UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 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: (978) 688-1811 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at October 31, 1997 Class A Common, $.10 par value 15,903,727 Class B Common, $.10 par value 11,159,127 WATTS INDUSTRIES, INC. AND SUBSIDIARIES INDEX Part I. Financial Information Page# Item 1. Condensed Consolidated Balance Sheets at September 30, 1997 and June 30, 1997 3 Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 1997 and September 30, 1996 4 Condensed Consolidated Statements of Cash Flows for the Three Months Ended September 30, 1997 and September 30, 1996 5 Notes to Condensed Consolidated Financial 6-7 Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7-9 Part II. Other Information Item 1. Legal Proceedings 9-10 Item 6. Exhibits and Reports on Form 8-K 11 Signatures 12 Exhibit Index 13 Exhibit 11 - Computation of Per Share Earnings 14 Exhibit 27 - Financial Data Schedule 15 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) Sept. 30, June 30, 1997 1997 --------- --------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 4,664 $ 13,904 Short-term investments 11,641 518 Trade accounts receivable, less allowance for doubtful accounts of $8,731 at September 30, 1997 and $7,945 at June 30, 1997 131,691 121,349 Inventories: Raw materials 66,589 64,261 Work in process 27,131 26,030 Finished goods 79,005 80,926 --------- --------- Total Inventories 172,725 171,217 Prepaid expenses and other assets 13,117 13,087 Deferred income taxes 22,666 22,480 Net assets held for sale 3,030 3,037 --------- --------- Total Current Assets 359,534 345,592 OTHER ASSETS: Goodwill, net of accumulated amortization of $14,494 at September 30, 1997 and $13,484 at June 30, 1997 110,829 110,928 Other 12,709 12,869 PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment, at cost 287,564 281,231 Accumulated depreciation (132,764) (128,537) --------- --------- Property, plant and equipment, net 154,800 152,694 --------- --------- TOTAL ASSETS $ 637,872 $ 622,083 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 45,113 $ 48,896 Accrued expenses and other liabilities 61,893 53,738 Accrued compensation and benefits 13,102 15,834 Current portion of long-term debt 2,362 2,422 --------- --------- Total Current Liabilities 122,470 120,890 LONG-TERM DEBT, NET OF CURRENT PORTION 128,258 125,937 DEFERRED INCOME TAXES 17,051 16,675 OTHER NONCURRENT LIABILITIES 13,418 13,796 MINORITY INTEREST 10,965 11,146 STOCKHOLDERS' EQUITY: Preferred Stock,$.10 par value; 5,000,000 shares authorized; no shares issued or outstanding - - Class A Common Stock, $.10 par value; 1 vote per share; 80,000,000 shares authorized; issued and outstanding: 15,878,927 at September 30, 1997 and 15,797,460 shares at June 30, 1997 1,588 1,580 Class B Common Stock, $.10 par value; 10 votes per share; 25,000,000 shares authorized; issued and outstanding: 11,159,127 at September 30, 1997 and 11,215,627 shares at June 30, 1997 1,116 1,121 Additional paid-in capital 45,134 44,643 Retained earnings 304,695 293,170 Cumulative translation adjustment (6,823) (6,875) --------- --------- Total Stockholders' Equity 345,710 333,639 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 637,872 $ 622,083 ========= ========= See accompanying notes to condensed consolidated financial statements. WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands, except per share information) (Unaudited) Three Months Ended -------------------- Sept. 30, Sept. 30, 1997 1996 --------- --------- Net sales $ 179,460 $ 176,008 Cost of goods sold 115,553 115,652 --------- --------- GROSS PROFIT 63,907 60,356 Selling, general & administrative expenses 40,032 38,090 --------- --------- OPERATING INCOME 23,875 22,266 --------- --------- Other (income) expense: Interest income (273) (99) Interest expense 2,542 2,754 Other - net 698 189 --------- --------- 2,967 2,844 --------- --------- INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 20,908 19,422 Provision for income taxes 7,288 7,076 --------- --------- INCOME FROM CONTINUING OPERATIONS 13,620 12,346 Income from discontinued operations, net of taxes - 79 Gain on disposal of discontinued operations, net of taxes - 3,208 --------- --------- NET INCOME $ 13,620 $ 15,633 ========= ========= Income per common share : Continuing operations $ 0.50 $ 0.45 Discontinued operations - - Gain on disposal of discontinued operations - 0.12 --------- --------- NET INCOME $ 0.50 $ 0.57 ========= ========= Dividends per common share $ 0.0775 $ 0.0700 ========= ========= See accompanying notes to condensed consolidated financial statements. WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) (Unaudited) Three Months Ended -------------------- Sept. 30, Sept. 30, 1997 1996 --------- --------- OPERATING ACTIVITIES Income from continuing operations $ 13,620 $ 12,346 Adjustments to reconcile net income from continuing operations to net cash provided by continuing operating activities: Restructuring payments (732) (795) Depreciation and amortization 5,506 5,618 Deferred income taxes 179 255 Gain on disposal of equipment (12) (41) Equity in undistributed earnings of affiliates (59) - Changes in operating assets and liabilities, net of