Watts Water Annual Report 2003

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FY2003 Annual Report · Watts Water

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Watts Water Technologies
Annual Report 2003

Innovative Water Solutions

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Innovative Water Solutions Since 1874

Only 1% of the Earth's water is

available for agricultural, residential,

manufacturing, community and

personal needs.

C o m f o r t

Q u a l i t y

S a f e t y

2003_AnnualReport_final_pb 4/2/04 3:57 PM Page 3

pproximately 70% of the Earth is covered in

water, yet only 1% of the Earth’s water is

considered drinkable. This 1% is all we

have to meet agricultural, residential,

manufacturing, community, and personal needs.

Water is so critical in our lives, we drink it, bathe with

it, heat with it and grow food with it. Water is truly

Earth’s most precious resource.

In 2003 Watts Industries, Inc. changed its name to

Watts Water Technologies, Inc. to more accurately

reflect our focus on water and on developing innova-

tive products for its safe use, quality and conservation.

Since our founding in 1874 as Watts Regulator

Company, we have grown into a global manufacturer

of safety and flow control products for the residential

and commercial plumbing & heating and

water quality markets. Our diverse product offering

ranges from simple under

sink water shutoffs to resi-

dential and commercial

water

filtration units

There is the same

amount of water on

earth today as there

was when the Earth

complex turf warming sys-

was formed.

tems used in professional stadiums.

In 2004, we plan to continue our focus on five

strategic water applications: quality, safety, control,

The average American uses

over 100 gallons of water

conservation and comfort. We believe that

these applications provide our customers

per day; the average

with the products they desire and provide our

residence uses over 100,000

gallons during a year.

shareholders with the growth opportunity

they require.

This Annual Report contains “forward-looking” statements within the
meaning of the Private Securities Litigation Reform Act of 1995. All
statements that relate to prospective events or developments are for-
ward-looking statements. Also, words such as “believe,” “anticipate,”
“plan,” “expect,” “will” and similar expressions identify forward-look-
ing statements. We cannot assure investors that our assumptions and
expectations will prove to have been correct. There are a number of
important factors that could cause our actual results to differ materi-
ally from those indicated or implied by forward-looking statements.
These factors include, but are not limited to, those set forth in the
section entitled “Certain Factors Affecting Future Results” in our
Annual Report on Form 10-K for the year ended December 31, 2003
included in this Annual Report. We undertake no intention or obliga-
tion to update or revise any forward-looking statements, whether as a
result of new information, future events or otherwise.

C o n s e r v a t i o n

C o n t r o l

2003_AnnualReport_final_pb 4/2/04 3:58 PM Page 4

To Our Shareholders

In 2003, earnings and sales from continuing operations reached the highest levels in the company’s

history. This was accomplished despite the weak economy in Europe and the soft commercial con-

struction market in North America. Net sales for the twelve-month period ending December 31,

2003 increased 15% to $705.7 million from $615.5 million in 2002. Net income from continuing oper-

ations increased 12% to $36.5 million in 2003 from $32.6 million in 2002. I encourage you to read

our “Management's Discussion and Analysis of Financial Condition and Results of Operations” includ-

ed elsewhere in this report. These positive results have been achieved due to favorable foreign exchange

rates, continued success of our acquisition program, internal growth in spite of difficult market condi-

tions, and the success of our product cost reduction programs.

PATRICK S. O'KEEFE
President and
Chief Executive Officer

Our North American wholesale market sales growth accelerated during the year resulting in an

increase of 6% in the fourth quarter and 2% for the full year compared to the comparable periods

last year, despite a decline in commercial construction. This sales growth is primarily due to the intro-

duction of our Hunter Innovations backflow product line, increased sales of our specialty plumbing products and

increased sales of our under-floor radiant heating product lines. The acquisition of Hunter Innovations in 2002 pro-

vided us with the next generation of backflow technology. As we introduced this product to the market during the

course of 2003, it received an enthusiastic reception from our customers. We intend to introduce additional models

of our new backflow preventer product line to the market in 2004 as we receive additional regulatory approvals. The

acquisition of Powers Process Controls in 2001, in conjunction

with Hunter, has significantly strengthened our commercial

product offering, and we believe we are well positioned to take

advantage of what appears to be a strengthening commercial

construction market in North America.

Our sales into the North American home improvement market

grew by 13% during 2003. This is our ninth consecutive year of double-digit sales increases in this market. We attribute our

success to providing strong service levels, the increasing store count of our large customers, successful introduction of new

products, and increased sales of existing products. Our success in this market was demonstrated this year by the receipt of

the “Vendor Partner of the Year” award in the rough plumbing category from The Home Depot, Inc. This is the second time

in four years that we have received this award. We are very pleased and grateful that one of our most important customers

recognized us in this manner.

Our major markets in Europe continued to be soft due to the weak economies, specifically in, Italy, France, Germany,

and Poland, which were in near-recession conditions. Despite these weak economies, our internal sales growth in Europe

was 9% in 2003. The primary contributor to this sales growth was our success in serving our European O.E.M customers.

The acquisitions we have completed during the last several years enable us to offer a broader product offering to a broad-

er customer base. We achieved an internal sales growth rate to our European O.E.M customers of 15% in 2003.

We completed two acquisitions during 2003. In April we acquired Martin Orgee UK Ltd. Martin Orgee distributes a

line of plumbing and heating products to both wholesale, commercial and O.E.M. customers in the U.K., which expand-

ed our product offerings in these markets. In July we acquired Giuliani Anello S.r.l. Giuliani Anello expanded our exist-

ing line of valves and safety devices sold into the European heating market. They manufacture and distribute valves and

filters utilized in heating applications including strainer filters, solenoid valves, flow stop valves, stainless steel water fil-

ter elements, and steam-cleaning filters.

2003_AnnualReport_final_pb 4/2/04 3:58 PM Page 5

ers

Additionally, in November we entered into an agreement to acquire substantially all of the assets of Flowmatic Systems,

Inc., and completed the acquisition in January 2004. The acquisition of Flowmatic expanded our product offering of high-

quality reverse osmosis components and filtration equipment. Flowmatic also broadens our distribution capability for fil-

tration products. We currently provide a line of filtration products into the North American retail channel, and Flowmatic

provides us with a dealer network, an O.E.M. customer base, and a group of stocking distributors. We believe the com-

bination of our recently introduced Zero Waste Reverse Osmosis Filtration line with the Flowmatic dealer network will

provide us with an opportunity to leverage this fast-growing marketplace.

As we look to the future, we believe our strategy of offering both residential and commercial point-of-use solutions to

our customers’ water-based needs provides the opportunity for above-average growth in sales and profits. As consumers

continue to demand high-quality water and as the cost of that water continues to increase, we believe our products are

well suited to address the needs these trends will present to the market. Our products help to ensure the quality of water

and increase the safety of consumers who utilize water in their residential and commercial environments, but also offer

the opportunity for water conservation without decreasing performance or enjoyment.

2003_AnnualReport_final_pb 4/2/04 3:59 PM Page 6

To Our Shareholders

W e are pleased to report to you that in fiscal 2003 we achieved record levels of sales

flow in a difficult operating environment by effectively managing our working cap-

and earnings from continuing operations. We maintained healthy levels of cash

ital. Further, we strengthened our capitalization through a private placement of debt as well as

a public offering of our Class A Common stock.

Sales increased by $90.1 million, or 15%, to $705.7 million in 2003 from $615.5 million in

2002. The components of this growth are as follows:

Foreign Exchange

$35.0 million

Internal Growth

Acquisitions

Impact of FIN 46R

27.4 million

23.9 million

3.8 million

Increase in Sales

$90.1 million

15%

WILLIAM C. MCCARTNEY
Chief Financial Officer,
Treasurer and Secretary

Our results were favorably impacted in 2003 by the euro’s continuing strength against the U.S.

dollar, which increased sales by $35.0 million. Patrick O’Keefe has discussed the increase in internal growth and

acquisitions during 2003 in his Letter To Our Shareholders. The last component of our sales growth resulted from the

recently enacted Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest

Entities Revised” (FIN 46R). We hold a 49% interest in Jameco International LLC which distributes plumbing fixtures

to the North American home improvement market. FIN 46R required us to consolidate this entity into our financial

statements, effective October 1, 2003, resulting in a sales increase of $3.8 million.

Earnings per share from continuing operations increased to $1.32 in 2003 from $1.21 in

2002. This improvement is primarily attributable to the favorable foreign exchange rate

impact, the profit contribution from acquired companies, a reduction in restructuring charges

and increased profit from internal growth. However, our increased profits were partially off-

set by higher insurance and pension costs in North America, asset write-downs at one of our

joint ventures in Tianjin, China, and start-up costs at our wholly-owned manufacturing subsidiary, also in Tianjin.

We systematically increased inventory levels by $8.4 million to support increased sales into the European O.E.M

market and to ensure service levels to our customers as we extended our global supply chain into low cost coun-

tries. We also funded our pension plan with $6.8 million which has not been a cash requirement for the last sev-

eral years. Despite these operational pressures, we generated $24.9 million of free cash flow (1) (defined as cash

provided by continuing operations, less net capital expenditures, less dividends) in 2003 compared to $28.5 mil-

lion of free cash flow generated in 2002. Our working capital less cash to sales ratio declined for the seventh con-

secutive year to 20.8% in 2003 from 21.0% in 2002 as net sales grew at a faster rate than the investment in

working capital. We will continue to focus on cash generation and working capital management.

In May 2003, we refinanced our $75.0 million 83/8% notes with a $125.0 million private placement of debt.

The new debt has a weighted average term of 8.8 years with a weighted average cost of 5.23%. We refinanced

near the bottom of the treasury yield curves, which provided us with cost effective long-term debt. In December

2003 we sold 4,600,000 shares of our Class A common stock, which raised approximately $82.5 million in net

proceeds. As we look toward 2004, our strengthened capital structure allows us flexibility in funding future acqui-

sitions, which remains a critical component of our growth strategy.

2003_AnnualReport_final_pb 4/2/04 3:59 PM Page 7

Net Sales

$ 700

600

500

400

1999 1999.5 2000 2001 2002 2003

1999.5 Annualized

In Millions

North American Retail Market
Net Sales

Working Capital
(Less Cash) to Sales

$150

100

$ 1.25

1.00

.75

.50

% 25

1999 2000

2001 2002

2003

In Millions

4th quarter sales annualized
2002* excludes $75 million current debt

1999 1999.5 2000 2001 2002* 2003

Earnings Per Share
Continuing Operations

Free Cash Flow(1)

$30

1999 1999.5 2000 2001 2002 2003

1999.5 Annualized

In Millions

Net Debt to Capital Employed (1)

(1)

“Free cash flow" and "net debt to capital

% 30

employed" are not measures calculated in accor-
dance with generally accepted accounting princi-
ples, or GAAP. For further discussion of “free cash
flow” and “net debt to capital employed,” as well
as a reconciliation to the comparable GAAP meas-
ure, see the section entitled “Management’s
Discussion and Analysis of Financial Condition
and Results of Operations” in our Form 10-K
included in this Annual Report to Shareholders.

1999.5

2000

2001

2002

2003

2003_AnnualReport_final_pb 4/2/04 4:00 PM Page 8

C o m f o r t

Innovative Water Solutions

Q u a l i t y

W atts Water Technologies is committed to

providing innovative water solutions to

our customers. Our products promote

the comfort and safety of people, utilize the latest tech-

nologies to control and conserve water and provide end

users with constant access to high quality drinking water.

Our emphasis on providing superior water quality solu-

tions is evident with the acquisition of a number of water

quality focused companies over the past several years.

S a f e t y

C o n s e r v a t i o n

C o n t r o l

Premier Systems

Hunter Innovations

Flowmatic Systems

In 2001, we acquired Premier
Systems, a leading manufactur-
er of water filtration and purifi-
cation products. Premier’s
product offering includes the
innovative Zero-Waste Reverse
Osmosis System. Typical filtra-
tion systems waste 4 or more
gallons for every 1 gallon of
drinking water produced.
Premier’s Zero-Waste system
provides high quality pure
water while eliminating waste.

In 2002, we acquired Hunter Innovations. This
acquisition allowed us to provide enhanced back-
flow prevention technology and performance to
our customers. Backflow is the reverse flow of a
liquid into the potable water supply, a serious and
dangerous condition. Hunter’s backflow preven-
ters incorporate a number of unique features
making them easy to install and maintain, posi-
tioning them as the next generation of backflow
preventers.

In 2003, we entered into an
agreement to acquire substan-
tially all of the assets of
Flowmatic Systems. Flowmatic
offers a comprehensive line of
high quality reverse osmosis
components and
filtration
equipment. This acquisition
further strengthens our water
filtration offering and broadens
our distribution capabilities.

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(cid:1) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

or
(cid:2) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-11499

WATTS WATER TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)

Delaware
(State of incorporation)

04-2916536
(I.R.S. Employer Identification No.)

815 Chestnut Street, North Andover, MA
(Address of principal executive offices)

01845
(Zip Code)

Registrant’s telephone number, including area code: (978) 688-1811

Securities registered pursuant to Section 12(b) of the Act:
Class A Common Stock, par value $.10 per share
Name of exchange on which registered: New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None

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 (cid:1) No (cid:2)

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not

contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (cid:1)

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes (cid:1) No(cid:2)

Aggregate market value of the voting common stock of the Registrant held by non-affiliates of the Registrant

on June 30, 2003 was $342,879,115.

As of February 29, 2004, 24,709,427 shares of Class A Common Stock, $.10 par value, 7,471,700 shares of

Class B Common Stock, $.10 par value, of the Registrant were outstanding.

Documents Incorporated by Reference

Portions of the Registrant’s Proxy Statement for its Annual Meeting of Stockholders to be held on May 5,

2004, are incorporated by reference into Part III of this Annual Report on Form 10-K.

Item 1. BUSINESS.

PART I

This annual report on Form 10-K contains 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 contain projections of our future results of operations, our financial position or state
other forward-looking information. In some cases you can identify these statements by forward-looking
words such as ‘‘anticipate,’’ ‘‘believe,’’ ‘‘could,’’ ‘‘estimate,’’ ‘‘expect,’’ ‘‘intend,’’ ‘‘may,’’ ‘‘should,’’ ‘‘will’’ and
‘‘would’’ or similar words. You should not rely on forward-looking statements, because they involve known
and unknown risks, uncertainties and other factors, some of which are beyond our control. These risks,
uncertainties and other factors may cause our actual results, performance or achievements to differ
materially from the anticipated future results, performance or achievements expressed or implied by the
forward-looking statements. Some of the factors that might cause these differences are described under
Item 7—‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations—
Certain Factors Affecting Future Results.’’ You should carefully review all of these factors, and you should be
aware that there may be other factors that could cause these differences. These forward-looking statements
were based on information, plans and estimates at the date of this report, and we undertake no obligation
to update any forward-looking statements to reflect changes in underlying assumptions or factors, new
information, future events or other changes.

In this annual report on Form 10-K, references to ‘‘the Company,’’ ‘‘we’’ or ‘‘us’’ refer to Watts

Water Technologies, Inc. and its consolidated subsidiaries.

Overview

Watts Water Technologies, Inc. was founded by Joseph E. Watts in 1874 in Lawrence,

Massachusetts, as Watts Regulator Co. The Company started as a small machine shop supplying parts
to the New England textile mills of the 19th century and has grown into a global manufacturer of safety
and flow control products for the residential and commercial plumbing, heating and water quality
markets. The Company was incorporated in Delaware in 1985 under the name Watts Industries, Inc.
The Company’s name was changed to Watts Water Technologies, Inc. in October 2003.

Our ‘‘Water by Watts’’ strategy is to be the leading provider of water quality, water conservation,

water safety and water flow control products for the residential and commercial markets in North
America and Europe. Our primary objective is to grow earnings by increasing sales within existing
markets, expanding into new markets, making selected acquisitions and reducing manufacturing costs.
We intend to continue to introduce products in existing markets by enhancing our preferred brands,
developing new complementary products, promoting plumbing code development to drive sales of
safety and water quality products and continuously improving merchandising in both the do-it-yourself
(DIY) and wholesale distribution channels. We also target selected new markets based on growth
potential and intend to continue to introduce new products appropriate for these new markets. We
intend to continue to generate additional growth through selected acquisitions, both in our core
markets as well as in new complementary markets. Lastly, we are committed to reducing our
manufacturing costs through a combination of expanding manufacturing in lower-cost countries and
consolidating our diverse manufacturing operations in North America and Europe.

Our products are sold to wholesale distributors, major DIY chains and original equipment
manufacturers (OEMs). Most of our sales are for products that have been approved under regulatory
standards incorporated into state and municipal plumbing, heating, building and fire protection codes in
North America and Europe. We consistently advocate the development and enforcement of plumbing
codes and are committed to providing products to meet these standards, particularly for safety and
control valve products. We maintain quality control and testing procedures at each of our
manufacturing facilities in order to manufacture products in compliance with code requirements.

Additionally, a majority of our manufacturing facilities are ISO 9000, 9001 or 9002 certified by the
International Organization for Standardization.

Our business is reported in three geographic segments: North America, Europe and China. The

contributions of each segment to net sales, operating income and the presentation of certain other
financial information by segment are reported in Note 17 of the Notes to Consolidated Financial
Statements and in the Management’s Discussion and Analysis included elsewhere in this report.

Recent Developments

On February 20, 2004, we entered into an agreement with Yuhuan County Cheng Guan Metal
Hose Factory to acquire its 40% equity interest in our Taizhou Shida Plumbing Manufacturing Co., Ltd.
(Shida) joint venture for an expected purchase price of $3.0 million, the assumption of approximately
$6.0 million of debt and the payment of $3.5 million in connection with a three-year non-compete
agreement. After the transaction, we will own 100% of Shida. The closing of the transaction is subject
to the satisfaction of certain closing conditions and is expected to occur during the second quarter of
2004.

On January 5, 2004, we acquired substantially all of the assets of Flowmatic Systems, Inc. located

in Dunnellon, Florida, for approximately $16.5 million in cash. Flowmatic designs and distributes a
complete line of high quality reverse osmosis components and filtration equipment. Flowmatic’s
product line includes stainless steel and plastic housings, filter cartridges, storage tanks, control valves,
as well as complete reverse osmosis systems for residential and commercial applications.

On December 15, 2003, we completed a public offering of 4.6 million shares of our Class A

Common Stock resulting in net proceeds of approximately $82.5 million in cash.

In October 2003, we changed our name from Watts Industries, Inc. to Watts Water
Technologies, Inc. to more accurately reflect our strategic focus on providing solutions to our
customers’ water based needs.

On July 30, 2003, we acquired Giuliani Anello S.r.l. located in Cento Bologna, Italy, for

approximately $10.6 million in cash net of acquired cash of $1.4 million. Giuliani Anello manufactures
and distributes valves and filters utilized in heating applications including strainer filters, solenoid
valves, flow stop valves, stainless steel water filter elements and steam cleaning filters.

On May 15, 2003 we refinanced our $75.0 million 83⁄8% notes due December 1, 2003 through a

private placement of $50.0 million 4.87% senior notes due May 15, 2010 and $75.0 million 5.47%
senior notes due May 15, 2013.

On April 18, 2003, we acquired Martin Orgee U.K. Ltd. located in Kidderminster, West Midlands,

United Kingdom for approximately $1.6 million in cash. Martin Orgee distributes a line of plumbing
and heating products to the wholesale, commercial and OEM markets in the United Kingdom and
Southern Ireland. Martin Orgee also assembles pumping systems for under-floor radiant heat
applications.

Over the last 25 months, we have consolidated several of our manufacturing plants in North
America and Europe and expanded our manufacturing capacity in lower cost countries such as China,
Tunisia and Bulgaria. These manufacturing plant relocations and consolidations are an important part
of our ongoing commitment to reduce production costs. We anticipate recording a pre-tax charge of
approximately $6.0 million for additional manufacturing restructuring costs during 2004. These charges
will be attributable to accelerated depreciation associated with the expected closure of one of our U.S.
manufacturing plants and a reduction in estimated useful lives of manufacturing equipment due to the
transfer of production to lower cost countries.

Products

We believe that we have the broadest product lines in terms of design distinction, size and

configuration within a majority of the product lines we manufacture and market. Our principal product
lines include:

(cid:127) backflow preventers for preventing contamination of potable water caused by reverse flow within

water supply lines and fire protection systems;

(cid:127) a wide range of water pressure regulators for both commercial and residential applications;

(cid:127) water supply and drainage products for commercial and residential applications;

(cid:127) temperature and pressure relief valves for water heaters, boilers and associated systems;

(cid:127) point-of-use water filtration and reverse osmosis systems for both commercial and residential

applications;

(cid:127) thermostatic mixing valves for tempering water in commercial and residential applications; and

(cid:127) pumping systems for under-floor radiant applications.

Customers and Markets

We sell our products to plumbing, heating and mechanical wholesale distributors, major DIY

chains and OEMs.

Wholesalers. Approximately 62% of our 2003 sales were to wholesale distributors for both

commercial and residential applications. We rely on commissioned manufacturers’ representatives, some
of which maintain a consigned inventory of our products, to market our product lines.

DIY. Approximately 20% of our 2003 sales were to DIY customers, primarily in North America.
Our DIY customers demand less technical products, but are highly receptive to innovative designs and
new product ideas. Our DIY sales over the past several years have increased as a result of our
development of unique new products and successful merchandising efforts and the expansion of the
market with the large national chains.

OEMs. Approximately 18% of our 2003 sales were to OEMs in both North America and Europe.

In North America, our typical OEM customers are water heater manufacturers, equipment
manufacturers needing flow control devices and water systems manufacturers needing backflow
preventers. Our sales to OEMs in Europe are primarily to boiler manufacturers and radiant systems
manufacturers.

Our largest customer, The Home Depot, Inc., accounted for approximately $74.8 million, or

10.6%, of our total net sales in 2003. Our top ten customers accounted for approximately
$176.3 million, or 25.0%, of our total net sales in 2003. Thousands of other customers comprised the
remaining 75.0% of our net sales in 2003.

Marketing and Sales

We rely primarily on commissioned manufacturers’ representatives, some of which maintain a
consigned inventory of our products. These representatives sell primarily to plumbing and heating
wholesalers or service DIY store locations in North America. We also sell products for the residential
construction and home repair and remodeling industries through DIY plumbing retailers, national
catalog distribution companies, hardware stores, building material outlets and retail home center chains
and through our existing plumbing and heating wholesalers. In addition, we sell products directly to
certain large OEMs and private label accounts.

Manufacturing

We have integrated and automated manufacturing capabilities, including bronze and iron foundries,

machining, plastic injection molding and assembly operations. Our foundry operations include metal
pouring systems, automatic core making, yellow brass forging and brass and bronze die castings. Our
machining operations feature computer-controlled machine tools, high-speed chucking machines with
robotics and automatic screw machines for machining bronze, brass and steel components. We have
invested heavily in recent years to expand our manufacturing base and to ensure the availability of the
most efficient and productive equipment. We are committed to maintaining our manufacturing
equipment at a level consistent with current technology in order to maintain high levels of quality and
manufacturing efficiencies.

We continue to implement an integrated enterprise-wide software system in our North American

locations with a focus on inventory management; production scheduling and electronic data
interchange. This system has enabled us to provide better service to our customers, improve working
capital management, lower transaction costs and improve e-commerce capabilities.

Capital expenditures and depreciation and amortization for the following periods were as follows:

Period

Capital
Expenditures

Depreciation and
Amortization

Year ended December 31, 2003 . . . . . . . . . . . . . . . .
Year ended December 31, 2002 . . . . . . . . . . . . . . . .
Year ended December 31, 2001 . . . . . . . . . . . . . . . .

$20.0 million
$19.6 million
$16.0 million

$21.3 million
$22.3 million
$23.7 million

Our capital expenditure budget for 2004 is approximately $18.5 million, primarily for

manufacturing machinery and equipment.

Raw Materials

The five significant raw materials used in our production processes are bronze ingot, brass rod,

cast iron, steel and plastic. We historically have not experienced significant difficulties in obtaining
these commodities in quantities sufficient for our operations. There have been significant changes in
the costs of certain of these materials, including recent increases in the costs of bronze, brass, cast iron
and steel. Our gross profit margins are adversely affected to the extent that the selling prices of our
products do not increase proportionately with increases in the costs of these raw materials. Any
significant unanticipated increase or decrease in the costs of these commodities could materially affect
our results of operations. 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. In addition, on a limited basis, we use commodity futures
contracts to manage this risk. We did not purchase any commodity futures contracts during 2003. See
‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations—
Quantitative and Qualitative Disclosures About Market Risk.’’ We have begun to implement some price
increases in response to the recent increases in the cost of bronze, brass, cast iron and steel. At this
point, it is too early to determine if these price increases will be successful in reducing or eliminating
the impact of the increases in raw material costs.

Code Compliance

Products representing a majority of our sales are subject to regulatory standards and code

enforcement which typically requires that these products meet stringent performance criteria. Standards
are established by such industry test and certification organizations as the American Society of
Mechanical Engineers (A.S.M.E.), the Canadian Standards Association (C.S.A.), the American Society

of Sanitary Engineers (A.S.S.E.), the University of Southern California Foundation for Cross-
Connection Control (USC FCC&HR), the International Association of Plumbing and Mechanical
Officials (I.A.P.M.O.), Factory Mutual (F.M.), the National Sanitation Foundation (N.S.F.) and
Underwriters Laboratory (U.L.). These standards are incorporated into state and municipal plumbing
and heating, building and fire protection codes.

National regulatory standards in Europe vary by country. The major standards and/or guidelines
which our products must meet are AFNOR (France), DVGW (Germany), UNI/ICIN (Italy), KIWA
(Netherlands), SVGW (Switzerland), SITAC (Sweden) and WRAS (United Kingdom). Through the
Committee for European Normalization (CEN) European applications and product standards will be
adopted in each country and implemented in each certification system.

Together with our commissioned manufacturers’ representatives, we have consistently advocated
the development and enforcement of plumbing codes. We maintain stringent quality control and testing
procedures at each of our manufacturing facilities in order to manufacture products in compliance with
code requirements. We believe that significant product testing capability and investment in plant and
equipment is needed to manufacture products in compliance with code requirements, which creates a
barrier to entry for competitors. Additionally, a majority of our manufacturing facilities are ISO 9000,
9001 or 9002 certified by the International Organization for Standardization.

Product Development and Engineering

We maintain our own product development and design teams in North America, Europe and

China that continuously enhance our existing products and develop new products. We maintain
sophisticated product development and testing laboratories. Our efforts in this area have been
particularly successful in the DIY market, which values innovation in product design.

Competition

The domestic and international markets for water safety and flow control devices are intensely
competitive and require us to compete against some companies possessing greater financial, marketing
and other resources than ours. Our management considers brand preference, engineering specifications,
plumbing code requirements, price, technological expertise, delivery times and breadth of product
offerings to be the primary competitive factors. We believe that new product development and product
engineering are also important to success in the water industry and that our position in the industry is
attributable in significant part to our ability to develop new and innovative products quickly and to
adapt and enhance existing products. We continue to develop new and innovative products to enhance
market position and are continuing to implement manufacturing and design programs to reduce costs.
We cannot be certain that our efforts to develop new products will be successful or that our customers
will accept our new products. Although we own certain patents and trademarks that we consider to be
of importance, we do not believe that our business and competitiveness as a whole are dependent on
any one of our patents or trademarks or on patent or trademark protection generally.

