UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
For the quarterly period ended April 4, 2015
or
For the transition period from to .
Commission File Number: 01-14010
Waters Corporation
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
34 Maple Street
Milford, Massachusetts 01757
(Address, including zip code, of principal executive offices)
(508) 478-2000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
Indicate the number of shares outstanding of the registrant’s common stock as of May 1, 2015: 82,692,719
WATERS CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
INDEX
PART I
FINANCIAL INFORMATION
Item 1.
Financial Statements
Consolidated Balance Sheets (unaudited) as of April 4, 2015 and December 31, 2014
Consolidated Statements of Operations (unaudited) for the three months ended April 4, 2015 and March 29, 2014
Consolidated Statements of Comprehensive Income (unaudited) for the three months ended April 4, 2015 and March 29, 2014
Consolidated Statements of Cash Flows (unaudited) for the three months ended April 4, 2015 and March 29, 2014
Condensed Notes to Consolidated Financial Statements (unaudited)
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
PART II
OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
Signature
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents
Investments
Accounts receivable, less allowances for doubtful accounts and sales returns of $7,002 and $7,179 at April 4, 2015 and December 31, 2014, respectively
Inventories
Other current assets
Total current assets
Property, plant and equipment, net
Intangible assets, net
Goodwill
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Notes payable and debt
Accounts payable
Accrued employee compensation
Deferred revenue and customer advances
Accrued income taxes
Accrued warranty
Other current liabilities
Total current liabilities
Long-term liabilities:
Long-term debt
Long-term portion of retirement benefits
Long-term income tax liabilities
Other long-term liabilities
Total long-term liabilities
Total liabilities
Commitments and contingencies (Notes 5, 6 and 9)
Stockholders’ equity:
Preferred stock, par value $0.01 per share, 5,000 shares authorized, none issued at April 4, 2015 and December 31, 2014
Common stock, par value $0.01 per share, 400,000 shares authorized, 157,030 and 156,716 shares issued, 82,701 and 83,147 shares outstanding at April 4, 2015 and December 31, 2014, respectively
Additional paid-in capital
Retained earnings
Treasury stock, at cost, 74,329 and 73,569 shares at April 4, 2015 and December 31, 2014, respectively
Accumulated other comprehensive loss
Total stockholders’ equity
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of the interim consolidated financial statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
Product sales
Service sales
Total net sales
Cost of product sales
Cost of service sales
Total cost of sales
Gross profit
Selling and administrative expenses
Research and development expenses
Purchased intangibles amortization
Operating income
Interest expense
Interest income
Income from operations before income taxes
Provision for income taxes
Net income
Net income per basic common share
Weighted-average number of basic common shares
Net income per diluted common share
Weighted-average number of diluted common shares and equivalents
2
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
Other comprehensive (loss) income:
Foreign currency translation
Unrealized gains on investments before income taxes
Income tax (expense) benefit
Unrealized gains on investments, net of tax
Retirement liability adjustment before reclassifications
Amounts reclassified to selling and administrative expenses
Retirement liability adjustment before income taxes
Retirement liability adjustment, net of tax
Other comprehensive (loss) income
Comprehensive income
3
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Provisions for doubtful accounts on accounts receivable
Provisions on inventory
Stock-based compensation
Deferred income taxes
Depreciation
Amortization of intangibles
Change in operating assets and liabilities, net of acquisitions:
Decrease in accounts receivable
Increase in inventories
Increase in other current assets
Increase in other assets
Decrease in accounts payable and other current liabilities
Increase in deferred revenue and customer advances
Increase in other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Additions to property, plant, equipment and software capitalization
Business acquisitions, net of cash acquired
Purchases of investments
Maturities of investments
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from debt issuances
Payments on debt
Proceeds from stock plans
Purchases of treasury shares
Excess tax benefit related to stock option plans
Payments of derivative contracts
Net cash used in financing activities
Effect of exchange rate changes on cash and cash equivalents
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Waters Corporation (“Waters®” or the “Company”) is an analytical instrument manufacturer that primarily designs, manufactures, sells and services, through its Waters Division, high performance liquid chromatography (“HPLC”), ultra performance liquid chromatography (“UPLC®” and together with HPLC, referred to as “LC”) and mass spectrometry (“MS”) technology systems and support products, including chromatography columns, other consumable products and comprehensive post-warranty service plans. These systems are complementary products that are frequently employed together (“LC-MS”) and sold as integrated instrument systems using a common software platform. LC is a standard technique and is utilized in a broad range of industries to detect, identify, monitor and measure the chemical, physical and biological composition of materials, and to purify a full range of compounds. MS instruments are used in drug discovery and development, including clinical trial testing, the analysis of proteins in disease processes (known as “proteomics”), nutritional safety analysis and environmental testing. LC-MS instruments combine a liquid phase sample introduction and separation system with mass spectrometric compound identification and quantification. Through its TA Division (“TA®”), the Company primarily designs, manufactures, sells and services thermal analysis, rheometry and calorimetry instruments, which are used in predicting the suitability and stability of fine chemicals, pharmaceuticals, water, polymers and viscous liquids for various industrial, consumer goods and healthcare products, as well as for life science research. The Company is also a developer and supplier of software-based products that interface with the Company’s instruments, as well as other suppliers’ instruments, and are typically purchased by customers as part of the instrument system.
