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 December 31, 1998
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 January 31, 1999
Class A Common, $.10 par value 16,358,807
Class B Common, $.10 par value 10,285,247
WATTS INDUSTRIES, INC. AND SUBSIDIARIES
INDEX
Part I. Financial Information
Page #
Item 1. Financial Statements
Consolidated Balance Sheets at December 31, 1998 and June 30, 1998 3
Consolidated Statements of Income for the Three Months Ended
December 31, 1998 and December 31, 1997 4
Consolidated Statements of Income for the Six Months Ended
December 31, 1998 and December 31, 1997 5
Consolidated Statements of Cash Flows for the Six Months Ended
December 31, 1998 and December 31, 1997 6
Notes to Consolidated Financial Statements 7-11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-16
Part II. Other Information
Item 1. Legal Proceedings 16-19
Item 4. Submission of Matters to a Vote of Security Holders 19-20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
Exhibit Index 22
Exhibit 27 - Financial Data Schedule 23
Exhibit 27.1 - Restated Financial Data Schedule - September 30, 1998 24
Exhibit 27.2 - Restated Financial Data Schedule - June 30, 1998 25
Exhibit 27.3 - Restated financial Data Schedule - December 31, 1997 26
PART I. FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS
----------------------
WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share information)
(Unaudited)
Dec. 31, June 30,
1998 1998
--------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 14,285 $ 10,177
Short-term investments 328 590
Trade accounts receivable, less allowance for doubtful
accounts of $7,083 at December 31, 1998 and $6,821
at June 30, 1998 83,148 77,325
Inventories, net:
Raw materials 30,082 30,793
Work in process 7,673 9,704
Finished goods 60,081 66,637
--------- ---------
Total Inventories 97,836 107,134
Prepaid expenses and other assets 7,385 7,811
Deferred income taxes 24,472 22,974
Net assets held for sale 2,046 2,046
Net current assets of discontinued operations 117,822 92,237
--------- ---------
Total Current Assets 347,322 320,294
--------- ---------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, at cost 203,008 193,812
Accumulated depreciation (95,565) (87,971)
--------- ---------
Property, plant and equipment, net 107,443 105,841
--------- ---------
OTHER ASSETS:
Goodwill, net of accumulated amortization of $12,867 at
December 31, 1998 and $11,708 at June 30, 1998 83,480 83,003
Other 9,604 9,765
Net noncurrent assets of discontinued operations 46,122 38,343
--------- ---------
TOTAL ASSETS $ 593,971 $ 557,246
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 29,977 $ 29,706
Accrued expenses and other liabilities 43,060 37,209
Accrued compensation and benefits 12,012 10,995
Current portion of long-term debt 5,984 5,011
--------- ---------
Total Current Liabilities 91,033 82,921
--------- ---------
LONG-TERM DEBT, NET OF CURRENT PORTION 78,823 71,646
DEFERRED INCOME TAXES 15,915 14,220
OTHER NONCURRENT LIABILITIES 7,504 6,798
MINORITY INTEREST 7,969 7,646
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:
16,568,807 shares at December 31, 1998 and 16,859,027
shares at June 30, 1998 1,657 1,686
Class B Common Stock, $.10 par value; 25,000,000 shares
authorized; 10 votes per share; issued and outstanding:
10,285,247 at December 31, 1998 and 10,296,827
shares at June 30, 1998 1,029 1,030
Additional paid-in capital 41,582 47,647
Retained earnings 356,454 337,565
Treasury stock, at cost, 10,000 shares at
December 31, 1998 and 100,000 shares at June 30, 1998 (179) (2,583)
Accumulated other comprehensive income (7,816) (11,330)
--------- ---------
Total Stockholders' Equity 392,727 374,015
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 593,971 $ 557,246
========= =========
See accompanying notes to consolidated financial statements.
3
WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share information)
(Unaudited)
Three Months Ended
---------------------
Dec. 31, Dec. 31,
1998 1997
--------- ---------
Net sales $ 114,310 $ 111,844
Cost of goods sold 73,477 71,348
--------- ---------
GROSS PROFIT 40,833 40,496
Selling, general & administrative expenses 29,035 27,850
--------- ---------
OPERATING INCOME 11,798 12,646
--------- ---------
Other (income) expense:
Interest income (227) (210)
Interest expense 1,115 1,547
Other, net 203 189
--------- ---------
1,091 1,526
--------- ---------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 10,707 11,120
Provision for income taxes 3,375 3,507
--------- ---------
INCOME FROM CONTINUING OPERATIONS 7,332 7,613
Income from discontinued operations, net of taxes 3,924 5,996
--------- ---------
NET INCOME $ 11,256 $ 13,609
========= =========
Basic earnings per share :
Continuing operations $ 0.27 $ 0.28
Discontinued operations 0.15 0.22
--------- ---------
NET INCOME $ 0.42 $ 0.50
========= =========
Weighted average number of shares 26,855 27,059
========= =========
Diluted earnings per share :
Continuing operations $ 0.27 $ 0.28
Discontinued operations 0.15 0.22
--------- ---------
NET INCOME $ 0.42 $ 0.50
========= =========
Weighted average number of shares 26,954 27,423
========= =========
Dividends per common share $ 0.0875 $ 0.0775
========= =========
See accompanying notes to consolidated financial statements.
