Edgar Filing: WATTS WATER TECHNOLOGIES INC

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

FORM 10-Q

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

		For the quarterly period ended October 1, 2006

		or

o		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 001-11499

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

Delaware		04-2916536
(State or other jurisdiction of incorporation or organization)		(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

(Former Name, Former Address and Former Fiscal year, if changed since last report.)

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 o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated filer x Accelerated filer o Non-Accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

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

Class		Outstanding at October 31, 2006
Class A Common Stock, $.10 par value		25,440,882

Class B Common Stock, $.10 par value		7,293,880

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

INDEX

Part I. Financial Information

Item 1. Financial Statements

Consolidated Balance Sheets at October 1, 2006 and December 31, 2005 (unaudited)

Consolidated Statements of Operations for the Third Quarters Ended October 1, 2006 and October 2, 2005 (unaudited)

Consolidated Statements of Operations for the Nine Months Ended October 1, 2006 and October 2, 2005 (unaudited)

Consolidated Statements of Cash Flows for the Nine Months Ended October 1, 2006 and October 2, 2005 (unaudited)

Notes to Consolidated Financial Statements

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

Part II. Other Information

Item 1. Legal Proceedings

Item 1A. Risk Factors

Item 6. Exhibits

Signatures

Exhibit Index

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share information)
(Unaudited)

	October 1, 2006			December 31, 2005
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	116,621		$	45,758
Trade accounts receivable, less allowance for doubtful accounts of $10,733 at October 1, 2006 and $9,296 at December 31, 2005	237,707			177,364
Inventories, net:
Raw materials	102,152			84,087
Work in process	44,860			23,201
Finished goods	166,258			135,549
Total Inventories	313,270			242,837
Prepaid expenses and other assets	20,610			25,361
Deferred income taxes	37,303			27,540
Assets of discontinued operations	10,072			9,555
Total Current Assets	735,583			528,415
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, at cost	383,992			328,812
Accumulated depreciation	(179,960		)	(163,813		)
Property, plant and equipment, net	204,032			164,999
OTHER ASSETS:
Goodwill	349,595			296,636
Other, net	145,824			110,920
TOTAL ASSETS	$	1,435,034		$	1,100,970

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	110,619		$	91,053
Accrued expenses and other liabilities	105,151			67,071
Accrued compensation and benefits	38,391			28,496
Current portion of long-term debt	7,616			13,635
Liabilities of discontinued operations	27,940			23,068
Total Current Liabilities	289,717			223,323
LONG-TERM DEBT, NET OF CURRENT PORTION	457,981			293,350
DEFERRED INCOME TAXES	42,611			24,803
OTHER NONCURRENT LIABILITIES	50,585			32,187
MINORITY INTEREST	7,559			7,831

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: 25,440,882 shares at October 1, 2006 and 25,205,210 shares at December 31, 2005	2,544			2,521
Class B Common Stock, $.10 par value; 25,000,000 shares authorized; 10 votes per share; issued and outstanding: 7,293,880 shares at October 1, 2006 and 7,343,880 shares at December 31, 2005	729			734
Additional paid-in capital	146,829			142,694
Retained earnings	414,882			368,264
Accumulated other comprehensive income	21,597			5,263
Total Stockholders’ Equity	586,581			519,476
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,435,034		$	1,100,970

See accompanying notes to consolidated financial statements.

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share information)
(Unaudited)

	Third Quarter Ended
	October 1, 2006			October 2, 2005
Net sales	$	325,137		$	232,729
Cost of goods sold	213,218			152,916
GROSS PROFIT	111,919			79,813
Selling, general & administrative expenses	75,549			56,904
Restructuring and other charges	332			4
OPERATING INCOME	36,038			22,905
Other (income) expense:
Interest income	(1,150		)	(243		)
Interest expense	6,520			2,579
Minority interest	(273		)	106
Other	(560		)	(369		)
	4,537			2,073
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	31,501			20,832
Provision for income taxes	10,177			7,393
INCOME FROM CONTINUING OPERATIONS	21,324			13,439
Loss from discontinued operations, net of taxes	(3,137		)	(71		)
NET INCOME	$	18,187		$	13,368

BASIC EPS
Income per share:
Continuing operations	$	.65		$	.41
Discontinued operations	(.10		)	—
NET INCOME	$	.56		$	.41
Weighted average number of shares	32,707			32,525

DILUTED EPS
Income per share:
Continuing operations	$	.65		$	.41
Discontinued operations	(.09		)	—
NET INCOME	$	.55		$	.40
Weighted average number of shares	33,051			33,062

Dividends per share	$	.09		$	.08

See accompanying notes to consolidated financial statements.

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share information)
(Unaudited)

	Nine Months Ended
	October 1, 2006			October 2, 2005
Net sales	$	900,262		$	679,939
Cost of goods sold	586,166			441,565
GROSS PROFIT	314,096			238,374
Selling, general & administrative expenses	218,399			169,496
Restructuring and other charges	(5,109		)	462
OPERATING INCOME	100,806			68,416
Other (income) expense:
Interest income	(2,459		)	(881		)
Interest expense	15,664			7,667
Minority interest	(131		)	243
Other	(1,946		)	(546		)
	11,128			6,483
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	89,678			61,933
Provision for income taxes	30,724			22,109
INCOME FROM CONTINUING OPERATIONS	58,954			39,824
Loss from discontinued operations, net of taxes	(3,358		)	(185		)
NET INCOME	$	55,596		$	39,639

BASIC EPS
Income per share:
Continuing operations	$	1.81		$	1.23
Discontinued operations	(.10		)	(.01		)
NET INCOME	$	1.70		$	1.22
Weighted average number of shares	32,651			32,470

DILUTED EPS
Income per share:
Continuing operations	$	1.79		$	1.21
Discontinued operations	(.10		)	(.01		)
NET INCOME	$	1.68		$	1.20
Weighted average number of shares	33,027			33,006

Dividends per share	$	.27		$	.24

See accompanying notes to consolidated financial statements.

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)

	Nine Months Ended
	October 1, 2006			October 2, 2005
OPERATING ACTIVITIES
Income from continuing operations	$	58,954		$	39,824
Adjustments to reconcile net income from continuing operations to net cash provided by (used in) continuing operating activities:
Depreciation	20,123			18,238
Amortization	5,456			1,730
Stock-based compensation	2,077			—
Deferred income taxes	(8,041		)	(1,700		)
(Gain) loss on disposal of property, plant and equipment	(6,539		)	465
Other	(669		)	41
Changes in operating assets and liabilities, net of effects from business acquisitions and divestitures:
Accounts receivable	(29,879		)	(24,295		)
Inventories	(38,810		)	(21,287		)
Prepaid expenses and other assets	(3,180		)	(3,556		)
Accounts payable, accrued expenses and other liabilities	33,919			10,559
Net cash provided by operating activities	33,411			20,019

INVESTING ACTIVITIES
Additions to property, plant and equipment	(35,348		)	(13,816		)
Proceeds from the sale of property, plant and equipment	27,615			130
Proceeds from maturity of securities	—			26,600
Increase in other assets	(663		)	(221		)
Business acquisitions, net of cash acquired	(93,027		)	(46,846		)
Net cash used in investing activities	(101,423		)	(34,153		)

FINANCING ACTIVITIES
Proceeds from long-term borrowings	356,566			33,279
Payments of long-term debt	(206,962		)	(21,955		)
Proceeds from exercise of stock options	1,825			2,810
Tax benefit of options exercised	251			—
Debt issue costs	(2,377		)	—
Payment of capital lease	(3,876		)	—
Dividends	(8,977		)	(7,828		)
Net cash provided by financing activities	136,450			6,306
Effect of exchange rate changes on cash and cash equivalents	1,427			(316		)
Net cash provided by (used in) operating activities of discontinued operations	998			(893		)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	70,863			(9,037		)
Cash and cash equivalents at beginning of period	45,758			65,913
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	116,621		$	56,876

NON CASH INVESTING AND FINANCING ACTIVITIES
Acquisition of businesses:
Fair value of assets acquired	$	158,707		$	53,568
Cash paid, net of cash acquired	(93,027		)	(46,846		)
Liabilities assumed	$	65,680		$	6,722

Acquisitions of fixed assets under capital lease	$	15,957		$	—
Retirement of variable rate demand bonds with cash collateral	$	8,900		$	—

CASH PAID FOR
Interest	$	10,989		$	5,187
Taxes	$	31,783		$	21,179

See accompanying notes to consolidated financial statements.

