Waters Corporation — Q3 2017 Form 10-Q
Business and period: Waters designs, sells and services liquid chromatography, mass spectrometry, thermal analysis and related products, consumables and software for life, materials and food sciences. The unaudited quarter ended September 30, 2017; comparisons are with the quarter ended October 1, 2016. Nine-month results are also summarized below. Amounts are in U.S. dollars.
Financial performance
| Metric | Q3 2017 | Q3 2016 | First nine months 2017 | First nine months 2016 |
|---|---|---|---|---|
| Net sales | $565.6 million | $526.8 million | $1,621.8 million | $1,538.6 million |
| Operating income | $159.0 million | $151.7 million | $431.7 million | $416.0 million |
| Operating margin | 28.1% | 28.8% | 26.6% | 27.0% |
| Net income | $136.1 million | $124.9 million | $373.5 million | $347.1 million |
| Diluted EPS | $1.69 | $1.53 | $4.63 | $4.26 |
| Operating cash flow | — | $505.5 million | $469.0 million |
Quarterly sales rose 7%, operating income 5%, net income 9% and diluted EPS 10%. Nine-month sales rose 5%, operating income 4%, net income 8% and diluted EPS 9%. Product and service sales both grew 7% in Q3 and 5% year to date. Recurring revenue, comprising service and chemistry consumables, grew 8% in Q3 and 6% year to date. Sales growth was broad across products and customer markets, with instrument systems also benefiting from LC-MS and TA demand.
Operating margin declined year over year in both comparison periods despite higher sales. Management cited higher operating costs and several specific charges; higher sales volume and controlled spending partly offset these pressures. Net interest expense declined year to date, mainly because higher cash and investment balances generated more interest income. The effective tax rate was 11.5% for Q3 and 10.1% year to date, versus 14.2% and 12.7%, respectively, in 2016.
Liquidity, cash flow and debt
- At September 30, 2017, cash and cash equivalents were $603.8 million and investments were $2,651.2 million, or $3,255.0 million combined. Total debt was $1,957.8 million, up from $1,827.3 million at year-end 2016.
- Cash from operations was $505.5 million for the first nine months. Capital expenditures and capitalized software were $55.3 million, implying approximate operating-cash-flow less capital-expenditure cash flow of $450.2 million.
- Cash used in investing was $404.0 million and cash used in financing was $39.5 million; cash increased by $98.2 million during the period. Investment purchases and maturities were substantial and largely reflect the company’s investment portfolio activity.
- The company reported $338 million available under its credit agreement after letters of credit and was in compliance with debt covenants. Its revolving credit facility matures in April 2020.
- $3,212 million of cash, cash equivalents and investments was held by foreign subsidiaries and may be subject to material tax effects on distribution to U.S. entities. Management said U.S. funding needs are managed through U.S. operating cash flow and the revolving facility.
Material changes, outlook and risks
- Regional performance varied: Europe grew 20% in Q3 and 8% year to date; Asia grew 7% and 11%. U.S. sales grew 1% in Q3 but fell 2% year to date. China remained strong, while Indian customer orders were delayed during implementation of the GST system. Natural disasters affected some markets; management said their Q3 impact on overall growth was not significant, but the timing of a return to normal conditions was uncertain.
- Unusual and non-recurring items included a $10.0 million provision for a German patent-litigation verdict, $12 million of year-to-date severance and early-retirement costs, and a $5.0 million charge for licensed mass-spectrometry intellectual property not yet commercialized. Q3 selling and administrative expense included a $4 million charge for accelerated stock awards. The litigation accrual was $17 million at quarter-end.
- The IP licensing arrangement may require up to $7 million in additional milestone payments, plus royalties on future net sales. Management gave no specific sales or earnings guidance in the provided filing text. It noted that current foreign-exchange rates could support sales but still pressure gross profit, in part because of U.K. manufacturing costs.
- Management expected cash resources, future operating cash flow and borrowing capacity to be sufficient for at least the next 12 months. It also noted that most liquid resources are overseas. The company authorized up to $1 billion of share repurchases over three years; $885 million of authorization remained at September 30, and it repurchased $238 million of shares during the first nine months.
- Key risks discussed include foreign-exchange movements, customer spending and funding patterns, competition and product acceptance, regulatory requirements, intellectual-property litigation, tax audits and changes in tax rules. A hypothetical 10% adverse currency move was estimated to reduce the value of non-U.S.-dollar cash, cash equivalents and investments by about $34 million. The filing reported no material change in risk factors from the 2016 Form 10-K.
Important facts for investors to verify
- Whether U.S. pharmaceutical demand improves and whether Indian order delays and natural-disaster effects normalize.
- The final cost and status of the German patent case, including the $17 million accrued amount and any further exposure.
- How much foreign-held liquidity is practically available to fund U.S. needs, including any tax consequences of repatriation.
- The effect of debt-funded activity, share repurchases and debt maturities on leverage and liquidity; total debt increased year to date.
- Whether the Singapore 0% contractual tax rate remains available through March 2021 and whether related milestones continue to be met.
- The timing and potential financial impact of future IP-license milestones and royalties; the filing does not quantify future royalties.