UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2001
or
|_| Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to ____________
Commission file number 0-14787
WATTS INDUSTRIES, INC.
----------------------
(Exact name of registrant as specified in its charter)
Delaware 04-2916536
-------- ----------
(State of incorporation) (I.R.S. Employer Identification No.)
815 Chestnut Street, North Andover, MA 01845
- ---------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (978) 688-1811
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at October 31, 2001
----- -------------------------------
Class A Common, $.10 par value 17,780,704
Class B Common, $.10 par value 8,735,224
WATTS INDUSTRIES, INC. AND SUBSIDIARIES
---------------------------------------
INDEX
-----
Part I. Financial Information Page #
---------------------
Item 1. Financial Statements
--------------------
Consolidated Balance Sheets at September 30, 2001
and December 31, 2000 3
Consolidated Statements of Income for the
Three Months Ended September 30, 2001 and 2000 4
Consolidated Statements of Income for the
Nine Months Ended September 30, 2001 and 2000 5
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2001 and 2000 6
Notes to Consolidated Financial Statements 7-14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14-24
Part II. Other Information
-----------------
Item 1. Legal Proceedings 24-26
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
Exhibit Index 29
WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands, except share amounts)
(Unaudited)
Sept. 30, Dec. 31,
2001 2000
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 15,375 $ 15,235
Trade accounts receivable, less allowance for doubtful accounts of
$7,452 at September 30, 2001 and $6,614 at December 31, 2000 100,375 97,718
Inventories:
Raw materials 40,062 35,483
Work in process 16,366 16,390
Finished goods 63,674 57,078
------------ ------------
Total Inventories 120,102 108,951
Prepaid expenses and other assets 7,729 6,850
Deferred income taxes 20,794 20,486
------------ ------------
Total Current Assets 264,375 249,240
------------ ------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, at cost 223,732 202,492
Accumulated depreciation (90,477) (76,682)
------------ ------------
Property, plant and equipment, net 133,255 125,810
------------ ------------
OTHER ASSETS:
Goodwill, net of accumulated amortization of $17,041 at
September 30, 2001 and $14,665 at December 31, 2000 127,723 98,179
Other 11,061 8,796
------------ ------------
TOTAL ASSETS $ 536,414 $ 482,025
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 37,006 $ 39,569
Accrued expenses and other liabilities 57,986 59,088
Accrued compensation and benefits 12,498 12,200
Current portion of long-term debt 4,390 1,241
------------ ------------
Total Current Liabilities 111,880 112,098
------------ ------------
LONG-TERM DEBT, NET OF CURRENT PORTION 140,198 105,377
DEFERRED INCOME TAXES 15,794 15,463
OTHER NONCURRENT LIABILITIES 12,798 9,770
MINORITY INTEREST 7,286 6,775
STOCKHOLDERS' EQUITY:
Preferred Stock, $.10 par value; 5,000,000 shares authorized;
no shares issued or outstanding -- --
Class A Common Stock, $.10 par value; 80,000,000 shares authorized;
1 vote per share; issued and outstanding: 17,689,615 shares at
September 30, 2001 and 17,225,965 shares at December 31, 2000 1,769 1,723
Class B Common Stock, $.10 par value; 25,000,000 shares authorized;
10 votes per share; issued and outstanding: 8,835,224 shares at
September 30, 2001 and 9,235,224 shares at December 31, 2000 884 924
Additional paid-in capital 37,170 35,996
Retained earnings 230,901 213,627
Treasury stock (360) --
Accumulated other comprehensive income/(loss) (21,906) (19,728)
------------ ------------
Total Stockholders' Equity 248,458 232,542
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 536,414 $ 482,025
============ ============
See accompanying notes to consolidated financial statements.
3
WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Thousands, except per share amounts)
(Unaudited)
Three Months Ended
------------------------
Sept. 30, Sept. 30,
2001 2000
---------- ----------
Net sales $ 138,009 $ 125,656
Cost of goods sold 91,066 79,800
---------- ----------
GROSS PROFIT 46,943 45,856
Selling, general & administrative expenses 32,511 30,759
---------- ----------
OPERATING INCOME 14,432 15,097
---------- ----------
Other (income) expense:
Interest income (264) (164)
Interest expense 2,587 2,474
Other, net 269 568
Minority interest 59 49
---------- ----------
2,651 2,927
---------- ----------
INCOME BEFORE INCOME TAXES 11,781 12,170
Provision for income taxes 3,972 4,500
---------- ----------
NET INCOME $ 7,809 $ 7,670
========== ==========
BASIC EARNINGS PER SHARE
NET INCOME $ .29 $ .29
========== ==========
Weighted average number of shares 26,527 26,404
========== ==========
DILUTED EARNINGS PER SHARE
NET INCOME $ .29 $ .29
========== ==========
Weighted average number of shares 26,838 26,513
========== ==========
Dividends per common share $ .0600 $ .0600
========== ==========
See accompanying notes to consolidated financial statements.
4
WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Thousands, except per share amounts)
(Unaudited)
Nine Months Ended
-----------------------
Sept. 30, Sept. 30,
2001 2000
---------- ----------
Net sales $ 409,496 $ 388,491
Cost of goods sold 269,540 248,032
---------- ----------
GROSS PROFIT 139,956 140,459
Selling, general & administrative expenses 98,633 94,517
---------- ----------
OPERATING INCOME 41,323 45,942
---------- ----------
Other (income) expense:
Interest income (518) (557)
Interest expense 7,395 7,581
Other, net 425 1,593
Minority interest 176 (4)
---------- ----------
7,478 8,613
---------- ----------
INCOME BEFORE INCOME TAXES 33,845 37,329
Provision for income taxes 11,728 13,692
---------- ----------
NET INCOME $ 22,117 $ 23,637
========== ==========
BASIC EARNINGS PER SHARE
NET INCOME $ .83 $ .90
========== ==========
Weighted average number of shares 26,497 26,395
========== ==========
DILUTED EARNINGS PER SHARE
NET INCOME $ .82 $ .89
========== ==========
Weighted average number of shares 26,850 26,585
========== ==========
Dividends per common share $ .1800 $ .2075
========== ==========
See accompanying notes to consolidated financial statements.