The Company’s interim fiscal quarter typically ends on the thirteenth Saturday of each quarter. Since the Company’s fiscal year end is December 31, the first and fourth fiscal quarters may have more or less than thirteen complete weeks. The Company’s first fiscal quarters for 2015 and 2014 ended on April 4, 2015 and March 29, 2014, respectively.
The accompanying unaudited interim consolidated financial statements have been prepared in accordance with the instructions to the Quarterly Report on Form 10-Q and do not include all of the information and note disclosures required by generally accepted accounting principles (“GAAP”) in the United States of America. The consolidated financial statements include the accounts of the Company and its subsidiaries, most of which are wholly owned. All material inter-company balances and transactions have been eliminated.
The preparation of consolidated financial statements in conformity with GAAP requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities at the dates of the financial statements. Actual amounts may differ from these estimates under different assumptions or conditions.
It is management’s opinion that the accompanying interim consolidated financial statements reflect all adjustments (which are normal and recurring) that are necessary for a fair statement of the results for the interim periods. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the U.S. Securities and Exchange Commission on February 27, 2015.
Cash, Cash Equivalents and Investments
Cash equivalents represent highly liquid investments, with original maturities of 90 days or less, while investments with longer maturities are classified as investments. The Company maintains cash balances in various operating accounts in excess of federally insured limits, and in foreign subsidiary accounts in currencies other than U.S. dollars. As of April 4, 2015 and December 31, 2014, $2,067 million out of $2,109 million and $1,971 million out of $2,055 million, respectively, of the Company’s total cash, cash equivalents and investments were held by foreign subsidiaries and may be subject to material tax effects on distribution to U.S. legal entities.
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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) – (Continued)
Fair Value Measurements
In accordance with the accounting standards for fair value measurements and disclosures, certain of the Company’s assets and liabilities are measured at fair value on a recurring basis as of April 4, 2015 and December 31, 2014. Fair values determined by Level 1 inputs utilize observable data, such as quoted prices in active markets. Fair values determined by Level 2 inputs utilize data points other than quoted prices in active markets that are observable either directly or indirectly. Fair values determined by Level 3 inputs utilize unobservable data points for which there is little or no market data, which require the reporting entity to develop its own assumptions.
The following table represents the Company’s assets and liabilities measured at fair value on a recurring basis at April 4, 2015 (in thousands):
Assets:
U.S. Treasury securities
Foreign government securities
Corporate debt securities
Time deposits
Equity securities
Other cash equivalents
Waters 401(k) Restoration Plan assets
Foreign currency exchange contracts
Total
Liabilities:
Contingent consideration
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The following table represents the Company’s assets and liabilities measured at fair value on a recurring basis at December 31, 2014 (in thousands):
The fair values of the Company’s cash equivalents, investments, 401(k) restoration plan assets and foreign currency exchange contracts are determined through market and observable sources and have been classified as Level 2. These assets and liabilities have been initially valued at the transaction price and subsequently valued, typically utilizing third-party pricing services. The pricing services use many inputs to determine value, including reportable trades, benchmark yields, credit spreads, broker/dealer quotes, current spot rates and other industry and economic events. The Company validates the prices provided by third-party pricing services by reviewing their pricing methods and obtaining market values from other pricing sources. After completing these validation procedures, the Company did not adjust or override any fair value measurements provided by third-party pricing services as of April 4, 2015 and December 31, 2014.
