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 March 31, 1997 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: (508) 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 April 30, 1997 Class A Common, $.10 par value 15,847,460 Class B Common, $.10 par value 11,265,627 WATTS INDUSTRIES, INC. AND SUBSIDIARIES INDEX Part I. Financial Information Page # Item 1. Condensed Consolidated Balance Sheets at March 31, 1997 and June 30, 1996 3 Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 1997 and March 31, 1996 4 Condensed Consolidated Statements of Operations for the Nine Months Ended March 31, 1997 and March 31, 1996 5 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 1997 and March 31, 1996 6 Notes to Condensed Consolidated Financial Statements 7-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-16 Part II. Other Information Item 1. Legal Proceedings 16-18 Item 6. Exhibits and Reports on Form 8-K 18 Signatures 19 Exhibit Index 20 Exhibit 11 - Computation of Per Share Earnings 21 Exhibit 27 - Financial Data Schedule 22 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Amounts in thousands, except share information) (Unaudited) (Audited) March 31, June 30, 1997 1996 _________ _________ CURRENT ASSETS Cash and cash equivalents.......................$ 3,380 $ 0 Trade accounts receivable, less allowance for doubtful accounts of $7,855 and $8,822.... 133,117 116,370 Inventories: Finished goods............................ 83,124 86,922 Work in process........................... 33,710 30,994 Raw materials............................. 67,366 64,182 _________ _________ 184,200 182,098 Prepaid expenses and other current assets....... 13,020 9,283 Deferred income taxes .......................... 21,722 24,662 Net assets of discountinued operations.......... 0 78,401 _________ _________ Total Current Assets....................... 355,439 410,814 OTHER ASSETS Intangible assets, net.......................... 5,776 6,248 Goodwill, net................................... 111,131 79,489 Other........................................... 6,118 6,457 PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment, at cost.......... 275,379 260,328 Less allowance for depreciation................. (124,087) (112,378) _________ _________ 151,292 147,950 _________ _________ TOTAL ASSETS $ 629,756 $ 650,958 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable................................$ 45,340 $ 46,022 Accrued expenses and other current liabilities.. 74,854 78,573 Accrued compensation and benefits............... 10,300 7,756 Income taxes payable............................ 3,707 687 Current portion of long-term debt............... 2,310 2,907 _________ _________ Total Current Liabilities.................. 136,511 135,945 LONG-TERM DEBT, less current portion............... 132,742 160,243 DEFERRED INCOME TAXES.............................. 13,211 13,842 OTHER NONCURRENT LIABILITIES....................... 9,307 10,291 MINORITY INTEREST.................................. 11,482 11,054 STOCKHOLDERS' EQUITY Class A Common Stock, $.10 par value;1 vote per share 80,000,000 shares authorized, 15,775,860 shares issued and outstanding at March 31....... 1,578 1,686 Class B Common Stock, $.10 par value;10 votes per share 25,000,000 shares authorized, 11,265,627 shares issued and outstanding at March 31....... 1,126 1,136 Additional paid-in capital...................... 45,725 67,930 Retained earnings............................... 283,756 249,415 Cumulative translation adjustment............... (5,682) (584) _________ _________ Total Stockholders' Equity................. 326,503 319,583 _________ _________ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.........$ 629,756 $ 650,958 ========= ========= See accompanying notes to condensed consolidated financial statements. WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands, except per share data) (Unaudited) Three Months Ended ____________________ March 31, March 31, 1997 1996 _________ _________ Net sales .........................................$ 184,191 $ 159,823 Cost of goods sold ................................ 120,461 114,882 _________ _________ GROSS PROFIT ................................... 63,730 44,941 Selling, general & administrative expenses ........ 40,983 51,053 Restructuring charges.............................. 0 19,891 Impairment of long-lived assets.................... 0 63,065 _________ _________ OPERATING INCOME (LOSS)......................... 22,747 (89,068) Other (income) expense: Interest income ................................ (125) (163) Interest expense ............................... 