Backlog

Backlog was $40.0 million at February 20, 2004 and $42.7 million at February 14, 2003. We do not

believe that our backlog at any point in time is indicative of future operating results.

Employees

As of December 31, 2003, our domestic and foreign operations employed approximately 3,700
people, plus 1,400 employees in our joint ventures in China. None of our employees in North America
are covered by collective bargaining agreements. Our European employees are subject to the traditional
national collective bargaining agreements. We believe that our employee relations are good.

Available Information

We maintain a website with the address www.wattswater.com. The information contained on our

website is not included as a part of, or incorporated by reference into, this Annual Report on
Form 10-K. Other than an investor’s own internet access charges, we make available free of charge
through our website our Annual Report on Form 10-K, quarterly reports on Form 10-Q and current
reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we
have electronically filed such material with, or furnished such material to, the Securities and Exchange
Commission.

Executive Officers and Directors

Set forth below are the names of our executive officers and directors, their respective ages and

positions with our Company and a brief summary of their business experience for the past five years:

Name

Age

Position

Patrick S. O’Keefe . . . . . . . . . . . . . . . . . . . . .

51 Chief Executive Officer, President and Director

William C. McCartney . . . . . . . . . . . . . . . . . .

50 Chief Financial Officer, Treasurer and

Secretary

Ernest E. Elliott . . . . . . . . . . . . . . . . . . . . . . .

52 Executive Vice President of Wholesale

Marketing

Jeffrey A. Polofsky . . . . . . . . . . . . . . . . . . . . .

45 Executive Vice President of Retail Sales and

Marketing

Lynn A. McVay . . . . . . . . . . . . . . . . . . . . . . .

36 Executive Vice President of Wholesale Sales

Paul A. Lacourciere . . . . . . . . . . . . . . . . . . . .

48 Corporate Vice President of Manufacturing

J. Dennis Cawte . . . . . . . . . . . . . . . . . . . . . . .

53 Group Managing Director Europe

Lester J. Taufen . . . . . . . . . . . . . . . . . . . . . . .

60 General Counsel and Vice President of Legal

Affairs

Douglas T. White . . . . . . . . . . . . . . . . . . . . . .

59 Group Vice President

J. Timothy McCullough . . . . . . . . . . . . . . . . . .

62 Vice President of Human Resources

Timothy P. Horne . . . . . . . . . . . . . . . . . . . . . .

65 Director

Kenneth J. McAvoy(1)(2)(3) . . . . . . . . . . . . . .

63 Director

Gordon W. Moran(1)(2)(3) . . . . . . . . . . . . . . .

65 Non-Executive Chairman of the Board and

Daniel J. Murphy, III(1)(2)(3) . . . . . . . . . . . . .

62 Director

Roger A. Young(1)(3) . . . . . . . . . . . . . . . . . . .

58 Director

John K. McGillicuddy(1)(3) . . . . . . . . . . . . . . .

60 Director

Director

(1) Member of the Audit Committee

(2) Member of the Compensation Committee

(3) Member of the Nominating and Corporate Governance Committee

Patrick S. O’Keefe joined our Company in August 2002. Prior to joining our Company, he served as

President, Chief Executive Officer and Director of Industrial Distribution Group, a supplier of
maintenance, repair, operating and production products, from 1999 to 2001. He was Chief Executive
Officer of Zep Manufacturing, a unit of National Service Industries and a manufacturer of specialty
chemicals throughout North America, Europe and Australia, from 1997 to 1999. He has also held
various senior management positions with Crane Co. from 1994 to 1997.

William C. McCartney joined our Company in 1985 as Controller. He was appointed our Vice

President of Finance in 1994 and served as our Corporate Controller from April 1988 to
December 1999. He was appointed Chief Financial Officer, Treasurer and Secretary on January 1, 2000.

Ernest E. Elliott joined our Company in 1986, serving in a variety of sales and marketing roles. He

was appointed Vice President of Sales in 1991 and Executive Vice President of Wholesale Sales and
Marketing in 1996. Prior to joining our Company, he was Vice President of BTR Inc.’s Valve Group, a
diversified manufacturer of industrial and commercial valve products.

Jeffrey A. Polofsky joined our Company in October 1998 as the Vice President and General
Manager of Anderson Barrows Metals Company. He was named Executive Vice President of Retail
Sales and Marketing in January 2000. Prior to joining our Company, he was employed at Desa
International, a manufacturer of consumer hard goods, from 1988 to 1998.

Lynn A. McVay joined our Company as Executive Vice President of Wholesale Sales in

March 2003. Prior to joining our Company, he was the Vice President of Sales and Marketing for Little
Giant Pump Company, a water pump manufacturing company and a wholly-owned subsidiary of
Tecumseh Products Company.

Paul A. Lacourciere joined our Company in 1986 as Vice President of New Hampshire operations

in 1989. He also served our wholly-owned subsidiary Watts Regulator Co. as Vice President of
Manufacturing from 1991 to 1993; Executive Vice President from 1993-1995 and President from
1995-1997. In 1997 he was appointed Corporate Vice President of Manufacturing of our Company.

J. Dennis Cawte joined our Company in October 2001 and was appointed Group Managing
Director Europe. Prior to joining our Company, he was European President of PCC Valve and
Controls, a division of Precision Castparts Corp., a manufacturer of components and castings to the
aeronautical industry, from 1999 to 2001. He had also worked for Keystone Valve International, a
manufacturer and distributor of industrial valves, for 20 years, his most recent position was the Director
of Northern European Operations.

Lester J. Taufen joined our Company in January 1999 as Associate Corporate Counsel. He was

appointed General Counsel and Vice President of Legal Affairs, and Assistant Secretary in
January 2000. Prior to joining our Company, he was employed for 13 years at Elf Atochem North
America, a chemical manufacturing company, serving as Senior Counsel.

Douglas T. White joined our Company in September 2001 as Group Vice President. Prior to joining

our Company he was employed by Honeywell International, Inc., a diversified technology and
manufacturing company, as Vice President of Marketing—Consumer Products Group.

J. Timothy McCullough joined our Company as Director of Human Resources in May 1998. He was

appointed Vice President of Human Resources in November 2003.

Timothy P. Horne has been a Director since 1962. He was employed by our Company since
September 1959 and served as our President from 1976 to 1978, from 1994 to April 1997 and from
October 1999 to August 2002. He served as Chief Executive Officer from 1978 to August 2002, and he
served as Chairman of our Board of Directors from April 1986 to August 2002. He retired from our
Company on December 31, 2002.

Kenneth J. McAvoy was Controller of our Company from 1981 to 1986 and Chief Financial Officer
and Treasurer from 1986 to 1999. He also served the offices of Vice President of Finance from 1984 to
1994; Executive Vice President of European Operations from 1994 to 1996; and Secretary from 1985 to
1999. He retired from our Company on December 31, 1999.

Gordon W. Moran has been the Chairman of Hollingsworth & Vose Company, a paper

manufacturer, since 1997, and served as its President and Chief Executive Officer from 1983 to 1998.

Daniel J. Murphy, III has been the Chairman of Northmark Bank, a commercial bank, since
August 1987. Prior to forming Northmark Bank in 1987, he was a Managing Director of Knightsbridge
Partners, a venture capital firm, from January to August 1987, and President and a Director of Arltru
Bancorporation, a bank holding company, and its wholly-owned subsidiary, Arlington Trust Company
from 1980 to 1986.

Roger A. Young served as Chairman of the Board of Directors of Bay State Gas Company, a
wholly-owned subsidiary of NiSource, Inc., from 1996 to 2003 and served on its Board from 1975 to
2003. He was elected President and Chief Operating Officer of Bay State Gas Company in 1981 and
Chief Executive Officer in 1990, serving in such positions until 1999. He has also been a Director of
NiSource, Inc. since 1999.

John K. McGillicuddy was employed by KPMG LLP, a public accounting firm, from June 1965 until
his retirement in June 2000. He was elected into the Partnership at KPMG LLP in June 1975 where he
served as Audit Partner, SEC Reviewing Partner, Partner-in-Charge of Professional Practice,
Partner-in-Charge of College Recruiting and Partner-in-Charge of Staff Scheduling. He is a Director of
Brooks Automation, Inc.

Product Liability, Environmental and Other Litigation Matters

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.

Contingencies

James Jones Litigation

As previously disclosed, on June 25, 1997, Nora Armenta (the Relator) sued James Jones
Company, Watts Water Technologies, Inc, which formerly owned James Jones, Mueller Co. and Tyco
International (U.S.) in the California Superior Court for Los Angeles County. 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,
11 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 allegations in the First Amended Complaint is the suggestion that because some of the

purchased James Jones products were made of ’81 bronze (UNS No. C8440) and contain more lead
than the specified ’85 bronze (UNS No. C83600), 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. We believe 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, we 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.

In this case, the Relator seeks three times an unspecified amount of actual damages and alleges
that the municipalities have suffered hundreds of millions of dollars in damages. The Relator 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
$2.0 million toward this settlement. In August 2003, an additional settlement payment was made for
$13 million ($11 million from us and $2 million from the James Jones Company) which settled the
claims of the three Phase I cities (Santa Monica, San Francisco and East Bay Municipal Water District)
chosen by the Relator as having the strongest claims to be tried first. This settlement payment included
the Relator’s statutory share, and the claims of these three cities have been dismissed. In addition to
this $13 million payment, we are obligated to pay the Relator’s attorney’s fees.

After the Phase I settlement, the Court permitted the Company and the other defendants to select

five additional cities (Contra Costa, Corona, Santa Ana, Santa Cruz and Vallejo) to serve as the
plaintiffs in a second trial phase of the case. The Company and James Jones subsequently reached an
agreement to settle the City of Santa Ana’s claims for $45,000, and we are responsible for $38,000 of
this settlement amount. Santa Ana has submitted this claim to the Court for approval in March 2004.
The trial of the claims of the remaining Phase II cities is scheduled for September 2004.

We have a reserve of approximately $9.3 million with respect to the James Jones Litigation in our

consolidated balance sheet as of December 31, 2003. We believe, on the basis of all available
information, that this reserve is adequate to cover the probable and reasonably estimable losses
resulting from the James Jones Litigation and the insurance coverage litigation with Zurich discussed
below. We are currently unable to make an estimate of the range of any additional losses.

On February 14, 2001, we filed a complaint in the California Superior Court against our 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 (Zurich) 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. On October 24, 2002, the California Superior Court made another
summary adjudication ruling that Zurich must indemnify and pay us for the amounts we must pay
under our settlement agreement with the City of Los Angeles. Zurich has asserted that all amounts
(both defense costs and indemnity amounts paid for settlements) paid by it to us are subject to
reimbursement under Deductible Agreements between Zurich and us. However, management and
counsel anticipate that we will ultimately prevail on reimbursement issues. Zurich appealed the orders
requiring it to pay defense costs, the California Court of Appeal accepted that appeal, and it is
currently pending. Zurich also sought appellate review of the order that found coverage and required
Zurich to indemnify us for the settlement with the City of Los Angeles. On March 26, 2003, the
California Court of Appeal denied Zurich’s petition for appellate review of this order, but Zurich will
still be able to appeal this order at the end of the case. We are currently unable to predict the finality
of the order on indemnity for the Los Angeles settlement. We have recorded reimbursed indemnity
settlement amounts (but not reimbursed defense costs) as a liability. We intend to contest vigorously
the Armenta case and its related litigation.

Based on management’s assessment, we do not believe that the ultimate outcome of the James

Jones case will have a material adverse effect on our liquidity, financial condition or results of
operations. While this assessment is based on all available information, litigation is inherently uncertain,
the actual liability to us to fully resolve this litigation cannot be predicted with any certainty and there
exists a reasonable possibility that we may ultimately incur losses in the James Jones Litigation in
excess of the amount accrued. We intend to continue to contest vigorously the James Jones case and its
related litigation.

Environmental Remediation

We have been named as a potentially responsible party (PRP) with respect to a limited number of
identified contaminated sites. The level of contamination varies significantly from site to site as do the
related levels of remediation efforts. Environmental liabilities are recorded based on the most probable
cost, if known, or on the estimated minimum cost of remediation. We accrue estimated environmental
liabilities based on assumptions, which are subject to a number of factors and uncertainties.
Circumstances which can affect the reliability and precision of these estimates include identification of
additional sites, environmental regulations, level of cleanup required, technologies available, number
and financial condition of other contributors to remediation and the time period over which
remediation may occur. We recognize changes in estimates as new remediation requirements are
defined or as new information becomes available. We have a reserve of approximately $2.5 million, and
we estimate that our accrued environmental remediation liabilities will likely be paid over the next five
to ten years. Based on the facts currently known to us, we do not believe that the ultimate outcome of
these claims will have a material adverse effect on our liquidity, financial condition or results of
operations.

For several years, the New York Attorney General (NYAG) has threatened to bring suit against

approximately 16 PRPs, including Watts Water Technologies, Inc as successor to Jameco
Industries, Inc., for incurred remediation costs and for operation and maintenance costs that will be
incurred in connection with the cleanup of a landfill site in Babylon, New York. The NYAG has
identified recovery numbers between $19 million and $24 million, but it is too early to know what the
final recovery number will be, what the final number of PRPs will be or what proportion of the final
costs may be allocated to us. In 2003, 139 PRPs were identified by our defense group, and they are in
the process of being invited to join the PRPs identified so far by the NYAG. Based on the facts
currently known to us, we do not believe that the ultimate outcome of the Babylon matter will have a
material adverse effect on our liquidity, financial condition or results of operations.

Asbestos Litigation

We are a defendant in approximately 115 actions filed primarily, but not exclusively, 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
particular products of ours as a source of asbestos exposure. To date the Company has been dismissed
from each case when the scheduled trial date comes near. Based on the facts currently known to us, we
do not believe that the ultimate outcome of these claims will have a material adverse effect on our
liquidity, financial condition or results of operations.

Other Litigation

On or about March 26, 2003, a class action complaint was filed against the Company by North

Carolina Hospitality Group, Inc. in the Circuit Court of Maryland, Prince George’s County. It alleges
that certain commercial valve models contain a design defect that causes them to fail prematurely. Our
extensive investigation of the evidence, including the physical evidence presented so far by the plaintiff,
demonstrates that the allegations in the complaint are without merit, and we intend to defend this
lawsuit vigorously. Based on the facts currently known to us, we do not believe that the ultimate
outcome of this matter will have a material adverse effect on our liquidity, financial condition or results
of operations.

Other lawsuits and proceedings or claims, arising from the ordinary course of operations, are also
pending or threatened against us. Based on the facts currently 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 operations.

However, litigation is inherently uncertain, and we believe that there exists a reasonable possibility

that we may ultimately incur losses in other litigation in excess of the amount accrued.

Item 2. PROPERTIES.

We maintain 45 facilities worldwide with our corporate headquarters located in North Andover,

Massachusetts. Our manufacturing operations include four casting foundries, two of which are located
in the United States and two in Tianjin, China. Additionally, we maintain one yellow brass forging
foundry located in Italy. Castings and forgings from these foundries and other components are
machined and assembled into finished valves at 25 manufacturing facilities located in the United States,
Canada, Europe, China and Tunisia. Many of these facilities contain sales offices, warehouses, or sales
and distribution centers from which we ship finished goods to customers and commissioned
manufacturers’ representatives. All our operating facilities and the related real estate are owned by us,
except the buildings and land operated by one of our joint ventures located in Tianjin, China, which is
leased with a remaining term of approximately 22 years, the land on which our manufacturing facility is
located in Taizhou, China with a remaining term of 49 years and except for the following facilities, each
of which is leased:

Type of Facility

Location

Lease Expiration

Springfield, MO

Sacramento, CA
Santa Ana, CA

Manufacturing . . . . . . . . . . . . .
Manufacturing . . . . . . . . . . . . . Phoenix, AZ
Manufacturing . . . . . . . . . . . . . Woodland, CA
Manufacturing . . . . . . . . . . . . .
Manufacturing . . . . . . . . . . . . .
Warehouse . . . . . . . . . . . . . . . . Reno, NV
Warehouse . . . . . . . . . . . . . . . . Dallas, TX
Warehouse . . . . . . . . . . . . . . . . Alsip, IL
Sales Office . . . . . . . . . . . . . . . Kennesaw, GA
Sales Office . . . . . . . . . . . . . . . Des Plaines, IL
Manufacturing . . . . . . . . . . . . . Rosieres, France
Manufacturing . . . . . . . . . . . . . Monastir, Tunisia
Manufacturing . . . . . . . . . . . . . Neuenburg am Rhein, Germany
Sales/Distribution . . . . . . . . . . . Barcelona, Spain
Sales/Distribution . . . . . . . . . . . Evesham, UK
Sales/Distribution . . . . . . . . . . . Molndal, Sweden
Sales/Distribution . . . . . . . . . . . Gliwice, Poland
Sales/Distribution . . . . . . . . . . . Vilnius, Lithuania
Sales/Distribution . . . . . . . . . . . Wingene, Belgium
Sales/Distribution . . . . . . . . . . . Chartres, France
Sales/Distribution . . . . . . . . . . . Calgary, Alberta, Canada
Sales/Distribution . . . . . . . . . . . Worcestershire, U.K.

2004
2010
2008
2005
2008
2005
2006
2008
2007
2008
2015
2004
2004
2004
2016
2007
(1)
(1)
(2)
2004
2006
2005

(1) We operate in this facility pursuant to a month-to-month lease.

(2) We operate in this facility pursuant to a lease with an indefinite term that may be terminated by

either party upon six months notice.

Certain of our facilities are subject to mortgages and collateral assignments under loan agreements

with long-term lenders. In general, we believe that our properties, including machinery, tools and
equipment, are in good condition, well maintained and adequate and suitable for their intended uses.
We believe that our manufacturing facilities are currently operating at a level that our management
considers normal capacity, except for our two recently expanded plants in China which are under
utilized. Management believes capacity utilization will be increasing in 2004 at these plants. This
utilization is subject to change as a result of increases or decreases in sales.

Item 3. LEGAL PROCEEDINGS.

Item 3(a). We are from time to time involved in various legal and administrative procedures. See

Part I, Item 1, ‘‘Business—Product Liability, Environmental and Other Litigation Matters.’’

Item 3(b).

See Part I, Item 1, ‘‘Business—Product Liability, Environmental and Other Litigation
Matters.’’

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

There were no matters submitted during the fourth quarter of the fiscal year covered by this

Annual Report to a vote of security holders through solicitation of proxies or otherwise.

Item 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER

PART II

MATTERS.

Market Information

The following table sets forth the high and low sales prices of our Class A Common Stock on the

New York Stock Exchange during 2003 and 2002 and cash dividends paid per share.

First Quarter . . . . . . . . . . . .
Second Quarter . . . . . . . . . .
Third Quarter . . . . . . . . . . .
Fourth Quarter . . . . . . . . . . .

High

$16.75
19.00
19.55
22.50

2003

Low

$13.53
15.40
17.27
17.48

Dividend

High

$0.06
0.06
0.06
0.07

$17.22
20.00
20.12
18.30

2002

Low

$13.82
16.05
15.82
14.80

Dividend

$0.06
0.06
0.06
0.06

There is no established public trading market for our Class B Common Stock, which is held

exclusively by members of the Horne family. The principal holders of such stock are subject to
restrictions on transfer with respect to their shares. Each share of our Class B Common Stock (10 votes
per share) is convertible into one share of Class A Common Stock (1 vote per share).

Aggregate common stock dividend payments for 2003 and 2002 were $6,859,000 and $6,490,000,
respectively. While we presently intend to continue to pay cash dividends, the payment of future cash
dividends depends upon the Board of Directors’ assessment of our earnings, financial condition, capital
requirements and other factors.

The number of record holders of our Class A Common Stock as of February 29, 2004 was 132.

The number of record holders of our Class B Common Stock as of February 19, 2004 was 9.

Item 6. SELECTED FINANCIAL DATA.

The selected financial data set forth below should be read in conjunction with our consolidated
financial statements, related Notes thereto and ‘‘Management’s Discussion and Analysis of Financial
Condition and Results of Operations’’ included herein.

FIVE YEAR FINANCIAL SUMMARY
(Amounts in thousands, except per share information)

Selected Data
Net sales . . . . . . . . . . . . . . . . . .
Income from continuing

operations . . . . . . . . . . . . . . .

Income (loss) from discontinued

operations, net of taxes . . . . . .
Net income . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . .
Long-term debt, net of current

portion . . . . . . . . . . . . . . . . . .

Income per share from

continuing operations—diluted .

Income (loss) per share from
discontinued operations—
diluted . . . . . . . . . . . . . . . . . .
Net income per share—diluted . .
Cash dividends declared per

Year
Ended

Six
Months
Ended

Year
Ended

12/31/03(1)(4) 12/31/02(2) 12/31/01(3) 12/31/00(4) 12/31/99(5)(6)(7) 6/30/99(4)(6)

$705,651

$615,526 $548,940 $516,100

$261,019

$477,869

36,473

32,622

26,556

31,171

16,468

29,454

(3,111)
33,362
838,643

—
32,622
635,472

— (7,170)
24,001
482,025

26,556
520,470

(1,226)
15,242
487,078

6,502
35,956
637,742

179,061

56,276

123,212

105,377

123,991

118,916

1.32

1.21

0.99

1.17

0.61

(0.11)
1.21

—
1.21

—
0.99

(0.27)
0.90

(0.05)
0.56

1.10

0.24
1.34

common share . . . . . . . . . . . .

0.25

0.24 $

0.268

0.175

0.35

(1) For the year ended December 31, 2003, net income includes the following pre-tax costs:

restructuring of $426,000; other costs consist of: inventory and other asset write-downs and
accelerated depreciation of $479,000; and $750,000 of other related charges. The after tax cost of
these items was $1,084,000.

(2) For the year ended December 31, 2002, net income includes the following pre-tax costs:

restructuring of $638,000; other costs consist of: inventory and other asset write-downs and
accelerated depreciation of $2,491,000; and $960,000 of other related charges. The after-tax cost of
these items was $2,552,000.

(3) For the year ended December 31, 2001, net income includes the following pre-tax costs:

restructuring of $1,454,000; other costs consist of: inventory and other asset write-downs and
accelerated depreciation of $4,300,000; and $77,000 of other related charges. The after-tax cost of
these items was $3,593,000.

(4) In September 1996, we divested our Municipal Water Group of businesses, which included Henry

Pratt, James Jones Company and Edward Barber and Company Ltd. Costs and expenses related to
the Municipal Water Group, for 2003, 2000 and 1999 relate to legal and settlement costs associated
with the James Jones Litigation. The loss, net of taxes, consists of $3,111,000, $7,170,000 and
$3,000,000 for the years ended December 31, 2003, 2000 and June 30, 1999, respectively.

(5) For the six months ended December 31, 1999, net income includes restructuring and other costs of

$1,460,000 pre-tax or $861,000 net of tax.

(6) On October 18,1999, we spun-off our industrial and oil and gas businesses into a separate publicly-

traded company, CIRCOR International, Inc., or CIRCOR. Under the terms of the spin-off
transaction, we distributed to our shareholders a tax-free dividend of one share of CIRCOR
common stock for every two shares of our common stock owned as of the record date.

(7) In May 1999, we changed our fiscal year end from June 30 to a calendar year. As a result, we

reported a six-month transition period ending December 31, 1999.

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS.

Overview

We are a leading supplier of products for use in the water quality, water safety, water flow control
and water conservation markets in both North America and Europe. For more than 125 years, we have
designed and manufactured products that promote the comfort and safety of people and the quality
and conservation for water used in commercial, residential and light industrial applications. We earn
revenue and income almost exclusively from the sale of our products. Our principal product lines
include:

(cid:127) backflow preventers for preventing contamination of potable water caused by reverse flow within

water supply lines and fire protection systems;

(cid:127) a wide range of water pressure regulators for both commercial and residential applications;

(cid:127) water supply and drainage products for commercial and residential applications;

(cid:127) temperature and pressure relief valves for water heaters, boilers and associated systems;

(cid:127) point-of-use water filtration and reverse osmosis systems for both commercial and residential

applications;

(cid:127) thermostatic mixing valves for tempering water in commercial and residential applications; and

(cid:127) pumping systems for under-floor radiant applications.

Our business is reported in three geographic segments, North America, Europe and China. We

distribute our products through three primary distribution channels, wholesale, DIY and OEMs.
Increases in Gross National Product (GNP) indicate a healthy economic environment which we believe
positively impacts our results of operations. The economic factors that we believe have the most
significant direct effect on the demand for our products are the number of new housing construction
starts and non-residential, or commercial, construction starts. Interest rates have a significant indirect
effect on the demand for our products due to the effect such rates have on the number of new
residential and commercial construction starts and remodeling projects. An additional factor that has
had a significant effect on our sales is fluctuations in foreign currencies, as a significant portion of our
sales and certain portions of our costs, assets and liabilities are denominated in currencies other than
the U.S. dollar. Approximately 37.2% of our sales during the year ended December 31, 2003 were from
sales outside of the U.S. compared to 31.4% for the year ended December 31, 2002.

We believe that the most significant factors relating to our future growth include our ability to

continue to make selected acquisitions, both in our core markets as well as new complementary
markets, regulatory requirements relating to the quality and conservation of water and increased
demand for clean water and continued enforcement of plumbing and building codes. We have
completed fourteen acquisitions since divesting our industrial and oil and gas business in 1999. Our
acquisition strategy focuses on businesses that manufacture preferred brand name products that address
our themes of water quality, water safety, water conservation and water flow control. We target
businesses that will provide us with one or more of the following: an entry to new markets, an increase
in shelf space with existing customers, a new or improved technology or an expansion of the breadth of
our water quality, water conservation, water safety and water flow control products for the residential
and commercial markets.

Products representing a majority of our sales are subject to regulatory standards and code

enforcement, which typically require that these products meet stringent performance criteria. Together
with our commissioned manufacturers’ representatives, we have consistently advocated the development
and enforcement of such plumbing codes. We are focused on maintaining stringent quality control and

testing procedures at each of our manufacturing facilities in order to manufacture products in
compliance with code requirements and take advantage of the resulting demand for compliant
products. We believe that significant product development, product testing capability and investment in
plant and equipment is needed to manufacture products in compliance with code requirements, which
represents a significant barrier to entry for competitors. We believe there is an increasing demand
among consumers for products to ensure water quality, which creates growth opportunities for our
products.

A significant risk we face is our ability to deal effectively with increases in raw material costs. We

require substantial amounts of raw materials, including bronze, brass, cast iron, steel and plastic to
produce our products and substantially all of the raw materials we require are purchased from outside
sources. Recently, we have experienced increases in the costs of bronze, brass, cast iron and steel. If we
are not able to reduce or eliminate the effect of these cost increases by reducing production costs or
successfully implementing price increases, these increases in raw material costs could reduce our profit
margins.

Another significant risk we face in all areas of our business is competition. We consider brand
preference, engineering specifications, plumbing code requirements, price, technological expertise,
delivery times and breadth of product offerings to be the primary competitive factors. As mentioned
previously, we believe that significant product development, product testing capability and investment in
plant and equipment is needed to manufacture products in compliance with code requirements, which
represents a significant barrier to entry for competitors. We are committed to maintaining our capital
equipment at a level consistent with current technologies and we have invested $20.0 million in capital
equipment in 2003 and we expect to invest approximately $18.5 million in 2004. We are also committed
to expanding our manufacturing capacity in lower cost countries such as China, Tunisia and Bulgaria.
These manufacturing plant relocations and consolidations are an important part of our ongoing
commitment to reduce production costs.