5
WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands)
(Unaudited)
Nine Months Ended
-----------------------
Sept. 30, Sept. 30,
2001 2000
---------- ----------
OPERATING ACTIVITIES
Net income $ 22,117 $ 23,637
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 14,720 12,769
Amortization 2,676 2,381
Deferred income taxes -- (160)
Gain / (Loss) on disposal of assets 32 (276)
Equity in undistributed earnings (loss) of affiliates 13 (102)
Changes in operating assets and liabilities, net of effects
from acquisitions and dispositions:
Accounts receivable 2,756 (7,460)
Inventories 403 1,377
Prepaid expenses and other assets (860) 5,945
Accounts payable, accrued expenses and other liabilities (8,413) (158)
---------- ----------
Net cash provided by operating activities 33,444 37,953
---------- ----------
INVESTING ACTIVITIES
Additions to property, plant and equipment (11,539) (11,390)
Proceeds from sale of property, plant and equipment 85 1,722
Business acquisitions, net of cash acquired (43,377) (9,387)
Decrease/(Increase) in other assets 248 (558)
---------- ----------
Net cash used in investing activities (54,583) (19,613)
---------- ----------
FINANCING ACTIVITIES
Proceeds from long-term borrowings 96,704 51,755
Payments of long-term debt (68,972) (63,946)
Proceeds from exercise of stock options 1,180 359
Dividends (4,842) (5,517)
Purchase of treasury stock (360) --
---------- ----------
Net cash provided by (used in) financing activities 23,710 (17,349)
---------- ----------
Effect of exchange rate changes on cash and cash equivalents (915) (649)
Net cash used in discontinued operations (1,516) (2,237)
---------- ----------
CHANGE IN CASH AND CASH EQUIVALENTS 140 (1,895)
Cash and cash equivalents at beginning of period 15,235 13,016
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 15,375 $ 11,121
========== ==========
NON CASH INVESTING AND FINANCING ACTIVITIES
Acquisitions of businesses:
Fair value of assets acquired $ 64,146 $ 10,232
Cash Paid 43,377 9,387
---------- ----------
Liabilities Assumed 20,769 845
Change in fair market value of derivatives $ 77 $ --
See accompanying notes to consolidated financial statements.
6
WATTS INDUSTRIES, INC. AND SUBSIDIARIES
- ---------------------------------------
Notes to Consolidated Financial Statements
- ------------------------------------------
(Unaudited)
- -----------
1. In the opinion of management, the accompanying unaudited, consolidated
financial statements contain all necessary adjustments, consisting only of
adjustments of a normal recurring nature, to present fairly Watts Industries,
Inc.'s Consolidated Balance Sheet as of September 30, 2001, its Consolidated
Statements of Income for the three and nine months ended September 30, 2001 and
2000, and its Consolidated Statements of Cash Flows for the nine months ended
September 30, 2001 and 2000.
The balance sheet at December 31, 2000 has been derived from the audited
financial statements at that date. The accounting policies followed by the
Company are described in the December 31, 2000 financial statements which are
contained in the Company's December 31, 2000 Annual Report on Form 10-K. It is
suggested that the financial statements included in this report be read in
conjunction with the financial statements and notes included in the December 31,
2000 Annual Report on Form 10-K.
2. The Company's shipping and handling costs included in selling, general and
administrative expense amounted to $5,459,000 and $4,663,000 for the three
months ended September 30, 2001 and 2000, respectively, and $16,180,000 and
$14,260,000 for the nine months ended September 30, 2001 and 2000, respectively.
3. The Company adopted Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities" (SFAS 133), as
amended by SFAS No. 137 and SFAS No. 138, on January 1, 2001. SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and
hedging activities. It requires the recognition of all derivative instruments as
assets or liabilities in the Company's balance sheet and measurement of those
instruments at fair value. The adoption of SFAS No. 133 on January 1, 2001 did
not have a material effect on assets, liabilities, accumulated other
comprehensive income or net income.
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 its policies. The Company's hedging transactions include, but
are not limited to, the use of various derivative financial and commodity
instruments. As a matter of policy, the Company does not use derivative
instruments unless there is an underlying exposure. Any change in the value of
our derivative instruments would be substantially offset by an opposite change
in the value of the underlying hedged items. The Company does not use derivative
instruments for trading or speculative purposes.
7
Accounting Policies
- -------------------
Using qualifying criteria defined in SFAS No. 133, derivative instruments
are designated and accounted for as either a hedge of a recognized asset or
liability (fair value hedge) or a hedge of a forecasted transaction (cash flow
hedge). For a fair value hedge, both the effective and ineffective portions of
the change in fair value of the derivative instrument, along with an adjustment
to the carrying amount of the hedged item for fair value changes attributable to
the hedged risk, are recognized in earnings. For a cash flow hedge, changes in
the fair value of the derivative instrument that are highly effective are
deferred in accumulated other comprehensive income or loss until the underlying
hedged item is recognized in earnings. The ineffective portion of fair value
changes on qualifying hedges is recognized in earnings immediately. If a fair
value or cash flow hedge were to cease to qualify for hedge accounting or be
terminated, it would continue to be carried on the balance sheet at fair value
until settled, but hedge accounting would be discontinued prospectively. If a
forecasted transaction were no longer probable of occurring, amounts previously
deferred in accumulated other comprehensive income would be recognized
immediately in earnings. On occasion, the Company may enter into a derivative
instrument for which hedge accounting is not required because it is entered into
to offset changes in the fair value of an underlying transaction which is
required to be recognized in earnings (natural hedge). These instruments are
reflected in the Consolidated Balance Sheet at fair value with changes in fair
value recognized in earnings.
The Company adopted SFAS No. 141 and certain provisions of SFAS No. 142 in
connection with the acquisition of the assets of Powers Process Controls. Please
refer to the New Accounting Standards Section of Management's Discussion and
Analysis for a more complete discussion of SFAS No. 141 and SFAS No. 142.
Foreign Currency Risk
- ---------------------
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. For the nine
months ended September 30, 2001, the Company used foreign currency forward
contracts as a means of hedging exposure to foreign currency risks. The
Company's foreign currency forwards have been designated and qualify as cash
flow hedges under the criteria of SFAS 133. SFAS 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. The net gain on
these contracts recorded in other comprehensive income for the three months
ended September 30, 2001 was $29,000 and for the nine months ended September 30,
2001 was $55,000.
8
Interest Rate Risk
- ------------------
The Company uses interest rate swaps as an economic hedge on forecasted
interest costs. SFAS 133 requires that unrealized gains and losses on
derivatives not qualifying for hedge accounting be recognized currently in
earnings. During the quarter ended September 30, 2001, the Company entered into
an interest rate swap for its $75,000,000 notes. The Company swapped the fixed
interest rate of 8 3/8% to floating LIBOR plus 3.74%. The term of the swap
matches the maturity date of the notes (December 2003). The fair value of this
swap at September 30, 2001 was approximately $1.5 million. This swap qualifies
for hedge accounting treatment. The Company has a swap that converts 10 million
Euro of its variable rate debt in Europe to a fixed rate of 4.3%. This swap does
not qualify for hedge accounting. For the three months ended September 30, 2001,
the Company recorded $52,000 to interest income and for the nine months ended
September 30, 2001 recorded $125,000 to interest income to reflect the change in
the fair value of its interest rate swaps.
Other Derivatives
- -----------------
The Company also utilizes, on a limited basis, certain commodity
derivatives, primarily on copper used in its manufacturing process, to hedge the
cost of its anticipated production requirements. The Company did not utilize any
commodity derivatives for the nine months ended September 30, 2001.
