Waters Corporation — Q1 2019 Form 10-Q
Business context and reporting period. Waters designs, manufactures, sells and services analytical instruments, consumables and related software, including liquid chromatography, mass spectrometry and thermal analysis products. The unaudited quarter ended March 30, 2019; comparisons are with the quarter ended March 31, 2018. Dollar figures below are in millions unless stated otherwise.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $513.9 | $530.7 | Down 3% |
| Product sales | $320.5 | $339.1 | Down 5% |
| Service sales | $193.4 | $191.6 | Up 1% |
| Operating income | $121.2 | $144.4 | Down 16% |
| Operating margin | 23.6% | 27.2% | Down 3.6 percentage points |
| Net income | $109.0 | $112.0 | Down 3% |
| Diluted EPS | $1.51 | $1.40 | Up 8% |
| Cash from operations | $175.8 | $175.8 | Essentially unchanged |
Gross profit was $292.8 million, or approximately 57.0% of sales, versus $309.2 million, or approximately 58.3%, a year earlier. Net income was slightly lower, while diluted EPS rose as the weighted-average diluted share count fell to 72.4 million from 79.7 million, reflecting substantial share repurchases. Net interest expense was $3.2 million, down from $4.2 million.
Revenue mix and drivers. Waters product sales declined 4% to $283.9 million, including instrument systems down 7% and chemistry consumables up 1%; Waters service sales rose 1% to $176.0 million. TA sales declined 9% to $53.9 million, as instrument systems fell 13% while service rose 1%. Pharmaceutical and industrial customer sales each declined 4%; academic and governmental sales increased 2%. By geography, Europe fell 12%, while Asia and the Americas were approximately flat. Foreign currency translation reduced overall sales growth by 3%.
Cash, debt and liquidity
- Cash and cash equivalents were $685.0 million and investments were $482.3 million at March 30, 2019, totaling $1.167 billion, down from $1.735 billion at year-end 2018.
- Total debt was $1.149 billion, including $100.3 million classified as current; long-term debt was $1.048 billion. Net debt against cash and investments was approximately zero, with cash and investments exceeding debt by about $18.7 million.
- The company had $1.208 billion available under its revolving credit agreement after letters of credit and was in compliance with debt covenants. The reported weighted-average interest rate on notes and credit-agreement borrowings was 3.80%.
- Current assets were $2.078 billion and current liabilities $603.3 million. The filing reports no liquidity shortfall; the simple current ratio was approximately 3.4.
- Investing cash flow was positive $434.0 million, mainly reflecting $486.4 million of investment maturities and sales. Financing cash flow was negative $723.1 million, principally reflecting $753.1 million of treasury-share purchases. Capital expenditures and capitalized software were $25.7 million.
Material changes, outlook and risks
- Management attributed weaker instrument-system demand to customer caution amid Brexit-related macroeconomic uncertainty and governmental or regulatory policy changes in certain regions, including China. Lower sales volumes contributed to the operating-income decline. Q1 2019 also included $8 million of severance costs following a workforce reduction affecting about 1% of employees; Q1 2018 included a $2 million litigation-settlement benefit.
- The effective tax rate was 7.1%, versus 20.3%. Q1 2019 included a $3 million benefit from finalizing certain Tax Act regulations; the prior-year rate included $12 million of additional Tax Act-related expense. A Singapore contractual 0% tax rate on qualifying activities is expected to continue through March 2021, subject to milestones.
- The board authorized up to $4 billion of repurchases over two years. The company repurchased approximately 3.3 million shares for $747 million during the quarter and had $3.4 billion remaining under the authorization at quarter-end. Management expected to increase repurchases in 2019 and planned to use cash, operating cash flow and borrowing capacity; it described a plan to increase debt to approximately 2.5 times net debt-to-EBITDA to fund a significant portion. The filing does not provide a formal sales or earnings forecast.
- The company expects to spend approximately $215 million to build and equip a U.S. precision-chemistry consumables facility; $26 million had been incurred through quarter-end. Management said it expects to fund the project with existing cash and investments, without issuing debt for the expansion.
- Management stated that available resources and expected cash flows should be sufficient for operations, capital spending, debt service, repurchases and potential acquisitions for at least the next 12 months. It also expected currency translation to negatively affect gross profit for the remainder of 2019. A further $110 million cross-currency swap was entered into in April, after quarter-end; the company said its $410 million of such swaps were expected to reduce net interest expense by approximately $12 million annually over their three-year terms.
- Key risks include foreign-exchange movements, trade or tariff changes, Brexit and other political or regulatory uncertainty, customer capital-spending decisions, competition and product acceptance, supply-chain and manufacturing capacity, litigation and tax audits. Management said there were no material changes to previously reported risk factors or legal proceedings and believed existing litigation outcomes would not be material.
- Lease-accounting adoption added approximately $100 million of right-of-use assets and lease liabilities at January 1, 2019, with no material effect on earnings, cash flows or retained earnings. Quarter-end lease liabilities were $94.7 million. Stockholders’ equity fell to $967.7 million from $1.567 billion at year-end, largely reflecting treasury-share purchases.
Important facts for investors to verify
- Whether instrument-system demand, particularly in Europe and China, recovers and whether recurring consumables and service growth persists.
- The extent to which currency translation, lower volumes, product mix and manufacturing efficiency continue to pressure gross and operating margins.
- The pace and funding of the $4 billion repurchase program, including the effect of additional borrowing and the company’s stated leverage objective.
- Progress, total cost and funding of the planned $215 million manufacturing facility.
- The sustainability of the low effective tax rate, including Singapore tax incentives, tax audits and uncertain tax positions.
- Debt maturities and covenant headroom, and the implications of the April 2019 cross-currency swap entered into after quarter-end.