2003 Highlights

Highlights for the year ended December 31, 2003 include the following:

(cid:127) Net sales increased $90.1 million, or 14.6%, in 2003 compared to 2002 due to the following:

Foreign Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Internal Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Impact of FIN 46R . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(in millions)
35.0
$
27.4
23.9
3.8
90.1

5.7%
4.4%
3.9%
0.6%
14.6%

(cid:127) Operating margins increased to 9.9% in 2003 from 9.3% in 2002.

(cid:127) Income from continuing operations increased 11.8% to $36.5 million in 2003 from $32.6 million

in 2002.

(cid:127) Diluted earnings per share from continuing operations increased to $1.32 in 2003 from $1.21 in

2002.

(cid:127) On May 15, 2003, the Company refinanced its $75.0 million 83⁄8% notes due December 1, 2003
through a private placement of $50.0 million 4.87% notes and $75.0 million 5.47% notes. The
Company experienced additional interest expense of approximately $3.5 million from May 15,
2003 to December 1, 2003.

(cid:127) On December 15, 2003, the Company completed a public offering of 4.6 million shares of its
Class A Common Stock resulting in net proceeds of approximately $82.5 million in cash.

(cid:127) The Company consummated two acquisitions in Europe and entered into an agreement to

acquire substantially all of the assets of Flowmatic Systems, Inc. located in Dunnellon, Florida.

(cid:127) Working capital (less cash) to sales ratio was reduced for the seventh consecutive year.

(cid:127) Net cash provided by continuing operations was $50.0 million despite a $6.8 million pension

contribution and various working capital pressures.

(cid:127) The Euro appreciated approximately 21% over 2002 and the Canadian dollar appreciated

approximately 13% over 2002 against the U.S. dollar.

(cid:127) The Company’s wholly-owned facility in China started operations.

(cid:127) Effective October 1, 2003, the Company adopted Financial Accounting Standards Board

Interpretation No. 46 ‘‘Consolidation of Variable Interest Entities—Revised’’ (FIN 46R) and
consolidated its variable interest entity, Jameco International LLC, located in Lakewood, New
Jersey.

(cid:127) The Company recorded an after tax charge to discontinued operations of $3.1 million primarily

for legal and settlement costs and expenses related to the James Jones Litigation.

(cid:127) The Company recorded an adjustment of $2.2 million of revenue previously recorded at its TWT

joint venture in Tianjin, China, which reduced earnings by $0.02 per share.

(cid:127) The Company recorded an after tax charge of $1.1 million, or $0.04 per share, for costs
associated with its manufacturing restructuring plan. The Company expects to incur
approximately $3.6 million after tax of similar costs in 2004.

(cid:127) On July 30, 2003, we acquired Giuliani Anello S.r.l. located in Cento Bologna, Italy, for
approximately $10.6 million in cash net of acquired cash of $1.4 million. Giuliani Anello
manufactures and distributes valves and filters utilized in heating applications including strainer
filters, solenoid valves, flow stop valves, stainless steel water filter elements and steam cleaning
filters.

(cid:127) On April 18, 2003, we acquired Martin Orgee UK Ltd located in Kidderminster, West Midlands,

United Kingdom for approximately $1.6 million in cash. Martin Orgee distributes a line of
plumbing and heating products to the wholesale, commercial and OEM markets in the United
Kingdom and Southern Ireland. Martin Orgee also assembles pumping systems for under-floor
radiant heat applications.

Recent Developments

On February 20, 2004, we entered into an agreement with Yuhuan County Cheng Guan Metal
Hose Factory to acquire its 40% equity interest in our Shida joint venture for an expected purchase
price of $3.0 million, the assumption of approximately $6.0 million of debt and the payment of
$3.5 million in connection with a three-year non-compete agreement. After the transaction, we will own
100% of Shida. The closing of the transaction is subject to the satisfaction of certain closing conditions
and is expected to occur during the second quarter of 2004.

On January 5, 2004, we acquired substantially all of the assets of Flowmatic Systems, Inc. located

in Dunnellon, Florida, for approximately $16.5 million in cash. Flowmatic designs and distributes a
complete line of high quality reverse osmosis components and filtration equipment. Their product line
includes stainless steel and plastic housings, filter cartridges, storage tanks, control valves, as well as
complete reverse osmosis systems for residential and commercial applications.

We continue to implement a plan to consolidate several of our manufacturing plants in North
America and Europe. At the same time we are expanding our manufacturing capacity in China and
other low cost areas of the world. The implementation of this manufacturing restructuring plan began
during the fourth quarter of 2001 and will continue in 2004. The projects for which charges were
recorded in the fourth quarter of 2001 are essentially complete. During 2002, we decided to expand the
scope of the manufacturing restructuring plan and transfer certain production to low cost

manufacturing plants in Tunisia and Bulgaria. We expect to record an additional $6.0 million in 2004
attributable to accelerated depreciation associated with the anticipated closure of one of our U.S.
manufacturing plants and a reduction in estimated useful lives of manufacturing equipment due to the
transfer of production to lower cost countries. The Company recorded pre-tax manufacturing
restructuring and other costs of $1.7 million net of recoveries for 2003. The manufacturing restructuring
and other costs recorded consist primarily of severance costs, asset write-downs and accelerated
depreciation. The severance costs, which have been recorded as restructuring, are for 48 employees in
manufacturing and administration groups. We expect to make all of these severance payments during
the first quarter of 2004. Asset write-downs consist primarily of write-offs of inventory related to
product lines that we have discontinued as part of this restructuring plan and are recorded in cost of
goods sold. Accelerated depreciation is based on shorter remaining estimated useful lives of certain
fixed assets and has been recorded in cost of goods sold. Other costs consist primarily of removal and
shipping costs associated with relocation of manufacturing equipment and have been recorded in cost
of goods sold and have been expensed as incurred.

Results of Operations

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Net Sales. Our business is reported in three geographic segments: North America, Europe and
China. Our net sales in each of these segments for each of the years ended December 31, 2003 and
2002 were as follows:

Year Ended
December 31,

2003

% Sales

2002

% Sales

Change

% Change

(in thousands)

North America . . . . . . . . . . . . . . . . . .
Europe . . . . . . . . . . . . . . . . . . . . . . . .
China . . . . . . . . . . . . . . . . . . . . . . . . .

$476,310
210,614
18,727

67.5% $450,233
29.8% 145,629
19,664
2.7%

73.1% $26,077
23.7% 64,985
(937)
3.2%

Total . . . . . . . . . . . . . . . . . . . . . . . . . .

$705,651

100% $615,526

100% $90,125

4.2%
10.6%
(0.2)%

14.6%

The increase in net sales in North America in 2003 compared to 2002 is due to internal growth of
$18,381,000, or 3.0%, the appreciation of the Canadian dollar against the U.S. dollar, which accounted
for $3,904,000, or 0.6%, of the increase and the impact of the adoption of FIN 46R which accounted
for $3,792,000, or 0.6%, of the increase. We cannot predict whether the Canadian dollar will continue
to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate
fluctuations will have a positive or negative impact on our net sales. The increase in the internal growth
rate in North America is primarily due to increased unit sales into the DIY and wholesale markets.
Our sales into the North American DIY market grew by 12.8% in 2003 over 2002 due to the increasing
store count of our large customers, the successful introduction of new products and consistent and
reliable delivery of our products. Our wholesale market grew by 2.1% in 2003 over 2002 due to
increased sales of backflow preventors. A significant increase or decrease in interest rates or an
increase or drop in the new housing construction market could have a positive or negative impact on
our sales. Not included in either the DIY or wholesale market comparisons are fourth quarter sales of
$3,792,000 from Jameco International LLC. In October 2003 we determined that our 49% minority
interest in Jameco International, LLC qualified as a variable interest in a variable interest entity under
FIN 46R and, as we are the primary beneficiary, should be consolidated into our North American
results. Jameco International LLC’s annual sales for the year ended 2003 were approximately
$16,079,000. Since the adoption was effective October 1, 2003, we should continue to have this impact
for the next three quarters as we continue to consolidate Jameco International LLC in accordance with
FIN 46R.

The increase in net sales in Europe in 2003 compared to 2002 is primarily due to the appreciation

of the euro against the U.S. dollar, which accounted for $31,107,000, or 5.1% of the increase, the
inclusion of net sales of acquired companies of $21,313,000, or 3.5%, and internal growth of
$12,565,000, or 2.0%. The foreign exchange growth is due to our average year to date euro rate
increasing 20.6% over the average year to date rate for 2002. We cannot predict whether the euro will
continue to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate
fluctuations will have a positive or negative impact on our net sales. The acquired growth is due to the
inclusion of the net sales of ADEV Electronic SA and E.K. Eminent A.B. both acquired on July 15,
2002, F&R Foerster and Rothman GmbH, acquired on July 29, 2002, Martin Orgee, acquired on
April 18, 2003, and Giuliani Anello, acquired on July 30, 2003. We expect these recent acquisitions will
have a positive impact on sales for the next two quarters. The internal growth in sales is primarily due
to increased sales into the European OEM market. Inclusive of the acquisitions, and exclusive of the
impact of foreign exchange, our sales into the European OEM market increased approximately
$28,900,000, or 37.2%.

The decrease in net sales in China in 2003 compared to 2002 is primarily due to an adjustment of

$2,200,000 made in the second quarter of 2003 for previously recorded sales and increased sales rebates
and returns recorded at our TWT joint venture in Tianjin. This was partially offset by the inclusion of
net sales of our Shida joint venture, which we established on March 5, 2002, of approximately
$2,636,000.

Gross Profit. Gross profit for 2003 increased $31,941,000, or 15.3%, compared to 2002. This
increase is primarily due to internal growth of $12,007,000, the change in foreign exchange rates, which
accounted for $11,075,000 of the increase, the inclusion of gross profit from acquired companies of
$5,961,000, a reduction of restructuring and other charges of $2,103,000 in 2003 compared to 2002, and
the inclusion of the gross profit of Jameco International LLC of $795,000. Excluding the costs of
restructuring for both periods, gross profits would have increased $29,838,000, or 14.1%. The internal
growth is primarily due to the North American segment, which increased internal gross profits by
$11,408,000. This increase is primarily due to improved manufacturing efficiencies and increased sales
volume. The internal growth in gross profit was offset by a loss in our China segment of $3,873,000.
This loss is due to start-up costs and under absorbed manufacturing costs due to a delay in production
at our new wholly-owned manufacturing plant in China. We believe capacity utilization will be
increasing in 2004 at this plant. It was also offset by inventory write-downs, increased sales rebates and
returns and other net adjustments at our TWT joint venture located in Tianjin, China.

Selling, General and Administrative Expenses. Selling, General and Administrative, or SG&A,
expenses for 2003 increased $19,642,000, or 13.0%, compared to 2002. This increase is primarily due to
an internal increase of $8,386,000, the change in foreign exchange rates, which accounted for $6,935,000
of the increase, and the inclusion of operating expenses of acquired companies and Jameco
International LLC, which together accounted for $4,321,000 of the increase. The internal increase in
SG&A expenses is primarily due to increased product liability expense, workers compensation expenses,
professional fees, which include legal and audit expenses, pension costs and variable selling expenses
due to increased sales volumes. Although there is an absolute increase in our SG&A expense over
2002, our SG&A expense as a percent of sales for 2003 decreased to 24.1% compared to 24.5% for
2002.

Operating Income. Operating income by geographic segment for each of the years ended

December 31, 2003 and 2002 was as follows:

North America . . . . . . . . . . . . . . . . . . . . . . . . . .
Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Years Ended
December 31,

2003

2002

Change

$ 64,414
22,592
(3,834)
(13,132)

(in thousands)
$ 55,313
13,608
(625)
(10,767)

$ 9,101
8,984
(3,209)
(2,365)

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 70,040

$ 57,529

$ 12,511

The increase in operating income in North America in 2003 compared to 2002 is primarily due to

internal growth of $6,754,000, a reduction of restructuring and other charges of $1,691,000, the
appreciation of the Canadian dollar against the U.S. dollar, which accounted for $618,000 of the
increase, and inclusion of income from Jameco International LLC of $38,000. The internal growth is
due to our increased gross profit partially offset by increased SG&A expense. To the extent we are
unable to recover raw material cost increases from our customer these cost increases would adversely
affect our operating income. For 2003, we recorded $162,000 compared to $1,853,000 in 2002 for costs
associated with our manufacturing restructuring plan. Excluding these costs, the operating income in
North America would have been $64,576,000 for 2003 compared to $57,166,000 for 2002. We expect to
record approximately $6,000,000 in 2004 for additional manufacturing restructuring expenses primarily
attributable to accelerated depreciation associated with the anticipated closure of one of our U.S.
manufacturing plants and a reduction in estimated useful lives of manufacturing equipment due to the
transfer of production to lower cost countries.

The increase in operating income in Europe in 2003 compared to 2002 is due to the euro

appreciating against the U.S. dollar, which accounted for $3,522,000 of the increase, internal growth of
$2,744,000, the inclusion of income from acquired companies of $1,932,000, and a reduction of
restructuring and other charges of $786,000. We cannot predict whether the euro will continue to
appreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations
will have a positive or negative impact on our operating income. The internal operating profit is
primarily due to the increased sales volume partially offset by increased SG&A expenses. We recorded
$906,000 in 2003 compared to $1,692,000 in 2002 for costs associated with our manufacturing
restructuring plan. Excluding these costs associated in both periods, operating income in Europe would
have increased to $23,498,000 in 2003 from $15,300,000 in 2002. We do not anticipate recording any
additional manufacturing restructuring costs in 2004 for our European operations.

The increase in operating losses in China in 2003 compared to 2002 is due to an increase in

internal operating losses of $3,512,000 partially offset by the inclusion of income from acquired
companies of $465,000. In December 2003, we incurred a restructuring charge in our TWT facility of
$162,000 for severance. The internal operating loss was due to inventory write-downs, increased sales
rebates and returns and other net adjustments at our TWT joint venture and under absorbed
manufacturing costs due to a delay in production and start up costs associated with our new wholly-
owned manufacturing plant in China.

Corporate expenses are primarily for compensation expense, professional fees, including legal and
audit expenses and benefit administration costs. The increase in corporate expenses is primarily due to
increased legal and audit expenses in 2003.

Interest Expense.

Interest expense increased $3,422,000, or 39.4%, in 2003 compared to 2002,

primarily due to the inclusion of the interest expense on the $125,000,000 senior notes issued on
May 15, 2003. On December 1, 2003, we repaid our $75,000,000 83⁄8% notes and expect that interest
expense will decrease as a result of this repayment. On September 1, 2001, we entered into an interest
rate swap with respect to our $75,000,000 83⁄8% notes due December 2003. The swap converted the
interest from fixed to floating. On August 5, 2002, we sold the swap and received $2,315,000 in cash. In
the year ended December 31, 2003, we reduced interest expense by $1,420,000 by amortizing the
adjustment to the fair value of the swap. In the year ended December 31, 2002, we reduced interest
expense by $1,711,000 for the effectiveness of the swap. The amortization of the swap was completed
upon repayment of the $75,000,000 83⁄8% notes. On July 1, 2003, we entered into an interest rate swap
for a notional amount of 25,000,000 euros outstanding on our Revolving Credit Facility. We swapped
the variable rate from the Revolving Credit Facility, which is three month EURIBOR plus 0.7%, for a
fixed rate of 2.33%. The impact of swap was immaterial to the overall interest expense.

Income Taxes. Our effective tax rate for continuing operations for 2003 increased to 38.0% from
35.0% for 2002. The increase is primarily due to losses in China, for which we have not received a tax
benefit in accordance with FAS 109 and because certain of our Chinese entities are in a tax holiday.

Income From Continuing Operations.

Income from continuing operations for 2003 increased

$3,851,000, or 11.8%, to $36,473,000 or $1.32 per common share, from $32,622,000 or $1.21 per
common share, for 2002, in each case, on a diluted basis. The appreciation of the euro against the U.S.
dollar resulted in a positive impact on income from continuing operations of $0.07 per share for the
year ended December 31, 2003 compared to the prior year. We cannot predict whether the euro will
continue to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate
fluctuations will have a positive or negative impact on our net income. Excluding the manufacturing
restructuring costs incurred in both periods, income from continuing operations would have increased
$2,383,000 or 6.8%.

To supplement our consolidated financial statements presented in accordance with accounting
principles generally accepted in the United States of America (GAAP) we sometimes use non-GAAP
measures of net income, net income per share, income from continuing operations or income from
continuing operations per share, and net cash provided by continuing operations that we believe are
appropriate to enhance an overall understanding of our historical financial performance and future
prospects. The non-GAAP results, which are adjusted to exclude certain costs, expenses, gains and
losses from the comparable GAAP measures, are an indication of our baseline performance before
gains, losses or other charges that are considered by management to be outside of our core operating
results. These non-GAAP results are among the primary indicators management uses as a basis for
evaluating our financial performance as well as for forecasting future periods. For these reasons,
management believes these non-GAAP measures can be useful to investors, potential investors and

others. The presentation of this additional information is not meant to be considered in isolation or as
a substitute for net income or income per share prepared in accordance with GAAP.

Years Ended December 31,

2003

2002

2001

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Add back: loss from discontinued operations . . . . . . . . . . . . .

(in thousands, except per share
information)
$32,622
—

$26,556
—

$33,362
3,111

Income from continuing operations . . . . . . . . . . . . . . . . . . . . .

36,473

32,622

26,556

Add back: cost of restructuring and other charges . . . . . . . . .

1,084

2,552

Add back: goodwill amortization . . . . . . . . . . . . . . . . . . . . .

—

3,593

3,220

Adjusted income from continuing operations . . . . . . . . . . . . . .

$37,557

$35,174

$33,369

Diluted earnings per share:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Add back: discontinued operations . . . . . . . . . . . . . . . . . . . .

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Add back: cost of restructuring and other charges . . . . . . . . .

Add back: goodwill amortization . . . . . . . . . . . . . . . . . . . . .

1.21
0.11

1.32

0.04

—

1.21
—

1.21

0.09

—

0.99
—

0.99

0.13

0.12

Adjusted income from continuing operations . . . . . . . . . . . . . .

1.36

1.30

1.24

Loss From Discontinued Operations. We recorded a charge net of tax to discontinued operations

for 2003 of $3,111,000, or $0.11 per common share on a diluted basis. The charge is primarily
attributable to legal expenses associated with the litigation involving the James Jones Company. We
also recorded a charge in the second quarter of 2003 attributed to payments to be made to the selling
shareholders of the James Jones Company pursuant to our original purchase agreement. See Part I,
Item 1, ‘‘Business—Product Liability, Environmental and other Litigation Matters’’.

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

Net Sales. Net sales for the year ended December 31, 2002 increased $66,586,000, or 12.1%, to

$615,526,000 compared to $548,940,000 for the same period in 2001. The increase in net sales was
attributable to the following:

Internal Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Foreign Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(in thousands)

$11,773
47,080
7,733

$66,586

2.1%
8.6%
1.4%

12.1%

The increase in net sales from internal growth was primarily attributable to increased unit sales in

the DIY market in North America. The growth in net sales from acquired businesses was due to the
inclusion of the net sales from Powers Process Controls of Skokie, Illinois, acquired on September 28,
2001; Premier Manufactured Systems of Phoenix, Arizona, acquired on June 13, 2001; Fimet of Milan,
Italy, acquired on June 1, 2001; Shida, 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 was 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 geographic segments: North America, Europe and China. As
outlined below, North America, Europe and China accounted for 73.1%, 23.7% and 3.2% of net sales,
respectively, in the year ended December 31, 2002 compared to 75.7%, 22.1%, and 2.2%, respectively,
in the year ended in December 31, 2001.

Our net sales in each of these geographic segments for the years ended December 31, 2002 and

2001 were as follows:

Years Ended
December 31,

2002

2001

Change

North America . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$450,233
145,629
19,664

(in thousands)
$415,689
121,228
12,023

$34,544
24,401
7,641

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$615,526

$548,940

$66,586

The increase in net sales in North America was due to the inclusion of Powers Process Controls

and Premier Manufactured Systems, as well as increased unit sales to the DIY market. The increase in
net sales in Europe was due to the inclusion of Fimet, ADEV, Eminent and F&R and the appreciation
of the euro against the U.S. dollar. The increase in net sales in China was primarily due to the
inclusion of our Chen Guan joint venture.

Gross Profit. Gross profit for the year ended December 31, 2002 increased $25,188,000, or 13.7%,

from the prior year and increased as a percentage of net sales to 33.9% from 33.4%. We charged
$2,907,000 and $4,253,000 of costs associated with our manufacturing restructuring plan to cost of sales
in 2002 and 2001, respectively. Excluding the cost associated with the manufacturing restructuring plan
in 2002 and 2001, gross profit would have increased $23,842,000, or 12.7%, and would have increased
as a percentage of net sales to 34.4% from 34.2%.

Selling, General and Administrative Expenses. SG&A expenses increased $18,758,000, or 14.2%, to
$150,553,000 from $131,795,000 for the comparable prior year period. This increase was attributable to
the inclusion of the SG&A expenses of acquired companies, an increase in the cost of product and
general liability insurance and administrative start-up costs associated with our new manufacturing plant
in China. We adopted Financial Accounting Standards Board Statement No. 142 ‘‘Goodwill and Other
Intangibles’’ (FAS142) on January 1, 2002, and accordingly did not record any goodwill amortization for
2002. We recorded goodwill amortization of $3,220,000 as part of our SG&A expenses for 2001.

Restructuring and Other Charges. Restructuring and other charges for the year ended

December 31, 2002 decreased $816,000, or 56.1%, to $638,000 compared to $1,454,000 for the same
period in 2001. These costs are primarily for severance costs. The costs related to the year ended
December 31, 2002 were for 24 employees, 12 of which have been terminated as of December 31, 2002,
compared to the costs related to December 31, 2001 which were for 14 employees, all of which have
been terminated as of December 31, 2002.

Operating Income. Operating income for the year ended December 31, 2002 increased $7,246,000,

or 14.4%, to $57,529,000 compared to $50,283,000 for the same period in 2001 due to increased gross
profit and the cessation of goodwill amortization, partially offset by increased other selling, general and

administrative expenses. Operating income by segment for the years ended December 31, 2002 and
2001 was as follows:

North America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Years Ended
December 31,

2002

2001

Change

$55,313
13,608
(625)
(10,767)

(in thousands)
$47,294
11,308
1,365
(9,684)

$8,019
2,300
(1,990)
(1,083)

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$57,529

$50,283

$7,246

The increase in North America was due to increased gross profit, primarily due to the inclusion of
operating results of acquired companies partially offset by increased premiums for product and general
liability insurance. The increase in Europe was due to the inclusion of the operating results of acquired
companies and the euro appreciating against the U.S. dollar compared to the prior year. The decrease
in China was primarily due to increased bad debt and warranty expense. Corporate expenses are
primarily for compensation expense, professional fees, including legal and audit expenses and benefit
administration costs. The increase in corporate expenses was primarily due to increased legal and audit
expenses and administrative start-up costs associated with our new manufacturing plant in China.

Interest Expense.

Interest expense for the year ended December 31, 2002 decreased $730,000, or

7.7%, to $8,692,000 compared to $9,422,000 for the same period in 2001, primarily due to lower
interest rates on variable rate indebtedness and capitalized construction period interest on our startup
manufacturing plant in China, partially offset by the increased levels of debt incurred to fund
acquisitions. On September 1, 2001, we entered into an interest rate swap with respect to our
$75,000,000 83⁄8% notes due December 2003. The swap converted the interest from fixed to floating.
On August 5, 2002, we sold the swap and received $2,315,000 in cash. Interest expense for the year
ended December 31, 2002 had been reduced by $1,711,000 from the benefit of the swap while active
and by the amortization of the adjustment to the fair value subsequent to the sale of the swap.

Income Taxes. Our effective tax rate for continuing operations for the year ended December 31,

2002, increased to 35.0% from 33.9% for the comparable prior year period. The increase was primarily
due to a change in our earnings mix to jurisdictions with higher tax rates. Also in 2001, the costs for
the manufacturing restructuring plan were recorded in tax jurisdictions with tax rates higher than our
effective rate, which caused the overall effective rate for 2001 to be lower than would normally be
expected. Excluding the impact of the after-tax manufacturing costs and goodwill amortization in both
2002 and 2001, the effective tax rate would have increased to 35.2% from 32.2%.

Income From Continuing Operations and Net Income.

Income from continuing operations for the

year ended December 31, 2002 increased $6,066,000, or 22.8%, to $32,622,000, or $1.21 per common
share compared to $26,556,000, or $0.99 per common share, for the year ended December 31, 2001 on
a diluted basis.

Liquidity and Capital Resources

We generated $49,990,000 of net cash from continuing operations for 2003. We experienced an

increase in inventories in North America, Europe and China. The increase in inventory in North
America is primarily due to planned increases in imported raw materials and finished goods to support
our delivery capability as we extend our supply chain to lower cost regions, as well as an increase in
inventory to support increased retail business. The increase in inventory in Europe is primarily due to
increased safety stock growth to cover planned distribution relocations and to support the delivery

requirements of OEM customers in Europe. The increase in inventory in China is the result of our
wholly-owned manufacturing plant start-up operations. We had reductions in accounts receivable in
Europe and China, partially offset by increased accounts receivable in North America. The increase in
North America is due to increased sales volume. We funded $6,800,000 into our pension plans in the
year ended December 31, 2003.

We used $37,045,000 of net cash for investing activities. We invested $20,035,000 in capital

equipment for the year ended December 31, 2003. Capital expenditures were primarily for
manufacturing machinery and equipment as part of our ongoing commitment to improve our
manufacturing capabilities. The two largest components of this expenditure were for a building added
to our Shida joint venture facility in Taizhou, China and for additional machinery and equipment for
our wholly-owned manufacturing plant in Tianjin, China. We expect to invest approximately $18,500,000
in capital equipment in 2004.

On January 29, 2003, we invested an additional $3,040,000 in our Shida joint venture, bringing our

total amount to approximately $8,040,000. This joint venture is owned 60% by us and 40% by our
Chinese partner. On May 6, 2003 we paid $3,750,000 of debt owed to the former shareholders of
Hunter Innovations, leaving a balance of $11,250,000 remaining to be paid. In addition, on April 18,
2003, we paid approximately $1,600,000 to acquire Martin Orgee UK Limited, and on July 30, 2003, we
paid approximately $10,600,000, which is net of cash acquired of $1,400,000, to acquire Giuliani Anello
S.r.l.

We generated $128,050,000 of net cash in financing activities. On December 10, 2003, we

completed a public offering of 4,600,000 shares of newly issued Class A Common Stock at $19.00 per
share. Net proceeds were approximately $82,500,000, after taking into account underwriter discounts
and expenses associated with the transaction. We intend to use the net proceeds from the offering to
fund potential acquisitions and for general corporate purposes.