4. The following tables set forth the reconciliation of the calculation of
earnings per share:
For the Three Months Ended September 30, 2001
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
- ---------
Net Income $7,809,000 26,527,312 $0.29
Effect of Dilutive Securities
- -----------------------------
Common Stock Equivalents -- 310,852 --
---------- ---------- -----
Diluted EPS $7,809,000 26,838,164 $0.29
========== ========== =====
For the Three Months Ended September 30, 2000
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
- ---------
Net Income $7,670,000 26,404,463 $0.29
Effect of Dilutive Securities
- -----------------------------
Common Stock Equivalents -- 108,567 --
---------- ---------- -----
Diluted EPS $7,670,000 26,513,030 $0.29
========== ========== =====
9
Stock options to purchase 758,803 and 1,592,396 shares of common stock
were outstanding as of September 30, 2001 and 2000, respectively, but were not
included in the computation of diluted earnings per share because the options'
exercise price was greater than the average market price of the common shares
and therefore, the effect would have been antidilutive.
For the Nine Months Ended September 30, 2001
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
- ---------
Net Income $22,117,000 26,496,534 $ 0.83
Effect of Dilutive Securities
- -----------------------------
Common Stock Equivalents -- 352,972 (0.01)
----------- ---------- ------
Diluted EPS $22,117,000 26,849,506 $ 0.82
=========== ========== ======
For the Nine Months Ended September 30, 2001
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
- ---------
Net Income $23,637,000 26,395,133 $ 0.90
Effect of Dilutive Securities
- -----------------------------
Common Stock Equivalents -- 189,763 (0.01)
----------- ---------- ------
Diluted EPS $23,637,000 26,584,896 $ 0.89
=========== ========== ======
Stock options to purchase 549,933 and 887,938 shares of common stock were
outstanding as of September 30, 2001 and 2000, respectively, but were not
included in the computation of diluted earnings per share because the options'
exercise price was greater than the average market price of the common shares
and therefore, the effect would have been antidilutive.
5. Segment Information - the following table presents certain operating segment
information:
(Thousands of dollars)
Three months ended North Corporate/
September 30, 2001: America Europe Asia Other Consolidated
- ------------------- ------- ------ ---- ------- ------------
Net Sales $103,635 $31,474 $2,900 $ -- $138,009
Operating income 12,631 3,777 118 (2,094) 14,432
Capital Expenditures 1,927 544 131 -- 2,602
Depreciation and Amortization 3,895 1,699 185 -- 5,779
10
Three Months Ended
September 30, 2000:
- -------------------
Net Sales $ 99,557 $23,286 $2,813 $ -- $125,656
Operating income 14,046 3,150 182 (2,281) 15,097
Capital Expenditures 3,281 1,265 1 -- 4,547
Depreciation and Amortization 3,612 1,217 184 -- 5,013
Nine Months Ended
September 30, 2001:
- -------------------
Net Sales $310,873 $89,249 $9,374 $ -- $409,496
Operating income 38,054 9,548 415 (6,694) 41,323
Capital Expenditures 8,532 1,623 1,384 -- 11,539
Depreciation and Amortization 11,969 4,883 544 -- 17,396
Nine Months Ended
September 30, 2000:
- -------------------
Net Sales $301,275 $77,809 $9,407 $ -- $388,491
Operating income 41,913 10,798 383 (7,152) 45,942
Capital Expenditures 8,860 2,457 73 -- 11,390
Depreciation and Amortization 10,708 3,890 552 -- 15,150
The above operating segments are presented on a basis consistent with the
presentation included in the Company's December 31, 2000 consolidated financial
statements. The following table contains additional segment information.
North America Europe Asia Consolidated
------------- ------ ---- ------------
Nine Months Ended
September 30, 2001
- ------------------
Identifiable Assets $349,395 $162,368 $24,651 $536,414
Twelve Months Ended
December 31, 2000
- -----------------
Identifiable Assets $332,621 $125,213 $24,191 $482,025
11
6. The accumulated balances for the components of the Other Comprehensive
Income/(Loss) are:
Accumulated
Foreign Other
Currency Cash Flow Comprehensive
Translation Hedges Income/(Loss)
Balance December 31, 1999 (15,199) -- (15,199)
Change in period (3,098) -- (3,098)
------- ---- -------
Balance March 31, 2000 (18,297) -- (18,297)
------- ---- -------
Change in period (659) -- (659)
------- ---- -------
Balance June 30, 2000 (18,956) -- (18,956)
------- ---- -------
Change in Period (4,619) -- (4,619)
------- ---- -------
Balance September 30, 2000 (23,575) -- (23,575)
======= ==== =======
Balance December 31, 2000 (19,728) -- (19,728)
Change in period (5,034) 160 (4,874)
------- ---- -------
Balance March 31, 2001 (24,762) 160 (24,602)
------- ---- -------
Change in period (1,969) (134) (2,103)
------- ---- -------
Balance June 30, 2001 (26,731) 26 (26,705)
------- ---- -------
Change in period 4,770 29 4,799
------- ---- -------
Balance September 30, 2001 (21,961) 55 (21,906)
======= ==== =======
Accumulated other comprehensive income/(loss) in the Consolidated Balance
Sheets as of September 30, 2001 and December 31, 2000 consists of cumulative
translation adjustments and as of September 30, 2001 changes in the fair value
of certain financial instruments which qualify for hedge accounting as required
by SFAS 133. The Company's total comprehensive income was as follows:
Three Months Ended September 30,
2001 2000
---- ----
Net Income $ 7,809 $ 7,670
Unrealized Gains Derivative Instruments, Net of Tax 29 --
Foreign Currency Translation Adjustments 4,770 (4,619)
------- -------
Total Comprehensive Income $12,608 $ 3,051
======= =======
12
Nine Months Ended September 30,
2001 2000
---- ----
Net Income $ 22,117 $ 23,637
Unrealized Gains Derivative Instruments, Net of Tax 55 --
Foreign Currency Translation Adjustments (2,233) (8,376)
-------- --------
Total Comprehensive Income $ 19,939 $ 15,261
======== ========
7. Acquisitions
On September 28, 2001, a wholly-owned subsidiary of the Company acquired
the assets of the Powers Process Controls Division of Mark Controls Corporation,
a subsidiary of Crane Co. located in Skokie, Illinois and Mississauga, Ontario,
Canada for approximately $13 million in cash. The September 30, 2001
Consolidated Balance Sheet of the Company contains a preliminary purchase price
allocation of the Powers acquisition, consistent with the guidelines in SFAS 141
and SFAS 142. Powers designs and manufactures thermostatic mixing valves for
personal safety and process control applications in commercial and institutional
facilities. It also manufactures control valves and commercial plumbing brass
products including shower valves and lavatory faucets. Powers annualized sales
prior to the acquisition were approximately $20 million.
