Waters Corporation (WAT) — Q2 2016 Form 10-Q
Business context and period. Waters designs, manufactures, sells and services liquid chromatography, mass spectrometry, thermal analysis and related chemistry, software and service products. The quarter ended July 2, 2016; comparisons are with the quarter ended July 4, 2015. Financial amounts below are in millions unless noted.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net sales | $536.6 | $494.7 | $1,011.8 | $955.1 |
| Gross profit / margin | $316.2 / 58.9% | $286.0 / 57.8% | $590.3 / 58.3% | $557.2 / 58.3% |
| Operating income / margin | $151.6 / 28.3% | $130.3 / 26.3% | $264.3 / 26.1% | $250.3 / 26.2% |
| Net income | $128.2 | $105.7 | $222.3 | $201.7 |
| Diluted EPS | $1.57 | $1.27 | $2.72 | $2.41 |
| Operating cash flow | Not separately provided | Not separately provided | $316.9 | $267.5 |
- Q2 sales increased 8%; product sales rose 8% and service sales 9%. First-half sales increased 6%.
- Q2 sales growth was strong in China and Japan (19% each) and Europe (12%); U.S. sales rose 5%, while sales in the rest of Asia declined 5%.
- Management attributed growth to demand from pharmaceutical, fine chemical and nutritional safety customers, product launches and increased recurring revenue. Chemistry and service sales were particular contributors.
- Q2 gross margin improved 1.1 percentage points, principally from higher sales volume and a modest favorable currency effect. First-half gross margin was unchanged year over year.
- Q2 diluted EPS rose 24%; first-half diluted EPS rose 13%. Higher sales, lower share counts following repurchases and lower effective tax rates contributed to earnings growth.
Cash, debt and liquidity
- At July 2, 2016, cash and cash equivalents were $463.4 million and investments were $2,136.4 million, totaling approximately $2.60 billion. Total debt was approximately $1.76 billion; the resulting cash-and-investments excess over debt was about $843 million.
- Current assets were $3.41 billion and current liabilities $522.6 million. The filing states that most cash, cash equivalents and investments—$2.559 billion—were held by foreign subsidiaries and could be subject to material tax effects if distributed to U.S. entities.
- First-half operating cash flow increased to $316.9 million from $267.5 million. Management cited higher sales and timing of customer collections and vendor payments. Investing cash outflow was $267.7 million, including $49.7 million of capital expenditures and software capitalization; financing cash outflow was $64.9 million.
- In May, Waters issued $250 million of senior unsecured notes, using $225 million to repay revolving borrowings. Debt outstanding increased from $1.67 billion at year-end 2015 to $1.76 billion. Available borrowing capacity under credit agreements was $538 million; Waters reported compliance with debt covenants.
- The company repurchased $166 million of common stock in the first half and had $275 million remaining under its authorization. No dividends had been paid, and management said none were planned at that time.
Outlook, commentary and risks
- Management expected foreign currency translation to have a slightly favorable effect on gross profit for the rest of 2016, based on then-current exchange rates. No specific revenue or earnings guidance was stated in the provided filing text.
- Management said available financial resources, expected cash flows and committed borrowing capacity should be sufficient for debt service, working capital, capital spending, authorized repurchases and potential acquisitions. Expected 2016 defined-benefit plan contributions were approximately $5–$10 million.
- The first-half effective tax rate was 11.8%, versus 14.9% in 2015. The decline reflected, among other items, a valuation-allowance release and a tax benefit related to modified stock awards. Waters’ Singapore contractual 0% tax rate runs through March 2021 subject to milestones; management said it expected to continue meeting them. The rate added $10 million to first-half net income, or $0.12 per diluted share, compared with the statutory Singapore rate.
- Unusual items included $7 million of first-quarter stock-compensation expense from modifying awards upon senior executive retirements, and foreign-exchange contract losses of $8.5 million pretax for the first half.
- Key disclosed risks include foreign-exchange movements, global economic and political conditions (including the U.K. vote to leave the EU), changes in customer spending and government procurement, competition and pricing, product acceptance, regulatory requirements, intellectual-property litigation and tax audits. Management reported no material change in risk factors or legal proceedings versus the 2015 Form 10-K and believed current litigation would not materially affect results or financial position.
Important facts for investors to verify
- Whether overseas cash can be accessed for U.S. needs without material tax consequences, and the implications of the company’s foreign-cash concentration.
- Whether the Singapore tax-rate milestones remain achievable and how tax benefits affect earnings comparability.
- Debt maturities, variable-rate exposure, covenant headroom and the company’s planned repayment of $125 million classified as short-term debt.
- Whether sales momentum persists across geographies and customer groups, particularly given the decline in the rest of Asia and weaker government and academic demand.
- The sustainability of share repurchases and earnings growth alongside increased debt, stock-based compensation and foreign-currency exposure.