4
WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share information)
(Unaudited)
Six Months Ended
---------------------
Dec. 31, Dec. 31,
1998 1997
--------- ---------
Net sales $ 227,579 $ 223,683
Cost of goods sold 145,660 142,024
--------- ---------
GROSS PROFIT 81,919 81,659
Selling, general & administrative expenses 56,798 55,540
--------- ---------
OPERATING INCOME 25,121 26,119
--------- ---------
Other (income) expense:
Interest income (413) (400)
Interest expense 2,673 3,274
Other, net 434 1,127
--------- ---------
2,694 4,001
--------- ---------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 22,427 22,118
Provision for income taxes 7,202 7,179
--------- ---------
INCOME FROM CONTINUING OPERATIONS 15,225 14,939
Income from discontinued operations, net of taxes 8,419 12,290
--------- ---------
NET INCOME $ 23,644 $ 27,229
========= =========
Basic earnings per share :
Continuing operations $ 0.57 $ 0.55
Discontinued operations 0.31 0.46
--------- ---------
NET INCOME $ 0.88 $ 1.01
========= =========
Weighted average number of shares 26,935 27,042
========= =========
Diluted earnings per share :
Continuing operations $ 0.56 $ 0.55
Discontinued operations 0.31 0.45
--------- ---------
NET INCOME $ 0.87 $ 1.00
========= =========
Weighted average number of shares 27,062 27,361
========= =========
Dividends per common share $ 0.1750 $ 0.1550
========= =========
See accompanying notes to consolidated financial statements.
5
WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
Six Months Ended
---------------------
Dec. 31, Dec. 31,
1998 1997
--------- ---------
OPERATING ACTIVITIES
Net income from continuing operations $ 15,225 $ 14,939
Adjustments to reconcile net income from continuing
operations to net cash provided by continuing
operating activities:
Restructuring payments - (1,091)
Depreciation 7,119 6,594
Amortization 1,366 1,212
Deferred income taxes 314 202
Gain on disposal of assets (14) (588)
Equity in undistributed earnings of affiliates (113) (53)
Changes in operating assets and liabilities, net of
effects from acquisitions and dispositions:
Accounts receivable (4,416) (9,045)
Inventories 10,227 (6,091)
Prepaid expenses and other assets 972 (5,228)
Accounts payable, accrued expenses and
other liabilities 4,415 7,954
--------- ---------
35,095 8,805
Net cash provided (used) by discontinued operations (4,441) 6,855
--------- ---------
Net cash provided by operating activities 30,654 15,660
--------- ---------
INVESTING ACTIVITIES
Additions to property, plant and equipment (7,542) (13,009)
Proceeds from sale of assets 46 6,176
Business acquisitions, net of cash acquired (487) (686)
Increase in other assets (660) (505)
Net changes in short-term investments 262 (1,182)
Discontinued operations:
Business acquisitions, net of cash acquired (63,875) (7,162)
--------- ---------
Net cash used in investing activities (72,256) (16,368)
--------- ---------
FINANCING ACTIVITIES
Proceeds from long-term borrowings 27,757 46,169
Payments of long-term debt (19,272) (46,728)
Proceeds from exercise of stock options 61 1,143
Dividends (4,713) (4,193)
Purchase of treasury stock (3,871) -
Discontinued operations:
Proceeds from long-term borrowings 66,750 5,372
Payments of long-term debt (22,487) (139)
--------- ---------
Net cash provided by financing activities 44,225 1,624
--------- ---------
Effect of exchange rate changes on cash and
cash equivalents 1,485 143
--------- ---------
CHANGE IN CASH AND CASH EQUIVALENTS 4,108 1,059
Cash and cash equivalents at beginning of period 10,177 18,139
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 14,285 $ 19,198
========= =========
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 December 31, 1998, its Consolidated
Statements of Income for the three and six months ended December 31, 1998 and
1997, and its Consolidated Statements of Cash Flows for the six months ended
December 31, 1998 and 1997.
