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

FORM 10-Q

|X| Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the quarterly period ended June 30, 2003
-------------

or

|_| Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the transition period from __________ to ____________

Commission file number 1-11499

WATTS INDUSTRIES, INC.
---------------------
(Exact name of registrant as specified in its charter)

Delaware 04-2916536
-------- ----------
(State of incorporation) (I.R.S. Employer Identification No.)

815 Chestnut Street, North Andover, MA 01845
-------------------------------------- -----
(Address of principal executive offices) (Zip Code)

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

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|

Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

Class Outstanding at August 1, 2003
----- -----------------------------

Class A Common, $.10 par value 19,446,907

Class B Common, $.10 par value 7,805,224


WATTS INDUSTRIES, INC. AND SUBSIDIARIES
- ---------------------------------------

INDEX
-----

Part I. Financial Information Page #
--------------------- ------

Item 1. Financial Statements

Consolidated Balance Sheets at June 30, 2003
and December 31, 2002 (unaudited) 3

Consolidated Statements of Income for the Three
Months Ended June 30, 2003 and 2002 (unaudited) 4

Consolidated Statements of Income for the Six
Months Ended June 30, 2003 and 2002 (unaudited) 5

Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2003 and 2002 (unaudited) 6

Notes to Consolidated Financial Statements 7-17

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18-27

Item 3. Quantitative and Qualitative Disclosures About
Market Risk 27-28

Item 4. Controls and Procedures 28

Part II. Other Information
-----------------

Item 1. Legal Proceedings 29-30

Item 4. Submission of Matters to a Vote of Security Holders 31

Item 6. Exhibits and Reports on Form 8-K 32

Signatures 33

Exhibit Index 34



PART I. FINANCIAL INFORMATION
---------------------

ITEM 1. FINANCIAL STATEMENTS
--------------------

WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands, except share amounts)
(Unaudited)



June 30, December 31,
2003 2002
--------- ------------

ASSETS

CURRENT ASSETS:
Cash and cash equivalents ............................................ $ 35,293 $ 10,973
Restricted treasury securities ....................................... 77,834 --
Trade accounts receivable, less allowance for doubtful accounts of
$7,997 at June 30, 2003 and $7,322 at December 31, 2002 ........... 142,017 123,504
Inventories:
Raw materials ..................................................... 44,290 40,591
Work in process ................................................... 21,255 17,289
Finished goods .................................................... 89,202 75,535
--------- ---------
Total Inventories .............................................. 154,747 133,415
Prepaid expenses and other assets .................................... 12,599 10,732
Deferred income taxes ................................................ 24,388 21,927
Net assets held for sale ............................................. 2,478 2,464
--------- ---------
Total Current Assets .............................................. 449,356 303,015
--------- ---------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, at cost ............................... 265,722 248,933
Accumulated depreciation ............................................. (129,326) (114,557)
--------- ---------
Property, plant and equipment, net ................................ 136,396 134,376
--------- ---------
OTHER ASSETS:
Goodwill ............................................................. 169,951 163,226
Other ................................................................ 36,541 33,895
--------- ---------
TOTAL ASSETS ............................................................. $ 792,244 $ 634,512
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ..................................................... $ 67,671 $ 64,704
Accrued expenses and other liabilities ............................... 69,296 69,202
Accrued compensation and benefits .................................... 14,668 15,514
Current portion of long-term debt .................................... 87,660 82,211
--------- ---------
Total Current Liabilities ......................................... 239,295 231,631
--------- ---------
LONG-TERM DEBT, NET OF CURRENT PORTION ................................... 177,128 56,276
DEFERRED INCOME TAXES .................................................... 21,883 20,792
OTHER NONCURRENT LIABILITIES ............................................. 21,018 19,743
MINORITY INTEREST ........................................................ 10,185 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: 19,457,466 shares at
June 30, 2003 and 18,863,482 shares at December 31, 2002 .......... 1,946 1,886
Class B Common Stock, $.10 par value; 25,000,000 shares authorized;
10 votes per share; issued and outstanding: 7,805,224 shares at
June 30, 2003 and 8,185,224 shares at December 31, 2002 ........... 781 819
Additional paid-in capital ........................................... 47,840 45,132
Retained earnings .................................................... 271,323 259,893
Accumulated other comprehensive income (loss) ........................ 845 (11,794)
--------- ---------
Total Stockholders' Equity ........................................ 322,735 295,936
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............................... $ 792,244 $ 634,512
========= =========


See accompanying notes to consolidated financial statements.


3


WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Thousands, except per share amounts)
(Unaudited)



Three Months Ended
----------------------
June 30, June 30,
2003 2002
--------- ---------


Net sales ...................................................... $ 173,512 $ 151,505
Cost of goods sold ............................................. 114,947 99,273
--------- ---------
GROSS PROFIT ............................................... 58,565 52,232
Selling, general & administrative expenses ..................... 42,111 37,138
Restructuring .................................................. 114 --
--------- ---------
OPERATING INCOME ........................................... 16,340 15,094
--------- ---------
Other (income) expense:
Interest income ............................................ (267) (370)
Interest expense ........................................... 2,820 2,299
Other, net ................................................. (90) (200)
Minority interest .......................................... (17) 71
--------- ---------
2,446 1,800
--------- ---------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ..... 13,894 13,294
Provision for income taxes ..................................... 5,214 4,661
--------- ---------
INCOME FROM CONTINUING OPERATIONS .......................... 8,680 8,633
Loss from discontinued operations, net of tax benefit of $361 .. (574) --
--------- ---------
NET INCOME ................................................. $ 8,106 $ 8,633
========= =========
BASIC EARNINGS PER SHARE
Continuing operations ...................................... $ .32 $ .32
Discontinued operations .................................... (.02) --
--------- ---------
NET INCOME ................................................. $ .30 $ .32
========= =========
Weighted average number of shares .............................. 27,210 26,637
========= =========
DILUTED EARNINGS PER SHARE
Continuing operations ...................................... $ .32 $ .32
Discontinued operations .................................... (.02) --
--------- ---------
NET INCOME ................................................. $ .30 $ .32
========= =========
Weighted average number of shares .............................. 27,472 27,172
========= =========
Dividends per common share ................................ $ .06 $ .06
========= =========


See accompanying notes to consolidated financial statements.


4


WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Thousands, except per share amounts)
(Unaudited)



Six Months Ended
-----------------------
June 30, June 30,
2003 2002
--------- ---------


Net sales ......................................................... $ 339,204 $ 294,825
Cost of goods sold ................................................ 224,875 193,114
--------- ---------
GROSS PROFIT .................................................. 114,329 101,711
Selling, general & administrative expenses ........................ 81,965 72,365
Restructuring ..................................................... 114 10
--------- ---------
OPERATING INCOME .............................................. 32,250 29,336
--------- ---------
Other (income) expense:
Interest income ............................................... (382) (456)
Interest expense .............................................. 4,904 4,129
Other, net .................................................... (152) (125)
Minority interest ............................................. (38) 106
--------- ---------
4,332 3,654
--------- ---------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ........ 27,918 25,682
Provision for income taxes ........................................ 10,302 8,993
--------- ---------
INCOME FROM CONTINUING OPERATIONS ............................. 17,616 16,689
Loss from discontinued operations, net of tax benefit of $1,816 ... (2,900) --
--------- ---------
NET INCOME .................................................... $ 14,716 $ 16,689
========= =========
BASIC EARNINGS PER SHARE
Continuing operations ......................................... $ .65 $ .63
Discontinued operations ....................................... (.11) --
--------- ---------
NET INCOME .................................................... $ .54 $ .63
========= =========
Weighted average number of shares ................................. 27,139 26,586
========= =========
DILUTED EARNINGS PER SHARE
Continuing operations ......................................... $ .65 $ .62
Discontinued operations ....................................... (.11) --
--------- ---------
NET INCOME .................................................... $ .54 $ .62
========= =========
Weighted average number of shares ................................. 27,352 27,048
========= =========
Dividends per common share ................................... $ .12 $ .12
========= =========


See accompanying notes to consolidated financial statements.


