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, 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 April 30, 1998 Class A Common, $.10 par value 16,756,027 Class B Common, $.10 par value 10,296,827 WATTS INDUSTRIES, INC. AND SUBSIDIARIES INDEX Part I. Financial Information Page # Item 1. Financial Statements Condensed Consolidated Balance Sheets at March 31, 1998 and June 30, 1997 3 Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 1998 and March 31, 1997 4 Condensed Consolidated Statements of Operations for the Nine Months Ended March 31, 1998 and March 31, 1997 5 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 1998 and March 31, 1997 6 Notes to Condensed Consolidated Financial Statements 7-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-15 Part II. Other Information Item 1. Legal Proceedings 15-17 Item 6. Exhibits and Reports on Form 8-K 17 Signatures 18 Exhibit Index 19 Exhibit 27.1 - Financial Data Schedule-March 31, 1998 20 Exhibit 27.2 - Restated Financial Data Schedule-March 31, 1997 21 Exhibit 27.3 - Restated Financial Data Schedule- September 30, 1996 22 PART I. FINANCIAL INFORMATION - ------------------------------ ITEM 1. FINANCIAL STATEMENTS ---------------------- WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in thousands) (Unaudited) (Audited) Mar. 31, June 30, 1998 1997 --------- --------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 9,954 $ 13,904 Short-term investments 257 518 Trade accounts receivable, less allowance for doubtful accounts of $8,592 at March 31, 1998 and $7,945 at June 30, 1997 140,392 121,349 Inventories: Raw materials 64,306 64,261 Work in process 37,216 26,030 Finished goods 90,502 80,926 --------- --------- Total Inventories 192,024 171,217 Prepaid expenses and other assets 13,169 13,087 Deferred income taxes 21,616 22,480 Net assets held for sale 2,046 3,037 --------- --------- Total Current Assets 379,458 345,592 --------- --------- PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment, at cost 298,996 281,231 Accumulated depreciation (140,609) (128,537) --------- --------- Property, plant and equipment, net 158,387 152,694 --------- --------- OTHER ASSETS: Goodwill, net of accumulated amortization of $15,799 at March 31, 1998 and $13,484 at June 30, 1997 119,985 110,928 Other 13,769 12,869 --------- --------- TOTAL ASSETS $ 671,599 $ 622,083 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 46,459 $ 48,896 Accrued expenses and other liabilities 59,351 53,738 Accrued compensation and benefits 15,519 15,834 Income taxes payable 7,911 - Current portion of long-term debt 1,583 2,422 --------- --------- Total Current Liabilities 130,823 120,890 --------- --------- LONG-TERM DEBT, NET OF CURRENT PORTION 133,006 125,937 DEFERRED INCOME TAXES 16,365 16,675 OTHER NONCURRENT LIABILITIES 12,037 13,796 MINORITY INTEREST 11,787 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: 16,451,077 shares at March 31, 1998 and 15,797,460 shares at June 30, 1997 1,645 1,580 Class B Common Stock, $.10 par value; 10 votes per share; 25,000,000 shares authorized; issued and outstanding: 10,701,777 at March 31, 1998 and 11,215,627 shares at June 30, 1997 1,070 1,121 Additional paid-in capital 47,598 44,643 Retained earnings 327,834 293,170 Cumulative translation adjustment (10,566) (6,875) --------- --------- Total Stockholders' Equity 367,581 333,639 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 671,599 $ 622,083 ========= ========= See accompanying notes to condensed consolidated financial statements. WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share information) (Unaudited) Three Months Ended -------------------- Mar. 31, Mar. 31, 1998 1997 --------- --------- Net sales $ 183,615 $ 184,191 Cost of goods sold 119,381 120,461 --------- --------- GROSS PROFIT 64,234 63,730 Selling, general & administrative expenses 40,835 40,983 --------- --------- OPERATING INCOME 23,399 22,747 --------- --------- Other (income) expense: Interest income (659) (125) Interest expense 2,677 2,715 Other, net (183) (280) --------- --------- 1,835 2,310 --------- --------- INCOME BEFORE INCOME TAXES 21,564 20,437 Provision for income taxes 7,523 7,548 --------- --------- NET INCOME $ 14,041 $ 12,889 ========= ========= Income per common share : Basic $ 0.52 $ 0.48 ========= ========= Diluted $ 0.51 $ 0.47 ========= ========= Dividends per common share $ 0.0875 $ 0.0775 ========= ========= See accompanying notes to condensed consolidated financial statements. WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share information) (Unaudited) Nine Months Ended -------------------- Mar. 31, Mar. 31, 1998 1997 --------- --------- Net sales $ 542,273 $ 534,419 Cost of goods sold 350,424 350,181 --------- --------- GROSS PROFIT 191,849 184,238 Selling, general & administrative expenses 121,575 118,087 --------- --------- OPERATING INCOME 70,274 66,151 --------- --------- Other (income) expense: Interest income (1,243) (397) Interest expense 7,653 7,938 Other, net 778 171 --------- --------- 7,188 7,712 --------- --------- INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 63,086 58,439 Provision for income taxes 21,816 21,454 --------- --------- INCOME FROM CONTINUING OPERATIONS 41,270 36,985 Income from discontinued operations, net