On June 13, 2001, a wholly-owned subsidiary of the Company acquired
Premier Manufactured Systems, Inc., located in Phoenix, Arizona for
approximately $5 million in cash. Premier manufactures water filtration systems
for both residential and commercial applications and other filtration products
including under-the-counter Ultraviolet filtration as well as a variety of
Sediment and Carbon filters. Premier's annualized sales prior to the acquisition
were approximately $10 million.
On June 1, 2001, a wholly-owned subsidiary of the Company acquired Fimet
S.r.l. (Fabbrica Italiana Manometri e Termometri) located in Milan, Italy and
its wholly-owned subsidiary, MTB AD, which is located in Bulgaria for
approximately $6 million (U.S.). The acquired business manufactures pressure and
temperature gauges for use in the HVAC market. Fimet's annualized sales prior to
the acquisition were approximately 10 million Euro.
On January 5, 2001, the Company acquired Dumser Metallbau GmbH & Co. KG
located in Landau, Germany for approximately $20 million (U.S.). The main
products of Dumser include brass, steel and stainless steel manifolds used as a
prime distribution device in hydronic heating systems. Dumser had approximately
$24 million (U.S.) in total sales for the twelve months ended December 31, 2000.
Dumser has a 51% controlling share of Stern Rubunetti, which had annual sales
prior to the acquisition of $4 million (U.S.). Stern Rubunetti is an Italian
manufacturing company producing brass components located in Brescia, Italy.
On August 30, 2000, a wholly-owned subsidiary of the Company acquired
certain assets of Chiles Power Supply and Bask LLC, doing business as Heatway,
located in Springfield, Missouri for approximately $3 million in cash. The
acquired business, now operating under the
13
name Watts Radiant, manufactures and distributes a complete line of hydronic and
electric radiant heating and snow melting systems. Heatway's annualized sales
prior to the acquisition were approximately $11 million.
On May 12, 2000, a wholly-owned subsidiary of the Company acquired
McCraney, Inc., located in Santa Ana, California for approximately $7 million in
cash. McCraney, doing business as Spacemaker, manufactures a complete line of
seismic restraint straps for water heaters as well as water heater stands and
enclosures. Spacemaker's twelve months sales prior to the acquisition were
approximately $5 million.
8. Contingencies
In April 1998, the Company became aware of a complaint that was filed
under seal in the State of California alleging violations of the California
False Claims Act. The complaint alleges that a former subsidiary of the Company
sold products utilized in municipal water systems which failed to meet
contractually specified standards and falsely certified that such standards had
been met. The complaint further alleges that the municipal entities have
suffered tens of millions of dollars in damages as a result of defective
products and seeks treble damages, reimbursement of legal costs and penalties.
In June 2001, the Company and the other defendants reached a proposed settlement
with one of the municipal entities, the Los Angeles Department of Water and
Power ("LADWP") in the James Jones case (Los Angeles Department of Water and
Power, ex rel. Nora Amenta v. James Jones Company, et al). A proposed settlement
has now been approved by the California Superior Court and submitted to the Los
Angeles Board of Water and Power Commissioners for approval. The Company is
vigorously contesting this matter. Other lawsuits and proceedings or claims,
arising from the ordinary course of operations, are also pending or threatened
against the Company and its subsidiaries.
The Company has established reserves, which it presently believes are
adequate in light of probable and estimable exposure to pending and threatened
litigation of which it has knowledge. However, resolution of any such matters
during a specific reporting period could have a material effect on the Quarterly
or Annual operating results for that period. Also see Part II, Item 1.
Item 2. Management's Discussions and Analysis of Financial Condition and Results
------------------------------------------------------------------------
of Operations
-------------
Recent Developments
- -------------------
On September 28, 2001, a wholly-owned subsidiary of the Company acquired
the assets of the Powers Process Controls Division of Mark Controls Corporation,
a subsidiary of Crane Co. located in Skokie, Illinois and Mississauga, Ontario,
Canada for approximately $13 million in cash. The September 30, 2001
Consolidated Balance Sheet of the Company contains a preliminary purchase price
allocation of the Powers acquisition, consistent with the guidelines in SFAS 141
and SFAS 142. Powers designs and manufactures thermostatic mixing valves for
personal safety and process control applications in commercial and institutional
facilities. It also manufactures control valves and commercial plumbing brass
products including shower valves
14
and lavatory faucets. Powers annualized sales prior to the acquisition were
approximately $20 million.
On June 13, 2001, a wholly-owned subsidiary of the Company acquired
Premier Manufactured Systems, Inc., located in Phoenix, Arizona for
approximately $5 million in cash. Premier manufactures water filtration systems
for both residential and commercial applications and other filtration products
including under-the-counter Ultraviolet filtration as well as a variety of
Sediment and Carbon filters. Premier's annualized sales prior to the acquisition
were approximately $10 million.
On June 1, 2001, a wholly-owned subsidiary of the Company acquired Fimet
S.r.l. (Fabbrica Italiana Manometri e Termometri) located in Milan, Italy and
its wholly-owned subsidiary, MTB AD, which is located in Bulgaria for
approximately $6 million (U.S.). The acquired business manufactures pressure and
temperature gauges for use in the HVAC market. Fimet's annualized sales prior to
the acquisition were approximately 10 million Euro.
On January 5, 2001, the Company acquired Dumser Metallbau GmbH & Co. KG
located in Landau, Germany for approximately $20 million (U.S.). The main
products of Dumser include brass, steel and stainless steel manifolds used as a
prime distribution device in hydronic heating systems. Dumser had approximately
$24 million (U.S.) in total sales for the twelve months ended December 31, 2000.
Dumser has a 51% controlling share of Stern Rubunetti, which had annual sales
prior to the acquisition of $4 million (U.S.). Stern Rubunetti is an Italian
manufacturing company producing brass components located in Brescia, Italy.
Three Months Ended September 30, 2001 Compared to
- -------------------------------------------------
Three Months Ended September 30, 2000
- -------------------------------------
Net sales for the three months ended September 30, 2001 increased
$12,353,000 (9.8%) to $138,009,000 compared to the same period in 2000. The
increase in net sales is attributable to the following:
Internal Growth $ (1,831) (1.5%)
Acquisitions 13,640 10.9%
Foreign Exchange 544 0.4%
-------- ----
Total Change $ 12,353 9.8%
======== ====
The decrease in net sales from internal growth is attributable to
decreased unit sales to European and North American Plumbing and Heating
wholesalers. This is a result of the continued softness in the North American
plumbing market and the weakness in the European economies. These decreases were
partially offset by increased unit sales to the North American Retail Home
Improvement market. The growth in net sales from acquired businesses is due to
the inclusion of the net sales from Premier Manufactured Systems of Phoenix,
Arizona, acquired on June 13, 2001, Fimet of Milan, Italy, acquired on June 1,
2001, Dumser Metallbau GmbH &
15
Co. KG of Landau, Germany, acquired on January 5, 2001, the business acquired
from Chiles Power Supply and Bask, LLC of Springfield, Missouri, now doing
business as Watts Radiant, acquired on August 30, 2000. The increase in foreign
exchange is due primarily to the Euro being at a higher rate compared to the
same period in 2000.
