Waters Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 30, 2013; comparison is the three months ended March 31, 2012. Waters designs, manufactures, sells and services analytical instruments, consumables and software, principally in liquid chromatography and mass spectrometry, as well as thermal analysis products. Its Waters and TA divisions are aggregated into one reportable segment. Dollar amounts below are in millions unless noted.
Financial results and key metrics
| Metric | Q1 2013 | Q1 2012 | Change / context |
|---|---|---|---|
| Net sales | $430.3 | $420.5 | Up 2%; product sales up 3%, service sales up 2% |
| Gross profit / margin | $255.8 / 59.4% | $253.2 / 60.2% | Profit up 1%; margin down 0.8 percentage points |
| Operating income / margin | $109.4 / 25.4% | $110.2 / 26.2% | Down 1%; margin down 0.8 percentage points |
| Income before taxes | $103.4 | $104.5 | Down 1% |
| Net income | $121.1 | $88.7 | Up 37%, substantially affected by tax benefits |
| Diluted EPS | $1.39 | $0.98 | Up 42%; filing attributes $0.39 per share to tax benefits |
| Operating cash flow | $127.8 | $111.2 | Increase primarily reflected timing of vendor payments |
Cost of sales increased 4%, faster than revenue. Management attributed lower gross margin principally to instrument-product mix, amortization on the newly launched UNIFI software, and foreign currency effects. R&D expense rose 8% to $25.3 million; selling and administrative expense rose 1% to $118.7 million.
Balance sheet and liquidity at March 30, 2013: Cash and cash equivalents were $472.0 million and investments were $1,117.8 million, or $1,589.9 million combined. Approximately $1,556 million of cash, cash equivalents and investments was held by foreign subsidiaries and could incur material tax effects if distributed to U.S. entities. Total debt was $1,233.2 million, compared with $1,177.8 million at year-end 2012. The company had $373 million available under its 2011 Credit Agreement after letters of credit and reported compliance with debt covenants. The weighted-average rate on senior notes and credit-agreement borrowings was 2.07%.
Cash movements: Investing activities used $90.5 million, including $30.6 million for property, equipment and software; financing activities used $34.6 million, including $101.4 million for treasury-share purchases, partly offset by debt issuance and other financing proceeds. Cash declined by $9.0 million during the quarter, including an $11.8 million adverse foreign-exchange effect.
Material changes versus the prior period
- Sales increased 2%, but foreign currency translation reduced reported sales by 3%, principally because of the weaker yen. Instrument-system sales rose 4%, while chemistry sales fell 2%; service sales increased 2%.
- Geographically, U.S. sales rose 6% and China sales rose 9%; Japan fell 17% and Europe fell 1%. Management cited currency translation as a major factor in the Japan and Europe declines.
- Operating income slipped despite higher sales, with gross margin pressure and increased R&D contributing. Net income growth was not primarily operational: pretax income declined slightly while the tax line shifted to a benefit.
- Capital expenditures increased to $30.6 million from $15.5 million, including $12 million for a multi-year U.K. facility consolidation project. No acquisition cash outlay was reported for Q1 2013; Q1 2012 included $18.4 million.
Outlook, commentary, risks and unusual items
- Tax items: Q1 included a $31 million reduction in unrecognized tax benefits following progress in tax examinations and a $3 million benefit from the retroactively extended R&D tax credit. Together, these benefits lowered the effective tax rate by 32.9 percentage points. Management expected approximately $8 million of additional reductions in unrecognized tax benefits and related interest and penalties within the next 12 months.
- Operating outlook: Management expected full-year 2013 R&D expense growth in the mid-single digits and higher selling and administrative expense due to headcount additions and acquisitions made in 2012. It expected foreign exchange to weigh significantly on full-year diluted EPS versus 2012 at then-current rates, partly offset by further share repurchases. The filing does not provide a clear numerical revenue or EPS guidance range.
- Margin and investment outlook: Management said foreign currency and amortization of capitalized software could continue to pressure gross margin. Intangible amortization was estimated at $40–$45 million annually for each of the next five years. The new UNIFI software platform had a carrying value of approximately $103 million and was to be amortized over ten years.
- Capital allocation and commitments: The board’s two-year share-repurchase authorization was $750 million; $202 million had been spent under the program by quarter-end, leaving approximately $548 million authorized. The U.K. facility consolidation was expected to cost up to $40 million more to complete. Expected 2013 defined-benefit plan contributions were $8–$10 million. The company stated it had no current plans to pay dividends.
- Key risks: Foreign exchange exposure; uneven customer demand and customer capital spending; competitive and pricing pressures; acceptance and costs of new products; regulatory requirements; intellectual-property litigation; and tax examinations and changes in tax laws. Management reported no material change in risk factors or market risk during the quarter. It considered ordinary-course litigation outcomes unlikely to be material, but outcomes remain uncertain.
- Management said disclosure controls were effective and reported no material change in internal control over financial reporting. No material subsequent events were reported.
Important facts for investors to verify
- How much of the 37% net-income increase and $1.39 diluted EPS is attributable to the non-recurring tax examination resolution and retroactive tax credit, and what earnings look like excluding those benefits.
- Whether instrument-system demand, especially in China and the U.S., can offset currency-related declines and weaker chemistry sales, particularly in Japan and Europe.
- Whether gross-margin pressure from product mix, software amortization and foreign exchange persists, and whether the expected software amortization aligns with future product adoption and revenue.
- How working-capital timing, including vendor payments and DSO rising to 80 days from 76 days year over year, affects the sustainability of operating cash flow.
- The availability and practical use of substantial overseas cash, the company’s debt and refinancing needs, and its capacity to fund buybacks, the U.K. project and other obligations.
- Progress on tax examinations, the anticipated additional tax-benefit reductions, and any related cash-tax or jurisdictional effects.