Waters Corporation — Q1 2017 Form 10-Q
Business context and period. Waters designs, sells and services liquid chromatography, mass spectrometry and thermal-analysis instruments, consumables and related services. This unaudited report covers the three months ended April 1, 2017; comparison is with the three months ended April 2, 2016. Management notes Q1 2017 had two fewer calendar days than the comparable quarter.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $498.0 million | $475.2 million | +5% |
| Product sales | $324.3 million | $307.9 million | +5% |
| Service sales | $173.7 million | $167.4 million | +4% |
| Operating income | $118.9 million | $112.7 million | +6% |
| Operating margin | 23.9% | 23.7% | +0.2 percentage points |
| Net income | $105.6 million | $94.1 million | +12% |
| Diluted EPS | $1.31 | $1.15 | +14% |
| Operating cash flow | $174.2 million | $161.5 million | +$12.7 million |
Cost of sales was $211.1 million versus $201.2 million; gross margin, calculated from reported sales and cost of sales, was approximately 57.6% versus 57.7%. Net interest expense was $5.4 million, down from $6.0 million, principally because of higher interest income. The effective tax rate fell to 7.0% from 11.8%, materially benefiting reported earnings.
Liquidity, cash flow and debt
- At April 1, 2017, cash and cash equivalents were $584.4 million and investments were $2.382 billion, totaling $2.966 billion. Cash and investments increased from $2.813 billion at year-end 2016.
- Operating cash flow was $174.2 million. Investing used $97.0 million, including $17.7 million for property, equipment and software and a $7 million investment in an analytical-solutions developer. Financing used $12.4 million, including $89.2 million of treasury-share purchases and $40 million of debt proceeds.
- Total debt was $1.867 billion, versus $1.827 billion at December 31, 2016. The company reported $428 million available under its credit agreement, after letters of credit, and compliance with all debt covenants. The $1.3 billion revolving facility matures in April 2020.
- Current assets were $3.778 billion and current liabilities $632.2 million. Most cash and investments—$2.929 billion—were held by foreign subsidiaries and may incur material tax effects if distributed to U.S. entities; $295 million was held in non-U.S.-dollar currencies.
Changes, outlook and risks
- Sales growth was led by pharmaceutical customers (+8%) and industrial customers (+5%); government and academic sales declined 9%. Asia sales increased 14%, including China +20% and other Asia +22%; U.S. and Japan sales each declined 7%. Foreign currency translation reduced overall sales growth by 1%.
- Instrument-system sales grew 6%; recurring revenue (chemistry consumables and services) grew 4%, with the shorter quarter weighing on recurring revenue. Management attributed growth to pharmaceutical and industrial demand, particularly in China and India. Acquisitions had minimal effect on total sales growth.
- Q1 operating results included $9 million of severance and transition-incentive costs and a $5 million acquired in-process R&D charge for licensed, uncommercialized mass-spectrometry technology. The licensing arrangement could require up to $7 million in additional milestone payments, plus royalties.
- A newly adopted stock-compensation accounting rule reduced Q1 tax expense by $7 million and added $0.09 to diluted EPS. Management also cited a $5 million benefit to net income from Singapore’s contractual 0% tax rate on qualifying activities.
- Management said foreign-exchange translation may negatively affect gross profit for the rest of 2017 as the benefit from a weaker pound is expected to be offset by weakness in other major currencies. It provided no specific sales or earnings guidance in the supplied filing text.
- Management believes available resources, expected cash flows and borrowing capacity will meet needs for at least the next 12 months. The company expects $6–$11 million of 2017 contributions to defined-benefit plans and stated it has no current plans to pay dividends. It repurchased $82 million of shares under its authorization, with $41 million remaining at quarter-end.
- Key stated risks include currency movements, customer capital-spending and funding variability, competition and new-product acceptance, regulatory and supply-chain issues, tax audits and changing tax rules, and intellectual-property litigation. Management reported no material change in risk factors or legal proceedings; it considers current litigation outcomes unlikely to be material.
Important facts for investors to verify
- Whether sales growth persists, especially in pharmaceutical and industrial markets, and whether weakness in U.S., Japan, and government/academic demand continues.
- The underlying tax rate and earnings contribution from the stock-compensation tax benefit and Singapore tax arrangement.
- How foreign-exchange movements affect sales, margins and the value or accessibility of foreign-held cash and investments.
- Debt levels, planned repayment of the $125 million short-term borrowing, covenant compliance and the availability of U.S. liquidity.
- Potential milestone and royalty costs under the mass-spectrometry licensing arrangement, and the impact of restructuring costs and share repurchases.