On May 15, 2003, we completed a private placement of $125,000,000 of senior unsecured notes
consisting of $50,000,000 principal amount of 4.87% senior notes due 2010 and $75,000,000 principal
amount of 5.47% senior notes due 2013. We used the net proceeds from the private placement to
purchase restricted treasury securities for repayment of principal of, and interest on, our $75,000,000
principal amount of 83⁄8% notes due December 1, 2003. On December 1, 2003 the principal of, and
interest on, our $75,000,000 83⁄8% notes were paid with our restricted treasury securities. Additional net
proceeds were used to repay approximately $32,000,000 outstanding under our Revolving Credit
Facility. The balance of the net proceeds will be used for general corporate purposes. The payment of
interest on the senior unsecured notes is due semi-annually on May 15th and November 15th of each
year.
The senior unsecured notes were issued by the Company and are subordinated to our
revolving credit facility, which is at the subsidiary level. The senior unsecured notes allow us to have
(i) debt senior to the new notes in an amount up to $150,000,000 plus 5% of our stockholders’ equity
and (ii) debt pari passu or junior to the senior unsecured notes to the extent we maintain compliance
with a 2.00 to 1.00 fixed charge coverage ratio. The notes include a prepayment provision which might
require a make-whole payment to the note holders. Such payment is dependent upon the level of the
respective treasuries. The notes include other customary terms and conditions, including events of
default.

Our revolving credit facility with a syndicate of banks (as amended, the Revolving Credit Facility)

provides for borrowings of up to $150,000,000 which includes a $75,000,000 tranche for euro-based
borrowings and matures in February 2005. The Revolving Credit Facility is being used to support our
acquisition program, working capital requirements and for general corporate purposes. As of
December 31, 2003, long-term debt included $44,089,000 outstanding on the Revolving Credit Facility
for euro-based borrowings and no amounts were outstanding for U.S. dollar borrowings. This facility
was amended during the fourth quarter of 2003 to permit us to enter into a guarantee of a $2,000,000

credit line utilized by our European subsidiaries and to allow us to use the proceeds from our
December 2003 public offering for purposes other than the repayment of our credit facility.

Outstanding indebtedness under the Revolving Credit Facility bears interest at a rate determined

by the type (currency) of loan plus an applicable margin determined by the Company’s debt rating,
depending on the applicable base rate and our bond rating. The average interest rate for borrowings
under the Revolving Credit Facility was approximately 2.8% at December 31, 2003. We have
$105,911,000 of unused and available revolving credit at December 31, 2003. 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. At December 31, 2003, we were in compliance with all covenants related to the
Revolving Credit Facility.

Effective July 1, 2003, we entered into an interest rate swap for a notional amount of 25,000,000

euros outstanding under our Revolving Credit Facility. We swapped the variable rate from the
Revolving Credit Facility which is three month EURIBOR plus 0.7% for a fixed rate of 2.33%. The
term of the swap is two years. We have designated the swap as a hedging instrument using the cash
flow method. The swap hedges the cash flows associated with interest payments on the first 25,000,000
euros of our Revolving Credit Facility. We mark to market the changes in value of the swap through
other comprehensive income. Any ineffectiveness has been recorded in income. The fair value recorded
in other comprehensive income as of December 31, 2003 was $46,000.

On November 4, 2003, we declared a quarterly dividend of $0.07 per share on our common stock.

This was an increase of $0.01 per share over the dividends paid in each of the ten previous quarters.
Dividends increased to $6,859,000 in 2003 from $6,490,000 in 2002.

We used $6,643,000 of net cash for discontinued operations. During the year ended December 31,
2003, we received $3,139,000 in cash as an indemnification payment for settlement costs we incurred in
the James Jones case. This cash has been recorded as a liability at December 31, 2003 because of the
possibility that we might have to reimburse the insurance company if it is ultimately successful with a
future appeal. We also received $2,932,000 in cash for reimbursement of defense costs related to the
James Jones case. We paid $2,283,000 for defense costs and $2,859,000 for indemnity costs we incurred
in the James Jones case. Additionally, on September 2, 2003 we paid $11,000,000 relating to a
settlement agreement in the James Jones case. See Part I, Item 1, ‘‘Business—Product Liability,
Environmental and Other Litigation Matters.’’

Working capital (defined as current assets less current liabilities) as of December 31, 2003 was

$308,135,000 compared to $71,384,000 as of December 31, 2002. This increase is primarily due to the
net proceeds received from the $125,000,000 private placement and the stock offering that raised net
cash of approximately $82,500,000. The ratio of current assets to current liabilities was 2.8 to 1 as of
December 31, 2003 compared to 1.3 to 1 as of December 31, 2002. Cash and cash equivalents were
$149,361,000 as of December 31, 2003 compared to $10,973,000 as of December 31, 2002. Our total
debt increased to $192,312,000 as of December 31, 2003 from $138,487,000 as of December 31, 2002
primarily due to the issuance of our $125,000,000 senior notes reduced by the repayment of our
$75,000,000 principal amount of 83⁄8% notes due December 1, 2003.

We had positive free cash flow of $24,861,000 (defined as net cash provided by continuing

operations minus capital expenditures and dividends plus proceeds from sale of assets) during the year
ended December 31, 2003 versus positive free cash flow of $28,536,000 in the comparable prior year
period. This decrease in 2003 compared to 2002 was primarily due to increased inventories, pension
funding of $6,800,000 and increased dividends partially offset by increases in accounts payable and
reductions in accounts receivable. The effect of the free cash flow and proceeds from our stock offering
has been to reduce our net debt to capitalization ratio (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) to 8.8% for 2003 from 29.4% for 2002.

We believe free cash flow to be an appropriate supplemental measure of the operating

performance of our Company because it provides investors with a measure of our ability to repay debt
and to fund acquisitions. Our computation may not be comparable to other companies that may define
free cash flow differently. Free cash flow does not represent cash generated from operating activities in
accordance with GAAP. Therefore it should not be considered an alternative to net cash flows from
operating activities as an indication of our performance. Free cash flow should also not be considered
an alternative to net cash flows from operating activities as defined by GAAP.

A reconciliation of free cash flow to net cash provided by continuing operations is provided below:

Net cash provided by continuing operations . . . . . . . . . . . . . . .
Less: additions to property, plant, and equipment . . . . . . . . . . .
Plus: proceeds from the sale of property, plant, and equipment .
Less: dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Years Ended December 31,

2003

2002

2001

$49,990
(20,035)
1,765
(6,859)

(in thousands)
$51,425
(19,593)
3,194
(6,490)

$51,237
(16,047)
267
(6,422)

Free cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$24,861

$28,536

$29,035

Our net debt to capitalization is not computed in accordance with GAAP. Management believes it

to be an appropriate supplemental measure because it helps investors understand our ability to meet
our financing needs. Our computation may not be comparable to other companies that may define debt
to capitalization differently.

A reconciliation of net debt is provided below:

December 31,

2003

2002

(in thousands)

Current portion of long-term debt . . . . . . . . . . . . . . . . . . . . .
Plus: long-term debt, net of current portion . . . . . . . . . . . . . .
Less: cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . .

$ 13,251
179,061
(149,361)

$ 82,211
56,276
(10,973)

Net debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 42,951

$127,514

A reconciliation of capitalization is provided below:

December 31,

2003

2002

(in thousands)

Net debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . .
Plus: minority interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 42,951
436,391
9,286

$127,514
295,936
10,134

Capitalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$488,628

$433,584

We anticipate that available funds from current operations, existing cash and other sources of
liquidity will be sufficient to meet current operating requirements and anticipated capital expenditures
for at least the next 12 months. However, we may have to consider external sources of financing for
any large future acquisitions. Our current Revolving Credit Facility expires in February 2005. We are

currently reviewing proposals from our syndicate of banks with the intention of structuring a new
revolving line of credit.

Our long-term contractual obligations as of December 31, 2003 are presented in the following

table:

Contractual Obligations

Payments Due by Period

Total

Less than
1 year

1-3 years

3-5 years

(in thousands)

More than
5 years

Long-term debt obligations, including current

maturities(a) . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating lease obligations . . . . . . . . . . . . . . . . .
Capital lease obligations . . . . . . . . . . . . . . . . . . .

$192,312
9,615
1,364

$13,251
1,992
653

$52,551
3,531
579

$1,111
2,362
132

$125,399
1,730
—

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$203,291

$15,896

$56,661

$3,605

$127,129

(a) as recognized in the consolidated balance sheet

We maintain letters of credit that guarantee our performance or payment to third parties in
accordance with specified terms and conditions. Amounts outstanding were approximately $29,880,000
as of December 31, 2003 and $19,522,000 as of December 31, 2002. Our letters of credit are primarily
letters of credit associated with insurance coverage and to a lesser extent foreign purchases. Our letters
of credits generally expire within one year of issuance. The increase is primarily associated with
insurance coverage. These instruments may exist or expire without being drawn down. Therefore, they
do not necessarily represent future cash flow obligations.

Critical Accounting Policies and Key Estimates

The preparation of our consolidated financial statements in accordance with GAAP requires

management to make judgments, assumptions and estimates that effect the amounts reported. A critical
accounting estimate is an assumption about highly uncertain matters and could have a material effect
on the consolidated financial statements if another, also reasonable, amount were used, or, a change in
the estimate is reasonably likely from period to period. We base our assumptions on historical
experience and on other estimates that we believe are reasonable under the circumstances. Actual
results could differ significantly from these estimates. Except as noted in product liability and pension
benefits below, there were no changes in accounting policies or significant changes in accounting
estimates during 2003.

We have discussed the development, selection and disclosure of the estimates with the Audit
Committee. Management believes the following critical accounting policies reflect its’ more significant
estimates and assumptions.

Revenue recognition

We recognize revenue when all of the following criteria are met: (1) we have entered into a

binding agreement, (2) the product has shipped and title has passed, (3) the sales price to the customer
is fixed or is determinable and (4) collectibility is reasonably assured. We recognize revenue based upon
a determination that all criteria for revenue recognition have been met, which, based on the majority of
our shipping terms, is considered to have occurred upon shipment of the finished product. Some
shipping terms require the goods to be received by the customer before title passes. In those instances,
revenues are not recognized until the customer has received the goods. We record estimated reductions
to revenue for customer returns and allowances and for customer programs. Provisions for returns and
allowances are made at the time of sale, derived from historical trends and form a portion of the

allowance for doubtful accounts. Customer programs, which are primarily annual volume incentive
plans, allow customers to earn credit for attaining agreed upon purchase targets from us. We record
customer programs as an adjustment to net sales.

Allowance for doubtful accounts

The allowance for doubtful accounts is established to represent our best estimate of the net

realizable value of the outstanding accounts receivable. The development of our allowance for doubtful
accounts varies by region but in general is based on a review of past due amounts, historical write-off
experience, as well as aging trends affecting specific accounts and general operational factors affecting
all accounts. In North America, management specifically analyzes individual accounts receivable and
establishes specific reserves against financially troubled customers. In addition, factors are developed
utilizing historical trends in bad debts, returns and allowances. The ratio of these factors to sales on a
rolling twelve-month basis is applied to total outstanding receivables (net of accounts specifically
identified) to establish a reserve. In Europe, management develops their bad debt allowance through an
aging analysis of all their accounts, with analysis on the aging of specific delinquent accounts. In China,
where payment terms are generally extended, we reserve all accounts receivable in excess of one year
from the invoice date and specifically reserve for identified uncollectible accounts receivable less than
one year old.

We uniformly consider current economic trends and changes in customer payment terms when
evaluating the adequacy of the allowance for doubtful accounts. We also aggressively monitor the credit
worthiness of our largest customers, and periodically review customer credit limits to reduce risk. If
circumstances relating to specific customers change or unanticipated changes occur in the general
business environment, our estimates of the recoverability of receivables could be further adjusted.

Inventory valuation

Inventories are stated at the lower of cost or market with costs generally determined on a first-in

first-out basis. We utilize both specific product identification and historical product demand as the basis
for determining our excess or obsolete inventory reserve. We identify all inventories that exceed a range
of one to three years in sales. This is determined by comparing the current inventory balance against
unit sales for the trailing twelve months. New products added to inventory within the past twelve
months are excluded from this analysis. A portion of our products contain recoverable materials,
therefore the excess and obsolete reserve is established net of any recoverable amounts. Changes in
market conditions, lower than expected customer demand or changes in technology or features could
result in additional obsolete inventory that is not saleable and could require additional inventory
reserve provisions.

In certain countries, additional inventory reserves are maintained for potential losses experienced

in the manufacturing process. The reserve is established based on the prior year’s inventory losses
adjusted for any change in the gross inventory balance.

Goodwill and other intangibles

We adopted Financial Accounting Standards Board Statement No. 142 ‘‘Goodwill and Other
Intangible Assets’’ (FAS 142) on January 1, 2002, and as a result we no longer amortize goodwill.
Goodwill and intangible assets with indefinite lives are tested annually for impairment in accordance
with the provisions of FAS 142. We use judgment in assessing whether assets may have become
impaired between annual impairment tests.

Intangible assets such as purchased technology are generally recorded in connection with a

business acquisition. In our larger, more complex acquisitions, the value assigned to intangible assets is

determined by an independent valuation firm based on estimates and judgments regarding expectations
of the success and life cycle of products and technology acquired.

This is the second year since adoption, and for both years we have had excess economic support
for the carrying value of our goodwill and intangibles. While we believe that our estimates of future
cash flows are reasonable, different assumptions regarding such factors as future sales volume, selling
price changes, material cost changes, cost savings programs and capital expenditures could significantly
affect our valuations. Other changes that may affect our valuations include, but are not limited to
product acceptances and regulatory approval. If actual product acceptance differs significantly from the
estimates, we may be required to record an impairment charge to write down the assets to their
realizable value. A severe decline in market value could result in an unexpected impairment charge to
goodwill, which could have a material impact on the results of operations and financial position.

Product liability and workers compensation costs

Because of retention requirements associated with our insurance policies, we are generally
self-insured for potential product liability claims and for workers’ compensation costs associated with
workplace accidents. For product liability cases in the U.S., management estimates expected settlement
costs by utilizing stop loss reports provided by our third party administrators as well as developing
internal historical trend factors based on our specific claims experience. Prior to 2003, we used
insurance carrier trend factors to determine our product liability reserves. However, we determined
circumstances inherent in those trends were not necessarily indicative of our own circumstances
regarding our claims. Management believes the internal trend factors will more accurately reflect final
expected settlement costs. In other countries, we maintain insurance coverage with relatively high
deductible payments, as product liability claims tend to be smaller than those experienced in the U.S.
Changes in the nature of claims or the actual settlement amounts could affect the adequacy of this
estimate and require changes to the provisions.

Workers compensation liabilities in the U.S. are recognized for claims incurred (including claims

incurred but not reported) and for changes in the status of individual case reserves. At the time a
workers’ compensation claim is filed, a liability is estimated to settle the claim. The liability for
workers’ compensation claims is determined based on management’s estimates of the nature and
severity of the claims and based on analysis provided by third party administrators and by various state
statutes and reserve requirements. We have developed our own trend factors based on our specific
claims experience. In other countries where workers compensation costs are applicable, we maintain
insurance coverage with limited deductible payments. Because the liability is an estimate, the ultimate
liability may be more or less than reported.

We maintain excess liability insurance with outside insurance carriers to minimize our risks related
to catastrophic claims in excess of all self-insured positions. Any material change in the aforementioned
factors could have an adverse impact on our operating results.

Legal contingencies

We are a defendant in numerous legal matters including those involving environmental law and
product liability as discussed further in Note 15 of Notes to Consolidated Financial Statements. As
required by Financial Accounting Standards Board Statement No. 5 ‘‘Accounting for Contingencies’’
(FAS 5), we determine whether an estimated loss from a loss contingency should be accrued by
assessing whether a loss is deemed probable and the loss amount can be reasonably estimated, net of
any applicable insurance proceeds. Estimates of potential outcomes of these contingencies are
developed in consultation with outside counsel. While this assessment is based upon all available
information, litigation is inherently uncertain and the actual liability to fully resolve this litigation

cannot be predicted with any assurance of accuracy. Final settlement of these matters could possibly
result in significant effects on our results of operations, cash flows and financial position.

Pension benefits

We account for our pension plans in accordance with Financial Accounting Standards Board
Statement No. 87 ‘‘Employers Accounting for Pensions’’ (FAS 87). In applying FAS 87, assumptions are
made regarding the valuation of benefit obligations and the performance of plan assets. The primary
assumptions are as follows:

(cid:127) Weighted average discount rate—this rate is used to estimate the current value of future

benefits. This rate is adjusted based on movement in long-term interest rates. In 2003, we
reduced the discount rate to 6.00% from 6.75% in 2002 to reflect the high quality bond yields as
of the measurement date, which is September 30.

(cid:127) Expected long-term rate of return on assets—this rate is used to estimate future growth in
investments and investment earnings. The expected return is based upon a combination of
historical market performance and anticipated future returns for a portfolio reflecting the mix of
equity, debt and other investments indicative of our plan assets. The expected long-term rate of
return was reduced in 2003 to 8.50% from 9.00% in 2002, as management believes it more
properly reflects the long-term rate of return achievable with the asset allocation required by our
Retirement Plan Investment Policy.

(cid:127) Rates of increase in compensation levels—this rate is used to estimate projected annual pay
increases, which are used to determine the wage base used to project employees’ pension
benefits at retirement. This rate remained unchanged in 2003 at 4.00%, and is reasonable in
management’s estimation.

We determine these assumptions based on consultation with outside actuaries and investment
advisors. Any variance in the above assumptions could have a significant impact on future recognized
pension costs, assets and liabilities.

Income taxes

We estimate and use our expected annual effective income tax rates to accrue income taxes.
Effective tax rates are determined based on budgeted earnings before taxes including our best estimate
of permanent items that will impact the effective rate for the year. Management periodically reviews
these rates with outside tax advisors and changes are made if material discrepancies from expectations
are identified.

We recognize deferred taxes for the expected future consequences of events that have been
reflected in the consolidated financial statements in accordance with the rules of Financial Accounting
Standards Board Statement No. 109 ‘‘Accounting for Income Taxes’’ (FAS 109). Under FAS 109,
deferred tax assets and liabilities are determined based on differences between the book values and tax
bases of particular assets and liabilities, using tax rates in effect for the years in which the differences
are expected to reverse. A valuation allowance is provided to offset any net deferred tax assets if, based
upon the available evidence, it is more likely than not that some or all of the deferred tax assets will
not be realized. We consider estimated future taxable income and ongoing prudent tax planning
strategies in assessing the need for a valuation allowance.

Certain Factors Affecting Future Results

We face intense competition and, if we are not able to respond to competition in our markets, our revenues
may decrease.

Competitive pressures in our markets could adversely affect our competitive position, leading to a

possible loss of market share or a decrease in prices, either of which could result in decreased revenues
and profits. We encounter intense competition in all areas of our business. Additionally, customers for
our products are attempting to reduce the number of vendors from which they purchase in order to
reduce the size and diversity of their inventories and their transaction costs. To remain competitive, we
will need to invest continuously in manufacturing, marketing, customer service and support and our
distribution networks. We may not have sufficient resources to continue to make such investments and
we may be unable to maintain our competitive position. In addition, we anticipate that we may have to
reduce the prices of some of our products to stay competitive, potentially resulting in a reduction in the
profit margin for, and inventory valuation of, these products. Some of our competitors are based in
foreign countries and have cost structures and prices in foreign currencies. Accordingly, currency
fluctuations could cause our U.S. dollar-priced products to be less competitive than our competitors’
products which are priced in other currencies.

Reductions or interruptions in the supply of raw materials and increases in the costs of raw materials could
reduce our profit margins and adversely impact our ability to meet our customer delivery commitments.

We require substantial amounts of raw materials, including bronze, brass, cast iron, steel and
plastic and substantially all of the raw materials we require are purchased from outside sources. The
availability and costs of raw materials may be subject to curtailment or change due to, among other
things, new laws or regulations, suppliers’ allocations to other purchasers, interruptions in production
by suppliers and changes in exchange rates and worldwide price and demand levels. We are not
currently party to any long-term supply agreements. Our inability to obtain adequate supplies of raw
materials for our products at favorable costs, or at all, could have a material adverse effect on our
business, financial condition or results of operations by decreasing our profit margins and by hindering
our ability to deliver products to our customers on a timely basis. Recently, we have experienced an
increase in the costs of bronze, brass, cast iron, and steel. If we are not able to reduce or eliminate the
effect of these cost increases through lowering other costs of production or successfully implementing
price increases to our customers, such cost increases from our vendors could have a negative effect on
our financial results.

Implementation of our acquisition strategy may not be successful, which could affect our ability to increase
our revenues or our profitability.

One of our strategies is to increase our revenues and profitability and expand our markets through
acquisitions that will provide us with complementary water-related products. We cannot be certain that
we will be able to identify, acquire or profitably manage additional companies or successfully integrate
such additional companies without substantial costs, delays or other problems. Also, companies
acquired recently and in the future may not achieve revenues, profitability or cash flows that justify our
investment in them. We expect to spend significant time and effort in expanding our existing businesses
and identifying, completing and integrating acquisitions. We have faced increasing competition for
acquisition candidates which have resulted in significant increases in the purchase prices of many
acquisition candidates. This competition, and the resulting purchase price increases, may limit the
number of acquisition opportunities available to us, possibly leading to a decrease in the rate of growth
of our revenues and profitability. In addition, acquisitions may involve a number of special risks,
including, but not limited to:

(cid:127) adverse short-term effects on our reported operating results;

(cid:127) diversion of management’s attention;

(cid:127) loss of key personnel at acquired companies; and

(cid:127) unanticipated management or operational problems or legal liabilities.

Down economic cycles, particularly reduced levels of housing starts and remodeling, could have an adverse
effect on our revenues and operating results.

We have experienced and expect to continue to experience fluctuations in revenues and operating

results due to economic and business cycles. The businesses of most of our customers, particularly
plumbing and heating wholesalers and home improvement retailers, are cyclical. Therefore, the level of
our business activity has been cyclical, fluctuating with economic cycles. We also believe our level of
business activity is influenced by housing starts and renovation and remodeling, which are, in turn,
heavily influenced by interest rates, consumer debt levels, changes in disposable income, employment
growth and consumer confidence. If these and other factors cause a material reduction in housing and
remodeling starts, our revenues and profits would decrease and result in a material adverse effect on
our financial condition and results of operations.

Economic, political and other risks associated with international sales and operations could adversely affect
our business and future operating results.

Since we sell and manufacture our products worldwide, our business is subject to risks associated

with doing business internationally. Our business and future operating results could be harmed by a
variety of factors, including:

(cid:127) trade protection measures and import or export licensing requirements, which could increase our

costs of doing business internationally;

(cid:127) potentially negative consequences from changes in tax laws, which could have an adverse impact

on our profits;

(cid:127) the costs of hiring and retaining senior management in overseas operations;

(cid:127) difficulty in staffing and managing widespread operations, which could reduce our productivity;

(cid:127) costs of compliance with differing labor regulations, especially in connection with restructuring

our overseas operations;

(cid:127) laws of some foreign countries, which may not protect our intellectual property rights to the

same extent as the laws of the United States;

(cid:127) substantial amounts of raw materials, including bronze, plastic, brass, cast iron, steel and plastics
we require are purchased from outside sources and fluctuations in foreign exchange could have
an adverse impact on our profits;

(cid:127) unexpected changes in regulatory requirements, which may be costly and require significant time

to implement; and

(cid:127) political risks specific to foreign jurisdictions.

Fluctuations in foreign exchange rates could materially affect our reported results.

We are exposed to fluctuations in foreign currencies, as a significant portion of our sales and
certain portions of our costs, assets and liabilities are denominated in currencies other than U.S.
dollars. Approximately 37.2% of our sales during the year ended December 31, 2003 were from sales
outside of the U.S. compared to 31.4% for the year ended December 31, 2002. For the year ended
December 31, 2003, the appreciation of the euro against the U.S. dollar had a positive impact on sales

of approximately $31.1 million. For the year ended December 31, 2002, the appreciation of the euro
against the U.S. dollar had a positive impact on sales of approximately $7.9 million. For the year ended
December 31, 2001, the depreciation of the euro against the U.S. dollar had an adverse impact on sales
of approximately $3.4 million. If our share of revenue in non-dollar denominated currencies continues
to increase in future periods, exchange rate fluctuations will likely have a greater impact on our results
of operations and financial condition. Further, the Chinese government may cease its utilization of a
fixed rate of exchange of the Chinese RMB against the U.S. dollar which could adversely affect our
current favorable cost structure for goods we source from our joint ventures, our wholly-owned
subsidiary in China and our outside vendors.

There are significant risks in expanding our manufacturing operations in China.

As part of our strategy, we are shifting a significant portion of our manufacturing operations to

China to reduce our production costs. Due to the outbreak of the SARS virus, some of these cost
reduction efforts were delayed, and there can be no assurance that we will not experience additional
delays. This shift will subject a greater portion of our operations to the risks of doing business in
China. The Chinese legal system is relatively new and lacks transparency, which gives the Chinese
central and local government authorities a higher degree of control over our business in China than is
customary in developed economies and makes the process of obtaining necessary regulatory approval in
China inherently unpredictable. In addition, the protection accorded our proprietary technology and
know-how under the Chinese legal system is not as strong as in the United States and, as a result, we
may lose valuable trade secrets and competitive advantage.

Although the Chinese government has been pursuing economic reform and a policy of welcoming
foreign investments for the past two decades, there can be no assurance that the Chinese government
will not change its current policies in the future, making continued business operations in China
difficult or unprofitable.

To the extent we are not successful in implementing our manufacturing restructuring plan, our results of
operations and financial condition could be adversely affected.

Our manufacturing restructuring plan, which we began in 2001, was initiated to reduce our
manufacturing costs. If our planned manufacturing plant consolidations in the United States and
Europe and our production capability expansion in China are not successful, our results of operations
and financial condition could be materially adversely affected.

If we cannot continue operating our manufacturing facilities at current or higher utilization levels, our
results of operations could be adversely affected.

The equipment and management systems necessary for the operation of our manufacturing

facilities may break-down, perform poorly or fail, resulting in fluctuations in our ability to manufacture
our products and to achieve manufacturing efficiencies. We operate a number of manufacturing
facilities, all of which are subject to this risk, and such fluctuations at any of these facilities could cause
an increase in our production costs and a corresponding decrease in our profitability. For example, in
2001 one of our manufacturing facilities was shut down for a period of time as a result of a fire and we
were required to source products from external vendors at substantially higher costs. We also have a
vertically-integrated manufacturing process. Each segment is dependent upon the prior process and any
breakdown in one segment will adversely affect all later components. Fluctuations in our production
process may affect our ability to deliver products to our customers on a timely basis. Our inability to
meet our delivery obligations could result in a loss of our customers and negatively impact our
business, financial condition and results of operations.

If we experience delays in introducing new products or if our existing or new products do not achieve or
maintain market acceptance and regulatory approvals, our revenues and our profitability may decrease.

Our failure to develop new and innovative products or to custom design existing products could

result in the loss of existing customers to competitors or the inability to attract new business, either of
which may adversely affect our revenues. Our industry is characterized by:

(cid:127) intense competition;

(cid:127) changes in specifications required by our customers, plumbing codes and/or regulatory agencies;

(cid:127) technically complex products; and

(cid:127) constant improvement to existing products and introductions of new products.

We believe our future success will depend, in part, on our ability to anticipate or adapt to these

factors and to offer, on a timely basis, products that meet customer demands and the requirements of
plumbing codes and/or regulatory agencies. The development of new or enhanced products is a
complex and uncertain process requiring the anticipation of technological and market trends. We may
experience design, manufacturing, marketing or other difficulties, such as an inability to attract a
sufficient number of experienced engineers, that could delay or prevent our development, introduction,
approval or marketing of new products or enhancements and result in unexpected expenses. Such
difficulties could cause us to lose business from our customers and could adversely affect our
competitive position; in addition, added expenses could decrease the profitability associated with those
products that do not gain market acceptance.

