Waters Corporation — Q1 2010 Form 10-Q
Business context and period: Waters designs, manufactures, sells and services analytical instruments and related consumables, software and service plans. Its Waters Division focuses on liquid chromatography and mass spectrometry; its TA Division sells thermal analysis, rheometry and calorimetry products. The report covers the three months ended April 3, 2010, compared with the three months ended April 4, 2009. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Net sales | $367.7 | $333.1 | +10% |
| Gross profit / gross margin | $221.8 / 60.3% | $205.6 / 61.7% | Profit +8%; margin down 1.4 points |
| Operating income / operating margin | $92.4 / 25.1% | $85.5 / 25.7% | Income +8% |
| Net income | $75.5 | $73.3 | +3% |
| Diluted EPS | $0.79 | $0.75 | +5% |
| Operating cash flow | $103.2 | $80.7 | +$22.5 |
| Capital expenditures | $10.2 | $22.2 | Down from prior-year facility spending |
Product sales were $253.0 million, up 11%; service sales were $114.7 million, up 9%. Instrument system sales rose 11%, while chemistry consumables and services together grew 10%. Sales increased 21% in Asia, 9% in Europe, 2% in the U.S. and 10% in the rest of the world. Foreign currency translation added approximately 4% to total sales growth.
Gross margin declined primarily because of currency movements between manufacturing/service and sales currencies, partly offset by cost reductions. Selling and administrative expense rose 8% to $106.7 million, while R&D expense rose 10% to $20.1 million, partly reflecting products planned for launch later in 2010. Operating income growth reflected higher sales volume, partly offset by these expenses. Diluted EPS benefited from higher sales and lower weighted-average shares following repurchases; the Q1 2010 tax benefit added about $0.02 per diluted share, versus about $0.05 in Q1 2009.
Liquidity, debt and capital allocation
- At April 3, 2010, cash and cash equivalents were $297.0 million and short-term investments were $395.2 million, totaling $692.2 million. Cash declined $44.1 million during the quarter.
- Total debt was $712.4 million, versus $631.8 million at December 31, 2009. It included $700 million of long-term debt and $12.4 million of short-term borrowings. The company reported $599 million of borrowing availability after letters of credit and compliance with credit agreement covenants.
- Q1 financing included $200 million of new senior unsecured notes: $100 million at 3.75%, due 2015, and $100 million at 5.00%, due 2020. Proceeds were used to repay other debt and for general corporate purposes.
- The company repurchased approximately 1.7 million shares for $101 million. As of April 3, $242 million remained under the $500 million repurchase authorization.
- Operating cash flow increased, helped by lower incentive compensation payments, the absence of the prior-year $6 million litigation payment, and timing of customer receipts and vendor payments. Investing cash use included net purchases of short-term investments.
Outlook, commentary and risks
- Management attributed sales growth to improving global economic conditions, new product introductions, increased academic and industrial spending, and currency translation. It cited the Synapt G-2 and ACQUITY UPLC H-Class systems as contributors. The filing provides no specific revenue or earnings guidance.
- The company expects $70 million to $90 million of capital expenditures over the next few years to consolidate certain U.K. manufacturing locations into one facility. It expects to fund the project through operating cash flow and committed borrowing capacity.
- Management said cash, short-term investments, expected operating cash flow and available credit should cover working capital, capital spending, authorized repurchases, potential acquisitions and litigation needs for at least the next twelve months. It also expects $3 million to $5 million of 2010 contributions to defined benefit plans.
- The effective tax rate was 16.2%, compared with 11.9% in the prior-year quarter. Q1 2010 included a $2 million tax benefit from resolving a pre-acquisition tax exposure; Q1 2009 included a $5 million benefit related to changes in tax regulations. The company does not expect a material effect from the anticipated settlement of a U.K. tax audit.
- Risks highlighted include economic and customer-spending uncertainty, competition and pricing pressure, acceptance and timing of new products, foreign-exchange movements, tax-rate variability, and litigation. In the Agilent patent matter, the company had appealed a French judgment; no provision was recorded for the German case, which management did not expect to materially affect its financial position. A securities class action was dismissed in March 2010, and the plaintiff appealed in April.
- Management reported no material change in market risk or risk factors from the 2009 Form 10-K, no material recognizable subsequent events, and effective disclosure controls as of April 3, 2010.
Most important facts for investors to verify
- Whether sales growth and new-product demand persist, particularly across regions and customer groups, and how much growth remains attributable to foreign exchange.
- Whether gross margin stabilizes after the reported currency-related pressure and whether increased R&D spending produces the planned product launches.
- Debt levels, covenant headroom, the use of the $599 million available borrowing capacity, and the financing and schedule for the planned U.K. facility.
- Execution of the share repurchase authorization and its impact on cash, debt and diluted share count.
- Developments in the Agilent patent litigation, the appealed securities action, and tax audits or uncertain tax positions.