5


WATTS INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands)
(Unaudited)



Six Months Ended
---------------------
June 30, June 30,
2003 2002
--------- --------


OPERATING ACTIVITIES
Income from continuing operations ....................................... $ 17,616 $ 16,689
Adjustments to reconcile net income from continuing operations to net
cash provided by (used in) continuing operating activities:
Depreciation ......................................................... 11,198 11,395
Amortization ......................................................... 467 191
Deferred income taxes (benefit) ...................................... (1,313) 78
Gain on disposal of assets ........................................... (11) (98)
Equity in undistributed loss of affiliates ........................... (29) (23)
Changes in operating assets and liabilities, net of effects
from acquisitions and dispositions:
Accounts receivable, net .......................................... (12,636) (19,866)
Inventories ....................................................... (15,236) (2,216)
Prepaid expenses and other assets ................................ (3,613) (2,677)
Accounts payable, accrued expenses and other liabilities .......... (2,289) (1,273)
--------- --------
Net cash provided by (used in) operating activities ..................... (5,846) 2,200
--------- --------
INVESTING ACTIVITIES
Additions to property, plant and equipment .............................. (8,698) (12,205)
Proceeds from sale of property, plant and equipment ..................... 172 245
Business acquisitions, net of cash acquired ............................. (4,985) (15,127)
Increase in restricted treasury securities .............................. (77,834) --
Decrease / (Increase) in other assets ................................... (293) 42
--------- --------
Net cash used in investing activities ................................... (91,638) (27,045)
--------- --------
FINANCING ACTIVITIES
Proceeds from long-term borrowings ...................................... 203,666 67,253
Payments of long-term debt .............................................. (81,166) (41,166)
Debt issue costs ........................................................ (1,612) --
Proceeds from exercise of stock options ................................. 2,730 2,535
Dividends ............................................................... (3,286) (3,205)
--------- --------
Net cash provided by financing activities ............................... 120,332 25,417
--------- --------
Effect of exchange rate changes on cash and cash equivalents ................ 992 735
Net cash provided by (used in) discontinued operations ...................... 480 (3,030)
--------- --------
CHANGE IN CASH AND CASH EQUIVALENTS ........................................ 24,320 (1,723)
Cash and cash equivalents at beginning of period ............................ 10,973 11,997
--------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD .................................. $ 35,293 $ 10,274
========= ========

NON CASH INVESTING AND FINANCING ACTIVITIES
Acquisitions of businesses:
Fair value of assets acquired ..................................... $ 5,642 $ 40,800
Cash Paid ......................................................... 4,985 15,127
--------- --------
Liabilities Assumed ............................................... $ 657 $ 25,673
========= ========


See accompanying notes to consolidated financial statements.


6


WATTS INDUSTRIES, INC. AND SUBSIDIARIES
- ---------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
- ------------------------------------------------------

1. Basis of Presentation

In the opinion of management, the accompanying unaudited, consolidated
financial statements contain all necessary adjustments, consisting only of
adjustments of a normal recurring nature, to present fairly Watts Industries,
Inc.'s Consolidated Balance Sheet as of June 30, 2003, its Consolidated
Statements of Income for the three and six months ended June 30, 2003 and 2002,
and its Consolidated Statements of Cash Flows for the six months ended June 30,
2003 and 2002.

The balance sheet at December 31, 2002 has been derived from the audited
financial statements at that date. The accounting policies followed by the
Company are described in the Company's December 31, 2002 Annual Report on Form
10-K. It is suggested that the financial statements included in this report be
read in conjunction with the financial statements and notes included in the
December 31, 2002 Annual Report on Form 10-K.

Certain amounts in fiscal year 2002 have been reclassified to permit
comparison with the 2003 presentation.

2. Accounting Policies

Shipping and Handling

The Company's shipping costs included in selling, general and
administrative expense amounted to $5,508,000 and $5,155,000 for the three
months ended June 30, 2003 and 2002, respectively, and $10,568,000 and
$10,175,000 for the six months ended June 30, 2003 and 2002, respectively.

Goodwill and Other Intangible Assets

The Company adopted Financial Accounting Standards Board Statement No. 142
"Goodwill and Other Intangible Assets" (FAS 142) on January 1, 2002, and as a
result no longer amortizes goodwill. The valuation of goodwill and intangible
assets is reviewed for impairment annually in accordance with FAS 142.
Intangible assets such as purchased technology are generally recorded in
connection with a business acquisition. In 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. If actual product
acceptance differs significantly from the estimates, the Company may be required
to record an impairment charge to write down the assets to their realizable
value. The annual goodwill impairment test involves the use of estimates related
to the fair market value of the business unit with which the goodwill is
associated. The value is estimated using the future cash flow valuation
methodology. The Company has elected to perform its annual tests for indications
of goodwill impairment in the fourth quarter.

The changes in the carrying amount of goodwill for the six months ended
June 30, 2003 are as follows:

(in thousands)

Carrying amount as of December 31, 2002............. $163,226
Acquired goodwill during the period................. 1,062
Adjustments to goodwill during the period........... 79
Effect of change in rates used for translation...... 5,584
--------
Carrying amount as of June 30, 2003................. $169,951
========


7


Other Intangible Assets include the following and are presented in "Other
Assets: "Other", in the Consolidated Balance Sheet:



As of June 30, 2003
Gross Carrying Accumulated
Amount Amortization
------ ------------
(in thousands)

Patents ........................................... $ 8,583 $(3,628)
Other ............................................. 4,888 (1,201)
------- -------
Total amortizable intangibles ..................... 13,471 (4,829)
Intangible assets not subject to amortization ..... 10,256 --
------- -------
Total .......................................... $23,727 $(4,829)
======= =======


Aggregate amortization expense for amortized other intangible assets for
the three and six months ended June 30, 2003 are $281,000 and $467,000,
respectively. Additionally, future amortization expense on other intangible
assets approximates $379,000 for the remainder of fiscal 2003, $542,000 for
fiscal 2004, and $521,000 for fiscal 2005, 2006 and 2007.

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.

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 as if the Company had applied the fair value method to measure
stock-based compensation as required under the disclosure provisions of
Financial Accounting Standards Board Statement No. 123, "Accounting for
Stock-Based Compensation"(FAS 123) as amended by Financial Accounting Standards
Board Statement No. 148 "Accounting for Stock-Based Compensation Transition and
Disclosure"(FAS 148).



Three Months Ended Three Months Ended
June 30, 2003 June 30, 2002
------------- -------------
(in thousands)

Net income, as reported .......................... $ 8,106 $ 8,633
Add: Stock-based employee compensation expense
from the Management Stock Purchase Plan
included in reported net income, net of tax ... 51 55
Deduct: Stock-based employee expense determined
under the fair value method, net of tax:
Restricted stock units (Management Stock
Purchase Plan) .............................. (64) (49)
Employee stock options ........................ (129) (146)
------- -------
Pro-forma net income ............................. $ 7,964 $ 8,493
======= =======

Earnings per share:
Basic--as reported ............................ $ 0.30 $ 0.32
Basic--pro-forma .............................. $ 0.29 $ 0.31
Dilutive--as reported ......................... $ 0.30 $ 0.32
Dilutive--pro-forma ........................... $ 0.29 $ 0.31



8




Six Months Ended Six Months Ended
June 30, 2003 June 30, 2002
------------- -------------
(in thousands)

Net income, as reported .......................... $ 14,716 $ 16,689
Add: Stock-based employee compensation expense
from the Management Stock Purchase Plan
included in reported net income, net of tax ... 102 110
Deduct: Stock-based employee expense determined
under the fair value method, net of tax:
Restricted stock units (Management Stock
Purchase Plan) .............................. (127) (98)
Employee stock options ........................ (258) (292)
-------- --------
Pro-forma net income ............................. $ 14,433 $ 16,409
======== ========

Earnings per share:
Basic--as reported ............................ $ 0.54 $ 0.63
Basic--pro-forma .............................. $ 0.53 $ 0.62
Dilutive--as reported ......................... $ 0.54 $ 0.62
Dilutive--pro-forma ........................... $ 0.53 $ 0.61


Restricted Treasury Securities

Restricted treasury securities at June 30, 2003, (bearing an interest rate
yield of approximately 1%) represents securities purchased with proceeds from
the Company's private placement completed during the second quarter and are
being held for the repayment of the Company's $75,000,000 principal amount of 8
3/8% notes and interest due December 1, 2003. Such amounts were held in a trust
account at June 30, 2003, and are to be used to generate the cash required to
settle the principal and interest payments owed to the bondholders on December
1, 2003. See Note 10.

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.
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 Issue
94-3 relates to its requirements for recognition of a liability for a cost
associated with an exit or disposal activity. This Statement requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. Under Issue 94-3, a liability for an exit cost
as defined in Issue 94-3 was recognized at the date of an entity's commitment to
an exit plan. The provisions of this statement are effective for exit or
disposal activities that are initiated after December 31, 2002. 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


9


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. The Company will apply 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, but the returns under warranty have been immaterial. The
warranty reserve is part of the sales returns and allowances, 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 Standard Board
Statement No. 148, "Accounting for Stock-Based Compensation, Transition and
Disclosure" (FAS148). 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 are
effective for fiscal years ended after December 15, 2002. The Company will
currently continue to account for stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25. The Company has included additional
disclosures in accordance with FAS 148 in the footnotes to these consolidated
financial statements.