effects from business acquisitions: Accounts receivable (10,602) (9,641) Inventories (1,785) (961) Prepaid expenses and other assets (178) (2,593) Accounts payable, accrued expenses and other liabilities 2,151 (2,656) --------- --------- Net cash provided by continuing operations 8,088 1,532 Net cash provided by discontinued operations - 653 --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 8,088 2,185 --------- --------- INVESTING ACTIVITIES Additions to property, plant and equipment (6,610) (6,724) Proceeds from sale of property, plant and equipment 67 176 Increase in other assets (617) (727) Discontinued Operations: Additions to property, plant and equipment - (142) Proceeds from disposal of discontinued operations - 90,581 Business acquisitions, net of cash acquired (686) (862) Net changes in short-term investments (11,123) - --------- --------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (18,969) 82,302 --------- --------- FINANCING ACTIVITIES Proceeds from long-term borrowings 16,000 18,173 Payments of long-term debt (13,698) (79,705) Proceeds from exercise of stock options 494 43 Dividends paid (2,096) (1,927) Purchase of treasury stock - (8,385) Purchase and retirement of common stock - (12,657) --------- --------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 700 (84,458) --------- --------- Effect of exchange rate changes on cash and cash equivalents 941 (29) --------- --------- CHANGE IN CASH AND CASH EQUIVALENTS (9,240) - CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 13,904 - --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,664 $ - ========= ========= See accompanying notes to condensed consolidated financial statements. 5 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 September 30, 1997, its Condensed Consolidated Statements of Operations for the three months ended September 30, 1997 and 1996, and its condensed Consolidated Statements of Cash Flows for the three months ended September 30, 1997 and 1996. The balance sheet at June 30, 1997 has been derived from the audited financial statements at that date. The accounting policies followed by the Company are described in the June 30, 1997 financial statements which are contained in the Company's 1997 Annual Report. It is suggested that these financial statements be read in conjunction with the financial statements and notes included in the 1997 Annual Report to stockholders. 2. During September 1997, a wholly owned subsidiary of the Company purchased the Orion Fittings Division of Kelstan Plastic Products, Ltd. The Orion Fittings Division has manufactured corrosion resistant polyolefin piping systems for laboratory drainage and high purity process installations since 1963. The product line includes pipe, fittings, sinks, neutralizing tanks, pH alarm and monitoring systems and sediment interceptors. Sales have been concentrated in the Canadian market and were approximately $584,000 for the 12 months ended August 31, 1997. 3. During the quarter ended March 31, 1996, the Company decided to undertake certain restructuring initiatives aimed at improving the efficiency of certain of its continuing operations. The two most significant of those initiatives are the consolidation and downsizing of Pibiviesse S.p.A. and the relocation of Jameco Industries, Inc. from Wyandanch, New York to the Company's existing Spindale, North Carolina manufacturing facility. In connection with this restructuring plan and during the year ended June 30, 1996, the Company recorded a $25,415,000 restructuring charge for related severance costs, plant closure costs and asset write-downs. Cash payments for accrued employee severance and other plant closure costs were $732,000 during the quarter ended September 30, 1997 and the Company's remaining accrued restructuring liability was $3,126,000 at September 30, 1997. It is expected that the restructuring initiatives will be substantially complete by June 30, 1998. Since commencement of the restructuring plan, there has been a related net reduction of 213 employees. At September 30, 1997, it is expected that approximately 82 additional restructuring related terminations will occur. 4. On September 4, 1996, the Company sold its Municipal Water Group of businesses. Sales revenue from these businesses amounted to $14,027,000 during the period between July 1, 1996 and September 4, 1996. This revenue, net of all related expense including income taxes, has been classified as income from discontinued operations in the accompanying statement of operations for the three months ended September 30, 1996. 5. Information in "Note (12) Contingencies and Environmental Remediation" set forth in the Registrant's Form 10-K is incorporated herein by reference. 