Watts monitors its net sales in three geographical segments: North
America, Europe and Asia. As outlined below, North America, Europe and Asia
accounted for 75.1%, 22.8% and 2.1% of net sales, respectively, in the three
months ended September 30, 2001 compared to 79.2%, 18.5% and 2.3%, respectively,
in the three months ended September 30, 2000. The Company's net sales in these
groups for the three months ended September 30, 2001 and 2000 were as follows:
9/30/01 9/30/00 Change
------- ------- ------
North America $103,635 $ 99,557 $ 4,078
Europe 31,474 23,286 8,188
Asia 2,900 2,813 87
-------- -------- -------
Total $138,009 $125,656 $12,353
======== ======== =======
The increase in North America's net sales is due to the Premier
Manufactured Systems and Watts Radiant acquisitions and increased unit sales to
the North American Retail Home Improvement market, partially offset by decreased
units sales to Plumbing and Heating wholesalers. The increase in Europe's net
sales is due to the acquisitions of Fimet and Dumser, partially offset by
decreased unit sales to European Plumbing and Heating wholesalers. Excluding
acquisitions, sales in the European market on a local currency basis were 7.1%
below the comparable prior year period. The increase in Asia's net sales is due
to increased domestic sales.
Gross profit for the three months ended September 30, 2001 increased
$1,087,000 (2.4%) and decreased as a percentage of net sales from 36.5% to
34.0%. The increase in gross profit is primarily attributable to the inclusion
of the gross profit of acquired companies. Gross profit percentage reductions
are attributable to the inclusion of some of the acquired companies, which
operate at a lower gross margin than the rest of the Company, and to a less
favorable product mix caused by the decreased unit sales to Plumbing and Heating
wholesalers.
Selling, general and administrative expenses increased $1,752,000 (5.7%)
to $32,511,000. This increase is attributable to the inclusion of the selling,
general and administrative expenses of acquired companies.
Operating income for the three months ended September 30, 2001 decreased
$665,000 (4.4%) to $14,432,000 compared to the same period in 2000 due to
reduced gross profit. The Company's operating income by segment for the three
months ended September 30, 2001 and 2000 were as follows:
16
9/30/01 9/30/00 Change
------- ------- ------
North America $ 12,631 $ 14,046 $(1,415)
Europe 3,777 3,150 627
Asia 118 182 (64)
Corporate/Other (2,094) (2,281) 187
-------- -------- -------
Total $ 14,432 $ 15,097 $ (665)
======== ======== =======
The decrease in North America operating income is primarily attributable
to decreased unit sales to Plumbing and Heating wholesalers, partially offset by
the inclusion of operating income from the acquired companies.
Interest expense increased $113,000 in the quarter ended September 30,
2001 compared to the same period in 2000, primarily due to acquisition debt. The
Company reduced interest expense by $125,000 in the quarter due to the swap of
its $75,000,000 notes at 8.375% fixed to a floating rate of LIBOR plus 3.74%.
The Company's effective tax rate for continuing operations decreased from
37.0% to 33.7%. The decrease is primarily attributable to statutory rate
reductions affecting income tax in Canada as well as other tax planning
opportunities.
Net income for the three months ended September 30, 2001 increased
$139,000 (1.8%) to $7,809,000 or $.29 per common share compared to $.29 per
common share for the three months ended September 30, 2000 on a diluted basis.
Nine Months Ended September 30, 2001 Compared to
- ------------------------------------------------
Nine Months Ended September 30, 2000
- ------------------------------------
Net sales for the nine months ended September 30, 2001 increased
$21,005,000 (5.4%) to $409,496,000 compared to the same period in 2000. The
increase in net sales is attributable to the following:
Internal Growth $ (8,254) (2.1%)
Acquisition 34,030 8.7%
Foreign Exchange (4,771) (1.2%)
-------- ----
Total Change $ 21,005 5.4%
======== ====
The decrease in net sales from internal growth is attributable to
decreased unit sales to North American and European Plumbing and Heating
wholesalers resulting from the continued weakness in the North American plumbing
market and the weakened European economy. These decreases were partially offset
by increased unit sales in the North American Retail Home Improvement market.
The growth in net sales from acquired businesses is due to the inclusion of the
net sales from Premier Manufactured Systems of Phoenix, Arizona, acquired on
June 13, 2001, Fimet of Milan, Italy, acquired on June 1, 2001, Dumser Metallbau
GmbH & Co. KG of Landau, Germany, acquired on January 5, 2001, the business
acquired from Chiles Power Supply
17
and Bask, LLC of Springfield, Missouri, now doing business as Watts Radiant,
acquired on August 30, 2000, and McCraney, Inc. of Santa Ana, California, doing
business as Spacemaker, acquired on May 12, 2000. The decrease in foreign
exchange is due primarily to the Euro devaluation against the U.S. dollar
compared to the same period in 2000.
Watts monitors its net sales in three geographical segments: North
America, Europe and Asia. As outlined below, North America, Europe and Asia
accounted for 75.9%, 21.8% and 2.3% of net sales, respectively, in the nine
months ended September 30, 2001 compared to 77.6%, 20.0% and 2.4%, respectively,
in the nine months ended in September 30, 2000. The Company's net sales in these
groups for the nine months ended September 30, 2001 and 2000 were as follows:
9/30/01 9/30/00 Change
------- ------- ------
North America $310,873 $301,275 $ 9,598
Europe 89,249 77,809 11,440
Asia 9,374 9,407 (33)
-------- -------- --------
Total $409,496 $388,491 $ 21,005
======== ======== ========
The increase in North America's net sales is due to the Premier
Manufactured Systems, Watts Radiant, and Spacemaker acquisitions, as well as
increased unit sales to the Retail Home Improvement market, partially offset by
decreased unit sales to Plumbing and Heating wholesalers. The increase in
Europe's net sales is due to the Fimet and Dumser acquisitions, partially offset
by decreased unit sales to European Plumbing and Heating wholesalers and the
Euro's devaluation against the U.S. dollar. Excluding acquisitions, sales in the
European market on a local currency basis were 6.1% below the comparable prior
year period.
Gross profit for the nine months ended September 30, 2001 decreased
$503,000 (0.4%) and decreased as a percentage of net sales from 36.2% to 34.2%.
The decrease in gross profit is primarily attributable to decreased net sales to
North American and European Plumbing and Heating wholesalers. Gross profit
percentage reductions are attributable to the inclusion of acquired companies,
of which some operate at a lower gross profit percentage than the remainder of
the Company, and a less favorable product mix caused by decreased sales to the
North American and European Plumbing and Heating wholesalers.
Selling, general and administrative expenses increased $4,116,000 (4.4%)
to $98,633,000. This increase is attributable to the inclusion of the selling,
general and administrative expenses of acquired companies, partially offset by
the lower exchange rate of the Euro relative to the U.S. dollar and reduced
spending levels.
