-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, G7ztTkxSJMbJIVIYHUrjaUskv7x3kFPzVm8TAmHF4SdCn//HgK1ffCe7lyuvROQ4 OswArOH84zMrNC8WIY+tcg== 0001171520-02-000122.txt : 20021112 0001171520-02-000122.hdr.sgml : 20021111 20021112171317 ACCESSION NUMBER: 0001171520-02-000122 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20020930 FILED AS OF DATE: 20021112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: WATTS INDUSTRIES INC CENTRAL INDEX KEY: 0000795403 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS FABRICATED METAL PRODUCTS [3490] IRS NUMBER: 042916536 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-11499 FILM NUMBER: 02817897 BUSINESS ADDRESS: STREET 1: 815 CHESTNUT ST CITY: NORTH ANDOVER STATE: MA ZIP: 01845 BUSINESS PHONE: 9786881811 MAIL ADDRESS: STREET 1: 815 CHESTNUT STREET CITY: NORTH ANDOVER STATE: MA ZIP: 01845 10-Q 1 d02-1057.txt WATTS INDUSTRIES, INC. 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, 2002 ------------------ 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 1-11499 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, 2002 ----- ------------------------------- Class A Common, $.10 par value 18,868,388 Class B Common, $.10 par value 8,185,224 WATTS INDUSTRIES, INC. AND SUBSIDIARIES --------------------------------------- INDEX ----- Part I. Financial Information Page # --------------------- ------ Item 1. Financial Statements -------------------- Consolidated Balance Sheets at September 30, 2002 (unaudited) and December 31, 2001 3 Consolidated Statements of Income for the Three Months Ended September 30, 2002 and 2001 (unaudited) 4 Consolidated Statements of Income for the Nine Months Ended September 30, 2002 and 2001 (unaudited) 5 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2002 and 2001 (unaudited) 6 Notes to Consolidated Financial Statements 7-16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 17-25 Item 3. Quantitative and Qualitative Disclosures about Market Risk 25-26 Item 4. Controls and Procedures 26 Part II. Other Information ----------------- Item 1. Legal Proceedings 27-28 Item 6. Exhibits and Reports on Form 8-K 29 Signatures 30 Certifications 31-32 Exhibit Index 33 PART I. FINANCIAL INFORMATION --------------------- ITEM 1. FINANCIAL STATEMENTS -------------------- WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Thousands, except share amounts)
(Unaudited) Sept. 30, Dec. 31, 2002 2001 --------- --------- ASSETS CURRENT ASSETS: Cash and cash equivalents ............................................ $ 16,117 $ 11,997 Trade accounts receivable, less allowance for doubtful accounts of $7,008 at September 30, 2002 and $6,070 at December 31, 2001 ...... 130,289 95,498 Inventories: Raw materials ..................................................... 39,624 34,276 Work in process ................................................... 16,171 13,032 Finished goods .................................................... 74,149 68,556 --------- --------- Total Inventories .............................................. 129,944 115,864 Prepaid expenses and other assets .................................... 9,204 7,087 Deferred income taxes ................................................ 26,428 25,329 Net assets held for sale ............................................. 2,293 349 --------- --------- Total Current Assets .............................................. 314,275 256,124 --------- --------- PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment, at cost ............................... 241,792 218,235 Accumulated depreciation ............................................. (107,670) (89,629) --------- --------- Property, plant and equipment, net ................................ 134,122 128,606 --------- --------- OTHER ASSETS: Goodwill, net of accumulated amortization of $17,885 at September 30, 2002 and at December 31, 2001 ....................... 158,117 124,544 Other ................................................................ 24,908 11,196 --------- --------- TOTAL ASSETS .............................................................. $ 631,422 $ 520,470 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable ..................................................... $ 55,021 $ 42,873 Accrued expenses and other liabilities ............................... 67,243 55,930 Accrued compensation and benefits .................................... 14,978 11,033 Current portion of long-term debt .................................... 9,211 3,693 --------- --------- Total Current Liabilities ......................................... 146,453 113,529 --------- --------- LONG-TERM DEBT, NET OF CURRENT PORTION .................................... 159,978 123,212 DEFERRED INCOME TAXES ..................................................... 20,235 15,692 OTHER NONCURRENT LIABILITIES .............................................. 11,753 11,414 MINORITY INTEREST ......................................................... 10,614 7,309 STOCKHOLDERS' EQUITY: Preferred Stock, $.10 par value; 5,000,000 shares authorized; no shares issued or outstanding ................................... -- -- Class A Common Stock, $.10 par value; 80,000,000 shares authorized; 1 vote per share; issued and outstanding: 18,578,408 shares at September 30, 2002 and 17,776,509 shares at December 31, 2001 ..... 1,858 1,778 Class B Common Stock, $.10 par value; 25,000,000 shares authorized; 10 votes per share; issued and outstanding: 8,185,224 shares at September 30, 2002 and 8,735,224 shares at December 31, 2001 ...... 819 874 Additional paid-in capital ........................................... 40,716 37,182 Retained earnings .................................................... 254,363 233,761 Accumulated other comprehensive income/(loss) ........................ (15,367) (24,281) --------- --------- Total Stockholders' Equity ........................................ 282,389 249,314 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................ $ 631,422 $ 520,470 ========= =========
See accompanying notes to consolidated financial statements. 3 WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Thousands, except per share amounts) (Unaudited) Three Months Ended ------------------------ Sept. 30, Sept. 30, 2002 2001 --------- --------- Net sales ........................................ $ 159,811 $ 138,009 Cost of goods sold ............................... 106,304 91,066 --------- --------- GROSS PROFIT ................................ 53,507 46,943 Selling, general & administrative expenses ....... 37,532 32,511 Restructuring .................................... 208 -- --------- --------- OPERATING INCOME ............................ 15,767 14,432 --------- --------- Other (income) expense: Interest income ............................. (122) (264) Interest expense ............................ 2,447 2,587 Other, net .................................. (39) 269 Minority interest ........................... 156 59 --------- --------- 2,442 2,651 --------- --------- INCOME BEFORE INCOME TAXES .................. 13,325 11,781 Provision for income taxes ....................... 4,552 3,972 --------- --------- NET INCOME .................................. $ 8,773 $ 7,809 ========= ========= BASIC EARNINGS PER SHARE NET INCOME .................................. $ .33 $ .29 ========= ========= Weighted average number of shares ................ 26,717 26,527 ========= ========= DILUTED EARNINGS PER SHARE NET INCOME .................................. $ .32 $ .29 ========= ========= Weighted average number of shares ................ 27,249 26,838 ========= ========= Dividends per common share ................. $ .06 $ .06 ========= ========= See accompanying notes to consolidated financial statements. 4 WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Thousands, except per share amounts) (Unaudited) Nine Months Ended ------------------------ Sept. 30, Sept. 30, 2002 2001 --------- --------- Net sales ........................................ $ 454,636 $ 409,496 Cost of goods sold ............................... 299,418 269,540 --------- --------- GROSS PROFIT ................................ 155,218 139,956 Selling, general & administrative expenses ....... 109,897 98,633 Restructuring .................................... 218 -- --------- --------- OPERATING INCOME ............................ 45,103 41,323 --------- --------- Other (income) expense: Interest income ............................. (578) (518) Interest expense ............................ 6,576 7,395 Other, net .................................. (164) 425 Minority interest ........................... 262 176 --------- --------- 6,096 7,478 --------- --------- INCOME BEFORE INCOME TAXES .................. 39,007 33,845 Provision for income taxes ....................... 13,545 11,728 --------- --------- NET INCOME .................................. $ 25,462 $ 22,117 ========= ========= BASIC EARNINGS PER SHARE NET INCOME .................................. $ .96 $ .83 ========= ========= Weighted average number of shares ................ 26,630 26,497 ========= ========= DILUTED EARNINGS PER SHARE NET INCOME .................................. $ .94 $ .82 ========= ========= Weighted average number of shares ................ 27,112 26,850 ========= ========= Dividends per common share ................. $ .18 $ .18 ========= ========= See accompanying notes to consolidated financial statements. 5 WATTS INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands) (Unaudited)
Nine Months Ended -------------------- Sept. 30, Sept. 30, 2002 2001 -------- -------- OPERATING ACTIVITIES Net income ...................................................... $ 25,462 $ 22,117 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation ................................................. 17,104 14,720 Amortization ................................................. 327 2,676 Deferred income taxes ........................................ 296 -- Gain/loss on disposal of assets .............................. (88) 32 Equity in undistributed earnings (loss) of affiliates ........ (105) 13 Changes in operating assets and liabilities, net of effects from acquisitions and dispositions: Accounts receivable ....................................... (23,788) 2,756 Inventories ............................................... (2,093) 403 Prepaid expenses and other assets ........................ (1,184) (860) Accounts payable, accrued expenses and other liabilities .. 5,801 (8,413) -------- -------- Net cash provided by operating activities ....................... 21,732 33,444 -------- -------- INVESTING ACTIVITIES Additions to property, plant and equipment ...................... (16,967) (11,539) Proceeds from sale of property, plant and equipment ............. 2,883 85 Business acquisitions, net of cash acquired ..................... (25,689) (43,377) Decrease in other assets ........................................ 41 248 -------- -------- Net cash used in investing activities ........................... (39,732) (54,583) -------- -------- FINANCING ACTIVITIES Proceeds from long-term borrowings .............................. 94,858 96,704 Payments of long-term debt ...................................... (75,901) (68,972) Proceeds from exercise of stock options ......................... 3,559 1,180 Dividends ....................................................... (4,860) (4,842) Purchase of treasury stock ...................................... -- (360) -------- -------- Net cash provided by financing activities ....................... 17,656 23,710 -------- -------- Effect of exchange rate changes on cash and cash equivalents ......... 1,858 (915) Net cash provided by/(used in) discontinued operations ............... 2,606 (1,516) -------- -------- CHANGE IN CASH AND CASH EQUIVALENTS ................................. 4,120 140 Cash and cash equivalents at beginning of period ..................... 11,997 15,235 -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD ........................... $ 16,117 $ 15,375 ======== ======== NON CASH INVESTING AND FINANCING ACTIVITIES Acquisitions of businesses: Fair value of assets acquired ................................ $ 65,479 $ 64,146 Cash Paid .................................................... 25,689 43,377 -------- -------- Liabilities Assumed .......................................... $ 39,790 $ 20,769 ======== ========
See accompanying notes to consolidated financial statements. 6 WATTS INDUSTRIES, INC. AND SUBSIDIARIES - --------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) - ------------------------------------------------------ 1. Basis of Presentation In the opinion of management, the accompanying unaudited, consolidated financial statements contain all necessary adjustments, consisting only of adjustments of a normal recurring nature, to present fairly Watts Industries, Inc.'s Consolidated Balance Sheet as of September 30, 2002 (unaudited), its Consolidated Statements of Income for the three months and nine months ended September 30, 2002 and 2001 (unaudited), and its Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001 (unaudited). The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date. The accounting policies followed by the Company are described in the December 31, 2001 financial statements which are contained in the Company's December 31, 2001 Annual Report on Form 10-K. It is suggested that the financial statements included in this report be read in conjunction with the financial statements and notes included in the December 31, 2001 Annual Report on Form 10-K. 2. Accounting Policies The Company's shipping costs included in selling, general and administrative expense amounted to $5,087,000 and $5,459,000 for the three months ended September 30, 2002 and 2001, respectively, and $15,262,000 and $16,180,000 for the nine months ended September 30, 2002 and 2001, respectively. The Company adopted Financial Accounting Standards Board Statement No. 141, "Business Combinations" ("FAS 141") in fiscal 2001 and Financial Accounting Standards Board Statement No. 142, "Goodwill and Other Intangible Assets" ("FAS 142") on January 1, 2002. FAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. FAS 141 also specifies the criteria that intangible assets acquired in a purchase method business combination must meet in order to be recognized and reported apart from goodwill. FAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment, at least annually, in accordance with the provisions of FAS 142. FAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment in accordance with Financial Accounting Standards Board Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("FAS 144"). FAS 142 requires the Company to perform an assessment of whether there is an indication that the remaining recorded goodwill is impaired as of the date of adoption. This assessment involves a two-step transitional impairment test. To accomplish this, the Company must identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of January 1, 2002. To the extent that a reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired and the Company must perform the second step of the transitional impairment test. Any transitional impairment loss will be recognized as a cumulative effect of a change in accounting principle. In connection with the adoption of FAS 142, the Company has completed the first step of the transitional goodwill impairment test, which requires the Company to compare the fair value of its reporting units to the carrying value of the net assets of the respective reporting units as of January 1, 2002. Based on this analysis, the Company has concluded that no impairment existed at the time of adoption, and accordingly, the Company has not recognized any transitional impairment loss. FAS 142 also requires goodwill to be tested annually and between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company has elected to perform its annual tests for indications of goodwill impairment as of the end of fiscal October of each year. 7 The effect of the adoption of the standard on prior period earnings, excluding goodwill amortization expense, net of tax, is as follows: Three Months Ended ------------------ September 30, ------------- 2002 2001 ---- ---- (in thousands, except per share information) Net income....................................... $8,773 $7,809 Add back: goodwill amortization, net of tax...... -- 836 -------------------------- Adjusted net income.............................. $8,773 $8,645 ========================== Basic earnings per share: Net income....................................... $.33 $.29 Goodwill amortization............................ -- .03 -------------------------- Adjusted net income.............................. $.33 $.32 ========================== Diluted earnings per share: Net income....................................... $.32 $.29 Goodwill amortization............................ -- .03 -------------------------- Adjusted net income.............................. $.32 $.32 ========================== Nine Months Ended ----------------- September 30, ------------- 2002 2001 ---- ---- (in thousands, except per share information) Net income....................................... $25,462 $22,117 Add back: goodwill amortization, net of tax...... -- 2,361 -------------------------- Adjusted net income.............................. $25,462 $24,478 ========================== Basic earnings per share: Net income....................................... $.96 $.83 Goodwill amortization............................ -- .09 -------------------------- Adjusted net income.............................. $.96 $.92 ========================== Diluted earnings per share: Net income....................................... $.94 $.82 Goodwill amortization............................ -- .09 -------------------------- Adjusted net income.............................. $.94 $.91 ========================== 8 The changes in the carrying amount of goodwill for the nine months ended September 30, 2002 are as follows: (in thousands) Carrying amount as of December 31, 2001..................... $124,544 Goodwill acquired during the year........................... 29,697 Effect of change in rates used for translation.............. 3,876 ---------------- Carrying amount as of September 30, 2002.................... $158,117 ================ Amortized Intangible Assets (a): As of September 30, 2002 ------------------------ Gross Carrying Accumulated Amount Amortization ------ ------------ (in thousands) Patents................................... $8,285 $(3,338) Other..................................... 