Environmental compliance costs and liabilities could increase our expenses or reduce our profitability.

Our operations and properties are subject to extensive and increasingly stringent laws and

regulations relating to environmental protection, including laws and regulations governing air emissions,
water discharges, waste management and disposal and workplace safety. Such laws and regulations can
impose substantial fines and sanctions for violations and require the installation of costly pollution
control equipment or operational changes to limit pollution emissions and/or decrease the likelihood of
accidental hazardous substance releases. We also could be required to halt one or more portions of our
operations until a violation is cured. We could also be liable for the costs of property damage or
personal injury to others. Although we attempt to operate in compliance with these environmental laws,
we may not succeed in this effort at all times. The costs of curing violations or resolving enforcement
actions that might be initiated by government authorities could be substantial.

Under certain environmental laws, the current and past owners or operators of real property may

be liable for the costs of cleaning up contamination, even if they did not know of or were not
responsible for such contamination. These laws also impose liability on any person who arranges for the
disposal or treatment of hazardous waste at any site. Therefore, our ownership and operation of real
property and our disposal of waste could lead to liabilities under these laws.

We have incurred, and expect to continue to incur, costs relating to these environmental matters.

In addition, new laws and regulations, stricter enforcement of existing laws and regulations, the
discovery of previously unknown contamination or the imposition of new clean up requirements could
require us to incur additional costs or become the basis for new or increased liabilities that could be
significant. Environmental litigation, enforcement and compliance are inherently uncertain and we may
experience significant costs in connection with environmental matters. For more information, see Part I,
Item 1, ‘‘Business—Product Liability, Environmental, and Other Litigation Matters.’’

Third parties may infringe our intellectual property and we may expend significant resources enforcing our
rights or suffer competitive injury.

We rely on a combination of patents, copyrights, trademarks, trade secrets, confidentiality
provisions and licensing arrangements to establish and protect our proprietary rights. We may be
required to spend significant resources to monitor and police our intellectual property rights. If we fail
to successfully enforce our intellectual property rights, our competitive position could suffer, which
could harm our operating results. We have been limited from selling products from time-to-time
because of existing patents.

We face risks from product liability and other lawsuits, which may adversely affect our business.

We may be subjected to various product liability claims or other lawsuits, including, among others

that our products include inadequate or improper instructions for use or installation, or inadequate
warnings concerning the effects of the failure of our products. In the event that we do not have
adequate insurance or contractual indemnification, damages from these claims would have to be paid
from our assets and could have a material adverse effect on our results of operations, liquidity and
financial condition. In particular, if we settle or conclude litigation in a quarterly or annual reporting
period, there could be a material impact on our operating results for that quarter or year. We, like
other manufacturers and distributors of products designed to control and regulate fluids, face an
inherent risk of exposure to product liability claims and other lawsuits in the event that the use of our
products results in personal injury, property damage or business interruption to our customers.
Although we maintain strict quality controls and procedures, including the testing of raw materials and
safety testing of selected finished products, we cannot be certain that our products will be completely
free from defect. In addition, in certain cases, we rely on third-party manufacturers for our products or
components of our products. Although we have product liability and general insurance coverage, we
cannot be certain that this insurance coverage will continue to be available to us at a reasonable cost,
or, if available, will be adequate to cover any such liabilities. For more information, see Part I, Item 1,
‘‘Business—Product Liability, Environmental, and Other Litigation Matters.’’

The requirements of FAS 142 may result in a write-off of all or a portion of our goodwill, which would
negatively impact our operating results and financial condition.

If we are required to take an impairment charge to our goodwill in connection with the
requirements of FAS 142, our operating results may decrease and our financial condition may be
harmed. As of December 31, 2003, we had goodwill of $184.9 million, or 22.1% of our total assets and
42.4% of our total stockholders’ equity. Under FAS 142, goodwill and identifiable intangible assets that
have indefinite useful lives are no longer amortized. In lieu of amortization, we were required to
perform an initial impairment review of goodwill and are required to perform annual impairment
reviews thereafter. We have concluded that no impairment existed at January 1, 2002, the time of
adoption of FAS 142 and at October 26, 2003, the time of our annual review. We perform our annual
test for indications of goodwill impairment in the fourth quarter of our fiscal year or sooner if
indicators exist.

The loss of a major customer could have an adverse effect on our results of operations.

Our largest customer, The Home Depot, Inc., accounted for approximately $74.8 million, or
10.6%, of our total net sales for the year ended December 31, 2003, and $63.0 million, or 10.2%, of
our total net sales for year ended December 31, 2002. Our customers generally are not obligated to
purchase any minimum volume of products from us and are able to terminate their relationships with
us at any time. A significant reduction in orders or change in terms from The Home Depot, Inc. could
have a material adverse effect on our future results of operations.

Certain indebtedness may limit our ability to pay dividends, incur additional debt and make acquisitions
and other investments.

Our revolving credit facility and other senior indebtedness contain operational and financial

covenants that restrict our ability to make distributions to stockholders, incur additional debt and make
acquisitions and other investments unless we satisfy certain financial tests and comply with various
financial ratios. If we do not maintain compliance with these covenants, our creditors could declare a
default under our revolving credit facility and our indebtedness could be declared immediately due and
payable. Our ability to comply with the provisions of our indebtedness may be affected by changes in
economic or business conditions beyond our control.

One of our stockholders can exercise substantial influence over our company.

As of February 1, 2004, Timothy P. Horne, a member of our board of directors, beneficially owned
approximately 23.8% of our outstanding shares of Class A Common Stock (assuming conversion of all
shares of Class B Common Stock beneficially owned by Mr. Horne into Class A Common Stock) and
approximately 96.8% of our outstanding shares of Class B Common Stock, which represents
approximately 73.2% of the total outstanding voting power. As long as Mr. Horne controls shares
representing at least a majority of the total voting power of our outstanding stock, Mr. Horne will be
able to unilaterally determine the outcome of all stockholder votes and other stockholders will not be
able to affect the outcome of any stockholder vote.

Shares of our Class A Common Stock eligible for public sale could adversely affect the market price of our
Class A Common Stock.

As of February 1, 2004 there were outstanding 24,607,425 shares of our Class A Common Stock

and 7,471,700 shares of our Class B Common Stock. Shares of our Class B Common Stock may be
converted into Class A Common Stock at any time on a one for one basis. All of the shares of Class A
Common Stock are freely transferable without restriction or further registration under the federal
securities laws, except for any shares held by our affiliates, sales of which will be limited by Rule 144
under the Securities Act. In addition, under the terms of a registration rights agreement with respect to
outstanding shares of our class B common stock, the holders of our Class B Common Stock have rights
with respect to the registration of the underlying Class A Common Stock. Under these registration
rights, the holders of Class B Common Stock may require, on up to two occasions, that we register
their shares for public resale. If we are eligible to use Form S-3 or a similar short-form registration
statement, the holders of Class B Common Stock may require that we register their shares for public
resale up to two times per year. If we elect to register any shares of Class A Common Stock for any
public offering, the holders of Class B Common Stock are entitled to include shares of Class A
Common Stock into which such shares of Class B Common Stock may be converted in such
registration. However, we may reduce the number of shares proposed to be registered in view of
market conditions. We will pay all expenses in connection with any registration, other than underwriting
discounts and commissions. Pursuant to the exercise of these registration rights, we have registered the
resale of 1,200,000 shares of our Class A Common Stock on a Form S-3 shelf registration statement, of
which 610,000 shares remained available for resale as of February 29, 2004. If all of the available
registered shares are sold into the public market the trading price of our Class A Common Stock could
decline.

Our Class A Common Stock has insignificant voting power.

Our Class B Common Stock entitles its holders to ten votes for each share and our Class A

Common Stock entitles its holders to one vote per share. As of January 31, 2004, our Class B Common
Stock constituted 23.3% of our total outstanding common stock and 75.2% of the total outstanding
voting power and thus is able to exercise a controlling influence over our business.

The trading price of our Class A Common Stock may be volatile.

The trading price of our Class A Common Stock may be volatile and fluctuations in the trading
price may result in substantial losses for investors. The trading price of our Class A Common Stock
could decline or fluctuate in response to a variety of factors, including, but not limited to, our failure to
meet the performance estimates of securities analysts, changes in financial estimates of our revenues
and operating results and/or buy/sell recommendations by securities analysts, the timing of
announcements by us or our competitors concerning significant product line developments, contracts or
acquisitions or publicity regarding actual or potential results or performance, fluctuation in our
quarterly operating results caused by fluctuations in revenues and expenses, substantial sales of our
Class A Common Stock by our existing shareholders, general stock market conditions and other
economic or external factors.

Provisions in our charter documents and Delaware law may prevent or delay an acquisition of us, which
could decrease the value of our Class A Common Stock.

Our certificate of incorporation and bylaws and Delaware law contain provisions that could make

it more difficult for a third party to acquire us without the consent of our board of directors. These
provisions include those that:

(cid:127) authorize the issuance of up to 5,000,000 shares of preferred stock in one or more series without

a stockholder vote;

(cid:127) limit stockholders’ ability to call special meetings; and

(cid:127) establish advance notice requirements for nominations for election to the board of directors or

for proposing matters that can be acted on by stockholders at stockholder meetings.

Delaware law also imposes restrictions on mergers and other business combinations between us

and any holder of 15% or more of our outstanding common stock.

New Accounting Standards

In August 2001, the Financial Accounting Standards Board (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. We have adopted FAS 143 effective January 1, 2003 and its adoption
was not material to our consolidated financial statements.

In July 2002, the FASB issued Financial Accounting Standards Board Statement No. 146,

‘‘Accounting for Costs Associated with Exit or Disposal Activities’’ (FAS 146). The principal difference
between this Statement and Emerging Issues Task Force (EITF) Issue No. 94-3 ‘‘Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit on Activity (including Certain
Costs Incurred in a Restructuring)’’ (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 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. We adopted FAS 146 effective January 1, 2003 and its adoption was not material
to our consolidated financial statements.

In November 2002, the FASB issued Financial Accounting Standards Board Interpretation No. 45,
‘‘Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness of Others’’ (FIN 45). FIN 45 requires that a liability be recorded in the guarantor’s
balance sheet upon issuance of certain guarantees. In addition, FIN 45 requires disclosures about the
guarantees that an entity has issued, including a roll-forward of the entity’s product warranty liabilities.
FIN 45 required the application of the recognition provisions of FIN 45 prospectively to guarantees
issued after December 31, 2002. We adopted the disclosure provisions of FIN 45 effective
December 31, 2002. We do offer warranties on our products, but the returns under warranty have been
immaterial. The warranty reserve is part of the sales returns and allowances, a component of our
allowance for doubtful accounts. We adopted FIN 45 effective January 1, 2003 and its adoption was not
material to our consolidated financial statements.

In December 2002, the FASB issued Financial Accounting Standards Board Statement No. 148,
‘‘Accounting for Stock-Based Compensation, Transition and Disclosure’’ (FAS 148). FAS 148 provides
alternative methods of transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. FAS 148 also requires that disclosures of the pro forma effect
of using the fair value method of accounting for stock-based employee compensation be displayed more
prominently and in a tabular format. Additionally, FAS 148 requires disclosure of the pro forma effect
in interim financial statements. The additional disclosure requirements of FAS 148 were effective for
fiscal years ended after December 15, 2002. We are currently continuing to account for stock-based
compensation in accordance with Accounting Principles Board Opinion No. 25 ‘‘Accounting for Stock
Issued to Employees’’ (APB No. 25) and we provided the disclosures required by FAS 148.

In December 2002, the EITF issued EITF 00-21, ‘‘Accounting for Revenue Arrangements with
Multiple Deliverables.’’ This consensus provides guidance in determining when a revenue arrangement
with multiple deliverables should be divided into separate units of accounting, and, if separation is
appropriate, how the arrangement consideration should be allocated to the identified accounting units.
The provisions of EITF 00-21 are effective for revenue arrangements entered during fiscal periods
beginning after June 15, 2003. We adopted EITF 00-21 effective July 1, 2003 and its adoption was not
material to our consolidated financial statements.

In January 2003, the FASB issued Financial Accounting Standards Board Interpretation No. 46,

‘‘Consolidation of Variable Interest Entities’’ (FIN 46) which requires the consolidation of variable
interest entities (VIE) by the primary beneficiary of the entity if the equity investors in the entity do
not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial support from other parties.
FIN 46 was effective for all new VIEs created or acquired after January 31, 2003. In October 2003, the
FASB delayed the effective date for some VIEs that existed prior to February 1, 2003, provided the
reporting entity had not ‘‘issued’’ financial statements reporting the VIE in accordance with
Interpretation 46. FIN 46 was effective for the first interim or annual period ending after December 15,
2003. In December 2003, the FASB issued a revision to FIN 46 (FIN 46R). Under the revised
provisions, public entities are required to apply the guidance if the entity has interests in VIEs
commonly referred to as special-purpose entities for periods ending after December 15, 2003. We
adopted FIN 46R and as a result have consolidated Jameco International, LLC (the LLC) effective
October 1, 2003 (the fourth quarter of fiscal 2003). The LLC imports and sells vitreous china, imported
faucets and faucet parts and imported bathroom accessories to the North American home improvement
retail market. Its annual sales for the twelve months ended December 31, 2003, were approximately
$16,079,000. The LLC maintains a line of credit with a financial institution collateralized by a first

security interest in the LLC’s assets. The creditors have no recourse to the Company. The assets as of
December 31, 2003 of $3,960,000 are comprised primarily of accounts receivable and inventory which
we believe are collectable and saleable, respectively, within the normal course of business. We have a
subordinated security interest in the assets of the LLC pertaining to our loan receivable of $2,230,680
at December 31, 2003, which eliminates in consolidation as the result of the application of FIN 46R.
Prior to the adoption of FIN 46R, we accounted for our investment of 49% in the LLC using the
equity method.

We also maintain another variable interest in a VIE. In 2000 we entered into an agreement with
Plumworld.co.uk Ltd in which we maintain a 20% interest in Plumbworld. Plumbworld is primarily an
e-business that sells bathroom and sanitary appliances, as well as, plumbing and heating products, tools
and plumbing consumables. Its annualized sales are approximately $7,100,000. We maintain a notional
amount of approximately $500 investment in Plumbworld and maintain a loan receivable in the amount
of approximately $850,000 with Plumbworld. We continue to account for our investment in Plumbworld
using the equity method.

In April 2003, the FASB issued Financial Accounting Standards Board Statement No. 149,

‘‘Amendment of Statement 133 on Derivative Instruments and Hedging Activities’’ (FAS 149). FAS 149
amends and clarifies financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities under FAS 133,
‘‘Accounting for Derivative Instruments and Hedging Activities’’ (FAS 133). FAS 149 has multiple
effective date provisions depending on the nature of the amendments to FAS 133, including one for
contracts entered into or modified after June 30, 2003. We adopted FAS 149 and its adoption was not
material to our consolidated financial statements.

In May 2003, the FASB issued Financial Accounting Standards Board Statement No. 150,
‘‘Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity’’
(FAS 150). FAS 150 establishes standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. FAS 150 is effective for certain financial
instruments entered into or modified after May 31, 2003. For unmodified financial instruments existing
at May 31, 2003, FAS 150 is effective at the beginning of the first interim period beginning after
June 15, 2003. The Company adopted FAS 150 apart from the deferral by FASB Staff Position 150-3
(FAS 150-3) of certain mandatorilly redeemable non controlling interests and its adoption was not
material to the consolidated financial statements.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We use derivative financial instruments primarily to reduce exposure to adverse fluctuations in
foreign exchange rates, interest rates and costs 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 United States dollars are subject to translation
risks due to changes in foreign currency exchange rates. This risk is concentrated in the exchange rate
between the U.S. dollar and the euro; the U.S. dollar and the Canadian dollar; and the U.S. dollar and
the Chinese RMB.

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 year and certain open foreign currency denominated commitments to sell products to third parties.

At December 31, 2003, we had no forward contracts to buy foreign currencies and no unrealized gains
or losses.

We have historically had a very low exposure on the cost of our debt to changes in interest rates.
Interest rate swaps are used to mitigate the impact of interest rate fluctuations on certain variable rate
debt instruments and reduce interest expense on certain fixed rate instruments. Information about our
long-term debt including principal amounts and related interest rates appears in Note 11 of the Notes
to the Consolidated Financial Statements included herein.

We purchase significant amounts of bronze ingot, brass rod, cast iron, steel and plastic, 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, but we did not in 2003.

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The index to financial statements is included in page 45 of this Report.

Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND

FINANCIAL DISCLOSURE.

None.

Item 9A. CONTROLS AND PROCEDURES.

As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as of the end of the

period covered by this report, we carried out an evaluation under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the design and operation of our disclosure controls and procedures. In designing
and evaluating our disclosure controls and procedures, we recognize that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and our management necessarily was required to apply its judgment in
evaluating and implementing possible controls and procedures. The effectiveness of our disclosure
controls and procedures is necessarily limited by the staff and other resources available to us and,
although we have designed our disclosure controls and procedures to address the geographic diversity
of our operations, this diversity inherently may limit the effectiveness of those controls and procedures.
Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as
of the end of the period covered by this report, our disclosure controls and procedures were effective,
in that they provide reasonable assurance that information required to be disclosed by us in the reports
we file or submit 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. There was no
change in our internal control over financial reporting that occurred during the period covered by this
report that has materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting. In connection with these rules, we will continue to review and document 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.

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

PART III

Directors

The information appearing under the caption ‘‘Information as to Nominees for Director’’ in the

Registrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 5,
2004 is incorporated herein by reference. With respect to Directors and Executive Officers, the
information appearing under the caption ‘‘Section 16(a) Beneficial Ownership Reporting Compliance’’
in the Registrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on
May 5, 2004 is incorporated herein by reference.

Executive Officers

Information with respect to the executive officers of the Company is set forth in Item 1 of this

Report under the caption ‘‘Executive Officers and Directors.’’

Code of Ethics

We have adopted a Code of Business Conduct and Ethics applicable to all officers, employees and

Board members. The Code of Business Conduct and Ethics is posted on our website,
www.wattswater.com. In order to access this portion of our website, click on the ‘‘Investor Relations’’
tab. The Code of Business Conduct and Ethics is located under the ‘‘Corporate Governance’’ caption.
Any amendments to, or waivers of, the Code of Business Conduct and Ethics which applies to our chief
executive officer, chief financial officer, corporate controllers or any person performing similar
functions will be disclosed on our website promptly following the date of such amendment or waiver.

Item 11. EXECUTIVE COMPENSATION.

The information appearing under the caption ‘‘Compensation Arrangements’’ in the Registrant’s

Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 5, 2004 is
incorporated herein by reference.

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The information appearing under the caption ‘‘Principal Stockholders’’ in the Registrant’s Proxy
Statement relating to the Annual Meeting of Stockholders to be held on May 5, 2004 is incorporated
herein by reference.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information appearing under the caption ‘‘Compensation Arrangements-Certain Relationships

and Related Transactions’’ in the Registrant’s Proxy Statement relating to the Annual Meeting of
Stockholders to be held on May 5, 2004 is incorporated herein by reference.

Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

The information appearing under the caption ‘‘Ratification of Independent Auditors’’ in the

Registrant’s Proxy Statement relating to the Annual Meeting of Stockholders to be held on May 5,
2004 is incorporated herein by reference.

PART IV

Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(a)(1) Financial Statements

The following financial statements are included in a separate section of this Report commencing

on the page numbers specified below:

Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Consolidated Statements of Operations for the years ended December 31,

2003, 2002 and 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Consolidated Balance Sheets as of December 31, 2003 and 2002 . . . . . . . . . .

Consolidated Statements of Stockholders’ Equity for the years ended

December 31, 2003, 2002 and 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Consolidated Statements of Cash Flows for the years ended December 31,

2003, 2002 and 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . .

55-83

(a)(2) Schedules

Schedule II—Valuation and Qualifying Accounts for the years ended

December 31, 2003, 2002 and 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

All other schedules for which provision is made in the applicable accounting regulations of the

Securities and Exchange Commission are included in the Notes to the Consolidated Financial
Statements, or are not required under the related instructions or are inapplicable, and therefore have
been omitted.

(a)(3) Exhibits

Exhibit No.

Description

2.1

3.1

3.2

9.1

10.1*

10.2*

10.3*

Distribution Agreement dated as of October 1, 1999 between the Registrant and CIRCOR
International, Inc. (17)

Restated Certificate of Incorporation, as amended (1)

Amended and Restated By-Laws, as amended (1)

The Amended and Restated George B. Horne Voting Trust Agreement—1997 dated as of
September 14, 1999 (18)

Supplemental Compensation Agreement effective as of September 1, 1996 between the
Registrant and Timothy P. Horne (11), Amendment No. 1, dated July 25, 2000 (19), and
Amendment No. 2 dated October 23, 2002 (3)

Deferred Compensation Agreement between the Registrant and Timothy P. Horne, as
amended (4)

Form of Indemnification Agreement between the Registrant and certain directors and
officers of the Registrant dated February 10, 2004

Exhibit No.

10.4*

10.5*

10.6*

10.7*

10.8

10.9*

10.10

Description

1996 Stock Option Plan, dated October 15, 1996 (12), and First Amendment dated
February 28, 2003 (3)

1986 Incentive Stock Option Plan, as amended

Watts Industries, Inc. Retirement Plan for Salaried Employees dated December 30, 1994, as
amended and restated effective as of January 1, 1994 (9), Amendment No. 1 (11),
Amendment No. 2 (11), Amendment No. 3 (11), Amendment No. 4 dated September 4,
1996 (15), Amendment No. 5 dated January 1, 1998 (18), Amendment No. 6 dated May 3,
1999 (18), and Amendment No. 7 dated June 7, 1999 (18)

Watts Industries, Inc. Pension Plan (amended and restated effective as of January 1, 1997)
(3) and First Amendment dated October 25, 2002 (3)

Registration Rights Agreement dated July 25, 1986 (5)

Executive Incentive Bonus Plan, as amended (9)

Amended and Restated Stock Restriction Agreement dated October 30, 1991 (2), and
Amendment dated August 26, 1997 (15)

10.11* Watts Industries, Inc. 1991 Non-Employee Directors’ Nonqualified Stock Option Plan (6),

and Amendment No. 1 (11)

10.12* Watts Industries, Inc. 2003 Non-Employee Directors’ Stock Option Plan (3)

10.13

10.14

10.15

10.16

Letter of Credit issued by Fleet National Bank (as successor to BankBoston, N.A.) for the
benefit of Zurich-American Insurance Company dated June 25, 1999, as amended
January 22, 2001

Form of Stock Restriction Agreement for management stockholders (5)

Letter of Credit issued by Fleet National Bank for the benefit of ACE Property and
Casualty Insurance Company and Pacific Employers’ Insurance Company dated January 23,
2002, as amended February 6, 2003

Revolving Credit Agreement dated as of February 28, 2002 among the Registrant, Watts
Regulator Co., Watts Industries Europe B.V., the lenders listed therein and Fleet National
Bank, as Administrative Agent (20), First Amendment dated March 28, 2003 (7), Second
Amendment dated July 25, 2003 (8), and Third Amendment dated December 16, 2003

10.17* Watts Industries, Inc. Management Stock Purchase Plan dated October 17, 1995 (10),

Amendment No. 1 dated August 5, 1997 (15), Amendment No 2 dated November 1, 1999
(14), Amendment No. 3 dated March 1, 2001 (3)

10.18

10.19

Stock Purchase Agreement dated as of June 19, 1996 by and among Mueller Co., Tyco
Valves Limited, Watts Investment Company, Tyco International Ltd. and the Registrant (13)

Guaranty dated as of February 28, 2002 among the Registrant, Watts Investment Company,
Watts Spacemaker, Inc., Watts Distribution Company, Inc., Anderson-Barrows Metals
Corporation, Watts Drainage Products, Inc., Webster Valve, Inc. and Jameco Industries, Inc.
in favor of Fleet National Bank and the lenders under the Revolving Credit Agreement
dated February 28, 2002 (20), and Ratification of Guaranty dated as of February 28, 2002
(7)

10.20

Form of Promissory Note dated as of May 9, 2002 issued by Watts Regulator Company and
the Registrant as borrowers, to the former shareholders of Hunter Innovations, Inc. (21)

Exhibit No.

10.21

Description

Note Purchase Agreement dated as of May 15, 2003 between the Registrant and the
Purchasers named in Schedule A thereto relating to the Registrant’s $50,000,000 4.87%
Senior Notes, Series A, due May 15, 2010 and $75,000,000 5.47% Senior Notes, Series B,
due May 15, 2013 (7)

10.22

10.23

Form of 4.87% Senior Note due May 15, 2010 (7)

Form of 5.47% Senior Note due May 15, 2013 (7)

10.24* Watts Water Technologies, Inc. 2004 Stock Incentive Plan

31.1

31.2

32.1

32.2

Statement Regarding Computation of Earnings per Common Share (16)

Subsidiaries

Consent of KPMG LLP

Certification of Principal Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of
the Securities Exchange Act of 1934, as amended

Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of
the Securities Exchange Act of 1934, as amended

Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350

Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350

(1) Incorporated by reference to the Registrant’s Registration Statement on Form S-3

(No. 333-105989) filed with the Securities and Exchange Commission on June 10, 2003.

(2) Incorporated by reference to the Registrant’s Form 8-K dated November 14, 1991.

(3) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended

December 31, 2002.

(4) Incorporated by reference to the Registrant’s Form S-1 (No. 33-6515) dated June 17, 1986.

(5) Incorporated by reference to the Registrant’s Form S-1 (No. 33-6515) as part of the Second

Amendment to such Form S-1 dated August 21, 1986.

(6) Incorporated by reference to Amendment No. 1 to the Registrant’s Annual Report on Form 10-K

for year ended June 30, 1992.

(7) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for quarter ended

June 30, 2003.

(8) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter

ended September 30, 2003.

(9) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended

June 30, 1995.

(10) Incorporated by reference to the Registrant’s Form S-8 (No. 33-64627) dated November 29, 1995.

(11) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended

June 30, 1996.

(12) Incorporated by reference to the Registrant’s Form S-8 (No. 333-32685) dated August 1, 1997.

(13) Incorporated by reference to the Registrant’s Form 8-K dated September 4, 1996.

(14) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended

December 31, 2000.

(15) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended

June 30, 1997.

(16) Incorporated by reference to notes to Consolidated Financial Statements, Note 2 of this Report.

(17) Incorporated by reference to exhibit 2.1 to CIRCOR International, Inc. Amendment No. 1 to its

registration statement on Form 10 filed on September 22, 1999. (File No. 000-26961).

(18) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for year ended

June 30, 1999.

(19) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for quarter ended

September 30, 2000.

(20) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter

ended March 31, 2002.

(21) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter

ended June 30, 2002.

* Management contract or compensatory plan or arrangement.

(b) Reports on Form 8-K

The following Current Reports on Form 8-K were filed by the Registrant during the quarter ended

December 31, 2003:

1. The Registrant filed a Current Report on Form 8-K on December 11, 2003 reporting under

Item 5 that, on December 10, 2003, the Registrant entered into an underwriting agreement to
sell 4,000,000 shares of its Class A Common Stock plus up to an additional 600,000 shares of
its Class A Common Stock to cover over-allotments, if any.