Operating income for the nine months ended September 30, 2001 decreased
$4,619,000 (10.1%) to $41,323,000 compared to the same period in 2000 due to
reduced gross profit. The Company's operating income by segment for the nine
months ended September 30, 2001 and 2000 were as follows:
18
9/30/01 9/30/00 Change
------- ------- ------
North America $ 38,054 $ 41,913 $(3,859)
Europe 9,548 10,798 (1,250)
Asia 415 383 32
Corporate/Other (6,694) (7,152) 458
-------- -------- -------
Total $ 41,323 $ 45,942 $(4,619)
======== ======== =======
The decrease in both North American and European operating income is due
to decreased unit sales to plumbing and heating wholesalers. These decreases
were partially offset by the operating earnings of acquired companies.
Interest Expense for the nine months ended September 30, 2001 decreased
$186,000 (2.5%) compared to the same period in 2000, primarily due to lower
interest rates on variable rate indebtedness, despite the increased levels of
debt due to acquisitions.
Other income and expense for the nine months ended September 30, 2001
decreased $1,168,000 (73.3%).
The Company's effective tax rate for continuing operations decreased from
36.7% to 34.7%. The decrease is primarily due to statutory rate reductions
affecting income tax in Canada and other tax planning opportunities.
Net income for the nine months ended September 30, 2001 decreased
$1,520,000 (6.4%) to $22,117,000 or $.82 per common share compared to $.89 per
common share for the nine months ended September 30, 2001 on a diluted basis.
Liquidity and Capital Resources
- -------------------------------
During the nine month period ended September 30, 2001 the Company
generated $33,444,000 in cash flow from continuing operations, which was
principally used to fund the purchase of $11,539,000 in capital equipment,
contribute to the funding of acquisitions, and to pay cash dividends to common
shareholders. Capital expenditures were primarily for manufacturing machinery
and equipment as part of the Company's commitment to continuously improve its
manufacturing capabilities. The Company's capital expenditure budget for the
twelve months ended December 31, 2001 is $18,100,000. However, due to the
weakness in the markets in which the Company serves, the Company is reducing its
capital spending for fiscal 2001 and anticipates that capital spending will be
several million dollars less than the originally approved budget.
The Company invested $43,377,000 to acquire businesses during the nine
months ended September 30, 2001. These acquisitions were Dumser Metallbau GmbH &
Co. KG of Landau, Germany; Fimet S.r.l. of Milan, Italy; and Premier
Manufactured Systems, Inc. of Phoenix, Arizona; and Powers Process Control of
Skokie, Illinois and Mississauga, Ontario, Canada. The
19
purchase price of these acquisitions was primarily funded through the Company's
use of the domestic and foreign revolving lines of credit.
The Company maintains a revolving line of credit facility of $100,000,000,
which expires in March 2003, to support the Company's acquisition program,
working capital requirements of acquired companies, and for general corporate
purposes. As of September 30, 2001 long-term debt included $15,000,000
outstanding on the line of credit and the Company was in compliance with all
covenants related to this facility.
As of September 30, 2001, the Company maintained a syndicated credit
facility with a group of European banks in the amount of 41,050,000 Euro. This
credit facility has several tranches, one of which was reinstated in the current
fiscal year, that provides credit to the Company through September, 2004. The
purpose of this credit facility is to fund acquisitions in Europe, to support
the working capital requirements of acquired companies, and for general
corporate purposes. This line of credit was completely utilized as of September
30, 2001.
Working capital as of September 30, 2001 was $152,495,000 compared to
$137,142,000 at December 31, 2000. This increase is primarily attributable to
the inclusion of working capital of acquired companies. The ratio of current
assets to current liabilities was 2.4 to 1 at September 30, 2001 compared to 2.2
to 1 at December 31, 2000. Cash and cash equivalents were $15,375,000 at
September 30, 2001 compared to $15,235,000 at December 31, 2000. The increase in
long-term debt to $140,198,000 at September 30, 2001 from $105,377,000 at
December 31, 2000 was due to the funding of acquisitions of Powers Process
Controls, Premier Manufactured Systems, Inc., Fimet, and Dumser. Debt as a
percentage of total capital employed (short-term and long-term debt as a
percentage of the sum of short-term and long-term debt plus equity) was 36.8% at
September 30, 2001 compared to 31.4% at December 31, 2000.
The Company anticipates that available funds and those funds provided by
the current operations will be sufficient to meet current operating requirements
and anticipated capital expenditures for at the least the next 24 months.
The Company from time to time is involved in environmental proceedings and
other legal proceedings and incurs costs on an on-going basis related to these
matters. The Company has not incurred material expenditures in fiscal 2001 in
connection with any of these matters. See Part II, Item 1, Legal Proceedings.
Conversion to the Euro
- ----------------------
On January 1, 1999, 11 of the 15 member countries of the European Union
adopted the Euro as their common legal currency and established fixed conversion
rates between their existing sovereign currencies and the Euro. The Euro trades
on currency exchanges and is available for non-cash transactions. The Euro
affects the Company as the Company has manufacturing and distribution facilities
in several of the member countries and trades extensively across Europe. The
long-term competitive implications of the conversion are
20
currently being assessed by the Company, however the Company has experienced an
immediate reduction in the risks associated with foreign exchange. At this time,
the Company is not anticipating that any significant costs will be incurred due
to the introduction and conversion to the Euro. The Company is currently able to
make and receive payments in Euro and will convert financial and information
technology systems to be able to use the Euro as its base currency in relevant
markets prior to January 1, 2002.
New Accounting Standards
- ------------------------
During 2000, the Financial Accounting Standards Board's Emerging Issues
Task Force (EITF) added to its agenda various revenue recognition issues that
could impact the income statement classification of certain promotional
payments. In May 2000, the EITF reached a consensus on Issue 00-14, Accounting
for Certain Sales Incentives. EITF 00-14 addresses the recognition and income
statement classification of various sales incentives. Among its requirements,
the consensus will require the costs related to consumer coupons currently
classified as marketing costs to be classified as a reduction of revenue. The
impact of adopting this consensus is not expected to have a material impact on
our results of operations. In April 2001, the EITF announced that it would delay
the effective date for this consensus to 2002.
In January 2001, the EITF reached a consensus on Issue 00-22, Accounting
for "Points" and Certain Other Time-Based or Volume-Based Sales Incentive
Offers, and Offers for Free Products or Services to Be Delivered in the Future.
Issue 00-22 requires that certain volume-based cash rebates to customers
currently recognized as marketing costs be classified as a reduction of revenue.
The consensus was effective for the first quarter of 2001 and was not material
to our consolidated financial statements.
In April 2001, the EITF reached a consensus on Issue 00-25, Vendor Income
Statement Characterization of Consideration to a Purchaser of the Vendor's
Products or Services. EITF 00-25 addresses the income statement classification
of consideration, other than that directly addressed in Issue 00-14, from a
vendor to a reseller, or another party that purchases the vendor's products.