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 into in fiscal periods beginning after June 15, 2003. The
Company is currently evaluating the effect, if any, the provisions of EITF 00-21
will have on its results of operations and financial condition.

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 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 is effective for all
new variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after June 15, 2003 (Q3 of fiscal 2003). The Company anticipates
consolidating Jameco International LLC in the third quarter of fiscal 2003.
Jameco International, LLC imports and sells vitreous china, imported faucets and
faucet parts and imported bathroom accessories to the North American retail
market. Its annual sales for the twelve months ended December 31, 2002, were
$16,685,000. The Company has a 49% interest in Jameco LLC and is currently
consolidating its earnings in minority interest. For this reason the Company
does not anticipate any change in its earnings for the adoption of FIN 46.

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 does not believe that the adoption of FAS 149
will have a material effect on its results of operations and financial
condition.

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 all 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 is currently evaluating the effect, if any, the provisions of
FAS 150 will have on its results of operations and financial condition.


10


3. Discontinued Operations

In September 1996, the Company divested its 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
fiscal 2003 relate to legal and settlement costs associated with the James Jones
litigation (see Note 11). Specifically, in 2003, an offer of $13 million, of
which Watts is responsible for $11 million, 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 offer
included the Relator's statutory share. Subject to approval by their governing
bodies, these three cities have accepted this $13 million offer, and the
material terms of this settlement embodied in a memorandum of understanding have
been confirmed in California Superior Court proceedings. This offer and other
legal fees required the Company to record a net of tax charge for the three and
six months ended June 30, 2003, of $128,000 and $2,454,000, respectively.

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 three and six months ended June 30, 2003,
the Company recorded a net of tax charge of $446,000.

4. Derivative Instruments

Certain forecasted transactions, primarily intercompany sales between the
United States and Canada, and assets are exposed to foreign currency risk. The
Company monitors its foreign currency exposures on an ongoing basis to maximize
the overall effectiveness of its foreign currency hedge positions. During the
six months ended June 30, 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. There were no ineffective
amounts for the six months ended June 30, 2003.

The Company also utilizes, on a limited basis, certain commodity
derivatives, primarily on copper used in its manufacturing process, to hedge the
cost of its anticipated production requirements. The Company did not utilize any
commodity derivatives for the six months ended June 30, 2003.

5. Restructuring

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 fiscal 2001. The projects for which charges were recorded
in the fourth quarter of fiscal 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 expected to be completed by the end of fiscal
2003. The Company recorded pre-tax manufacturing restructuring and other costs
of $637,000 and $1,083,000 for the three and six months ended June 30, 2003,
respectively, $4,089,000 for fiscal 2002 and $5,831,000 in the fourth quarter of
fiscal 2001. 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 38
employees in manufacturing and administration groups, 31 of whom have been
terminated as of June 30, 2003. 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 has been recorded in cost of
goods sold.


11


Details of our manufacturing restructuring plan through June 30, 2003 are as
follows:



Initial Utilized Balance Provisions Utilized Balance Provisions Utilized Balance
Provision 2001 12/31/01 2002 2002 12/31/02 2003 2003 6/30/03
--------- ---- -------- ---- ---- -------- ---- ---- -------
(in thousands)

Restructuring/other .. $1,454 $ 692 $762 $ 638 $ 981 $419 $ 114 $ 111 $422
Asset write-downs .... 4,300 4,300 -- 2,491 2,491 -- 400 400 --
Other costs .......... 77 77 -- 960 960 -- 569 569 --
------ ------ ---- ------ ------ ---- ------ ------ ----
Total ................ $5,831 $5,069 $762 $4,089 $4,432 $419 $1,083 $1,080 $422
====== ====== ==== ====== ====== ==== ====== ====== ====


6. Earnings per Share

The following tables set forth the reconciliation of the calculation of
earnings per share:

For the Three Months Ended June 30, 2003
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
Income from continuing
operations ...................... $ 8,680,000 27,209,813 $ 0.32
Loss from discontinued perations ... (574,000) (0.02)
----------- --------
Net income ......................... $ 8,106,000 $ 0.30
=========== ========

Effect of dilutive securities
Common stock equivalents ........... 262,506
----------
Diluted EPS
Income from continuing operations .. $ 8,680,000 $ 0.32
Loss from discontinued operations .. (574,000) (0.02)
----------- --------
Net income ......................... $ 8,106,000 27,472,319 $ 0.30
=========== ========== ========

For the Three Months Ended June 30, 2002
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
Net income ..................... $8,633,000 26,636,659 $0.32
Effect of dilutive securities
Common stock equivalents ....... 535,515
----------
Diluted EPS
Net income ..................... $8,633,000 27,172,174 $0.32
========== ========== =====

For the Six Months Ended June 30, 2003
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
Income from continuing operations .. $ 17,616,000 27,139,406 $ 0.65
Loss from discontinued operations .. (2,900,000) (0.11)
------------ -------
Net income ......................... $ 14,716,000 $ 0.54
============ =======
Effect of dilutive securities
Common stock equivalents ........... 212,301
----------
Diluted EPS
Income from continuing operations .. $ 17,616,000 $ 0.65
Loss from discontinued operations .. (2,900,000) (0.11)
------------ -------
Net income ......................... $ 14,716,000 27,351,707 $ 0.54
============ ========== =======

12


For the Six Months Ended June 30, 2002
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
Net income ..................... $16,689,000 26,585,899 $0.63
Effect of dilutive securities
Common stock equivalents ....... 461,857 (0.01)
---------- -----
Diluted EPS
Net income ..................... $16,689,000 27,047,756 $0.62
=========== ========== =====

Stock options to purchase 74,266 shares of common stock were outstanding
at June 30, 2003, but were not included in the computation of diluted earnings
per share for the six-month period because the options' exercise price was
greater than the average market price of the common shares and therefore, the
effect would have been antidilutive.

7. Segment Information

The following table presents certain operating segment information:



(in thousands)
North
America Europe Asia Corporate Consolidated
------- ------ ---- --------- ------------

Three months ended June 30, 2003:
Net sales ..................................... $118,162 $ 50,229 $ 5,121 $ -- $173,512
Operating income (loss) ....................... 16,807 4,310 (641) (4,136) 16,340
Capital expenditures .......................... 1,466 1,102 1,083 -- 3,651
Depreciation and amortization ................. 3,197 2,243 523 -- 5,963

Three months ended June 30, 2002:
Net sales ..................................... $113,677 $ 31,844 $ 5,984 $ -- $151,505
Operating income (loss) ....................... 15,182 3,066 175 (3,329) 15,094
Capital expenditures .......................... 1,353 2,378 2,937 -- 6,668
Depreciation and amortization ................. 3,903 1,584 289 -- 5,776


North
America Europe Asia Corporate Consolidated
------- ------ ---- --------- ------------

Six months ended June 30, 2003:
Net sales ..................................... $231,117 $ 98,898 $ 9,189 $ -- $339,204
Operating income (loss) ....................... 31,969 9,170 (1,124) (7,765) 32,250
Capital expenditures .......................... 2,962 1,709 4,027 -- 8,698
Depreciation and amortization ................. 6,439 4,317 909 -- 11,665
Identifiable assets ........................... 488,293 245,276 58,675 -- 792,244

Six months ended June 30, 2002:
Net sales ..................................... $223,558 $ 63,215 $ 8,052 $ -- $294,825
Operating income (loss) ....................... 29,013 6,398 213 (6,288) 29,336
Capital expenditures .......................... 3,413 3,334 5,458 -- 12,205
Depreciation and amortization ................. 7,803 3,288 495 -- 11,586
Identifiable assets ........................... 385,026 177,901 42,980 -- 605,907


The above operating segments are presented on a basis consistent with the
presentation included in the Company's December 31, 2002 financial statements.
There have been no material changes in the identifiable assets of the individual
segments since December 31, 2002.

The corporate segment consists primarily of compensation expense for
corporate headquarters' staff, professional fees, including legal and audit, and
product and general liability insurances.