12,642 (874) ---------------------------------- Total.................................. $20,927 $(4,212) ================================== (a) as recognized in "Other Assets: "Other", in the consolidated balance sheet Aggregate amortization expense for amortized other intangible assets for the nine months ended September 30, 2002 is $327,000. Additionally, future amortization expense on other intangible assets approximates $163,000 for the remainder of fiscal 2002, $567,000 for fiscal 2003, $500,000 for fiscal 2004 and $487,000 for fiscal 2005 and 2006. In August 2001, the FASB issued Financial Accounting Standards Board Statement No. 143, "Accounting for Asset Retirement Obligations" ("FAS 143") which requires companies to record the fair value of an asset retirement obligation as a liability in the period it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal use of the assets. The company must also record a corresponding increase in the carrying value of the related long-lived asset and depreciate that cost over the remaining useful life of the asset. The liability must be increased each period for the passage of time with the offset recorded as an operating expense. The liability must also be adjusted for changes in the estimated future cash flows underlying the initial fair value measurement. Companies must also recognize a gain or loss on the settlement of the liability. The provisions of FAS 143 are effective for fiscal years beginning after June 15, 2002. At the date of the adoption of FAS 143, companies are required to recognize a liability for all existing asset retirement obligations and the associated asset retirement costs. The Company is currently evaluating the effect that the adoption of FAS 143 will have on its results of operations and its financial position. Effective January 1, 2002, the Company also adopted FAS 144, which addresses the accounting and reporting for the impairment or disposal of long-lived assets. FAS 144 supercedes Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("FAS 121") but retains many of the fundamental provisions of FAS 121. FAS 144 also supercedes the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB 30") for the disposal of a segment of a business. However, FAS 144 retains the requirements of APB 30 to report discontinued operations separately and extends that reporting requirement to components of an entity that has either been disposed of or is classified as held for sale. FAS 144 excludes goodwill and other intangibles that are not amortized from its scope. For assets to be held and used, FAS 144 addresses the recoverability of an asset or group of assets, clarifies how an impairment loss should be allocated, and creates a requirement to use a fair value if market prices are not available and uncertainties exist about the timing and amount of cash flows. For long-lived assets to be disposed of by sale, FAS 144 establishes the criteria to be met to qualify for this classification, defines the timing of 9 when the related sale must be consummated, eliminates the net realizable value measurement approach for segments of a business and certain acquired assets in a business combination, and defines costs to sell the asset. FAS 144 was effective for fiscal years beginning after December 15, 2001 and its adoption was not material to the Company's consolidated financial statements. In April 2002, FAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued. FAS 145 rescinds FAS 4 and FAS 64 related to classification of gains and losses on debt extinguishment such that most debt extinguishment gains and losses will no longer be classified as extraordinary. FAS 145 also amends FAS 13 with respect to sales-leaseback transactions. The Company adopted the provisions of FAS 145 effective April 1, 2002, and its adoption was not material to its consolidated financial statements. In July 2002, the FASB issued FAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The principal difference between this Statement and Issue 94-3 relates to its requirements for recognition of a liability for a cost associated with an exit or disposal activity. This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as defined in Issue 94-3 was recognized at the date of an entity's commitment to an exit plan. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. 3. Sales Incentives and Other During 2000, the Financial Accounting Standards Board's Emerging Issues Task Force (EITF) added to its agenda various revenue recognition issues that could impact the income statement classification of certain promotional payments. In May 2000, the EITF reached a consensus on Issue 00-14, "Accounting for Certain Sales Incentives". EITF 00-14 addresses the recognition and income statement classification of various sales incentives. The consensus became effective in the first quarter of 2002 and was not material to the Company's consolidated financial statements. In April 2001, the EITF reached a consensus on Issue 00-25, "Vendor Income Statement Characterization of Consideration to a Purchaser of the Vendor's Products or Services". EITF 00-25 addresses the income statement classification of consideration, other than that directly addressed in Issue 00-14, from a vendor to a reseller, or another party that purchases the vendor's products. The consensus became effective in the first quarter of 2002 and was not material to the Company's consolidated financial statements. 4. Derivative Instruments Certain forecasted transactions, primarily intercompany sales between the United States and Canada, and assets are exposed to foreign currency risk. The Company monitors its foreign currency exposures on an ongoing basis to maximize the overall effectiveness of its foreign currency hedge positions. During the nine months ended September 30, 2002, the Company used foreign currency forward contracts as a means of hedging exposure to foreign currency risks. The Company's foreign currency forwards have been designated and qualify as cash flow hedges under the criteria of FAS 133. FAS 133 requires that changes in fair value of derivatives that qualify as cash flow hedges be recognized in other comprehensive income while the ineffective portion of the derivative's change in fair value be recognized immediately in earnings. The net loss on these contracts recorded in other comprehensive income during the quarter ended September 30, 2002 was $51,000 and the net gain for the nine months ended September 30, 2002 was $49,000. There were no ineffective amounts for the three and nine months ended September 30, 2002. The Company has used interest rate swaps as an economic hedge on forecasted interest costs. During the quarter ended September 30, 2001, the Company entered into an interest rate swap for its $75,000,000 notes. The Company swapped the fixed interest rate of 8 3/8% to floating LIBOR plus 3.74%. The term of the swap matched the maturity date of the notes (December 2003). On August 5, 2002, the Company sold the swap and received $2,315,000 in cash. This amount is being recognized as a deferred liability and is amortized over the remaining term of the notes. 10 The Company also utilizes, on a limited basis, certain commodity derivatives, primarily on copper used in its manufacturing process, to hedge the cost of its anticipated production requirements. The Company did not utilize any commodity derivatives for the three and nine-month periods ended September 30, 2002. 5. Restructuring The Company is implementing a plan to consolidate several of its manufacturing plants both in North America and Europe. At the same time it is expanding its manufacturing capacity in China. The implementation of this manufacturing restructuring plan began during the fourth quarter of fiscal 2001. The projects, for which charges were recorded in the fourth quarter of fiscal 2001, are essentially complete. The Company decided to expand the scope of the manufacturing restructuring plan and transfer certain production to low cost manufacturing plants in Tunisia and Bulgaria. The criteria for recognition of these expanded costs have not been met as of September 30, 2002. The expanded plan is expected to be completed by the end of fiscal 2003. The Company anticipates that the pre-tax cost of the manufacturing restructuring plan will be $12,500,000. The Company recorded pre-tax manufacturing restructuring plan costs of $5,831,000 in the fourth quarter of fiscal 2001, $651,000 in the third quarter of 2002 and $2,331,000 in the nine months ended September 30, 2002. The Company anticipates recording additional pre-tax costs of approximately $1,600,000 in the fourth quarter of 2002 and $2,700,000 in 2003 as it continues to implement the program. The manufacturing restructuring plan costs recorded in 2001 and the nine months in 2002 consist primarily of severance costs, asset write-downs and accelerated depreciation. The severance costs, which have been recorded as restructuring, are for 41 employees in manufacturing and administration groups, 40 of whom have been terminated as of September 30, 2002. Asset write-downs consist primarily of write-offs of inventory related to product lines that the Company has discontinued as part of this restructuring plan and they have been recorded in cost of goods sold. Accelerated depreciation is based on shorter estimated useful lives of certain fixed assets and has been recorded in cost of goods sold. The tax benefits of costs incurred and asset write-downs will approximate the amount of cash outlays to implement this program, which would allow the Company to complete the restructuring plan with a minimum consumption of cash. The Company estimates an annual pre-tax savings of approximately $5,000,000 following the completion of the plan. Details of our manufacturing restructuring plan through September 30, 2002 are as follows: Initial Utilized Balance Additional Utilized Remaining Provision During 2001 2001 Provisions During 2002 Balance --------- ----------- ---- ---------- ----------- ------- (in thousands) Restructuring/Other.... $1,454 $692 $762 $218 $586 $394 Asset Write-downs...... 4,300 4,300 -- 1,253 1,253 -- Other costs............ 77 77 -- 860 860 -- --------------------------------------------------------------------------------- Total.................. $5,831 $5,069 $762 $2,331 $2,699 $394 =================================================================================
11 6. Earnings per Share The following tables set forth the reconciliation of the calculation of earnings per share: For the Three Months Ended September 30, 2002 --------------------------------------------- Income Shares Per Share (Numerator) (Denominator) Amount ----------- ------------- ------ Basic EPS Net Income.................. $8,773,000 26,716,744 $0.33 Effect of Dilutive Securities Common Stock Equivalents.... -- 532,581 (0.01) ---------------------------------------------- Diluted EPS....................... $8,773,000 27,249,325 $0.32 ============================================== For the Three Months Ended September 30, 2001 --------------------------------------------- Income Shares Per Share (Numerator) (Denominator) Amount ----------- ------------- ------ Basic EPS Net Income.................. $7,809,000 26,527,312 $0.29 Effect of Dilutive Securities Common Stock Equivalents.... -- 310,852 -- ---------------------------------------------- Diluted EPS....................... $7,809,000 26,838,164 $0.29 ============================================== Stock options to purchase 758,803 shares of common stock were outstanding at September 30, 2001, but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares and therefore, the effect would have been antidilutive. For the Nine Months Ended September 30, 2002 -------------------------------------------- Income Shares Per Share (Numerator) (Denominator) Amount ----------- ------------- ------ Basic EPS Net Income.................. $25,462,000 26,629,981 $0.96 Effect of Dilutive Securities Common Stock Equivalents.... -- 481,681 (0.02) ---------------------------------------------- Diluted EPS...................... $25,462,000 27,111,662 $0.94 ============================================== For the Nine Months Ended September 30, 2001 -------------------------------------------- Income Shares Per Share (Numerator) (Denominator) Amount ----------- ------------- ------ Basic EPS Net Income.................. $22,117,000 26,496,534 $0.83 Effect of Dilutive Securities Common Stock Equivalent..... -- 352,972 (0.01) ---------------------------------------------- Diluted EPS....................... $22,117,000 26,849,506 $0.82 ============================================== Stock options to purchase 549,933 shares of common stock were outstanding at September 30, 2001, but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares and therefore, the effect would have been antidilutive. 12 7. Segment Information The following table presents certain operating segment information: (in thousands) Three months ended North September 30, 2002: America Europe Asia Corporate Consolidated - ------------------- ------- ------ ---- --------- ------------ Net Sales.......................... $114,135 $38,791 $6,885 $-- $159,811 Operating Income................... 14,863 4,016 529 (3,641) 15,767 Capital Expenditures............... 939 2,062 1,761 -- 4,762 Depreciation and Amortization...... 3,349 2,167 329 -- 5,845 Three months ended September 30, 2001: - ------------------- Net Sales.......................... $103,635 $31,474 $2,900 $-- $138,009 Operating Income................... 12,631 3,777 118 (2,094) 14,432 Capital Expenditures............... 1,927 544 131 -- 2,602 Depreciation and Amortization...... 3,895 1,699 185 -- 5,779 Nine months ended September 30, 2002: - ------------------- Net Sales.......................... $337,693 $102,006 $14,937 $-- $454,636 Operating Income................... 43,876 10,414 742 (9,929) 45,103 Capital Expenditures............... 4,352 5,396 7,219 -- 16,967 Depreciation and Amortization...... 11,152 5,455 824 -- 17,431 Identifiable Assets................ 378,686 205,358 47,378 -- 631,422 Nine months ended September 30, 2001: - ------------------- Net Sales.......................... $310,873 $89,249 $9,374 $-- $409,496 Operating Income................... 38,054 9,548 415 (6,694) 41,323 Capital Expenditures............... 8,532 1,623 1,384 -- 11,539 Depreciation and Amortization...... 11,969 4,883 544 -- 17,396 Identifiable Assets................ 349,395 162,368 24,651 -- 536,414
The above operating segments are presented on a basis consistent with the presentation included in the Company's December 31, 2001 financial statements. There have been no material changes in the identifiable assets of the individual segments since December 31, 2001. The corporate segment consists primarily of compensation expense for corporate headquarters' staff, professional fees, including legal and audit, and product and general liability insurances. 13 8. Other Comprehensive Income The accumulated balances for the components of the Other Comprehensive Income/(Loss) are: Accumulated Foreign Other Currency Cash Flow Comprehensive Translation Hedges Income/(Loss) ----------- ------ ------------- (in thousands) Balance December 31, 2000....... $(19,728) -- $(19,728) Change in period................ (5,034) 160 (4,874) ---------------------------------------------- Balance March 31, 2001.......... (24,762) 160 (24,602) Change in period................ (1,969) (134) (2,103) ---------------------------------------------- Balance June 30, 2001........... (26,731) 26 (26,705) Change in Period................ 4,770 29 4,799 ---------------------------------------------- Balance September 30, 2001...... $(21,961) 55 $(21,906) ============================================== Balance December 31, 2001....... $(24,281) -- $(24,281) Change in period................ (1,761) 32 (1,729) ---------------------------------------------- Balance March 31, 2002.......... (26,042) 32 (26,010) Change in period................ 12,458 68 12,526 ---------------------------------------------- Balance June 30, 2002........... (13,584) 100 (13,484) Change in period................ (1,832) (51) (1,883) ---------------------------------------------- Balance September 30, 2002...... $(15,416) 49 $(15,367) ============================================== Accumulated other comprehensive income/(loss) in the Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001 consists of cumulative translation adjustments and changes in the fair value of certain financial instruments that qualify for hedge accounting as required by FAS 133. The Company's total comprehensive income was as follows: Three Months Ended ------------------ September 30, ------------- 2002 2001 ---- ---- (in thousands) Net income..................................................... $8,773 $7,809 Unrealized gains/(loss) derivative instruments, net of tax..... (51) 29 Foreign currency translation adjustments....................... (1,832) 4,770 ------------------- Total comprehensive income..................................... $6,890 $12,608 ===================
Nine Months Ended ----------------- September 30, ------------- 2002 2001 ---- ---- (in thousands) Net income..................................................... $25,462 $22,117 Unrealized gains derivative instruments, net of tax............ 49 55 Foreign currency translation adjustments....................... 8,865 (2,233) --------------------- Total comprehensive income..................................... $34,376 $19,939 =====================
