Waters Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter ended September 27, 2014; comparative quarter ended September 28, 2013. Year-to-date figures cover the nine months ended on those dates. Amounts are in U.S. dollars; financial statement amounts below are in millions unless noted.
Business context
Waters designs, manufactures, sells and services analytical instruments and related products, including liquid chromatography and mass spectrometry systems, chemistry consumables, and thermal analysis instruments. It reports one segment, combining its Waters and TA divisions.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $493.2 | $457.3 | $1,405.5 | $1,338.8 |
| Gross profit | $290.9 | $265.7 | $813.7 | $784.3 |
| Gross margin | 59.0% | 58.1% | 57.9% | 58.6% |
| Operating income | $138.7 | $119.1 | $345.9 | $341.2 |
| Operating margin | 28.1% | 26.0% | 24.6% | 25.5% |
| Net income | $113.5 | $98.0 | $280.3 | $308.4 |
| Diluted EPS | $1.34 | $1.14 | $3.29 | $3.56 |
| Cash from operating activities | Not stated by quarter | $349.9 | $341.6 |
- Quarterly sales rose 8%: product sales increased 6% and service sales 12%. Management attributed growth mainly to higher LC/LC-MS instrument and service sales; recurring revenue grew 9%.
- Year-to-date sales rose 5%, with recurring revenues up 7% and instrument system sales up 3%. Quarterly margin improvement reflected sales mix and higher-volume leverage; year-to-date gross margin was lower, primarily due to unfavorable currency translation.
- Q3 diluted EPS increased 18%. Nine-month net income and diluted EPS declined 9% and 8%, respectively, partly reflecting a prior-year tax benefit: 2013 included a $31 million benefit from completed tax audits and a benefit from the R&D tax credit. The 2014 nine-month effective tax rate was 14.1%, versus 3.9% in 2013.
Cash, liquidity and debt
- At September 27, 2014, cash and cash equivalents were $357.0 million and investments were $1,589.4 million, totaling $1,946.4 million. Total current assets were $2,699.4 million and current liabilities $574.5 million.
- Cash from operations for the first nine months was $349.9 million. Investing used $322.4 million and financing used $104.8 million; cash declined $83.8 million to $357.0 million.
- Capital expenditures and capitalized software were $70.4 million year-to-date. Inventory increased $36.8 million in operating cash-flow movements, primarily reflecting ramp-up for new product launches.
- Total debt was $1,430.0 million, compared with $1,323.3 million at year-end 2013. The company had $569 million of remaining availability under its credit agreement, after letters of credit, and reported compliance with debt covenants.
- About $1,899 million of cash, cash equivalents and investments was held by foreign subsidiaries and may be subject to material tax effects if distributed to U.S. entities. Management said U.S. cash needs are managed through U.S. operating cash flow and the revolving credit facility, and it believed available resources and expected cash flows were sufficient to meet obligations and planned needs.
Material changes, outlook and notable items
- Regional results were uneven: Q3 sales grew 11% in Europe and 8% in the U.S.; China fell 5% and Japan fell 2%. Year-to-date China sales were down 5% and Japan down 1%. Management linked China weakness mainly to lower research-focused instrument purchases by government-funded customers, and Japan weakness partly to currency.
- Research and development expense rose 16% in Q3 and 7% year-to-date, primarily due to new-product spending and unfavorable currency effects. Year-to-date selling and administrative expense included $6 million of severance costs and a $4 million U.K. building impairment; expenses were reduced by a $2 million arbitration award.
- The company issued $200 million of senior unsecured notes in June, using proceeds to repay existing debt and for general corporate purposes. Year-to-date share repurchases under the May 2012 authorization cost $255 million. The board also authorized a new $750 million repurchase program over three years; the filing reported $843 million authorized for future repurchases across the programs.
- Acquisitions included Medimass for approximately $23 million cash, plus estimated contingent consideration, and ULSP for approximately $4 million. Their contribution to year-to-date revenue and net income was immaterial. Management estimated intangible amortization at approximately $50 million annually for each of the next five years.
- Management expected currency translation to marginally reduce gross profit for the rest of 2014 based on then-current exchange rates. The filing provides no numerical sales or earnings guidance.
- The company expected defined-benefit plan contributions of approximately $29–31 million in 2014; $25 million had been contributed through the first nine months. It had no current plans to pay dividends.
- Risks highlighted include foreign-exchange movements, constrained spending by government-funded and academic customers, competition and product acceptance, regulatory and intellectual-property matters, tax outcomes, and CEO succession; the CEO had announced an intention to retire by the end of 2015. The company reported no material changes to its stated risk factors, no material legal-proceeding changes, and no material subsequent events.
Important facts for investors to verify
- Whether service and other recurring-revenue growth can continue to offset softer instrument demand in China and Japan.
- How currency movements affect sales, gross margin and earnings, particularly given management’s stated remainder-of-2014 margin headwind.
- The drivers of the year-to-date earnings decline, including the unusually low 2013 tax rate and the sustainability of the current tax rate.
- Debt maturities, credit-facility availability, refinancing and U.S. liquidity needs, considering the concentration of cash and investments in foreign subsidiaries.
- The pace and funding of authorized share repurchases, plus integration and commercial progress from Medimass and ULSP and related amortization or contingent payments.
- Potential effects of CEO succession, tax examinations, litigation or regulatory developments; the filing states that no material legal changes were identified.