13


8. Other Comprehensive Income (Loss)

The accumulated balances for the components of the Accumulated Other
Comprehensive Income (Loss) are:

Accumulated
Foreign Other
Currency Cash Flow Comprehensive
Translation Hedges Income (Loss)
----------- ------ -------------
(in thousands)
Balance December 31, 2002 ..... $(11,794) $ -- $(11,794)
Change in period .............. 3,533 (221) 3,312
-------- ----- --------
Balance March 31, 2003 ........ (8,261) (221) (8,482)
Change in period .............. 9,564 (237) 9,327
-------- ----- --------
Balance June 30, 2003 ......... $ 1,303 $(458) $ 845
======== ===== ========

Balance December 31, 2001 ..... $(24,281) $ -- $(24,281)
Change in period .............. (1,761) 32 (1,729)
-------- ----- --------
Balance March 31, 2002 ........ (26,042) 32 (26,010)
Change in period .............. 12,458 68 12,526
-------- ----- --------
Balance June 30, 2002 ......... $(13,584) $ 100 $(13,484)
======== ===== ========

Accumulated other comprehensive income/(loss) in the Consolidated Balance
Sheets as of June 30, 2003 and June 30, 2002 consists of cumulative translation
adjustments and changes in the fair value of certain financial instruments that
qualify for hedge accounting as required by FAS 133. The Company's total
comprehensive income was as follows:



Three Months Ended
June 30,
--------
2003 2002
---- ----
(in thousands)

Net income ..................................................... $ 8,106 $ 8,633
Unrealized gains/(loss) on derivative instruments, net of tax .. (237) 68
Foreign currency translation adjustments ....................... 9,564 12,458
-------- -------
Total comprehensive income ..................................... $ 17,433 $21,159
======== =======


Six Months Ended
June 30,
--------
2003 2002
---- ----
(in thousands)

Net income ..................................................... $ 14,716 $16,689
Unrealized gains/(loss) on derivative instruments, net of tax .. (458) 100
Foreign currency translation adjustments ....................... 13,097 10,697
-------- -------
Total comprehensive income ..................................... $ 27,355 $27,486
======== =======


9. Acquisitions

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 $1.3 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 groups for
under-floor radiant heat systems.

On July 29, 2002, a wholly-owned subsidiary of the Company acquired F&R
Foerster and Rothmann GmbH (F&R) located in Neuenburg am Rhein, Germany, for
approximately $2.3 million in cash less assumed net debt of $0.8 million. F&R
manufactures and distributes a line of gauges predominately to the French and
German OEM markets.

14


On July 15, 2002, a wholly-owned subsidiary of the Company acquired ADEV
nElectronic SA (ADEV) located in Rosieres, France and its closely affiliated
distributor, E.K. Eminent A.B. (Eminent) located in Gothenburg, Sweden for
approximately $12.9 million in cash less assumed net debt of $3.5 million. 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 million, of which approximately
$10 million 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 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, we made our final payment of $3.0 million
associated with our Cheng Guan joint venture. Prior to this payment, we had
invested approximately $5.0 million. This joint venture is owned 60% by us and
40% by its Chinese partner. The Company has invested $8.0 million to obtain this
60% interest.

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.

Subsequent Event

On July 30, 2003, a wholly-owned subsidiary of the Company acquired
Giuliani Anello S.r.l. located in Cento (Ferrara) Bologna Italy, for
approximately $12 million in cash. 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.

10. Debt Issuance

On February 28, 2002, the Company entered into a revolving credit facility
with a syndicate of banks (the Revolving Credit Facility). Outstanding
indebtedness under the Revolving Credit Facility bears interest at one of three
customary rates plus a margin of 100 basis points, depending on the applicable
base rate and the Company's bond rating. The average interest rate for
borrowings under the Revolving Credit Facility was approximately 2.9% at June
30, 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 June 30, 2003, the Company was in compliance
with all covenants related to the Revolving Credit Facility and the total amount
outstanding on the facility was $41,144,000 for euro-based borrowings and no
amounts were outstanding for U.S. dollar borrowings.

On May 15, 2003, the Company completed a private placement of $125 million
of senior unsecured notes consisting of $50 million principal amount of 4.87%
Senior Notes due 2010 and $75 million principal amount of 5.47% Senior Notes due
2013. The net proceeds from the private placement are being used to repay the
Company's $75 million principal amount of 8 3/8% Notes due December 2003 and
were used to repay approximately $32 million outstanding under the Company's
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 Industries, Inc., our parent holding
company, and are structurally subordinated to the revolving credit facility,
which is at the subsidiary level. The senior unsecured notes require compliance
with a fixed charge coverage ratio, allow the Company to have debt senior to the
new notes in an amount up to 5% of stockholders' equity and,


15


assuming compliance with the coverage ratio, allow the Company to incur
unlimited amounts of debt pari passu or junior to the senior unsecured notes.
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.

Subsequent Event

Effective July 1, 2003, we entered into an interest rate swap for a
notional amount of 25,000,000 euro 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 term of the swap is two
years.

11. Contingencies and Environmental Remediation

Contingencies

In April 1998, the Company became aware of a complaint (the Armenta case)
that was filed 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, 14 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.

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. An additional offer was made on May 8, 2003, for $13
million ($11 million from the Company and $2 million from the James Jones
Company), plus payment of Relator's attorney's fees, 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 to be tried first. This
offer included the Relator's statutory share. These three cities have accepted
this $13 million offer, and the terms of this settlement have been approved by
the California Superior Court. The settlement provides that the claims of these
three cities will be dismissed upon payment of these settlement funds.

After the Company settled with the City of Los Angeles, the Relator made
an offer to settle the balance of this case for $121.9 million, which the
Company has rejected. The Company has a reserve in the amount of $12.8 million
after-tax with respect to the James Jones Litigation in its consolidated balance
sheet as of June 30, 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. Zurich has subsequently paid the Company
approximately $11.3 million for defense costs. 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, and, since then, Zurich
has paid the Company approximately $3.1 million in compliance with this order.
Zurich has asserted that all amounts (both


16


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. The Company has recorded reimbursed indemnity settlement
amounts (but not reimbursed defense costs) as a liability. 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 outcome of the litigation relating to the Los Angeles
indemnification coverage. The Company intends to contest vigorously the Armenta
case and its related litigation.

Environmental Remediation

The Company has been named as a potentially responsible party (PRP's) 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.

For several years, the New York Attorney General (NYAG) has threatened to
bring suit against approximately 16 PRP's, including Watts (Jameco) 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, Long Island. 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 PRP's will be or what proportion of the final costs may be allocated
to the Company.

Asbestos Litigation

As of June 30, 2003, the Company was a defendant in approximately 100
actions filed 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 ours as a source of asbestos exposure. Based on the facts
currently known to it, the Company does not believe that the ultimate outcome of
these filings will have a material effect on the Company's liquidity, financial
condition or results of operations.

Other Litigation

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 other litigation 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 the
James Jones Litigation and other litigation in excess of the amount accrued.


17


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-----------------------------------------------------------------------
OF OPERATIONS
-------------

Recent Developments

On July 30, 2003, a wholly-owned subsidiary of the Company acquired
Giuliani Anello S.r.l. located in Cento (Ferrara) Bologna Italy, for
approximately $12 million in cash. 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. Giuliani Anello's annual revenue, prior to the
acquisition, was approximately $7 million at the exchange rate in effect as of
the closing date.

On May 15, 2003, we completed a private placement of $125 million of
senior unsecured notes consisting of $50 million principal amount of 4.87%
Senior Notes due 2010 and $75 million principal amount of 5.47% senior Notes due
2013. The net proceeds from the private placement are being used to repay our
$75 million principal amount of 8 3/8% Notes due December 2003 and were used to
repay approximately $32 million outstanding under our revolving credit facility.
The balance of the net proceeds will be used for general corporate purposes.

Acquisitions

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 $1.3 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 groups for
under-floor radiant heat systems. Martin Orgee's annual sales, prior to the
acquisition, were $2.7 million.

On July 29, 2002, a wholly-owned subsidiary of the Company acquired F&R
Foerster and Rothmann GmbH (F&R) located in Neuenburg am Rhein, Germany, for
approximately $2.3 million in cash less assumed net debt of $0.8 million. F&R
manufactures and distributes a line of gauges predominately to the French and
German OEM markets.

On July 15, 2002, a wholly-owned subsidiary of the Company acquired ADEV
Electronic SA (ADEV) located in Rosieres, France and its closely affiliated
distributor, E.K. Eminent A.B. (Eminent) located in Gothenburg, Sweden for
approximately $12.9 million in cash less assumed net debt of $3.5 million. 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 million, of which approximately
$10 million 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 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. The Company has invested $8.0 million to obtain this 60% interest.

The acquisitions above have been accounted for utilizing the purchase
method of accounting. The proforma results have not been displayed as the
combined results are not significant.

18


Results of Operations

Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002

Net Sales. Net sales for the three months ended June 30, 2003 increased
$22,007,000 (14.5%) to $173,512,000 compared to $151,505,000 for the same period
in 2002. The increase in net sales is attributable to the following:

(in thousands)
Internal Growth .......................... $ 6,091 4.0%
Acquisitions ............................. 7,957 5.2%
Foreign Exchange ......................... 7,959 5.3%
------- -------
Total Change ............................. $22,007 14.5%
======= =======

The increase in net sales from internal growth is primarily attributable
to increased units sales in the do-it-yourself (DIY) market in North America and
increased unit sales in the original equipment manufacturers (OEM) market in
Europe. The growth in net sales from acquired businesses is due to the inclusion
of the net sales of ADEV and Eminent, acquired on July 15, 2002 and F&R,
acquired on July 29, 2002. The favorable impact of foreign exchange is due
primarily to the euro appreciating against the U.S. dollar compared to the same
period in 2002.