2. The Registrant filed a Current Report on Form 8-K on December 2, 2003 reporting under

Item 5 that, on December 1, 2003, the Registrant announced its intention to offer 4,000,000
shares of its Class A Common Stock plus up to an additional 600,000 shares of its Class A
Common Stock to cover over-allotments, if any, pursuant to an effective shelf registration
statement.

3. The Registrant filed a Current Report on Form 8-K on October 15, 2003 reporting under

Item 5 that the Registrant had changed its name from Watts Industries, Inc. to Watts Water
Technologies, Inc.

4. The Registrant filed a Current Report on Form 8-K on October 9, 2003 reporting under Item
5 that the Registrant would change its name from Watts Industries, Inc. to Watts Water
Technologies, Inc. effective on October 15, 2003.

Pursuant to the requirements of Section 13 or 15(d) 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.

SIGNATURES

WATTS WATER TECHNOLOGIES, INC.

By:

/s/ PATRICK S. O’KEEFE

Patrick S. O’Keefe
Chief Executive Officer
President and Director

DATED: March 12, 2004

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed

below by the following persons on behalf of the registrant and in the capacities and on the dates
indicated.

Signature

Title

Date

/s/ PATRICK S. O’KEEFE

Patrick S. O’Keefe

Chief Executive Officer

President and Director

March 12, 2004

/s/ WILLIAM C. MCCARTNEY

William C. McCartney

Chief Financial Officer and Treasurer
(Principal Financial and Accounting
Officer), Secretary

March 12, 2004

/s/ GORDON W. MORAN

Gordon W. Moran

/s/ TIMOTHY P. HORNE

Timothy P. Horne

/s/ KENNETH J. MCAVOY

Kenneth J. McAvoy

/s/ DANIEL J. MURPHY, III

Daniel J. Murphy, III

/s/ ROGER A. YOUNG

Roger A. Young

/s/ JOHN K. MCGILLICUDDY

John K. McGillicuddy

Chairman of the Board

March 12, 2004

Director

March 12, 2004

Independent Auditors’ Report

The Board of Directors and Stockholders
Watts Water Technologies, Inc.:

We have audited the accompanying consolidated balance sheets of Watts Water Technologies, Inc.

and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of
operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended
December 31, 2003. In connection with our audits of the consolidated financial statements, we have
also audited the financial statement schedule. These consolidated financial statements and financial
statement schedule are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these consolidated financial statements and financial statement schedule based
on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United
States of America. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Watts Water Technologies, Inc. and subsidiaries as of
December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, the financial statement
schedule, when considered in relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.

As discussed in Note 2 to the financial statements, effective January 1, 2002, the Company
changed its method of accounting for goodwill and other intangible assets based on the adoption of
Financial Accounting Standards No. 142, ‘‘Goodwill and Other Intangible Assets.’’

Boston, Massachusetts
February 3, 2004,
except as to the first
paragraph of Note 19,
which is as of
February 20, 2004.

Watts Water Technologies, Inc. and Subsidiaries

Consolidated Statements of Operations

(Amounts in thousands, except per share information)

Years Ended December 31,

2003

2002

2001

Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$705,651
464,990

$615,526
406,806

$548,940
365,408

GROSS PROFIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Selling, general and administrative expenses . . . . . . . . . . . . . . . . . . .
Restructuring and other charges . . . . . . . . . . . . . . . . . . . . . . . . . . . .

240,661
170,195
426

208,720
150,553
638

183,532
131,795
1,454

OPERATING INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

70,040

57,529

50,283

Other (income) expense:

Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Minority interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INCOME FROM CONTINUING OPERATIONS

BEFORE INCOME TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INCOME FROM CONTINUING OPERATIONS . . . . . . . . . . . . .
Loss from discontinued operations, net of taxes of $1,947 . . . . . . . . .

(1,021)
12,114
(463)
581

11,211

58,829
22,356

36,473
(3,111)

(992)
8,692
(117)
(272)

7,311

50,218
17,596

32,622
—

(685)
9,422
198
1,180

10,115

40,168
13,612

26,556
—

NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 33,362

$ 32,622

$ 26,556

Basic EPS
Income (loss) per share:

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.33
(0.11)

1.22

1.22
—

1.22

1.00
—

1.00

Weighted average number of shares . . . . . . . . . . . . . . . . . . . . . . . . .

27,455

26,718

26,497

Diluted EPS
Income (loss) per share:

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.32
(0.11)

1.21

1.21
—

1.21

0.99
—

0.99

Weighted average number of shares . . . . . . . . . . . . . . . . . . . . . . . . .

27,692

27,056

26,802

Dividends per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0.25

0.24

The accompanying notes are an integral part of these consolidated financial statements.

Watts Water Technologies, Inc. and Subsidiaries

Consolidated Balance Sheets

(Amounts in thousands, except share information)

December 31,

2003

2002

ASSETS
CURRENT ASSETS:

Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Trade accounts receivable, less allowance for doubtful accounts of $7,772 in 2003

and $7,322 in 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Inventories, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepaid expenses and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assets held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assets of discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Current Assets

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PROPERTY, PLANT AND EQUIPMENT, NET . . . . . . . . . . . . . . . . . . . . . . . . . .

$149,361

$ 10,973

136,064
156,599
8,500
23,552
1,938
4,460

480,474
145,711

123,504
133,415
8,818
21,927
2,464
8,655

309,756
134,376

OTHER ASSETS:

Goodwill
Other

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

184,901
27,557

163,226
28,114

TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$838,643

$635,472

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued expenses and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued compensation and benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current portion of long-term debt
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Liabilities of discontinued operations

Total Current Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
LONG-TERM DEBT, NET OF CURRENT PORTION . . . . . . . . . . . . . . . . . . . . . .
DEFERRED INCOME TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
OTHER NONCURRENT LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
MINORITY INTEREST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 74,068
55,252
18,466
13,251
11,302

172,339
179,061
15,978
25,588
9,286

$ 64,704
57,037
15,514
82,211
18,906

238,372
56,276
15,011
19,743
10,134

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, 24,459,121 shares in 2003 and 18,863,482 shares in
2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Class B Common Stock, $.10 par value; 25,000,000 shares authorized; 10 votes per
share; issued and outstanding, 7,605,224 shares in 2003 and 8,185,224 shares in
2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . . .

Total Stockholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,446

1,886

761
132,983
286,396
13,805

436,391

819
45,132
259,893
(11,794)

295,936

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY . . . . . . . . . . . . . . . . . . .

$838,643

$635,472

The accompanying notes are an integral part of these consolidated financial statements.

Watts Water Technologies, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(Amounts in thousands, except share information)

Class A
Common Stock

Class B
Common Stock

Amount

Additional
Paid-In
Capital

Accumulated
Other

Total

Retained Comprehensive Treasury Stockholders’
Earnings

Income (loss)

Equity

Stock

Balance at December 31, 2000 . . . . . . . 17,225,965 $1,723 9,235,224

$924

$ 35,996

$213,627

$(19,728)

$ — $232,542

Comprehensive income:

Net income . . . . . . . . . . . . . . . .
.
Cumulative translation adjustment

Comprehensive income . . . . . . .

Shares of Class B Common Stock
converted to Class A Common
Stock . . . . . . . . . . . . . . . . . . . .

Shares of Class A Common Stock

issued upon the exercise of stock
options

. . . . . . . . . . . . . . . . . .

Purchase of treasury stock, 110,300

shares at cost . . . . . . . . . . . . . . .
Retirement of treasury stock . . . . . .
Net change in restricted stock units . .

Common Stock dividends

. . . . . . . .

26,556

(4,553)

500,000

(500,000)

(50)

110,510

(110,300)
50,334

(11)
5

1,572

(1,374)
988

(6,422)

(1,385)
1,385

26,556
(4,553)

22,003

1,583

(1,385)

993

(6,422)

Balance at December 31, 2001 . . . . . . . 17,776,509 $1,778 8,735,224

$874

$ 37,182

$233,761

$(24,281)

$ — $249,314

Comprehensive income:

Net income . . . . . . . . . . . . . . . .
Cumulative translation adjustment
.
Pension plan additional minimum

liability, net of tax of $2,444 . . . .

Comprehensive income . . . . . . . . . .

Shares of Class B Common Stock
converted to Class A Common
Stock . . . . . . . . . . . . . . . . . . . .

Shares of Class A Common Stock

issued upon the exercise of stock
options

. . . . . . . . . . . . . . . . . .

Tax benefit for stock options

exercised . . . . . . . . . . . . . . . . .
Net change in restricted stock units . .
. . . . . . . .
Common Stock dividends

32,622

16,475

(3,988)

550,000

(550,000)

(55)

501,646

35,327

6,297

855
798

(6,490)

32,622
16,475

(3,988)

45,109

6,347

855
801
(6,490)

Balance at December 31, 2002 . . . . . . . 18,863,482 $1,886 8,185,224

$819

$ 45,132

$259,893

$(11,794)

$ — $295,936

Comprehensive income:

Net income . . . . . . . . . . . . . . . .
Cumulative translation adjustment

and other . . . . . . . . . . . . . . .

Pension plan additional minimum

liability, net of tax of $1,205 . . . .

Comprehensive income . . . . . . .

Shares of Class B Common Stock
converted to Class A Common
Stock . . . . . . . . . . . . . . . . . . . .

Shares of Class A Common Stock

issued upon the exercise of stock
options

. . . . . . . . . . . . . . . . . .
Tax benefit for stock options exercised .
Net change in restricted stock units . .
Shares of Class A Common Stock
issued in Stock Offering net of
offering costs of $4,874 . . . . . . . .
Common Stock dividends . . . . . . . .

33,362

27,440

(1,841)

580,000

(580,000)

(58)

301,011

114,628

4,600,000

460

4,029
423
1,333

82,066

(6,859)

33,362

27,440

(1,841)

58,961

4,059
423
1,345

82,526
(6,859)

Balance at December 31, 2003 . . . . . . . 24,459,121 $2,446 7,605,224

$761

$132,983

$286,396

$ 13,805

$ — $436,391

The accompanying notes are an integral part of these consolidated financial statements.

Watts Water Technologies, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Amounts in thousands)

Years Ended December 31,

2003

2002

2001

OPERATING ACTIVITIES

Income from continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 36,473 $ 32,622 $ 26,556
Adjustments to reconcile net income from continuing operations to net

cash provided by continuing operating activities:

Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred income taxes (benefit) . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss (gain) on disposal of property, plant and equipment . . . . . . . .
Assets held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity in undistributed earnings (loss) of affiliates . . . . . . . . . . . . .
Changes in operating assets and liabilities, net of effects from

business acquisitions and divestures:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepaid expenses and other assets . . . . . . . . . . . . . . . . . . . . . . .
Accounts payable, accrued expenses and other liabilities . . . . . . .
Net cash provided by continuing operations . . . . . . . . . . . . . . . . . . .

20,521
763
(75)
156
946
(37)

2,180
(8,367)
(2,556)
(14)
49,990

INVESTING ACTIVITIES

Additions to property, plant and equipment . . . . . . . . . . . . . . . . . . . . .
Proceeds from the sale of property, plant and equipment
. . . . . . . . . . .
Decrease (increase) in other assets . . . . . . . . . . . . . . . . . . . . . . . . . . .
Business acquisitions, net of cash acquired . . . . . . . . . . . . . . . . . . . . . .
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . .

(20,035)
1,765
(191)
(18,584)
(37,045)

FINANCING ACTIVITIES

21,817
477
1,884
(134)
—
(101)

(13,762)
(2,764)
(3,405)
14,791
51,425

(19,593)
3,194
(1,189)
(26,233)
(43,821)

19,971
3,704
(3,421)
1,923
—
6

6,295
4,213
(780)
(7,230)
51,237

(16,047)
267
508
(42,977)
(58,249)

124,992
Proceeds from long-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . .
(114,033)
Payments of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,576
Proceeds from exercise of stock options . . . . . . . . . . . . . . . . . . . . . . . .
—
Tax benefit of stock options exercised . . . . . . . . . . . . . . . . . . . . . . . . .
—
Proceeds from stock offering, net . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(6,422)
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(1,385)
Purchase and retirement of common stock . . . . . . . . . . . . . . . . . . . . . .
5,728
Net cash provided by (used in) financing activities . . . . . . . . . . . . . . .
(214)
Effect of exchange rate changes on cash and cash equivalents . . . . . . . . . .
(1,740)
Net cash provided by (used in) discontinued operations . . . . . . . . . . . . . .
(3,238)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS . . . .
Cash and cash equivalents at beginning of year . . . . . . . . . . . . . . . . . . . .
15,235
CASH AND CASH EQUIVALENTS AT END OF YEAR . . . . . . . . . . . $ 149,361 $ 10,973 $ 11,997

220,722
(174,166)
5,404
423
82,526
(6,859)
—
128,050
3,856
(6,463)
138,388
10,973

122,917
(137,513)
7,148
855
—
(6,490)
—
(13,083)
2,281
2,174
(1,024)
11,997

NON CASH INVESTING AND FINANCING ACTIVITIES

Acquisition of businesses

Fair value of assets acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 22,604 $ 66,176 $ 64,951
Cash paid, net of cash acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . .
42,977
26,233
4,020 $ 39,943 $ 21,974
Liabilities assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $

18,584

CASH PAID FOR:

Interest

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 13,499 $ 10,084 $ 10,416

Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 17,700 $ 16,400 $ 19,700

The accompanying notes are an integral part of these consolidated financial statements.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(1) Description of Business

Watts Water Technologies, Inc. (the Company) designs, manufactures and sells an extensive line of
water safety and flow control products for the water quality, water safety, water flow control and water
conservation markets located predominantly in North America, Europe, and China.

On October 15, 2003, the Company changed its name from Watts Industries, Inc. to Watts Water
Technologies, Inc. to more accurately reflect its strategic focus on providing solutions to its customers’
water based needs.

(2) Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its majority and
wholly owned subsidiaries. Upon consolidation, all significant intercompany accounts and transactions
are eliminated.

Cash Equivalents

Cash equivalents consist of highly liquid investments with maturities of three months or less at the

date of original issuance.

Allowance for Doubtful Accounts

Allowance for doubtful accounts includes reserves for bad debts and sales returns and allowances.
The Company analyzes the aging of accounts receivable, individual accounts receivable, historical bad
debts, concentration of receivables by customer, customer credit worthiness, current economic trends
and changes in customer payment terms. The Company specifically analyzes individual accounts
receivable and establishes specific reserves against financially troubled customers. In addition, factors
are developed in certain regions utilizing historical trends of sales and returns and allowances to derive
a reserve for returns and allowances.

Concentration of Credit

The Company sells products to a diversified customer base and, therefore, has no significant
concentrations of credit risk, except that approximately 10.6% and 10.2% of the Company’s total sales
in 2003 and 2002, respectively, are to one company.

Inventories

Inventories are stated at the lower of cost (first-in, first-out method) or market. Market value is
determined by replacement cost or net realizable value. Historical experience is used as the basis for
determining the reserve for excess or obsolete inventories.

Goodwill and Other Intangible Assets

Goodwill is recorded when the consideration paid for acquisitions exceeds the fair value of net

tangible and intangible assets acquired. In June 2001, the Financial Accounting Standards Board
(FASB) issued Financial Accounting Standards Board Statement No. 141 ‘‘Business Combinations’’
(FAS 141) and Financial Accounting Standards Board Statement No. 142 ‘‘Goodwill and Other

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

Intangible Assets’’ (FAS 142). FAS 141 requires that the purchase method of accounting be used for all
business combinations completed after June 30, 2001. FAS 142 requires that goodwill and other
intangible assets with indefinite useful lives no longer be amortized, but rather be tested annually for
impairment.

Prior to the adoption of FAS 142, goodwill was amortized over 40 years using the straight-line
method. Also, the Company previously assessed the recoverability of intangible assets by determining
whether the intangible asset balance could be recovered through undiscounted cash flows of the
acquired businesses. The amount of impairment, if any, was measured based on projected discounted
future operating cash flows using a discount rate reflecting the Company’s average cost of funds.

Impairment of Goodwill and Long-Lived Assets

Goodwill and intangible assets with indefinite lives are tested annually for impairment in

accordance with the provisions of FAS 142. The Company’s impairment review is based on a discounted
cash flow approach at the reporting unit level that requires management judgment with respect to
revenue and expense growth rates, changes in working capital and the selection and use of an
appropriate discount rate. The Company uses its judgment in assessing whether assets may have
become impaired between annual impairment tests. Indicators such as unexpected adverse business
conditions, economic factors, unanticipated technological change or competitive activities, loss of key
personnel and acts by governments and courts, may signal that an asset has become impaired.

Intangible assets with estimable lives and other long-lived assets are reviewed for impairment
whenever events of changes in circumstances indicate that the carrying amount of an asset or asset
group may not be recoverable in accordance with Financial Accounting Standards Board Statement
No. 144, ‘‘Accounting for the Impairment or Disposal of Long-Lived Assets’’ (FAS 144). Recoverability
of intangible assets with estimable lives and other long-lived assets is measured by a comparison of the
carrying amount of an asset or asset group to future net undiscounted pretax cash flows expected to be
generated by the asset or asset group. If these comparisons indicate that an asset is not recoverable, the
impairment loss recognized is the amount by which the carrying amount of the asset or asset group
exceeds the related estimated fair value. Estimated fair value is based on either discounted future
pretax operating cash flows or appraised values, depending on the nature of the asset. The Company
determines the discount rate for this analysis based on the expected internal rate of return for the
related business and does not allocate interest charges to the asset or asset group being measured.
Judgment is required to estimate discounted future operating cash flows.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

The following table adjusts net income in 2001 to reflect what it would have been if FAS 142 was

adopted on January 1, 2001:

Years Ended December 31,

2003

2002

2001

Net income, as reported . . . . . . . . . . . . . . . . . . . . . . .
Add back: goodwill amortization, net of tax . . . . . . . .

(in thousands, except
per share information)
$32,622
—

$33,362
—

$26,556
3,220

Adjusted net income . . . . . . . . . . . . . . . . . . . . . . . . .

$33,362

$32,622

$29,776

Basic earnings per share:
Net income, as reported . . . . . . . . . . . . . . . . . . . . . . .
Goodwill amortization . . . . . . . . . . . . . . . . . . . . . . . .

Adjusted net income . . . . . . . . . . . . . . . . . . . . . . . . .

Diluted earnings per share:
Net income, as reported . . . . . . . . . . . . . . . . . . . . . . .
Goodwill amortization . . . . . . . . . . . . . . . . . . . . . . . .

Adjusted net income . . . . . . . . . . . . . . . . . . . . . . . . .

1.22
—

1.22

1.21
—

1.21

1.22
—

1.22

1.21
—

1.21

1.00
0.12

1.12

0.99
0.12

1.11

The changes in the carrying amount of goodwill are as follows:

December 31,

2003

2002

(in thousands)

Carrying amount at the beginning of year . . . . . . . . . . . . . . . .
Goodwill acquired during the year . . . . . . . . . . . . . . . . . . . . .
Adjustments to goodwill during the period . . . . . . . . . . . . . . .
Effect of change in exchange rates used for translation . . . . . .

$163,226
8,451
(130)
13,354

$124,544
30,662
—
8,020

Carrying amount at end of year . . . . . . . . . . . . . . . . . . . . . . .

$184,901

$163,226

Other intangible assets include the following and are presented in ‘‘Other Assets: ‘‘Other’’, in the

Consolidated Balance Sheets:

December 31,

2003

2002

Gross
Carrying
Amount

Accumulated
Amortization

Gross
Carrying
Amount

Accumulated
Amortization

(in thousands)

Patents . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . .

$ 8,449
3,377

$(3,862)
(1,245)

$ 8,353
4,888

$(3,445)
(917)

Total amortizable intangibles . . . .

11,826

(5,107)

13,241

(4,362)

Intangible assets not subject to

amortization.

. . . . . . . . . . . . . . . . .

10,029

—

10,256

—

Total . . . . . . . . . . . . . . . . . . . . . .

$21,855

$(5,107)

$23,497

$(4,362)

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

Aggregate amortization expense for amortized other intangible assets for the year ended
December 31, 2003, 2002 and 2001 was $763,000, $477,000 and $484,000, respectively. Additionally,
future amortization expense on other intangible assets approximates $517,000 for 2004, $511,000 for
2005 and $472,000 for 2006 and 2007 and $448,000 for 2008.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Depreciation is provided on a straight-line
basis over the estimated useful lives of the assets, which range from 10 to 40 years for buildings and
improvements and 3 to 15 years for machinery and equipment.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and

liabilities are recognized for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and their respective tax bases and
operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment date.

Foreign Currency Translation

The financial statements of subsidiaries located outside the United States generally are measured

using the local currency as the functional currency. Balance sheet accounts, including goodwill, of
foreign subsidiaries are translated into United States dollars at year-end exchange rates. Income and
expense items are translated at weighted average exchange rates for each period. Net translation gains
or losses are included in other comprehensive income, a separate component of stockholders’ equity.
The Company does not provide for U.S. income taxes on foreign currency translation adjustments since
it does not provide for such taxes on undistributed earnings of foreign subsidiaries. Gains and losses
from foreign currency transactions of these subsidiaries are included in net earnings.

Stock Based Compensation

The Company accounts for stock based compensations in accordance with Accounting Principles

Board Opinion No. 25, ‘‘Accounting for Stock Issued to Employees’’ (APB No. 25), and related
interpretations. The Company records stock based compensation expense associated with its
Management Stock Purchase Plan due to the discount from market price. Stock-based compensation
expense is amortized to expense on a straight-line basis over the vesting period. The following table
illustrates the effect on reported net income and earnings per common share if the Company had
applied the fair value method to measure stock-based compensation, which is described more fully in
Note 13 as required under the disclosure provisions of Financial Accounting Standards Board No. 123,

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

‘‘Accounting for Stock-Based Compensation’’ (FAS 123) as amended by Financial Accounting Standards
Board No. 148 ‘‘Accounting for Stock-Based Compensation Transition and Disclosure’’ (FAS 148).

Net income, as reported . . . . . . . . . . . . . . . . . . . . . . .

$33,362

(in thousands)
$32,622

$26,556

Years Ended December 31,

2003

2002

2001

Add: Stock-based employee compensation expense

from the Management Stock Purchase Plan included
in reported net income, net of tax . . . . . . . . . . . . . .

Deduct: Stock-based employee expense determined

under the fair value method, net of tax:

131

164

184

Restricted stock units (Management Stock Purchase

Plan) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Employee stock options . . . . . . . . . . . . . . . . . . . . .

(271)
(575)

(220)
(573)

(192)
(551)

Proforma net income . . . . . . . . . . . . . . . . . . . . . . . . .

$32,647

$31,993

$25,997

Earnings per share:

Basic—as reported . . . . . . . . . . . . . . . . . . . . . . . . .
Basic—proforma . . . . . . . . . . . . . . . . . . . . . . . . . .
Dilutive—as reported . . . . . . . . . . . . . . . . . . . . . . .
Dilutive—proforma . . . . . . . . . . . . . . . . . . . . . . . .

1.22
1.19
1.21
1.18

1.22
1.20
1.21
1.19

1.00
0.98
0.99
0.97

Net Income Per Common Share

Basic net income per common share is calculated by dividing net income by the weighted average

number of common shares outstanding. The calculation of diluted earnings per share assumes the
conversion of all dilutive securities (see Note 13).

Net income and number of shares used to compute net earnings per share, basic and assuming full

dilution, are reconciled below:

Years Ended December 31,

2003

2002

2001

Net
Income

Per
Share
Shares Amount

Net
Income

Per
Share
Shares Amount

Net
Income

Per
Share
Shares Amount

(Amounts in thousands, except per share information)

Basic EPS . . . . . . . . . . . . . . . . $33,362 27,455 $1.22 $32,622 26,718 $1.22 $26,556 26,497 $1.00
Dilutive securities principally

common stock options . . . . .

— 237

0.01

— 338

0.01

— 305

0.01

Diluted EPS . . . . . . . . . . . . . . $33,362 27,692 $1.21 $32,622 27,056 $1.21 $26,556 26,802 $0.99

Stock options to purchase 706,656 shares of common stock were outstanding at December 31, 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. There were none outstanding at December 31, 2003 and 2002.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

Derivative Financial Instruments

In the normal course of business, the Company manages risks associated with commodity prices,
foreign exchange rates and interest rates through a variety of strategies, including the use of hedging
transactions, executed in accordance with the Company’s policies. The Company’s hedging transactions
include, but are not limited to, the use of various derivative financial and commodity instruments. As a
matter of policy, the Company does not use derivative instruments unless there is an underlying
exposure. Any change in the value of our derivative instruments would be substantially offset by an
opposite change in the value of the underlying hedged items. The Company does not use derivative
instruments for trading or speculative purposes.

Using qualifying criteria defined in Financial Accounting Standards Board Statement No. 133
‘‘Accounting for Derivative Instruments and Hedging Activities’’ (FAS 133), derivative instruments are
designated and accounted for as either a hedge of a recognized asset or liability (fair value hedge) or a
hedge of a forecasted transaction (cash flow hedge). For a fair value hedge, both the effective and
ineffective portions of the change in fair value of the derivative instrument, along with an adjustment to
the carrying amount of the hedged item for fair value changes attributable to the hedged risk, are
recognized in earnings. For a cash flow hedge, changes in the fair value of the derivative instrument
that are highly effective are deferred in accumulated other comprehensive income or loss until the
underlying hedged item is recognized in earnings.

The ineffective portion of fair value changes on qualifying hedges is recognized in earnings
immediately. If a fair value or cash flow hedge were to cease to qualify for hedge accounting or be
terminated, it would continue to be carried on the balance sheet at fair value until settled, but hedge
accounting would be discontinued prospectively. If a forecasted transaction were no longer probable of
occurring, amounts previously deferred in accumulated other comprehensive income would be
recognized immediately in earnings. On occasion, the Company may enter into a derivative instrument
for which hedge accounting is not required because it is entered into to offset changes in the fair value
of an underlying transaction which is required to be recognized in earnings (natural hedge). These
instruments are reflected in the Consolidated Balance Sheets at fair value with changes in fair value
recognized in earnings.

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 2003, 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.

Portions of the Company’s outstanding debt are exposed to interest rate risks. The Company

monitors its interest rate exposures on an ongoing basis to maximize the overall effectiveness of its
interest rates. During 2003, the Company entered into an interest rate swap as a means of hedging
exposure to interest rate risks (see Note 11). The Company’s swap was designated as a cash flow hedge
under the criteria of FAS 133.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

Shipping and Handling

Shipping and handling costs included in selling, general and administrative expense amounted to

$22,111,000, $20,900,000 and $21,002,000 for the years ended December 31, 2003, 2002 and 2001,
respectively.

Research and Development

Research and development costs included in selling, general, and administrative expense amounted

to $9,178,000, $9,132,000 and $6,584,000 for the years ended December 31, 2003, 2002 and 2001,
respectively.

Revenue Recognition

The Company recognizes revenue when all of the following criteria have been met: the Company
has entered into a binding agreement, the product has been shipped and title passes, the sales price to
the customer is fixed or is determinable, and collectability is reasonably assured. Provisions for
estimated returns and allowances are made at the time of sale, and are recorded as a reduction of sales
and included in the allowance for doubtful accounts in the Consolidated Balance Sheets. The Company
records provisions for sales incentives (primarily volume rebates), as an adjustment to net sales in
accordance with the Financial Accounting Standards Board’s Emerging Issues Task Force (EITF) Issue
00-14, ‘‘Accounting for Certain Sales Incentives’’(EITF 00-14) and EITF Issue No 01-9, ‘‘Accounting for
Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products’’.