Fair Value of Contingent Consideration
The fair value of the Company’s liability for contingent consideration related to the July 2014 acquisition of Medimass Research, Development and Service Kft. is determined using a probability-weighted discounted cash flow model, which uses significant unobservable inputs, and has been classified as Level 3. Subsequent changes in the fair value of the contingent consideration liability are recorded in the results of operations. The fair value of the contingent consideration liability associated with future earnout payments is based on several factors, including the development of future products, estimated sales of those products and a discount rate reflective of the Company’s creditworthiness. A change in any of these unobservable inputs can significantly change the fair value of the contingent consideration. Although there is no contractual limit, the fair value of future contingent consideration payments was estimated to be $4 million at both April 4, 2015 and December 31, 2014, based on the Company’s best estimate, as the earnout is based on future sales of certain products through 2034. There have been no changes in significant assumptions since December 31, 2014 and the change in fair value since then is primarily due to change in time value of money.
Fair Value of Other Financial Instruments
The Company’s cash, accounts receivable, accounts payable and variable interest rate debt are recorded at cost, which approximates fair value. The carrying value of the Company’s fixed interest rate debt was $500 million and $600 million at April 4, 2015 and December 31, 2014, respectively. The fair value of the Company’s fixed interest rate debt was estimated using discounted cash flow models, based on estimated current rates offered for similar debt under current market conditions for the Company. The fair value of the Company’s fixed interest rate debt was estimated to be $515 million and $608 million at April 4, 2015 and December 31, 2014, respectively, using Level 2 inputs.
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Derivative Transactions
The Company enters into foreign currency exchange contracts to manage exposures to changes in foreign currency exchange rates on certain inter-company balances and short-term assets and liabilities. Principal hedged currencies include the Euro, Japanese yen, British pound and Brazilian real. At April 4, 2015 and December 31, 2014, the Company held forward foreign exchange contracts with notional amounts totaling $109 million and $110 million, respectively.
The Company’s foreign currency exchange contracts included in the consolidated balance sheets are classified as follows (in thousands):
The following is a summary of the activity in cost of sales in the statements of operations related to the forward foreign exchange contracts (in thousands):
Realized losses on closed contracts
Unrealized gains (losses) on open contracts
Cumulative net pre-tax losses
Stockholders’ Equity
In May 2014, the Company’s Board of Directors authorized the Company to repurchase up to $750 million of its outstanding common stock over a three-year period and authorized the extension of the May 2012 program until May 2015. During the three months ended April 4, 2015 and March 29, 2014, the Company repurchased 0.7 million and 0.8 million shares of the Company’s outstanding common stock at a cost of $85 million and $86 million, respectively, under the May 2012 and May 2014 authorizations. As of April 4, 2015, the Company repurchased an aggregate of 7.6 million shares at a cost of $750 million under the May 2012 repurchase program, which is now completed. The Company has a total of $684 million authorized for future repurchases under the May 2014 plan. In addition, the Company repurchased $6 million and $7 million of common stock related to the vesting of restricted stock units during the three months ended April 4, 2015 and March 29, 2014, respectively. The Company believes that it has the financial flexibility to fund these share repurchases given current cash levels and debt borrowing capacity, as well as to invest in research, technology and business acquisitions to further grow the Company’s sales and profits.
Product Warranty Costs
The Company accrues estimated product warranty costs at the time of sale, which are included in cost of sales in the consolidated statements of operations. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers, the Company’s warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. The amount of the accrued warranty liability is based on historical information, such as past experience, product failure rates, number of units repaired and estimated costs of material and labor. The liability is reviewed for reasonableness at least quarterly.
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The following is a summary of the activity of the Company’s accrued warranty liability for the three months ended April 4, 2015 and March 29, 2014 (in thousands):
Accrued warranty liability:
April 4, 2015
March 29, 2014
Subsequent Events
The Company did not have any material subsequent events, except for the amendment of the Company’s credit agreement discussed in Note 5, “Debt”.