Among its requirements, the consensus will require certain of our customer
promotional incentives currently classified as marketing costs to be classified
as a reduction of revenue. The consensus is effective for fiscal 2002. The
Company is currently assessing the impact of adopting Issue 00-25, but
anticipates no material change to our consolidated financial statements.
In July 2001, the Financial Standards Accounting Board ("FASB") issued
Financial Accounting Standards Board Statement No. 141, Business Combinations
("FAS 141") and Financial Accounting Standards Board Statement No. 142, Goodwill
and Other Intangible Assets ("FAS 142"). FAS 141 requires that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001. FAS 141 also specifies the criteria that intangible assets acquired in
a purchase method business combination must meet to be recognized and reported
apart from goodwill. FAS 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead be tested for
impairment, at least
21
annually, in accordance with the provisions of FAS 142. FAS 142 will also
require that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with financial Accounting Standards Board
Statement No. 121, Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to be Disposed Of.
The provisions of FAS 141 are effective immediately, except with regard to
business combinations initiated prior to July 1, 2001. FAS 142 will be effective
as of January 1, 2002. Goodwill and other intangible assets determined to have
an indefinite useful life that are acquired in a purchase business combination
completed after June 30, 2001 will not be amortized, but will continue to be
evaluated for impairment in accordance with appropriate pre-FAS 142 accounting
literature. Goodwill and other intangible assets acquired in business
combinations completed before July 1, 2001, will continue to be amortized prior
to the adoption of FAS 142. The Company is currently evaluating the effect that
the adoption of FAS 141 and FAS 142 will have on its results of operations and
its financial position.
In August 2001, the FASB issued Financial Accounting Standards Board
Statement No. 143, Accounting for Asset Retirement Obligations ("FAS 143") which
requires companies to record the fair value of an asset retirement obligation as
a liability in the period it incurs a legal obligation associated with the
retirement of tangible long-lived assets that result from the acquisition,
construction, development and or normal use of the assets. The company must also
record a corresponding increase in the carrying value of the related
long-lived asset and depreciate that cost over the remaining useful life of the
asset. The liability must be increased each period for the passage of time with
the offset recorded as an operating expense. The liability must also be adjusted
for changes in the estimated future cash flows underlying the initial fair value
measurement. Companies must also recognize a gain or loss on the settlement of
the liability. The provisions of FAS 143 are effective for fiscal years
beginning after June 15, 2002. At the date of the adoption of FAS 143, companies
are required to recognize a liability for all existing asset retirement
obligations and the associated asset retirement costs. The Company is currently
evaluating the effect that the adoption of FAS 143 will have on its results of
operations and its financial position.
In August 2001, the FASB issued Financial Accounting Standards Board
Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets ("FAS 144") which addresses the accounting and reporting for the
impairment or disposal of long-lived assets. FAS 144 supercedes Financial
Accounting Standards Board Statement No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-lived Assets to be Disposed Of ("FAS 121") but
retains many of the fundamental provisions of FAS 121. FAS 144 also supercedes
the accounting and reporting provisions of Accounting Principles Board Opinion
No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" ("APB 30") for the disposal of a segment of a
business. However, FAS 144 retains the requirements of APB 30 to report
discontinued operations separately and extends that reporting requirement to
components of an entity that has either been disposed of or is classified as
held for sale. FAS 144 excludes
22
goodwill and other intangibles that are not amortized from its scope. For assets
to be held and used, FAS 144 addresses how cash flows should be estimated to
test the recoverability of an asset or group of assets, clarifies how an
impairment loss should be allocated, and creates a requirement to use an
expected present value technique to estimate fair value if market prices are not
available and uncertainties exist about the timing and amount of future cash
flows. For long-lived assets to be disposed of by sale, FAS 144 establishes the
criteria to be met to qualify for this classification, defines the timing of
when the related sale must be consummated, eliminates the net realizable value
measurement approach for segments of a business and certain acquired assets in a
business combination, and defines costs to sell the asset. The provisions of FAS
144 are effective for fiscal years beginning after December 15, 2001 and are
generally to be applied prospectively. The Company is currently evaluating the
effect that the adoption of FAS 144 will have on its results of operations and
its financial position.
Quantitative and Qualitative Disclosures About Market Risk
- ----------------------------------------------------------
The Company uses derivative financial instruments primarily to reduce
exposure to adverse fluctuations in foreign exchange rates, interest rates and
prices of certain raw materials used in the manufacturing process. The Company
does not enter into derivative financial instruments for trading purposes. As a
matter of policy, all derivative positions are used to reduce risk by hedging
underlying economic exposure. The derivatives the Company uses are instruments
with liquid markets.
The Company manages most of its foreign currency exposures on a
consolidated basis. The Company identifies all of its known exposures. As part
of that process, all natural hedges are identified. The Company then nets these
natural hedges from its gross exposures.
The Company's consolidated earnings, which are reported in United States
dollars are subject to translation risks due to changes in foreign currency
exchange rates. However, its overall exposure to such fluctuations is reduced by
the diversity of its foreign operating locations which encompass a number of
different European locations, Canada, and China.
The Company's 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. The Company uses foreign currency
forward exchange contracts to manage the risk related to intercompany purchases
that occur during the course of a fiscal year and certain open foreign currency
denominated commitments to sell products to third parties.
The Company has historically had a very low exposure to changes in
interest rates. Interest rate swaps are used to mitigate the impact of interest
rate fluctuations on certain variable rate debt instruments. However, the
Company's senior notes and its U.S. revolving line of credit are subject to the
impact of changes in interest rates.
23
The Company purchases significant amounts of bronze ingot, brass rod and
cast iron which are utilized in manufacturing its many product lines. The
Company's operating results can be adversely affected by changes in commodity
prices if it is unable to pass on related price increases to its customers. The
Company manages this risk by monitoring related market prices, working with its
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 its customers, to the maximum extent possible, when they
occur. Additionally, on a limited basis, the Company uses commodity futures
contracts to manage this risk.
Other
- -----
This report may include 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 reflects the
Company's current views about future events and financial performance. Investors
should not rely on forward looking statements, because they are subject to a
variety of risks, uncertainty, and other factors that could cause actual results
to differ materially from the Company's expectations and the Company expressly
does not undertake any duty to update forward looking statements. These factors
include, but are not limited to, the following: loss of market share through
competition, introduction of competing products by other companies, pressure on
prices from competitors, suppliers, and/or customers' regulatory obstacles, lack
of acceptance of new products, changes in plumbing and heating markets, changes
in global demand for the Company's products, changes for distribution of the
Company's products, interest rates, foreign exchange fluctuations, cyclicality
of industries in which the Company markets certain of its products, and general
economic factors in markets where the Company's products are sold, manufactured,
or marketed, changes in the status of current litigation, including the James
Jones case, and other factors discussed in the Company's reports filed with the
Securities and Exchange Commission.
