Waters Corporation — Q3 2022 Form 10-Q
Business context and reporting period
Waters designs, manufactures, sells and services analytical instruments, consumables and related software, principally for pharmaceutical, industrial, academic and government customers. Its Waters and TA operating segments are aggregated into one reportable segment. The quarter ended October 1, 2022; comparisons are with the quarter ended October 2, 2021. Nine-month figures cover the periods ended on those dates.
Financial performance and position
| Metric | Three months | Nine months |
|---|---|---|
| Net sales | $708.6 million, up 7% | $2.113 billion, up 8% |
| Operating income | $192.0 million, essentially flat | $587.1 million, up 5% |
| Operating margin | 27.1%, versus 29.1% | 27.8%, versus 28.7% |
| Net income | $156.0 million, down 3% | $480.7 million, up 1% |
| Diluted EPS | $2.60, unchanged | $7.94, up 4% |
| Operating cash flow | Not separately reported | $413.0 million, versus $529.3 million |
- Product sales rose 11% in Q3 and 12% year to date; service sales rose 1% and 3%, respectively. Instrument-system sales increased 14% in both periods. Recurring revenue—consumables and services—increased 2% in Q3 and 4% year to date.
- Foreign currency translation reduced reported sales growth by 8 percentage points in Q3 and 6 points year to date. Management said the stronger U.S. dollar also negatively affected operating profits.
- Cost of sales grew 13% in Q3 and 12% year to date, outpacing revenue growth. Approximate gross margin, calculated from reported sales and cost of sales, was 56.6% in Q3 versus 58.9%, and 57.4% year to date versus 58.7%.
- At October 1, cash and cash equivalents were $443.6 million and investments were $0.9 million. Total debt was $1.545 billion, including $50 million current debt; the revolving facility had $240 million drawn and approximately $1.6 billion available. The filing reports covenant compliance. Current assets were $1.576 billion and current liabilities $732.0 million.
- Nine-month capital expenditures and software capitalization were $113.7 million. Financing used $398.2 million, including $477.2 million of treasury-share purchases, partly offset by net debt issuance.
Changes versus prior comparable periods
- Q3 sales growth was led by instrument systems and broad-based demand, while service growth was modest. China sales increased 21% in Q3; Europe declined 1% and Japan declined 16%, with currency materially weighing on both.
- Q3 operating income was flat as volume and pricing gains were offset by electronic-component and freight inflation and currency effects. Higher tax expense contributed to the decline in quarterly net income; the effective tax rate was 14.9%, versus 11.8%.
- Nine-month operating cash flow declined by $116.4 million. Management attributed the decrease primarily to higher inventories and incentive compensation payments. Inventory rose to $442.2 million from $356.1 million at year-end 2021; days sales outstanding increased to 77 from 74 a year earlier.
- Year-to-date other income was $2.6 million versus $18.1 million. The prior-year comparison included a $10 million unrealized investment gain and a patent-litigation settlement with guaranteed payments; 2022 included approximately $7 million of investment-sale gains and $6 million of equity-investment losses.
Outlook, commentary and risks
- The filing provides no specific full-year revenue or earnings guidance. Management expected foreign currency translation at then-current rates to significantly reduce gross profit for the remainder of 2022 and the first half of 2023.
- COVID-related disruption in China delayed components in Q2; management said it did not experience those significant delays in Q3 but warned future supply-chain disruption could affect results. The company also cited inflation, currency volatility, demand uncertainty, rising interest rates, geopolitical conditions and regulatory, competitive and intellectual-property risks.
- Waters acquired Megadalton charge-detection mass-spectrometry technology for approximately $10 million and expensed $9.8 million as acquired in-process R&D during the first nine months. The technology requires further development; approximately $4 million of payments were described as due over time through 2029.
- The company had spent $221 million through the first nine months on a U.S. precision-chemistry facility expansion and anticipated approximately $30 million of additional spending to complete it in 2022. It repurchased $467 million of shares during the nine months; $418 million remained authorized under the program, which was scheduled to end January 21, 2023.
- Management reported no material change in litigation or risk factors from the 2021 Form 10-K, no debt-covenant violations, and no material COVID-related impact on consolidated financial position, results or cash flows through issuance. It cautioned that future disruption could have a material effect. No dividends were planned.
Most important facts for investors to verify
- Whether demand and instrument-system growth can offset weaker recurring-revenue growth and adverse foreign-exchange effects.
- Whether component and freight inflation, product mix and currency pressure continue to compress gross and operating margins.
- Whether inventory normalizes and operating cash flow recovers after the substantial year-to-date working-capital use.
- Debt repayment and refinancing needs, interest-rate exposure, and the level and pace of share repurchases relative to cash generation.
- Progress, remaining cost and timing of the facility expansion, and development and commercialization prospects for the acquired CDMS technology.
- Potential tax outcomes: the company expected an $18 million reduction in unrecognized tax benefits and related interest and penalties within twelve months; verify settlement timing and realized effect.