Watts Water Falls Short of Estimates

Watts Water Technologies, Inc. (WTS - Snapshot Report) reported second-quarter 2012 adjusted earnings per share (EPS) of 53 cents per share, up 6% from the year-ago quarter EPS of 50 cents but short of the Zacks Consensus Estimate of 56 cents. On a reported basis, including special items, EPS in the quarter stood at 51 cents compared with 34 cents in the year-ago quarter.

Total revenue inched down 1% to $371 million and missed the Zacks Consensus Estimate of $385 million. Acquisitions contributed 3% to revenues, offset by an unfavorable foreign currency translation of 4%. Organic growth remained flat as increases in North America and Asia were mitigated by weakness in Europe, Middle East and Africa (EMEA).

Cost and Margins

Cost of sales improved 2% year over year to $239 million in the quarter. Gross profit inched up 1% to $132 million. Consequently, gross margin expanded 80 basis points (bps) to 35.5% in the quarter.

Selling General and Administrative expenses declined 1% to $97 million. Adjusted operating profit declined 2% to $34.9 million and adjusted operating margin contracted 10 bps to 9.4%.

Segment Performance

North America: Sales increased 5% year over year to $221.8 million, aided by acquired sales of $3.1 million and a 3.6% rise in organic sales, offset partially by unfavorable foreign currency translation. Operating profit increased 2% to $26.7 million in the quarter.

EMEA: Net sales were $142.8 million, down 10% on a year-over-year basis as contributions from acquisitions of $9.8 million were offset by unfavorable foreign exchange movements of $15.5 million and a 5.9% decline in organic sales. Operating profit increased 74% to $12 million.

Asia: The segment reported net sales of $6.5 million, up 10% from the year-ago quarter. Operating profit jumped 133% to $2.1 million in the quarter.

Financial Updates

Cash and cash equivalents were $167.8 million as of July 1, 2012, compared with $230.8 million as of April 1, 2012. Cash flow from operations during the first half of fiscal 2012 was $23.9 million versus $20.7 million in the year-ago comparable period.

Long-term debt excluding current portion amounted to $308.1 million as of July 1, 2012, compared with $393.5 million as of April 1, 2012. Net debt-to-capitalization ratio increased to 20% as of July 1, 2012, compared with 14.7% as of April 1, 2012.

Watts Water completed its previously announced share repurchase program during the first week of July, purchasing approximately $63.2 million worth of shares during the quarter, and $65.8 million in total.

Our Take

Watts Water has taken several cost recovery actions, which will lead to increase in margins. Gradual improvement in the U.S housing market will help improve Watts Water’s business. However, the weakness in Europe remains a concern.

Watts Water Technologies, Inc., through its subsidiaries, is a leading manufacturer of innovative products that control the efficiency, safety and quality of water within residential, commercial and institutional applications. Watts Water faces competition from companies like Flowserve Corp. (FLS - Analyst Report) and IMI plc (IMIAY). The stock currently retains a short-term Zacks #3 Rank (Hold).