The balance sheet at June 30, 1998 has been derived from the audited
financial statements at that date. Certain amounts have been reclassified to
conform with the fiscal 1999 presentation. The accounting policies followed
by the Company are described in the June 30, 1998 financial statements which
are contained in the Company's 1998 Annual Report. It is suggested that these
financial statements be read in conjunction with the financial statements and
notes included in the 1998 Annual Report to Stockholders.
2. On December 15, 1998 the Company announced that it plans to separate its
industrial, oil and gas business from its plumbing and heating and water
quality business. To accomplish this separation, the Company will continue
its existing plumbing and heating and water quality business and will transfer
the industrial, oil and gas business to a new subsidiary. The Company will
then spin off the new subsidiary to the Watts' stockholders in the form of a
pro-rata stock dividend. Completion of the spin-off will be subject to
certain conditions, including receipt from the Internal Revenue Service of a
Private Letter Ruling ("PLR") as to the tax-free treatment of the spin-off,
necessary governmental approvals, and any required consents of third parties.
Subject to such conditions, the spin-off will be completed following receipt
of the PLR, which the Company currently expects to receive in the third
calendar quarter of 1999.
Accordingly, the Company is treating its industrial, oil and gas
business as a discontinued operation effective with the quarter ended December
31, 1998.
The following table summarizes the results of operations of the
industrial, oil and gas group:
Three Months Ended December 31,
1998 1997
Sales, Net $84,747 $67,354
Costs and Expenses 78,187 57,860
------- -------
Income Before Income Taxes 6,560 9,494
Income Taxes 2,636 3,498
------- -------
Income from Discontinued Operations $ 3,924 $ 5,996
======== =======
Six Months Ended December 31,
1998 1997
Sales, Net $165,403 $134,975
Costs and Expenses 151,108 115,571
-------- ---------
Income Before Income Taxes 14,295 19,404
Income Taxes 5,876 7,114
-------- ---------
Income from Discontinued Operations $ 8,419 $ 12,290
======== ========
Net assets reported in the accompanying consolidated balance sheets consist of
the following:
December 31, June 30,
1998 1998
Accounts Receivable $ 56,470 $ 53,565
Inventories 104,467 86,852
Other Current Assets 21,905 9,483
Accounts Payable (23,601) (26,966)
Other Current Liabilities (41,419) (30,697)
--------- --------
Net Current Assets $ 117,822 $ 92,237
========= ========
Property, Plant and Equipment $ 68,200 $ 55,629
Goodwill 97,930 36,006
Other Noncurrent Assets 6,924 3,911
Long-Term Debt, Net of Current Portion (107,272) (43,735)
Other Noncurrent Liabilities ( 19,660) (13,468)
--------- --------
Net Noncurrent Assets $ 46,122 $ 38,343
========= ========
The Company presently expects to incur approximately $5,000,000 of
direct costs from the spin-off transaction and has accrued such a liability at
December 31, 1998. As required by APB Opinion No. 30, the Company has also
accrued the amount of future operating income from its industrial, oil and gas
business necessary to fully offset these costs. This accrual of future income
is required because the Company expects income from these businesses during
the period between January 1, 1999 and completion of the spin-off will exceed
the direct costs of the spin-off transaction.
3. The following tables set forth the reconciliation of the calculation of
earnings per share per SFAS 128:
For the Three Months Ended December 31, 1998
Income Shares Per Share
(Numerator) (Denominator) Amount
Basic EPS
Income from Continuing Operations $ 7,332,000 26,855,002 $.27
Income from Discontinued Operations 3,924,000 .15
----------- ----
Net Income $11,256,000 $.42
Effect of Dilutive Securities
Common Stock Equivalents - 98,620
----------- ---------- ----
Diluted EPS $11,256,000 26,953,622 $.42
=========== ========== ====
For the Six Months Ended December 31, 1998
Income Shares Per Share
(Numerator) (Denominator) Amount
Basic EPS
Income from Continuing Operations $15,225,000 26,935,240 $.57
Income from Discontinued Operations 8,419,000 .31
----------- ---------- ----
Net Income $23,644,000 $.88
Effect of Dilutive Securities
Common Stock Equivalents - 126,708
----------- ---------- ----
Diluted EPS $23,644,000 27,061,948 $.87
=========== ========== ====
Options to purchase 1,083,553 shares and 838,700 shares of common stock at
prices ranging from $18.44 to $25.38 were outstanding during the three-month
and six-month periods ended December 31, 1998, respectively. These options
were not included in the related computations of diluted EPS since the
exercise price of the options was greater than the average market price of the
common shares during those respective periods.