The Company’s marketable securities within cash equivalents and investments included in the consolidated balance sheets are detailed as follows (in thousands):
Amounts included in:
Cash equivalents
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The estimated fair value of marketable debt securities by maturity date is as follows (in thousands):
Due in one year or less
Due after one year through three years
Inventories are classified as follows (in thousands):
Raw materials
Work in progress
Finished goods
Total inventories
The carrying amount of goodwill was $350 million and $355 million at April 4, 2015 and December 31, 2014, respectively. During the three months ended April 4, 2015, the effect of foreign currency translation decreased goodwill by $5 million.
The Company’s intangible assets included in the consolidated balance sheets are detailed as follows (in thousands):
Capitalized software
Purchased intangibles
Trademarks and IPR&D
Licenses
Patents and other intangibles
During the three months ended April 4, 2015, the effect of foreign currency translation decreased the gross carrying value of intangible assets and accumulated amortization for intangible assets by $42 million and $24 million, respectively. Amortization expense for intangible assets was $11 million and $12 million for the three months ended April 4, 2015 and March 29, 2014, respectively. Amortization expense for intangible assets is estimated to be approximately $44 million per year for each of the next five years.
In June 2013, the Company entered into a credit agreement (the “2013 Credit Agreement”) that provides for a $1.1 billion revolving facility and a $300 million term loan facility. The revolving facility and term loan facility both mature on June 25, 2018 and require no scheduled prepayments before that date.
The interest rates applicable to the 2013 Credit Agreement are, at the Company’s option, equal to either the alternate base rate calculated daily (which is a rate per annum equal to the greatest of (a) the prime rate in effect on such day, (b) the federal funds effective rate in effect on such day plus 1/2% per annum, or (c) the adjusted LIBO rate on such day (or if such day is not a business day, the immediately preceding business day) for a deposit in U.S. dollars with a
10
maturity of one month plus 1% per annum) or the applicable 1, 2, 3 or 6 month adjusted LIBO rate, in each case, plus an interest rate margin based upon the Company’s leverage ratio, which can range between 0 to 12.5 basis points for alternate base rate loans and between 75 basis points and 112.5 basis points for adjusted LIBO rate loans. The facility fee on the 2013 Credit Agreement ranges between 12.5 basis points and 25 basis points. The 2013 Credit Agreement requires that the Company comply with an interest coverage ratio test of not less than 3.50:1 as of the end of any fiscal quarter for any period of four consecutive fiscal quarters and a leverage ratio test of not more than 3.50:1 as of the end of any fiscal quarter. In addition, the 2013 Credit Agreement includes negative covenants, affirmative covenants, representations and warranties and events of default that are customary for investment grade credit facilities.
As of April 4, 2015, $125 million of the outstanding portion of the revolving facility were classified as short-term liabilities in the consolidated balance sheet due to the fact that the Company expects to repay this portion of the borrowing under the revolving line of credit within the next twelve months. The remaining $560 million of the outstanding portion of the revolving facility were classified as long-term liabilities in the consolidated balance sheet, as this portion is not expected to be repaid within the next twelve months.
As of April 4, 2015 and December 31, 2014, the Company had a total of $500 million and $600 million of outstanding senior unsecured notes, respectively. Interest on the fixed rate senior unsecured notes is payable semi-annually each year. Interest on the floating rate senior unsecured notes is payable quarterly. The Company may prepay all or some of the senior unsecured notes at any time in an amount not less than 10% of the aggregate principal amount outstanding, plus the applicable make-whole amount or prepayment premium for Series H senior unsecured notes. In the event of a change in control of the Company (as defined in the note purchase agreement), the Company may be required to prepay the senior unsecured notes at a price equal to 100% of the principal amount thereof, plus accrued and unpaid interest. These senior unsecured notes require that the Company comply with an interest coverage ratio test of not less than 3.50:1 for any period of four consecutive fiscal quarters and a leverage ratio test of not more than 3.50:1 as of the end of any fiscal quarter. In addition, these senior unsecured notes include customary negative covenants, affirmative covenants, representations and warranties and events of default.
