Waters Corporation — Q2 2014 Form 10-Q
Business context and reporting period. Waters designs, manufactures, sells and services liquid chromatography, mass spectrometry, thermal analysis and related instruments, consumables, software and services. This unaudited quarterly report covers the quarter ended June 28, 2014, and compares results with the quarter ended June 29, 2013; year-to-date figures cover the first six months.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $481.8m | $451.1m | $912.3m | $881.5m |
| Gross profit | $279.9m | $262.8m | $522.7m | $518.6m |
| Gross margin | 58.1% | 58.3% | 57.3% | 58.8% |
| Operating income | $118.4m | $112.7m | $207.2m | $222.1m |
| Operating margin | 24.6% | 25.0% | 22.7% | 25.2% |
| Net income | $96.5m | $89.3m | $166.8m | $210.4m |
| Diluted EPS | $1.13 | $1.03 | $1.95 | $2.42 |
| Operating cash flow | Not presented by quarter | $222.1m | $236.8m |
- Quarterly sales rose 7%; product sales increased 5% and service sales 10%. Year-to-date sales increased 4%, with product sales up 1% and services up 8%.
- Q2 growth was supported by instrument demand and recurring revenue. Sales to China declined 10% in the quarter and 4% year-to-date; U.S. sales rose 11% and 5%, respectively.
- Six-month net income fell 21%, despite sales growth, as operating income declined 7% and the prior-year period included significant tax benefits. Diluted EPS was down 19%.
- Q2 net income increased 8% and diluted EPS increased 10% year over year. Share repurchases reduced weighted-average diluted shares.
Cash, debt and liquidity
- At June 28, 2014, cash and cash equivalents were $428.7m and investments were $1,488.9m; combined cash, cash equivalents and investments were $1.918bn. Approximately $1.876bn was held by foreign subsidiaries and may incur material tax effects if distributed to U.S. entities.
- Total debt was $1.393bn, including $233.4m classified as current and $1.160bn long-term. The company had $413m available under its 2013 credit agreement after letters of credit and reported compliance with debt covenants.
- Six-month operating cash flow was $222.1m; investing cash outflow was $173.8m and financing cash outflow was $65.7m. Capital expenditures and capitalized software were $44.2m. Cash declined $12.1m from year-end.
- Waters repurchased $178m of shares in the first half under its existing program. The board authorized an additional $750m repurchase program over three years and extended the prior program through May 2015.
Outlook, commentary and notable items
- Management expected foreign currency translation to have a marginally negative effect on gross profit for the remainder of 2014, based on then-current exchange rates. No specific full-year revenue or earnings guidance is provided in the filing text.
- Management said its financial position, expected cash flows and borrowing capacity should be sufficient for debt service, working capital, capital spending, authorized repurchases and potential acquisitions. It noted the need to manage U.S. cash needs given the concentration of funds overseas.
- Q2 SG&A included a $4m impairment charge for a U.K. building held for sale. First-half SG&A also included $6m in severance costs related to a workforce reduction. The impairment reduced the building’s carrying value to $5m.
- The 2013 first-half tax provision included a $31m benefit from completed tax audits and a $3m benefit related to the R&D tax credit. Those benefits lowered the 2013 effective tax rate by 16.4 percentage points; the credit was not applicable in 2014. Waters expected approximately $6m of further reductions in unrecognized tax benefits within 12 months.
- Waters acquired ULSP for approximately $4m in January 2014. In July, after quarter-end, it acquired Medimass net assets for approximately $23m. Also on June 30, it issued $200m of senior unsecured notes, using proceeds to repay revolving debt and for general corporate purposes.
- Waters expected 2014 defined-benefit plan contributions of approximately $29m–$31m; it had contributed $22m through the first half, including $21m to certain non-U.S. plans. Estimated annual intangible amortization was approximately $49m for each of the next five years.
- Risks highlighted include foreign-exchange movements, weaker demand or funding among government and academic customers, competitive and pricing pressure, product acceptance, supply-chain constraints, regulatory requirements, intellectual-property litigation, and tax uncertainty. The CEO had announced an intention to retire by the end of 2015.
Important facts for investors to verify
- Whether recurring-revenue growth can continue to offset modest instrument-system growth, particularly amid continued weakness in China and government/academic demand.
- How foreign exchange, product mix and rising operating expenses affect margins and earnings in the remainder of 2014.
- The quality and sustainability of cash generation, including inventory growth, DSO of 76 days versus 74 a year earlier, and timing of vendor payments and customer collections.
- Debt refinancing and liquidity after the June 30 note issuance, plus the practical availability of overseas cash to fund U.S. commitments.
- The impact of ongoing share repurchases, future acquisition spending, pension contributions and the significant tax benefit in the 2013 comparison period.