We monitor our net sales in three geographical segments: North America,
Europe and Asia. As outlined below, North America, Europe and Asia accounted for
68.1%, 28.9% and 3.0% of net sales, respectively, in the three months ended June
30, 2003, compared to 75.0%, 21.0% and 4.0% of net sales, respectively, in the
three months ended June 30, 2002:

June 30, 2003 June 30, 2002 Change
------------- ------------- ------
(in thousands)
North America ........ $118,162 $113,677 $ 4,485
Europe ............... 50,229 31,844 18,385
Asia ................. 5,121 5,984 (863)
-------- -------- --------
Total ................ $173,512 $151,505 $ 22,007
======== ======== ========

The increase in net sales in North America is due to increased unit
shipments in the do-it-yourself market and increased sales of our backflow
product line which is distributed through our wholesale network. The increase in
net sales in Europe is primarily due to the ADEV, Eminent and F&R acquisitions
and the appreciation of the euro against the U.S. dollar. The decrease in net
sales in Asia is due to an adjustment of $2,200,000 made in the current quarter
for previously recorded sales at our TWT joint venture in Tianjin partially
offset by increased sales in the Chinese domestic market.

Gross Profit. Gross profit for the three months ended June 30, 2003 increased
$6,333,000 (12.1%) to $58,565,000 from $52,232,000 for the comparable quarter
last year and decreased as a percentage of net sales to 33.8% from 34.5%. We
charged $523,000 and $714,000 of costs associated with our manufacturing
restructuring plan to cost of sales for the three months ended June 30, 2003 and
2002, respectively. Excluding the costs associated with the manufacturing
restructuring plan for both periods, gross profit would have increased
$6,142,000 (11.6%) and decreased as a percentage of sales to 34.1% from 34.9%.
The gross profit increase is primarily attributable to inclusion of the gross
profit of acquired companies and the appreciation of the euro against the U.S
dollar partially offset by start-up costs associated with our new manufacturing
plant in China. The gross profit percentage decrease is primarily due to
acquired companies operating at lower gross margins than the rest of the
company, increased percentage of total unit shipments to the DIY market in North
America and under absorbed manufacturing costs due to a delay in production at
our new wholly-owned manufacturing plant in China.


19


Selling, General and Administrative Expense. Selling, general and administrative
expenses for the three months ended June 30, 2003 increased $4,973,000 (13.4%)
to $42,111,000 compared to $37,138,000 for the same period in 2002. This
increase is attributable to the inclusion of selling, general and administrative
expenses of acquired companies, the appreciation of the euro against the U.S.
dollar compared to the prior period and increased professional fees and pension
expenses.

Restructuring Expense. Restructuring expense for the three months ended June 30,
2003 was $114,000. There was no restructuring expense in the three months ended
June 30, 2002. Restructuring expense is for severance costs associated with our
manufacturing restructuring plan.

Operating Income. Operating income for the three months ended June 30, 2003,
increased $1,246,000 (8.3%) to $16,340,000 compared to $15,094,000 for the same
period in 2002 due to increased gross profit, partially offset by increased
selling, general and administrative expenses. The manufacturing restructuring
plan costs reduced operating income by $637,000 and $714,000 in the three months
ending June 30, 2003 and 2002, respectively.

Our operating income/(loss) by segment for the three months ended June 30,
2003, and 2002 was as follows:

June 30, 2003 June 30, 2002 Change
------------- ------------- ------
(in thousands)
North America...................... $16,807 $15,182 $1,625
Europe............................. 4,310 3,066 1,244
Asia............................... (641) 175 (816)
Corporate.......................... (4,136) (3,329) (807)
------- ------- ------
Total.............................. $16,340 $15,094 $1,246
======= ======= ======

The increase in operating income in North America is primarily due to
increased sales volume and reduced factory overhead spending offset by increased
pension and worker's compensation expense. The increased operating income in
Europe is primarily due to the inclusion of operating earnings of acquired
companies. The decrease in operating income in China is due to a under absorbed
manufacturing costs due to a delay in production at our new wholly-owned
manufacturing plant in China, as well as a decrease in gross profit due to the
adjustment made in the current quarter for previously recorded sales at our TWT
joint venture. This adjustment reduced earnings per share by $0.02 in the three
months ended June 30, 2003. Corporate expenses are primarily for compensation
expense, professional fees, including legal and audit expenses, product and
general liability insurances. The increase in corporate expenses is primarily
due to increased professional fees and pension expenses.

Interest Expense. Interest expense increased $521,000 (22.7%) in the quarter
ended June 30, 2003 to $2,820,000 compared to $2,299,000 for the same period in
2002, primarily due to the inclusion of the $125,000,000 senior notes which we
issued on May 15, 2003. On September 1, 2001, we entered into an interest rate
swap with respect to our $75,000,000 8 3/8% 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 quarter ended June 30, 2003, we
reduced interest expense by $393,000 by amortizing the adjustment to the fair
value. In the quarter ended June 30, 2002, we reduced interest expense by
$475,000 for the effectiveness of the swap.

Income Taxes. Our effective tax rate for continuing operations for the three
months ended June 30, 2003 increased to 37.5% from 35.1% for the three months
ended June 30, 2002. The increase is primarily due to an increase in our
domestic state tax rate and increased losses in China, which we are unable to
tax benefit because the majority of the Chinese entities are in a tax holiday.
In the quarter ended June 30, 2002, we had a one-time favorable tax adjustment
in Canada due to a change in the Canadian tax law.

Income From Continuing Operations. Income from continuing operations for the
three months ended June 30, 2003 increased $47,000 (0.5%) to $8,680,000, or
$0.32 per common share, compared to $8,633,000, or $0.32 per common share, for
the three months ended June 30, 2002, in each case, on a diluted basis.


20


Loss From Discontinued Operations. We recorded a charge net of tax to
discontinued operations for the three months ended June 30, 2003 of $574,000, or
($0.02) per common share on a diluted basis. This charge is primarily
attributable to payments to be made to the selling shareholders of the James
Jones Company pursuant to our original purchase agreement.

Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002

Net Sales. Net sales for the six months ended June 30, 2003 increased
$44,379,000 (15.1%) to $339,204,000 compared to $294,825,000 for the same period
in 2002. The increase in net sales is attributable to the following:

(in thousands)
Internal Growth ......................... $ 8,999 3.1%
Acquisitions ............................ 19,321 6.6%
Foreign Exchange ........................ 16,059 5.4%
------- ----
Total Change ............................ $44,379 15.1%
======= ====

The increase in net sales from internal growth is primarily attributable
to increased units sales in the DIY market in North America and increased unit
sales in the original equipment manufacturers (OEM) market in Europe. The growth
in net sales from acquired businesses is due to the inclusion of the net sales
of Cheng Guan, our most recent China 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 favorable impact of foreign exchange is due primarily to the
euro appreciating against the U.S. dollar compared to the same period in 2002 as
well as a higher percentage of total revenue being generated in Europe.

We monitor our net sales in three geographical segments: North America,
Europe and Asia. As outlined below, North America, Europe and Asia accounted for
68.1%, 29.2% and 2.7% of net sales, respectively, in the six months ended June
30, 2003, compared to 75.8%, 21.5% and 2.7% of net sales, respectively, in the
six months ended June 30, 2002:

June 30, 2003 June 30, 2002 Change
------------- ------------- ------
(in thousands)
North America .......... $231,117 $223,558 $ 7,559
Europe ................. 98,898 63,215 35,683
Asia ................... 9,189 8,052 1,137
-------- -------- -------
Total .................. $339,204 $294,825 $44,379
======== ======== =======

The increase in net sales in North America is due to increased unit
shipments in the do-it-yourself market. The increase in net sales in Europe is
primarily due to the ADEV, Eminent and F&R acquisitions and the appreciation of
the euro against the U.S. dollar. The increase in net sales in Asia is primarily
due to the inclusion of our Cheng Guan joint venture which we established on
March 5, 2002, partially offset by the adjustment of $2,200,000 made in the
quarter ending June 30, 2003, for previously recorded sales at our TWT joint
venture in Tianjin.

