Common Share (13)
    21Subsidiaries
    23Consent of KPMG LLP
    31.1Certification of Principal Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
    31.2Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended
    32.1Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350
    32.2Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350

    (1)
    Incorporated by reference to the Registrant's Current Report on Form 8-K dated February 5, 2007 (File No. 001-11499).

    (2)
    Incorporated by reference to the Registrant's Current Report on 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 Current Report on Form 8-K dated April 27, 2006 (File No. 001-11499).

    (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 Current Report on Form 8-K dated February 8, 2005 (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 Quarterly Report on Form 10-Q for the quarter ended July 3, 2005 (File No. 001-11499).

    (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 September 30, 2007 (File No. 001-11499).

    (19)
    Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 26, 2004 (File No. 001-11499).

    (20)
    Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended July 1, 2007 (File No. 001-11499).

    *
    Management contract or compensatory plan or arrangement.



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    DOCUMENTS INCOPORATED BY REFERENCE
    PART I
    PART II
    Report of Independent Registered Public Accounting Firm
    PART III
    PART IV
    SIGNATURES
    Report of Independent Registered Public Accounting Firm
    Watts Water Technologies, Inc. and Subsidiaries Consolidated Statements of Operations (Amounts in millions, except per share information)
    Watts Water Technologies, Inc. and Subsidiaries Consolidated Balance Sheets (Amounts in millions, except share information)
    Watts Water Technologies, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity (Amounts in millions, except share information)
    Watts Water Technologies, Inc. and Subsidiaries Consolidated Statements of Cash Flows (Amounts in millions)
    Watts Water Technologies, Inc. and Subsidiaries Notes to Consolidated Financial Statements
    Watts Water Technologies, Inc. and Subsidiaries Schedule II—Valuation and Qualifying Accounts (Amounts in millions)
    EXHIBIT INDEX