WATTS WATER TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included in Watts Water Technologies, Inc.’s Consolidated Balance Sheet as of October 1, 2006, its Consolidated Statements of Operations for the third quarter and nine months ended October 1, 2006 and the third quarter and nine months ended October 2, 2005, and its Consolidated Statements of Cash Flows for the nine months ended October 1, 2006 and the nine months ended October 2, 2005.

The balance sheet at December 31, 2005 has been derived from the audited financial statements at that date. The accounting policies followed by the Company are described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005. The financial statements included in this report should be read in conjunction with the financial statements and notes included in the Annual Report on Form 10-K for the year ended December 31, 2005. Operating results for the interim period presented are not necessarily indicative of the results to be expected for the year ending December 31, 2006.

The Company operates on a 52-week fiscal year ending on December 31. Any third quarter ended data contained in this Report on Form 10-Q reflects the results of operations for the 13-week period ended on the Sunday nearest September 30 of the respective year.

Certain amounts in fiscal year 2005 have been reclassified to permit comparison with the 2006 presentation. These reclassifications had no effect on reported results of operations or stockholders’ equity.

2. Accounting Policies

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.

Goodwill and Long-Lived Assets

The changes in the carrying amount of goodwill by geographic segment from December 31, 2005 to October 1, 2006 are as follows:

	North America		Europe		China		Total
	(in thousands)

Carrying amount at the beginning of period	$	193,597	$	97,438	$	5,601	$	296,636
Goodwill acquired during the period	—		38,457		5,973		44,430
Adjustments to goodwill during the period	883		—		—		883
Effect of change in exchange rates used for translation	205		7,243		198		7,646
Carrying amount at end of period	$	194,685	$	143,138	$	11,772	$	349,595

Other intangible assets include the following and are presented in “Other Assets: Other, net”, in the October 1, 2006 Consolidated Balance Sheet:

	Gross Carrying Amount		Accumulated Amortization
	(in thousands)

Patents	$	13,348	$	(5,096	)
Other	83,361		(9,728		)
Total amortizable intangibles	96,709		(14,824		)
Intangible assets not subject to amortization	51,458		—
Total	$	148,167	$	(14,824	)

Aggregate amortization expense for amortized other intangible assets for the third quarters of 2006 and 2005 was $2,261,000 and $693,000, respectively, and for the nine-month periods of 2006 and 2005 was $5,456,000 and $1,730,000, respectively. Additionally, future amortization expense on other intangible assets will be approximately $2,365,000 for the remainder of 2006, $9,081,000 for 2007, $8,011,000 for 2008, $7,723,000 for 2009 and $7,689,000 for 2010. Amortization expense is calculated on a straight-line basis over the estimated useful lives of the intangible assets. The weighted-average remaining life of total amortizable intangibles is 12.4 years. Patents and other amortizable intangibles have weighted-average remaining lives of 11.0 years and 12.6 years, respectively. Other amortizable intangibles primarily include customer relationships and non-compete agreements. Intangible assets not subject to amortization primarily include trademarks and unpatented technology.

Stock-Based Compensation

The Company maintains four stock incentive plans under which key employees and outside directors have been granted outstanding incentive stock options (ISOs) and nonqualified stock options (NSOs) to purchase the Company’s Class A Common Stock. Only one plan, the 2004 Stock Incentive Plan, is currently available for the grant of new equity awards. Stock options granted under prior plans became exercisable over a five-year period at the rate of 20% per year and expire ten years after the date of grant. Under the 2004 Stock Incentive Plan, options become exercisable over a four -year period at the rate of 25% per year and expire ten years after the grant date. ISOs and NSOs granted under the plans may have exercise prices of not less than 100% and 50% of the fair market value of the common stock on the date of grant, respectively. The Company’s current practice is to issue all options at fair market value on the grant date.

The Company has also granted shares of restricted stock to key employees and non-employee members of the Company’s Board of Directors under the 2004 Stock Incentive Plan, which vest over three years. The restricted stock awards are amortized to expense on a straight-line basis over the vesting period.

The Company also has a Management Stock Purchase Plan that allows for the purchase of Restricted Stock Units (RSUs) by key employees of up to an aggregate of 1,000,000 shares of Class A Common Stock at 67% of the fair market value on the date of grant. RSUs vest annually over a three-year period from the date of grant.

A more detailed description of each of these stock and stock option plans can be found in Note 13 of Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2005.

Effective January 1, 2006, the Company adopted Financial Accounting Standards Board Statement No. 123R, “Share-Based Payment”(FAS 123R) utilizing the “modified prospective” method as described in FAS 123R. Under the “modified prospective” method, compensation cost is recognized for all share-based payments granted after the effective date and for all unvested awards granted prior to the effective date. In accordance with FAS 123R, prior period amounts were not restated. FAS 123R also requires the tax benefits associated with these share-based payments to be classified as financing activities in the Statements of Consolidated Cash Flows, rather than as operating cash flows as required under previous regulations. At October 1, 2006, the Company had three stock-based compensation plans with total unrecognized compensation costs related to unvested stock-based compensation arrangements of approximately $8,164,000 and a total weighted average remaining term of 2.3 years. For the third quarter and first nine months of 2006, the Company recognized compensation costs related to stock-based programs of approximately $862,000 and $2,077,000, respectively, in selling, general and administrative expenses. The Company recorded approximately $30,000 of tax benefit during the third quarter and first nine months of 2006 for the compensation expense relating to its stock options. For the third quarter and nine months ended October 1, 2006, the Company recorded approximately $173,000 and $404,000 of tax benefit for its other stock-based plans. The recognition of total stock-based compensation expense impacted both basic net income per common share and diluted net income per common share by $0.02 during the third quarter. For the nine months ended October 1, 2006, the recognition of total stock-based compensation expense impacted both basic net income per common share and diluted net income per common share by $0.05.

Prior to the effective date, the stock-based compensation plans were accounted for under Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Pro-forma information regarding the impact of total stock-based compensation on net income and income per share for prior periods is required by FAS 123R.

Such pro-forma information, determined as if the Company had accounted for its employee stock options and RSUs under 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) during the third quarter and nine months ended October 2, 2005, is illustrated in the following tables:

	Third Quarter Ended
	October 2, 2005
	(amounts in thousands, except per share information)
Net income, as reported	$	13,368
Add: Stock-based employee compensation expense from the Management Stock Purchase Plan included in reported net income, net of tax	117
Deduct: Stock-based employee compensation expense determined under the fair value method, net of tax:
Restricted stock units (Management Stock Purchase Plan)	(159		)
Employee stock options	(427		)
Pro-forma net income	$	12,899

Earnings per share:
Basic-as reported	$	.41
Basic-pro-forma	$	.40
Diluted-as reported	$	.40
Diluted-pro-forma	$	.39

	Nine Months Ended
	October 2, 2005
	(amounts in thousands, except per share information)
Net income, as reported	$	39,639
Add: Stock-based employee compensation expense from the Management Stock Purchase Plan included in reported net income, net of tax	433
Deduct: Stock-based employee compensation expense determined under the fair value method, net of tax:
Restricted stock units (Management Stock Purchase Plan)	(477		)
Employee stock options	(597		)
Pro-forma net income	$	38,998

Earnings per share:
Basic-as reported	$	1.22
Basic-pro-forma	$	1.20
Diluted-as reported	$	1.20
Diluted-pro-forma	$	1.17

The fair value of each option granted under the 2004 Stock Incentive Plan is estimated on the date of grant, using the Black-Scholes-Merton Model, based on the following weighted average assumptions for the first nine months of 2006 and 2005:

	Nine months Ended
	October 1, 2006		October 2, 2005

Expected life (years)	5.8		5.8
Risk-free interest rate	4.9	%	4.0	%
Volatility	35.9	%	36.2	%
Dividend yield	1.0	%	1.0	%

There were 163,500 and 260,000 options issued under the 2004 Stock Incentive Plan in the third quarters of 2006 and 2005, respectively.

The fair value of each share issued under the Management Stock Purchase Plan is estimated on the date of grant, using the Black-Scholes-Merton Model, based on the following weighted average assumptions for the first nine months of 2006 and 2005:

	Nine months Ended
	October 1, 2006		October 2, 2005

Expected life (years)	3.0		3.0
Risk-free interest rate	4.5	%	3.4	%
Volatility	25.7	%	26.0	%
Dividend yield	1.5	%	1.4	%

There were 87,125 and 120,036 RSUs issued under the Management Stock Purchase Plan in the first quarters of 2006 and 2005, respectively. There were no RSUs issued in the second and third quarters of 2006 or 2005.

