Waters Corporation (WATERS) — Form 10-Q Summary
Reporting period: Second quarter and six months ended June 29, 2013; comparisons are with the periods ended June 30, 2012. Amounts are in millions of dollars except per-share data.
Business context
Waters designs, manufactures, sells and services analytical instruments and related consumables, software and services, principally for life science, pharmaceutical, industrial, environmental, academic and government customers. Its Waters Division and TA Division are aggregated as one reportable segment. The unaudited interim statements should be read with the 2012 Form 10-K.
Financial results and key metrics
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Net sales | $451.1 | $451.5 | $881.5 | $871.9 |
| Gross profit | $262.8 | $272.2 | $518.6 | $525.4 |
| Gross margin | 58.3% | 60.3% | 58.8% | 60.3% |
| Operating income | $112.7 | $120.1 | $222.1 | $230.3 |
| Operating margin | 25.0% | 26.6% | 25.2% | 26.4% |
| Net income | $89.3 | $97.7 | $210.4 | $186.4 |
| Diluted EPS | $1.03 | $1.09 | $2.42 | $2.08 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $236.8 | $216.3 |
- Q2 sales were essentially flat year over year; product sales fell 3% while service sales rose 6%. First-half sales increased 1%, with service sales up 4% and product sales approximately flat.
- Q2 net income declined 9% and diluted EPS declined 6%. For the first half, net income rose 13% and diluted EPS rose 16%, substantially reflecting tax benefits described below and lower average share counts.
- First-half operating cash flow was $236.8 million. Investing cash outflow was $198.0 million, including $61.3 million of property, equipment and software spending; financing cash outflow was $53.1 million. Cash and equivalents declined $26.0 million to $455.0 million.
- At June 29, cash, cash equivalents and investments totaled $1.650 billion, compared with total debt of $1.268 billion. Approximately $1.607 billion of those liquid assets was held by foreign subsidiaries and may incur material tax effects if distributed to U.S. entities.
- Current assets were $2.344 billion and current liabilities $475.0 million. Total debt increased $90.1 million from year-end 2012. The company had $538 million available to borrow under its credit agreements after letters of credit.
Material changes and management commentary
- Instrument-system sales fell 5% in Q2, primarily due to delayed customer capital spending in the U.S. and late receipt of some international orders; management said the delays increased backlog. Chemistry and service sales together grew 5%.
- Foreign-currency translation reduced Q2 sales by 2% overall and first-half sales by 3%, principally due to yen weakness. Management estimated translation reduced diluted EPS by about $0.09 in Q2 and $0.14 year to date, and expected a significant negative full-year 2013 EPS impact at then-current exchange rates.
- Gross-margin pressure reflected currency, product mix and amortization associated with the recently launched UNIFI software platform. Amortization expense is estimated at $40–$45 million annually for each of the next five years; management said software and product-mix effects could continue to affect gross profit.
- In June, Waters entered a new credit agreement with a $1.1 billion revolving facility and a $300 million term loan, both maturing in 2018. It used $860 million of proceeds to repay its prior credit agreement. Waters reported compliance with debt covenants at quarter-end.
- During the first half, the company repurchased $165 million of shares. The May 2012 program had $478 million remaining under its $750 million authorization at June 29. No dividends were paid, and management said it had no current plans to pay dividends.
Outlook, unusual items and risks
- First-half income tax results included a net $31 million benefit from resolving U.S. and Japanese tax audits, plus a $3 million benefit related to the retroactive 2012 R&D tax credit. These items reduced the first-half effective tax rate by 16.4 percentage points. The reported first-half tax provision was a $2.25 million benefit; results therefore include material nonrecurring tax benefits.
- Q2 included a $1.6 million other-than-temporary investment impairment charge. The 2012 comparison included a $3 million litigation settlement provision.
- Management expected $8–$10 million of defined-benefit plan contributions during 2013. Completing the U.K. facility consolidation was expected to cost up to $30 million; first-half construction spending on the project was $23 million.
- In July 2013, Waters acquired Scarabaeus Mess-und Produktionstechnik GmbH, a rheometer manufacturer, for approximately $4 million cash.
- Key disclosed risks include foreign-exchange movements, delayed or reduced customer capital spending, competition and product acceptance, regulatory and supply-chain issues, intellectual-property litigation, tax examinations and changes in tax rules. Management said there were no material changes to the risk factors in its 2012 Form 10-K and no material changes in market risk.
- The filing provides no specific full-year sales or EPS guidance. Management did state that currency was expected to continue to pressure results and described anticipated software-related amortization and capital spending.
Important facts for investors to verify
- How much of first-half earnings growth is sustainable after excluding the $31 million tax-audit benefit and the $3 million R&D credit benefit.
- Whether instrument-order delays convert to sales, and whether backlog, customer capital spending and regional demand improve.
- The ongoing effects of yen and other currency movements on sales, margins and EPS.
- The availability and practical accessibility of overseas cash, alongside debt levels, refinancing terms and covenant headroom.
- The realized cost and margin impact of UNIFI and other software launches, the U.K. facility project, and the share-repurchase program.