Waters Corporation — Q2 2009 Form 10-Q
Reporting period: Three and six months ended July 4, 2009; comparatives ended June 28, 2008. Waters manufactures and services analytical instruments, consumables and related software. Unless otherwise noted, financial amounts below are in millions of U.S. dollars.
Financial results
| Metric | Q2 2009 | Q2 2008 | First half 2009 | First half 2008 |
|---|---|---|---|---|
| Net sales | $362.8 | $398.8 | $695.9 | $770.5 |
| Gross profit / margin | $218.7 / 60.3% | $223.5 / 56.1% | $424.3 / 61.0% | $439.8 / 57.1% |
| Operating income | $86.7 | $87.0 | $172.2 | $175.4 |
| Net income | $69.9 | $83.1 | $143.3 | $151.6 |
| Diluted EPS | $0.72 | $0.82 | $1.47 | $1.49 |
| Operating cash flow | Not presented by quarter | $173.8 | $203.3 |
Q2 sales declined 9% year over year and first-half sales declined 10%. Product sales fell 12% in Q2 and 14% for the first half; service sales declined 2% in Q2 but rose 1% for the first half. Operating margin was approximately 23.9% in Q2 and 24.7% for the first half. The filing reports gross margins but does not provide a separate cash-flow margin.
Balance sheet, debt and liquidity
- At July 4, cash and cash equivalents were $358.4 million and short-term investments were $147.2 million, totaling approximately $505.7 million, versus $428.5 million of cash and no short-term investments at year-end 2008.
- Total assets were $1.80 billion; total liabilities were $1.07 billion. Current assets were $1.06 billion and current liabilities $400.1 million.
- Borrowings under the main credit agreement totaled $595 million, including $500 million classified as long-term and $95 million as short-term; separate short-term borrowings were $36 million. The balance sheet reports $130.8 million of current notes payable and debt and $500 million of long-term debt.
- The company had $504 million available under its $600 million revolving facilities after letters of credit. The credit agreement matures January 2012; Waters reported compliance with its covenants.
- First-half investing cash outflow was $241.1 million, including $57.8 million for property, equipment and software, $36.1 million for acquisitions and $147.2 million for short-term investments. Financing cash outflow was $5.9 million. Cash declined $70.1 million during the period.
Changes, outlook and material items
- Management attributed lower sales primarily to recession-driven weakness in customer instrument spending and unfavorable currency translation, which reduced sales by 5% in both the quarter and first half. Instrument-system sales fell 13% and 17%, respectively. Government and academic sales increased, while pharmaceutical and industrial sales declined.
- Gross margin improved year over year, helped by product mix, favorable currency effects and lower manufacturing costs. Lower selling, administrative and R&D expenses partly offset weaker sales; a $6 million charge for terminating the old TA facility lease weighed on operating results.
- First-half operating cash flow fell $29 million year over year. Management cited lower customer collections, a $6 million patent-litigation payment and the $6 million TA lease termination payment. Days sales outstanding increased to 74 from 70 a year earlier.
- Capital spending rose to $57.8 million from $32.6 million, including $25 million for a new TA facility, completed and operational in June. Management expected capital spending to return to 2008 levels beginning in Q4 2009.
- Waters acquired the remaining shares of Thar Instruments in February for $36 million in cash, including assumption of $4 million in debt. Management expected Thar to contribute about $20 million in product sales and be approximately earnings-neutral in 2009 after debt service.
- The 2009 first-half results included an approximately $5 million tax benefit from reversal of a prior tax provision. The 2008 comparative periods included out-of-period adjustments: a $16 million tax benefit and $9 million of additional software amortization; these increased 2008 net income by $8 million. Prior statements were not restated, and the company said the errors were not material to previously issued periods.
- The board authorized a new $500 million share-repurchase program over two years. Waters repurchased $107 million of shares in the first half under current and prior programs; $445.6 million remained under the new program at July 4.
- Management said cash, short-term investments, expected operating cash flow and borrowing capacity should fund working capital, capital spending, authorized repurchases, potential acquisitions and litigation needs for at least 12 months. No dividend was planned. The filing gives no formal revenue or earnings guidance.
Risks and contingencies
- Risks cited include prolonged recession and reduced customer capital spending, foreign-exchange movements, competition and pricing pressure, product acceptance and regulatory delays, acquisition integration, access to capital, and litigation.
- Waters was appealing a French patent judgment in favor of Agilent; it paid $6 million for related damages and fees during the first half. No provision was recorded for related German patent litigation. The company also faced a securities class action alleging misstatements concerning projections and Japan business activity; it was seeking dismissal and intended to defend the case.
- Unrecognized tax benefits were $75.0 million. If all became recognizable, the company estimated a potential $74 million reduction in income tax provision, but could not estimate how much might occur within 12 months.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether instrument demand and recurring consumables and service trends stabilized after the reported recession-related declines.
- Whether gross-margin improvement and expense reductions are sustainable as sales mix, currency and volumes change.
- Cash conversion, receivables and inventory trends, and the effect of planned repurchases and capital spending on liquidity and debt.
- Thar’s realized sales and earnings contribution versus management’s 2009 expectation, and integration progress.
- Developments in the Agilent patent cases, the securities class action and uncertain tax positions.
- The comparability impact of the 2008 out-of-period accounting adjustments when evaluating year-over-year earnings and tax rates.