14 9. Acquisitions On July 29, 2002 a wholly-owned subsidiary of the Company acquired F&R Foerster and Rothmann GmbH located in Neuenburg am Rhein, Germany, for approximately 2.3 million euro in cash. F&R manufactures and distributes a line of gauges predominately to the French and German OEM markets. F&R's annual revenue, prior to the acquisition, was approximately 4 million euro. The September 30, 2002 Consolidated Balance Sheet of the Company contains a preliminary purchase price allocation consistent with the guidelines in FAS 141 and FAS 142. On July 15, 2002, a wholly-owned subsidiary of the Company acquired ADEV Electronic SA located in Rosieres, France and its closely affiliated distributor, E.K. Eminent A.B. located in Gothenburg, Sweden for approximately 12.9 million euro in cash. ADEV also has a low cost manufacturing facility located in Tunisia. ADEV manufactures and distributes electronic systems predominantly to the OEM market. Their product lines include thermostats and controls for heating, ventilation and air conditioning, control systems for hydronic and electric floor warming systems, and controls for other residential applications. Eminent distributes electronic controls, mechanical thermostats and other electric control related products throughout the European Nordic countries. The two companies' combined annual revenue preceding the acquisition was approximately 30 million euro. The September 30, 2002 Consolidated Balance Sheet of the Company contains a preliminary purchase price allocation consistent with the guidelines in FAS 141 and FAS 142. On May 9, 2002, a wholly-owned subsidiary of the Company acquired Hunter Innovations of Sacramento, California for $25 million, of which approximately $10 million was paid in cash at the closing and the balance in interest bearing notes, payable in equal installments over the next four years. Hunter Innovations was founded in 1995 as a technology development company and has developed a line of large backflow prevention devices that represent a significant advance in technology. The improved product features that are important to the backflow prevention markets include lighter weight, more compact design, better flow characteristics, improved serviceability and multiple end-connection and shutoff valve options. Hunter Innovations' sales during the twelve months preceding the acquisition were approximately $1.5 million. Unlike most of our acquisitions, Hunter did not have significant historical revenues or earnings. Nonetheless, the purchase price was based on projected revenues and earnings as utilized in other acquisitions. During the quarter ending September 30, 2002, the Company obtained a third party valuation to allocate the purchase price. Consistent with the guidelines in FAS 141, the allocation for goodwill was approximately $16.8 million and approximately $11.7 million was for intangibles, which are classified in "Other Assets: Other" in the Company's Consolidated Balance Sheet as of September 30, 2002. Of the $11.7 million of acquired intangible assets, $9.2 million was assigned to unpatented technology that are not subject to amortization and $2.5 million to patents (twenty-year useful life). The $16.8 million of goodwill was assigned to the North American segment, none of which is deductible for tax purposes. On March 5, 2002, the Company entered into a joint venture with the Yuhuan County Cheng Guan Metal Hose Factory ("Cheng Guan") located in Taizhou, Zhejiang Province of the People's Republic of China. Cheng Guan, with annual sales prior to the transaction of approximately $15 million, is a manufacturer of a variety of plumbing products sold both into the Chinese domestic market and export markets. Their product lines were contributed to the joint venture and include hose, hose connectors, multi-layer tubing and stainless steel braided hose. The joint venture is owned 60% by Watts and 40% by our Chinese partner. The Company has invested $7.8 million to obtain this 60% interest. The September 30, 2002 Consolidated Balance Sheet of the Company contains a preliminary purchase price allocation of the joint venture. The preliminary allocation for goodwill was approximately $3 million and approximately $2 million was for other amortizable intangibles, which are classified in "Other Assets: Other" in the Company's Consolidated Balance Sheet as of September 30, 2002. On September 28, 2001, a wholly-owned subsidiary of the Company acquired the assets of the Powers Process Controls Division of Mark Controls Corporation, a subsidiary of Crane Co. located in Skokie, Illinois and Mississauga, Ontario, Canada for approximately $13 million in cash. Powers designs and manufactures thermostatic mixing valves for personal safety and process control applications in commercial and institutional facilities. It also manufactures control valves and commercial plumbing brass products including shower valves and lavatory faucets. Powers annualized sales prior to the acquisition were approximately $20 million. 15 On June 13, 2001, a wholly-owned subsidiary of the Company acquired Premier Manufactured Systems, Inc., located in Phoenix, Arizona for approximately $5 million in cash. Premier manufactures water filtration systems for both residential and commercial applications and other filtration products including under-the-counter ultraviolet filtration as well as a variety of sediment and carbon filters. Premier's annualized sales prior to the acquisition were approximately $10 million. On June 1, 2001, a wholly-owned subsidiary of the Company acquired Fimet S.r.l. (Fabbrica Italiana Manometri e Terometri) located in Milan, Italy and its wholly-owned subsidiary, MTB AD, which is located in Bulgaria for approximately $6 million in cash. The acquired business manufactures pressure and temperature gauges for use in the HVAC market. Fimet's annualized sales prior to the acquisition were approximately $9 million. 10. Debt Issuance On February 28, 2002, the Company entered into a revolving credit facility with a syndicate of banks (the "Revolving Credit Facility"), which replaced the Company's $100 million (U.S.) facility and its 39,350,000 euro facility. The Revolving Credit Facility provides for borrowings of up to $150 million (U.S.), which includes a $100 million tranche for U.S. dollar borrowings and a $50 million tranche for euro based borrowings and matures in February 2005. Approximately $46 million of borrowings under the Revolving Credit Facility were used to repay amounts outstanding under the prior facilities. The Revolving Credit Facility is being used to support the Company's acquisition program, working capital requirements and for general corporate purposes. Outstanding indebtedness under the Revolving Credit Facility bears interest at one of three customary rates plus a margin of 100 basis points, depending on the applicable base rate and the Company's bond rating. The average interest rate for borrowings under the Revolving Credit Facility was approximately 3.3% at September 30, 2002. The Revolving Credit Facility includes operational and financial covenants customary for facilities of this type, including, among others, restrictions on additional indebtedness, liens and investments and maintenance of certain leverage ratios. As of September 30, 2002, the Company was in compliance with all covenants related to the Revolving Credit Facility. 11. Contingencies In April 1998, the Company became aware of a complaint that was filed under seal in the State of California alleging violations of the California False Claims Act (the "James Jones case"). The complaint alleges that a former subsidiary of the Company sold products utilized in municipal water systems that failed to meet contractually specified standards and falsely certified that such standards had been met. The complaint further alleges that the municipal entities have suffered tens of millions of dollars in damages as a result of defective products and seeks treble damages, reimbursement of legal costs and penalties. The original complaint has been amended, and the total number of named plaintiffs is 161, 14 of which have intervened and 47 of which have been ordered excluded from the case. In June 2001, the Company and the other defendants reached a proposed settlement with the Los Angeles Department of Water and Power ("LADWP"), one of the plaintiffs in the James Jones case, which was approved by the California Superior Court on October 31, 2001 and by the Los Angeles City Council on December 14, 2001. The other plaintiffs remain, and the Company is vigorously contesting this matter. The Company established initial reserves with respect to the James Jones case in the amount of $10,170,000 after tax, which amount was approximately $9,062,000 after tax as of September 30, 2002, and is classified under the item "Accrued expenses and other liabilities" in the Company's Consolidated Balance Sheet as of September 30, 2002. The Company presently believes, on the basis of all available information, that these reserves are adequate to cover the Company's probable and reasonably estimable losses resulting from the James Jones case. However, litigation is inherently uncertain and the Company believes that there exists a reasonable possibility that it may ultimately incur losses in the James Jones case in excess of the amount accrued for that matter. The Company is currently unable to make an estimate of the range of any additional losses. See Part II, Item 1, Legal Proceedings. Other lawsuits and proceedings or claims, arising from the ordinary course of operations, are also pending or threatened against the Company and its subsidiaries. Based on the facts presently known to it, the Company does not believe that the ultimate outcome of these other litigation matters will have a material adverse effect on its liquidity, financial condition or results of operations. 16 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS ----------------------------------------------------------------------- OF OPERATIONS ------------- Recent Developments - ------------------- On August 7, 2002, the Company announced the appointment of a new Chief Executive Officer, Patrick S. O'Keefe, to replace Timothy P. Horne who has resigned his position as Chief Executive Officer and Chairman of the Board. Mr. Horne will remain as a Director. The Board has nominated and elected Mr. Gordon W. Moran as its non-executive Chairman. Mr. Moran has served on the Board since 1990. Mr. O'Keefe has also been elected to the Board. On July 29, 2002 a wholly-owned subsidiary of the Company acquired F&R Foerster and Rothmann GmbH ("F&R") located in Neuenburg am Rhein, Germany, for approximately 2.3 million euro in cash. F&R manufactures and distributes a line of gauges predominately to the French and German OEM markets. F&R's annual revenue, prior to the acquisition, was approximately 4 million euro. The September 30, 2002 Consolidated Balance Sheet of the Company contains a preliminary purchase price allocation consistent with the guidelines in FAS 141 and FAS 142. On July 15, 2002, a wholly-owned subsidiary of the Company acquired ADEV Electronic SA ("ADEV") located in Rosieres, France and its closely affiliated distributor, E.K. Eminent A.B. ("Eminent") located in Gothenburg, Sweden for approximately 12.9 million euro in cash. ADEV also has a low cost manufacturing facility located in Tunisia. ADEV manufactures and distributes electronic systems predominantly to the OEM market. Their product lines include thermostats and controls for heating, ventilation and air conditioning, control systems for hydronic and electric floor warming systems, and controls for other residential applications. Eminent distributes electronic controls, mechanical thermostats and other electric control related products throughout the European Nordic countries. The two companies' combined annual revenue preceding the acquisition was approximately 30 million euro. The September 30, 2002 Consolidated Balance Sheet of the Company contains a preliminary purchase price allocation consistent with the guidelines in FAS 141 and FAS 142. On May 9, 2002, a wholly-owned subsidiary of the Company acquired Hunter Innovations of Sacramento, California for $25 million, of which approximately $10 million was paid in cash at the closing and the balance in interest bearing notes, payable in equal installments over the next four years. Hunter Innovations was founded in 1995 as a technology development company and has developed a line of large backflow prevention devices that represent a significant advance in technology. The improved product features that are important to the backflow prevention markets include lighter weight, more compact design, better flow characteristics, improved serviceability and multiple end-connection and shutoff valve options. Hunter Innovations' sales during the twelve months preceding the acquisition were approximately $1.5 million. Unlike most of our acquisitions, Hunter did not have significant historical revenues or earnings. Nonetheless, the purchase price was based on projected revenues and earnings as utilized in other acquisitions. During the quarter ending September 30, 2002, the Company obtained a third party valuation to allocate the purchase price. Consistent with the guidelines in FAS 141, the allocation for goodwill was approximately $16.8 million and approximately $11.7 million was for intangibles, which are classified in "Other Assets: Other" in the Company's Consolidated Balance Sheet as of September 30, 2002. Of the $11.7 million of acquired intangible assets, $9.2 million was assigned to unpatented technology that are not subject to amortization and $2.5 million to patents (twenty-year useful life). The $16.8 million of goodwill was assigned to North American segment, none, of which, is deductible for tax purposes. On March 5, 2002, the Company entered into a joint venture with the Yuhuan County Cheng Guan Metal Hose Factory ("Cheng Guan") located in Taizhou, Zhejiang Province of the People's Republic of China. Cheng Guan, with annual sales prior to the transaction of approximately $15 million, is a manufacturer of a variety of plumbing products sold both into the Chinese domestic market and export markets. Its product lines were contributed to the joint venture and include hose, hose connectors, multi-layer tubing and stainless steel braided hose. The joint venture is owned 60% by us and 40% by our Chinese partner. We have invested $7.8 million to obtain this 60% interest. Our September 30, 2002, Consolidated Balance Sheet contains a preliminary purchase price allocation of the joint venture. The preliminary allocation for goodwill was approximately $3 million and approximately $2 million was for other amortizable 17 intangibles, which are classified in "Other Assets: Other" in the Company's Consolidated Balance Sheet as of September 30, 2002. As part of our $18.7 million capital expenditure budget for fiscal 2002, we expected to invest approximately $9.0 million to establish a 100% controlled bronze and brass manufacturing plant in Tianjin, China. We anticipate that the construction of the plant will be completed in early 2003. Any remaining costs will be disbursed over the next two quarters. As of September 30, 2002, we have spent approximately $4.7 million. The Company is implementing a plan to consolidate several of its manufacturing plants both in North America and Europe. At the same time it is expanding its manufacturing capacity in China. The implementation of this manufacturing restructuring plan began during the fourth quarter of fiscal 2001. The projects, for which charges were recorded in the fourth quarter of fiscal 2001, are essentially complete. The Company decided to expand the scope of the manufacturing restructuring plan and transfer certain production to low cost manufacturing plants in Tunisia and Bulgaria. The expanded plan is expected to be completed by the end of fiscal 2003. The Company anticipates that the pre-tax cost of the manufacturing restructuring plan will be $12,500,000. The Company recorded pre-tax manufacturing restructuring plan costs of $5,831,000 in the fourth quarter of fiscal 2001, $651,000 in the third quarter of 2002 and $2,331,000 in the nine months ended September 30, 2002. The Company anticipates recording additional pre-tax costs of approximately $1,600,000 in the fourth quarter of 2002 and $2,700,000 in 2003 as it continues to implement the program. The manufacturing restructuring plan costs recorded in 2001 and the nine months in 2002 consist primarily of severance costs, asset write-downs and accelerated depreciation. The severance costs, which have been recorded as restructuring, are for 41 employees in manufacturing and administration groups, 40 of whom have been terminated as of September 30, 2002. Asset write-downs consist primarily of write-offs of inventory related to product lines that the Company has discontinued as part of this restructuring plan and they have been recorded in cost of goods sold. Accelerated depreciation is based on shorter estimated useful lives of certain fixed assets and has been recorded in cost of goods sold. The tax benefits of costs incurred and asset write-downs will approximate the amount of cash outlays to implement this program, which would allow the Company to complete the restructuring plan with a minimum consumption of cash. The Company estimates an annual pre-tax savings of approximately $5,000,000 following the completion of the plan. Results of Operations - --------------------- Three Months Ended September 30, 2002 Compared to Three Months Ended September - ------------------------------------------------------------------------------ 30, 2001 - -------- Net Sales. Net sales for the three months ended September 30, 2002 increased $21,802,000 (15.8%) to $159,811,000 compared to $138,009,000 for the same period in 2001. The increase in net sales is attributable to the following: (in thousands) Internal Growth..................... $5,559 4.0% Acquisitions........................ 14,415 10.5% Foreign Exchange.................... 1,828 1.3% ------------------------------ Total Change........................ $21,802 15.8% ============================== The increase in internal growth of net sales is primarily due to increased unit shipments into the North American do-it-yourself market. The growth in net sales from acquired businesses is due to the inclusion of the net sales of Powers Process Controls, acquired on September 28, 2001; Cheng Guan, our joint venture, which we established on March 5, 2002; ADEV and Eminent, acquired on July 15, 2002; and F&R, acquired on July 29, 2002. The increase in foreign exchange is due primarily to the euro appreciating against the U.S. dollar compared to the same period in 2001. We monitor our net sales in three geographical segments: North America, Europe and Asia. As outlined below, North America, Europe and Asia accounted for 71.4%, 24.3% and 4.3% of net sales, respectively, in the three 18 months ended September 30, 2002, compared to 75.1%, 22.8% and 2.1% of net sales, respectively, in the three months ended September 30, 2001: September 30, September 30, Change ------------- ------------- ------ 2002 2001 ---- ---- (in thousands) North America........ $114,135 $103,635 $10,500 Europe............... 38,791 31,474 7,317 Asia................. 6,885 2,900 3,985 ----------------------------------------------- Total................ $159,811 $138,009 $21,802 =============================================== The increase in North America's net sales is due to the Powers Process Controls acquisition and increased unit shipments in the do-it-yourself market. The increase in Europe's net sales is primarily due to the ADEV, Eminent and F&R acquisitions and to a lesser extent, the euro appreciating against the U.S. dollar compared to the same period in 2001. The increase in Asia's net sales is primarily due to the inclusion of our Cheng Guan joint venture. Gross Profit. Gross profit for the three months ended September 30, 2002 increased $6,564,000 (14.0%) to $53,507,000 from $46,943,000 for the comparable quarter last year and decreased as a percentage of net sales to 33.5% from 34.0%. We charged $312,000 of costs incurred due to our manufacturing restructuring plan to cost of sales in the current quarter. Excluding the manufacturing restructuring plan costs, our gross profit would have increased $6,876,000 and decreased as a percentage of sales to 33.7% from 34.0%. The gross profit increase is primarily attributable to inclusion of the acquired companies. The gross profit percentage decrease is primarily due to lower gross profit percentages of acquired companies partially offset by reduced spending in manufacturing fixed overhead as well as improved efficiencies in manufacturing compared to the comparable quarter last year. Selling, General and Administrative Expense. Selling, general and administrative expenses for the three months ended September 30, 2002 increased $5,021,000 (15.4%) to $37,532,000 compared to $32,511,000 for the same period in 2001. This increase is attributable to the inclusion of selling, general and administrative expenses of acquired companies, an increase in the cost of product and general liability insurance and the euro appreciating against the U.S. dollar compared to the prior period. We adopted FAS 142 "Goodwill and Other Intangible Assets" on January 1, 2002, and accordingly did not record goodwill amortization for the quarter ended September 30, 2002. We recorded goodwill amortization of $841,000 as part of our selling, general and administrative expenses in the quarter ended September 30, 2001. Restructuring Expense. The restructuring expense is for severance costs associated with our manufacturing restructuring plan. Operating Income. Operating income for the three months ended September 30, 2002, increased $1,335,000 (9.3%) to $15,767,000 compared to $14,432,000 for the same period in 2001 due to increased gross profit and the cessation of goodwill amortization, partially offset by increased selling, general and administrative expenses. The manufacturing restructuring plan costs reduced operating income by $520,000. 19 Our operating income by segment for the three months ended September 30, 2002, and 2001 was as follows: September 30, September 30, Change ------------- ------------- ------ 2002 2001 ---- ---- (in thousands) North America............ $14,863 $12,631 $2,232 Europe................... 4,016 3,777 239 Asia..................... 529 118 411 Corporate................ (3,641) (2,094) (1,547) ------------------------------------------------ Total.................... $15,767 $14,432 $1,335 ================================================ The increase in North America is primarily due to the inclusion of operating earnings of the Powers Process Controls acquisition. The increase in Europe is primarily due to the inclusion of operating earnings of acquired companies. Corporate expenses are primarily for compensation expense, professional fees, including legal and audit expenses, product and general liability insurances. The increase in corporate expenses is primarily due to increased premiums for product and general liability insurance and administrative start-up costs associated with our new manufacturing plant in China. Interest Expense. Interest expense decreased $140,000 in the quarter ended September 30, 2002 to $2,447,000 compared to $2,587,000 for the same period in 2001, primarily due to lower interest rates on variable rate indebtedness partially offset by increased indebtedness incurred to fund acquisitions. On September 1, 2001, we entered into an interest rate swap on our $75,000,000 8 3/8% notes. The swap converted the interest from fixed to floating. On August 5, 2002, we sold the swap and received $2,315,000 in cash, which was recognized as a deferred liability. In the quarter ended September 30, 2002, we reduced interest expense by $327,000 by amortizing this deferred liability. Income Taxes. Our effective tax rate for continuing operations increased to 34.2% from 33.7% for the three months ended September 30, 2002 and 2001, respectively. The increase is primarily attributable to the increased earnings in the North American segment, which has a higher tax rate than our other segments, partially offset by the elimination of goodwill, which was not tax deductible. Net Income From Continuing Operations. Net income for the three months ended September 30, 2002 increased $964,000 (12.3%) to $8,773,000, or $0.32 per common share, compared to $7,809,000, or $0.29 per common share, for the three months ended September 30, 2001 on a diluted basis. Nine Months Ended September 30, 2002 Compared to Nine Months Ended September 30, - -------------------------------------------------------------------------------- 2001 - ---- Net Sales. Net sales for the nine months ended September 30, 2002 increased $45,140,000 (11.0%) to $454,636,000 compared to $409,496,000 for the same period in 2001. The increase in net sales is attributable to the following: (in thousands) Internal Growth................ $6,218 1.5% Acquisitions................... 35,614 8.7% Foreign Exchange............... 3,308 0.8% ----------------------------------- Total Change................... $45,140 11.0% =================================== The increase in internal growth of net sales is due to increased unit shipments into the North American do-it-yourself market partially offset by decreased unit shipments to North American plumbing and heating wholesalers. The growth in net sales from acquired businesses is due to the inclusion of the net sales of Powers Process Controls, acquired on September 28, 2001; Premier Manufactured Systems, acquired on June 13, 2001; Fimet S.r.l., acquired on June 1, 2001; Cheng Guan, our joint venture, which we established on March 5, 2002; ADEV and Eminent, acquired on July 20 14, 2002; and F&R, acquired on July 29, 2002. The increase in foreign exchange is due primarily to the euro appreciating against the U.S. dollar compared to the same period in 2001. We monitor our net sales in three geographical segments: North America, Europe and Asia. As outlined below, North America, Europe and Asia accounted for 74.3%, 22.4% and 3.3% of net sales, respectively, in the nine months ended September 30, 2002, compared to 75.9%, 21.8% and 2.3% of net sales, respectively, in the nine months ended September 30, 2001: September 30, September 30, Change ------------- ------------- ------ 2002 2001 ---- ---- (in thousands) North America........... $337,693 $310,873 $26,820 Europe.................. 102,006 89,249 12,757 Asia.................... 14,937 9,374 5,563 ---------------------------------------------------- Total................... $454,636 $409,496 $45,140 ==================================================== The increase in North America's net sales is due to the Powers Process Controls and Premier acquisitions and increased unit shipments into the North American do-it-yourself market partially offset by decreased unit shipments to the North American plumbing and heating wholesalers. The increase in Europe's net sales is due primarily to the Fimet, ADEV, Eminent and F&R acquisitions and the euro appreciating against the U.S. dollar. The increase in Asia's net sales is primarily due to the inclusion of our Cheng Guan joint venture. Gross Profit. Gross profit for the nine months ended September 30, 2002 increased $15,262,000 (10.9%) to $155,218,000 from $139,956,000 for the comparable period last year and decreased as a percentage of net sales to 34.1% from 34.2%. We charged $1,873,000 of costs associated with our manufacturing restructuring plan to cost of sales. Excluding the manufacturing restructuring plan costs, our gross profit would have increased $17,135,000 and would have increased as a percentage of sales to 34.6% from 34.2%. The gross profit increase is primarily attributable to the inclusion of acquired companies. The gross profit percentage increase is primarily attributable to reduced spending in manufacturing fixed overhead as well as improved efficiencies in manufacturing compared to the comparable period last year partially offset by lower gross profit percentages from acquired companies. Selling, General and Administrative Expense. Selling, general and administrative expenses for the nine months ended September 30, 2002 increased $11,264,000 (11.4%) to $109,897,000 compared to $98,633,000 for the same period in 2001. This increase is attributable to the inclusion of selling, general and administrative expenses of acquired companies, an increase in the cost of product and general liability insurance and start-up costs associated with our regional distribution centers. We adopted FAS 142 "Goodwill and Other Intangible Assets" on January 1, 2002 and accordingly did not record goodwill amortization for the first nine months of 2002. We recorded goodwill amortization of $2,376,000 as part of our selling, general and administrative expenses for the nine months ended September 30, 2001. Restructuring Expense. The restructuring expense is for severance costs associated with our manufacturing restructuring plan. Operating Income. Operating income for the nine months ended September 30, 2002, increased $3,780,000 (9.2%) to $45,103,000 compared to $41,323,000 for the same period in 2001 due to increased gross profit and the cessation of goodwill amortization, partially offset by increased selling, general and administrative expenses. The manufacturing restructuring plan costs reduced operating income by $2,091,000. 21 Our operating income by segment for the nine months ended September 30, 2002, and 2001, were as follows: September 30, September 30, Change 2002 2001 ------ ---- ---- (in thousands) North America........... $43,876 $38,054 $5,822 Europe.................. 10,414 9,548 866 Asia.................... 742 415 327 Corporate............... (9,929) (6,694) (3,235) --------------------------------------------------- Total................... $45,103 $41,323 $3,780 =================================================== The increase in North America is due to increased gross profit, primarily due to the inclusion of operating earnings of acquired companies. The increase in Europe is due to the inclusion of the operating earnings of acquired companies and by the euro appreciating against the U.S. dollar compared to the prior year. Corporate expenses are primarily for compensation expense, professional fees, including legal and audit expenses, product liability and general liability insurances. The increase in corporate expenses is primarily due to increased premiums for product and general liability insurance and administrative start-up costs associated with our new manufacturing plant in China. Interest Expense. Interest expense decreased $819,000 in the nine months ended September 30, 2002, to $6,576,000 compared to $7,395,000 for the same period in 2001, primarily due to lower interest rates on variable rate indebtedness, partially offset by increased indebtedness incurred to fund acquisitions. On September 1, 2001, we entered into an interest rate swap on our $75,000,000 8 3/8% notes. The swap converted the interest from fixed to floating. On August 5, 2002, we sold the swap and received $2,315,000 in cash, which was recognized as a deferred liability. Interest expense for the nine months ended September 30, 2002, has been reduced by $1,318,000 by the effectiveness of the swap and by the amortization of the deferred liability. Income Taxes. Our effective tax rate for continuing operations remained at 34.7% for the nine months ended September 30, 2002 and 2001, respectively. The rate remains constant due to the elimination of goodwill amortization which was not tax deductible, offset by a change in earnings mix to jurisdictions that have higher tax rates. Net Income From Continuing Operations. Net income for the nine months ended September 30, 2002 increased $3,345,000 (15.1%) to $25,462,000, or $0.94 per common share, compared to $22,117,000, or $0.82 per common share, for the nine months ended September 30, 2001 on a diluted basis. Liquidity and Capital Resources - ------------------------------- During the nine month period ended September 30, 2002, we provided $21,732,000 of cash flow from continuing operations. We spent $14,084,000 on capital equipment for the nine months ended September 30, 2002, net of proceeds of $2,883,000, primarily from the sale of a facility that was closed as part of our manufacturing restructuring plan. Capital expenditures were primarily for manufacturing machinery and equipment as part of our commitment to continuously improve our manufacturing capabilities. Our net capital expenditure budget for the twelve months ending December 31, 2002 is $18,700,000, which includes the expected proceeds from the sale of two of our facilities that were closed as part of our manufacturing restructuring plan. The largest component of this budget is the establishment of a 100% controlled bronze and brass manufacturing plant in Tianjin, China, for an estimated cost of $9,000,000, of which approximately $4,700,000 was invested in the nine months ended September 30, 2002. In addition, during the nine months ended September 30, 2002, we invested approximately $5,000,000 to establish our joint venture in China, $10,000,000 to acquire Hunter Innovations, and approximately $10,500,000 for our three acquisitions in Europe, ADEV, Eminent and F&R. We had positive free cash flow of $2,788,000 (defined as net cash provided by continuing operations minus capital expenditures and dividends plus proceeds from sale of assets) during the nine months ended September 30, 2002 22 versus positive free cash flow of $17,148,000 in the comparable prior year period. The decrease in free cash flow is attributable to a decrease in cash provided by operations and increased capital spending compared to the comparable period of fiscal 2001. The decrease in cash provided from operations is primarily due to an increase in accounts receivable between September 30, 2002 and December 31, 2001. This increase in accounts receivable is due to increased sales volume, a change in industry-wide payment terms from our largest customer while remaining within normal industry standards, and the addition of receivables from our Cheng Guan joint venture established in March 2002. On September 6, 2002, we received $9,524,000 of cash from Zurich American Insurance Company for reimbursement of defense costs incurred by us in the James Jones case since April 23, 1998. This cash, net of tax, is classified as discontinued operations in our Consolidated Statements of Cash Flows. On February 28, 2002, we entered into a revolving credit facility with a syndicate of banks (the "Revolving Credit Facility"), which replaced our $100.0 million (U.S.) facility and our 39.4 million euro facility. The Revolving Credit Facility provides for borrowings of up to $150.0 million (U.S.), which includes a $100.0 million tranche for U.S. dollar borrowings and a $50.0 million tranche for euro-based borrowings and matures in February 2005. Approximately $46.0 million of borrowings under the Revolving Credit Facility were used to repay amounts outstanding under the prior facilities. The Revolving Credit Facility is being used to support our acquisition program, working capital requirements and for general corporate purposes. As of September 30, 2002, long-term debt included $69.9 million outstanding on the Revolving Credit Facility for both U.S. dollar and euro-based borrowings. Outstanding indebtedness under the Revolving Credit Facility bears interest at one of three customary rates plus a margin of 100 basis points, depending on the applicable base rate and our bond rating. The average interest rate for borrowings under the Revolving Credit Facility was approximately 3.3% at September 30, 2002. The Revolving Credit Facility includes operational and financial covenants customary for facilities of this type, including, among others, restrictions on additional indebtedness, liens and investments and maintenance of certain leverage ratios. As of September 30, 2002, we were in compliance with all covenants related to the Revolving Credit Facility. Working capital (defined as current assets less current liabilities) as of September 30, 2002 was $167.8 million compared to $142.6 million as of December 31, 2001. This increase is primarily due to the increase in accounts receivable. The ratio of current assets to current liabilities was 2.1 to 1 as of September 30, 2002 compared to 2.3 to 1 as of December 31, 2001. Cash and cash equivalents were $16.1 million as of September 30, 2002 compared to $12.0 million as of December 31, 2001. The increase in long-term debt to $160.0 million as of September 30, 2002 from $123.2 million as of December 31, 2001 was due to the funding of acquisitions, the increase in working capital and debt incurred to fund capital expenditures. Net debt to capitalization (defined as short and long term interest-bearing liabilities less cash and cash equivalents as a percentage of the sum of short and long term interest-bearing liabilities less cash and cash equivalents plus total stockholders equity, including minority interest) was 34.4% as of September 30, 2002 compared to 31.2% as of December 31, 2001. We anticipate that available funds from current operations and other sources of liquidity will be sufficient to meet current operating requirements and anticipated capital expenditures for at least the next 24 months. However, we may have to consider external sources of financing for any large future acquisitions. Our long-term financial obligations are presented in the following table: Less than After Total 1 year 1-3 years 4-5 years 5 years ----- ------ --------- --------- ------- (in thousands) Long-term debt, including current maturities(a).... $169,189 $9,211 $154,296 $4,724 $958 Operating leases................................... 2,484 894 1,441 149 -- ---------------------------------------------------------- Total.............................................. $171,673 $10,105 $155,737 $4,873 $958 ==========================================================
