Waters Corporation (WAT) - 10-Q Summary
Business Context and Reporting Period
This report covers the quarterly period ended September 30, 2002. Waters Corporation is the world's largest manufacturer of high-performance liquid chromatography (HPLC) instruments and a leader in mass spectrometry and thermal analysis. The company operates three segments (Waters, Micromass, and TAI) which are aggregated into one reporting segment.
Key Financial Metrics
| Metric | Q3 2002 | Q3 2001 | 9M 2002 | 9M 2001 |
|---|---|---|---|---|
| Net Sales | $216.0 million | $202.7 million | $633.6 million | $610.5 million |
| Gross Profit | $141.1 million | $129.6 million | $411.3 million | $388.6 million |
| Gross Margin | 65.3% | 63.9% | 64.9% | 63.6% |
| Operating Income | $49.0 million | $49.1 million | $140.6 million | $148.7 million |
| Net Income | $39.0 million | $38.2 million | $107.5 million | $116.0 million |
| Diluted EPS | $0.29 | $0.28 | $0.79 | $0.84 |
| Cash from Operations (9M) | $163.7 million | |||
| Cash & Equivalents (End Period) | $235.8 million | |||
| Restricted Cash | $69.4 million |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 7% in Q3 and 4% for the nine-month period compared to 2001. Excluding currency effects, growth was 4% for the quarter and 3% for the period.
- Product Mix: HPLC sales grew in the low double digits. Mass spectrometry sales decreased in the low double digits due to an unfavorable patent ruling and a temporary production issue. Thermal analysis sales were slightly down.
- Expenses: Selling, general, and administrative (SG&A) expenses increased 16% in Q3 and 13% for the nine-month period, driven by headcount increases and a change in accounting for patent costs (expensed as incurred rather than capitalized).
- Accounting Changes: The company adopted SFAS 142, eliminating goodwill amortization. Additionally, a $4.5 million cumulative effect charge was recorded for the change in accounting for patent-related costs.
- Investment Impairments: The company recorded $7.6 million in pre-tax charges for impairments of investments in GeneProt and Variagenics, partially offset by a $7.7 million termination fee received from GeneProt.
Guidance, Outlook, and Risks
- Restructuring: The company plans to integrate Micromass and Waters sales/service groups, expecting $4.0 to $6.0 million in non-recurring restructuring costs in Q4 2002.
- Reclassification: Certain service labor costs will be reclassified from SG&A to Cost of Sales, which will decrease gross margin by approximately six percentage points for the full year 2002 without affecting operating income.
- Capital Allocation: The company continues a $200 million stock repurchase program, having spent $54.3 million in the first nine months. It expects to borrow against its credit facility in Q4 to fund repurchases.
- Acquisitions: An agreement was reached in October 2002 to acquire Rheometric Scientific's rheology business for $17.0 million cash plus $6.0 million debt assumption.
- Legal Risks:
- Applera Litigation: A jury awarded $47.5 million in damages plus interest. The company has accrued $74.8 million (including interest and legal fees) and issued a $55.4 million letter of credit, restricting $69.4 million of cash. The company is appealing.
- HP/Agilent Litigation: Ongoing disputes regarding patent infringement in Europe; the company is appealing adverse rulings.
- Perkin-Elmer Litigation: A subsequent jury verdict awarded the company $13.3 million in damages; judgment has not yet been entered.
Investor Verification Checklist
- Verify the status of the Applera patent appeal and potential impact on the $74.8 million accrued liability and restricted cash.
- Monitor the reclassification of service costs to Cost of Sales and its effect on reported gross margins in Q4.
- Assess the resolution of the mass spectrometry production issue and its impact on order backlog and future revenue.
- Confirm the closing of the Rheometric Scientific acquisition and integration costs.
- Review the stock repurchase pace and potential reliance on credit facilities in Q4.