Waters Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended April 2, 2016; comparisons are with the three months ended April 4, 2015. Waters develops and sells analytical instruments, chemistry consumables, software and services, principally for pharmaceutical, industrial, academic and government customers. Figures below are in millions of dollars except per-share data.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $475.2 | $460.4 | +3% |
| Gross profit / gross margin | $274.1 / 57.7% | $271.2 / 58.9% | Profit +1%; margin -1.2 pts |
| Operating income / operating margin | $112.7 / 23.7% | $120.0 / 26.1% | Income -6%; margin -2.4 pts |
| Net income | $94.1 | $96.1 | -2% |
| Diluted EPS | $1.15 | $1.15 | Unchanged |
| Operating cash flow | $159.9 | $154.6 | +$5.3 |
| Capital expenditures and capitalized software | $24.7 | $21.4 | +$3.2 |
| Cash and investments at period end | $2,505.2 | $2,399.3 at Dec. 31, 2015 | — |
| Total debt at period end | $1,718.8 | $1,668.3 at Dec. 31, 2015 | +$50.5 |
Operating cash flow less capital expenditures and capitalized software was approximately $135.2 million, versus $133.2 million a year earlier. Cash and cash equivalents alone declined to $416.4 million from $487.7 million at year-end; the company’s substantial investment purchases and maturities drove much of the investing cash flow. Cash and investments exceeded debt by approximately $786 million, but most funds were held overseas.
Business trends and changes from prior year
- Recurring revenue (chemistry consumables and services) grew 7%; instrument-system sales were flat. Pharmaceutical customer sales rose 7%, while combined industrial/chemical, nutritional safety and environmental sales fell 1%, and government and academic sales fell 2%.
- Sales by geography increased 2% in the United States, 1% in Europe and 8% in Asia. China and Japan grew 14% and 13%, respectively. Foreign-exchange translation reduced reported sales growth by 2% overall.
- Waters segment sales rose 4% to $424.2 million; chemistry sales increased 8% and Waters service sales 6%. TA sales rose 1% to $51.1 million, as 9% service growth more than offset a 3% decline in instrument systems.
- Gross profit increased modestly, helped by volume and favorable sales mix, but currency effects and higher costs reduced gross margin. Selling and administrative expense increased 8%, contributing to lower operating income.
- Net interest expense declined 9%, mainly because of higher interest income on cash and investments. The effective tax rate decreased to 11.8% from 15.3%; diluted EPS was unchanged despite lower net income, partly reflecting fewer shares outstanding following repurchases.
Outlook, commentary and risks
- The filing provides no specific full-year sales or EPS guidance. Management expected foreign-currency translation to have a slightly negative effect on full-year gross profit at then-current exchange rates.
- Management said financial resources, expected cash flows and committed borrowing capacity should be sufficient for debt service, working capital, capital spending, share repurchases and potential acquisitions. The company reported compliance with debt covenants and $328 million available under its amended credit agreement after letters of credit.
- Q1 included $7 million of stock-compensation expense from modifications to certain awards upon senior executive retirements. Management also cited this award-related tax benefit as a factor in the lower effective tax rate. The 0% contractual Singapore tax rate, expected to continue through March 2021 subject to milestones, increased Q1 net income by about $4 million, or diluted EPS by $0.05.
- Foreign-exchange movements, customer spending and funding—especially among government, academic and research customers—competition, product-launch execution, regulation, intellectual-property litigation and tax audits are among the disclosed risks. The filing noted Chinese government restrictions on procurement by government-funded customers as a risk.
- $2.478 billion of the $2.505 billion in cash and investments was held by foreign subsidiaries and could be subject to material tax effects if distributed to U.S. entities. Management said U.S. funding needs are managed through U.S. operating cash flow and the revolving credit facility.
- The company reported no material changes to its previously disclosed legal proceedings, risk factors, market risks or contractual obligations. It reported no dividends paid and no current plans to pay dividends. Defined-benefit plan contributions of approximately $5 million to $10 million were expected for 2016.
Important facts for investors to verify
- Whether recurring-revenue growth continues and instrument-system demand improves, particularly across customer types and geographies.
- Whether foreign exchange and the reported gross-margin decline persist, and how operating expenses evolve after the executive-award modification charge.
- The availability and practical accessibility of overseas cash for U.S. obligations, including any tax consequences of repatriation.
- Debt levels, revolver availability, covenant compliance and the company’s capacity to fund repurchases while investing in the business.
- Whether the Singapore tax-rate milestones are maintained and how tax audits or changes in jurisdictional income mix affect future tax rates.
- Management’s stated outlook and risk assumptions against subsequent results; this filing does not provide a numerical full-year revenue or EPS forecast.