Gross Profit. Gross profit for the six months ended June 30, 2003 increased
$12,618,000 (12.4%) to $114,329,000 from $101,711,000 for the comparable quarter
last year and decreased as a percentage of net sales to 33.7% from 34.5%. We
charged $969,000 and $1,561,000 of costs associated with our manufacturing
restructuring plan to cost of sales for the six months ended June 30, 2003 and
2002, respectively. Excluding the costs associated with the manufacturing
restructuring plan for both periods, gross profit would have increased
$12,026,000 (11.6%) and decreased as a percentage of sales to 34.0% from 35.0%.
The gross profit increase is primarily attributable to inclusion of the gross
profit of acquired companies and the appreciation of the euro against the U.S
dollar partially offset by start-up costs associated with our new manufacturing
plant in China. The gross profit percentage decrease is primarily due to
acquired companies operating at lower gross margins than the rest of the
company, increased percentage of total unit shipments to the DIY market in North
America and the start-up costs and for under absorbed manufacturing costs due to
a delay in production at our new wholly-owned manufacturing plant in China.


21


Selling, General and Administrative Expense. Selling, general and administrative
expenses for the six months ended June 30, 2003 increased $9,600,000 (13.3%) to
$81,965,000 compared to $72,365,000 for the same period in 2002. This increase
is attributable to the appreciation of the euro against the U.S. dollar compared
to the prior period, the inclusion of selling, general and administrative
expenses of acquired companies and an increase in professional fees and pension
expenses.

Restructuring Expense. Restructuring expense for the six months ended June 30,
2003 was $114,000 compared to $10,000 for the six months ended June 30, 2002.
Restructuring expense is for severance costs associated with our manufacturing
restructuring plan.

Operating Income. Operating income for the six months ended June 30, 2003,
increased $2,914,000 (9.9%) to $32,250,000 compared to $29,336,000 for the same
period in 2002 due to increased gross profit, partially offset by increased
selling, general and administrative expenses. The manufacturing restructuring
plan costs reduced operating income by $1,083,000 and $1,571,000 in the six
months ending June 30, 2003 and 2002, respectively.

Our operating income/(loss) by segment for the six months ended June 30,
2003, and 2002 was as follows:

June 30, 2003 June 30, 2002 Change
------------- ------------- ------
(in thousands)
North America ......... $ 31,969 $ 29,013 $ 2,956
Europe ................ 9,170 6,398 2,772
Asia .................. (1,124) 213 (1,337)
Corporate ............. (7,765) (6,288) (1,477)
-------- -------- -------
Total ................. $ 32,250 $ 29,336 $ 2,914
======== ======== =======

The increase in operating income in North America is primarily due to
increased sales volume and reduced factory overhead spending offset by increased
pension and worker's compensation expense. The increased operating income in
Europe is primarily due to the inclusion of operating earnings of acquired
companies. The decrease in operating income in China is due to under absorbed
manufacturing costs due to a delay in production and start up costs associated
with our new wholly-owned manufacturing plant in China and a decrease in gross
profit due to the adjustment made in the quarter ended June 30, 2003, for
previously recorded sales at our TWT joint venture. This adjustment reduced
earnings per share by $0.02 in the six months ended June 30, 2003. Corporate
expenses are primarily for compensation expense, professional fees, including
legal and audit expenses, product and general liability insurances. The increase
in corporate expenses is primarily due to increased professional fees and
pension expenses.

Interest Expense. Interest expense increased $775,000 (18.8%) in the six months
ended June 30, 2003 to $4,904,000 compared to $4,129,000 for the same period in
2002, primarily due to the inclusion of the $125,000,000 senior notes which we
issued on May 15, 2003. On September 1, 2001, we entered into an interest rate
swap with respect to our $75,000,000 8 3/8% 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 six months ended June 30, 2003, we
reduced interest expense by $786,000 by amortizing the adjustment to the fair
value. In the six months ended June 30, 2002, we reduced interest expense by
$991,000 for the effectiveness of the swap.

Income Taxes. Our effective tax rate for continuing operations for the six
months ended June 30, 2003 increased to 36.9% from 35.0% for the six months
ended June 30, 2002. The increase is primarily due to an increase in our
domestic state tax rate and increased losses in China, which we are unable to
tax benefit because the majority of the Chinese entities are in a tax holiday.

Income From Continuing Operations. Income from continuing operations for the six
months ended June 30, 2003 increased $927,000 (5.6%) to $17,616,000, or $0.65
per common share, compared to $16,689,000, or $0.62 per common share, for the
six months ended June 30, 2002, in each case, on a diluted basis.

Loss From Discontinued Operations. We recorded a charge net of tax to
discontinued operations for the six months ended June 30, 2003 of $2,900,000, or
($0.11) per common share on a diluted basis. The charge is primarily


22


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 II, Item 1, "Legal
Proceedings".

Liquidity and Capital Resources

During the six-month period ended June 30, 2003, we utilized $5,846,000 of
cash for continuing operations. This utilization was primarily due to increased
inventories and accounts receivable, in both North America and Europe, and
pension contributions of $3,690,000 in the six-month period ended June 30, 2003.
The increase in inventory in North America is primarily due to planned increases
in imported raw materials and finished goods, as well as an increase in
inventory to support increased retail business. The increase in inventory in
Europe is primarily due to safety stock growth to cover planned distribution
relocations and plant summer shutdowns. The increase in accounts receivable is
due to increased sales volume in Europe, which typically has longer payment
terms, and timing of certain cash receipts that is consistent with last year and
increased volume in North America.

We spent $8,526,000 on capital equipment for the six months ended June 30,
2003, net of proceeds from sales of property, plant and equipment of $172,000.
Capital expenditures were primarily for manufacturing machinery and equipment as
part of our ongoing commitment to improve our manufacturing capabilities. Our
net capital expenditure budget for the twelve months ending December 31, 2003 is
$15,536,000, which takes into account the expected proceeds from the sale of one
of our facilities that was closed as part of our manufacturing restructuring
plan. The two largest components of this budget are for a building to be added
to our joint venture facility in Taizhou, China and for additional machinery and
equipment for our wholly-owned bronze and brass manufacturing plant in Tianjin,
China.

On January 29, 2003, we made our final payment of $3,040,000 associated
with our Cheng Guan joint venture. Prior to this payment, we had invested
approximately $5,000,000. This joint venture is owned 60% by us and 40% by our
Chinese partner. In addition, on April 18, 2003, we invested approximately
$1,300,000 to acquire Martin Orgee UK Limited.

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. The net proceeds from the private placement are being used to repay our
$75,000,000 principal amount of 8 3/8% Notes due December 2003 and 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
Watts Industries, Inc., our parent holding company, and are structurally
subordinated to our revolving credit facility, which is at the subsidiary level.
The senior unsecured notes require compliance with a fixed charge coverage
ratio, allow us to have debt senior to the new notes in an amount up to 5% of
stockholders' equity and, assuming compliance with the coverage ratio, allow us
to incur unlimited amounts of debt pari passu or junior to the senior unsecured
notes. 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, we 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 (U.S.), 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
June 30, 2003, long-term debt included $41,144,000 outstanding on the Revolving
Credit Facility for euro-based borrowings and no amounts were outstanding for
U.S. dollar borrowings.

Effective July 1, 2003, we entered into an interest rate swap for a
notional amount of 25,000,000 euro 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 term of the swap is two
years.

Outstanding indebtedness under the Revolving Credit Facility bears
interest at one of three customary rates plus a margin of 100 basis points,
depending on the applicable base rate and our bond rating. The average interest
rate


23


for borrowings under the Revolving Credit Facility was approximately 2.9% at
June 30, 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 June 30, 2003, we were in compliance with all
covenants related to the Revolving Credit Facility.

During the six-month period ended June 30, 2003, we received $3,139,000 in
cash as an indemnification payment for costs we incurred in the James Jones
case. This cash has been recorded as a liability at June 30, 2003. We also
received $1,760,000 in cash for reimbursement of defense costs related to the
James Jones case.

Working capital (defined as current assets less current liabilities) as of
June 30, 2003 was $210,061,000 compared to $71,384,000 as of December 31, 2002.
This increase is primarily due to the funds received from the $125,000,000
private placement and an increase in accounts receivable and inventory. The
ratio of current assets to current liabilities was 1.9 to 1 as of June 30, 2003
compared to 1.3 to 1 as of December 31, 2002. Cash and cash equivalents were
$35,293,000 as of June 30, 2003 compared to $10,973,000 as of December 31, 2002.
Restricted treasury securities of $77,834,000 as of June 30, 2003 is required
for the repayment of principal of, and interest on, our $75,000,000 8 3/8% notes
due December 1, 2003. Our total debt increased to $264,788,000 as of June 30,
2003 from $138,487,000 as of December 31, 2002 primarily due to our $125,000,000
private placement.

We anticipate that available funds from current operations and other
sources of liquidity will be sufficient to meet current operating requirements
and anticipated capital expenditures for at least the next 12 months. However,
we may have to consider external sources of financing for any large future
acquisitions.