2,715 2,521 Other - net .................................... (280) 159 _________ _________ 2,310 2,517 _________ _________ INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ................. 20,437 (91,585) Income tax provision (benefit) .................... 7,548 (11,282) _________ _________ INCOME (LOSS)FROM CONTINUING OPERATIONS ........$ 12,889 $ (80,303) INCOME FROM DISCONTINUED OPERATIONS ............ 0 1,030 _________ _________ NET INCOME (LOSS)...............................$ 12,889 $ (79,273) ========= ========= Primary and fully-diluted income (loss) per share : CONTINUING OPERATIONS ............................ $.47 ($2.70) DISCONTINUED OPERATIONS .......................... 0.00 0.03 __________ _________ NET INCOME (LOSS)................................. $.47 ($2.67) ========== ========= Cash dividends per share............................. $ .0775 $ .0700 ========== ========= See accompanying notes to condensed consolidated financial statements. WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands, except per share data) (Unaudited) Nine Months Ended _____________________ March 31, March 31, 1997 1996 _________ _________ Net sales .........................................$ 534,419 $ 470,545 Cost of goods sold ................................ 350,181 312,770 _________ _________ GROSS PROFIT ................................... 184,238 157,775 Selling, general & administrative expenses ........ 118,087 123,104 Restructuring charges.............................. 0 19,891 Impairment of long-lived assets.................... 0 63,065 _________ _________ OPERATING INCOME (LOSS)......................... 66,151 (48,285) Other (income) expense: Interest income ................................ (397) (540) Interest expense ............................... 7,938 7,496 Other - net .................................... 170 981 _________ _________ 7,711 7,937 _________ _________ INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ................. 58,440 (56,222) Income tax provision .............................. 21,454 2,366 _________ _________ INCOME (LOSS)FROM CONTINUING OPERATIONS ........$ 36,986 $ (58,588) INCOME FROM DISCONTINUED OPERATIONS ............ 79 2,226 GAIN ON DISPOSAL OF DISCONTINUED OPERATIONS .... 3,208 0 _________ _________ NET INCOME (LOSS)...............................$ 40,273 $ (56,362) ========= ========= Primary and fully-diluted income (loss) per share : CONTINUING OPERATIONS ............................ $1.35 ($1.97) DISCONTINUED OPERATIONS .......................... 0.00 0.08 GAIN ON DISPOSAL OF DISCONTINUED OPERATIONS ...... 0.12 0.00 __________ _________ NET INCOME (LOSS)................................. $1.47 ($1.89) ========== ========= Cash dividends per share............................. $ .2175 $ .1950 ========== ========= See accompanying notes to condensed consolidated financial statements. WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) (Unaudited) Nine Months Ended ___________________ March 31, March 31, 1997 1996 _________ _________ OPERATING ACTIVITIES Income (loss) from continuing operations $ 36,986 $ (58,588) Adjustments to reconcile net earnings to net cash provided by operating activities: Restrucuring (4,335) 18,734 Impairment of long-lived assets 0 63,065 Depreciation and amortization 17,026 17,508 Provision (benefit) for deferred income taxes 1,080 (18,234) Gain on disposal of fixed assets (561) (15) Changes in operating assets and liabilities, net of effects from business acquisitions : Accounts receivable (16,966) 2,550 Inventories (2,612) (5,282) Prepaid expenses and other assets (2,621) 786 Accounts payable and accrued expenses (3,370) 18,279 _________ _________ 24,627 38,803 Net cash provided by discontinued operations 653 842 _________ _________ NET CASH PROVIDED BY OPERATING ACTIVITIES 25,280 39,645 INVESTING ACTIVITIES Additions to property, plant and equipment (21,075) (19,906) Proceeds from disposal of equipment 1,756 2,267 Increase in intangible assets (771) (1,392) Discontinued Operations: Additions to property, plant and equipment (142) (839) Proceeds from disposal of equipment 0 17 Proceeds from sale of discontinued operations 90,581 0 Business acquisitions, net of cash acquired (37,575) (13,110) Net changes in short-term investments 0 4,483 _________ _________ NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 32,774 (28,480) FINANCING ACTIVITIES Purchase and retirement of common stock (23,069) 0 Proceeds from exercise of stock options 746 681 Proceeds of long-term borrowings 91,376 42,567 Payments of long-term debt (119,088) (52,425) Cash dividends (5,932) (5,782) _________ _________ NET CASH USED IN FINANCING ACTIVITIES (55,967) (14,959) Effect of exchange rate changes on cash and cash equivalents 1,293 451 _________ _________ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,380 (3,343) Cash and cash equivalents at beginning of period 0 3,343 _________ _________ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,380 $ 0 ========= ========= See accompanying notes to condensed consolidated financial statements. WATTS INDUSTRIES, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) 1. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all necessary adjustments, consisting only of adjustments of a normal recurring nature, to present fairly Watts Industries, Inc.'s Condensed Consolidated Balance Sheet as of March 31, 1997, the Condensed Consolidated Statements of Operations for the three and nine months ended March 31, 1997 and March 31, 1996, and the Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 1997 and March 31, 1996. The balance sheet at June 30, 1996 has been derived from the audited financial statements at that date. Certain amounts have been reclassified to conform with the 1997 presentation. The accounting policies followed by the Company are described in the June 30, 1996 financial statements which are contained in the Company's 1996 Annual Report. It is suggested that these financial statements be read in conjunction with the financial statements and notes included in the 1996 Annual Report to stockholders. Additional information about certain accounting policies follows. Revenue Recognition The Company records revenue, net of a provision for estimated returns and allowances, upon shipment. Property, Plant and Equipment The estimated useful lives of each major class of property, plant and equipment are as follows: Buildings and improvements 10-40 years Machinery and equipment 5-15 years Long-Lived Assets Impairment losses on long-lived assets are recognized when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets carrying amount. The amount of such losses is recorded by reducing the value of the affected long-lived assets to fair value, as determined using information that is available in the circumstances. 2. In January 1996, the Board of Directors of the Company approved a plan to dispose of the Company's Municipal Water Group of businesses, including Henry Pratt Company, James Jones Company and Edward Barber & Co., Ltd. These companies were sold on September 4, 1996. The results of operations of these companies for all periods prior to the sale have been reported as income from discontinued operations, net of income taxes. The following table sets forth summary information relating to the Municipal Water Group: Dollars in thousands July 1, 1996 Nine Months Ended through September 4, 1996 March 31, 1996 Revenues $13,958 $61,655 Costs and expenses $13,830 $57,909 Income before income taxes $ 128 $3,746 Income taxes $ 49 $1,520 Income from Discontinued Operations $ 79 $2,226 3. The Company decided to undertake certain restructuring initiatives aimed at improving the efficiency of certain of its continuing operations during the quarter ended March 31, 1996. The two most significant restructuring initiatives are the relocation of Jameco Industries, Inc. ("Jameco") from Wyandanch, New York to the Company's existing Spindale, North Carolina manufacturing facility and the downsizing of Pibiviesse S.p.A. ("PBVS"). As a result of this initiative, the Company recorded a $25,415,000 restructuring charge during the year ended June 30, 1996. This charge was made to recognize severance payments, other incremental costs and asset write-downs that were expected to result from the restructuring. At March 31, 1997, $8,743,000 of the estimated costs of the restructuring initiative remained unpaid. Such unpaid costs were principally future severance payments and contract termination costs. During the twelve months ended March 31, 1997, 236 employees were released and $3,628,000 in severance payments were made to those employees. There were no additional severance expense provisions or other adjustments to the related accrued liability during that period. The Company presently expects that, on a net basis, approximately 54 additional employees will be released in connection with the restructuring initiative and that the balance of accrued but unpaid severance costs are expected to be paid before June 1999. Other payments made in connection with the Company's restructuring initiative during the twelve months ended March 31, 1997 amounted to $4,487,000 and were made principally in connection with the relocation of Jameco and the downsizing of PBVS. It is presently expected that these initiatives will be complete by June 30, 1997 and June 30, 1998, respectively. There were no other expense provisions for such costs or other adjustments to the related accrued liability during the nine months ended March 31, 1997. 