The risk-free interest rate is based upon the U.S. Treasury yield curve at the time of grant for the respective expected life of the option. The expected life (estimated period of time outstanding) of options and volatility were calculated using historical data. The expected dividend yield of stock is the Company’s best estimate of the expected future dividend yield. The Company applied an estimated forfeiture rate of 15% for its stock options and 10% for its RSUs. These rates were calculated based upon historical activity and are an estimate of granted shares not expected to vest. If actual forfeitures differ from the expected rates, the Company may be required to make additional adjustments to compensation expense in future periods.

The above assumptions were used to determine the weighted average grant-date fair value of stock options of $13.50 and $11.54 during the first nine months of 2006 and 2005, respectively. Also, the weighted average grant-date fair values of RSUs granted were $13.60 and $12.41 during the first nine months of 2006 and 2005, respectively.

The Company distributed dividends of $0.09 and $0.27 per share for the third quarter and first nine months of 2006, respectively, and $0.08 and $0.24 per share for the third quarter and first nine months of 2005, respectively, on the Company’s Class A Common Stock and Class B Common Stock.

2004 Stock Incentive Plan

For a description of the 2004 Stock Incentive Plan’s terms, see Note 13 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

There were 163,500 options issued during the first nine months of 2006 under the 2004 Stock Incentive Plan. At October 1, 2006, there were 1,191,896 options granted and outstanding to certain officers and key employees. There were 2,000 options forfeited during the first nine months of 2006. Total unrecognized compensation cost related to the unvested stock options was approximately $4,621,000 at October 1, 2006, and is being amortized on a straight-line basis over a five or four-year vesting period. For the third quarter and first nine months of 2006, the Company recognized compensation cost of $407,000 and $1,012,000, respectively, in selling, general and administrative expenses.

A summary of the Company’s stock option activity and related information for the first nine months of 2006 is shown in the following table:

	As of October 1, 2006
	Options		Weighted Average Exercise Price		Aggregate Intrinsic Value
	(options in thousands)
Outstanding at beginning of period	1,089		$	21.70
Granted	164		35.20
Cancelled	(2	)	32.07
Exercised	(59	)	17.41
Outstanding at end of period	1,192		$	23.75	$	8.01
Exercisable at end of period	586		$	18.88	$	12.88

As of October 1, 2006, the aggregate intrinsic values of outstanding and exercisable options were approximately $9,547,000 and $7,548,000, respectively, representing the total pre-tax intrinsic value, based on the Company’s closing Class A common stock price of $31.76 as of October 1, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. The total intrinsic value of options exercised for the first nine months of 2006 was approximately $1,106,000. Upon exercise of options, the Company issues shares of Class A common stock.

The following table summarizes information about options outstanding at October 1, 2006:

	Options Outstanding							Options Exercisable
Range of Exercise Prices	Number Outstanding		Weighted Average Remaining Contractual Life (years)		Weighted Average Exercise Price			Number Exercisable		Weighted Average Exercise Price
	(options in thousands)
$10.58		43		3.9		$	10.58		43		$	10.58
$11.75—$12.44		43		3.5		12.00			43		12.00
$15.40—$35.20		1,106		7.7		24.77			500		20.20
		1,192		7.4		$	23.75		586		$	18.88

Additionally at October 1, 2006, there were 74,067 unvested shares of restricted stock outstanding that were granted to key employees and the non-employee members of the Company’s Board of Directors. The Company issued 59,612 shares of restricted stock during the third quarter and first nine months ended October 1, 2006. At October 1, 2006, total unrecognized compensation cost related to unvested restricted stock was approximately $2,094,000, which is being amortized on a straight-line basis over the three-year

vesting period. For the third quarter and first nine months ended October 1, 2006, the Company recognized compensation costs of $186,000 and $345,000, respectively, in selling, general and administrative expenses. The Company applied an estimated forfeiture rate of 10% for restricted stock issued to key employees. The aggregate intrinsic value of restricted stock granted and outstanding approximated $2,352,000 representing the total pre-tax intrinsic value based on the Company’s closing Class A common stock price of $31.76 as of October 1, 2006.

Management Stock Purchase Plan

For a description of the Management Stock Purchase Plan terms, see Note 13 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

There were 87,125 RSUs issued during the first nine months of 2006 with an aggregate grant-date fair value approximating $1,185,000. At October 1, 2006, there were 346,687 RSUs granted and outstanding to certain officers and key employees. There were no RSUs forfeited during the first nine months of 2006. Total unrecognized compensation cost related to unvested RSUs was approximately $1,449,000 at October 1, 2006, and is being amortized on a straight-line basis over a three-year vesting period. For the third quarter and first nine months of 2006 the Company recognized compensation cost of $269,000 and $720,000, respectively, in selling, general and administrative expenses.

A summary of the Company’s RSUs activity and related information for the first nine months of 2006 is shown in the following table:

	As of October 1, 2006
	RSUs		Weighted Average Purchase Price		Aggregate Intrinsic Value
	(RSUs in thousands)
Outstanding at beginning of period	328		$	16.02
Granted	87		23.34
Settled	(68	)	10.20
Outstanding at end of period	347		$	19.00	$	12.76
Vested at end of period	148		$	15.64	$	16.12

As of October 1, 2006, the aggregate intrinsic values of outstanding and vested RSUs were approximately $4,424,000 and $2,384,000, respectively, representing the total pre-tax intrinsic value, based on the Company’s closing Class A common stock price of $31.76 as of October 1, 2006, which would have been received by the RSUs holders had all RSUs settled as of that date. The total intrinsic value of RSUs settled for the first nine months of 2006 was approximately $1,745,000. Upon settlement of RSUs, the Company issues shares of Class A common stock.

The following table summarizes information about RSUs outstanding at October 1, 2006:

	RSUs Outstanding							RSUs Vested
Range of Purchase Prices	Number Outstanding		Weighted Average Remaining Contractual Life (years)		Weighted Average Purchase Price			Number Vested		Weighted Average Purchase Price
	(RSUs in thousands)
$7.93—$8.34		12		—		$	8.13		12		$	8.13
$9.36—$9.54		5		—		9.47			5		9.47
$10.00—$12.30		23		—		10.66			23		10.66
$15.50—$23.34		307		1.4		20.22			108		17.84
		347		1.4		$	19.00		148		$	15.64

Shipping and Handling

The Company’s shipping costs included in selling, general and administrative expense were $9,528,000 and $7,418,000 for the third quarter of 2006 and 2005, respectively, and were $27,270,000 and $20,423,000 for the first nine months of 2006 and 2005, respectively.

Research and Development

Research and development costs included in selling, general and administrative expense were $3,091,000 and $2,780,000 for the third quarters of 2006 and 2005, respectively, and were $9,400,000 and $8,688,000 for the first nine months of 2006 and 2005, respectively.

New Accounting Standards

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements” (SAB 108), which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after November 15, 2006. The Company will adopt the

provisions of SAB 108 for its annual financial statements for fiscal year 2006. The Company does not expect the impact of SAB 108 will be material to its consolidated financial statements.

In September 2006, the Financial Accounting Standards Board (FASB) issued FAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R),” (FAS 158) which requires an employer to: (a) recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status; (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year; and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in other comprehensive income. The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006 for companies with publicly traded equity securities. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008, although earlier adoption is permitted. As a result of the requirement to recognize the funded status of its benefit plans as of December 31, 2006, the Company expects to record an increase in its pension liability of approximately $8,000,000 and a decrease in stockholders’ equity of approximately $5,500,000, net of tax.

In September 2006, FASB issued FAS No. 157, “Fair Value Measurements,” (FAS 157) which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Earlier application is encouraged provided that the reporting company has not yet issued financial statements for that fiscal year including financial statements for an interim period within that fiscal year. The Company does not expect the impact of FAS 157 will be material to its consolidated financial statements.

In July 2006, the FASB issued Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (FIN 48) which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, based on the technical merits. This interpretation also provides guidance on measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 will become effective for fiscal years beginning after December 15, 2006. The Company does not expect the impact of FIN 48 will be material to its consolidated financial statements.

In March 2006, the FASB issued Financial Accounting Standards Board Statement No. 156 “Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140,” (FAS 156). FAS 156 amends FAS Statement No.140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. FAS 156 addresses the recognition and measurement of separately recognized servicing assets and liabilities and provides an approach to simplify efforts to obtain hedge-like (offset) accounting. The Company is required to adopt the provisions of FAS 156 as of January 1, 2007, although earlier adoption is permitted. The Company does not expect the impact of FAS 156 will be material to its consolidated financial statements.

In February 2006, the FASB issued Financial Accounting Standards Board Statement No. 155 “Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140” (FAS 155). FAS 155 amends FAS 133, “Accounting for Derivatives and Hedging Activities,” and FAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” and allows an entity to remeasure at fair value a hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation from the host, if the holder irrevocably elects to account for the whole instrument on a fair value basis. Subsequent changes in the fair value of the instrument would be recognized in earnings. The Company is required to adopt the provision of FAS 155 as of January 1, 2007, although earlier adoption is permitted. The Company does not expect the impact of FAS 155 will be material to its consolidated financial statements.