Our long-term financial obligations as of June 30, 2003 are presented in
the following table:



Less than After
Total 1 year 1-3 years 4-5 years 5 years
----- ------ --------- --------- -------
(in thousands)

Long-term debt, including current
maturities(a) ................... $264,788 $87,660 $49,453 $1,161 $126,514
Operating leases ................... 6,862 960 2,008 1,365 2,529
Capital leases ..................... 1,392 393 744 255 --
-------- ------- ------- ------ --------
Total .............................. $273,042 $89,013 $52,205 $2,781 $129,043
======== ======= ======= ====== ========


(a) as recognized in the unaudited consolidated balance sheet

Letters of credit are purchased guarantees that ensure our performance or
payment to third parties in accordance with specified terms and conditions.
Amounts outstanding were approximately $30,671,000 as of June 30, 2003 and
$19,522,000 as of December 31, 2002. These instruments may exist or expire
without being drawn down. Therefore, they do not necessarily represent future
cash flow obligations.

Certain of our loan agreements contain covenants that require, among other
items, the maintenance of certain financial ratios and limit our ability to
enter into secured borrowing arrangements.

We from time to time are involved with environmental proceedings and other
legal proceedings and incur costs on an ongoing basis related to these matters.
We have not incurred material costs that have not been reimbursed in fiscal 2003
in connection with any of these matters.

Critical Accounting Policies and Key Estimates

The preparation of our financial statements in accordance with accounting
principles generally accepted in the United States (GAAP) requires us to make
judgments, assumptions and estimates that affect the amounts reported. A
critical accounting estimate is an assumption about highly uncertain matters and
could have a material effect on the 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 assumption on historical experience and on
other estimates that we believe are reasonable


24


under the circumstances. Actual results could differ significantly from these
estimates. See Note 2 of Notes to Consolidated Financial Statements in our
Annual Report on Form 10-K for the year ended December 31, 2002 that describes
the significant accounting policies utilized in the preparation of the
consolidated financial statements.

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

Allowance for doubtful accounts

We encounter risks associated with the collectibility of customer
accounts. Management specifically analyzes individual accounts receivable,
historical bad debts and allowances, concentration of receivables by customer,
customer credit worthiness, current economic trends and changes in customer
payment terms when evaluating the allowance for doubtful accounts. These factors
along with the aging of the accounts receivable are used in determining the
adequacy of the allowance. If circumstances relating to specific customers
change, our estimates of the recoverability of receivables could be further
adjusted.

Inventory valuation

Inventories are generally stated at the lower of cost or market with costs
determined on a first-in, first-out basis. We utilize our historical experience
as the basis for determining the value of our excess or obsolete inventories.
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.

Legal contingencies

We are a defendant in numerous legal matters including those involving
environmental law and product liability as discussed in Note 15 of Notes to
Consolidated Financial Statements in our Annual Report on Form 10-K for the year
ended December 31, 2002 and Note 11 to Form 10-Q. As required by Financial
Accounting Standards Board Statement No. 5 "Accounting for Contingencies", 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. We develop our
estimates in consultation with outside counsel handling our defense in these
matters, which involves an analysis of potential results. Final settlement of
these matters could result in significant effects on the Company's results of
operations, cash flows and financial position.

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. The valuation of goodwill and intangible
assets is reviewed for impairment annually in accordance with FAS 142.
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.
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. The annual goodwill impairment test involves the use of
estimates related to the fair market value of the business unit with which the
goodwill is associated. The value is estimated using the future cash flow
valuation methodology. 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.

Business combinations

In addition to the requirements set forth in Financial Accounting
Standards Board Statement No. 141 "Business Combinations" (FAS 141) regarding
intangible assets, it is necessary to make other estimates relating to the
assets acquired, liabilities assumed, and assumptions of future growth of the
acquired companies. There are no assurances that such estimates or assumptions
will be accurate.


25


Pension benefits

The calculation of employee pension benefit costs and obligations by
actuaries are dependent on our assumptions. These assumptions include salary
growth, long-term return on plan assets, discount rates and other factors. The
key factors utilized by the actuaries are discussed in further detail in Note 14
of Notes to Consolidated Financial Statements in our Annual Report on Form 10-K
for the year ended December 31, 2002.

Income taxes

We recognize deferred tax liabilities and assets for the expected future
consequences of events that have been reflected in our consolidated financial
statements. We present our financials in accordance with the rules of Financial
Accounting Standards Board Statement No. 109 "Accounting for Income Taxes" (FAS
109). Deferred tax liabilities and assets 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.

New Accounting Standards

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 into in fiscal periods beginning after June 15, 2003. We
are currently evaluating the effect, if any, the provisions of EITF 00-21 will
have on our results of operations and financial condition.

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 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 is effective for all
new variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after June 15, 2003 (Q3 of fiscal 2003). We anticipate consolidating
Jameco International LLC in the third quarter of Fiscal 2003. Jameco
International, LLC imports and sells vitreous china, imported faucets and faucet
parts and imported bathroom accessories to the North American retail market. Its
annual sales for the twelve months ended December 31, 2002, were $16,685,000. We
have a 49% interest in Jameco LLC and are currently consolidating its earnings
in minority interest. For this reason we do not anticipate any change in our
earnings for the adoption of FIN 46.

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 do not believe that the adoption of FAS 149 will have a
material effect on our results of operations and financial condition.

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 all 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, except for mandatorily redeemable financial instruments of nonpublic
entities. For nonpublic entities, mandatorily redeemable financial instruments
are subject to the provisions of this


26


Statement for the first fiscal period beginning after December 15, 2003. We are
currently evaluating the effect, if any, the provisions of FAS 150 will have on
our results of operations and financial condition.

Item 3. Quantitative and Qualitative Disclosures about Market Risks
-----------------------------------------------------------

We use derivative financial instruments primarily to reduce our exposure
to adverse fluctuations in foreign exchange rates, interest rates and prices of
certain raw materials used in the manufacturing process. We do not enter into
derivative financial instruments for trading purposes. As a matter of policy,
all derivative positions are used to reduce risk by hedging underlying economic
exposure. The derivatives we use are instruments with liquid markets.

Our consolidated earnings, which are reported in U.S. dollars, are subject
to translation risks due to changes in foreign currency exchange rates. However,
our overall exposure to such fluctuations is reduced by the diversity of our
foreign operating locations which encompass a number of different European
locations, Canada and China.

Our foreign subsidiaries transact most business, including certain
intercompany transactions, in foreign currencies. Such transactions are
principally purchases or sales of materials and are denominated in European
currencies or the U.S. or Canadian dollar. We use foreign currency forward
exchange contracts to manage the risk related to intercompany purchases that
occur during the course of a fiscal year and certain open foreign currency
denominated commitments to sell products to third parties. At June 30, 2003, we
maintained an insignificant amount in notional value of Canadian currency
forward contracts. As such, with any change in the Canadian exchange rate we do
not expect a material impact on our consolidated financial statements.

We have historically had a very low exposure to changes in interest rates.
Interest rate swaps are used on a limited basis to mitigate the impact of
interest rate fluctuations on certain variable rate debt instruments. However,
our Revolving Credit Facility is subject to the impact of changes in interest
rates. Based on our full repayment of the U.S. dollar borrowing, our remaining
outstanding variable rate debt on the revolving credit facility of $41,144,000
is for euro-based borrowings.

We purchase significant amounts of bronze ingot, brass rod and cast iron,
which are utilized in manufacturing our many product lines. Our operating
results can be adversely affected by changes in commodity prices if we are
unable to pass on related price increases to our customers. We manage this risk
by monitoring related market prices, working with our suppliers to achieve the
maximum level of stability in their costs and related pricing, seeking
alternative supply sources when necessary and passing increases in commodity
costs to our customers, to the maximum extent possible, when they occur.
Additionally, on a limited basis, we use commodity futures contracts to manage
this risk.

Certain Factors Affecting Future Results

This report includes statements which are not historical facts and are
considered forward looking within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward looking statements reflect the
Company's current views about future results of operation and other forward
looking information and may be identified by their use of words like "plan",
"believe", "expect", "will", "anticipate", "estimate" and other words of similar
meaning. You should not rely on forward looking statements, because the
Company's actual results may differ materially from those indicated by these
forward looking statements as a result of a number of important factors. These
factors include, but are not limited to, the following: loss of market share
through competition, introduction of competing products by other companies,
pressure on prices from competitors, suppliers, and/or customers, failure or
delay in developing new products, lack of acceptance of new products, failure to
successfully implement the Company's acquisition strategy; foreign exchange rate
fluctuations, risks associated with international sales and operations,
including China; reductions or interruptions in the supply of raw materials,
increases in the prices of raw materials, economic factors, such as the levels
of housing starts and remodeling, impacting the markets where the Company's
products are sold, manufactured, or marketed, environmental compliance costs,
product liability risks, loss of a major customer; the results and timing of the
Company's manufacturing restructuring plan, changes in the status of current
litigation, including the James Jones case, and other risks and uncertainties
discussed under "Managements Discussion and Analysis of Financial Condition and
Results of Operation - Certain Factors Affecting Future Results" in the


27


Company's Annual Report on Form 10-K for the year ended December 31, 2002 filed
with the Securities Exchange Commission and other reports Watts files from time
to time with the Securities and Exchange Commission.

