Waters Corporation — Q3 2016 Form 10-Q
Reporting period: Fiscal quarter ended October 1, 2016; comparisons are with the quarter ended October 3, 2015. Financial statements are unaudited. Amounts below are in millions, except per-share data.
Business context
Waters designs, manufactures, sells and services liquid chromatography, mass spectrometry, thermal analysis and related instruments, consumables, software and services. It reports one aggregated segment. Management attributed growth principally to pharmaceutical customers and recurring service and chemistry sales; instrument demand from non-pharmaceutical customers was weaker.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | First nine months 2016 | First nine months 2015 |
|---|---|---|---|---|
| Net sales | $526.8 | $500.6 | $1,538.6 | $1,455.7 |
| Operating income | $151.7 | $135.8 | $416.0 | $386.1 |
| Operating margin | 28.8% | 27.1% | 27.0% | 26.5% |
| Net income | $124.9 | $116.3 | $347.1 | $318.0 |
| Diluted EPS | $1.53 | $1.40 | $4.26 | $3.82 |
| Operating cash flow | — | — | $456.1 | $406.6 |
- Q3 sales rose 5%; product sales increased 4% and service sales 8%. Nine-month sales rose 6%, with products up 5% and services up 8%.
- Approximate gross margin was 58.6% in Q3 and 58.4% year to date, versus 58.7% and 58.5%, respectively, in 2015; calculations use reported net sales less cost of sales.
- At October 1, cash and cash equivalents were $430.2 and investments were $2,282.8. Total cash, cash equivalents and investments were $2,713; $2,664 was held by foreign subsidiaries and may be subject to material tax effects if distributed to U.S. entities.
- Total debt was $1,782.0, up from $1,668.3 at December 31, 2015. The company had $513 available under its credit agreement and reported compliance with debt covenants. Weighted-average interest on senior notes and credit-agreement borrowings was 2.45%.
- Current assets were $3,534.4 and current liabilities $519.5. Management said available cash, expected operating cash flows and committed borrowing capacity should fund operations, capital spending, debt service, authorized repurchases and potential acquisitions.
Material changes and notable items
- Pharmaceutical customer sales grew 13% in Q3 and 11% year to date. China sales increased 31% and 21%, respectively; Japan increased 16% in both periods, with growth substantially aided by currency translation. U.S. and European sales declined slightly in Q3.
- Instrument-system sales rose 3% in both periods; recurring chemistry and service revenues grew 8%. Management cited new ACQUITY Arc and Vion IMS Q-Tof systems and a larger, more utilized installed base.
- Operating cash flow rose $49.5 year to date. Investing cash outflow increased to $438.7, mainly reflecting net purchases of investments; capital expenditures and software capitalization were $72.3, broadly unchanged year over year. Financing cash outflow was $66.8.
- Waters issued $250 of senior notes in May 2016, using $225 to repay revolving borrowings. It repurchased $236 of shares in the first nine months, with $205.6 remaining under the repurchase authorization at quarter end.
- Q3 and year-to-date results included a $2 gain on sale of an equity investment. Year-to-date selling and administrative expense included $7 of stock-compensation expense related to modifications of awards following senior executive retirements. Singapore’s 0% contractual tax rate increased first-nine-month net income by $16, or $0.20 per diluted share.
Outlook, commentary and risks
The filing gives no specific revenue or earnings guidance. Management expected foreign-currency translation to have a slightly favorable effect on gross profit for the remainder of 2016, based on then-current rates. It expected to contribute approximately $5–$10 to defined benefit plans for full-year 2016. The company had no current plan to pay dividends.
Risks highlighted include foreign-exchange movements; global economic and political uncertainty, including the U.K.’s vote to leave the EU and Chinese restrictions on government-funded procurement; customer spending and funding; competition, pricing and new-product acceptance; supply-chain and regulatory matters; intellectual-property litigation; and tax audits, tax-law changes and shifts in income among jurisdictions. Management reported no material changes to previously disclosed risk factors or legal proceedings. It also reported effective disclosure controls and no material change in internal control over financial reporting.
Investor verification priorities
- Assess how much reported growth depended on pharmaceutical demand, China, currency translation and recurring revenues, and whether weaker non-pharmaceutical instrument demand persists.
- Review the quality and sustainability of operating cash flow, including inventory growth and timing-related receivables and vendor payments.
- Monitor debt levels, refinancing needs, interest costs and covenant headroom alongside continued share repurchases.
- Evaluate the concentration of liquidity in foreign subsidiaries and potential tax consequences of repatriation, as well as the durability of the Singapore tax arrangement.
- Track stock-compensation, tax, currency and other unusual items when comparing underlying earnings across periods.