For the Three Months Ended December 31, 1997
Income Shares Per Share
(Numerator) (Denominator) Amount
Basic EPS
Income from Continuing Operations $ 7,613,000 27,059,430 $.28
Income from Discontinued Operations 5,996,000 .22
------------ ----
Net Income $13,609,000 $.50
Effect of Dilutive Securities
Common Stock Equivalents - 363,787
----------- ---------- ----
Diluted EPS $13,609,000 27,423,217 $.50
=========== ========== ====
For the Six Months Ended December 31, 1997
Income Shares Per Share
(Numerator) (Denominator) Amount
Basic EPS
Income from Continuing Operations $14,939,000 27,041,929 $ .55
Income from Discontinued Operations 12,290,000 .46
----------- ----
Net Income $27,229,000 $1.01
Effect of Dilutive Securities
Common Stock Equivalents - 319,289
----------- ---------- -----
Diluted EPS $27,229,000 27,361,218 $1.00
=========== ========== =====
At December 31, 1997, there were no outstanding options to purchase shares of
common stock with exercise prices greater than the average market price of the
common shares during the three-month and six-month periods then ended.
4. During December 1997, the Company sold a small Italian valve
manufacturing division which was not part of the Company's core business. The
division's sales for the three-month and six-month periods ended December 31,
1997 were $2,074,000 and $3,386,000, respectively.
5. The Company uses foreign currency forward exchange contracts to reduce
the impact of currency fluctuations on certain anticipated purchase
transactions that are expected to occur within the fiscal year and other known
currency exposures. The notional amount of such contracts and the related
realized and unrealized gains and losses as of December 31, 1998 are not
material.
6. Effective July 1, 1998, the Company was required to adopt Statement of
Financial Accounting Standards ("SFAS") No. 130, Reporting Comprehensive
Income. This statement establishes standards for reporting and presentation of
comprehensive income and its components in financial statements. Accumulated
other comprehensive income in the consolidated balance sheets as of December
31, 1998 and June 30, 1998 consists of cumulative translation adjustments. The
Company's total comprehensive income was as follows:
Three Months Ended December 31,
1998 1997
Income from Continuing Operations $7,332 $ 7,613
Income from Discontinued Operations 3,924 5,996
Foreign Currency Translation Adjustments (1,547) (2,141)
------ -------
Total Comprehensive Income $9,709 $11,468
====== =======
Six Months Ended December 31,
1998 1997
Income from Continuing Operations $15,225 $14,939
Income from Discontinued Operations 8,419 12,290
Foreign Currency Translation Adjustments 3,515 (2,089)
------- -------
Total Comprehensive Income $27,159 $25,140
======= =======
7. Contingencies and Environmental Remediation
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.
The complaint was amended on November 4, 1998 to include additional municipal
entities, consisting of the East Bay Municipal Utility District, the San
Gabriel Valley Municipal Water District, and 31 cities in the State of
California. The amended complaint alleges that the additional municipal
entities have also suffered damages and also seeks treble damages, legal
costs, attorneys' fees and civil penalties. On December 9, 1998, the Los
Angeles Department of Water and Power ("LADWP") filed a Complaint in
Intervention which incorporated the amended complaint and added claims for
breach of contract, fraud and deceit-negligent misrepresentation and unjust
enrichment. The Company intends to vigorously contest this matter but cannot
presently determine whether any loss will result from it. Other lawsuits and
proceedings or claims, arising from the ordinary course of operations, are
also pending or threatened against the Company and its subsidiaries. With
respect to these other litigation matters, 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. Also see Part II, Item 1.
Environmental Remediation
The Company has been named a potentially responsible party with respect
to identified contaminated sites. The level of contamination varies
significantly from site to site as do the related levels of remediation
efforts. Environmental liabilities are recorded based on the most probable
cost, if known, or on the estimated minimum cost of remediation. The
Company's accrued estimated environmental liabilities are based on assumptions
which are subject to a number of factors and uncertainties. Circumstances
which can affect the reliability and precision of these estimates include
identification of additional sites, environmental regulations, level of
cleanup required, technologies available, number and financial condition of
other contributors to remediation and the time period over which remediation
may occur. The Company recognizes changes in estimates as new remediation
requirements are defined or as new information becomes available. The Company
estimates that its accrued environmental remediation liabilities will likely
be paid over the next five to ten years. Also see Part II, Item 1.
Item 2. WATTS INDUSTRIES, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operations
On December 15, 1998 the company announced its plan to spin off its
industrial, oil and gas business through a pro-rata stock dividend.
Accordingly, the Company is now required to treat this industrial, oil and gas
business as a discontinued operation for accounting purposes. Please see Note
2 to the Notes to the Consolidated Financial Statements for a discussion of
the spin-off.
