Waters Corporation — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 28, 2013; comparisons are with the periods ended September 29, 2012. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context
Waters designs, manufactures, sells and services liquid chromatography and mass spectrometry systems, related chemistry consumables and software, and thermal analysis, rheometry and calorimetry instruments. Its customers span pharmaceutical, life science, industrial, academic, government and other markets. The Waters and TA divisions are aggregated into one reportable segment.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $457.3 | $450.0 | $1,338.8 | $1,321.9 |
| Gross profit | $265.7 | $267.3 | $784.3 | $792.6 |
| Gross margin | 58.1% | 59.4% | 58.6% | 60.0% |
| Operating income | $119.1 | $121.7 | $341.2 | $352.1 |
| Operating margin | 26.0% | 27.1% | 25.5% | 26.6% |
| Net income | $98.0 | $99.1 | $308.4 | $285.5 |
| Diluted EPS | $1.14 | $1.12 | $3.56 | $3.19 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $341.6 | $317.6 |
- Q3 sales rose 2% year over year; nine-month sales rose 1%. Service sales increased 4% in both periods, while product sales increased 1% in Q3 and were essentially flat year to date.
- Q3 net income declined 1%, while diluted EPS increased 2%, helped by fewer shares outstanding following repurchases. Nine-month net income increased 8% and diluted EPS increased 12%.
- Gross and operating margins contracted in both comparisons. Management attributed gross-margin pressure primarily to foreign currency, amortization of the recently launched UNIFI software and product mix. Selling and administrative expenses rose 5% in Q3 and 2% year to date.
- Nine-month cash from operations increased about $24 million. Capital expenditures and software capitalization were $92.8 million; operating cash flow less these expenditures was approximately $248.8 million, versus approximately $244.6 million in 2012.
Balance sheet, debt and liquidity
- At September 28, 2013, cash and cash equivalents were $431.0 million and investments were $1,268.1 million. Total cash, cash equivalents and investments were $1,699 million, of which $1,670 million was held by foreign subsidiaries and could be subject to material tax effects upon distribution to U.S. entities.
- Total debt was $1,293.8 million, up from $1,177.8 million at year-end 2012. Cash and investments exceeded reported debt by approximately $405 million; this comparison does not account for geographic restrictions or potential repatriation taxes.
- Current assets were $2,429.1 million and current liabilities were $492.9 million. The company reported $513 million of borrowing capacity under credit agreements after letters of credit.
- A June 2013 credit agreement provides a $1.1 billion revolving facility and a $300 million term loan facility, both maturing in 2018 with no scheduled prepayments before maturity. The company reported compliance with debt covenants.
- Nine-month investing cash outflow was $329.4 million, including $26.4 million for acquisitions and $92.8 million for capital spending/software. Financing cash outflow was $62.1 million, including $226.2 million of treasury-share purchases, partly offset by debt issuance proceeds.
Material changes and unusual items
- Foreign-currency translation reduced Q3 sales by 2% and year-to-date sales by 2%; management said the weaker yen was the principal factor. Japan sales declined 16% in Q3 and 19% year to date in reported dollars. Currency translation reduced diluted EPS by approximately $0.09 for Q3 and $0.23 year to date.
- Instrument-system sales were weak, reflecting lower capital spending by larger pharmaceutical customers. Q3 pharmaceutical sales fell 2%; year-to-date pharmaceutical sales were flat. Industrial, nutritional safety and environmental sales rose 7% in Q3, and government and academic sales rose 6%.
- Year-to-date income tax expense included a net $31 million benefit from resolution of U.S. and Japanese tax examinations, and a $3 million benefit from the retroactive 2012 R&D tax credit. These benefits reduced the nine-month effective tax rate by 10.6 percentage points; management attributed $0.39 of year-to-date diluted EPS increase to tax benefits. The filing says an additional approximately $6 million reduction in unrecognized tax benefits was expected within 12 months.
- The company recorded a $1.6 million investment impairment charge in Q2. Q3 2012 included a one-time $4 million amortization charge related to a discontinued trade name; 2012 also included a $3 million litigation provision.
- Two 2013 acquisitions—Nonlinear Dynamics, a proteomics and metabolomics software developer, and Scarabaeus, a rheometer maker—had combined cash consideration of approximately $26.7 million. Their contribution to net income since acquisition was not significant.
Outlook, commentary and risks
- No specific numerical sales or earnings guidance is stated in the supplied filing text. Management expected foreign-currency translation to continue to weigh significantly on full-year 2013 diluted EPS at then-current exchange rates, and expected currency pressure on gross profit for the remainder of 2013.
- Management said the UNIFI software launch and related amortization could continue to affect product mix and gross profit. Annual intangible amortization was estimated at $42–$47 million for each of the next five years.
- The company expected total 2013 defined-benefit plan contributions of approximately $8–$10 million. Completing its U.K. facility consolidation was expected to cost up to $20 million.
- Management believed available financial resources, operating cash flows and committed borrowing capacity would be sufficient for debt service, working capital, capital spending, authorized share repurchases, potential acquisitions and possible adverse litigation or tax outcomes. It reported no material changes in contractual obligations or risk factors from the 2012 Form 10-K.
- Key disclosed risks include foreign-exchange movements, weaker customer capital spending or funding, competition and pricing pressure, new-product acceptance and development, regulatory requirements, intellectual-property litigation, and uncertain tax examinations and rates. The CEO had announced an intention to retire by the end of August 2015.
- The filing reported no material subsequent events or material changes in legal proceedings. Disclosure controls were judged effective, and no material change in internal control over financial reporting was identified.
Important facts for investors to verify
- How much of the year-to-date earnings and EPS growth is attributable to the $31 million tax-examination benefit and the R&D tax credit, rather than recurring operations.
- Whether instrument demand—particularly from pharmaceutical customers—recovers, and whether service and consumables growth can offset subdued system sales.
- The ongoing effects of foreign exchange, especially the yen, on reported revenue, margins and EPS.
- Whether gross margins stabilize as UNIFI amortization, product mix and currency effects evolve.
- The availability and practical usability of foreign-held cash, the planned repayment of $125 million of revolving borrowings classified as current, and continued covenant compliance.
- Execution, future development costs and expected commercial contribution of the Nonlinear Dynamics software acquisition, as well as completion costs and timing for the U.K. facility project.