Mixed Bag from Watts Water

Watts Water Technologies, Inc.’s ( WTS - Snapshot Report ) third-quarter 2012 adjusted earnings of 63 cents per share were down 8.7% from the year-ago quarter’s EPS of 69 cents. The earnings, however, beat the Zacks Consensus Estimate of 58 cents. On a reported basis, including special items, earnings in the quarter were 53 cents per share compared with 63 cents in the year-ago quarter.

Total revenue declined 3% to $361.2 million, missing the Zacks Consensus Estimate of $364 million. Decline in revenues was driven by negative impacts of foreign currency translation (5%). Organic growth rose 2% year over year in the reported quarter, driven by growth in Europe, the Middle East and Africa (EMEA) and Asia, partially mitigated by year- over-year in-line growth in North America.

Cost and Margins

Cost of sales dropped 1.7% year over year to $231 million in the quarter. Gross profit declined 4.1% to $130.2 million. Consequently, gross margin contracted 60 basis points (bps) to 36% in the quarter.

Selling General and Administrative expenses inched up 1% to $93.5 million. Adjusted operating profit declined 16.5% to $37.5 million and adjusted operating margin contracted 170 bps to 10.4%.

Segment Performance

North America: Net sales went up 1% to $207.4 million, aided by acquired sales of $2.6 million and flat year-over-year organic sales, offset partially by unfavorable foreign currency translation. Operating profit decreased 17.5% to $25.9 million in the quarter.

EMEA: Net sales were $146.5 million, down 8% on a year-over-year basis due to a negative impact of foreign currency translation, partially offset by higher organic sales. Operating profit increased 3.4% to $15.1 million.

Asia: Net sales increased 24% to $7.3 million in the quarter. Operating profit dropped 20% to $2.1 million in the quarter.

Financial Updates

Cash and cash equivalents were $209.5 million as of September 30, 2012, compared with $250.6 million as of December 31, 2011. Cash flow from operations during the first nine months of 2012 was $73.7 million versus $56.5 million in the year-ago comparable period.

Long-term debt excluding current portion amounted to $307.8 million as of September 30, 2012, compared with $397.4 million as of December 31, 2011. Net debt-to-capitalization ratio improved to 29.7% as of September 30, 2012, compared with 30.5% as of December 31, 2011.

Our View

Watts Water’s cost saving initiatives will boost margins. However, weak economic condition in Europe is still a headwind for the company.

Watts Water, through its subsidiaries, is a world leader in the manufacture of innovative products to control the efficiency, safety, and quality of water within applications (residential, commercial, and institutional). Watts Water retains a short-term Zacks #3 Rank (Hold).