Waters Corporation — FY 2012 Form 10-K
Business context and reporting period. Waters designs, manufactures, sells and services analytical instruments, consumables and related software. Its Waters Division focuses on liquid chromatography and mass spectrometry; its TA Division provides thermal analysis, rheometry and calorimetry products. The company reports one aggregated segment. This filing covers the fiscal year ended December 31, 2012; fourth-quarter figures are noted separately below.
Financial performance
| Metric | FY 2012 | FY 2011 | Change |
|---|---|---|---|
| Net sales | $1.844 billion | $1.851 billion | Flat (about -0.4%) |
| Gross profit / gross margin | $1.106 billion / 60.0% | $1.121 billion / 60.5% | Margin down 0.5 percentage points |
| Operating income / operating margin | $511.5 million / 27.7% | $528.6 million / 28.6% | Income down 3% |
| Net income | $461.4 million | $433.0 million | Up 7% |
| Diluted EPS | $5.19 | $4.69 | Up 11% |
| Operating cash flow | $449.3 million | $497.4 million | Down $48.1 million |
- Products generated $1.281 billion of sales, down 3%; services generated $563.1 million, up 6%. Service revenue was about 31% of total sales.
- Waters Division sales declined 1% to $1.633 billion; TA Division sales increased 6% to $211.0 million. Waters instrument systems fell 6%, while Waters service rose 6% and TA service rose 11%.
- China sales increased 21% to $212.7 million. Europe declined 4%, including a 6% negative currency-translation effect; U.S. sales were essentially flat. About 71% of sales were outside the U.S.
- Cash, cash equivalents and short-term investments were $1.539 billion at year-end, versus total debt of $1.178 billion. Working capital was $1.753 billion. The company reported $428 million of additional borrowing capacity under committed credit facilities.
- Capital expenditures, including capitalized software, were $104.7 million. Operating cash flow less these expenditures was approximately $344.5 million, calculated from the reported figures.
Material changes and unusual items
- Flat sales reflected lower instrument-system sales and higher chemistry consumables and service revenue. Management cited customer capital-spending timing amid global uncertainty, currency effects and the weaker Indian rupee; currency translation reduced 2012 sales by 2% and operating profit by about $14 million.
- Net income rose despite lower operating income, substantially because the effective tax rate fell to 5.4% from 15.0%. Tax benefits included $36 million from recognizing a deferred tax asset tied to a non-U.S. loss carryforward and $6 million from a U.S. tax audit settlement.
- Operating income included $7.4 million of litigation provisions, including a $4 million provision related to Agilent patent litigation, and a one-time $4 million charge for discontinuing a product-trade-name intangible. The company also paid $3 million to settle a separate patent complaint.
- Operating cash flow declined as receivables increased and days sales outstanding rose to 71 days from 64, alongside incentive-plan payments and higher U.S. tax payments.
- Waters repurchased $290 million of stock in 2012. A May 2012 authorization permits up to $750 million of repurchases over two years; $643 million remained authorized at year-end. No common dividends were paid or planned.
Outlook, risks and contingencies
- Management expected instrument-system demand to improve in 2013 across most major regions, with China continuing at a double-digit growth rate. This is directional commentary, not quantified company-wide sales or earnings guidance.
- Based on then-current exchange rates, management expected currency translation to have a neutral effect on 2013 sales but a negative effect on operating profit. It also expected higher selling and administrative costs from headcount, acquisitions and restored incentive compensation, and anticipated $40 million to $45 million in annual intangible amortization for each of the next five years.
- The company expected $25 million to $50 million of additional capital spending to complete a U.K. facility consolidating mass-spectrometry research, manufacturing and distribution; it had spent $52 million through year-end. Expected 2013 defined-benefit plan contributions were $8 million to $10 million.
- Key risks include economic and customer capital-spending weakness, competition and new-product acceptance, foreign exchange exposure, reliance on international operations and suppliers, access to U.S. cash, debt covenants, tax examinations, intellectual-property litigation, regulatory compliance and operational disruption. Of $1.539 billion in cash and short-term investments, $1.489 billion was held by foreign subsidiaries and could face material tax effects upon distribution to U.S. entities.
- At year-end, unrecognized tax benefits were approximately $64 million; the company expected a $5 million to $39 million reduction within the next 12 months from statute expirations and audit settlements. Debt covenants were in compliance. Management believed ordinary-course litigation outcomes would not be material, while noting outcomes could change as matters develop.
- The company disclosed an out-of-period correction for previously omitted non-U.S. pension plans: a $6 million understatement of long-term pension liabilities, a $4 million understatement of accumulated other comprehensive income and a $2 million understatement of long-term deferred tax assets. Management concluded the correction was not material to the current or prior financial statements and said it did not affect operations or cash flows.
Fourth-quarter snapshot
Q4 2012 sales were $521.8 million versus $521.4 million in Q4 2011. Net income was $175.9 million versus $137.1 million, and diluted EPS was $2.00 versus $1.51. Q4 2012 included the $36 million deferred-tax benefit and $6 million tax-audit benefit, so the earnings comparison reflects significant tax items.
Important facts for investors to verify
- Whether the 2013 demand outlook materialized, particularly the projected double-digit China instrument growth, and whether instrument sales recovered outside China.
- How much reported earnings growth depended on the 2012 tax benefits, and the sustainability of the unusually low 5.4% effective tax rate.
- Whether receivables and DSO improved after rising to 71 days, and whether operating cash flow recovered.
- Progress on the U.K. facility, remaining capital requirements and the effect of higher software amortization on margins.
- Use of the remaining $643 million repurchase authorization, alongside debt levels, covenant headroom and the availability of cash held overseas.
- Developments in Agilent and other patent matters, tax audits and the expected resolution of uncertain tax positions.