Advertising

The Company records advertising expense as incurred.

Basis of Presentation

Certain amounts in years 2002 and 2001 have been reclassified to permit comparison with the 2003

presentation.

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted

in the United States requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

New Accounting Standards

In August 2001, the Financial Accounting Standards Board (FASB) issued Financial Accounting

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

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 has adopted FAS 143 effective January 1, 2003 and its
adoption was not material to the consolidated financial statements.

In July 2002, the FASB issued Financial Accounting Standards Board Statement No. 146,

‘‘Accounting for Costs Associated with Exit or Disposal Activities’’ (FAS 146). The principal difference
between this Statement and Emergency Issues Task Force (EITF) Issue No. 94-3 ‘‘Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring) (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 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. The Company adopted FAS 146 effective January 1, 2003 and its adoption was not
material to the consolidated financial statements.

In November 2002, the FASB issued Financial Accounting Standards Board Interpretation No. 45,
‘‘Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees
of Indebtedness of Others’’ (FIN 45). FIN 45 requires that a liability be recorded in the guarantor’s
balance sheet upon issuance of certain guarantees. In addition, FIN 45 requires disclosures about the
guarantees that an entity has issued, including a roll-forward of the entity’s product warranty liabilities.
FIN 45 required the application of the recognition provisions of FIN 45 prospectively to guarantees
issued after December 31, 2002. The Company adopted the disclosure provisions of FIN 45 effective
December 31, 2002. The Company does offer warranties for its products, but the returns under
warranty have been immaterial. The warranty reserve is part of the sales returns and allowances
reserve, a component of the Company’s allowance for doubtful accounts. The Company adopted FIN
45 effective January 1, 2003 and its adoption was not material to the consolidated financial statements.

In December 2002, the FASB issued Financial Accounting Standards Board Statement No. 148,
‘‘Accounting for Stock-Based Compensation, Transition and Disclosure’’ (FAS 148). FAS 148 provides
alternative methods of transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. FAS 148 also requires that disclosures of the pro forma effect
of using the fair value method of accounting for stock-based employee compensation be displayed more
prominently and in a tabular format. Additionally, FAS 148 requires disclosure of the pro forma effect
in interim financial statements. The additional disclosure requirements of FAS 148 were effective for
fiscal years ended after December 15, 2002. The Company currently continues to account for stock-
based compensation in accordance with Accounting Principles Board Opinion No. 25 and the Company
provided the disclosures required by FAS 148.

In December 2002, the EITF issued EITF 00-21, ‘‘Accounting for Revenue Arrangements with
Multiple Deliverables.’’ This consensus provides guidance in determining when a revenue arrangement
with multiple deliverables should be divided into separate units of accounting, and, if separation is
appropriate, how the arrangement consideration should be allocated to the identified accounting units.
The provisions of EITF 00-21 are effective for revenue arrangements entered during fiscal periods
beginning after June 15, 2003. The Company adopted EITF 00-21, effective July 1, 2003, and its
adoption was not material to the consolidated financial statements.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

In January 2003, the FASB issued Financial Accounting Standards Board Interpretation No. 46,

‘‘Consolidation of Variable Interest Entities’’ (FIN 46) which requires the consolidation of variable
interest entities (VIE) by the primary beneficiary of the entity if the equity investors in the entity do
not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial support from other parties.
FIN 46 was effective for all new VIEs created or acquired after January 31, 2003. In October 2003, the
FASB delayed the effective date for some VIEs that existed prior to February 1, 2003, provided the
reporting entity had not ‘‘issued’’ financial statements reporting the VIE in accordance with
Interpretation 46. FIN 46 was effective for the first interim or annual period ending after December 15,
2003. In December 2003, the FASB issued a revision to FIN 46 (FIN 46R). Under the revised
provisions, public entities are required to apply the guidance if the entity has interests in VIEs
commonly referred to as special-purpose entities for periods ending after December 15, 2003. The
Company adopted FIN 46R and as a result has consolidated Jameco International, LLC (the LLC)
effective October 1, 2003 (the fourth quarter of fiscal 2003). The LLC imports and sells vitreous china,
imported faucets and faucet parts and imported bathroom accessories to the North American home
improvement retail market. Its annual sales for the twelve months ended December 31, 2003, were
approximately $16,079,000. The LLC maintains a line of credit with a financial institution collateralized
by a first security interest in the LLC’s assets. The creditors have no recourse to the Company. The
assets as of December 31, 2003 of $3,960,000 are comprised primarily of accounts receivable and
inventory which the Company believes are collectable and saleable, respectively, within the normal
course of business. The Company has a subordinated security interest in the assets of the LLC
pertaining to its loan receivable of $2,230,680 at December 31, 2003, which eliminates in consolidation
as the result of the application of FIN 46R. Prior to the adoption of FIN 46R, the Company accounted
for its investment of 49% in the LLC using the equity method.

The Company also maintains another variable interest in a VIE. In 2000 the Company entered

into an agreement with Plumworld.co.uk Ltd in which the Company maintains a 20% interest in
Plumbworld. Plumbworld is primarily an e-business that sells bathroom and sanitary appliances, as well
as, plumbing and heating products, tools and plumbing consumables. Its annualized sales are
approximately $7,100,000. The Company maintains a notional amount of approximately $500 investment
in Plumbworld and maintains a loan receivable in amount of approximately $850,000 with Plumbworld.
The Company continues to account for its investment in Plumbworld using the equity method.

In April 2003, the FASB issued Financial Accounting Standards Board Statement No. 149,

‘‘Amendment of Statement 133 on Derivative Instruments and Hedging Activities’’ (FAS 149). FAS 149
amends and clarifies financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities under FAS 133,
‘‘Accounting for Derivative Instruments and Hedging Activities’’ (FAS 133). FAS 149 has multiple
effective date provisions depending on the nature of the amendments to FAS 133, including one for
contracts entered into or modified after June 30, 2003. The Company adopted FAS 149 and its
adoption was not material to the consolidated financial statements.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(3) Discontinued Operations

In September 1996, the Company divested its Municipal Water Group businesses, which included

Henry Pratt, James Jones Company and Edward Barber and Company Ltd. Costs and expenses related
to the Municipal Water Group for 2003 relate to legal and settlement costs associated with the James
Jones Litigation (see Note 15). Specifically, in 2003, a settlement payment of $13,000,000, of which the
Company paid $11,000,000, has been made to settle the claims of the three cities (Santa Monica, San
Francisco and East Bay Municipal Water District) chosen by the Relator as having the strongest claims.
This settlement, which was primarily expensed in prior years, and other legal fees, required the
Company to record additional net of tax charges for the year ended December 31, 2003, of $2,665,000.

The Company also recorded a charge attributable to payments to be made to the selling

shareholders of the James Jones Company pursuant to the Company’s original purchase agreement. For
the year ended December 31, 2003, the Company recorded a net of tax charge of $446,000.

Condensed operating statements and balance sheets for discontinued operations is summarized

below:

Years Ended December 31,

2003

2002

2001

Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Costs and expenses

$ —

(in thousands)
$—

Municipal Water Group . . . . . . . . . . . . . . . . . . . .

(5,058)

Loss before income taxes . . . . . . . . . . . . . . . . . . . . . .
Income tax benefit . . . . . . . . . . . . . . . . . . . . . . . . . . .

(5,058)
1,947

—

—
—

Loss from discontinued operations, net of taxes . . . . . .

$(3,111)

$—

—

—
—

$—

Prepaid expenses and other assets . . . . . . . . . . . . . . . . . . . . . . .
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

December 31,

2003

2002

(in thousands)
875
3,585

$ 1,914
6,741

Assets of discontinued operations . . . . . . . . . . . . . . . . . . . . . .

$ 4,460

$ 8,655

Accrued expenses and other liabilities . . . . . . . . . . . . . . . . . . . .

11,302

18,906

Liabilities of discontinued operations . . . . . . . . . . . . . . . . . . .

$11,302

$18,906

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(4) Restructuring and Other Charges

The Company continues to implement 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 and other low cost areas of the world. The implementation of this manufacturing restructuring
plan began during the fourth quarter of 2001. The projects for which charges were recorded in the
fourth quarter of 2001 are essentially complete. During 2002, 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 essentially complete as of
December 31, 2003. The Company recorded pre-tax manufacturing restructuring and other costs of
$1,655,000, net of recoveries, for the year ended December 31, 2003. The manufacturing restructuring
and other costs recorded consist primarily of severance costs, asset write-downs and accelerated
depreciation. The severance costs, which have been recorded as restructuring, are for 48 employees in
manufacturing and administration groups. The Company expects to complete severance payments by
the end of the first quarter of 2004. 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 are
recorded in cost of goods sold. Accelerated depreciation is based on shorter remaining estimated useful
lives of certain fixed assets and has been recorded in cost of goods sold. Other costs consist primarily
of removal and shipping costs associated with relocation of manufacturing equipment and have been
recorded in cost of goods sold and have been expensed as incurred.

Details of the Company’s manufacturing restructuring plan through December 31, 2003 are as

follows:

Balance Provisions Utilized Balance Provisions Utilized Balance
12/31/03
12/31/02
12/31/01

2002

2003

Restructuring . . . . . . . . . .
Asset write-downs . . . . . . .
Other costs . . . . . . . . . . . .

$762

$ 638
— 2,491
960
—

(in thousands)
$419
—
—

$ 981
2,491
960

$ 426
479
750

$ 804

$41
479 —
750 —

Total

. . . . . . . . . . . . . . . .

$762

$4,089

$4,432

$419

$1,655

$2,033

$41

(5) Business Acquisitions

On July 30, 2003, a wholly-owned subsidiary of the Company acquired Giuliani Anello S.r.l.

located in Cento Bologna, Italy for approximately $10,600,000 in cash net of acquired cash of
$1,400,000. Giuliani Anello manufactures and distributes valves and filters utilized in heating
applications including strainer filters, solenoid valves, flow stop valves, stainless steel water filter
elements and steam cleaning filters.

On April 18, 2003, a wholly-owned subsidiary of the Company acquired Martin Orgee UK Ltd.

located in Kidderminster, West Midlands, United Kingdom for approximately $1,600,000 in cash.
Martin Orgee distributes a line of plumbing and heating products to the wholesale, commercial and
OEM markets in the United Kingdom and Southern Ireland. Martin Orgee also assembles pumping
systems for under-floor radiant heat applications.

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 $2,300,000 in
cash less assumed net debt of $800,000. F&R manufactures and distributes a line of gauges
predominately to the French and German OEM markets.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

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 $12,900,000 in cash less assumed net debt of
$3,500,000. 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.

On May 9, 2002, a wholly-owned subsidiary of the Company acquired Hunter Innovations of

Sacramento, California for $25,000,000, of which approximately $10,000,000 was paid in cash at the
closing and the balance in interest bearing notes, payable in equal annual installments through 2006.
Hunter Innovations was founded in 1995 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. On
May 9, 2003, the Company made an additional payment of approximately $3,750,000 for the first
installment on the interest bearing notes.

In 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, 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 the Company and 40% by its Chinese partner. On January 29, 2003, the Company made
an additional payment of $3,000,000 associated with the Cheng Guan joint venture bringing the
aggregate cash investment to $8,000,000 for the 60% interest.

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 $13,000,000 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.

On June 13, 2001, a wholly-owned subsidiary of the Company acquired Premier Manufactured
Systems, Inc., located in Phoenix, Arizona for approximately $5,000,000 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.

On June 1, 2001, a wholly-owned subsidiary of the Company acquired Fimet S.r.l. (Fabbrica
Italiana Manometri e Termometri) located in Milan, Italy and its wholly-owned subsidiary, MTB AD,
which is located in Bulgaria for approximately $6,000,000. The acquired business manufactures pressure
and temperature gauges for use in the HVAC market.

On January 5, 2001, a wholly-owned subsidiary of the Company acquired Dumser Metallbau
GmbH & Co. KG located in Landau, Germany for approximately $20,000,000 in cash. The main
products of Dumser include brass, steel and stainless steel manifolds used as a prime distribution
device in hydronic heating systems. Dumser has a 51% controlling share of Stern Rubinetti. Stern
Rubinetti is an Italian manufacturing company producing brass components located in Brescia, Italy.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

The acquisitions above have been accounted for utilizing the purchase method of accounting. The

pro-forma results have not been displayed, as the combined results are not significant.

(6) Other Comprehensive Income (Loss)

Other comprehensive income (loss) consist of the following:

Foreign
Currency
Translation

Pension
Adjustment

Cash Flow
Hedges

Balance December 31, 2001 . . . . . .
Change in period . . . . . . . . . . . . .

$(24,281)
16,475

$ —
(3,988)

Balance December 31, 2002 . . . . . .
Change in period . . . . . . . . . . . . .

(7,806)
27,394

(3,988)
(1,841)

Balance December 31, 2003 . . . . . .

$ 19,588

$(5,829)

$—
—

—
46

$46

Accumulated
Other
Comprehensive
Income (Loss)

$(24,281)
12,487

(11,794)
25,599

$ 13,805

(7) Inventories

Inventories consist of the following:

December 31,

2003

2002

(in thousands)

Raw materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Work in process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Finished goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 41,998
24,348
90,253

$ 40,591
17,289
75,535

$156,599

$133,415

Finished goods of $11,015,000 and $13,774,000 as of December 31, 2003 and 2002, respectively,

were consigned.

(8) Property, Plant and Equipment

Property, plant and equipment consists of the following:

December 31,

2003

2002

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Buildings and improvements . . . . . . . . . . . . . . . . . . . . . . . .
Machinery and equipment . . . . . . . . . . . . . . . . . . . . . . . . . .
Construction in progress . . . . . . . . . . . . . . . . . . . . . . . . . . .

(in thousands)
9,354
75,428
194,248
5,220

8,980
64,935
166,684
8,334

Accumulated Depreciation . . . . . . . . . . . . . . . . . . . . . . . . .

284,250
(138,539)

248,933
(114,557)

$ 145,711

$ 134,376

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

The Company also maintains assets held for sale of $1,938,000 and $2,464,000 as of December 31,
2003 and 2002, respectively. These amounts are primarily for the Company’s former distribution center
for the German market that was closed during 2002 due to the Company’s manufacturing restructuring
plan. In accordance with FAS 144, the Company has classified this asset as an ‘‘Assets held for Sale’’ in
the Consolidated Balance Sheets as of December 31, 2003 and 2002 and is carrying the asset at the
estimated fair market value less costs to sell. The Company has kept this asset held for sale beyond one
year as it is still actively marketing the building. During 2003, the Company reduced the asking price
and in accordance with FAS 144 wrote down the asset to the estimated fair market value less costs
to sell.

(9) Income Taxes

The significant components of the Company’s deferred income tax liabilities and assets are as

follows:

December 31,

2003

2002

(in thousands)

Deferred income tax liabilities:

Excess tax over book depreciation . . . . . . . . . . . . . . . . . . . . .
Intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$16,447
4,400
2,598

$13,806
4,496
2,490

Total deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . .

23,445

20,792

Deferred income tax assets:

Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net operating loss carry-forward . . . . . . . . . . . . . . . . . . . . . .
Inventory reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

13,166
4,384
4,545
9,481

12,189
4,664
4,056
7,508

Total deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

31,576
(557)

28,417
(709)

Net deferred tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

31,019

27,708

Net deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 7,574

$ 6,916

The provision for income taxes from continuing operations is based on the following pre-tax

income:

Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$40,457
18,372

(in thousands)
$37,931
12,287

$30,152
10,016

$58,829

$50,218

$40,168

Years Ended December 31,

2003

2002

2001

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

The provision for income taxes from continuing operations consists of the following:

Years Ended December 31,

2003

2002

2001

(in thousands)

Current tax expense

Federal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$12,195
6,256
2,436

$12,408
4,241
2,139

$11,411
4,238
2,125

20,887

18,788

17,774

Deferred tax expense (benefit)

802
509
158

(358)
(630)
(204)

(2,096)
(1,593)
(473)

1,469

(1,192)

(4,162)

$22,356

$17,596

$13,612

Actual income taxes reported from continuing operations are different than would have been
computed by applying the federal statutory tax rate to income from continuing operations before
income taxes. The reasons for this difference are as follows:

Years Ended December 31,

Computed expected federal income expense . . . . . . . .
State income taxes, net of federal tax benefit
. . . . . . .
Goodwill amortization . . . . . . . . . . . . . . . . . . . . . . . .
Foreign tax rate differential . . . . . . . . . . . . . . . . . . . .
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2003

2002

2001

$20,590
1,686
—
335
(255)

(in thousands)
$17,576
1,257
—
(862)
(375)

$14,059
1,074
751
(1,025)
(1,247)

$22,356

$17,596

$13,612

At December 31, 2003, the Company had net operating loss carryforwards of $11,500,000 for
income tax purposes. All of the net operating losses are foreign losses and can be carried forward
indefinitely. The net operating losses relate to European operations. The Company had a valuation
allowance of $557,000 and $709,000 as of December 31, 2003 and 2002, respectively, against a portion
of the net operating loss carryforwards. The valuation allowance is primarily attributable to net
operating losses generated in locations in which the Company has not yet been able to determine with
certainty the recoverability. Undistributed earnings of the Company’s foreign subsidiaries amounted to
approximately $100,800,000 at December 31, 2003, $78,100,000 at December 31, 2002, and $55,500,000
at December 31, 2001. Those earnings are considered to be indefinitely reinvested, and, accordingly, no
provision for U.S. federal and state income taxes has been recorded thereon. Upon distribution of
those earnings, in the form of dividends or otherwise, the Company will be subject to withholding taxes
payable to the various foreign countries. Determination of the amount of U.S. income tax liability that
would be incurred is not practicable because of the complexities associated with its hypothetical
calculation; however, unrecognized foreign tax credits would be available to reduce some portion of any
U.S. income tax liability. Withholding taxes of approximately $3,900,000 would be payable upon
remittance of all previously unremitted earnings at December 31, 2003.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

The Company believes that it is more likely than not that it will be able to recover the deferred

tax assets not subject to valuation allowance.

(10) Accrued Expenses and Other Liabilities

Accrued expenses and other liabilities consist of the following:

December 31,

2003

2002

(in thousands)

Commissions and sales incentives payable . . . . . . . . . . . . . . . . .
Accrued insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Pension liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$18,869
16,104
1,501
15,689
3,089

$13,370
14,168
5,259
22,380
1,860

(11) Financing Arrangements

Long-term debt consists of the following:

$55,252

$57,037

December 31,

2002

2001

(in thousands)

83⁄8% notes due December 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.87% notes due May 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5.47% notes due May 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

— $ 75,000
—
—

50,000
75,000

Hunter Innovations notes with principal payable in three equal annual

installments, accruing interest monthly, due May 2006 (annual interest rate
of 2.70% and 4.11% at December 31, 2003 and 2002, respectively) . . . . . .

11,250

15,000

$150 million revolving credit facility maturing in February 2005, amended
to include a $75 million tranche for euro based borrowing. U.S. loan
interest accruing at a variable rate (4.25% at December 31, 2002) of
either Eurocurrency rate loans at a LIBOR rate plus the applicable
margin with respect to eurocurrency rate loans in effect for that period,
or the U.S. base rate, which is the higher of the ‘‘prime rate’’ or (0.5%)
above the Federal Funds Effective Rate. European loan interest accruing
at a variable rate (2.83% at December 31, 2003 and 3.84% at December
31, 2002) of either eurocurrency rate loans at a EURIBOR rate plus the
applicable margin with respect to eurocurrency rate loans in effect for that
period, or the euro base rate plus the greater of 1.0% and the applicable
margin with respect to euro base rate loans in effect for that period. At
December 2003, $44,089,000 was borrowed for euro based borrowings and
there were no outstanding U.S. borrowings. At December 2002, of the
$41,649,000, $6,000,000 was borrowed under the U.S. tranche and
$35,649,000 was borrowed for euro based borrowings . . . . . . . . . . . . . .

44,089

41,649

Other—which consists primarily of loans held by our Chinese joint

ventures (at interest rates ranging from 3.00% to 11.28%)

. . . . . . . . .

11,973

6,838

Less Current Maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

13,251

82,211

192,312

138,487

$179,061

$ 56,276

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

Principal payments during each of the next five years and thereafter are due as follows (in
thousands): 2004—$13,251; 2005—$48,357; 2006—$4,194; 2007—$867; 2008—$244 and thereafter—
$125,399.

On May 15, 2003, the Company completed a private placement of $125,000,000 of senior
unsecured notes consisting of $50,000,000 principal amount of 4.87% senior notes due 2010 and
$75,000,000 principal amount of 5.47% senior notes due 2013. The Company used the net proceeds
from the private placement to purchase treasury securities to repay the $75,000,000 principal amount of
83⁄8% Notes due December 2003. Additional net proceeds were used to repay approximately
$32,000,000 outstanding under the Revolving Credit Facility. The balance of the net proceeds will be
used for general corporate purposes. The payment of interest on the senior unsecured notes is due
semi-annually on May 15th and November 15th of each year. The senior unsecured notes were issued by
Watts Water Technologies, Inc. and are subordinated to the Revolving Credit Facility, which is at the
subsidiary level. The senior unsecured notes allow the Company to have (i) debt senior to the new
notes in an amount up to $150,000,000 plus 5% of stockholders’ equity and (ii) debt pari passu or
junior to the senior unsecured notes to the extent the Company maintains compliance with a 2.00 to
1.00 fixed charge coverage ratio. The notes include a prepayment provision which might require a
make-whole payment to the note holders. Such payment is dependent upon the level of the respective
treasuries. The notes include other customary terms and conditions, including events of default.

On February 28, 2002, the Company entered into a revolving credit facility with a syndicate of

banks (as amended, the Revolving Credit Facility). The Revolving Credit Facility provides for
borrowings of up to $150,000,000, which includes a $75,000,000 tranche for euro-based borrowings, and
matures in February 2005. The Revolving Credit Facility is being used to support the Company’s
acquisition program, working capital requirements and for general corporate purposes.

Effective July 1, 2003, the Company entered into an interest rate swap for a notional amount of

25,000,000 euro outstanding on our Revolving Credit Facility. The Company swapped the variable rate
from the Revolving Credit Facility which is three month EURIBOR plus 0.7% for a fixed rate of
2.33%. The term of the swap is two years. The Company has designated the swap as a hedging
instrument using the cash flow method. The swap hedges the cash flows associated with interest
payments on the first 25,000,000 euro of the Revolving Credit Facility. The Company marks to market
the changes in value of the swap through other comprehensive income. Any ineffectiveness has been
recorded in income. The fair value of the swap recorded in other comprehensive income as of
December 31, 2003 was $46,000.

Outstanding indebtedness under the Revolving Credit Facility bears interest at a rate determined
by the type (currency) of loan plus an applicable margin determined by the Company’s debt rating. The
average interest rate for borrowings under the Revolving Credit Facility was approximately 2.8% at
December 31, 2003. 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 December 31, 2003, The
Company was in compliance with all covenants related to the Revolving Credit Facility.

The Company maintains letters of credit that guarantee its performance or payment to third
parties in accordance with specified terms and conditions. Amounts outstanding were approximately
$29,880,000 as of December 31, 2003 and $19,522,000 as of December 31, 2002. The Company’s letters
of credit are primarily letters of credit associated with insurance coverage and to a lesser extent foreign
purchases. The Company’s letters of credit generally expire within one year of issuance. The increase is

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

primarily associated with insurance coverage. These instruments may exist or expire without being
drawn down. Therefore, they do not necessarily represent future cash flow obligations.

(12) Common Stock

Since 1997, the Company’s Board of Directors has authorized the repurchase of 4,380,200 shares

of the Company’s Common Stock in the open market and through private purchases. Since the
inception of this repurchase program, 3,716,000 shares of the Company’s Common Stock have been
repurchased and retired.

The Class A Common Stock and Class B Common Stock have equal dividend and liquidation
rights. Each share of the Company’s Class A Common Stock is entitled to one vote on all matters
submitted to stockholders and each share of Class B Common Stock is entitled to ten votes on all such
matters. Shares of Class B Common Stock are convertible into shares of Class A Common Stock, on a
one-to-one basis, at the option of the holder. As of December 31, 2003, the Company has reserved a
total of 3,528,825 of Class A Common Stock for issuance under its stock-based compensation plans and
7,605,224 shares for conversion of Class B Common Stock to Class A Common Stock.

(13) Stock-Based Compensation

The Company maintains four stock option plans under which key employees and outside directors

have been granted incentive (ISOs) and nonqualified (NSOs) options to purchase the Company’s
Class A Common Stock. Generally, options become exercisable over a five year period at the rate of
20% per year and expire ten years after the date of grant. ISOs and NSOs granted under the plans
have exercise prices of not less than 100% and 50% of the fair market value of the common stock on
the date of grant, respectively. At December 31, 2003, 3,528,825 shares of Class A Common Stock were
authorized for future grants of options under the Company’s stock option plans.

The following is a summary of stock option activity and related information:

Years Ended December 31,

2003

2002

2001

Weighted
Average
Exercise
Price

Options

Weighted
Average
Exercise
Price

Options

(Options in thousands)

Outstanding at beginning of year . . . 1,455
248
Granted . . . . . . . . . . . . . . . . . . . . .
(387)
Cancelled . . . . . . . . . . . . . . . . . . . .
(301)
Exercised . . . . . . . . . . . . . . . . . . . .

$14.29
16.70
13.35
14.98

1,757
273
(73)
(502)

$13.31
15.50
11.75
11.88

1,714
230
(76)
(111)

$13.03
15.19
13.89
12.54

Outstanding at end of year . . . . . . . 1,015

$14.90

1,455

$14.29

1,757

$13.31

Exercisable at end of year . . . . . . . .

504

$13.92

858

$14.11

1,171

$13.20

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

The following table summarizes information about options outstanding at December 31, 2003:

Range of Exercise Prices Outstanding

Number

$ 9.20—$10.59
$10.72—$14.05
$14.29—$17.50

90
153
772

1,015

Options Outstanding

Options Exercisable

Weighted Average
Remaining Contractual
Life (years)

Weighted Average
Exercise
Price

Number
Exercisable

Weighted Average
Exercise
Price

(Options in thousands)

5.2
6.7
7.0

6.3

$10.58
12.08
16.05

$14.90

90
111
303

504

$10.58
12.10
15.57

$13.92

The Company also has a Management Stock Purchase Plan that allows for the granting of
Restricted Stock Units (RSUs) to key employees to purchase up to 1,000,000 shares of Class A
Common Stock at 67% of the fair market value on the date of grant. RSUs vest annually over a three
year period from the date of grant. The difference between the RSU price and fair market value at the
date of grant is amortized to compensation expense ratably over the vesting period. At December 31,
2003, 200,692 RSUs were outstanding. Dividends declared for RSUs that remain unpaid at
December 31, 2003 total $62,172.

The Company has elected to follow APB No. 25 and related interpretations in accounting for its

stock-based compensation. In addition the Company provides proforma disclosure of stock-based
compensation, as measured under the fair value requirements of FAS 123. These proforma disclosures,
which are calculated for awards granted after June 30, 1995, are provided in Footnote 2 as required
under FAS 148. The weighted average grant date fair value of options granted are $4.48, $4.43 and
$6.74 for the years ending December 31, 2003, 2002 and 2001, respectively. Also, the weighted average
grant date fair value of RSUs related to Management Stock Purchase Plan are $6.55, $5.48 and $7.30
for the years ending December 31, 2003, 2002 and 2001, respectively.