of taxes - 79 Gain on disposal of discontinued operations, net of taxes - 3,208 --------- --------- NET INCOME $ 41,270 $ 40,272 ========= ========= Income per common share : Basic Continuing operations $ 1.52 $ 1.36 Discontinued operations - - Gain on disposal of discontinued operations - 0.12 --------- --------- Net Income $ 1.52 $ 1.48 ========= ========= Diluted Continuing operations $ 1.51 $ 1.35 Discontinued operations - - Gain on disposal of discontinued operations - 0.12 --------- --------- Net Income $ 1.51 $ 1.47 ========= ========= Dividends per common share $ 0.2425 $ 0.2175 ========= ========= See accompanying notes to condensed consolidated financial statements. WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (Unaudited) Nine Months Ended -------------------- Mar. 31, Mar. 31, 1998 1997 --------- --------- OPERATING ACTIVITIES Income from continuing operations $ 41,270 $ 36,985 Adjustments to reconcile net income from continuing operations to net cash provided by continuing operating activities: Restructuring payments (1,523) (4,335) Depreciation and amortization 17,136 17,026 Deferred income taxes 533 1,080 Gain on disposal of assets (1,170) (561) Equity in undistributed earnings of affiliates (77) - Changes in operating assets and liabilities, net of effects from acquisitions and dispositions: Accounts receivable (18,594) (16,966) Inventories (16,070) (2,612) Prepaid expenses and other assets (1,225) (2,621) Accounts payable, accrued expenses and other liabilities 10,980 (3,369) --------- --------- Net cash provided by continuing operations 31,260 24,627 Net cash provided by discontinued operations - 653 --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 31,260 25,280 --------- --------- INVESTING ACTIVITIES Additions to property, plant and equipment (21,927) (21,075) Proceeds from sale of assets 7,335 1,756 Increase in other assets (1,043) (771) Discontinued Operations: Additions to property, plant and equipment - (142) Proceeds from disposal of discontinued operations - 90,581 Business acquisitions, net of cash acquired (22,495) (37,575) Net changes in short-term investments 260 - --------- --------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (37,870) 32,774 --------- --------- FINANCING ACTIVITIES Proceeds from long-term borrowings 73,491 91,376 Payments of long-term debt (67,102) (119,088) Proceeds from exercise of stock options 2,699 746 Dividends paid (6,569) (5,932) Purchase and retirement of common stock - (23,069) --------- --------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 2,519 (55,967) --------- --------- Effect of exchange rate changes on cash and cash equivalents 141 1,293 --------- --------- CHANGE IN CASH AND CASH EQUIVALENTS (3,950) 3,380 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 13,904 - --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 9,954 $ 3,380 ========= ========= 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, 1998, its Condensed Consolidated Statements of Operations for the three and nine months ended March 31, 1998 and 1997, and its condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 1998 and 1997. The balance sheet at June 30, 1997 has been derived from the audited financial statements at that date. Certain amounts have been reclassified to conform with the 1998 presentation. 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 twelve months ended August 31, 1997. During December 1997, a wholly owned subsidiary of the Company purchased the pneumatic valve and motion switch business of Aerodyne Controls Corporation. The Aerodyne product line consists of high quality valve components for medical, analytical, military and aerospace applications. Sales for the twelve months ended October 1997 were approximately $7,000,000. During March 1998, a wholly owned subsidiary of the Company purchased the solenoid valve business of Atkomatic Valve Company. The Atkomatic product line consists of heavy duty process solenoid valves for clean air, gases, liquids, steam and corrosive and cryogenic fluids. Sales for the twelve months ended September 30, 1997 were $4,500,000. During March 1998, a wholly owned subsidiary of the Company purchased Telford Valve & Specialties, Inc. of Edmonton, Canada. Telford manufactures check valves, pipeline closures, and specialty gate valves that are used in industrial and oil and gas applications. Telford is also a distributor and authorized repair facility for a number of other independent manufacturers of oilfield products. Current annualized sales are approximately $15,000,000. The aggregate purchase price for these acquisitions was $22,495,000. 3. During fiscal year ended June 30, 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 were 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 $1,523,000 during the nine months ended March 31, 1998, and the Company's remaining accrued restructuring liability was $2,301,000 at March 31, 1998. It is expected that the restructuring initiatives will be substantially complete by June 30, 1998. The Company expects that some settlement payments will be paid subsequent to June 30, 1998. Since commencement of the restructuring plan, there has been a related net reduction of 246 employees. As of March 31, 1998, there are approximately 50 additional restructuring related terminations that are expected to 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 nine months ended March 31, 1997. 