(a) as recognized in the consolidated balance sheet 23 Letters of credit are purchased guarantees that ensure our performance or payment to third parties in accordance with specified terms and conditions. Amounts outstanding were approximately $19,551,000 as of September 30, 2002 and $16,443,000 as of September 30, 2001. These instruments may exist or expire without being drawn down. Therefore, they do not necessarily represent future cash flow obligations. Certain of our loan agreements contain covenants that require, among other items, the maintenance of certain financial ratios and limit our ability to enter into secured borrowing arrangements. We from time to time are involved with environmental proceedings and other legal proceedings and incur costs on an ongoing basis related to these matters. We have not incurred material costs in fiscal 2002 in connection with any of these matters. During the first nine months of 2002, we disbursed approximately $3.1 million after-tax of defense and settlement costs related to the James Jones case. In September 2002, we received $5.7 million after tax for reimbursement of defense costs related to the James Jones case. These amounts are recorded as discontinued operations in our consolidated statement of cash flows. See Part II, Item 1, Legal Proceedings. Critical Accounting Policies and Key Estimates - ---------------------------------------------- Our management considers the following accounting policies and key estimates as being critical in reporting our financial position and results of operations. o The proper application of revenue recognition criteria requires certain judgments and estimates, including the assessment of credit risk and sales return rates. Our management has used its best estimates based on historic trends to establish these reserves. o The valuation of inventory includes forecasted demand and anticipated market pricing for our products. o Contingencies and environmental remediation costs include estimates for clean-up costs which could be paid over several years. Estimates are based on management and legal counsel's best estimates of ultimate liability. o The liability reserve for the James Jones case, included in discontinued operations, is based on management and legal counsel's best estimate of defense and settlement costs, taking into consideration the probable number of parties involved in the suit and the recoveries received from the Company's insurers. o Product liability costs are estimated utilizing historic trends, considering known insurance recoveries. o In accounting for costs relating to the manufacturing restructuring plan, certain estimates have been made in measuring the cost of the plan and the impact on operations, including the estimated timing of facility closures. Our management believes that the estimates and assessments inherent in the application of these accounting policies have been applied on a reasonable basis. Actual results could differ from these estimates and assumptions, which could impact our financial position and results of operations. New Accounting Standards - ------------------------ In August 2001, the FASB issued Financial Accounting Standards Board Statement No. 143, "Accounting for Asset Retirement Obligations" ("FAS 143") which requires companies to record the fair value of an asset retirement obligation as a liability in the period it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal use of the assets. The company must also record a corresponding increase in the carrying value of the related long-lived asset and depreciate that cost over the remaining useful life of the asset. The liability must be increased each period for the passage of time with the offset recorded as an operating expense. The liability must also be adjusted for changes in the estimated future cash flows underlying the initial fair value measurement. Companies must also recognize a gain or loss on the settlement of the 24 liability. The provisions of FAS 143 are effective for fiscal years beginning after June 15, 2002. At the date of the adoption of FAS 143, companies are required to recognize a liability for all existing asset retirement obligations and the associated asset retirement costs. We are currently evaluating the effect that the adoption of FAS 143 will have on our results of operations and our financial position. Effective January 1, 2002, the Company also adopted FAS 144, which addresses the accounting and reporting for the impairment or disposal of long-lived assets. FAS 144 supercedes Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("FAS 121") but retains many of the fundamental provisions of FAS 121. FAS 144 also supercedes the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB 30") for the disposal of a segment of a business. However, FAS 144 retains the requirements of APB 30 to report discontinued operations separately and extends that reporting requirement to components of an entity that has either been disposed of or is classified as held for sale. FAS 144 excludes goodwill and other intangibles that are not amortized from its scope. For assets to be held and used, FAS 144 addresses the recoverability of an asset or group of assets, clarifies how an impairment loss should be allocated, and creates a requirement to use a fair value if market prices are not available and uncertainties exist about the timing and amount of cash flows. For long-lived assets to be disposed of by sale, FAS 144 establishes the criteria to be met to qualify for this classification, defines the timing of when the related sale must be consummated, eliminates the net realizable value measurement approach for segments of a business and certain acquired assets in a business combination, and defines costs to sell the asset. FAS 144 was effective for fiscal years beginning after December 15, 2001 and its adoption was not material to our consolidated financial statements. In April 2002, FAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued. FAS 145 rescinds FAS 4 and FAS 64 related to classification of gains and losses on debt extinguishment such that most debt extinguishment gains and losses will no longer be classified as extraordinary. FAS 145 also amends FAS 13 with respect to sales-leaseback transactions. The Company adopted the provisions of FAS 145 effective April 1, 2002, and its adoption was not material to our consolidated financial statements. In July 2002, the FASB issued FAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The principal difference between this Statement and Issue 94-3 relates to its requirements for recognition of a liability for a cost associated with an exit or disposal activity. This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as defined in Issue 94-3 was recognized as the date of an entity's commitment to an exit plan. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. Item 3. Quantitative and Qualitative Disclosures about Market Risks ----------------------------------------------------------- We use derivative financial instruments primarily to reduce our exposure to adverse fluctuations in foreign exchange rates, interest rates and prices of certain raw materials used in the manufacturing process. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all derivative positions are used to reduce risk by hedging underlying economic exposure. The derivatives we use are instruments with liquid markets. Our consolidated earnings, which are reported in U.S. dollars, are subject to translation risks due to changes in foreign currency exchange rates. However, our overall exposure to such fluctuations is reduced by the diversity of our foreign operating locations which encompass a number of different European locations, Canada and China. Our foreign subsidiaries transact most business, including certain intercompany transactions, in foreign currencies. Such transactions are principally purchases or sales of materials and are denominated in European currencies or the U.S. or Canadian dollar. We use foreign currency forward exchange contracts to manage the risk related to intercompany purchases that occur during the course of a fiscal year and certain open foreign currency denominated commitments to sell products to third parties. 25 We have historically had a very low exposure to changes in interest rates. Interest rate swaps are used on a limited basis to mitigate the impact of interest rate fluctuations on certain variable rate debt instruments. However, our Revolving Credit Facility is subject to the impact of changes in interest rates. We purchase significant amounts of bronze ingot, brass rod and cast iron which are utilized in manufacturing our many product lines. Our operating results can be adversely affected by changes in commodity prices if we are unable to pass on related price increases to our customers. We manage this risk by monitoring related market prices, working with our suppliers to achieve the maximum level of stability in their costs and related pricing, seeking alternative supply sources when necessary and passing increases in commodity costs to our customers, to the maximum extent possible, when they occur. Additionally, on a limited basis, we use commodity futures contracts to manage this risk. Certain Factors Affecting Future Results - ---------------------------------------- This report includes statements which are not historical facts and are considered forward looking within the meaning of the Private Securities Litigation Reform Act of 1995. These forward looking statements reflect the Company's current views about future results of operation and other forward looking information and may be identified by their use of words like "plan", "believe", "expect", "will", "anticipate", "estimate" and other words of similar meaning. You should not rely on forward looking statements, because the Company's actual results may differ materially from those indicated by these forward looking statements as a result of a number of important factors. These factors include, but are not limited to, the following: loss of market share through competition, introduction of competing products by other companies, pressure on prices from competitors, suppliers, and/or customers, failure or delay in developing new products, lack of acceptance of new products, failure to manufacture products that meet required performance and safety standards, foreign exchange fluctuations, cyclicality of industries, such as plumbing and heating wholesalers and home improvements retailers, in which the Company markets certain of its products, reductions in the supply of raw materials, increases in the prices of raw materials, economic factors, such as the levels of housing starts and remodeling, impacting the markets where the Company's products are sold, manufactured, or marketed, environmental compliance costs, product liability risks, the results and timing of the Company's manufacturing restructuring plan, changes in the status of current litigation, including the James Jones case, and other risks and uncertainties discussed under "Managements Discussion and Analysis of Financial Condition and Results of Operation - Certain Factors Affecting Future Results" in the Company's Annual Report on Form 10-K for the year ended December 31, 2001 filed with the Securities Exchange Commission and other reports Watts files from time to time with the Securities and Exchange Commission. Item 4. Controls and Procedures ----------------------- (a) Evaluation of disclosure controls and procedures. As required by new Rule 13a-15 under the Securities Exchange Act of 1934, within the 90 days prior to the date of this report, the Company carried out an evaluation under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. In connection with the new rules, we currently are in the process of further reviewing and documenting our disclosure controls and procedures, including our internal controls and procedures for financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business. (b) Changes in internal controls. None. 26 Part II - ------- Item l. Legal Proceedings ----------------- We are subject to a variety of potential liabilities connected with our business operations, including potential liabilities and expenses associated with possible product defects or failures and compliance with environmental laws. We maintain product liability and other insurance coverage, which we believe to be generally in accordance with industry practices. Nonetheless, such insurance coverage may not be adequate to protect us fully against substantial damage claims which may arise from product defects and failures. James Jones Litigation - ---------------------- On June 25, 1997, Nora Armenta (the "Relator") sued James Jones Company, Watts Industries, Inc. (which formerly owned James Jones), Mueller Co. and Tyco International (U.S.) in the California Superior Court for Los Angeles County with a complaint that sought tens of millions of dollars in damages. By this complaint and an amended complaint filed on November 4, 1998 ("First Amended Complaint"), Armenta, a former employee of James Jones, sued on behalf of 34 municipalities as a qui tam plaintiff under the California False Claims Act (the "Armenta case"). Late in 1998, the Los Angeles Department of Water and Power ("LADWP") intervened. In December 2000, the court allowed the Relator to file a Second Amended Complaint, which added a number of new cities and water districts as plaintiffs and brought the total number of plaintiffs to 161. On June 3, 2002, the California Superior Court excluded 47 cities from this total of 161. The Relator was not able to obtain appellate modification of this order. To date, 14 of the total number of plaintiffs have intervened. The First Amended Complaint alleges that our former subsidiary (James Jones Company) sold products that did not meet contractually specified standards used by the named municipalities for their water systems and falsely certified that such standards had been met. The Relator claims that these municipalities were damaged by their purchase of these products and seeks treble damages, legal costs, attorneys' fees and civil penalties under the False Claims Act. The LADWP's intervention, filed on December 9, 1998, adopted the First Amended Complaint and added claims for breach of contract, fraud and deceit, negligent misrepresentation and unjust enrichment. The LADWP also sought past and future reimbursement costs, punitive damages, contract difference in value damages, treble damages, civil penalties under the False Claims Act and costs of the suit. One of the First Amended Complaint's allegations is the suggestion that because some of the purchased James Jones products are out of specification and contain more lead than the `85 bronze specified, a risk to public health might exist. This contention is predicated on the average difference of about 2% lead content in `81 bronze (6% to 8% lead) and `85 bronze (4% to 6% lead) alloys and the assumption that this would mean increased consumable lead in public drinking water. The evidence and discovery available to date indicate that this is not the case. In addition, bronze that does not contain more than 8% lead, like `81 bronze, is approved for municipal and home plumbing systems by municipalities and national and local codes and the Federal Environmental Protection Agency defines metal for pipe fittings with no more than 8% lead as "lead free" under Section 1417 of the Federal Safe Drinking Water Act. In June 2001, our company and the other defendants reached a proposed settlement with the LADWP, one of the plaintiffs, which was approved by the California Superior Court on October 31, 2001 and by the Los Angeles City Council on December 14, 2001. The plaintiff seeks three times an unspecified amount of actual damages and alleges that the municipalities have suffered hundreds of millions of dollars in damages. The plaintiff also seeks civil penalties of $10,000 for each false claim and alleges that defendants are responsible for tens of thousands of false claims. We settled with the City of Los Angeles, by far the most significant city, for $5.7 million plus the Relator's statutory share and attorneys' fees. Co-defendants will contribute $2 million toward this settlement. The court has required the plaintiff to select cities with the strongest claims to be tried first. After we settled with the City of Los Angeles, the plaintiff made an offer to settle the 27 balance of this case for $121.9 million, which we have rejected. We have a reserve in the amount of $9.1 million after-tax with respect to the James Jones litigation in our consolidated balance sheet as of September 30, 2002. We believe, on the basis of all available information, that this reserve is adequate to cover our probable and reasonably estimable losses resulting from the James Jones litigation. We have provided for our estimates of probable losses for certain aspects of this case, which we believe are reasonably estimable. For other aspects of this case, we are unable to estimate a range of loss. However, litigation is inherently uncertain, and we believe that there exists a reasonable possibility that we may ultimately incur losses in the James Jones litigation in excess of the amount accrued. We are currently unable to make an estimate of the range of any additional losses. On February 14, 2001, Watts filed a complaint in the California Superior Court against its insurers for coverage of the claims in the Armenta case. The James Jones Company filed a similar complaint, the cases were consolidated, and on October 30, 2001 the California Superior Court made a summary adjudication ruling that Zurich American Insurance Company must pay all reasonable defense costs incurred by us in the Armenta case since April 23, 1998 as well as our future defense costs in this case until its final resolution. Zurich appealed the October 30, 2001 ruling, and on March 7, 2002, the California Court of Appeal granted Watts' motion to dismiss Zurich's appeal. After the trial court's resolution of the coverage case, Zurich can then appeal this ruling. On September 5, 2002, in compliance with the October 30, 2001 ruling, Zurich paid Watts approximately $9.5 million of defense costs which includes 10% interest that Watts had previously submitted to Zurich for payment. Zurich has asserted that this amount is subject to reimbursement under Deductible Agreements between Watts and Zurich. Management and counsel anticipate that the Company will still be challenged but that it will ultimately prevail on this issue. On October 24, 2002, the California Superior Court made another summary adjudication ruling that Zurich must indemnify and pay Watts for the amounts Watts must pay under its settlement agreement with the City of Los Angeles. Zurich will be able to appeal this ruling. We are currently unable to predict the outcome of the litigation relating to the Los Angeles indemnification coverage. We intend to continue to contest vigorously the Armenta case and its related litigation. Asbestos Litigation - ------------------- As of September 30, 2002, the Company was a defendant in approximately 55 actions filed in Mississippi and New Jersey state courts alleging injury or death as a result of exposure to asbestos. These filings typically name multiple defendants and are filed on behalf of many plaintiffs. They do not identify any products of the Company as a source of asbestos exposure. Based on the facts presently known to it, the Company does not believe this litigation will have a material adverse effect on its liquidity, financial condition or results of operations. Environmental - ------------- Our foundry and other operations, including our storage and disposal of solid and hazardous wastes, are subject to various foreign, federal, state and local laws and regulations relating to environmental matters. Compliance with these laws and regulations requires us to incur expenses and monitor our operations on an ongoing basis. We are currently a party to or otherwise involved in various administrative or legal proceedings under federal, state or local environmental laws or regulations involving a limited number of our sites or third party disposal sites. In addition, there may be soil or groundwater contamination at current or previously owned or operated properties or at third party sites to which our waste is sent for disposal. Based on facts presently known to us, we do not believe that the outcome of these environmental proceedings or other matters will have a material adverse effect on our liquidity, financial condition or results of operations. Given the nature, history and scope of our manufacturing operations, however, and given that there may be future changes to laws or the enforcement thereof, there can be no assurance that we will not become subject to other environmental proceedings or liabilities in the future which may be material to us. Other Litigation - ---------------- Other lawsuits and proceedings or claims, arising from the ordinary course of operations, are also pending or threatened against us and our subsidiaries. Based on the facts presently known to us, we do not believe that the ultimate outcome of these other litigation matters will have a material adverse effect on our financial condition or results of operation. 