The fair value of the Company’s stock-based awards to employees (used in reconciliation of
Footnote 2) was estimated using a Black-Scholes option pricing model and the following assumptions:

Years Ended December 31,

2003

2002

2001

Expected life (years) . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected stock price volatility . . . . . . . . . . . . . . . . . . .
Expected dividend yield . . . . . . . . . . . . . . . . . . . . . . . .
Risk-free interest rate . . . . . . . . . . . . . . . . . . . . . . . . .

5.0
28.3%
1.4%
3.25%

5.0

5.0
33.2% 52.4%
1.6%
1.6%
2.65% 4.36%

The fair value of the Company’s Management Stock Purchase Plan to employees (used in
reconciliation of Footnote 2) was estimated using a Black-Scholes option pricing model and the
following assumptions:

3.0
28.3%
1.5%
5.63%

3.0

3.0
33.2% 52.4%
1.7%
1.6%
2.65% 4.36%

Years Ended December 31,

2003

2002

2001

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(14) Employee Benefit Plans

The Company sponsors funded and unfunded defined benefit pension plans covering substantially

all of its domestic employees. Benefits are based primarily on years of service and employees’
compensation. The funding policy of the Company for these plans is to contribute an annual amount
that does not exceed the maximum amount that can be deducted for federal income tax purposes. The
Company uses a September 30 measurement date for its plans.

The funded status of the defined benefit plans and amounts recognized in the balance sheet are as

follows:

December 31,

2003

2002

(in thousands)

Change in projected benefit obligation
Balance at beginning of the year . . . . . . . . . . . . . . . . . . . . . . .
Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amendments/curtailments . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 41,961
2,021
2,789
6,550
150
(1,730)

$ 36,038
1,512
2,683
3,495
96
(1,863)

Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 51,741

$ 41,961

Change in fair value of plan assets
Balance at beginning of the year . . . . . . . . . . . . . . . . . . . . . . .
Actual gain (loss) on assets . . . . . . . . . . . . . . . . . . . . . . . . . .
Employer contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 25,535
4,611
3,773
(1,730)

$ 28,724
(1,514)
188
(1,863)

Fair value of plan assets at end of the year . . . . . . . . . . . . . . .

$ 32,189

$ 25,535

Funded Status . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrecognized transition obligation . . . . . . . . . . . . . . . . . . . . .
Unrecognized prior service costs . . . . . . . . . . . . . . . . . . . . . . .
Unrecognized net actuarial gain . . . . . . . . . . . . . . . . . . . . . . .
Contributions after measurement date and on or before fiscal

$(19,552) $(16,426)
(403)
1,567
10,003

(148)
1,498
13,681

year end . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3,020

—

Net amount recognized . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ (1,501) $ (5,259)

Amounts recognized in the statement of financial position are as follows:

Accrued benefit costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Minimum pension liability . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

December 31,

2003

2002

(in thousands)
$ (1,501) $(5,259)
$(10,551) $(7,526)
$ 1,073
$ 1,073

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

Information for pension plans with an accumulated benefit obligation in excess of plan assets are

as follows:

December 31,

2003

2002

(in thousands)

Projected benefit obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated benefit obligation . . . . . . . . . . . . . . . . . . . . . . . . .
Fair value of plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$51,741
$47,260
$32,189

$41,961
$38,320
$25,535

The components of net periodic benefit cost are as follows:

Service cost—benefits earned . . . . . . . . . . . . . . . . . . . . .
Interest costs on benefits obligation . . . . . . . . . . . . . . . . .
Estimated return on assets . . . . . . . . . . . . . . . . . . . . . . .
Transitional obligation/(asset) amortization . . . . . . . . . . . .
Prior service cost amortization . . . . . . . . . . . . . . . . . . . . .
Net loss/(gain) amortization . . . . . . . . . . . . . . . . . . . . . .

Years Ended December 31,

2003

2002

2001

(in thousands)
$1,512
2,683
(2,520)
(255)
205
—

$2,021
2,789
(2,281)
(255)
219
521

$1,383
2,487
(3,003)
(255)
146
(173)

Net periodic benefit cost . . . . . . . . . . . . . . . . . . . . . . . . .

$3,014

$1,625

$ 585

Additional Information:

December 31,

2003

2002

(in thousands)

Increase in minimum liability included in other comprehensive

income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$3,046

$6,432

Assumptions:

Weighted-average assumptions used to determine benefit obligations:

December 31,

2003

2002

Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rate of compensation increase . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.00% 6.75%
4.00% 4.00%

Weighted-average assumptions used to determine net periodic benefit costs:

Discount rate . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . .
Long-term rate of return on asset
Rate of compensation increase . . . . . . . . . . . . .

December 31,

2003

2002

2001

6.75%
8.50%
4.00%

7.50% 7.50%
9.00% 9.00%
4.50% 4.50%

In selecting the expected long-term rate of return on assets, the Company considers the average

rate of earnings expected on the funds invested or to be invested to provide for the benefits of this

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

plan. This includes considering the trust’s asset allocation and the expected returns likely to be earned
over the life of the plan. This basis is consistent with the prior year.

Plan assets:

The weighted average asset allocations by asset category is as follows:

Asset Category

Plan Assets At
December 31,

2003

2002

Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debt securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other/cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

74.8% 52.8%
25.2% 44.2%
—% —%
3.0%
—%

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

100.0% 100.0%

The Company’s written Retirement Plan Investment Policy sets forth the investment policy,
objectives and constraints of the Watts Water Technologies, Inc. Pension Plan. This Retirement Plan
Investment Policy, set forth by the Pension Plan Committee, defines general investment principles and
directs investment management policy, addressing preservation of capital, risk aversion and adherence
to investment discipline. Investment managers are to make a reasonable effort to control risk and are
evaluated quarterly against commonly accepted benchmarks to ensure that the risk assumed is
commensurate with the given investment style and objectives.

The portfolio is designed to achieve a balanced return of current income and modest growth of
capital, while achieving returns in excess of the rate of inflation over the investment horizon in order to
preserve purchasing power of Plan assets. All Plan assets are required to be invested in liquid
securities. Derivative investments will not be allowed.

Prohibited investments include, but are not limited to the following: commodities and futures
contracts, private placements, options, limited partnerships, venture-capital investments, real estate
properties, interest-only (IO), principal-only (PO), and residual tranche CMOs, and Watts Water
Technologies, Inc. stock.

Prohibited transactions include, but are not limited to the following: short selling and margin

transactions.

Allowable assets include: cash equivalents, fixed income securities, equity securities, mutual funds,

and GICs.

Specific guidelines regarding allocation of assets are as follows: equities shall comprise between

25% and 75% of the total portfolio, while fixed income shall comprise between 30% and 65%.
Investment performance is monitored on a regular basis and investments are re-allocated to stay within
specific guidelines. An equity/fixed income allocation of 55%/45% is preferred. The securities of any
one company or government agency should not exceed 10% of the total fund, and no more than 20%
of the total fund should be invested in any one industry. Individual treasury securities may represent
50% of the total fund, while the total allocation to treasury bonds and notes may represent up to 100%
of the Plan’s aggregate bond position.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

Cash flows:

The information related to the Company’s pension funds cash flow is as follows:

December 31,

2003

2002

(in thousands)

Employer Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefit Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$6,793
$1,730

$ 188
$1,863

Contributions expected to be paid during 2004 are approximately $105,000.

Additionally, substantially all of the Company’s domestic employees are eligible to participate in a

401(k) savings plan. Under this plan, the Company matches a specified percentage of employee
contributions, subject to certain limitations. The Company’s match expenses for the years ended
December 31, 2003, 2002, and 2001 were $300,000, $330,000, and $324,000, respectively.

The Company entered into a Supplemental Compensation Agreement (the Agreement) with
Timothy P. Horne on September 1, 1996. Per the Agreement, upon ceasing to be an employee of the
Company, Mr. Horne must make himself available, as requested by the Board, to work a minimum of
300 but not more than 500 hours per year as a consultant in return for certain annual compensation as
long he is physically able to do so. If Mr. Horne complies with the consulting provisions of the
agreement above, he shall receive supplemental compensation on an annual basis of $400,000 per year
in exchange for the services performed, as long as he is physically able to do so. In the event of
physical disability, subsequent to commencing consulting services for the Company, Mr. Horne will
continue to receive $400,000 annually. The payment for consulting services provided by Mr. Horne will
be expensed as incurred by the Company. Mr. Horne retired effective December 31, 2002, and
therefore the Supplemental Compensation period began on January 1, 2003. In accordance with
Financial Accounting Standards Board Statement No. 106, ‘‘Employers Accounting for Post Retirement
Benefits Other Than Pensions’’, the Company will accrue for the future post-retirement disability
benefits over the period from January 1, 2003, to the time in which Mr. Horne becomes physically
unable to perform his consulting services (the period in which the disability benefits are earned).

(15) Contingencies and Environmental Remediation

Contingencies

In April 1998, the Company became aware of a complaint (the Armenta case) that was filed by

Nora Armenta (the Relator) under seal in the State of California alleging violations of the California
False Claims Act. The complaint alleges that a former subsidiary of the Company (James Jones
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 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, 11 of which have intervened and 47 of which have been ordered
excluded from the case. In June 2001, the Company and other defendants reached a proposed
settlement with the Los Angeles Department of Water and Power, 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.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

In this case, the Relator seeks three times an unspecified amount of actual damages and alleges
that the municipalities have suffered hundreds of millions of dollars in damages. The Relator also seeks
civil penalties of $10,000 for each false claim and alleges that defendants are responsible for tens of
thousands of false claims. The Company 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 $2.0 million toward this settlement. In August 2003, an additional settlement payment
was made for $13 million ($11 million from the Company and $2 million from the James Jones
Company) which settled the claims of the three Phase I cities (Santa Monica, San Francisco and East
Bay Municipal Water District) chosen by the Relator as having the strongest claims to be tried first.
This settlement payment included the Relator’s statutory share, and the claims of these three cities
have been dismissed. In addition to this $13 million payment, the Company is obligated to pay the
Relator’s attorney’s fees.

After the Phase I settlement, the Court permitted the Company and the other defendants to select

five additional cities (Contra Costa, Corona, Santa Ana, Santa Cruz and Vallejo) to serve as the
plaintiffs in a second trial phase of the case. The Company and James Jones subsequently reached an
agreement to settle the City of Santa Ana’s claims for $45,000, and the Company is responsible for
$38,000 of this settlement amount. Santa Ana has submitted this claim to the Court for approval in
March 2004. The trial of the claims of the remaining Phase II cities is scheduled for September 2004.

The Company has a reserve of approximately $9.3 million with respect to the James Jones
Litigation in its consolidated balance sheet as of December 31, 2003. The Company believes, on the
basis of all available information, that this reserve is adequate to cover its probable and reasonably
estimable losses resulting from the James Jones Litigation and the insurance coverage litigation with
Zurich discussed below. The Company is currently unable to make an estimate of the range of any
additional losses.

On February 14, 2001, the Company 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 (Zurich) must pay all
reasonable defense costs incurred by the Company in the Armenta case since April 23, 1998 as well as
the Company’s future defense costs in this case until its final resolution. On October 24, 2002, the
California Superior Court made another summary adjudication ruling that Zurich must indemnify and
pay the Company for the amounts the Company must pay under its settlement agreement with the City
of Los Angeles. Zurich has asserted that all amounts (both defense costs and indemnity amounts paid
for settlements) paid by it to the Company are subject to reimbursement under Deductible Agreements
between the Company and Zurich. However, management and counsel anticipate that the Company
will ultimately prevail on reimbursement issues. Zurich appealed the orders requiring it to pay defense
costs, the California Court of Appeal accepted that appeal, and it is currently pending. Zurich also
sought appellate review of the order that found coverage and required Zurich to indemnify the
Company for the settlement with the City of Los Angeles. On March 26, 2003, the California Court of
Appeal denied Zurich’s petition for appellate review of this order, but Zurich will still be able to
appeal this order at the end of the case. The Company is currently unable to predict the finality of the
order on indemnity for the Los Angeles settlement. The Company has recorded reimbursed indemnity
settlement amounts (but not reimbursed defense costs) as a liability. The Company intends to contest
vigorously the Armenta case and its related litigation.

Based on management’s assessment, the Company does not believe that the ultimate outcome of

the James Jones case would have a material adverse effect on its liquidity, financial condition or results

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

of operations. While this assessment is based on all available information, litigation is inherently
uncertain, the actual liability to the Company to fully resolve this litigation cannot be predicted with
any certainty and there exists a reasonable possibility that the Company may ultimately incur losses in
the James Jones Litigation in excess of the amount accrued. The Company intends to continue to
contest vigorously the James Jones case and its related litigation.

Environmental Remediation

The Company has been named as a potentially responsible party (PRP) with respect to a limited

number of identified contaminated sites. The level of contamination varies significantly from site to site
as do the related levels of remediation efforts. Environmental liabilities are recorded based on the most
probable cost, if known, or on the estimated minimum cost of remediation. The Company’s accrued
estimated environmental liabilities are based on assumptions, which are subject to a number of factors
and uncertainties. Circumstances which can affect the reliability and precision of these estimates
include identification of additional sites, environmental regulations, level of cleanup required,
technologies available, number and financial condition of other contributors to remediation and the
time period over which remediation may occur. The Company recognizes changes in estimates as new
remediation requirements are defined or as new information becomes available. The Company has a
reserve of approximately $2.5 million and estimates that its accrued environmental remediation
liabilities will likely be paid over the next five to ten years. Based on the facts currently known to it,
the Company does not believe that the ultimate outcome of these claims will have a material adverse
effect on the Company’s liquidity, financial condition or results of operations.

For several years, the New York Attorney General (NYAG) has threatened to bring suit against

approximately 16 PRPs, including Watts Water Technologies, Inc as successor to Jameco
Industries, Inc., for incurred remediation costs and for operation and maintenance costs that will be
incurred in connection with the cleanup of a landfill site in Babylon, New York. The NYAG has
identified recovery numbers between $19 million and $24 million, but it is too early to know what the
final recovery number will be, what the final number of PRPs will be or what proportion of the final
costs may be allocated to the Company. In 2003, 139 PRPs were identified by the Company’s defense
group, and they are in the process of being invited to join the PRPs identified so far by the NYAG.
Based on the facts currently known to it, the Company does not believe that the ultimate outcome of
the Babylon matter will have a material adverse effect on the Company’s liquidity, financial condition
or results of operations.

Asbestos Litigation

The Company is a defendant in approximately 115 actions filed primarily, but not exclusively, in
Mississippi and New Jersey state courts and 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 particular products of the Company as a source of asbestos exposure. To date the
Company has been dismissed from each case when the scheduled trial date comes near. Based on the
facts currently known to it, the Company does not believe that the ultimate outcome of these claims
will have a material adverse effect on the Company’s liquidity, financial condition or results of
operations.

Other Litigation

On or about March 26, 2003, a class action complain was filed against the Company by North
Carolina Hospitality Group, Inc. in the Circuit Court of Maryland, Prince George’s County. It alleges

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

that certain commercial valve models contain a design defect that causes them to fail prematurely.
Based on the Company’s extensive investigation of the evidence, including the physical evidence
presented so far by the plaintiff, management believes that the allegations in the complaint are without
merit, and the Company intends to defend this lawsuit vigorously. Based on the facts currently known
to it, the Company does not believe that the ultimate outcome of these claims will have a material
adverse effect on the Company’s liquidity, financial condition or results of operations.

Other lawsuits and proceedings or claims, arising from the ordinary course of operations, are also
pending or threatened against the Company and its subsidiaries. Based on the facts currently known to
it, the Company does not believe that the ultimate outcome of these matters will have a material
adverse effect on its financial condition or results of operation.

However, litigation is inherently uncertain, and the Company believes that there exists a reasonable

possibility that it may ultimately incur losses in other litigation in excess of the amount accrued.

(16) Financial Instruments

Fair Value

The carrying amounts of cash and cash equivalents, trade receivables and trade payables

approximate fair value because of the short maturity of these financial instruments.

The fair value of the Company’s 4.87% senior notes, due 2010 and 5.47% senior notes due 2013, is

based on quoted market prices. The fair value of the Company’s variable rate debt approximates its
carrying value. The carrying amount and the estimated fair market value of the Company’s long-term
debt, including the current portion, are as follows:

December 31,

2003

2002

(in thousands)

Carrying amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Estimated fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$192,312
$193,130

$138,487
$142,162

Derivative Instruments

The Company uses foreign currency forward exchange contracts to reduce the impact of currency

fluctuations on certain anticipated intercompany purchase transactions that are expected to occur within
the year and certain other foreign currency transactions. Related gains and losses are recognized in
other income/expense when the contracts expire, which is generally in the same period as the
underlying foreign currency denominated transaction. These contracts do not subject the Company to
significant market risk from exchange movement because they offset gains and losses on the related
foreign currency denominated transactions. At December 31, 2003, 2002 and 2001, the Company had
no outstanding forward contracts to buy foreign currencies.

The Company uses commodity futures contracts to fix the price on a certain portion of certain raw
materials used in the manufacturing process. These contracts highly correlate to the actual purchases of
the commodity and the contract values are reflected in the cost of the commodity as it is actually
purchased. There were no commodity contracts utilized for years ended December 31, 2003, 2002 and
2001.

Effective July 1, 2003, the Company entered into an interest rate swap for a notional amount of

25,000,000 euro outstanding on our Revolving Credit Facility. The Company swapped the variable rate

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

from the Revolving Credit Facility which is three month EURIBOR plus 0.7% for a fixed rate of
2.33%. The term of the swap is two years. The Company designated the swap as a hedging instrument
using the cash flow method. The swap hedges the cash flows associated with interest payments on the
first 25,000,000 euro of our Revolving Credit Facility. The Company marks to market the changes in
value of the swap through other comprehensive income. Any ineffectiveness has been recorded in
income. The fair value recorded in other comprehensive income as of December 31, 2003 was $46,000.

At December 31, 2001, the Company had an outstanding interest rate swap that converted

20,000,000 euro of the borrowings under variable rate euro Line of Credit to a fixed rate borrowings at
4.3%. This swap agreement expired in March 2002 and its value and its impact on the Company’s
results was not material at December 31, 2002.

In September 2001, the Company entered an interest rate swap for its $75,000,000 83⁄8% notes. The

Company swapped the fixed interest rate of 83⁄8% to floating LIBOR plus 3.74%. On August 5, 2002,
the Company sold the swap and received $2,315,000 in cash. Based on the Company terminating this
hedge transaction, the adjustment to the fair value was amortized, over the term of the Notes which
matured December 1, 2003.

Leases

The Company leases certain manufacturing facilities, sales offices, warehouses, and equipment.

Generally the leases carry renewal provisions and require the Company to pay maintenance costs.
Future minimum lease payments under capital leases and non-cancelable operating leases as of
December 31, 2003 are as follows:

Operating Leases

Capital Leases

2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,992
1,834
1,697
1,175
1,187
1,730

$9,615

$ 653
356
223
132
—
—

$1,364

(17) Segment Information

Under the criteria set forth in Financial Accounting Standards Board No.131 ‘‘Disclosure about

Segments of an Enterprise and Related Information’’, the Company operates in three geographic
segments: North America, Europe, and China. Each of these segments is managed separately and has
separate financial results that are reviewed by the Company’s chief operating decision-maker. Sales by
region are based upon location of the entity recording the sale. The accounting policies for each
segment are the same as those described in the summary of significant accounting policies (see Note 2).

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

The following is a summary of our significant accounts and balances by segment, reconciled to our

consolidated totals:

Year ended December 31, 2003
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating income (loss) . . . . . . . . . . . . . . .
Identifiable assets . . . . . . . . . . . . . . . . . . . .
Long-lived assets . . . . . . . . . . . . . . . . . . . .
Capital expenditures . . . . . . . . . . . . . . . . . .
Depreciation and amortization . . . . . . . . . .

Year ended December 31, 2002
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating income (loss) . . . . . . . . . . . . . . .
Identifiable assets . . . . . . . . . . . . . . . . . . . .
Long-lived assets . . . . . . . . . . . . . . . . . . . .
Capital expenditures . . . . . . . . . . . . . . . . . .
Depreciation and amortization . . . . . . . . . .

Year ended December 31, 2001
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating income (loss) . . . . . . . . . . . . . . .
Identifiable assets . . . . . . . . . . . . . . . . . . . .
Long-lived assets . . . . . . . . . . . . . . . . . . . .
Capital expenditures . . . . . . . . . . . . . . . . . .
Depreciation and amortization . . . . . . . . . .

North
America

$476,310
64,414
509,010
72,592
6,500
12,542

$450,233
55,313
375,202
78,333
5,718
14,731

$415,689
47,294
343,187
86,409
10,508
16,109

Europe

China

Corporate(*)

Consolidated

(in thousands)

$210,614
22,592
266,849
48,882
4,832
6,593

$145,629
13,608
206,146
40,295
6,171
6,370

$121,228
11,308
153,007
36,495
3,351
6,820

$18,727
(3,834)
62,784
24,237
8,703
2,149

$19,664
(625)
54,124
15,748
7,704
1,193

$12,023
1,365
24,276
5,702
2,188
746

$
—
(13,132)
—
—
—
—

—
$
(10,767)
—
—
—
—

—
(9,684)
—
—
—
—

$705,651
70,040
838,643
145,711
20,035
21,284

$615,526
57,529
635,472
134,376
19,593
22,294

$548,940
50,283
520,470
128,606
16,047
23,675

* Corporate expenses are primarily for compensation expense, professional fees, including legal and
audit expenses and benefit administration costs. These costs are not allocated to the geographic
segments as they are viewed as corporate functions that support all activities.

The North American segment consists of U.S. net sales of $443,228,000, $422,703,000 and

$393,455,000 for the years ended December 31, 2003, 2002 and 2001, respectively. The North American
segment also consists of long-lived assets of $67,595,000, $73,907,000 and $81,723,000 for the years
ended December 31, 2003, 2002 and 2001, respectively.

Goodwill amounts to $184,901,000 of which $100,017,000 is reported in the North American
segment, $81,812,000 is reported in the European segment, and $3,072,000 is reported in the Chinese
segment as of December 31, 2003.

All intercompany transactions have been eliminated, and intersegment revenues are not significant.

Watts Water Technologies, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(18) Quarterly Financial Information (unaudited)

Year ended December 31, 2003
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income from continuing operations . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Per common share:
Basic

Income from continuing operations . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Diluted

Income from continuing operations . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividends per common share . . . . . . . . . . . . . . . . . . . . .

Year ended December 31, 2002
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income from continuing operations . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Per common share:
Basic

Income from continuing operations . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Diluted

(19) Subsequent Events

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

(in thousands, except per share information)

$165,692
55,764
8,936
6,610

$173,512
58,565
8,680
8,106

$175,509
59,373
9,019
8,905

$190,938
66,959
9,838
9,741

0.33
0.24

0.33
0.24
0.06

0.32
0.30

0.32
0.30
0.06

0.33
0.33

0.33
0.32
0.06

0.35
0.35

0.34
0.34
0.07

$143,320
49,479
8,056
8,056

$151,505
52,232
8,633
8,633

$159,811
53,507
8,773
8,773

$160,890
53,502
7,160
7,160

0.30
0.30

0.30
0.30
0.06

0.32
0.32

0.32
0.32
0.06

0.33
0.33

0.32
0.32
0.06

0.27
0.27

0.26
0.26
0.06

On February 20, 2004, the Company entered into an agreement with Yuhuan County Cheng Guan

Metal Hose Factory to acquire its 40% equity interest in its Taizhou Shida Plumbing Manufacturing
Co., Ltd. (Shida) joint venture for an expected purchase price of $3,000,000, the assumption of
approximately $6,000,000 of debt and the payment of $3,500,000 in connection with a three-year
non-compete agreement. After the transaction the Company will own 100% of Shida. The closing of
the transaction is subject to the satisfaction of certain closing conditions and is expected to occur
during the second quarter of 2004.

On January 5, 2004, a wholly-owned subsidiary of the Company acquired substantially all of the
assets of Flowmatic Systems, Inc. located in Dunnellon, Florida, for approximately $16,500,000 in cash.
Flowmatic designs and distributes a complete line of high quality reverse osmosis components and
filtration equipment. Their product line includes stainless steel and plastic housings, filter cartridges,
storage tanks, control valves, as well as complete reverse osmosis systems for residential and
commercial applications.

Watts Water Technologies, Inc. and Subsidiaries

Schedule II—Valuation and Qualifying Accounts

(Amounts in thousands)

For the Three Years Ended December 31:

Year Ended December 31, 2001
Allowance for doubtful accounts . . . . . .
Allowance for excess and obsolete

Balance At
Beginning of
Period

Additions
Charged To
Expense

Additions
Charged To
Other Accounts

Deductions

Balance At
End of
Period

$ 6,614

1,697

392

(2,633)

$ 6,070

inventories . . . . . . . . . . . . . . . . . . . .

$ 9,336

4,548

1,484

(4,221)

$11,147

Year Ended December 31, 2002
Allowance for doubtful accounts . . . . . .
Allowance for excess and obsolete

$ 6,070

1,225

inventories . . . . . . . . . . . . . . . . . . . .

$11,147

4,481

Year Ended December 31, 2003
Allowance for doubtful accounts . . . . . .
Allowance for excess and obsolete

$ 7,322

2,373

inventories . . . . . . . . . . . . . . . . . . . .

$13,201

3,558

167

470

172

(140)

$ 7,322

(2,897)

$13,201

(1,983)

$ 7,772

(2,686)

$14,245

2003_AnnualReport_final_pb 4/2/04 4:01 PM Page 9

Executive Officers

Patrick S. O'Keefe
Chief Executive Officer, President and
Director

William C. McCartney
Chief Financial Officer,
Treasurer and Secretary

Ernest E. Elliott
Executive Vice President
of Wholesale Marketing

Jeffrey A. Polofsky
Executive Vice President
of Retail Sales and Marketing

Lynn A. McVay
Executive Vice President
of Wholesale Sales

Paul A. Lacourciere
Corporate Vice President
of Manufacturing

J. Dennis Cawte
Group Managing Director
Europe

Lester J. Taufen
General Counsel,
Vice President of Legal Affairs
and Assistant Secretary

Douglas T. White
Group Vice President

J. Timothy McCullough
Vice President of Human Resources

Directors

Patrick S. O'Keefe
Chief Executive Officer, President and
Director

Timothy P. Horne
Director

Kenneth J. McAvoy
Director

John K. McGillicuddy
Director

Gordon W. Moran
Non-Executive Chariman of the Board
and Director

Daniel J. Murphy, III
Director

Roger A. Young
Director

Corporate
Information

Executive Offices
815 Chestnut Street
No. Andover, MA 01845-6098
Tel. 978-688-1811•Fax. 978-688-2976

Registrar and Transfer Agent
EquiServe Trust Company, N.A.
P.O. Box 43023, Providence, RI 02940-3023
www.equiserve.com.
Toll Free 1-877-282-1168

Counsel
Goodwin Procter LLP
Exchange Place, Boston, MA 02109

Auditors
KPMG LLP
99 High Street, Boston, MA 02110

Stock Listing
New York Stock Exchange Ticker Symbol: WTS

2003_AnnualReport_final_pb 4/2/04 4:01 PM Page 10

www.wattswater.com

Annual Report 0414

Printed in U.S.A.

0764-AR-04