5. During the quarter ended December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128 Earnings per Share. SFAS 128 required the Company to change the method formerly used to compute earnings per share and to restate all prior periods presented. The requirements for calculating basic earnings per share excludes the dilutive effect of securities. Diluted earnings per share assumes the conversion of all dilutive securities. The following table sets forth the reconciliation of the calculation per SFAS 128: For the Three Months Ended March 31, 1998 Income Shares Per Share (Numerator) (Denominator) Amount Basic EPS Net Income $14,041,000 27,162,904 $.52 Effect of Dilutive Securities - primarily stock options - 424,539 Diluted EPS $14,041,000 27,587,443 $.51 For the Nine Months Ended March 31, 1998 Income Shares Per Share (Numerator) (Denominator) Amount Basic EPS Net Income $41,270,000 27,082,038 $1.52 Effect of Dilutive Securities - primarily stock options - 337,762 Diluted EPS $41,270,000 27,419,800 $1.51 At March 31, 1998, 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 nine-month periods then ended. For the Three Months Ended March 31, 1997 Income Shares Per Share (Numerator) (Denominator) Amount Basic EPS Net Income $12,889,000 27,029,898 $.48 Effect of Dilutive Securities - primarily stock options - 275,854 Diluted EPS $12,889,000 27,305,752 $.47 For the Nine Months Ended March 31, 1997 Income Shares Per Share (Numerator) (Denominator) Amount Basic EPS Income from Continuing Operations $36,985,000 27,224,419 $1.36 Income from Discontinued Operations 79,000 - Gain on Disposal of Discontinued Operations 3,208,000 .12 Net Income $40,272,000 $1.48 Effect of Dilutive Securities - primarily stock options - 161,311 Diluted EPS $40,272,000 27,385,730 $1.47 Options to purchase 26,500 shares and 689,100 shares of common stock at prices ranging from $22.13 to $26.13 were outstanding during the three-month and nine-month periods ended March 31, 1997, 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. 6. During June 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 Company's Jameco business. The Company now has a 49% minority interest in the new joint venture and reports activities on the equity basis, thus excluding these sales from the Company's consolidated revenues. Revenues in fiscal 1997 were $13,415,000 for this business. 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 six-month period ended December 31, 1997 were $3,386,000. 7. On March 27, 1998, the Company entered into an amended and restated $125 million revolving credit agreement with a group of commercial banks to replace the existing agreement. The agreement expires on March 27, 2003. Interest payable on borrowings is variable based upon the Company's option of selecting either a LIBOR rate plus 0.165%, Prime Rate, or a competitive money market rate to be specified by the lender. 8. The Company has developed comprehensive global plans 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. As part of these plans, the Company is also communicating with its suppliers, distributors and others with whom it conducts business to coordinate year 2000 compliance. 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. However if the Company, its suppliers or distributors are unable to fully implement these plans related to year 2000 risk on a timely basis, it could result in a financial risk. 9. The Company uses foreign currency forward exchange contracts to reduce the impact of currency fluctuations on certain anticipated intercompany purchase transactions that are expected to occur within the fiscal year and other known exposures. The notional amount of such contracts and the related realized and unrealized gains and losses as of March 31, 1998 are not material. 10. 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 March 31, 1998 Compared to Three Months Ended March 31, 1997 Net sales decreased $576,000 (0.3%) to $183,615,000. An analysis of this change in net sales is as follows: Internal Growth $ 3,961,000 2.2% Acquisitions 3,625,000 2.0% Jameco Sales now through Joint Venture and Divestitures (5,062,000) (2.8%) Foreign Exchange Rate Effect (3,100,000) (1.7%) Total Decrease $ (576,000) (0.3%) The increase in net sales from internal growth is primarily attributable to increased unit shipments of European oil and gas valves and increased unit shipments of North American plumbing and heating valves. These increases were partially offset by decreased unit shipments of domestic oil and gas valves. Last year's sales included $3,010,000 for a segment of the Jameco business for imported vitreous china and faucets in which the Company now has a 49% minority interest, thereby eliminating these sales from current year results. 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. 