28 Item 6. Exhibits and Reports on Form 8-K -------------------------------- (a) The exhibits are furnished elsewhere in this report. (b) Reports filed on Form 8-K during the Quarter ended September 30, 2002. A Form 8-K was filed on August 9, 2002, under Item 9, attaching copies of the Certifications submitted to the SEC by Chief Executive Officer, Patrick S. O'Keefe and Chief Financial Officer, William C. McCartney of Watts Industries, Inc. required by 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. A Form 8-K was filed on August 20, 2002, under Item 5, incorporating by reference Watts Industries, Inc.'s August 15, 2002 press release announcing that the SEC had commenced a civil action against Mr. Timothy P. Horne, a Director of the Company, relating to his personal trading in the shares of Central Sprinkler Corporation in May 1999. 29 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 12, 2002 By: /s/ Patrick S. O'Keefe ------------------ ---------------------- Patrick S. O'Keefe Chief Executive Officer Date: November 12, 2002 By: /s/ William C. McCartney ----------------- ------------------------ William C. McCartney Chief Financial Officer and Treasurer 30 WATTS INDUSTRIES, INC. CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATIONS - -------------- I, Patrick S. O'Keefe, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Watts Industries, Inc. 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 ----------------- /s/ Patrick S. O'Keefe ---------------------- Patrick S. O'Keefe Chief Executive Officer 31 WATTS INDUSTRIES, INC. CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATIONS - -------------- I, William C. McCartney, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Watts Industries, Inc. 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 ----------------- /s/ William C. McCartney ----------------------------- William C. McCartney Chief Financial Officer and Treasurer 32 EXHIBIT INDEX - ------------- Listed and indexed below are all Exhibits filed as part of this report. Exhibit No. Description - ----------- ----------- 3.1 Restated Certificate of Incorporation, as amended. (1) 3.2 Amended and Restated By-Laws, as amended July 24, 2002 11 Computation of Earnings per Share (2) (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 Notes to Consolidated Financial Statements, Note 6, of this Report. EX-3.2 3 ex3-2.txt Exhibit 3.2 BY-LAWS of WATTS INDUSTRIES, INC. Amended and Restated as of April 21, 1992, amended as of May 11, 1999 and July 24, 2002 ARTICLE I --------- Stockholders ------------ Section 1. Annual Meeting. The annual meeting of stockholders shall be held at the hour, date and place within or without the United States which is fixed by the Board of Directors or the Chairman of the Board, which hour, date and place may subsequently be changed at any time by vote of the Board of Directors. If no annual meeting has been held for a period of thirteen months after the Corporation's last annual meeting of stockholders, a special meeting in lieu thereof may be held, and such special meeting shall have, for the purposes of these By-laws or otherwise, all the force and effect of an annual meeting. Any and all references hereafter in these By-laws to an annual meeting or annual meetings also shall be deemed to refer to any special meeting(s) in lieu thereof. Section 2. Matters to be Considered at Annual Meeting. At an annual meeting of stockholders, only such business shall be conducted, and only such proposals shall be acted upon, as shall have been properly brought before the annual meeting (a) by, or at the direction of, the Board of Directors or a designated committee thereof or (b) by any holder of record (both as of the time notice of such proposal is given by the stockholder as set forth below and as of the record date for the annual meeting in question) of any shares of capital stock of the Corporation entitled to vote at such annual meeting who complies with the procedures set forth in this Section 2 (or, with respect to nominations of candidates for election as Directors, as set forth in Section 3 of Article II hereof). In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a holder of record of any shares of capital stock entitled to vote at such annual meeting, the stockholder must have given timely notice thereof in writing to the Secretary of the Corporation as set forth in this Section 2 and such stockholder or his representative must be present at the annual meeting. To be timely, a stockholder's notice must be delivered to, or mailed to and received at, the principal executive offices of the Corporation (a) not less than 75 days nor more than 120 days prior to the anniversary date of the immediately preceding annual meeting of stockholders (the "Anniversary Date") or (b) in the event that the annual meeting of stockholders is called for a date more than 10 days prior to the Anniversary Date, not later than the close of business on (i) the 20th day (or if that day is not a business day of the Corporation, on the next succeeding business day) following the first date on which the date of such meeting was publicly disclosed or (ii) if such date of public disclosure occurs more than 75 days prior to such scheduled date of such meeting, then the later of (1) the 20th day (or if that day is not a business day for the Corporation, on the next succeeding business day) following the first date of public disclosure or (2) the 75th day prior to such scheduled date of such meeting (or if that day is not a business day for the Corporation, on the next succeeding business day). Any public disclosure of the scheduled date of the meeting made by the Corporation by means of a press release, a report or other document filed with the Securities and Exchange Commission, or a letter or report sent to stockholders of record of the Corporation, shall be deemed to be sufficient public disclosure of the date of such meeting for purposes of these By-laws. A stockholder's notice to the Secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting (a) a brief description of the proposal desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (b) the name and address, as they appear on the Corporation's stock transfer books, of the stockholder proposing such business and of the beneficial owners (if any) of the stock registered in such stockholder's name and the name and address of other stockholders known by such stockholder to be supporting such proposal on the date of such stockholder's notice, (c) the class and number of shares of the Corporation's capital stock which are held of record, beneficially owned or represented by proxy by the stockholder and by any other stockholders known by such stockholder to be supporting such proposal on the record date for the annual meeting in question (if such date shall then have been made publicly available) and on the date of such stockholder's notice, and (d) any material interest of the stockholder in such proposal. If the Board of Directors, or a designated committee thereof, determines that any stockholder proposal was not timely made in accordance with the provisions of this Section 2, or that the information provided in a stockholder's notice does not satisfy the informational requirements of this Section 2 in any material respect, then such proposal shall not be presented for action at the annual meeting in question. If neither the Board of Directors nor such committee makes a determination as to the validity of any stockholder proposal, the presiding officer of the annual meeting shall determine and declare at the annual meeting whether the stockholder proposal was made in accordance with the terms of this Section 2. If the presiding officer determines that a stockholder proposal was made in accordance with the terms of this Section 2, he shall so declare at the annual meeting and ballots shall be provided for use at the meeting with respect to any such proposal. If the presiding officer determines that a stockholder proposal was not made in accordance with the terms of this Section 2, he shall so declare at the annual meeting and any such proposal shall not be acted upon at the annual meeting. The provisions of this By-law shall not prevent the consideration and approval or disapproval at the annual meeting of reports of officers, Directors and committees of the Board of Directors, but in connection with such reports, no new business shall be acted upon at such annual meeting unless stated, filed and received as herein provided. Notwithstanding the foregoing provisions of this By-law, a stockholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the rules and regulations thereunder with respect to the matters set forth in this By-law. Nothing in this By-law shall be deemed to affect any rights of stockholders to request inclusion of proposals in the Corporation's proxy statement pursuant to Rule 14a-8 under the Exchange Act. Section 3. Special Meetings. Except as otherwise required by law, special meetings of the stockholders of the Corporation may be called only by the Board of Directors pursuant to a resolution approved by the affirmative vote of a majority of the Directors then in office or the Chairman of the Board. 3 Section 4. Matters to be Considered at Special Meetings. Only those matters set forth in the notice of the special meeting may be considered or acted upon at a special meeting of stockholders of the Corporation, unless otherwise provided by law. Section 5. Notice of Meetings; Adjournments. A written notice of each annual meeting of stockholders stating the place, date and hour of such annual meeting shall be given by the Secretary (or other person authorized by these By-laws or by law) not less than 10 days nor more than 60 days before the meeting, to each stockholder entitled to vote thereat and to each stockholder who, by law or under the Restated Certificate of Incorporation or under these By-laws, is entitled to such notice, by delivering such notice to him or by mailing it, postage prepaid, and addressed to such stockholder at the address of such stockholder as it appears in the records of the Corporation. Such notice shall be deemed to be delivered when hand delivered to such address or deposited in the mail so addressed, with postage prepaid. Notice of all special meetings of stockholders shall be given in the same manner as provided for annual meetings of the stockholders, except that the written notice of all special meetings shall state the purpose or purposes for which the meeting has been called. Notice of an annual or special meeting of stockholders need not be given to a stockholder if a written waiver of notice is executed before or after such meeting by such stockholder or such stockholder's authorized attorney, if communication with such stockholder is unlawful, or if such stockholder attends such meeting, unless such attendance was for the express purpose of objecting at the beginning of the meeting to the transaction of any business because the meeting was not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the stockholders need be specified in any written waiver of notice. The Board of Directors may postpone and reschedule any previously scheduled annual or special meeting of stockholders and any record date with respect thereto, regardless of whether any notice or public disclosure with respect to any such meeting has been sent or made pursuant to Section 2 of this Article I or Section 3 of Article II hereof or otherwise. When any meeting is convened, the presiding officer may adjourn the meeting if (a) no quorum is present for the transaction of business, (b) the Board of Directors determines that adjournment is necessary or appropriate to enable the stockholders to consider fully information which the Board of Directors determines has not been made sufficiently or timely available to stockholders, or (c) the Board of Directors determines that adjournment is otherwise in the best interests of the Corporation. When any annual or special meeting of stockholders is adjourned to another hour, date or place, notice need not be given of the adjourned meeting other than an announcement at the meeting at which the adjournment is taken of the hour, date and place to which the meeting is adjourned; provided, however, that if the adjournment is for more than 30 days, or if after the adjournment a new record date is fixed for the adjourned meeting, notice of the adjourned meeting shall be given to each stockholder of record entitled to vote thereat and each stockholder who, by law or under the Restated Certificate of Incorporation or these By-laws, is entitled to such notice. 4 Section 6. Quorum. At any annual or special meeting of stockholders, the holders of a majority of the voting power of all classes of stock issued, outstanding and entitled to vote at such meeting, represented in person or by proxy, shall constitute a quorum at such meeting; but if less than a quorum is present at such meeting, the holders of a majority of the voting power of all classes of stock issued, outstanding and entitled to vote at such meeting that are present in person or by proxy at such meeting or the presiding officer may adjourn the meeting from time to time, and the meeting may be held as adjourned without further notice, except as provided in Section 5 of this Article I. At such adjourned meeting at which a quorum is present, any business may be transacted which might have been transacted at the meeting as originally noticed. The stockholders present at a duly constituted meeting may continue to transact business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum. Section 7. Voting and Proxies. The voting power of each share of capital stock of the Corporation shall be as set forth in the Restated Certificate of Incorporation, with a proportionate vote for each fraction of any share. Stockholders may vote either in person or by written proxy, but no proxy shall be voted or acted upon after three years from its date, unless the proxy provides for a longer period. Proxies shall be filed with the Secretary of the meeting before being voted. Except as otherwise limited therein or as otherwise provided by law, proxies shall entitle the persons authorized thereby to vote at any adjournment of such meeting, but they shall not be valid after final adjournment of such meeting. A proxy with respect to stock held in the name of two or more persons shall be valid if executed by or on behalf of any one of them unless at or prior to the exercise of such proxy the Corporation receives a specific written notice to the contrary from any one of them. A proxy purporting to be executed by or on behalf of a stockholder shall be deemed valid, and the burden of proving invalidity shall rest on the challenger. Section 8. Action at Meeting. When a quorum is present, any matter before any annual or special meeting of stockholders shall be decided by vote of the holders of all classes of stock present in person or by proxy representing a majority of the votes of all classes of stock entitled to be cast at the meeting, except where a larger vote is required by law, by the Restated Certificate of Incorporation or by these By-laws. Any election by stockholders shall be determined by a plurality of the votes of all classes of stock cast, except where a larger vote is expressly required by law, by the Restated Certificate of Incorporation or by these By-laws. The Corporation shall not directly or indirectly vote any shares of its own stock; provided, however, that the Corporation may vote shares which it holds in a fiduciary capacity to the extent permitted by law. Section 9. Action by Consent. Any action required or permitted by law to be taken at any annual or special meeting of stockholders may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon 5 were present and voted. Prompt notice of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing. Section 10. Stockholder Lists. The Secretary (or the Corporation's transfer agent or other person authorized by these By-laws or by law) shall prepare and make, at least 10 days before every annual or special meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares of each class of stock registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least 10 days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the hour, date and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. Section 11. Presiding Officer. The Chairman of the Board, or in his absence, the President, shall preside at all annual or special meetings of stockholders and shall have the power, among other things, to adjourn such meeting at any time and from time to time, subject to Sections 5 and 6 of this Article I. The order of business and all other matters of procedure at any meeting of the stockholders shall be determined by the presiding officer. Section 12. Voting Procedures and Inspectors of Elections. The Corporation shall, in advance of any meeting of stockholders, appoint one or more inspectors to act at the meeting and make a written report thereof. The Corporation may designate one or more persons as alternate inspectors to replace any inspector who fails to act. If no inspector or alternate is able to act at a meeting of stockholders, the presiding officer shall appoint one or more inspectors to act at the meeting. Any inspector may, but need not, be an officer, employee or agent of the Corporation. Each inspector, before entering upon the discharge of his duties, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the best of his ability. The inspectors shall perform such duties as are required by the Delaware General Corporation Law, as amended from time to time, including the counting of all votes and ballots. The inspectors may, with the approval of the presiding officer, appoint or retain other persons or entities to assist the inspectors in the performance of the duties of the inspectors. The presiding officer may review all determinations made by the inspector(s), and in so doing the presiding officer shall be entitled to exercise his sole judgment and discretion and he shall not be bound by any determinations made by the inspector(s). All determinations by the inspector(s) and, if applicable, the presiding officer shall be subject to further review by any court of competent jurisdiction. 