4. In August of 1995, a wholly owned subsidiary of the Company purchased Societe des Etablissements Rene Trubert S.A.("Trubert") of Chartres, France. Trubert is a manufacturer of thermostatic mixing valves sold primarily for commercial and industrial applications to accurately control the temperature of water for human safety and process control. Trubert had net sales of approximately $8,000,000 for the twelve months ended June 30, 1995. In August of 1995, a wholly owned subsidiary of the Company acquired the Keane product line from Keane Controls Corporation. This product line consists of solenoid valves and regulators used in high pressure applications. The annual sales of these products, at the time of the acquisition, were approximately $1,500,000. In August of 1995, a wholly owned subsidiary acquired the Kieley Mueller Control Valve product line from International Valve Corporation. This product line consists of linear and rotary control valves sold primarily for industrial process applications to accurately control the pressure, flow, and temperature of steam and process fluids. The annual sales of these products, at the time of the acquisition, were approximately $2,800,000. In March of 1996, a wholly owned subsidiary of the Company purchased Artec, GmbH ("Artec") of Oberhausen, Germany. Artec assembles and distributes underfloor heating systems, radiator connection systems and plumbing pipe systems for the German plumbing and heating market. Artec had net sales of approximately $4,500,000 for the twelve months ended December 31, 1995. In September of 1996, a wholly owned subsidiary of the Company purchased certain assets and assumed certain liabilities of Consolidated Precision Corporation ("CPC") of Riviera Beach, Florida. CPC is a manufacturer of high quality control valves, manual and actuated shutoff valves, cryogenic filters, valve manifolds, and bayonet fittings for the cryogenic, ultra-high purity, and industrial gas markets. CPC had sales of approximately $2,500,000 for the 12 months ended May 31, 1996. In January of 1997, a wholly owned subsidiary of the Company purchased Ames Co., Inc. ("Ames") of Woodland, California. Ames designs, manufactures and markets UL/FM certified backflow prevention valves for use in the fire protection market. Ames had sales for the twelve months ended December 31, 1996 of approximately $27,000,000. The aggregate purchase price for these acquisitions was approximately $53,200,000. During the quarter ended March 31, 1997, the Company entered into a joint venture with the agent who has been marketing the imported vitreous china and faucets product lines, which have annual sales of approximately $15,000,000 in the DIY market and were originally part of the Jameco business. This decision should improve sales volume and profitability for this product line. The Company will have a 49% ownership and report future activities as a minority interest. The effective date of this joint venture is expected to be June 1, 1997. 5. On April 16, 1996, July 17, 1996, and April 15, 1997 the Board of Directors authorized the Company to repurchase 2,000,000 shares, 1,000,000 shares, and 500,000 shares, respectively, of its Class A Common Stock through open market and private purchases. Since the commencement of the share repurchase plan, the Company has purchased 2,680,200 shares for an aggregate price of $51,635,978. The funds used to finance these stock purchases were generated from the sale of the Municipal Water Group. 6. Certain of the Company's loan agreements contain covenants that require, among other items, the maintenance of certain financial ratios and net worth and limit the Company's ability to enter into secured borrowing arrangements. Under its most restrictive loan covenant, which requires the Company to maintain a net worth of not less than the sum of $295,000,000 and 50% of cumulative consolidated net income of the Company for full fiscal years subsequent to June 30, 1996, the Company had $31,500,000 available for the payment of dividends at March 31, 1997. 