Waters Corporation — Q3 2009 Form 10-Q
Reporting period: Quarter ended October 3, 2009; comparisons are to the quarter ended September 27, 2008. Nine-month comparisons are to the nine months ended September 27, 2008. Financial figures below are in millions except per-share amounts.
Business context
Waters designs, manufactures, sells and services analytical instruments, including liquid chromatography and mass spectrometry systems, related consumables and services, and thermal analysis instruments. The filing reports one consolidated segment, comprising the Waters and TA divisions.
Financial performance
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Net sales | $374.0 | $386.3 | $1,069.9 | $1,156.8 |
| Gross profit | $220.8 | $227.8 | $645.1 | $667.6 |
| Gross margin | 59.0% | 59.0% | 60.3% | 57.7% |
| Operating income | $96.1 | $98.0 | $268.3 | $273.4 |
| Operating margin | 25.7% | 25.4% | 25.1% | 23.6% |
| Net income | $75.9 | $71.5 | $219.2 | $223.1 |
| Diluted EPS | $0.79 | $0.71 | $2.26 | $2.21 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $298.4 | $306.0 |
- Quarterly sales declined 3%; product sales fell 7%, while service sales grew 5%. Nine-month sales declined 8%; product sales fell 11%, while service sales increased 2%.
- Quarterly net income rose about 6% despite lower sales; nine-month net income declined about 2%. Lower operating expenses and lower interest expense supported earnings, while nine-month results also included a $6 million TA lease-termination expense.
- Quarterly operating margin improved modestly; nine-month gross and operating margins increased. Management attributed margin support to favorable foreign exchange, lower manufacturing costs, and a greater mix of higher-margin chemistry consumables and service.
- Nine-month operating cash flow was $298.4 million, down $7.6 million year over year. Capital expenditures and software capitalization were $80.4 million, versus $49.1 million. Operating cash flow less these expenditures was approximately $218 million.
Liquidity, debt and capital allocation
- At October 3, 2009, cash and cash equivalents were $390.4 million and short-term investments were $187.7 million, totaling $578.1 million. Current assets were $1,121.8 million and current liabilities were $432.2 million.
- Balance-sheet debt was approximately $644.7 million: $144.7 million current and $500 million long-term. The company reported $610 million drawn under its main credit agreement and $490 million available under that facility after letters of credit; separate short-term lines had $35 million outstanding.
- The main credit agreement matures January 11, 2012; the company reported compliance with its covenants. Management said cash, investments, operating cash flow and committed borrowing capacity should fund needs for at least the next 12 months.
- Nine-month investing cash flow was a use of $304.2 million, principally reflecting purchases of short-term investments, capital spending and the Thar acquisition. Cash declined $38.1 million from year-end 2008.
- The company repurchased $156 million of shares during the nine-month period under current and prior programs. A February 2009 authorization permits up to $500 million of repurchases over two years, with $397 million remaining at quarter-end. The company said it does not plan to pay dividends in the foreseeable future.
Material changes, outlook and key risks
- Management attributed weaker instrument demand primarily to the global recession, especially among industrial and pharmaceutical customers. Instrument-system sales declined 10% in the quarter and 14% for the nine-month period; recurring chemistry and service sales increased 5% and 1%, respectively.
- TA sales fell 17% for the quarter and 14% for the nine-month period, primarily due to weaker industrial instrument demand. Waters Division sales declined 1% and 7%, respectively. Asia was comparatively resilient; quarterly sales there increased 4% overall, while nine-month sales were flat.
- The nine-month period had three more selling days than the comparable 2008 period; management noted there would be correspondingly fewer selling days in Q4 and said this was reflected in its business outlook. No specific company-wide revenue or earnings guidance is provided in the filing.
- Management expected capital spending to return to 2008 levels beginning in Q4 2009. Thar, acquired in February for approximately $36 million in cash including assumed debt, was expected to contribute about $18 million in product sales and be approximately neutral to 2009 earnings after debt service.
- Foreign exchange movements, recession-driven customer spending, competition and pricing pressure, product acceptance, acquisition integration, and litigation are identified risks. The company reported no material change to its previously disclosed risk factors.
- Unrecognized tax benefits were $76.1 million; the company said that if all became recognizable, income tax expense could decline by approximately $75 million, but it could not estimate what portion might occur in the next 12 months.
- Waters is defending a securities class action alleging misstatements concerning 2007–2008 revenue, earnings, tax-rate projections and Japanese business activity; a motion to dismiss was pending. In French patent litigation, an appeals court affirmed an infringement judgment, which Waters appealed; the company had paid $6 million in 2009. No provision was recorded for German patent litigation.
- The filing describes prior-period errors identified and corrected in 2008 involving tax provision and software amortization. The company did not restate prior statements, concluding the errors and adjustments were not material to those periods.
- Management concluded disclosure controls were effective as of October 3, 2009; no material change in internal control over financial reporting was identified during the quarter.
Important facts for investors to verify
- Whether instrument demand and sales trends improve, particularly in pharmaceutical and industrial markets, and how fewer Q4 selling days affect reported growth.
- Cash conversion and working-capital movements, including the inventory increase and DSO rise to 71 days from 68 days year over year.
- Debt and liquidity presentation: reconcile the $610 million drawn under the main facility, $35 million in separate short-term borrowings, and balance-sheet debt of approximately $645 million.
- Execution and returns from the Thar acquisition, the new TA facility, and the remaining share-repurchase authorization.
- Developments in the securities and patent litigation, and the timing and potential realization of uncertain tax benefits.
- Impact of the disclosed 2008 accounting errors and one-time tax and lease-termination items when assessing comparable earnings.