Item 4. Controls and Procedures
-----------------------

As required by Rule 13a-15 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 the 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 to ensure 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. In connection with the new 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.


28


Part II
- -------

Item l. Legal Proceedings
-----------------

James Jones Litigation

As previously disclosed, on June 25, 1997, Nora Armenta (the Relator) sued
James Jones Company, Watts Industries, 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, 14 of the total number of plaintiffs have intervened.

The First Amended Complaint alleges that our former subsidiary (James
Jones Company) sold products that did not meet contractually specified standards
used by the named municipalities for their water systems and falsely certified
that such standards had been met. The Relator claims that these municipalities
were damaged by their purchase of these products and seeks treble damages, legal
costs, attorneys' fees and civil penalties under the False Claims Act.

The LADWP's intervention, filed on December 9, 1998, adopted the First
Amended Complaint and added claims for breach of contract, fraud and deceit,
negligent misrepresentation and unjust enrichment. The LADWP also sought past
and future reimbursement costs, punitive damages, contract difference in value
damages, treble damages, civil penalties under the False Claims Act and costs of
the suit.

One of the First Amended Complaint's allegations is the suggestion that
because some of the purchased James Jones products are out of specification and
contain more lead than the `85 bronze specified, a risk to public health might
exist. This contention is predicated on the average difference of about 2% lead
content in `81 bronze (6% to 8% lead) and `85 bronze (4% to 6% lead) alloys and
the assumption that this would mean increased consumable lead in public drinking
water. The evidence and discovery available to date indicate that this is not
the case.

In addition, bronze that does not contain more than 8% lead, like `81
bronze, is approved for municipal and home plumbing systems by municipalities
and national and local codes, and the Federal Environmental Protection Agency
defines metal for pipe fittings with no more than 8% lead as "lead free" under
Section 1417 of the Federal Safe Drinking Water Act.

In June 2001, 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. An additional offer was made on May 8, 2003, for $13 million
($11 million from us and $2 million from the James Jones Company), plus payment
of Relator's attorney's fees, 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 to be tried first. This offer included
the Relator's statutory share. These three cities have accepted this $13 million
offer, and the terms of this settlement have been approved by the California
Superior Court. The settlement provides that the claims of these three cities
will be dismissed upon payment of these settlement funds.


29


After we settled with the City of Los Angeles, the Relator made an offer
to settle the balance of this case for $121.9 million, which has been rejected.
We have a reserve in the amount of $12.8 million after-tax with respect to the
James Jones Litigation in our consolidated balance sheet as of June 30, 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. Zurich has
subsequently paid us approximately $11.3 million for defense costs. 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, and, since then, Zurich has
paid us approximately $3.1 million in compliance with this order. 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 us and Zurich. We have recorded reimbursed indemnity
settlement amounts (but not reimbursed defense costs) as a liability. 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
outcome of the litigation relating to the Los Angeles indemnification coverage.
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, and
the actual liability to us to fully resolve this litigation cannot be predicted
with any certainty. We intend to continue to contest vigorously the James Jones
case and its related litigation.

Asbestos Litigation

As of June 30, 2003, we are a defendant in approximately 100 actions filed
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 ours as a source of asbestos exposure. Based on the facts
currently know to it, we do not believe that the ultimate outcome of these
filings will have a material effect on our liquidity, financial condition or
results of operations.

Other Litigation

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 other litigation matters will have a
material adverse effect on its financial condition or results of operation.

However, litigation is inherently uncertain, and we believe that there
exists a reasonable possibility that we may ultimately incur losses in the James
Jones Litigation and other litigation in excess of the amount accrued.


30


Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------

(a) The Annual Meeting of Stockholders of the Company was held on May 20,
2003.

(b) The results of the voting on the proposals considered at the Annual
Meeting of Stockholders were as follows:

1. Election of Directors
---------------------

Each of the following persons were elected as a Directors of the Company
for a term expiring at the Company's 2004 Annual Meeting of Stockholders
and until such Director's successor is duly elected and qualified.

The voting results were as follows:

DIRECTOR VOTES FOR VOTES WITHHELD
-------- --------- --------------
Timothy P. Horne 94,612,069 3,450,925
Kenneth J. McAvoy 93,979,480 4,083,514
John K. McGillicuddy 97,853,388 209,606
Gordon W. Moran 97,815,956 247,038
Daniel J. Murphy, III 97,817,996 244,998
Patrick S. O'Keefe 94,544,039 3,518,955
Roger A. Young 97,825,056 237,938

2. Ratification of Independent Auditors
------------------------------------

The selection of KPMG LLP as the independent auditors of the Company for
the current fiscal year was ratified and the voting results were as
follows:

97,665,451 votes FOR 357,225 votes AGAINST 40,318 votes ABSTAINED

3. Approval of the Watts Industries, Inc. 2003 Non-Employee Directors'
-------------------------------------------------------------------
Stock Option Plan
-----------------

The Watts Industries, Inc. 2003 Non-Employee Directors' Stock Option Plan
was approved and the voting results were as follows:

96,823,034 votes FOR 1,202,017 votes AGAINST 37,943 votes ABSTAINED


31


Item 6. Exhibits and Reports on Form 8-K
--------------------------------

(a) The exhibits are furnished elsewhere in this report.

(b) Reports filed on Form 8-K during the Quarter ended June 30, 2003.

We filed a Form 8-K on May 6, 2003, under Item 9, reporting that we issued
a press release announcing our financial results for the quarter ended
March 31, 2003 and furnishing the press release as an Exhibit.

We filed a Form 8-K on May 15, 2003, under Item 5, reporting that we
issued a press release announcing the completion of 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 filed the press release, Form of 4.87%
Senior Notes due 2010, Form of 5.47% Senior Notes due 2013, and the Note
Purchase Agreement dated as of May 15, 2003, as Exhibits.

We filed a Form 8-K on May 19, 2003, under Item 5, reporting that Mr.
Timothy P. Horne, a member of our Board of Directors, our controlling
stockholder, and our former Chief Executive Officer, President and
Chairman, established pre-arranged plans to sell shares of our Class A
Common Stock in accordance with Rule 10b5-1 under the Securities Exchange
Act of 1934.


32


SIGNATURES
----------

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

WATTS INDUSTRIES, INC.


Date: August 13, 2003 By: /s/ Patrick S. O'Keefe
--------------- ----------------------
Patrick S. O'Keefe
Chief Executive Officer


Date: August 13, 2003 By: /s/ William C. McCartney
--------------- ------------------------
William C. McCartney
Chief Financial Officer and Treasurer


33


EXHIBIT INDEX
-------------

Listed and indexed below are all Exhibits filed as part of this report.

Exhibit No. Description
- ----------- -----------

3.1 Restated Certificate of Incorporate, as amended (1)

3.2 Amended and Restated By-Laws, as amended July 24, 2002 (1)

10.1 First Amendment dated as of March 28, 2003 to Revolving Credit
Agreement, dated as of February 28, 2002, by and among Watts
Regulator Co., Watts Industries Europe B.V., Fleet National Bank
and the lenders listed therein.*

10.2 Ratification of Guaranty by Guarantors of the Revolving Credit
Agreement dated as of February 28, 2002.*

10.3 Note Purchase Agreement, dated as of May 15, 2003, among Watts
Industries, Inc., and the purchasers named therein. (2)

10.4 Form of 4.87% Senior Note due 2010. (2)(3)

10.5 Form of 5.47% Senior Note due 2013. (2)(4)

11 Computation of Earnings per Share (5)

31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Ac
of 2002.*

31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.*

32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.*

32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.*

- ----------
*Filed as an Exhibit to this Quarterly Report on Form 10-Q.

(1) Incorporated by reference to the relevant exhibit 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 relevant exhibit to the
Registrant's Form 8-K Current Report filed with the
Securities and Exchange Commission on May 15, 2003.

(3) This Senior Note is substantially similar on all
material respects to all other 4.87% Senior Notes due
2010.

(4) This Senior Note is substantially similar on all
material respects to all other 5.47% Senior Notes due
2013.

(5) Incorporated by reference to the Note 6 to the Notes to
Consolidated Financial Statements included in this
Report.


34