7. In February 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share, which is required to be adopted on December 31, 1997. At that time, the Company will be required to change the method currently used to compute earnings per share and to restate all prior periods. Under the new requirements for calculating earnings per share, the dilutive effect of common stock equivalents will be excluded. The impact is expected to result in an increase in primary earnings per share in the quarter ended March 31, 1997 of $0.005 per share. The impact of Statement No. 128 on the calculation of fully diluted earnings per share for the quarter ended March 31, 1997 is expected to be immaterial. Item 2. WATTS INDUSTRIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Management Initiatives In fiscal 1996, the Company reevaluated its strategy and decided to restructure its business in an effort to improve the efficiency of the Company's worldwide operations. Divestiture As part of this strategy, the Company decided to divest itself of the Municipal Water Group of Companies, which consisted of Henry Pratt Company, James Jones Company, and Edward Barber & Company Ltd. This divestiture was completed on September 4, 1996 resulting in an after-tax gain of $3,208,000 subject to potential post closing adjustments. The proceeds were used primarily to reduce long-term debt and fund the Company's share repurchase program. This divestiture will enable the Company to focus its acquisition and growth strategies on its core markets, namely Plumbing and Heating and Water Quality, and Industrial, and Oil and Gas. The results of operations of the Municipal Water Group for fiscal 1997 have been reported as income from discontinued operations, net of income taxes, and the statement of earnings for prior periods has been reclassified to conform with the fiscal 1997 presentation. Restructuring Activities The Company also decided to undertake certain restructuring initiatives aimed at improving the efficiency of certain of its continuing operations. The two most significant initiatives are the relocation of Jameco Industries, Inc. ("Jameco") and the downsizing of Pibiviesse S.p.A. ("PBVS"). The Company has decided to relocate the manufacturing operations of Jameco from Wyandanch, New York to a Watts Regulator plant in Spindale, North Carolina. The expansion of the Spindale facility, which will house the Jameco activity, is complete. The Company is currently moving manufacturing equipment and implementing administrative and information systems in North Carolina. The Company anticipates this relocation will be completed during this fiscal year. The Company also initiated a plan to consolidate and downsize the operations of its PBVS subsidiary in Italy. This consolidation will be completed during fiscal 1998. These actions will result in reduced headcount and a reduction in certain fixed overhead costs. Impairment of Long-Lived Assets The impairment of long-lived assets charge mainly pertains to the Company's Italian subsidiaries. Management concluded that the goodwill at Intermes was impaired due to a change in interpretation of the Italian tax law regarding the deductibility of goodwill amortization coupled with decreasing margins and operating profits. In addition, PBVS had experienced significant losses since acquisition. In connection with the reevaluation of its business strategy in Italy, management concluded an impairment had occurred and has recorded a loss by reducing the value of affected long- lived assets, primarily goodwill, to fair value, as determined using a discounted cash flow approach. Conclusion In fiscal 1996 the Company recorded an after-tax charge of $92,986,000, including $63,065,000 for impairment of long-lived assets, as part of these restructuring costs. The charge was recorded as follows: Fiscal 1996 (000's) Quarter Ended 3/31/96 6/30/96 Total Cost of Goods Sold $ 9,508 $ 9,508 Selling, General & Administrative 13,753 13,753 Restructuring 19,891 $5,524 25,415 Impairment of Long-Lived Assets 63,065 _____ 63,065 106,217 5,524 111,741 Income Tax Benefit 16,585 2,170 18,755 After-Tax Charge $89,632 $3,354 $92,986 The $25,415,000 of restructuring expense includes $9,300,000 of severance; $8,400,000 of asset write-downs for assets to be abandoned or sold; and $7,700,000 of exit costs. The $7,700,000 of exit costs are comprised primarily of lease and other contract termination costs and employee and plant relocation costs. The $13,753,000 of expense recorded in selling, general and administrative expense is primarily comprised of $4,000,000 of product liability costs; $3,500,000 of bad debts; $2,000,000 of environmental reserves; and $1,000,000 of consulting fees. It is expected that the restructuring plan will require at least two additional fiscal years to complete with some positive effects being realized during this fiscal year, although unanticipated events could affect the cost and timing of the restructuring plan. Results of Operations Quarter Ended March 31, 1997 Compared to Quarter Ended March 31, 1996 Net sales from continuing operations increased $24,368,000 (15.3%) to $184,191,000. This increase was primarily