Waters Corporation (WAT) — Q3 2019 Form 10-Q
Business and period: Waters designs, manufactures, sells and services analytical instruments, consumables and software, principally for pharmaceutical, industrial, academic and governmental customers. The quarter ended September 28, 2019; comparisons are with the quarter ended September 29, 2018. Unless stated otherwise, amounts are in U.S. dollars.
Financial performance
| Metric | Q3 2019 | Q3 2018 | First nine months 2019 | First nine months 2018 |
|---|---|---|---|---|
| Net sales | $577.3 million | $578.0 million | $1,690.3 million | $1,704.9 million |
| Operating income | $173.2 million | $171.7 million | $472.0 million | $495.2 million |
| Operating margin | 30.0% | 29.7% | 27.9% | 29.0% |
| Net income | $138.1 million | $141.0 million | $391.5 million | $408.6 million |
| Diluted EPS | $2.07 | $1.83 | $5.63 | $5.21 |
| Operating cash flow | — | $451.2 million | $422.9 million |
- Q3 product sales fell 2% to $370.6 million, while service sales rose 4% to $206.7 million. For the first nine months, product sales declined 3% and service sales increased 2%.
- Q3 diluted EPS increased despite lower net income, principally because the ongoing repurchase program reduced weighted-average diluted shares to 66.8 million from 77.1 million. Nine-month diluted shares were 69.5 million versus 78.4 million.
- Net interest expense was $8.0 million in Q3 and $16.8 million for the first nine months, reflecting higher debt and lower interest income from reduced cash and investment balances; cross-currency swap income partly offset the increase.
- Capital expenditures and capitalized software were $110.2 million for the first nine months, versus $64.2 million a year earlier. Operating cash flow less these expenditures was approximately $341 million.
Financial position and liquidity
- At September 28, 2019, cash and cash equivalents were $404.6 million; there were no investments reported on the balance sheet. Total debt was $1.36 billion, versus $1.15 billion at December 31, 2018. Cash less total debt therefore indicated net debt of approximately $951 million, compared with net cash of approximately $588 million at year-end 2018, when cash and investments totaled $1.74 billion.
- Current assets were $1.34 billion and current liabilities $597.2 million. The balance sheet included $100.0 million of debt due within a year, principally Series B notes due February 2020.
- The company issued $500 million of senior unsecured notes in September: $200 million at 3.31%, due 2026, and $300 million at 3.53%, due 2029. It reported $1.5 billion available under its revolving credit facility after letters of credit and compliance with all debt covenants.
- Financing activities used $1.66 billion in the first nine months, including $1.91 billion of treasury-share purchases. Cash declined by $391.6 million over that period.
Changes, outlook and management commentary
- Management attributed weaker instrument demand to macroeconomic uncertainty and policy changes. Instrument-system sales declined 4% in both Q3 and the first nine months; recurring revenues (consumables and services) grew 4% and 2%, respectively.
- Regional performance was mixed: Q3 sales rose 7% in Asia, declined 5% in the Americas and 4% in Europe. For the first nine months, Asia grew 3%, the Americas were flat and Europe declined 7%. Management cited softer U.S. pharmaceutical capital spending, Latin American political instability, Brexit-related uncertainty and foreign-exchange headwinds.
- Operating income rose 1% in Q3, helped by lower variable incentive compensation, but fell 5% year to date amid lower sales volume and $9 million of severance costs following a workforce reduction affecting 1% of employees.
- The board authorized up to $4 billion of repurchases over two years in January 2019. The company repurchased $1.9 billion of shares during the first nine months and had $2.3 billion remaining under the authorization at September 28. Management expects higher repurchase activity in 2019 than in 2018 and targets a near-term net-debt-to-EBITDA ratio of about 2.5 times.
- Management expects sufficient funding from cash flow, cash balances and committed borrowing capacity for operations, capital spending, debt service, repurchases and potential acquisitions for at least 12 months. It expects foreign-exchange translation to weigh on gross profit for the remainder of 2019.
- The company anticipated spending $215 million to build and equip a U.S. precision-chemistry consumables facility. The filing gives differing figures for spending to date; see investor checks below.
Risks, contingencies and unusual items
- Key risks discussed include foreign-exchange movements, tariffs and trade rules, macroeconomic and political uncertainty, customer reductions in capital spending, competition, product acceptance, supply-chain and regulatory issues, intellectual-property litigation and tax audits.
- The company reported no material changes in legal proceedings or risk factors since its prior annual filing, and said ordinary-course litigation was not expected to materially affect its financial position or results. Standard intellectual-property and other indemnification agreements can have unlimited maximum potential payments; management considers their estimated fair value immaterial based on historical experience.
- Singapore qualifying activities benefited from a contractual 0% tax rate through March 2021, subject to milestones management expects to meet. The benefit increased nine-month 2019 net income by $15 million, or diluted EPS by $0.21.
- Adoption of lease accounting added approximately $100 million of right-of-use assets and lease liabilities at January 1, 2019, without material impact on earnings or cash flows. September 28 lease liabilities were $85.3 million.
- No dividends had been paid, and the company said it had no current plans to pay them.
Most important facts for investors to verify
- Reconcile the precision-chemistry facility spending disclosures: the filing cites $48 million of Q1–Q3 capital expenditures for the expansion, $51 million of construction costs during the period, and $66 million incurred through the period end.
- Confirm debt maturities and the funding plan for the $4 billion repurchase authorization, especially given the shift from net cash at year-end 2018 to net debt at September 2019.
- Track instrument-system demand, service and consumables growth, and geographic exposure to Europe, China and Latin America, including currency effects.
- Monitor execution of the Singapore tax-rate milestones, the 2020 Series B maturity, and the company’s progress toward its stated leverage target.