6 ARTICLE II ---------- Directors --------- Section 1. Powers. All the power of the Corporation shall be exercised by or under the direction of the Board of Directors except as otherwise provided by the Restated Certificate of Incorporation or as required by law. In the event of a vacancy in the Board of Directors, the remaining Directors, except as otherwise provided by law, may exercise the powers of the full Board until the vacancy is filled. Section 2. Number; Election; Qualification. The Board of Directors shall consist of not more than fifteen (15) nor less than three (3) members. The exact number of Directors within the maximum and minimum limitations specified herein may be fixed from time to time by resolution of a majority of the Board of Directors then in office or by the stockholders at the annual meeting of stockholders. The Directors shall be elected by the stockholders at each annual meeting, except as provided in Section 5 of this Article II. No Director need be a stockholder. Section 3. Director Nominations. Nominations of candidates for election as Directors of the Corporation at any annual meeting of stockholders may be made (a) by, or at the direction of, a majority of the Board of Directors or a designated committee thereof, or (b) by any holder of record (both as of the time notice of such nomination is given by the stockholder as set forth below and as of the record date for the annual meeting in question) of any shares of the capital stock of the Corporation entitled to vote at such annual meeting who complies with the procedures set forth in this Section 3. Any stockholder who seeks to make such a nomination, or his representative, must be present in person at the annual meeting. Only persons nominated in accordance with the procedures set forth in this Section 3 shall be eligible for election as Directors at an annual meeting of stockholders. Nominations, other than those made by, or at the direction of, the Board of Directors or a designated committee thereof, shall be made pursuant to timely notice in writing to the Secretary of the Corporation as set forth in this Section 3. To be timely, a stockholder's notice shall be delivered to, or mailed and received, at the principal executive offices of the Corporation (a) not less than 75 days nor more than 120 days prior to the Anniversary Date or (b) in the event that the annual meeting of stockholders is called for a date more than seven days prior to the Anniversary Date, not later than the close of business on (i) the 20th day (or if that day is not a business day for the Corporation, on the next succeeding business day) following the first date on which the date of such meeting was publicly disclosed or (ii) if such date of public disclosure occurs more than 75 days prior to such scheduled date of such meeting, then the later of (1) the 20th day (or if that day is not a business day for the Corporation, on the next succeeding business day) following the first date of public disclosure of the date of such meeting or (2) the 75th day prior to such scheduled date of such meeting (or if that day is not a business day for the Corporation, on the next succeeding business day). Any public disclosure of the scheduled date of the meeting made by the Corporation by means of a press release, a report or other document filed with the Securities and Exchange Commission, or a letter or report sent to stockholders of record of the Corporation, shall be deemed to be sufficient public disclosure of the date of such meeting for purposes of these By-laws. 7 Such stockholder's notice shall set forth (a) as to each person whom the stockholder proposes to nominate for election or re-election as a director (i) the name, age, business address and residential address of such person, (ii) the principal occupation or employment of such person during the past five years, (iii) the class and number of shares of the Corporation's capital stock which are beneficially owned by such person on the date of such stockholder notice, (iv) a description of any of the following events that has occurred within the last five years and that is material to the evaluation of the ability or integrity of such proposed nominee: (1) a petition under federal bankruptcy laws or any state insolvency laws was filed by or against such person, (2) a conviction of such person in a criminal proceeding or the naming of such person as a subject of a criminal proceeding (excluding traffic violations and other minor offenses), (3) a finding by any court of competent jurisdiction that such person has violated any federal or state securities law or federal commodities law, which judgment or finding has not been subsequently reversed, suspended or vacated, or (4) the entry of any order, judgment or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or of any federal or state governmental or quasi-governmental agency, authority or commission enjoining such person or otherwise limiting him from engaging in any type of business practice or in any activity in connection with the purchase or sale of any security or commodity, and (v) the consent of each nominee to serve as a Director if so elected and (b) as to the stockholder giving the notice (i) the name and address, as they appear on the Corporation's stock transfer books, of such stockholder and of the beneficial owners (if any) of the stock registered in such stockholder's name and the name and address of other stockholders known by such stockholder to be supporting such nominee or nominees, (ii) the class and number of shares of the Corporation's capital stock which are beneficially owned by such stockholder and such beneficial owners (if any) on the date of such stockholder's notice and by any other stockholders known by such stockholder to be supporting such nominee or nominees on the date of such stockholder's notice, (iii) a representation that the stockholder or his representative intends to appear in person at the meeting to nominate the person or persons specified in the notice, (iv) a description of all arrangements or understandings between such stockholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by such stockholders; provided, that nothing in this -------- Section 3 shall require the stockholder giving such notice to provide to the Corporation copies of such stockholder's preliminary or definitive proxy, proxy statement, or other soliciting material filed with the Securities and Exchange Commission. At the request of the Board of Directors, any person nominated by, or at the direction of, the Board of Directors for election as a Director at an annual meeting shall furnish to the Secretary of the Corporation that information required to be set forth in a stockholder's notice of nomination which pertains to such nominee. No person shall be elected by the stockholders as a Director of the Corporation unless nominated in accordance with the procedures set forth in this Section 3. Election of Directors at the annual meeting need not be by written ballot, unless otherwise provided by the Board of Directors or presiding officer at such annual meeting. If written ballots are to be used, ballots bearing the names of all the persons who have been nominated for election as Directors at the 8 annual meeting in accordance with the procedures set forth in this Section 3 shall be provided for use at the annual meeting. If the Board of Directors, or a designated committee thereof, determines that any stockholder nomination was not timely made in accordance with the terms of this Section 3 or that the information provided in a stockholder's notice does not satisfy the informational requirements of this Section 3 in any material respect, then such nomination shall not be considered at the annual meeting in question. If neither the Board of Directors nor such committee makes a determination as to the validity of any nominations by a stockholder as set forth above, the presiding officer of the annual meeting shall determine and declare at the annual meeting whether a nomination was made in accordance with the terms of this Section 3. If the presiding officer determines that a nomination was made in accordance with the terms of this Section 3, he shall so declare at the annual meeting and ballots shall be provided for use at the meeting with respect to such nomination. If the presiding officer determines that a nomination was not made in accordance with the terms of this Section 3, he shall so declare at the annual meeting and such nomination shall be disregarded. Section 4. Tenure. Except as otherwise provided by law, by the Restated Certificate of Incorporation or by these By-laws, Directors shall hold office until the next annual meeting of stockholders and until their successors are elected and qualified or until their earlier resignation or removal. Section 5. Vacancies. Any vacancy occurring on the Board of Directors, including any vacancy resulting from death, resignation, retirement, disqualification, removal or other cause or created by reason of an increase in the authorized number of Directors shall be filled by the affirmative vote of a majority of the remaining Directors then in office, even if such majority is less than a quorum of the Board of Directors. Any Director appointed in accordance with the preceding sentence shall hold office subject to the provisions of these By-laws until the next annual meeting of stockholders and until such Director's successor is elected and qualified or until such Director resigns or is removed. In the event of a vacancy in the Board of Directors, the remaining Directors, except as otherwise provided by law, may exercise the powers of the full Board of Directors until the vacancy is filled. Section 6. Removal. Any Director (including persons elected by Directors to fill vacancies in the Board of Directors) or the entire Board of Directors may be removed with or without cause by the affirmative vote of the holders of at least a majority of the voting power of the shares of the Corporation then entitled to vote at an election of Directors, voting together as a single class. Any Director may be removed for cause by vote of a majority of the Directors then in office. A Director may be removed for cause only after reasonable notice and opportunity to be heard before the body proposing to remove him. Section 7. Resignation. A Director may resign at any time by giving written notice to the Chairman of the Board, the President or the Secretary. A resignation shall be effective upon receipt, unless the resignation otherwise provides. 9 Section 8. Regular Meetings. The regular annual meeting of the Board of Directors shall be held, without other notice than this By-law, on the same date and at the same place as the annual meeting of stockholders following the close of such meeting of stockholders. Other regular meetings of the Board of Directors may be held without call or notice at such hour, date and place as the Board of Directors may from time to time determine. Section 9. Special Meetings. Special meetings of the Board of Directors may be called, orally or in writing, by or at the request of the Chairman of the Board, the Treasurer, or two or more Directors designating the hour, date and place thereof. Section 10. Notice of Special Meetings. Notice of the hour, date and place of all special meetings of the Board of Directors shall be given to each Director by the Secretary or an Assistant Secretary, or in case of the death, absence, incapacity or refusal of such persons, by the President. Notice of any special meeting of the Board of Directors shall be given to each Director in person or by telephone, telex, telecopy or other written form of electronic communication, or by telegram sent to his business or home address at least 24 hours in advance of the meeting, or by written notice mailed to his business or home address at least 48 hours in advance of the meeting. Such notice shall be deemed to be delivered when hand delivered to such address, read to such Director by telephone, deposited in the mail so addressed, with postage thereon prepaid if mailed, dispatched or transmitted if telexed or telecopied, or when delivered to the telegraph company if sent by telegram. When any Board of Directors meeting, either regular or special, is adjourned for 30 days or more, notice of the adjourned meeting shall be given as in the case of an original meeting. It shall not be necessary to give any notice of the hour, date or place of any meeting adjourned for less than 30 days or of the business to be transacted thereat, other than an announcement at the meeting at which such adjournment is taken of the hour, date and place to which the meeting is adjourned. A written waiver of notice executed before or after a meeting by a Director and filed with the records of the meeting shall be deemed to be equivalent to notice of the meeting. The attendance of a Director at a meeting shall constitute a waiver of notice of such meeting, except where a Director attends a meeting for the express purpose of objecting to the transaction of any business because such meeting is not lawfully called or convened. Except as otherwise required by law, by the Restated Certificate of Incorporation or by these By-laws, neither the business to be transacted at, nor the purpose of, any meeting of the Board of Directors need be specified in the notice or waiver of notice of such meeting. Section 11. Quorum. At any meeting of the Board of Directors, a majority of the Directors then in office shall constitute a quorum for the transaction of business, but if less than a quorum is present at a meeting, a majority of the Directors present may adjourn the meeting from time to time, and the meeting may be held as adjourned without further notice, except as provided in 10 Section 10 of this Article II. Any business which might have been transacted at the meeting as originally noticed may be transacted at such adjourned meeting at which a quorum is present. Section 12. Action at Meeting. At any meeting of the Board of Directors at which a quorum is present, a majority of the Directors present may take any action on behalf of the Board of Directors, unless a larger number is required by law, by the Restated Certificate of Incorporation or by these By-laws. Section 13. Action by Consent. Any action required or permitted to be taken at any meeting of the Board of Directors may be taken without a meeting if all members of the Board of Directors consent thereto in writing. Such written consent shall be filed with the records of the meetings of the Board of Directors and shall be treated for all purposes as a vote at a meeting of the Board of Directors. Section 14. Manner of Participation. Directors may participate in meetings of the Board of Directors by means of conference telephone or similar communications equipment by means of which all Directors participating in the meeting can hear each other, and participation in a meeting in accordance herewith shall constitute presence in person at such meeting for purposes of these By-laws. Section 15. Chairman of the Board. The Chairman of the Board shall, subject to the direction of the Board of Directors, have general supervision and control of its business. The Chairman of the Board shall preside, when present, at all meetings of the Board of Directors, unless the Board of Directors shall otherwise provide, and at meetings of the stockholders as provided in Section 11 of Article I hereof. The Chairman is not an officer of the Corporation. Section 16. Committees. The Board of Directors, by vote of a majority of the Directors then in office, may elect from its number one or more committees, including an Executive Committee and an Audit Committee, and may delegate thereto some or all of its powers except those which by law, by the Restated Certificate of Incorporation, or by these By-laws may not be delegated. Except as the Board of Directors may otherwise determine, any such committee may make rules for the conduct of its business, but unless otherwise provided by the Board of Directors or in such rules, its business shall be conducted so far as possible in the same manner as is provided by these By-laws for the Board of Directors. All members of such committees shall hold such offices at the pleasure of the Board of Directors. The Board of Directors may abolish any such committee at any time. Any committee to which the Board of Directors delegates any of its powers or duties shall keep records of its meetings and shall report its action to the Board of Directors. The Board of Directors shall have power to rescind any action of any committee, but no such rescission shall have retroactive effect. 