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 period ended March 31, 1997 were $1,454,000. Gross profit increased $504,000 (0.8%) and increased as a percentage of net sales from 34.6% to 35.0%. This percentage increase is primarily attributable to improved gross margins for European oil and gas valves and domestic plumbing and heating valves. The gross margin on oil and gas valves improved due to increased sales volumes and factory efficiencies. The gross margin on domestic plumbing and heating valves increased primarily due to an improved sales mix. 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 decreased $148,000 (0.4%) to $40,835,000. This decrease is primarily attributable to the impact of foreign exchange rate changes and the elimination of the operating expenses associated with the segment of the Jameco business in which the Company now maintains a 49% minority interest. These reductions were partially offset by the inclusion of the expenses of acquired companies and increased variable selling expenses. The decrease in the effective tax rate from 36.9% to 34. 9% was primarily attributable to the implementation of tax planning strategies intended to reduce income tax expense. Net income increased $1,152,000 (8.9%) to $14,041,000. 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 net income for the quarter ended of approximately $350,000. Results of Operations Nine Months Ended March 31, 1998 Compared to Nine Months Ended March 31, 1997 Net sales from continuing operations increased $7,854,000 (1.5%) to $542,273,000. An analysis of this change in net sales is as follows: Internal Growth $12,669,000 2.4% Acquisitions/New Joint Ventures 21,039,000 3.9% Jameco Sales now through Joint Venture and Divestitures (12,521,000) (2.3%) Foreign Exchange Rate Effect (13,333,000) (2.5%) Total Increase $ 7,854,000 1.5% The increase in net sales from internal growth is primarily attributable to increased unit shipments of oil and gas valves and increased unit shipments of plumbing and heating valves. The increased sales due to acquisitions is primarily attributable to the inclusion of the sales of Ames, acquired in January 1997. Last year's sales included $9,271,000 for a segment of the Jameco business for imported vitreous china and faucets in which the Company now has a 49% minority interest, thereby eliminating these sales from current year results. 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. 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 six-month period ended December 31, 1997 were $3,386,000. Gross profit from continuing operations increased $7,611,000 (4.1%) and increased as a percentage of net sales from 34.5% to 35.4%. This percentage increase is primarily attributable to improved gross margins for European oil and gas valves and the inclusion of the gross margin of Ames which operates at a higher gross margin than the Company average. 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 $3,488,000 (3.0%) to $121,575,000. This increase is primarily attributable to the inclusion of the expenses of Ames and other acquired companies and increased variable selling expenses. This increase was partially offset by the effect of the change in foreign exchange rates and the exclusion of the expenses of the Jameco joint venture. Interest income increased $846,000 to $1,243,000 due to an increased level of cash and short-term investments. Other nonoperating expense increased by $607,000 (355.0%) to $778,000 for the nine months ended March 31, 1998. Minority interest expense charges, resulting from the improved operating results of the two Chinese joint ventures, were recognized during this period. Increased charges were partially offset by gains recognized on the sale of a Canadian manufacturing facility and a small Italian valve manufacturing division. The effective tax rate for continuing operations decreased from 36.7% to 34.6% primarily due to the implementation of tax planning strategies intended to reduce income tax expense. Income from continuing operations increased $4,285,000 (11.6%) to $41,270,000. 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 income from continuing operations of approximately $1,400,000. 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, or $.12 earnings per share on both a basic and diluted basis for the period ended March 31, 1997. Liquidity and Capital Resources During the nine-month period ended March 31, 1998, the Company generated $31,260,000 in cash flow from operations, which was principally used to fund capital expenditures of $21,927,000. 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 fiscal 1998 is $29,500,000. During the nine months ended March 31, 1998, the Company sold one of its facilities in Canada, consolidating the operations into another existing Canadian plant. Additionally, the Company sold a small Italian valve manufacturing division (ISI) which was not part of the Company's core business. The proceeds for these two transactions totaled $7,135,000. On December 18, 1997, the Company acquired Aerodyne Controls Corporation ("Aerodyne") located in Ronkonkoma, New York. Aerodyne is a manufacturer of pneumatic valve and motion switches. Aerodyne's sales for the twelve months ended October 1997 were approximately $7,000,000. Customers are primarily in the medical, analytical, military and aerospace markets. On March 26, 1998, the Company acquired Telford Valve and Specialties, Inc. ("Telford") located in Edmonton, Alberta, Canada. Telford manufactures check valves, pipeline closures, and specialty gate valves that are used in industrial and oil and gas applications. Telford is also a distributor and authorized repair facility for a number of other independent manufacturers of oil field products. Current annualized sales are approximately $15,000,000. The aggregate purchase price for the acquisitions of Aerodyne, Telford, and other product line acquisitions during the nine months ended March 31, 1998 is $22,495,000. 