Waters Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter ended September 29, 2018; year-to-date results cover the nine months ended that date. Unaudited consolidated financial statements. Waters develops and sells liquid chromatography, mass spectrometry, thermal-analysis instruments, consumables, software and related services for life, materials and food sciences.
Financial performance
Amounts are in USD millions except per-share data. Comparisons are with the corresponding 2017 period.
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | 578.0 | 565.6 | 1,704.9 | 1,621.8 |
| Operating income | 171.7 | 159.0 | 495.2 | 431.6 |
| Operating margin | 29.7% | 28.1% | 29.0% | 26.6% |
| Net income | 141.0 | 136.1 | 408.6 | 373.5 |
| Diluted EPS | $1.83 | $1.69 | $5.21 | $4.63 |
| Cash from operations | Not separately reported | Not separately reported | 422.9 | 505.5 |
- Q3 sales rose 2%; product sales grew 1% and service sales 5%. Nine-month sales rose 5%; product sales grew 3% and service sales 9%.
- Recurring revenue—chemistry consumables plus services—increased 4% in Q3 and 9% year to date. Instrument-system sales were flat in both periods.
- Operating income increased 8% in Q3 and 15% year to date. Diluted EPS increased 8% and 13%, respectively. Higher volume, lower selling and administrative expense in Q3, and prior-year expenses that did not recur contributed to operating-income growth.
- Effective tax rates were 16.7% in Q3 and 15.6% year to date, versus 11.5% and 10.1% in 2017. Higher rates moderated net-income growth.
Cash, liquidity and debt
- At September 29, cash and cash equivalents were $689.4 million and investments were $1,394.9 million, totaling $2.084 billion; total debt was $1.148 billion. At December 31, 2017, cash and investments totaled $3.394 billion and debt was $1.998 billion.
- Debt fell by $850 million during the first nine months, funded with cash repatriated following the 2017 Tax Act. The company reported $1.208 billion available under its credit agreement and compliance with debt covenants.
- Operating cash flow was $422.9 million, down from $505.5 million. Management attributed the decline primarily to $83 million of U.S. tax payments, a $15 million litigation settlement payment, pension contributions and other working-capital timing. Capital expenditures and software capitalization totaled $64.2 million.
- Investing activities provided $1.258 billion, largely reflecting net investment maturities and sales. Financing activities used $1.626 billion, including $850 million of debt repayments and $816.6 million of treasury-share purchases.
- Days sales outstanding increased to 77 from 73 a year earlier; inventory increased to $313.6 million from $270.3 million at year-end.
Material changes and management commentary
- Growth was uneven geographically: Q3 sales increased 6% in Asia and 2% in the Americas, but declined 3% in Europe. China grew 14% in both Q3 and year-to-date; U.S. sales were flat in Q3. Management cited weaker LC and MS instrument demand in the U.S., Europe and India. Year-to-date sales increased 7% in Europe and 6% in Asia and the Americas.
- Q3 recurring-revenue growth reflected a larger installed base and higher service demand. Nine-month service revenue rose 9%, while chemistry consumables rose 8%.
- The company adopted the new revenue-recognition standard on January 1, 2018 using the modified-retrospective method; it reported no material impact on financial position, results or cash flows.
- The board authorized a three-year, $3 billion repurchase program in April, bringing total authorization including the prior program to $3.5 billion. The company repurchased $809 million under authorized programs in the first nine months and said it expected to increase repurchases in 2019.
Outlook, risks and unusual items
- No specific revenue or earnings guidance is provided in the supplied filing text. Management expects sufficient liquidity to fund operations, capital spending, debt service, repurchases and potential acquisitions for at least the next 12 months.
- The company plans to spend an estimated $215 million to expand U.S. precision-chemistry consumables manufacturing, funded with existing cash and investments; it does not expect to issue debt for the project. It had incurred $5 million of costs through the first nine months.
- In July, Waters acquired DESI mass-spectrometry imaging intellectual-property rights for $30 million, with a future minimum royalty obligation of $3 million. It also invested $8 million in unaffiliated companies year to date.
- Tax uncertainty remains: following new guidance, the company reduced its provisional federal, state and foreign tax accrual by a net $19 million in Q3 and added $18 million of reserves for uncertain tax positions. It expected to complete its analysis of the Tax Act toll charge and related liabilities in Q4 2018. The filing also describes approximately $480 million of estimated Tax Act liabilities, with scheduled federal payments over several years.
- The company approved termination of frozen U.S. defined-benefit pension plans. Settlement could generate accounting charges, and final costs and cash needs were not yet known; $35 million of pre-tax actuarial losses in accumulated comprehensive income were expected to be charged as plans settled.
- At then-current exchange rates, management expected foreign-currency translation to negatively affect gross profit for the remainder of 2018. Risks cited include currency movements, tariffs and trade restrictions, weaker customer capital spending or funding, competition, product acceptance, regulation, supply-chain constraints, tax audits and intellectual-property litigation.
- Management said ordinary-course litigation was not expected to be material; no material changes to previously disclosed legal proceedings or risk factors were reported. The company had no current plan to pay dividends.
Most important facts for investors to verify
- Whether recurring-revenue growth can continue to offset flat instrument-system sales, particularly in the U.S., Europe and India.
- How much of reported growth and margin improvement is sustainable versus currency effects, prior-year litigation/severance and other nonrecurring comparisons.
- The final Tax Act toll-charge and uncertain-tax-position assessment, related payment schedule, and resulting effective tax rate.
- Cash-flow conversion and working-capital trends, including the increase in days sales outstanding and inventory.
- Funding and execution of the $215 million manufacturing expansion alongside planned share repurchases and debt management.
- The eventual cash and accounting impact of the U.S. pension-plan terminations and any litigation or other contingencies.