11 ARTICLE III ----------- Officers -------- Section 1. Enumeration. The officers of the Corporation shall consist of a President, a Secretary, a Treasurer, and such other officers, including without limitation one or more Executive Vice Presidents, Vice Presidents, Assistant Secretaries and Assistant Treasurers, as the Board of Directors may determine. Section 2. Election. At the regular annual meeting of the Board of Directors following the annual meeting of stockholders, the Board of Directors shall elect the President, the Secretary, and the Treasurer. Other officers may be elected by the Board of Directors at such regular annual meeting or at any other regular or special meeting. Section 3. Qualification. No officer need be a stockholder or a Director. Any person may occupy more than one office of the Corporation at any time. Any officer may be required by the Board of Directors to give bond for the faithful performance of his duties in such amount and with such sureties as the Board of Directors may determine. Section 4. Tenure. Except as otherwise provided by the Restated Certificate of Incorporation or by these By-laws, each officer of the Corporation shall hold office until the regular annual meeting of the Board of Directors following the next annual meeting of stockholders and until such officer's successor is elected and qualified or until such officer's earlier resignation or removal. Any officer may resign by delivering a written resignation to the Board of Directors, and such resignation shall be effective upon receipt unless it is specified to be effective at some other time or upon the happening of some other event. Section 5. Removal. Except as otherwise provided by law, the Board of Directors may remove any officer with or without cause by the affirmative vote of a majority of the Directors then in office. Section 6. Vacancies. Any vacancy in any office may be filled for the unexpired portion of the term by the Board of Directors. Section 7. President. The President shall be the chief operating officer of the Corporation and shall perform such duties as the Board of Directors or the Chairman of the Board may from time to time determine. In the absence of the Chairman of the Board, the President shall preside, when present, at meetings of the Board of Directors, unless the Board of Directors shall otherwise provide, and at meetings of the stockholders as provided in Section 11 of Article I hereof. Section 8. Executive Vice Presidents; Vice Presidents. Any Executive Vice President or Vice President shall have such powers and shall perform such duties as the Board of Directors, the Chairman of the Board or the President may from time to time designate. Section 9. Treasurer and Assistant Treasurers. The Treasurer shall, subject to the direction of the Board of Directors, have general charge of the financial affairs of the Corporation and shall 12 cause to be kept accurate books of account. He shall have custody of all funds, securities, and valuable documents of the Corporation, except as the Board of Directors may otherwise provide. Any Assistant Treasurer shall have such powers and perform such duties as the Board of Directors may from time to time designate. Section 10. Secretary and Assistant Secretaries. The Secretary shall record all the proceedings of the meetings of the stockholders and the Board of Directors (including committees of the Board) in books kept for that purpose. In his absence from any such meeting, a temporary secretary chosen at the meeting shall record the proceedings thereof. The Secretary shall have charge of the stock ledger (which may, however, be kept by any transfer or other agent of the Corporation). He shall have custody of the seal of the Corporation, and he, or an Assistant Secretary, shall have authority to affix it to any instrument requiring it, and, when so affixed, the seal may be attested by his signature or that of an Assistant Secretary. He shall have such other duties and powers as may be designated from time to time by the Board of Directors, the Chairman of the Board or the President. Any Assistant Secretary shall have such powers and perform such duties as the Board of Directors may from time to time designate. Section 11. Other Powers and Duties. Subject to these By-laws and to such limitations as the Board of Directors may from time to time prescribe, the officers of the Corporation shall each have such powers and duties as generally pertain to their respective offices, as well as such powers and duties as from time to time may be conferred by the Board of Directors. Section 12. Compensation. The compensation of the officers of the Corporation shall be fixed from time to time by the Board of Directors; provided, however, that the Board of Directors may authorize any officer or committee to fix the compensation of officers and employees. No officer shall be prevented from receiving compensation by reason of the fact that such officer is also a Director of the Corporation. ARTICLE IV ---------- Capital Stock ------------- Section 1. Certificates of Stock. Each stockholder shall be entitled to a certificate of the capital stock of the Corporation in such form as may from time to time be prescribed by the Board of Directors. Such certificate shall bear the Corporation seal and shall be signed by the Chairman of the Board or the President or a Vice President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary. The Corporation seal and the signatures by Corporation officers may be facsimiles if the certificate is manually countersigned by an authorized person on behalf of a transfer agent or registrar other than the Corporation or its employee. In case any officer, transfer agent or registrar who has signed or whose facsimile 13 signature has been placed on such certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if such officer, transfer agent or registrar were such officer, transfer agent or registrar at the time of its issue. Every certificate for shares of stock which are subject to any restriction on transfer and every certificate issued when the Corporation is authorized to issue more than one class or series of stock shall contain such legend with respect thereto as is required by law. The Corporation shall be permitted to issue fractional shares. Section 2. Transfers. Subject to any restrictions on transfer and unless otherwise provided by the Board of Directors, shares of stock may be transferred only on the books of the Corporation by the surrender to the Corporation or its transfer agent of the certificate therefor properly endorsed or accompanied by a written assignment or power of attorney properly executed, with transfer stamps (if necessary) affixed, and with such proof of the authenticity of signature as the Corporation or its transfer agent may reasonably require. Section 3. Record Holders. Except as may otherwise be required by law, by the Restated Certificate of Incorporation or by these By-laws, the Corporation shall be entitled to treat the record holder of stock as shown on its books as the owner of such stock for all purposes, including the payment of dividends and the right to vote with respect thereto, regardless of any transfer, pledge or other disposition of such stock, until the shares have been transferred on the books of the Corporation in accordance with the requirements of these By-laws. It shall be the duty of each stockholder to notify the Corporation of his, her or its post office address and any changes thereto. Section 4. Record Date. In order that the Corporation may determine the stockholders entitled to receive notice of or to vote at any meeting of stockholders or any adjournments thereof, or to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which, (i) with respect to any meeting of stockholders, shall be not more than 60 nor less than 10 days (except as otherwise required by law) before the date of such meeting, (ii) with respect to corporate action without a meeting, shall be not more than 10 days after the date on which the resolution fixing the record date is adopted by the Board of Directors and (iii) with respect to any other lawful action, shall be not more than 60 days prior to such action. In such case, only stockholders of record on such record date shall be so entitled, notwithstanding any transfer of stock on the books of the Corporation after the record date. If no record date is fixed: (i) the record date for determining stockholders entitled to receive notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held; (ii) the record date for determining stockholders entitled to express consent to corporate action in writing without a 14 meeting, when no prior action by the Board of Directors is necessary, shall be the day on which the first written consent is expressed; and (iii) the record date for determining stockholders for any other purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto. Section 5. Replacement of Certificates. In case of the alleged loss, destruction or mutilation of a certificate of stock, a duplicate certificate may be issued in place thereof, upon such terms as the Board of Directors may prescribe. ARTICLE V --------- Indemnification of Directors, Officers and Others ------------------------------------------------- Section 1. Indemnifiable Events; Extent of Indemnification. (a) The Corporation shall indemnify, to the fullest extent permitted by the General Corporation Law of the State of Delaware (as presently in effect or as hereafter amended): (i) Any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action or suit by or in the right of the Corporation) by reason of the fact that he is or was a Director or officer of the Corporation, or is or was serving at the request of the Corporation as a director or officer of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such suit, action or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Corporation or, with respect to any criminal action or proceeding, that the person had reasonable cause to believe that his conduct was unlawful. (ii) Any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was a Director or officer of the Corporation, or is or was serving at the request of the Corporation as a director or officer of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the 15 Corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his duty to the Corporation unless, and only to the extent that, the Court of Chancery of the State of Delaware or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. (iii) To the extent that a Director or officer of the Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in paragraphs (i) and (ii), or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith. (b) The Board of Directors, in its discretion, may authorize the Corporation to indemnify: (i) Any person who was or is a party or is threatened to be made a party to any threatened pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Corporation) by reason of the fact that he is or was an employee or agent of the Corporation, or is or was serving at the request of the Corporation as a Director or as an employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed tothe best interests of the Corporation or, with respect to any criminal action or proceeding, that the person had reasonable cause to believe that his conduct was unlawful. (ii) Any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was an employee or agent of the Corporation, or is or was serving at the request of the Corporation as a employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation and except that no indemnification shall be made in respect of any claim, issue 16 or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his duty to the Corporation unless, and only to the extent that, the Court of Chancery of the State of Delaware or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnify for such expenses which the Court of Chancery or such other court shall deem proper. Section 2. Determination of Entitlement. Any indemnification hereunder (unless required by law or ordered by a court) shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the Director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Section 1 of this Article V. Such determination shall be made (a) by the Board of Directors by a majority vote of a quorum consisting of Directors who were not parties to such action, suit or proceeding, or (b) if such a quorum is not obtainable, or, even if obtainable a quorum of disinterested Directors so directs, by independent legal counsel in a written opinion, or (c) by the stockholders of the Corporation. Section 3. Advance Payments. Expenses incurred in defending a civil or criminal action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding, only as authorized by the Board of Directors in the specific case (including by one or more Directors who may be parties to such action, suit or proceeding), upon receipt of an undertaking by or on behalf of the Director, officer, employee or agent to repay such amount unless it shall ultimately be determined that he is entitled to be indemnified by the Corporation as authorized in this Article V. Section 4. Non-Exclusive Nature of Indemnification. The indemnification provided herein shall not be deemed exclusive of any other rights to which any person, whether or not entitled to be indemnified hereunder, may be entitled under any statute, by-law, agreement, vote of stockholders or Directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a Director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. Each person who is or becomes a Director or officer as aforesaid shall be deemed to have served or to have continued to serve in such capacity in reliance upon the indemnity provided for in this Article V. Section 5. Insurance. To the extent obtainable, the Corporation may purchase and maintain insurance with reasonable limits on behalf of any person who is or was a Director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against such person and incurred by such person in any such capacity, or arising out of such person's status as such, whether or not the Corporation would have the power to indemnify such person against such liability under the provisions of the General Corporation Law of the State of Delaware (as presently in effect or 17 hereafter amended), the Restated Certificate of Incorporation of the Corporation or these By-laws. Section 6. No Duplicate Payments. The Corporation's indemnification under Section 1 of this Article V of any person who is or was a Director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall be reduced by any amounts such person receives as indemnification (i) under any policy of insurance purchased and maintained on such person's behalf by the Corporation, (ii) from such other Corporation, partnership, joint venture, trust or other enterprise, or (iii) under any other applicable indemnification provision. Section 7. Amendment. This Article V may be amended only so as to have a prospective effect. Any amendment to this Article V which would result in any person having a more limited entitlement to indemnification may be approved only by the stockholders. ARTICLE VI ---------- Transactions with Related Parties --------------------------------- Section 1. Transactions Not Void. No contract or transaction between the Corporation and one or more of its Directors or officers, or between the Corporation and any other corporation, partnership, association or other organization in which one or more of its Directors or officers are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the Director or officer is present at or participates in the meeting of the Board of Directors or committee thereof, which authorizes the contract or transaction, or solely because his or their votes are counted for such purpose, if: (a) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the Board of Directors, or the committee, and the Board of Directors or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested Directors, even though the disinterested Directors be less than a quorum; or (b) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or (c) The contract or transaction is fair as to the Corporation as of the time it is authorized, approved or ratified, by the Board of Directors, a committee thereof, or the stockholders. 18 Section 2. Quorum. Common or interested Directors may be counted in determining the presence of a quorum at a meeting of the Board of Directors or of a committee which authorizes the contract or transaction. Section 3. Limitation. Nothing herein contained shall protect or purport to protect any Director or officer of the Corporation against any liability to the Corporation or its security holders to which he would otherwise be subject by reason of his willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. ARTICLE VII ----------- Miscellaneous Provisions ------------------------ Section 1. Fiscal Year. Except as otherwise determined by the Board of Directors, the fiscal year of the Corporation shall end on December 31 of each year. Section 2. Seal. The Board of Directors shall have power to adopt and alter the seal of the Corporation. Section 3. Execution of Instruments. All deeds, leases, transfers, contracts, bonds, notes and other obligations to be entered into by the Corporation in the ordinary course of its business without Director action may be executed on behalf of the Corporation by the Chairman of the Board, the President, the Treasurer or any Vice President. Section 4. Voting of Securities. Unless the Board of Directors otherwise provides, the Chairman of the Board, the President or the Treasurer may waive notice of and act on behalf of this Corporation, or appoint another person or persons to act as proxy or attorney in fact for this Corporation with or without discretionary power and/or power of substitution, at any meeting of stockholders or stockholders of any other corporation or organization, any of whose securities are held by this Corporation. Section 5. Resident Agent. The Board of Directors may appoint a resident agent upon whom legal process may be served in any action or proceeding against the Corporation. Section 6. Corporate Records. The original or attested copies of the Restated Certificate of Incorporation, By-laws and records of all meetings of the incorporators, stockholders and the Board of Directors and the stock and transfer records, which shall contain the names of all stockholders, their record addresses and the amount of stock held by each, shall be kept at the principal office of the Corporation, at the office of its counsel, or at an office of its transfer agent. Section 7. Restated Certificate of Incorporation. All references in these By-laws to the Restated Certificate of Incorporation shall be deemed to refer to the Restated Certificate of Incorporation of the Corporation, as amended and in effect from time to time. 19 Section 8. Amendments. These By-laws may be altered, amended or repealed, to the extent permitted by applicable law, the Restated Certificate of Incorporation and agreements to which the Corporation may from time to time be a party, by the affirmative vote of the holders of a majority of the voting power of all classes of the stock of the Corporation then entitled to vote, voting together as a single class, at any regular or special meeting of the stockholders of the Corporation, or by the vote of a majority of the Board of Directors at any regular or special meeting thereof, without any action on the part of the stockholders, unless otherwise provided herein; provided, however, that (i) the Board of Directors may not amend or repeal this Section 8 nor may it amend or repeal any other provision of these By-laws to the extent such amendment or repeal requires action by the stockholders, and (ii) any amendment or repeal of these By-laws by the Board of Directors and any provision to these By-laws adopted by the Board of Directors may be amended or repealed by the stockholders. 20 -----END PRIVACY-ENHANCED MESSAGE-----