Waters Corporation — Q1 2014 Form 10-Q
Business context and reporting period. Waters designs, manufactures, sells and services analytical instruments and related products, including liquid chromatography, mass spectrometry and thermal analysis systems. The unaudited quarter ended March 29, 2014; comparisons are with the three months ended March 30, 2013. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenue | $430.5 million | $430.3 million | Flat |
| Gross profit / margin | $242.8 million / 56.4% | $255.8 million / 59.4% | Profit down 5%; margin down 3.0 percentage points |
| Operating income / margin | $88.8 million / 20.6% | $109.4 million / 25.4% | Income down 19% |
| Net income | $70.3 million | $121.1 million | Down 42% |
| Diluted EPS | $0.82 | $1.39 | Down 41% |
| Operating cash flow | $115.8 million | $127.8 million | Down $12.0 million |
- Product sales declined 3% to $284.8 million; service sales increased 7% to $145.7 million. Recurring revenue, defined by management as services plus chemistry consumables, rose 5%.
- Instrument-system sales fell 5%, with lower sales of higher-priced UPLC-MS and TA systems amid delayed customer capital spending. Chemistry sales rose 3%; service sales rose 7%.
- Management attributed weaker gross margin primarily to unfavorable foreign exchange, especially movements in the yen and pound. Selling and administrative expense rose 7% to $126.6 million, including $6 million of severance-related costs. R&D expense declined 2% to $24.7 million.
- The 2013 comparison included a $31 million benefit from tax-audit developments and a $3 million benefit from the 2012 R&D tax credit. The 2014 effective tax rate was 15.0%, versus a 17.1% tax benefit in 2013; management said these prior-year tax items reduced the 2013 effective rate by 32.9 percentage points.
Cash, debt and liquidity
- Cash and cash equivalents were $395.4 million and investments were $1.458 billion at March 29, 2014, totaling $1.853 billion. Cash and cash equivalents decreased $45.4 million during the quarter.
- Operating cash flow was $115.8 million; investing cash flow used $119.9 million and financing cash flow used $40.3 million. Capital expenditures and capitalized software were $21.4 million. Inventory increased $24.2 million, while deferred revenue and customer advances contributed $34.4 million of cash.
- Total debt was $1.332 billion, including $232.1 million classified as current and $1.100 billion as long-term. The company had $473 million available under its credit agreement after letters of credit and reported compliance with debt covenants.
- $1.824 billion of cash, cash equivalents and investments was held by foreign subsidiaries and may be subject to material tax effects if distributed to U.S. entities. Management said U.S. cash needs are managed through U.S. operating cash flow and revolving credit facilities, and believed available resources and expected cash flows would support operations, debt service, investment and authorized repurchases.
Changes, outlook and risks
- Waters Division sales increased 1% to $383.6 million, as service and chemistry growth offset weaker instrument systems. TA Division sales decreased 4% to $46.9 million.
- Regional sales were flat in Asia, up 8% in Europe (including a 6% favorable currency effect), down 2% in the U.S. and down 18% in other regions. Currency translation reduced diluted EPS by approximately $0.09.
- Management expected foreign exchange to marginally weigh on gross profit for the remainder of 2014 at then-current rates. No specific full-year revenue or earnings guidance is provided in the filing text.
- Management cited delayed customer spending, foreign-exchange exposure, competitive and pricing pressures, regulatory requirements, tax examinations, intellectual-property litigation and access to funding in certain customer markets as risks. The CEO had announced an intention to retire by the end of 2015.
- The company acquired ULSP B.V. for approximately $4 million in cash to bring low-temperature cooler manufacturing in-house and expand its product offering; its contribution to quarter results was immaterial. The company repurchased $86 million of shares under its authorization and had $262 million remaining for repurchases. It had no plans at the time to pay dividends.
- Waters expected to contribute approximately $8 million to $10 million to defined-benefit plans during 2014. It reported no material changes in legal proceedings, risk factors, contractual obligations or market risk from its 2013 Form 10-K, and no material subsequent events.
Key facts for investors to verify
- Whether delayed capital spending reverses and instrument-system demand improves, particularly for UPLC-MS and TA products.
- Whether service and chemistry growth can continue to offset weaker instrument sales, and whether gross margin stabilizes against currency and product-mix pressures.
- The sustainability of cash generation and working-capital trends, including higher inventory and DSO of 85 days versus 80 days a year earlier.
- Debt repayment and refinancing needs, access to revolving credit, and the availability of overseas-held funds for U.S. obligations.
- The resolution and timing of tax examinations, the expected approximately $6 million reduction in unrecognized tax benefits within twelve months, and the expiration of the Singapore tax arrangement’s contractual 0% rate after March 2016.
- Execution of the share-repurchase program and the impact of repurchases on capital allocation and share count.