In May 2005, the FASB issued Financial Accounting Standards Board Statement No. 154, “Accounting Changes and Error Correction Replacement of APB Opinion No. 20 and FASB Statement No. 3” (FAS 154). FAS 154 replaces APB Opinion No. 20, “Accounting Changes” (APB 20), and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements,” and changes the requirements for the accounting for and reporting of a change in accounting principle. APB 20 previously required that most voluntary changes in accounting principles be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. FAS 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle. FAS 154 defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used. FAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. The Company applied the provisions of this statement in January 2006 and the impact was not material to its consolidated financial statements.

In December 2004, the FASB issued Financial Accounting Standards Board Statement No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions” (FAS 153). The amendments made by FAS 153

are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion No. 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. The statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The provisions of this statement were applied prospectively in January 2006 and the impact was not material to the Company’s consolidated financial statements.

In November 2004, the FASB issued Financial Accounting Standards Board Statement No. 151, “Inventory Costs” (FAS 151). FAS 151 amends the guidance in Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for inventory costs. The provisions of this statement are effective for fiscal years beginning after June 15, 2005. The Company applied the provisions of this statement in January 2006 and the impact was not material to its consolidated financial statements.

3. Discontinued Operations

In September 1996, the Company divested its Municipal Water Group businesses, which included Henry Pratt, James Jones Company and Edward Barber and Company Ltd. Costs and expenses related to the Municipal Water Group for 2006 and 2005 primarily relate to legal and settlement costs associated with the James Jones Litigation, which is described in Part I, Item 1, “Product Liability, Environmental and Other Litigation Matters” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 and Note 13 of Notes to Consolidated Financial Statements in this Form 10-Q.

Condensed operating statements and balance sheets for discontinued operations are summarized below:

	Third Quarter Ended
	October 1, 2006			October 2, 2005
	(in thousands)
Cost and expenses- Municipal Water Group	$	(5,100	)	$	(115	)
Loss before income taxes	(5,100		)	(115		)
Income tax benefit	1,963			44
Loss from discontinued operations, net of taxes	$	(3,137	)	$	(71	)

	Nine Months Ended
	October 1, 2006			October 2, 2005
	(in thousands)
Cost and expenses- Municipal Water Group	$	(5,459	)	$	(299	)
Loss before income taxes	(5,459		)	(299		)
Income tax benefit	2,101			114
Loss from discontinued operations, net of taxes	$	(3,358	)	$	(185	)

	October 1, 2006		December 31, 2005
	(in thousands)
Prepaid expenses and other assets	$640		$2,511
Deferred income taxes	9,432		7,044
Assets of discontinued operations	$	10,072	$	9,555
Accrued expenses and other liabilities	27,940		23,068
Liabilities of discontinued operations	$	27,940	$	23,068

The assets and liabilities at October 1, 2006 and December 31, 2005 primarily relate to the reserves for the James Jones Litigation.

4. Derivative Instruments

The Company uses foreign currency forward exchange contracts as an economic hedge to reduce the impact of currency fluctuations on certain anticipated intercompany purchase transactions that are expected to occur during the next twelve months and certain other foreign currency transactions. Realized and unrealized gains and losses on the contracts are recognized in other income/expense. These contracts do not subject the Company to significant market risk from exchange movement because they offset gains and losses on the related foreign currency denominated transactions. At October 1, 2006, the fair value of the contracts was a loss of approximately $63,000.

The Company occasionally uses commodity futures contracts to fix the price on a certain portion of certain raw materials used in the manufacturing process. At October 1, 2006 and October 2, 2005, the Company had no commodity contracts.

5. Restructuring and Other Charges

The Company continues to implement a plan to consolidate several of its manufacturing plants in Europe. At the same time it is expanding its manufacturing capacity in China and other low-cost areas of the world. In the third quarter of 2006, the Company recorded pre-tax charge of approximately $1,281,000 compared to a pre-tax charge of $995,000 in the third quarter of 2005. Pre-tax costs of $949,000 and $991,000 were recorded in costs of goods sold in the third quarter of 2006 and 2005, respectively. Costs incurred for the third quarter of 2006 primarily included manufacturing severance costs related to the Company’s Chinese restructuring plan. Costs incurred for the third quarter of 2005 included accelerated depreciation for the closure of a U.S. manufacturing plant. The Company recorded pre-tax charges of $332,000 and $4,000 to restructuring and other charges in the third quarters of 2006 and 2005, respectively. The costs incurred for the third quarter of 2006 and 2005 are primarily for severance costs related to the Company’s Chinese and European restructuring plans.

For the first nine months of 2006, the Company recorded pre-tax income of approximately $4,153,000 compared to a pre-tax charge of $2,167,000 for the first nine months of 2005. Pre-tax costs of $956,000 and $1,705,000 were recorded in costs of goods sold in the first nine months of 2006 and 2005, respectively. Costs incurred for the first nine months of 2006 primarily included manufacturing severance costs related to the Company’s Chinese restructuring plan. Costs incurred for the first nine months of 2005 included accelerated depreciation for the closure of a U.S. manufacturing plant. The Company recorded income of $5,109,000 and a charge of $462,000 to restructuring and other charges in the first nine months of 2006 and 2005, respectively. In the second quarter of 2006, the Company recorded a gain of approximately $6,500,000 related to the sale of a building in Italy, which is partially offset by costs incurred for severance costs related to the Company’s Chinese and European restructuring plans. The costs incurred for the first nine months of 2005 are primarily for severance costs related to Company’s European restructuring plans.

6. Earnings per Share

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

	For the Third Quarter Ended October 1, 2006
	Income (Numerator)			Shares (Denominator)	Per Share Amount
	(amounts in thousands, except share and per share amounts)
Basic EPS
Income from continuing operations	$	21,324		32,707,343	$	.65
Loss from discontinued operations	(3,137		)		(.10		)
Net income	$	18,187			$	.56
Effect of dilutive securities
Common stock equivalents				343,327
Diluted EPS
Income from continuing operations	$	21,324			$	.65
Loss from discontinued operations	(3,137		)		(.09		)
Net income	$	18,187		33,050,670	$	.55

	For the Third Quarter Ended October 2, 2005
	Income (Numerator)			Shares (Denominator)	Per Share Amount
	(amounts in thousands, except share and per share amounts)
Basic EPS
Income from continuing operations	$	13,439		32,525,422	$	.41
Loss from discontinued operations	(71		)		—
Net income	$	13,368			$	.41
Effect of dilutive securities
Common stock equivalents				536,578
Diluted EPS
Income from continuing operations	$	13,439			$	.41
Loss from discontinued operations	(71		)		—
Net income	$	13,368		33,062,000	$	.40

	For the Nine Months Ended October 1, 2006
	Income (Numerator)			Shares (Denominator)	Per Share Amount
	(amounts in thousands, except share and per share amounts)
Basic EPS
Income from continuing operations	$	58,954		32,651,037	$	1.81
Loss from discontinued operations	(3,358		)		(.10		)
Net income	$	55,596			$	1.70
Effect of dilutive securities
Common stock equivalents				375,876
Diluted EPS
Income from continuing operations	$	58,954			$	1.79
Loss from discontinued operations	(3,358		)		(.10		)
Net income	$	55,596		33,026,913	$	1.68

	For the Nine Months Ended October 2, 2005
	Income (Numerator)			Shares (Denominator)	Per Share Amount
	(amounts in thousands, except share and per share amounts)
Basic EPS
Income from continuing operations	$	39,824		32,469,951	$	1.23
Loss from discontinued operations	(185		)		(.01		)
Net income	$	39,639			$	1.22
Effect of dilutive securities
Common stock equivalents				536,328
Diluted EPS
Income from continuing operations	$	39,824			$	1.21
Loss from discontinued operations	(185		)		(.01		)
Net income	$	39,639		33,006,279	$	1.20

7. Segment Information

Under the criteria set forth in Financial Accounting Standards Board Statement No.131 “Disclosure about Segments of an Enterprise and Related Information”, the Company operates in three geographic segments: North America, Europe, and China. Each of these segments is managed separately and has separate financial results that are reviewed by the Company’s senior management. Sales by region are based upon location of the entity recording the sale. The accounting policies for each segment are the same as those described in the summary of significant accounting policies.