Results of Operations
Three Months Ended December 31, 1998 Compared to
Three Months Ended December 31, 1997
Net sales for continuing operations increased $2,466,000 (2.2%) to
$114,310,000. This increase in net sales is primarily attributable to
increased unit shipments of domestic plumbing and heating valves. Last year's
sales included approximately $2,100,000 for product lines which the Company
subsequently divested. Shipments of European plumbing and heating valves were
consistent with last year.
Gross profit increased $337,000 (0.8%) but decreased as a percentage of
net sales from 36.2% to 35.7%. The gross margin percentage decrease is due to
decreased absorption of fixed manufacturing expenses associated with the
Company's domestic inventory reduction in the current fiscal quarter. This
decrease was partially offset by reduced material costs. The Company had an
inventory increase during the comparable period last fiscal year.
Selling, general and administrative expenses increased $1,185,000 (4.3%)
to $29,035,000. This increase is primarily attributable to increased variable
selling expenses including commissions and advertising, as well as increased
costs associated with the Company's new information system.
Interest expense decreased $432,000 (28.0%) to $1,115,000. This
decrease is due to decreased levels of long-term debt.
Net income from continuing operations decreased $281,000 (3.7%) to
$7,332,000. This decrease is primarily attributable to the decreased gross
margin percentage.
Income from discontinued operations net of taxes decreased $2,072,000
(34.6%) to $3,924,000. This decrease is primarily attributable to decreased
sales and decreased unit pricing in the Company's oil and gas subsidiaries.
These subsidiaries were adversely impacted by low energy prices which
significantly decreased demand for the Company's oil and gas products.
Domestic oil and gas valves experienced a sales decline of 30%. The
competition for the remaining business caused abnormally low pricing
realization and the reduced manufacturing levels caused a loss of
overhead absorption of fixed expenses. Sales of international oil and gas
valves will start to lag last year's performance during the second half of our
fiscal year as new project awards have significantly slowed owing to market
conditions. Please see Note 2 of the Notes to the Consolidated Financial
Statements for a discussion on the Company's intention to spin off its
industrial, oil and gas business.
The changes in foreign exchange rates had an immaterial effect on net
income for the three months ended December 31, 1998.
Results of Operations
Six Months Ended December 31, 1998 Compared to
Six Months Ended December 31, 1997
Net sales increased $3,896,000 (1.7%) to $227,579,000. This increase is
primarily attributable to increased unit shipments of domestic plumbing and
heating valves. Last year's sales included approximately $3,400,000 for
product lines which the Company subsequently divested. Shipments of European
plumbing and heating valves were consistent with last year. The change in
foreign exchange rates had an immaterial effect on the year-to-date sales.
Gross profit increased $260,000 (0.3%) to $81,919,000 but decreased as a
percentage of net sales from 36.5% to 36.0%. The decrease is primarily
attributable to decreased absorption of fixed manufacturing expenses due to
the Company's domestic inventory reduction program. This decrease was
partially offset by reduced material costs. The Company experienced an
inventory increase in the previous fiscal year.
Selling, general and administrative expenses increased $1,258,000 (2.3%)
to $56,798,000. This increase is primarily attributable to increased costs
associated with the Company's new information technology systems and increased
research and development expenditures.
Other expense decreased $693,000 (61.5%) to $434,000. This decrease is
primarily attributable to decreased foreign exchange expense.
Net income from continuing operations increased $286,000 (1.9%) to
$15,225,000.
Income from discontinued operations net of taxes decreased $3,871,000
(31.5%) to $8,419,000. This decrease is primarily attributable to decreased
sales and decreased unit pricing in the Company's oil and gas subsidiaries.
These subsidiaries were adversely impacted by low energy prices which
significantly decreased demand for the Company's oil and gas products.
Domestic oil and gas valves experienced a sales decline of 30%. The
competition for the remaining business caused abnormally low pricing
realization and the reduced manufacturing levels caused a loss of overhead
absorption of fixed expenses. Sales of international oil and gas valves will
start to lag last year's performance during the second half of our fiscal year
as new project awards have significantly slowed owing to market conditions.
Please see Note 2 of the Notes to the Consolidated Financial Statements for a
discussion on the Company's intention to spin off its industrial, oil and gas
business.
The changes in foreign exchange rates had an immaterial effect on net
income for the six months ended December 31, 1998.
Liquidity and Capital Resources
During the six-month period ended December 31, 1998, the Company
generated $35,095,000 in cash flow, from continuing operations, which was
principally used to fund capital expenditures of $7,542,000, pay down debt,
and fund the Company's stock buy-back program. These 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 continuing operations for fiscal
1999 is approximately $21,000,000.