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 Results of Operations Three Months Ended September 30, 1997 Compared to Three Months Ended September 30, 1996 Net sales from continuing operations increased $3,452,000 (2.0%) to $179,460,000. An analysis of this change in net sales is as follows: Internal Growth $ 3,049,000 1.7% Acquisitions/New Joint Ventures 10,344,000 5.9% Jameco Sales now through Joint Venture (3,834,000) (2.1%) Foreign Exchange Rate Effect (6,107,000) (3.5%) Total Increase $ 3,452,000 2.0% The increase in net sales from internal growth is primarily attributable to increased unit shipments in North America of plumbing and heating valves and oil and gas valves. The increased sales due to acquisitions is primarily attributable to the January 1997 acquisition of Ames Co., Inc. ("Ames") located in Woodland, California. During fiscal year 1997, the Company entered into a joint venture agreement with the sales agent who markets imported vitreous china and faucets into the do-it-yourself ("DIY") market. Prior to the July 1997 commencement of operations by the joint venture, the related sales were recorded as part of the Jameco business. This decision was made to improve sales volume and profitability for these imported product lines. The Company has a 49% minority interest and reports activities for this joint venture on an equity basis. Therefore, in the quarter ended September 30, 1997, sales of these product lines are not included in our consolidated revenues. Product line sales for this division included in the three-month and twelve-month periods ended September 30, 1996 and June 30, 1997 were $3,834,000 and $13,415,000, respectively. The unfavorable effect that changes in foreign exchange rates had on sales was primarily attributable to the Company's European operations. 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 $3,551,000 (5.9%) and increased as a percentage of net sales from 34.3% to 35.6%. This percentage increase is primarily attributable to improved gross margins for oil and gas valves due to increased sales volumes and factory efficiencies. Additionally, there was a favorable sales mix within domestic plumbing and heating valves. These improvements were partially offset by manufacturing inefficiencies associated with the relocation of the Jameco product line into a Watts Regulator factory in Spindale, North Carolina. Selling, general and administrative expenses increased $1,942,000 (5.1%) to $40,032,000. This increase is primarily attributable to the inclusion of the expenses of Ames and increased variable selling expenses from certain divisions. This increase was partially offset by the impact of foreign exchange rate changes. Income from continuing operations increased $1,274,000 (10.3%) to $13,620,000. In the quarter ended September 30, 1996 the Company sold its Municipal Water Group of companies. This divestiture resulted in an after-tax gain of $3,208,000. The Company's consolidated results of operations are impacted by the effect that changes in foreign currency exchange rates have on its international subsidiaries' operating results. Changes in foreign exchange rates had an adverse effect on the net income from continuing operations of approximately $500,000. The weighted average number of common shares outstanding on September 30, 1997 for primary earnings per share was 27,293,437 shares compared to 27,436,579 shares for the quarter ended September 30, 1996. Net earnings per share from continuing earnings were $.50 for the quarter ended September 30, 1997 compared to $.45 per share for the quarter ended September 30, 1996. In February 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share, which is required to be adopted for the quarter ended 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 of the implementation of the new requirements is expected to be immaterial. Liquidity and Capital Resources During the quarter ended September 30, 1997, the Company generated $8,088,000 in cash flow from operations, which was principally used to fund capital expenditures of $6,610,000. These capital expenditures were primarily for manufacturing machinery and equipment as part of its commitment to continuously improve its manufacturing capabilities. The Company's capital expenditure budget for fiscal 1998 is $29,500,000. 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 of acquired companies and for general corporate purposes. As of September 30, 1997 there was $32,000,000 borrowed under this line of credit. Working capital was $237,064,000 at September 30, 1997 compared to $224,702,000 at June 30, 1997. The ratio of current assets to current liabilities was 2.9 to 1 at both September 30, 1997 and June 30, 1997. Cash and short- term investments were $16,305,000 at September 30, 1997 compared to $14,422,000 at June 30, 1997. Debt as a percentage of total capital employed was 27.4% at September 30, 1997 compared to 27.8% at June 30, 1997. At September 30, 1997 the Company was in compliance with all covenants related to its existing debt. 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 1998 in connection with any of these environmentally contaminated sites. 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 ("PRP's"). 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 recently made a payment as part of 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 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 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 & Exchange Commission on September 10, 1997. 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: November 14, 1997 By: /s/ Timothy P. Horne Timothy P. Horne Chairman and Chief Executive Officer Date: November 14, 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.