The following is a summary of our significant accounts and balances by segment, reconciled to our consolidated totals:

	North America		Europe		China		*Corporate ()**			Consolidated
	(in thousands)
As of and for the quarter ended October 1, 2006
Net sales	$	211,769	$	101,437	$	11,931	$	—		$	325,137
Operating income (loss)	26,217		12,889		3,556		(6,624		)	36,038
Capital expenditures	2,413		2,424		719		—			5,556
Depreciation and amortization	4,482		3,038		1,161		—			8,681

As of and for the quarter ended October 2, 2005
Net sales	$	160,029	$	65,554	$	7,146	$	—		$	232,729
Operating income (loss)	18,388		7,854		1,433		(4,770		)	22,905
Capital expenditures	1,972		1,748		758		—			4,478
Depreciation and amortization	3,568		2,282		892		—			6,742

As of and for the nine months ended October 1, 2006

Net sales

616,584

257,553

26,125

—

900,262

Operating income (loss)

74,254

38,067

6,968

(18,483

)

100,806

Identifiable assets

825,958

489,338

119,738

—

1,435,034

Long-lived assets

97,224

78,864

27,944

—

204,032

Intangibles

77,979

46,203

9,161

—

133,343

Capital expenditures

8,849

24,716

1,783

—

35,348

Depreciation and amortization

13,289

8,553

3,737

—

25,579

As of and for the nine months ended October 2, 2005
Net sales	$	464,622	$	195,624	$	19,693	$	—		$	679,939
Operating income (loss)	57,088		23,299		2,550		(14,521		)	68,416
Identifiable assets	551,498		308,481		93,539		—			953,518
Long-lived assets	73,243		46,674		25,923		—			145,840
Intangibles	32,596		13,304		2,680		—			48,580
Capital expenditures	7,535		4,194		2,087		—			13,816
Depreciation and amortization	10,180		6,513		3,275		—			19,968

*Corporate expenses are primarily for compensation expense, Sarbanes-Oxley compliance, professional fees, including legal and audit expenses, shareholder services and benefit administration costs. These costs are not allocated to the geographic segments as they are viewed as corporate functions that support all segments.

The above operating segments are presented on a basis consistent with the presentation included in the Company’s December 31, 2005 financial statements included in its Annual Report on Form 10-K.

The North American segment consists of U.S. net sales of $196,372,000 and $147,640,000 for the third quarters of 2006 and 2005, respectively, and $573,135,000 and $430,175,000 for the first nine months of 2006 and 2005, respectively. The North American segment also consists of U.S. long-lived assets of $90,278,000 and $68,304,000 at October 1, 2006 and October 2, 2005, respectively.

Intersegment sales for the quarter ended October 1, 2006 for North America, Europe and China were $1,510,000, $958,000 and $21,991,000, respectively. Intersegment sales for the quarter ended October 2, 2005 for North America, Europe and China were $1,209,000, $1,072,000 and $13,677,000, respectively.

Intersegment sales for the first nine months ended October 1, 2006 for North America, Europe and China were $4,942,000, $2,188,000 and $54,379,000, respectively. Intersegment sales for the first nine months ended October 2, 2005 for North America, Europe and China were $3,740,000, $4,054,000 and $35,534,000, respectively.

On April 4, 2006, the Company sold an operating facility in northern Italy to the local Italian government. The net selling price of the land and building was approximately $9,200,000 resulting in a pre-tax gain of approximately $6,500,000 recognized in the second quarter of 2006. Taxes associated with this gain of approximately $2,400,000 are due in installments over the next five years. The Company then used the proceeds from sale of this facility plus additional bank financing to purchase another site, which was owned by the same governmental agency. The purchase price for the new facility (land and building) was approximately $16,300,000. Simultaneously, the Company entered into a 15-year sale and leaseback arrangement with a leasing company for the new facility’s building. The sale- leaseback transaction resulted in proceeds to the Company of approximately $16,000,000, partially used to repay the bank financing. There was no gain or loss recorded in connection with the sale-leaseback transaction.

8. Accumulated Other Comprehensive Income (Loss)

Accumulated other comprehensive income (loss) consists of the following:

	Foreign Currency Translation and Other			Pension Adjustment			Accumulated Other Comprehensive Income (Loss)
	(in thousands)

Balance December 31, 2005	$	13,090		$	(7,827	)	$	5,263
Change in period	4,611			—			4,611
Balance April 2, 2006	17,701			(7,827		)	9,874
Change in period	6,841			—			6,841
Balance July 2, 2006	$	24,542		$	(7,827	)	$	16,715
Change in period	4,882			—			4,882
Balance October 1, 2006	$	29,424		$	(7,827	)	$	21,597

Balance December 31, 2004	$	32,467		$	(5,849	)	$	26,618
Change in period	(6,885		)	—			(6,885		)
Balance April 3, 2005	25,582			(5,849		)	19,733
Change in period	(11,637		)	—			(11,637		)
Balance July 3, 2005	$	13,945		$	(5,849	)	$	8,096
Change in period	1,212			—			1,212
Balance October 2, 2005	$	15,157		$	(5,849	)	$	9,308

Accumulated other comprehensive income (loss) in the consolidated balance sheets as of October 1, 2006 and October 2, 2005 consists primarily of cumulative translation adjustments and minimum pension liability adjustments. The Company’s total comprehensive income (loss) was as follows:

	Third Quarter Ended
	October 1 2006		October 2, 2005
	(in thousands)

Net income	$	18,187	$	13,368
Foreign currency translation adjustments and other	4,882		1,212
Total comprehensive income	$	23,069	$	14,580

	Nine Months Ended
	October 1, 2006		October 2, 2005
	(in thousands)

Net income	$	55,596	$	39,639
Foreign currency translation adjustments and other	16,334		(17,310		)
Total comprehensive income	$	71,930	$	22,329

9. Acquisitions

On August 14, 2006, a wholly owned subsidiary of the Company acquired 100% of the outstanding stock of Black Teknigas, Limited (Teknigas) located in St. Neots, United Kingdom for approximately $8,700,000, which is net of cash acquired of approximately $300,000, plus assumed debt of approximately $1,087,000. The preliminary allocations for goodwill and intangible assets are approximately $4,186,000 and $3,718,000, respectively. The amount recorded as intangible assets is primarily for technology and customer relationships that have estimated useful lives ranging from 8 to 12 years and trade names with indefinite lives. Teknigas designs, develops and manufactures a range of gas control products and systems for combustion, industrial, medical, laboratory and specialty gas.

On June 7, 2006, a wholly owned subsidiary of the Company acquired 100% of the outstanding stock of Kim Olofsson Safe Corporation AB (KimSafe) located in Almhult, Sweden for approximately $5,700,000, which is net of cash acquired of approximately $2,900,000. The preliminary allocations for goodwill and intangible assets are approximately $1,627,000 and $3,532,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated useful lives of 5 years and trade names with indefinite lives. KimSafe manufactures electronic controls for heat pump, solar and pellet heaters, which provide the ability to heat water using renewable energy.

On June 2, 2006, a wholly owned subsidiary of the Company acquired the assets and business of Calflex Manufacturing, Inc. (Calflex) located in Vernon, California and the stock of Ningbo Best Metal & Plastic Manufacturing Company, Ltd. (Ningbo) located in Ningbo, China for approximately $6,600,000. The preliminary allocation for intangible assets is approximately $2,333,000. The amount recorded as intangible assets is primarily for customer relationships that have estimated useful lives of 12 years and trade names with indefinite lives. Calflex and Ningbo distribute and manufacture water connectors.

On May 19, 2006, a wholly owned subsidiary of the Company acquired 100% of the outstanding stock of ATS Expansion Group (ATS) located in Sorgues, Grenoble and Hautvilliers, France for approximately $62,000,000, which is net of cash acquired of approximately $5,600,000 plus assumed debt of approximately $14,100,000. The preliminary allocations for goodwill and intangible assets are approximately $32,644,000 and $26,858,000, respectively. The amount recorded as intangible assets is primarily for customer relationships with estimated useful lives ranging from 8 to 10 years, patents with estimated useful lives ranging from 7 to 12 years and trade names with indefinite lives. ATS’ products include a broad range of fittings, valves and manifolds for water, gas and heating applications and stainless steel flexible hoses.

On April 26, 2006, a wholly owned subsidiary of the Company acquired the assets and business of Changsha Valve Works (Changsha) located in Changsha, China for approximately $8,500,000, of which approximately $600,000 remains to be paid subject to certain conditions being met. The preliminary allocations for goodwill and intangible assets are approximately $5,975,000 and $2,800,000, respectively. The amount recorded as intangible assets is primarily for non-compete agreements that have estimated useful lives of 10 years and customer order backlog with an estimated useful life of 1 year. Changsha is a leading manufacturer of large diameter hydraulic-actuated butterfly valves for thermo-power and hydro-power plants, water distribution projects and water works projects in China.