attributable to increased unit shipments of both oil and gas valves and plumbing and heating valves. The increased unit shipments of oil and gas valves is supported by a strong worldwide oil and gas market. The increased unit shipments of plumbing and heating valves is primarily attributable to increased penetration into the home improvement retail market. The inclusion of the net sales of acquired companies accounted for $7,278,000 of the sales increase. These acquisitions include Ames Co., Inc. ("Ames") acquired in January of 1997 located in Woodland, California; Consolidated Precision Corporation ("CPC") acquired in September of 1996 located in Riviera Beach, Florida; and Artec, GmbH ("Artec") acquired in March of 1996 located in Oberhausen, Germany. The Company experienced a sales increase of $17,090,000 (10.7%) excluding the impact of acquisitions. The dollar strengthened relative to the functional currency of several of the Company's subsidiaries during the quarter ended March 31, 1997. Had these foreign exchange rates remained constant with the foreign exchange rates in effect during the quarter ended March 31, 1996, the Company would have experienced a sales increase of 12.9%, excluding the impact of acquisitions. The Company intends to maintain its strategy of seeking acquisition opportunities as well as expanding its existing market position to achieve sales growth. Gross profit from continuing operations increased $18,789,000 (41.8%) to $63,730,000. Excluding the $9,508,000 of inventory write- downs included in cost of sales in the quarter ended March 31, 1996 as part of the restructuring, gross profit would have increased $9,281,000 (17.1%) and would have increased as a percentage of net sales from 34.1% to 34.6%. This percentage increase is primarily the result of the increased sales volumes and gross margins at the Company's oil and gas valve manufacturing facilities. This increase from the oil and gas group was partially offset by an unfavorable sales mix and inventory reduction programs from certain of the Company's subsidiaries. Selling, general and administrative expenses in the quarter ended March 31, 1996 include $13,753,000 of restructuring related expenses; $19,891,000 of restructuring expenses; and $63,065,000 of impairment of long-lived assets. These charges are discussed in the management initiative section above. Excluding the effect of these charges, selling, general and administrative expenses increased $3,683,000 (9.9%) to $40,983,000 and decreased as a percentage of net sales from 23.3% to 22.2%. The increase in spending is primarily attributable to the inclusion of the expenses of acquired companies and increased variable selling expenses associated with the increased net sales. Excluding the $106,217,000 of restructuring and related charges recorded in the quarter ended March 31, 1996, operating earnings increased $5,598,000 (32.6%) to $22,747,000 and increased as a percentage of net sales from 10.7% to 12.4%. The increase in other income is primarily attributable to the gain on the sale of certain fixed assets. Earnings from continuing operations for the quarter ended March 31, 1997, excluding the after-tax restructuring and related charges of $89,632,000 recorded in the quarter ended March 31, 1996, increased $3,560,000 (38.2%) to $12,889,000. The change in foreign exchange rates had an adverse impact on the net earnings from continuing operations of approximately $300,000. The weighted average number of common shares outstanding on March 31, 1997, decreased to 27,303,784 from 29,732,876 for primary earnings per share. This decrease was attributable to the Company purchasing Class A Common Stock on the open market in connection with its previously announced share repurchase program. Primary and fully diluted earnings per share from continuing operations were $.47 for the three months ended March 31, 1997 compared to earnings of $.32 per share, excluding the restructuring charges discussed above, for the three months ended March 31, 1996. Results of Operations Nine Months Ended March 31, 1997 Compared to Nine Months Ended March 31, 1996 Net sales from continuing operations increased $63,874,000 (13.6%) to $534,419,000. This increase was primarily attributable to increased unit shipments of both oil and gas valves and plumbing and heating valves. The increased unit shipments of oil and gas valves is supported by a strong worldwide oil and gas market. The increased unit shipments of plumbing and heating valves is primarily associated with increased demand from plumbing and heating wholesalers and increased penetration into the home repair retail market. In addition, the inclusion of the net