Waters Corporation — Q2 2018 Form 10-Q
Business and period: Waters designs, manufactures, sells and services chromatography, mass spectrometry, thermal analysis and related products. This unaudited report covers the quarter and six months ended June 30, 2018; comparisons are with the quarter and six months ended July 1, 2017. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $596.2 million (+7%) | $558.3 million | $1,126.9 million (+7%) | $1,056.2 million |
| Operating income | $179.2 million (+16%) | $153.9 million | $323.6 million (+19%) | $272.6 million |
| Operating margin | 30.1% | 27.6% | 28.7% | 25.8% |
| Net income | $155.7 million (+18%) | $131.8 million | $267.6 million (+13%) | $237.4 million |
| Diluted EPS | $1.98 (+21%) | $1.63 | $3.39 (+15%) | $2.94 |
| Operating cash flow | Not separately stated for quarter | Not separately stated for quarter | $276.6 million | $351.3 million |
- Q2 product sales rose 4% to $388.9 million; service sales rose 12% to $207.4 million. First-half product sales grew 4% and service sales 11%.
- Gross margin, calculated from reported sales and cost of sales, was approximately 59.2% in Q2 versus 58.9%; first-half gross margin was approximately 58.8% versus 58.3%.
- First-half operating cash flow fell about $74.7 million year over year, primarily reflecting $65 million of U.S. tax payments related to tax reform and estimated taxes, a $15 million litigation settlement payment, and timing of other working-capital items.
- At June 30, cash and cash equivalents were $742.2 million and investments were $1,506.3 million. Total debt was $1,148.5 million, down from $1,997.8 million at year-end 2017. Available borrowing capacity under the 2017 credit agreement was $1,208 million; the company reported covenant compliance.
- Investing cash flow was positive $1,206.4 million, largely reflecting investment maturities and sales; financing cash flow was negative $1,370.2 million, including $850 million of debt repayments and $553.1 million of treasury-share purchases.
Changes and operating drivers
- Recurring revenue—chemistry consumables plus services—increased 11% in both Q2 and the first half, supported by a larger installed base and service demand. Waters service revenue grew 12% in Q2 and 11% year to date; TA instrument sales grew 15% and 12%, respectively.
- Instrument-system sales increased 3% in Q2 and 2% in the first half. Strong TA demand was partly offset by weaker demand for Waters LC and MS systems. U.S. Q2 sales declined 2%, primarily due to weaker high-end biomedical research LC-MS demand; China sales increased 17% in Q2.
- Foreign-currency translation contributed 2 percentage points to Q2 sales growth and 3 points to first-half growth. It contributed materially to Europe’s reported growth.
- Higher sales volume and the absence of certain prior-year costs supported operating-income growth. Prior-year items included a $10 million litigation provision, severance and early-retirement costs, and a $5 million acquired in-process R&D charge. A first-quarter 2018 settlement resolution produced a $1.7 million litigation gain in the first-half results.
- Net interest expense declined, reflecting the $850 million debt reduction and higher investment yields. First-half effective tax rate rose to 15.1% from 9.2%; Q2 rates were 10.8% and 11.0%. Rates reflect the 2017 Tax Act, GILTI and discrete tax items.
Outlook, risks and unusual items
- The filing provides no specific full-year sales, earnings or EPS guidance. Management said current currency rates were expected to weigh on gross profit for the remainder of 2018.
- The company plans an estimated $215 million expansion of precision-chemistry consumables manufacturing, funded with existing cash and investments; it does not expect to borrow for the project. It had incurred $2 million of related costs by Q2-end.
- Management expected to deploy approximately $550 million of additional repatriated cash during 2018 toward debt reduction and share repurchases. The board authorized up to $3 billion of repurchases over three years, supplementing the remaining prior authorization; $3.255 billion remained available at June 30.
- The company expects U.S. federal tax payments of about $40 million annually over the next four years for its estimated $550 million Tax Act liability, with the remaining 60% payable over three years beginning in 2023.
- In May 2018, the board approved termination of frozen U.S. defined-benefit pension plans. Settlement was expected to take six months to a year; approximately $36 million of accumulated actuarial losses may be charged to earnings as plans settle, and additional cash contributions may be required. The company separately expected $4 million to $10 million of 2018 contributions to other defined-benefit plans.
- In July 2018, after quarter-end, Waters acquired DESI imaging technology intellectual property for $30 million and entered a $150 million euro cross-currency swap; management anticipated approximately $5 million of annual net-interest savings over three years from the swap.
- Key risks identified include foreign-exchange movements, tariffs and trade restrictions, customer capital-spending and funding variability, competition and product acceptance, supply-chain and regulatory issues, intellectual-property litigation, and tax-law or tax-audit outcomes. Management reported no material change in risk factors from the 2017 Form 10-K and no material change in legal proceedings during the quarter.
- The company adopted the new revenue-recognition standard on January 1, 2018 using the modified-retrospective method; adoption had no material financial impact. It expected the lease standard, effective in 2019, to materially affect the balance sheet, but not overall results or cash flows.
Investor verification priorities
- Check whether recurring-revenue growth and installed-base service demand continue, and whether LC/MS instrument demand recovers in the U.S. and other soft markets.
- Assess the quality of earnings and cash conversion, including the tax-payment and litigation effects behind lower first-half operating cash flow.
- Track debt repayment, repurchases and liquidity against the planned facility expansion, tax obligations and stated cash deployment.
- Monitor currency exposure and the extent to which reported regional growth—particularly in Europe—reflects translation rather than underlying demand.
- Follow the Tax Act liability, Singapore tax-rate eligibility, pension-plan settlement costs and any related changes to effective tax rates or cash requirements.