The purchase price allocations for the acquisitions noted above are preliminary pending the final determination of fair values of intangible assets and certain assumed assets and liabilities.

On April 5, 2006, a wholly owned subsidiary of the Company completed the planned increase of its ownership in Watts Stern Rubinetti, S.r.l. (Stern) from 85% to 100%. The price paid for this additional 15% interest was approximately $387,000.

10. Debt

On April 27, 2006, the Company completed a private placement of $225,000,000 of 5.85% senior unsecured notes due April 2016 (the 2006 Note Purchase Agreement). The 2006 Note Purchase Agreement includes operational and financial covenants, with which the Company is required to comply, including, among others, maintenance of certain financial ratios and restrictions on additional indebtedness, liens and dispositions. Events of default under the 2006 Note Purchase Agreement include failure to comply with its financial and operational covenants, as well as bankruptcy and other insolvency events. The Company may, at its option, upon notice to the noteholders, prepay at any time all or part of the Notes in an amount not less than $1 million by paying the principal amount plus a make-whole amount, which is dependent upon the yield of respective U.S. Treasury Securities. The Company used the net proceeds from the private placement to repay $147,000,000 outstanding under its revolving credit facility. The balance of the net proceeds will be used to finance future acquisitions and for general corporate purposes. As of October 1, 2006, the Company was in compliance with all covenants related to the 2006 Note Purchase Agreement. The payment of interest on the senior unsecured notes is due semi-annually on April 30th and October 30th of each year. Additionally, the Company amended its 2003 Note Purchase Agreement to reflect the existence of the subsidiary guarantors and to substantially conform certain provisions of the 2003 Note Purchase Agreement to the 2006 Note Purchase Agreement.

On April 27, 2006, the Company amended and restated its unsecured revolving credit facility with a syndicate of banks (as amended, the revolving credit facility). The revolving credit facility provides for multi-currency unsecured borrowings and stand-by letters of credit of up to $350,000,000 and expires in April 2011. Borrowings outstanding under the revolving credit facility bear interest at a fluctuating rate per annum equal to an applicable percentage equal to (i) in the case of Eurocurrency rate loans, the British Bankers Association LIBOR rate plus an applicable percentage of 0.60%, which is determined by reference to the Company’s consolidated leverage ratio and debt rating, or (ii) in the case of base rate loans and swing line loans, the higher of (a) the federal funds rate plus 0.5% and (b) the rate of interest in effect for such day as announced by Bank of America, N.A. as its “prime rate.” For first nine months of 2006, the average interest rate under the revolving credit facility for euro-based borrowings was approximately 3.3%. 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 October 1, 2006, the Company was in compliance with all covenants related to the revolving credit facility; had $210,069,000 of unused and potentially available credit under the revolving credit facility; had no U.S dollar denominated debt and $107,290,000 of euro-based borrowings outstanding on its revolving credit facility; and had $32,641,000 for stand-by letters of credit outstanding on its revolving credit facility.

Effective July 1, 2005, the Company entered into a three-year interest rate swap with a counter party for a notional amount of €25,000,000, which is outstanding under the revolving credit facility. The Company swapped three-month EURIBOR plus 0.6% for a fixed rate of 3.02%. At October 1, 2006, the fair value of the swap was approximately $673,000, which was recorded as a reduction of

interest expense in the first nine months of 2006. The Company recorded an increase in interest expense of $120,000 in the third quarter of 2006 for changes in the fair value of the interest rate swap. The swap was terminated on October 3, 2006.

On December 28, 2005, the date of closing of the Dormont Manufacturing Company (Dormont) acquisition, Dormont had long-term debt outstanding of $8,900,000 in the form of two series of taxable variable rate demand bonds (1998 Series with $1,500,000 outstanding and the 2000 Series with $7,400,000 outstanding) which, due to the provisions of the trust agreements, could only be redeemed at dates subsequent to the closing. Each of these bonds was secured by a letter of credit from a bank, which maintained a security interest in the assets of Dormont. As a condition of the purchase and to gain the bank’s consent to the sale of Dormont to the Company, Dormont’s former owners were required to establish a cash collateral account for the bonds in an amount equal to the potential obligation of Dormont to the bank under the letter of credit reimbursement agreements. The entire obligation under the bonds approximated $9,096,000, which represented the $8,900,000 in bond principal plus interest and related fees. At closing, a portion of the Dormont purchase price was placed in a cash collateral account as a guarantee of payment. The Company recorded this escrow deposit in prepaid expenses and other assets at December 31, 2005. The 1998 series bonds were repaid in full on January 17, 2006 and the 2000 series bonds were repaid in full on February 1, 2006 by the former owners using the cash collateral account.

11. Contingencies and Environmental Remediation

As disclosed in Part I, Item 1, “Product Liability, Environmental and Other Litigation Matters” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, the Company is a party to litigation described as the James Jones Litigation.

12. Employee Benefit Plans

The Company sponsors funded and unfunded defined benefit pension plans covering substantially all of its domestic employees. Benefits are based primarily on years of service and employees’ compensation. The funding policy of the Company for these plans is to contribute an annual amount that does not exceed the maximum amount that can be deducted for federal income tax purposes. The Company uses a September 30 measurement date for its plans.

The components of net periodic benefit cost are as follows:

	Third Quarter Ended
	October 1, 2006			October 2, 2005
	(in thousands)

Service cost—benefits earned	$	887		$	715
Interest costs on benefits obligation	945			838
Estimated return on assets	(875		)	(797		)
Prior service cost amortization	71			60
Net loss amortization	303			216
Net periodic benefit cost	$	1,331		$	1,032

	Nine Months Ended
	October 1, 2006			October 2, 2005
	(in thousands)

Service cost—benefits earned	$	2,661		$	2,145
Interest costs on benefits obligation	2,835			2,514
Estimated return on assets	(2,625		)	(2,377		)
Prior service cost amortization	213			180
Net loss amortization	909			646
Net periodic benefit cost	$	3,993		$	3,108

Cash flows:

The information related to the Company’s pension funds cash flow is as follows:

	Nine Months Ended
	October 1, 2006		October 2, 2005
	(in thousands)

Employer contributions	$	3,194	$	1,786

13. Subsequent Event

In the insurance coverage portion of the James Jones Litigation, on October 20, 2006, the United States Court of Appeals for the Seventh Circuit affirmed that an arbitration panel could decide which deductible agreements between the Company and Zurich American Insurance Company (Zurich) would control Zurich’s reimbursement claim for defense costs paid in the James Jones case. As a result of this development, the Company recorded a pre-tax charge of $5,000,000 to discontinued operations in the third quarter of 2006.

Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

Overview

The following discussion and analysis are provided to increase understanding of, and should be read in conjunction with, the accompanying unaudited consolidated financial statements and notes. In this quarterly report on Form 10-Q, references to “the Company,” “Watts,” “we,” “us” or “our” refer to Watts Water Technologies, Inc. and its consolidated subsidiaries.

We operate on a 52-week fiscal year ending on December 31. Any third quarter ended data contained in this Report on Form 10-Q reflects the results of operations for the 13-week period ended on the Sunday nearest September 30 of the respective year.

We are a leading supplier of products used in the water quality, water conservation, water safety and water flow control markets in North America and Europe, with an emerging presence in China. For over 130 years, we have designed and manufactured products that promote the comfort and safety of people and the quality and conservation of water used in commercial and residential applications. We earn revenue and income almost exclusively from the sale of our products. Our principal product lines include:

· backflow preventers for preventing contamination of potable water caused by reverse flow within water supply lines and fire protection systems;

· a wide range of water pressure regulators for both commercial and residential applications;

· water supply and drainage products for commercial and residential applications;

· temperature and pressure relief valves for water heaters, boilers and associated systems;

· point-of-use water filtration and reverse osmosis systems for both commercial and residential applications;

· thermostatic mixing valves for tempering water in commercial and residential applications;

· systems for under-floor radiant applications and hydraulic pump groups for gas boiler manufacturers and renewable energy applications, including solar heat pumps;

· flexible stainless steel connectors for natural and liquid propane gas in commercial food service and residential applications; and

· large diameter butterfly valves for use in China’s water infrastructure.

Our business is reported in three geographic segments, North America, Europe and China. We distribute our products through three primary distribution channels, wholesale, do-it-yourself (DIY) and original equipment manufacturers (OEMs). Interest rates have an indirect effect on the demand for our products due to the effect such rates have on the number of new residential and commercial construction starts and remodeling projects. All three of these activities have an impact on our levels of sales and earnings. An additional factor that has had an effect on our sales is fluctuation in foreign currencies, as a portion of our sales and certain portions of our costs, assets and liabilities are denominated in currencies other than the U.S. dollar.