sales of acquired companies accounted for $11,116,000 of the sales increase. These acquisitions include Ames acquired in January of 1997 located in Woodland, California; CPC acquired in September of 1996 located in Riviera Beach, Florida; and Artec acquired in March of 1996 located in Oberhausen, Germany. Excluding the impact of these acquisitions, sales would have increased 11.2%. The dollar strengthened relative to the functional currency of several of the Company's subsidiaries during the nine months ended March 31, 1997. Had these foreign exchange rates remained constant with the foreign exchange rates in effect during fiscal 1996, the Company would have experienced a sales increase of 12% excluding the impact of acquisitions. The Company intends to maintain its strategy of seeking acquisition opportunities as well as expanding its existing market position to achieve sales growth. Gross profit from continuing operations increased $26,463,000 (16.8%). Excluding the $9,508,000 of inventory write-downs recorded in cost of sales last fiscal year as part of the restructuring charges, gross profit would have increased $16,955,000 (10.1%) to $184,238,000 and decreased as a percentage of net sales from 35.6% to 34.5%. The gross profit percentage was adversely affected by an unfavorable sales mix variance on certain valves within the plumbing and heating product line. The gross profit percentage was also adversely affected as a result of the higher sales of oil and gas valves whose gross margin percentage is lower than the Company's overall gross margin percentage. Selling, general and administrative expenses in the period ended March 31, 1996 include $63,065,000 of impairment of long- lived asset write-downs; $19,891,000 of restructuring costs; and $13,753,000 within selling, general and administrative expenses recorded as part of the overall restructuring. Selling, general and administrative expenses from continuing operations, excluding these charges, increased $8,736,000 (8.0%) to $118,087,000 and decreased as a percentage of sales from 23.2% to 22.1%. The increase in spending is primarily attributable to increased commissions and variable selling expenses associated with the increased sales and the inclusion of the expenses of acquired companies. Earnings from continuing operations, excluding the after-tax restructuring and related charges of $89,632,000 recorded in the quarter ended March 31, 1996, increased $5,942,000 (19.1%) to $36,986,000. The Company's return on average stockhholder's investment for continuing operations (excluding the gain on the sale of the Municipal Water Group) was 15.1% for the nine months ended March 31, 1997 compared to 10.4% for the nine months ended March 31, 1996. This calculation excludes the restructuring charges recorded last fiscal year. The weighted average number of common shares outstanding on March 31, 1997, decreased to 27,311,456 from 29,757,391 for primary earnings per share. This decrease was attributable to the Company purchasing Class A Common Stock on the open market in connection with its previously announced share repurchase program. Primary and fully diluted earnings per share from continuing operations were $1.35 (excluding the gain of $.12 per share on the sale of the Municipal Water Group) for the nine months ended March 31, 1997 compared to earnings per share of $1.05 (excluding restructuring and related expenses) for the nine months ended March 31, 1996. This is an increase of 28.6%. Earnings per share from discontinued operations were zero for the nine months ended March 31, 1997 compared to $.08 per share for the nine months ended March 31, 1996. Liquidity and Capital Resources During the nine months ended March 31, 1997, the Company received $90,581,000 of proceeds as a result of its sale of the Municipal Water Group. These proceeds were used to reduce the borrowings under its line of credit and to fund additional share purchases under its existing share repurchase program. During the nine months ended March 31, 1997, the Company spent $21,075,000 on capital expenditures for continuing operations, primarily manufacturing machinery and equipment, as part of its commitment to continuously improve its manufacturing capabilities. The Company's capital expenditure budget for fiscal 1997 is $31,000,000. During the nine months ended March 31, 1997, the Company invested in two acquisitions. In September of 1996, a wholly owned subsidiary of the Company purchased certain assets and assumed certain liabilities of CPC of Riviera Beach, Florida. CPC is a manufacturer of high quality control valves, manual and actuated shutoff valves, cryogenic filters, valve manifolds, and