During the six months ended December 31, 1998, the Company purchased
215,500 shares of its Class A Common Stock in open market purchases, as part
of its previously announced stock buy-back program. Total funds used to
purchase these shares were $3,871,000. During the same six- month period, the
company retired 305,500 shares previously repurchased and recorded as Treasury
Stock. Subsequent to the quarter ended December 31, 1998 the Company
purchased an additional 200,000 shares for an aggregate purchase price of
$2,842,000. The Company's Board of Directors has authorized the purchase of
an additional 500,000 shares of its Class A Common Stock during the next 12
months.
The Company has available an unsecured $125,000,000 line of credit which
expires on March 27, 2003. The Company's intent is to utilize this credit
facility to support the Company's acquisition program, working capital
requirements of acquired companies and for general corporate purposes. As of
June 30, 1998, $19,000,000 was borrowed under this line of credit. As of
December 31, 1998, $78,000,000 was borrowed under this line of credit. The
change in the outstanding borrowing is primarily attributable to the Company's
acquisition program.
The ratio of current assets to current liabilities was 3.8 to 1 at
December 31, 1998 and 3.9 to 1 at June 30, 1998. Cash and short-term
investments were $14,613,000 at December 31, 1998 compared to $10,767,000 at
June 30, 1998. Debt as a percentage of total capital employed was 17.8% at
December 31, 1998 compared to 17.0% at June 30, 1998. At December 31, 1998,
the Company was in compliance with all covenants related to its existing debt.
The Company anticipates that available funds and those funds provided
from current operations will be sufficient to meet current operating
requirements and anticipated capital expenditures for at least the next 24
months.
The Company from time to time is involved with product liability,
environmental proceedings and other litigation proceedings and incurs costs on
an ongoing basis related to these matters. The Company has not incurred
material expenditures in fiscal 1999 in connection with any of these matters.
See Part II, Item 1, Legal Proceedings.
The Company has developed a comprehensive global plan to assess and
address in a timely manner its information systems including customer service,
production, distribution and financial systems in conjunction with the year
2000. A significant portion of the Company's year 2000 issues are being
addressed as part of its program to upgrade its information systems which the
Company had committed to regardless of the year 2000 issue. This program
commenced in fiscal 1997 and should be substantially complete by the end of
fiscal 1999. The Company has spent approximately $8,700,000 on computer
hardware and software for this information systems upgrade program and expects
to spend approximately $1,100,000 on additional similar costs to complete the
upgrade. If it becomes necessary to dedicate additional financial and other
resources to complete the Company's information systems upgrade program by the
end of fiscal year 1999, or shortly thereafter, the Company will do so.
The Company is also communicating with its suppliers, distributors and
others with whom it conducts business to coordinate year 2000 compliance and
to identify alternative sources of supply for its materials. The
implementation of these plans is not expected to have a material adverse
effect on the results of operations or the financial condition of the Company.
The Company presently believes alternative sources of supply will be available
in the event of unforeseen year 2000 compliance issues that affect suppliers'
abilities to fulfill requirements. If production and other plans need to be
modified because of unforeseen year 2000 issues at distributors and others
with whom the Company conducts business, the Company will do so when the need
for such modification becomes apparent.
If the Company or its suppliers, distributors or others with whom it
conducts business are unable to identify and address the system issues related
to year 2000 risk on a timely basis, there could be a material adverse effect
on its results of operations and financial condition.
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 introduction of the Euro will affect 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 currently being assessed by the Company,
however, the Company will experience 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 uses foreign currency forward exchange contracts to reduce
the impact of currency fluctuations on certain intercompany purchase
transactions that will occur within the fiscal year and other known foreign
currency exposures. The notional amount of such contracts and the related
realized and unrealized gains and losses as of December 31, 1998 are not
material.
Certain statements contained herein are forward looking. Many factors
could cause actual results to differ from these statements, including 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 the
plumbing and heating and oil and gas markets; changes in global demand for the
Company's products; changes in 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 and economic
factors in markets where the Company's products are sold, manufactured or
marketed; and other factors discussed in the Company's reports filed with the
Securities and Exchange Commission.
Statement of Financial Accounting Standards ("SFAS") No. 131,
Disclosures about Segments of an Enterprise and Related Information, and SFAS
No. 132, Employers Disclosures About Pensions and Other Post-Retirement
Benefits, become effective during fiscal year 1999 and will be adopted
accordingly. Since these new standards require only additional disclosure,
adoption will have no effect on the Company's results of operation or
financial condition.
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, becomes effective in fiscal year 2000. This new standard will
require the Company to recognize all derivative instruments as either assets
or liabilities at fair value in its consolidated balance sheet. The Company
is currently evaluating the effect of this new standard.