This report includes forward looking statements which reflect the
Company's current views about future events and financial performance. Forward
looking statements do not relate strictly to historical or current facts and may
be identified by their use of words like "plan", "believe", "expect", "will",
"anticipate", "estimate" and other words of similar meaning. Investors should
not rely on forward looking statements because they are subject to a variety of
risks, uncertainties, and other factors that could cause actual results to
differ materially from our expectations. Some important factors that could cause
our actual results to differ materially from those projected in such forward
looking statements are discussed in the December 31, 2000 Annual Report on Form
10-K.
PART II
- -------
Item 1. Legal Proceedings
-----------------
The Company is subject to a variety of potential liabilities connected
with its business operations, including potential liabilities and expenses
associated with possible product defects or failures and compliance with
environmental laws. The Company maintains product liability
24
and other insurance coverage, which it believes to be generally in accordance
with industry practices. Nonetheless, such insurance coverage may not be
adequate to protect the Company fully against substantial damage claims which
may arise from product defects and failures.
James Jones Litigation
- ----------------------
On June 25, 1997, Nora Armenta sued James Jones Company, Watts Industries,
Inc., which formerly owned James Jones, Mueller Co., and Tyco International
(U.S.) Inc. in the California Superior Court for Los Angeles County with a
complaint that sought tens of millions of dollars in damages. By this complaint
and an amended complaint filed on November 4, 1998 ("First Amended Complaint"),
Armenta, a former employee of James Jones, sued on behalf of 34 municipalities
as a qui tam plaintiff under the California False Claims Act. Late in 1998, the
Los Angeles Department of Water and Power ("LADWP") intervened. To date, less
than half a dozen of the original thirty-four municipalities have subsequently
intervened. In December, 2000, the court allowed the Realtor to file a Second
Amended Complaint, which added a number of new cities and water districts as
plaintiffs and brought the total number of plaintiffs to 161.
The First Amended Complaint alleges that the Company's former subsidiary
(James Jones Company) sold products that did not meet contractually specified
standards used by the named municipalities for their water systems and falsely
certified that such standards had been met. Armenta claims that these
municipalities were damaged by their purchase of these products, and seeks
treble damages, legal costs, attorneys' fees and civil penalties under the False
Claims Act.
The LADWP's intervention filed on December 9, 1998 adopted the First
Amended Complaint and added claims for breach of contract, fraud and deceit,
negligent misrepresentation, and unjust enrichment. The LADWP seeks past and
future reimbursement costs, punitive damages, contract difference in value
damages, treble damages, civil penalties under the False Claims Act and costs of
the suit.
One of the First Amended Complaint's allegations is the suggestion that
because some of the purchased James Jones products are out of specification and
contain more lead than the `85 bronze specified, a risk to public health might
exist. This contention is predicated on the average difference of about 2% lead
content in `81 bronze (6% to 8% lead) and `85 bronze (4% to 6% lead) alloys and
the assumption that this would mean increased consumable lead in public drinking
water. The evidence and discovery available to date indicate that this is not
the case.
In addition, bronze that does not contain more than 8% lead, like '81
bronze, is approved for home plumbing fixtures by the City of Los Angeles, and
the Federal Environmental Protection Agency defines metal for pipe fittings with
no more than 8% lead as "lead free" under Section 1417 of the Federal Safe
Drinking Water Act.
In June, 2001, the Company and the other defendants reached a proposed
settlement with the LADWP, one of the plaintiffs, which has now been approved by
the California Superior Court and submitted to the Los Angeles Board of Water
and Power Commissioners for approval.
25
On January 19, 2001, the California False Claims Act claims filed by the City of
Pomona were dismissed. The California Court of Appeal reversed this dismissal,
and the California Supreme Court declined to review this reversal.
After the Company's insurers had denied coverage for the claims in this
case, the Company filed a complaint in the California Superior Court against its
insurers for coverage. The James Jones Company filed a similar complaint, and on
October 30, 2001 the California Superior Court ruled that Zurich American
Insurance Company must pay all reasonable defense costs incurred by the Company
in the James Jones case since April 23, 1998 as well as the Company's future
defense costs in this case until its final resolution. The Company is currently
unable to predict the outcome of the litigation relating to insurance coverage.
Based on management's assessment, the Company does not believe that the
ultimate outcome of the James Jones case will have a material adverse effect on
its liquidity, financial condition or results of operations. The Company intends
to continue to contest vigorously the James Jones case and its related
litigation.
Environmental
- -------------
Certain of the Company's operations generate solid and hazardous wastes,
which are disposed of elsewhere by arrangement with the owners or operators of
disposal sites or with transporters of such waste. The Company's foundry and
other operations are subject to various federal, state and local laws and
regulations relating to environmental quality. Compliance with these laws and
regulations requires the Company to incur expenses and monitor its operations on
an ongoing basis. The Company cannot predict the effect of future requirements
on its liquidity, financial condition or results of operations due to any
changes in federal, state or local environmental laws, regulations or
ordinances.
The Company is currently a party to or otherwise involved in various
administrative or legal proceedings under federal, state or local environmental
laws or regulations involving a limited number of sites. Based on facts
presently known to it, the Company does not believe that the outcome of these
environmental proceedings will have a material adverse effect on its liquidity,
financial condition or results of operations. Given the nature and scope of the
Company's manufacturing operations, there can be no assurance that the Company
will not become subject to other environmental proceedings and liabilities in
the future which may be material to the Company.
Other Litigation
- ----------------
Other lawsuits and proceedings or claims, arising from the ordinary course
of operations, are also pending or threatened against the Company and its
subsidiaries. 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.
26
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) The exhibits are furnished elsewhere in this report.
(b) Reports filed on Form 8-K during the Quarter ended September 30, 2001.
There were no reports filed on Form 8-K with the Securities and Exchange
Commission during the quarter ending September 30, 2001.
27
SIGNATURES
----------
Pursuant to the requirements 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 INDUSTRIES, INC.
Date: November 13, 2001 By: /s/ Timothy P. Horne
----------------- --------------------
Timothy P. Horne
Chairman and Chief Executive Officer
Date: November 13, 2001 By: /s/ William C. McCartney
----------------- ------------------------
William C. McCartney
Chief Financial Officer and Treasurer
28
EXHIBIT INDEX
Listed and indexed below are all Exhibits filed as part of this report.
Exhibit No. Description
- ----------- -----------
3.1 Restated Certificate of Incorporation, as amended. (1)
3.2 Amended and Restated By-Laws, as amended May 11, 1999 (2)
11 Computation of Earnings per Share (3)
(1) Incorporated by reference to the relevant exhibit to the Registrant's
Annual Report on Form 10-K filed with the Securities and Exchange
Commission on September 28, 1995.
(2) Incorporated by reference to the relevant exhibit to the Registrant's
Current Report on Form 10-Q for the Quarter ended March 31, 2000.
(3) Incorporated by reference to the Notes to Consolidated Financial
Statements, Note 4, of this Report.
29