WAT

Waters Corporation (WAT) - Q3 2006 10-Q Summary

Business Context and Reporting Period

This filing covers the quarterly period ended September 30, 2006. Waters Corporation is a manufacturer of analytical instruments, including high performance liquid chromatography (HPLC), ultra performance liquid chromatography (UPLC), and mass spectrometry (MS) systems, as well as thermal analysis and rheometry instruments. The company operates through two primary divisions: Waters Division and TA Instruments Division.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Sales increased 10% in Q3 and 8% year-to-date (YTD), driven primarily by new product initiatives (ACQUITY UPLC and Quattro Premier XE systems) and growth in chemistry consumables. Asian sales grew 16% in Q3 and 19% YTD.
• Profitability: Net income surged 96% in Q3 and 13% YTD. The Q3 tax rate dropped significantly to 14.7% from 57.6% in the prior year, largely due to a one-time $24.0 million tax expense in Q3 2005 related to the repatriation of foreign funds under the American Jobs Creation Act (AJCA).
• Stock-Based Compensation: The adoption of SFAS No. 123(R) in Q1 2006 added $7.1 million in Q3 and $21.7 million YTD to operating expenses, offsetting some of the gains from increased sales volume.
• Restructuring: The company incurred $7.7 million in restructuring charges YTD related to a cost reduction plan initiated in February 2006, involving 73 terminations and a facility closure in the Netherlands.
• Acquisitions: The company acquired VICAM (food safety) for $13.8 million and Thermometric AB (calorimeters) for $2.5 million in 2006.

Guidance, Outlook, and Risks

• Outlook: Management expects TA Instruments sales growth to return to first-half 2006 levels due to new product introductions. New low-end MS systems introduced in the period are expected to boost sales in Q4 2006. Full-year stock-based compensation is expected to be approximately $29.0 million.
• Share Repurchases: The company repurchased 5.3 million shares for $227.8 million YTD. As of September 30, 2006, $56.1 million remains authorized under the $500 million program.
• Liquidity: Cash and cash equivalents stood at $511.6 million. Management believes current cash, operating cash flows, and credit facilities are sufficient to fund operations, capital spending, and remaining share repurchases for at least the next 12 months.
• Risks: Key risks include reliance on pharmaceutical industry spending (approx. 51% of sales), foreign exchange rate fluctuations (68% of sales outside the U.S.), and ongoing patent litigation with Agilent/HP regarding the Alliance pump (settled in the UK, ongoing in France and Germany).

Investor Verification Checklist

• Tax Rate Normalization: Verify the sustainability of the 14.7% effective tax rate, noting the significant one-time tax expense in the prior year that skewed the comparison.
• Inventory Build: Review the $43.8 million increase in inventory YTD, attributed to ramping up for new MS products and outsourcing transitions, to ensure it aligns with demand.
• Pharma Exposure: Monitor the company's exposure to pharmaceutical capital spending, which management notes remains a cautious area despite recent rebounds.
• Restructuring Savings: Track the realization of the anticipated $7.1 million in annual cost savings from the 2006 restructuring plan.
• Stock-Based Compensation: Assess the impact of the $73.7 million in unrecognized stock-based compensation costs expected to be amortized over the next 2.7 years.