Part II. Other Information
Item 1. Legal Proceedings
The Company, like other worldwide manufacturing companies, 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 and other
litigation matters.
James Jones Litigation
On June 25, 1997, Nora Armenta, as a relator for the State of
California, filed a civil action in the Superior Court of California for the
County of Los Angeles against the Company and three other defendants. The
complaint, which was filed under seal, was brought pursuant to the qui tam
provision of the California False Claims Act, Cal. Govt. Code 12650 et seq
("False Claims Act"). The Company became aware of the complaint in April
1998, after the seal was lifted. The relator is a former employee of a former
subsidiary of the Company.
The complaint alleged 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 only municipal water system specifically identified in the
original complaint was the Los Angeles Department of Water and Power
("LADWP"). The relator alleged that municipal entities have suffered tens of
millions of dollars in damages as a result of their purchase of these
products. The relator also sought treble damages, legal costs, attorneys'
fees, and civil penalties. In May 1998, the Company and the other defendants
filed a demurrer to the complaint. On July 21, 1998, the Court sustained the
demurrer and gave the relator forty five (45) days to file an amended
complaint. This deadline was subsequently extended to November 4, 1998.
On November 4, 1998, the relator filed an amended complaint ("First
Amended Complaint") under the False Claims Act. In the First Amended
Complaint, the relator brings her action on behalf of the LADWP as well as
additional municipal entities, consisting of the East Bay Municipal Utility
District, the San Gabriel Valley Municipal Water District, and 31 cities in
the State of California. The relator alleges that the Company's former
subsidiary sold products which did not meet contractually specified standards
used by each of these entities in their water systems and falsely certified
such standards had been met. In addition to the damages alleged to have been
suffered by the LADWP, the relator claims that the additional municipal
entities have also suffered damages as a result of their purchase of these
products. The relator also seeks treble damages, legal costs, attorneys'
fees, and civil penalties under the False Claims Act.
On December 9, 1998, the LADWP filed a Complaint-in-Intervention which
incorporated the relator's First Amended Complaint and added claims for breach
of contract, fraud and deceit--negligent misrepresentation and unjust
enrichment. The Complaint-in-Intervention seeks past and future reimbursement
costs, punitive damages, contract difference in value damages, treble damages
and civil penalties under the False Claims Act and costs of suit. The Company
and other defendants have filed demurrers and a motion to strike which are
presently scheduled to be heard on March 19, 1999. To date, no other entity
has indicated that it intends to intervene in this action. The Company
intends to vigorously contest this matter, and discovery is currently under
way. Presently, the Company cannot determine whether any loss will result
from this action. See Note 7 of the Notes to the Consolidated Financial
Statements.
Product Liability
Leslie Controls, Inc. and Spence Engineering Company, both subsidiaries
of the Company, are involved as third-party defendants in various civil
product liability actions pending in the U.S. District Court, Northern
District of Ohio. The underlying claims have been filed by present or former
employees of various shipping companies for personal injuries allegedly
received as a result of exposure to asbestos. The shipping companies contend
that they installed in their vessels certain valves manufactured by Leslie
Controls and/or Spence Engineering which contained asbestos. Leslie Controls
is also a defendant in two similar matters pending in Superior Court of
California, San Francisco County. The Company maintains product liability 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. Coverage with respect to these matters has
been disputed by certain of the carriers and, therefore, recovery is
questionable, a factor which the Company has considered in its evaluation of
these matters. Based on facts presently known to it, the Company does not
believe the outcome of these proceedings will have a material adverse effect
on its financial condition or results of operations.
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 capital expenditures, earnings or competitive position due
to any changes in federal, state or local environmental laws, regulations or
ordinances.
The Company is currently a party to or otherwise involved with various
administrative or legal proceedings under federal, state or local
environmental laws or regulations involving a number of sites, in some cases
as a participant in a group of potentially responsible parties ("PRPs").
Three of these sites, the Sharkey and Combe Landfills in New Jersey, and the
San Gabriel Valley/El Monte, California water basin site, are listed on the
National Priorities List. With respect to the Sharkey Landfill, the Company
has been allocated .75% of the remediation costs, an amount which is not
material to the Company. No allocations have been made to date with respect
to the Combe Landfill or San Gabriel Valley sites. The EPA has formally
notified several entities that they have been identified as being potentially
responsible parties with respect to the San Gabriel Valley site. As the
Company was not included in this group, its potential involvement in this
matter is uncertain at this point given that either the PRPs named to date or
the EPA could seek to expand the list of potentially responsible parties. In
addition to the foregoing, the Solvent Recovery Service of New England site
and the Old Southington landfill site, both in Connecticut, are on the
National Priorities List, but, with respect thereto, the Company has resort to
indemnification from third parties and based on currently available
information, the Company believes it will be entitled to participate in a de
minimis capacity.
