WAT

Waters Corporation (WAT) 2005 Annual Report Summary

Business Context and Reporting Period

This summary covers the fiscal year ended December 31, 2005. Waters Corporation is a global manufacturer of analytical instruments, operating through two primary divisions: the Waters Division (Liquid Chromatography, Mass Spectrometry, and consumables) and the TA Instruments Division (Thermal Analysis and Rheometry). The company serves pharmaceutical, life science, industrial, academic, and government customers. In 2005, the company experienced a seasonal sales increase in the fourth quarter and continued to integrate its LC and MS operations.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Sales grew 5% in 2005, driven by a 9% increase in service sales and growth in LC consumables. However, demand from U.S. pharmaceutical customers weakened due to pipeline issues and litigation affecting those customers. Conversely, non-U.S. pharmaceutical sales grew 8%, and sales in Asia and Japan were strong (12% and 10% growth, respectively).
• Profitability: Operating income remained relatively flat despite sales growth, primarily due to a $3.1 million litigation provision related to a patent settlement with Hewlett-Packard (Agilent). In 2004, operating income benefited from a $17.1 million litigation judgment from Perkin-Elmer.
• Debt and Liquidity: Total debt increased significantly to $810.0 million from $440.0 million. This was driven by a new $250 million term loan and increased borrowings under the revolving credit facility to fund a $659.3 million stock repurchase program. Despite higher debt, operating cash flow improved to $298.1 million due to better working capital management (DSO improved to 70 days).
• Tax Rate: The effective tax rate rose to 26.4% from 21.6%, largely due to a one-time $24.0 million tax expense associated with the repatriation of $500 million in foreign earnings under the American Jobs Creation Act (AJCA).

Guidance, Outlook, and Risks

• Restructuring: In February 2006, the company initiated a cost reduction plan affecting approximately 70 employees and the closure of a sales office in the Netherlands. A one-time restructuring charge of $5.0 million to $7.0 million is expected in 2006.
• Accounting Changes: The adoption of SFAS No. 123(R) regarding share-based payments in 2006 is expected to negatively impact diluted EPS by approximately $0.21 to $0.24.
• Outlook: Management expects sales growth in 2006 driven by new products and service sales. Gross margins are expected to decline slightly due to the mix of new, higher-cost products and transitional expenses related to outsourcing manufacturing to Singapore.
• Risks: Key risks include intense competition, reliance on pharmaceutical capital spending, foreign currency fluctuations (65% of sales are outside the U.S.), and ongoing patent litigation (specifically the pending German case against Agilent).

Investor Verification Checklist

• Pharmaceutical Demand: Verify the recovery of U.S. pharmaceutical capital spending, which was a drag on 2005 performance.
• Debt Servicing: Confirm the company's ability to service the increased debt load ($810 million) while maintaining its aggressive stock repurchase program.
• Restructuring Execution: Monitor the realization of cost savings from the 2006 restructuring plan and the impact of the one-time charges on near-term earnings.
• Product Mix: Assess the margin impact of the ACQUITY UPLC and new MS systems versus the cannibalization of higher-margin legacy products.
• Legal Contingencies: Track the status of the pending German patent litigation with Agilent, as the outcome could result in additional provisions.