Waters Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; compared with the three months ended April 1, 2017. Waters designs, sells and services analytical instruments, consumables and related software, including liquid chromatography, mass spectrometry and thermal analysis products. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance and position
| Metric | Q1 2018 | Prior comparable quarter | Change |
|---|---|---|---|
| Net sales | $530.7 | $498.0 | +7% |
| Operating income | $144.4 | $118.7 | +22% |
| Operating margin | 27.2% | 23.8% | +3.4 percentage points |
| Net income | $112.0 | $105.6 | +6% |
| Diluted EPS | $1.40 | $1.31 | +7% |
| Operating cash flow | $175.8 | $174.2 | +1% |
- Gross margin was approximately 58.3%, versus 57.6% in the prior-year quarter, calculated from reported sales and cost of sales. Net margin was approximately 21.1%, versus 21.2%.
- Net interest expense was $4.2 million, down from $5.4 million, primarily reflecting debt reduction.
- At March 31, cash and cash equivalents were $716.5 million and investments were $1,835.4 million. Total cash, cash equivalents and investments were $2.552 billion, including $1.656 billion held by foreign subsidiaries.
- Total debt was $1.248 billion, down from $1.998 billion at year-end 2017 after $750 million of debt repayment. The company reported $1.148 billion available under its credit agreement, after letters of credit, and compliance with all debt covenants.
- Operating cash flow was $175.8 million. Investing activities provided $895.8 million, largely reflecting investment maturities and sales; financing activities used $1.006 billion, principally for debt repayment and share repurchases. Capital expenditures and capitalized software were $16.0 million.
Material changes and operating trends
- Sales growth included a 5% contribution from foreign-currency translation; management said instrument-system sales rose 2%, while recurring revenue—chemistry consumables and services—grew 11%.
- Service sales rose 10%; product sales rose 5%. Chemistry consumables increased 12%, Waters service 11%, and TA instrument systems 10%. Waters instrument-system sales were essentially flat, amid weaker LC and MS demand partly offset by TA growth.
- Sales grew 16% in Europe, 4% in the Americas and 3% in Asia. Europe’s growth included a 14% currency-translation benefit. China sales rose 10%; sales in India declined 8%, according to management.
- Pharmaceutical sales increased 9%, governmental and academic sales 11%, and industrial sales 1%.
- Operating income benefited from higher sales volume and a $1.7 million litigation settlement gain. The prior-year quarter included $9 million of severance and early-retirement costs and a $5 million acquired in-process R&D charge.
- The effective tax rate increased to 20.3% from 7.0%, reflecting the 2017 Tax Act and other items. The company reported a $6 million stock-compensation tax benefit and $12 million of additional expense related to currency movements on previously taxed earnings.
Outlook, risks and unusual items
- The filing provides no specific full-year revenue or earnings guidance. Management expected foreign-currency translation to benefit gross profit in 2018, partly offset by the stronger British pound’s effect on U.K. manufacturing costs.
- Waters expects to spend approximately $215 million to expand precision-chemistry consumables manufacturing, funded from existing cash and investments, with no debt issuance expected for the project.
- Following the Tax Act, the company expected approximately $40 million of annual U.S. federal tax payments for four years beginning Q2 2018, with the remaining 60% of the liability payable over three years beginning in 2023. It also expected $40 million of state and withholding tax payments in 2018.
- In April 2018, the board authorized a new $3 billion, three-year share-repurchase program, incorporating $526 million remaining under the prior authorization, for total authorization of $3.5 billion. The company also anticipated deploying approximately $550 million of additional cash during 2018 to reduce debt and repurchase shares.
- Management said liquidity, expected cash flows and committed borrowing capacity were sufficient for at least the next 12 months. The company did not plan to pay dividends.
- Key exposures include currency movements, shifts in customer demand and capital spending, competition and product acceptance, regulatory requirements, litigation and tax uncertainty. A hypothetical 10% strengthening of the U.S. dollar was estimated to reduce the value of non-U.S.-dollar cash, cash equivalents and investments by approximately $35 million. The filing reported no material changes to previously disclosed risk factors or legal proceedings.
- Other items to note: revenue-recognition guidance adopted January 1, 2018 had no material financial impact; the company expected new lease-accounting guidance to materially affect its balance sheet, but not materially affect results or cash flows. Potential future payments under a mass-spectrometry licensing arrangement include up to $7 million of milestones plus royalties.
Investor verification points
- Assess how much reported sales growth reflects currency translation versus underlying demand, particularly for instruments and across regions.
- Track the effective tax rate, Tax Act payment schedule and any revisions to the company’s provisional tax accrual.
- Review the pace and funding of the $215 million facility expansion alongside the new $3.5 billion repurchase authorization and planned debt reduction.
- Monitor cash and investments held overseas, foreign-exchange exposure, and debt covenant headroom and borrowing availability.
- Check whether service and consumables growth continues to offset softer LC/MS instrument demand, and whether inventory growth and working-capital movements normalize.