With respect to the Combe Landfill, the Company is one of approximately
30 potentially responsible parties. The Company and all other PRPs received a
Supplemental Directive from the New Jersey Department of Environmental
Protection & Energy in 1994 seeking to recover approximately $9 million in the
aggregate for the operation, maintenance, and monitoring of the implemented
remedial action taken up to that time in connection with the Combe Landfill
North site. Certain of the PRPs, including the Company, are currently
negotiating with the state. The Company and certain of the remaining PRPs
have recently entered into a Consent Order with the U.S. Environmental
Protection Agency to settle the federal exposure for this site in return for a
non-material payment.
During the quarter ending March 31, 1998, the Company received an
administrative order from the New Hampshire Department of Environmental
Services (the "NH DES") with respect to certain regulatory issues concerning
its Franklin, New Hampshire operation. The Company has recently entered into
an amended administrative order with the NH DES and has withdrawn its appeal
of this matter. The state agency has not as of yet issued any fines or
penalties in connection with this matter.
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 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. See Note
7 of the Notes to the Consolidated Financial Statements.
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 financial condition or results of
operation. See Note 7 of the Notes to the Consolidated Financial Statements.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Stockholders of the Company was held on October 20,
1998.
(c) The results of the voting on the proposals considered at the Annual
Meeting of Stockholders were as follows:
1. Election of Directors
Timothy P. Horne, David A. Bloss, Sr., Kenneth J. McAvoy, Noah T. Herndon,
Gordon W. Moran and Daniel J. Murphy were each elected as a Director of
the Company for a term expiring at the next Annual Meeting of
Stockholders.
The voting results were as follows:
Mr. T. Horne 106,425,250 votes FOR 11,062,349 votes WITHHELD
Mr. D. Bloss 106,425,800 votes FOR 11,061,799 votes WITHHELD
Mr. K. McAvoy 106,425,700 votes FOR 11,061,899 votes WITHHELD
Mr. N. Herndon 106,423,505 votes FOR 11,064,094 votes WITHHELD
Mr. G. Moran 106,425,110 votes FOR 11,062,489 votes WITHHELD
Mr. D. Murphy 106,426,170 votes FOR 11,061,429 votes WITHHELD
2. Ratification of Independent Auditors
The selection of KPMG Peat Marwick LLP as the independent auditors of the
Company for the current fiscal year was ratified and the voting results
were as follows:
117,444,427 votes FOR 30,704 votes WITHHELD 12,468 votes ABSTAINED
0 Broker Non-votes
3. Shareholder Proposal 1
The proposal to request that the Company's Board of Directors take the
steps necessary to amend and restate the Company's Amended and Restated
Certificate of Incorporation to provide for one class of Common Stock
having one vote per share was rejected and the voting results were as
follows:
22,047,507 votes FOR 93,275,941 votes AGAINST 42,702 votes ABSTAINED
2,121,449 Broker Non-votes
4. Shareholder Proposal 2
Shareholder Proposal 2, which was not timely delivered to the Company for
inclusion in the Proxy Statement, was brought before the Annual Meeting
for consideration by the shareholders. On this proposal to request that
the Board of Directors consider various alternatives to enhance the value
of Class A Common Stock and to also consider the advisability of adopting
a differential dividend for Class A Common Stock, with a premium over any
Class B Common Stock so long as the Class B Common Stock super voting
provisions continue to exist was rejected and the voting results were as
follows:
10,489,330 votes FOR 90,838,800 votes AGAINST
Item 6. Exhibits and Reports on Form 8-K
(a) The exhibits are furnished elsewhere in this report.
(b) A report on Form 8-K was filed with the Securities and Exchange
Commission on December 17, 1998. The following item was reported on:
(1) Item 5. Other Events. There were no financial statements filed.
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: February 15, 1999 By: /s/ Timothy P. Horne
Timothy P. Horne
Chairman and Chief Executive Officer
Date: February 15, 1999 By: /s/ Kenneth J. McAvoy
Kenneth J. McAvoy
Chief Financial Officer and Treasurer
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. (2)
11 Computation of Earnings per Share (3)
27 Financial Data Schedule*
27.1 Restated Financial Data Schedule - September 30, 1998*
27.2 Restated Financial Data Schedule - June 30, 1998*
27.3 Restated Financial Data Schedule - December 31, 1997*
(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 8-K filed with the Securities and Exchange
Commission on May 15, 1992.
(3) Incorporated by reference to the Notes to Consolidated Financial
Statements, Note 3, of this Report.
*Filed herewith.
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