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 March 31, 1998, $35,000,000 was borrowed under this line of credit. Working capital was $248,635,000 at March 31, 1998 compared to $224,702,000 at June 30, 1997. The ratio of current assets to current liabilities was 2.9 to 1 at both March 31, 1998 and June 30, 1997. Cash and short-term investments were $10,211,000 at March 31, 1998 compared to $14,422,000 at June 30, 1997. Debt as a percentage of total capital employed was 26.8% at March 31, 1998 compared to 27.8% at June 30, 1997. At March 31, 1998, 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. The Company has developed comprehensive global plans 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. As part of these plans, the Company is also communicating with its suppliers, distributors and others with whom it conducts business to coordinate year 2000 compliance. 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. However if the Company, its suppliers or distributors are unable to fully implement these plans related to year 2000 risk on a timely basis, it could result in a financial risk. 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 March 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. 130, Reporting Comprehensive Income, and SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, become effective during fiscal year 1999. At that time, the Company will report net income as currently reported and will begin to also report "comprehensive income" which will include the effect of currency translation adjustments. As the Company adopts SFAS No. 131, it will make the required disclosures concerning its segments. 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. Leslie Controls is also a defendant in two similar matters pending in Superior Court of California, San Francisco County. 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. On June 25, 1997, a complaint entitled State of California ex rel. Nora Armenta v. James Jones Company, Mueller Co., Tyco International, Ltd. and Watts Industries, Inc. was filed under seal in the Superior Court of Los Angeles County, California, alleging violations of the California False Claims Act. The Company became aware of the action in April 1998. The complaint alleges that since at least 1987, James Jones Company, (which was a subsidiary of the Company until September 1996 when it was sold to Tyco International Ltd.), sold products utilized in municipal water systems within the State of California which failed to meet contractually specified industry standards and falsely certified that such standards had been met. The complaint alleges that the municipal entities have suffered tens of millions of dollars of damages as a result of the defective products, and seeks injunctive relief, treble damages, civil penalties of up to $10,000 for each violation of the California False Claims Act, costs and attorney's fees. The Company has undertaken the defense of the action on behalf of other named defendants subject to contractual limitations with respect to its indemnification obligations. The action is filed by a former employee of James Jones Company, and no government entity is currently a party by intervention in the action. The Company intends to vigorously defend the action. 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. During the quarter ending March 31, 1998, the Company received an administrative order from the New Hampshire Department of Environmental Services with respect to certain regulatory issues concerning its Franklin, New Hampshire operation. The Company has appealed this administrative order. The state agency has not as of yet issued any fines or penalties in connection with this matter. 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 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 PRPs, 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 environmental 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) There were no reports filed on Form 8-K for the quarter ended March 31, 1998. 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 13, 1998 By: /s/ Timothy P.Horne Timothy P. Horne Chairman and Chief Executive Officer Date: May 13, 1998 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) 10.28 Amended and Restated Revolving Credit Agreement dated March 27, 1998 between and among Watts Investment Company, certain financial institutions, BankBoston N.A., as Administrative Agent, and the Registrant as Guarantor. * 11 Computation of earnings per share (3) 27.1 Financial Data Schedule-March 31, 1998* 27.2 Restated Financial Data Schedule-March 31, 1997* 27.3 Restated Financial Data Schedule-September 30, 1996* (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 Condensed Consolidated Financial Statements, Note 5, of this Report. *Filed herewith.