bayonet fittings for the cryogenic and ultra-high purity and industrial gas market. CPC had sales of approximately $2,500,000 for the twelve months ended May 31, 1996. In January of 1997, a wholly owned subsidiary of the Company purchased Ames of Woodland, California. Ames designs, manufactures, and markets UL/FM certified backflow prevention valves for use in the fire protection market. Ames had sales of approximately $27,000,000 for the twelve months ended December 31, 1996. The aggregate purchase price for these two acquisitions was $37,575,000. Working capital at March 31, 1997 was $218,928,000 compared to $196,468,000 at June 30, 1996. The ratio of current assets to current liabilities was 2.6 to 1 at March 31, 1997 compared to 2.5 to 1 at June 30, 1996. Cash and short-term investments were $3,380,000 at March 31, 1997 and zero at June 30, 1996. Debt as a percentage of total capital employed was 29.3% at March 31, 1997 compared to 33.8% at June 30, 1996. This decreased percentage resulted from the use of a portion of the proceeds from the sale of the Municipal Water Group to reduce long-term debt. The Company has available an unsecured $125,000,000 line of credit, which expires on August 31, 1999. The Company's intent is to utilize this credit facility to support the Company's acquisition program, working capital requirements from acquisitions, and for general corporate purposes. As of March 31, 1997, there was $35,000,000 borrowed under this line of credit. The Company from time to time is involved with environmental proceedings and incurs costs on an ongoing basis related to environmental matters. The Company currently anticipates that it will not incur significant expenditures in fiscal 1997 in connection with any of these environmentally contaminated sites. Please see Part II, Item 1. Legal Proceedings. 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. 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. 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. 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. The Company has resort to certain insurance coverage with respect to these matters. Coverage 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. The Company has established certain reserves which it currently believes are adequate in light of the probable and estimable exposure of pending and threatened litigation of which it has knowledge. 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, results of operations, or its liquidity. 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. Four of these sites, the Sharkey and Combe Landfills in New Jersey, the San Gabriel Valley/El Monte, California water basin site, and the Cherokee Oil Resources Site in Charlotte, North Carolina, 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. With respect to the Cherokee Oil Resources Site, the Company has elected to participate in a de minimis settlement. 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 PRP's have 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 PRP's, including the Company, are currently negotiating with the state only to assume maintenance of this site in an effort to reduce future costs. The Company and the remaining PRPs have also received a formal demand from the U.S. Environmental Protection Agency to recover approximately $17 million expended to date in the remediation of this site. The EPA has filed suit against certain of the PRP's, and the Company has recently been named a third-party defendant in this litigation. Based on facts presently known to it, the Company does not believe that the outcome of these proceedings will have a material adverse effect on its financial condition. The Company has established balance sheet accruals which it currently believes are adequate in light of the probable and estimable exposure of pending and threatened environmental litigation and proceedings of which it has knowledge. 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. 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 April 11, 1997. The following items were reported in the Form 8-K: (1) Item 4. Changes in Registrant's Certifying Accountant. (2) Item 7(c). Financial Statements, Pro Forma Financial Information and Exhibits. Letters from Ernst & Young LLP and Deloitte & Touche were filed as Exhibits (letter re change in certifying accountant). 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: May 15, 1997 By: /s/ Timothy P. Horne Timothy P. Horne Chairman and Chief Executive Officer Date: May 15, 1997 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 * 27 Financial Data Schedule* (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. * Filed herewith.