We believe that the factors relating to our future growth include our ability to continue to make selective acquisitions, both in our core markets as well as new complementary markets, regulatory requirements relating to the quality and conservation of water, increased demand for clean water and continued enforcement of plumbing and building codes and a healthy economic environment. We have completed 30 acquisitions since divesting our industrial and oil and gas business in 1999. Our acquisition strategy focuses on businesses that manufacture preferred brand name products that address our themes of water quality, water conservation, water safety and water flow control and related complementary markets. We target businesses that will provide us with one or more of the following: an entry into new markets, an increase in shelf space with existing customers, a new or improved technology or an expansion of the breadth of our water quality, water conservation, water safety and water flow control products for the residential and commercial markets. In the first nine months of 2006, sales from acquisitions contributed approximately 21.1% to our total sales growth over the comparable period of 2005.

Products representing a majority of our sales are subject to regulatory standards and code enforcement, which typically require that these products meet stringent performance criteria. Together with our commissioned manufacturers’ representatives, we have

consistently advocated for the development and enforcement of such plumbing codes. We are focused on maintaining stringent quality control and testing procedures at each of our manufacturing facilities in order to manufacture products in compliance with code requirements and take advantage of the resulting demand for compliant products. We believe that the product development, product testing capability and investment in plant and equipment needed to manufacture products in compliance with code requirements, represent a barrier to entry for competitors. We believe there is an increasing demand among consumers for products to ensure water quality, which creates growth opportunities for our products.

We require substantial amounts of raw materials to produce our products, including bronze, brass, cast iron, steel and plastic, and substantially all of the raw materials we require are purchased from outside sources. We have experienced increases in the costs of certain raw materials, particularly copper. Bronze and brass are copper-based alloys. The spot price of copper has increased approximately 89% from September 30, 2005 to September 30, 2006, and approximately 57% from December 31, 2005 to October 26, 2006.

A risk we face is our ability to deal effectively with increases in raw material costs. 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, implementing cost reduction programs and passing increases in costs to our customers, to the maximum extent possible, when they occur. Additionally from time to time we may use commodity futures contracts on a limited basis to manage this risk. We are not able to predict whether or for how long these cost increases will continue. If these cost increases continue and we are not able to reduce or eliminate the effect of the cost increases by reducing production costs or implementing price increases, our profit margins could decrease.

Another risk we face in all areas of our business is competition. We consider brand preference, engineering specifications, code requirements, price, technological expertise, delivery times and breadth of product offerings to be the primary competitive factors. As mentioned previously, we believe that the product development, product testing capability and investment in plant and equipment needed to manufacture products in compliance with code requirements, represent a barrier to entry for competitors. We are committed to maintaining our capital equipment at a level consistent with current technologies, and thus we expect to spend approximately $40,000,000 in 2006 (including approximately $18,000,000 related to the purchase and subsequent sale-leaseback of a building in Italy). We are committed to expanding our manufacturing capacity in lower cost countries such as China, Tunisia and Bulgaria. Manufacturing plant relocations and consolidations are an important part of our ongoing commitment to reduce production costs.

Acquisitions

On August 14, 2006, we acquired 100% of the outstanding stock of Black Teknigas, Limited (Teknigas) located in St. Neots, United Kingdom for approximately $8,700,000, which is net of cash acquired of approximately $300,000, plus assumed debt of approximately $1,087,000. The preliminary allocations for goodwill and intangible assets are approximately $4,186,000 and $3,718,000, respectively. The amount recorded as intangible assets is primarily for technology and customer relationships that have estimated useful lives ranging from 8 to 12 years and trade names with indefinite lives. Teknigas designs, develops and manufactures a range of gas control products and systems for combustion, industrial, medical, laboratory and specialty gas.

On June 7, 2006, we acquired 100% of the outstanding stock of Kim Olofsson Safe Corporation AB (KimSafe) located in Almhult, Sweden for approximately $5,700,000, which is net of cash acquired of approximately $2,900,000. The preliminary allocations for goodwill and intangible assets are approximately $1,627,000 and $3,532,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated useful lives of 5 years and trade names with indefinite lives. KimSafe manufactures electronic controls for heat pump, solar and pellet heaters, which provide the ability to heat water using renewable energy.

On June 2, 2006, we acquired the assets and business of Calflex Manufacturing, Inc. (Calflex) located in Vernon, California and the stock of Ningbo Best Metal & Plastic Manufacturing, Ltd (Ningbo) located in Ningbo, China for approximately $6,600,000. The preliminary allocation for intangible assets is approximately $2,333,000. The amount recorded as intangible assets is primarily for customer relationships that have estimated useful lives of 12 years and trade names with indefinite lives. Calflex and Ningbo distribute and manufacture water connectors.

On May 19, 2006, we acquired 100% of the outstanding stock of ATS Expansion Group (ATS) located in Sorgues, Grenoble and Hautvilliers, France for approximately $62,000,000, which is net of cash acquired of approximately $5,600,000 plus assumed debt of approximately $14,100,000. The preliminary allocations for goodwill and intangible assets are approximately $32,644,000 and $26,858,000, respectively. The amount recorded as intangible assets is primarily for customer relationships with estimated useful lives ranging from 8 to 10 years, patents with estimated useful lives from 7 to 12 years and trade names with indefinite lives. ATS’ products include a broad range of fittings, valves and manifolds for water, gas and heating applications and stainless steel flexible hoses.

On April 26, 2006, we acquired the assets and business of Changsha Valve Works (Changsha) located in Changsha, China for approximately $8,500,000 of which approximately $600,000 remains to be paid subject to certain conditions being met. The preliminary allocations for goodwill and intangible assets are approximately $5,975,000 and $2,800,000, respectively. The amount recorded as intangible assets is primarily for non-compete agreements that have estimated useful lives of 10 years and customer order

backlog with an estimated useful life of 1 year. Changsha is a leading manufacturer of large diameter hydraulic-actuated butterfly valves for thermo-power and hydro-power plants, water distribution projects and water works projects in China.

On April 5, 2006, we completed the planned increase of our ownership in Watts Stern Rubinetti, S.r.l. (Stern) from 85% to 100%. The price paid for this additional 15% interest was approximately $378,000.

On December 28, 2005, we acquired 100% of the stock of Dormont Manufacturing Company (Dormont) located in Export, Pennsylvania, for approximately $93,916,000 net of cash acquired of approximately $1,506,000. The preliminary allocations for goodwill and intangible assets are approximately $38,804,000 and $38,600,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated 13-year lives and trade names with indefinite lives. Dormont provides flexible stainless steel connectors for natural and liquid propane gas. Dormont works with appliance OEM’s to provide internal component assemblies and private label gas connectors, which are sold under the OEM brand with the appliance in multiple leading retail chains. Dormont also supplies residential gas connectors through multiple trade channels and home improvement retailers. Dormont provides a core-plumbing product, which is complementary to our existing water product lines.

On December 2, 2005, we acquired 100% of the stock of Core Industries Inc. (Core) from SPX Corporation for approximately $46,192,000 in cash. Core consists of FEBCO, Mueller Steam Specialty and Polyjet Valves product lines. The preliminary allocations for goodwill and intangible assets are approximately $16,560,000 and $8,320,000, respectively. The amount recorded as intangible assets is primarily for trade names with indefinite lives and customer relationships that have estimated 12-year lives. FEBCO is a manufacturer of backflow prevention valves and has a strong presence in both residential and commercial landscape irrigation. Mueller Steam Specialty allows us to expand into large diameter commercial strainers and check valves. Polyjet Valves offers a customized sleeve valve, which is used in severe service applications to provide precise flow and pressure control. We expect that this acquisition will allow us to offer a broader product line, improve operating efficiencies and provide better customer service.

On November 4, 2005, we acquired the assets of Flexflow Tubing LLP (Flexflow), located in Langley, British Columbia, Canada for approximately $6,220,000. The purchase agreement contains an earn-out provision to be calculated over a five-year period ending December 31, 2010. Earn-out payments under the purchase agreement, if any, will not exceed $4,300,000 and will be treated as additional purchase price. Flexflow manufactures pex tubing for potable and non-potable applications. The allocations for goodwill and intangible assets are approximately $3,195,000 and $868,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have estimated 12-year lives. The acquisition of Flexflow is consistent with our strategy to increase our presence in the under floor radiant heating and potable water markets. This acquisition allows us to expand our presence in the market for flexible pex pipes for hot and cold-water transport.

