Waters Corporation — Q3 2010 Form 10-Q
Business context and period: Waters designs, manufactures, sells, and services analytical instruments and related consumables, software, and services, principally for pharmaceutical, life-science, industrial, food-safety, academic, and government customers. The quarter ended October 2, 2010; comparisons are with the quarter ended October 3, 2009. The nine-month period also ended October 2, 2010.
Financial results and liquidity
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $401.0 million | $374.0 million | $1,159.8 million | $1,069.9 million |
| Gross profit / margin | $238.1 million / 59.4% | $220.8 million / 59.0% | $695.7 million / 60.0% | $645.1 million / 60.3% |
| Operating income / margin | $103.8 million / 25.9% | $96.1 million / 25.7% | $301.8 million / 26.0% | $268.3 million / 25.1% |
| Net income | $94.7 million | $75.9 million | $255.2 million | $219.2 million |
| Diluted EPS | $1.02 | $0.79 | $2.71 | $2.26 |
| Operating cash flow | Not separately presented for quarter | Not separately presented for quarter | $323.8 million | $298.4 million |
- Quarterly sales increased 7%, with product sales up 9% and service sales up 3%. Nine-month sales rose 8%, with product sales up 10% and service sales up 6%.
- Q3 sales growth reflected higher demand, new instrument systems, and improving global conditions. Asia sales rose 23% in the quarter, including strong growth in China and India; U.S. sales rose 11%, while Europe declined 10%. Nine-month sales increased 18% in Asia and 8% in the U.S.; Europe declined 1%.
- Management attributed higher operating income chiefly to sales volume. Nine-month gross margin eased from 60.3% to 60.0%, as currency effects were partly offset by manufacturing cost reductions.
- At October 2, cash and cash equivalents were $262.8 million and short-term investments were $574.3 million, totaling $837.1 million. Current assets were $1,438.3 million and current liabilities $417.4 million.
- Total debt was $792.2 million, up from $631.8 million at December 31, 2009. This included $200 million of new senior notes, $500 million under the term loan, $80 million of revolver borrowings, and $12.2 million of other short-term debt. Available borrowing capacity was $519 million; the company reported compliance with debt covenants.
- Nine-month investing cash use was $332.4 million, including $47.3 million in capital expenditures and software capitalization. Financing cash use was $58.9 million, including $244.9 million of treasury-share purchases, partly offset by debt issuance and stock-plan proceeds. Cash and equivalents declined $78.3 million; short-term investment purchases and maturities substantially affected investing cash flows.
Material changes, outlook, and risks
- Reported earnings benefited from tax items: an $8 million net benefit from a U.K. tax audit settlement lowered the effective tax rate by 7.5 percentage points in Q3 and 2.6 points year to date. A further $2 million benefit related to a pre-acquisition tax exposure was recorded year to date. The effective tax rates were 5.8% for Q3 and 12.9% year to date.
- In Q3, Waters released a $71 million valuation allowance related to foreign tax-credit carryforwards, recognized a $12 million benefit and expects a further $14 million benefit; the remaining deferred tax asset was reduced to $14 million. The filing says management expects that remaining amount to be realized.
- Waters issued $100 million of 3.75% senior notes due 2015 and $100 million of 5.00% notes due 2020. The proceeds were used to repay other debt and for general corporate purposes. The company had $102 million remaining under its $500 million share-repurchase authorization at October 2.
- Management said available cash, short-term investments, expected operating cash flow, and committed credit capacity should fund working capital, capital spending, authorized repurchases, potential acquisitions, and litigation outcomes for at least 12 months. No specific sales or earnings guidance is provided in the supplied filing text.
- The company expects $70–$90 million of capital expenditures over the next few years to consolidate U.K. manufacturing into one facility, funded from existing cash and operating cash flows. It expected total 2010 defined-benefit-plan contributions of approximately $4–$5 million and had contributed $4 million through the third quarter. It does not plan to pay dividends in the foreseeable future.
- Key risks include uncertain customer demand and capital spending, competition and new-product acceptance, foreign-exchange movements, regulatory and supply-chain issues, tax uncertainty, and litigation. In the Dearborn securities class action, dismissal was granted in March 2010 and appealed; oral argument occurred November 1, 2010, with no decision reported. Waters also disclosed ongoing Agilent patent litigation in France and Germany; the company had recorded a French-case provision and stated no provision for the German case.
- An immaterial correction to prior-period incentive-plan and other accrual balances reduced selling and administrative expense in Q2 2010. The filing states the error was not material to the affected periods or previously issued statements. A $3 million non-income-tax audit settlement expense increased Q3 selling and administrative expense.
Important facts for investors to verify
- Whether underlying growth and profitability persist after separating the tax benefits from reported earnings.
- Drivers of the increase in debt and share repurchases, and the company’s planned use of its $519 million borrowing capacity and remaining repurchase authorization.
- Cash conversion and working-capital trends, including the increase in inventory and receivables; days sales outstanding rose to 77 days from 71 a year earlier.
- Progress, timing, and final cost of the planned U.K. manufacturing consolidation and its $70–$90 million capital-expenditure estimate.
- Developments in the Dearborn appeal, Agilent patent cases, and tax audits or uncertain tax positions.