Waters Corporation — Q3 2012 Form 10-Q
Business context and reporting period. Waters designs, manufactures, sells and services analytical instruments, consumables and software, including liquid chromatography, mass spectrometry and thermal analysis products. The unaudited quarter ended September 29, 2012; comparisons are with the quarter ended October 1, 2011. Year-to-date figures cover nine months.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $450.0 million | $454.5 million | $1,321.9 million | $1,329.8 million |
| Gross margin | 59.4% | 60.3% | 60.0% | 60.4% |
| Operating income | $121.7 million | $127.3 million | $352.1 million | $363.7 million |
| Operating margin | 27.1% | 28.0% | 26.6% | 27.4% |
| Net income | $99.1 million | $101.3 million | $285.5 million | $295.8 million |
| Diluted EPS | $1.12 | $1.10 | $3.19 | $3.18 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $317.6 million | $347.3 million |
At September 29, cash and cash equivalents were $356.3 million and short-term investments were $1,092.1 million. Total debt was $1,147.7 million, including $447.7 million classified as current and $700.0 million long term. The company had $459 million available to borrow under its credit agreement, net of letters of credit, and reported compliance with debt covenants. Total assets were $3.00 billion and stockholders’ equity was $1.33 billion.
Material changes versus comparable periods
- Quarterly sales declined 1%; product sales fell 3%, partly offset by 4% growth in service sales. Year-to-date sales also declined 1%, with product sales down 3% and service sales up 6%.
- Instrument-system sales fell 5% in both the quarter and year-to-date period. Management cited customer delays in capital spending amid weak global conditions and currency weakness. Chemistry consumables and service sales were comparatively resilient.
- Foreign-exchange translation reduced sales by 3% in both the quarter and year-to-date periods. Quarterly sales fell 6% in Europe and 4% in the U.S., while Asia grew 6%; China had continued double-digit growth, partly offset by weaker Indian demand.
- Gross and operating margins declined year over year. Management attributed gross-margin pressure mainly to instrument mix and foreign exchange. Lower selling and administrative expense partly cushioned the effect; amortization expense increased.
- Nine-month net income fell 3%, while diluted EPS rose slightly to $3.19 from $3.18, principally reflecting fewer shares outstanding after repurchases.
- Nine-month operating cash flow declined by $29.7 million. Management cited lower net income and the timing of customer collections and vendor payments. Investing cash outflow increased, including higher capital spending and acquisitions.
Outlook, commentary, risks and unusual items
- The filing gives no quantified revenue or earnings guidance. Management described instrument demand as affected by economic weakness and delayed customer capital spending. It expected several new products and software platforms to launch beginning late in 2012.
- Management estimated annual amortization expense of about $43 million for 2013–2017, including costs associated with a new software platform; it cautioned that new products and software costs could slightly reduce product gross margin as a percentage of sales.
- The company acquired Blue Reference, a distributor in Israel and Baehr Thermoanalyse for a combined net cash outlay of about $31 million. The acquisitions were expected to add approximately $10 million to annual sales; their 2012 net-income impact was not significant.
- Capital spending was $73 million for the nine months, including $23 million related to a U.K. facility consolidation project expected to cost about $70 million. Management expected to fund it through operating cash flow and borrowing capacity.
- The company repurchased $229 million of shares during the nine months and had $704 million remaining authorized under its May 2012, two-year, $750 million program. It paid no dividends and said it did not plan to do so in the foreseeable future.
- Approximately $1.423 billion of $1.448 billion in cash, cash equivalents and short-term investments was held by foreign subsidiaries and may be subject to material tax repatriation effects. Management believed available cash flows and committed borrowing capacity would meet needs for at least twelve months, but noted the intention to repay revolving borrowings within the following twelve months could not be assured.
- Unusual items included a $3 million second-quarter litigation provision/payment to settle a patent-infringement complaint and $4 million of amortization associated with discontinuing a product trade name. The company reported ongoing tax examinations and approximately $71.3 million in unrecognized tax benefits; it expected about $5 million of reductions from statutes of limitations within twelve months.
- Key risks cited include foreign-exchange movements, customer capital-spending delays, global economic and European uncertainty, competition and new-product acceptance, regulatory requirements, intellectual-property litigation and tax-audit outcomes. Management reported no material changes to the risk factors in its prior annual report and no material changes in market risk or internal financial controls.
Important facts for investors to verify
- Whether instrument-system demand stabilizes and service and consumables growth continues, particularly across Europe, India and China.
- Whether cash conversion improves, given lower operating cash flow and increased inventory and capital expenditures.
- How the $1.15 billion debt balance, current revolving borrowings and planned repayment compare with cash generation and available credit.
- The location, tax accessibility and practical availability of the company’s substantial foreign-held cash and investments.
- The timing and commercial contribution of product launches, and the effect of rising software amortization on margins.
- Developments in tax examinations, the anticipated tax-benefit reduction, litigation matters and the U.K. facility project’s cost and funding.