On July 8, 2005, we acquired the water connector business of the Donald E. Savard Company (Savard) in an asset purchase transaction for approximately $3,680,000. The allocations for goodwill and intangible assets are approximately $1,350,000 and $1,750,000, respectively. The amount recorded as intangible assets is primarily for trade names with indefinite lives and customer relationships that have 14-year lives. The acquisition of the water connector business of Savard is consistent with our theme of water safety and control. This acquisition allows us to expand our presence in one of our leading product lines with a brand name that is well known to the plumbing wholesale market.

On July 5, 2005, we acquired 100% of the outstanding stock of Microflex N.V. (Microflex) located in Rotselaar, Belgium for approximately $14,900,000 net of cash acquired of approximately $875,000. The allocations for goodwill and intangible assets are approximately $6,507,000 and $5,315,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have 7-year lives and trade names that have indefinite lives. Microflex produces and distributes flexible, pre-insulated, pex pipes for hot and cold-water transport, as well as a range of accessory products including couplings, caps, and insulation kits to the HVAC and water protection markets.

On June 20, 2005, we acquired the water softener business of Alamo Water Refiners, Inc. (Alamo) located in San Antonio, Texas in an asset purchase transaction for approximately $5,100,000. The allocation for intangible assets is approximately $285,000 and is primarily for the trade name with an indefinite life. There was no allocation to goodwill. The water softener products of Alamo are consistent with our theme of water quality and provide many synergistic opportunities when utilized in conjunction with our existing water filtration and water quality businesses. The acquisition of Alamo also expands our distribution presence into the southwestern U.S. markets.

On May 11, 2005, we acquired 100% of the outstanding stock of Electro Controls Ltd. (Electro Controls) located in Hounslow, United Kingdom for approximately $11,737,000 net of cash acquired of approximately $5,014,000. The allocations for goodwill and intangible assets are approximately $5,788,000 and $315,000, respectively. The amount recorded as intangible assets is primarily for trade names that have indefinite lives. Electro Controls designs and assembles a range of electrical controls for the HVAC market, with sales primarily in the United Kingdom.

On January 5, 2005, we acquired 100% of the outstanding stock of HF Scientific, Inc. (HF) located in Fort Myers, Florida for approximately $7,260,000 in cash plus $800,000 in assumed debt. The allocations for goodwill and intangible assets are approximately $4,178,000 and $2,660,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have 15-year lives and trade names that have indefinite lives. HF manufactures and distributes a line of instrumentation equipment, test kits and chemical reagents used for monitoring water quality in a variety of applications.

On January 4, 2005, we acquired substantially all of the assets of Sea Tech, Inc. (Sea Tech) located in Wilmington, North Carolina for approximately $10,100,000 in cash. The purchase agreement contains an earn-out provision to be calculated on a cumulative basis over a three-year period ending December 31, 2007. Payments under the agreement, if any, will not exceed $5,000,000 and will be treated as additional purchase price. The allocations for goodwill and intangible assets are approximately $6,505,000 and $3,033,000, respectively. The amount recorded as intangible assets is primarily for customer relationships that have 15-year lives and trade names that have indefinite lives. Sea Tech provides cost-effective solutions for fluidic connection needs. Sea Tech offers a wide range of standard and custom quick connect fittings, valves and manifolds and pex tubing designed to address specific customer requirements.

Results of Operations

Third Quarter Ended October 1, 2006 Compared to Third Quarter Ended October 2, 2005

Net Sales. Our business is reported in three geographic segments: North America, Europe and China. Our net sales in each of these segments for each of the third quarters ended 2006 and 2005 were as follows:

	Third quarter Ended October 1, 2006				Third quarter Ended October 2, 2005						% Change to Consolidated
	Net Sales		% Sales		Net Sales		% Sales		Change		Net Sales
	(dollars in thousands)
North America	$	211,769	65.1	%	$	160,029	68.7	%	$	51,740	22.2	%
Europe	101,437		31.2		65,554		28.2		35,883		15.4
China	11,931		3.7		7,146		3.1		4,785		2.1
Total	$	325,137	100	%	$	232,729	100	%	$	92,408	39.7	%

The increase in net sales is attributable to the following:

									Change As a % of Consolidated Net Sales								Change As a % of Segment Net Sales
	North America		Europe		China		Total		North America		Europe		China		Total		North America		Europe		China
	(dollars in thousands)
Internal growth	$	17,447	$	14,239	$	262	$	31,948	7.5	%	6.1	%	.1	%	13.7	%	10.9	%	21.7	%	3.7	%
Foreign exchange	945		3,796		146		4,887		.4		1.6		.1		2.1		.6		5.8		2.0
Acquisitions	33,348		17,848		4,377		55,573		14.3		7.7		1.9		23.9		20.8		27.2		61.3
Total	$	51,740	$	35,883	$	4,785	$	92,408	22.2	%	15.4	%	2.1	%	39.7	%	32.3	%	54.7	%	67.0	%

The internal growth in net sales in North America was primarily due to increased sales prices and increased unit sales in certain product lines into the wholesale market. Our wholesale market in the third quarter of 2006, excluding the sales from the acquisitions of Flexflow, Core, Dormont and Calflex, grew by 14.2% compared to the third quarter of 2005. This was primarily due to increased sales of our plumbing and heating and backflow products. Our sales into the North American DIY market in the third quarter of 2006 increased by 1.5% compared to the third quarter of 2005 primarily due to increased prices in certain product lines partially offset by fewer retail product introductions in the third quarter of 2006 than during the third quarter of 2005.

The increase in net sales due to foreign exchange in North America was due to the Canadian dollar appreciating against the U.S. dollar. We cannot predict whether the Canadian dollar will continue to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.

The acquired growth in net sales in North America was due to the inclusion of net sales of Flexflow, acquired on November 4, 2005, Core, acquired on December 2, 2005, Dormont, acquired on December 28, 2005, and Calflex acquired on June 2, 2006.

The internal sales growth in Europe was broad-based, especially in Germany, with most markets and channels exhibiting improvement. Our sales into the wholesale and OEM markets in the third quarter of 2006, excluding the sales from the acquisitions of ATS, Kimsafe and Teknigas, grew by 15.7% and 29.2%, respectively, compared to the third quarter of 2005.

The increase in net sales due to foreign exchange in Europe was primarily due to the appreciation of the euro against the U.S. dollar. We cannot predict whether the euro will continue to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.

The acquired growth in net sales in Europe was due to the inclusion of the net sales of ATS, acquired on May 19, 2006, Kimsafe, acquired on June 7, 2006, and Teknigas, acquired on August 14, 2006.

The internal sales growth in China was adversely impacted in the third quarter of 2006 by an approximately four- week work stoppage at our joint-venture facility in Tianjin.

The increase in net sales due to foreign exchange in China was primarily due to the appreciation of the yuan against the U.S. dollar. We cannot predict whether the yuan will continue to appreciate against the U.S. dollar in future periods or whether future foreign exchange rate fluctuations will have a positive or negative impact on our net sales.

The acquired growth in net sales in China was due to the inclusion of the net sales of Changsha, acquired on April 26, 2006, and Ningbo, acquired on June 2, 2006.

Gross Profit. Gross profit and gross profit as a percent of sales (gross margin) for the third quarters of 2006 and 2005 were as follows:

	Third Quarter Ended
	October 1, 2006			October 2, 2005			Point Change
	(dollars in thousands)
Gross profit	$	111,919		$	79,813
Percent of total revenue	34.4		%	34.3		%	.1	%

Gross margin remained fairly flat in the third quarter of 2006 compared to third quarter of 2005 as price increases were implemented to offset related raw material cost increases, primarily increased copper costs, without increasing gross margin profits. North American margin percentages were enhanced by an improved sales mix, increased unit sales into the wholesale market and fewer new retail product rollouts in the third quarter of 2006 compared to the third quarter of 2005, partially offset by lower margin sales related to the Core acquisition. The European segment experienced reductions in gross margin as a percentage to sales primarily due to increased lower margin sales into the German wholesale and OEM markets, due to increased material costs, and from acquisition related charges. Our China segment increased its gross profit as a percent of sales primarily due to increased production levels and cost reductions.

In the third quarter of 2006, we recorded a charge of $949,000 to cost of sales primarily for severance costs as compared to a charge of $991,000 in the third quarter of 2005 for accelerated depreciation and other costs related to our manufacturing restructuring efforts.

Selling, General and Administrative Expenses. Selling, General and Administrative, or SG&A expenses, for the third quarter of 2006 increased $18,645,000, or 32.8%, compared to the third quarter of 2005. The increase in SG&A expenses was attributable to the following:

	(in thousands)		% Change

Internal growth	$	5,794	10.2	%
Foreign exchange	877		1.5
Acquisitions	11,974		21.1
Total