The Company had the following outstanding debt at April 4, 2015 and December 31, 2014 (in thousands):
Foreign subsidiary lines of credit
Senior unsecured notes - Series A - 3.75%, due February 2015
Senior unsecured notes - Series C - 2.50%, due March 2016
2013 Credit Agreement
Total notes payable and debt
Senior unsecured notes - Series B - 5.00%, due February 2020
Senior unsecured notes - Series D - 3.22%, due March 2018
Senior unsecured notes - Series E - 3.97%, due March 2021
Senior unsecured notes - Series F - 3.40%, due June 2021
Senior unsecured notes - Series G - 3.92%, due June 2024
Senior unsecured notes - Series H - floating rate*, due June 2024
Total long-term debt
Total debt
As of April 4, 2015 and December 31, 2014, the Company had a total amount available to borrow of $413 million and $533 million, respectively, after outstanding letters of credit, under the 2013 Credit Agreement. The weighted-average interest rates applicable to the senior unsecured notes and 2013 Credit Agreement borrowings collectively were 2.09% and 2.31% at April 4, 2015 and December 31, 2014, respectively. As of April 4, 2015, the Company was in compliance with all debt covenants.
11
The Company and its foreign subsidiaries also had available short-term lines of credit totaling $87 million and $88 million at April 4, 2015 and December 31, 2014, respectively, for the purpose of short-term borrowing and issuance of commercial guarantees. At April 4, 2015 and December 31, 2014, the weighted-average interest rates applicable to these short-term borrowings were 1.12% and 1.48%, respectively.
On April 23, 2015, Waters entered into an amendment to the 2013 Credit Agreement. The amended credit agreement provides for an increase of the revolving commitments from $1.1 billion to $1.3 billion and extends the maturity of the original credit agreement from June 25, 2018 until April 23, 2020. The Company plans to use future proceeds from the revolving facility for general corporate purposes.
The Company’s effective tax rate was 15.3% and 15.0% for the three months ended April 4, 2015 and March 29, 2014, respectively. The Company accounts for its uncertain tax return reporting positions in accordance with the accounting standards for income taxes, which require financial statement reporting of the expected future tax consequences of uncertain tax reporting positions on the presumption that all concerned tax authorities possess full knowledge of those reporting positions, as well as all of the pertinent facts and circumstances, but prohibit any discounting of unrecognized tax benefits associated with those reporting positions for the time value of money.
The following is a summary of the activity of the Company’s unrecognized tax benefits for the three months ended April 4, 2015 and March 29, 2014 (in thousands):
Balance at the beginning of the period
Net changes in uncertain tax benefits
Balance at the end of the period
With limited exceptions, the Company is no longer subject to tax audit examinations in significant jurisdictions for the years ended on or before December 31, 2007. However, carryforward attributes that were generated in years beginning on or before January 1, 2010 may still be adjusted upon examination by tax authorities if the attributes are utilized. The Company continuously monitors the lapsing of statutes of limitations on potential tax assessments for related changes in the measurement of unrecognized tax benefits, related net interest and penalties, and deferred tax assets and liabilities. As of April 4, 2015, the Company expects to record additional reductions in the measurement of its unrecognized tax benefits and related net interest and penalties of approximately $5 million within the next twelve months due to the lapsing of statutes of limitations on potential tax assessments. The Company does not expect to record any other material reductions in the measurement of its unrecognized tax benefits within the next twelve months.
The Company maintains various shareholder-approved, stock-based compensation plans which allow for the issuance of incentive or non-qualified stock options, stock appreciation rights, restricted stock or other types of awards (e.g. restricted stock units).
The Company accounts for stock-based compensation costs in accordance with the accounting standards for stock-based compensation, which require that all share-based payments to employees be recognized in the statements of operations based on their fair values. The Company recognizes the expense using the straight-line attribution method. The stock-based compensation expense recognized in the consolidated statements of operations is based on awards that ultimately are expected to vest; therefore, the amount of expense has been reduced for estimated forfeitures. The stock-based compensation accounting standards require forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience. If actual results differ significantly from these estimates, stock-based compensation expense and the Company’s results of operations could be materially impacted. In addition, if the Company employs different assumptions in the application of these standards, the compensation expense that the Company records in the future periods may differ significantly from what the Company has recorded in the current period.
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The consolidated statements of operations for the three months ended April 4, 2015 and March 29, 2014 include the following stock-based compensation expense related to stock option awards, restricted stock, restricted stock unit awards and the employee stock purchase plan (in thousands):
Cost of sales
Total stock-based compensation
Stock Options
In determining the fair value of the stock options, the Company makes a variety of assumptions and estimates, including volatility measures, expected yields and expected stock option lives. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model. The Company uses implied volatility on its publicly-traded options as the basis for its estimate of expected volatility. The Company believes that implied volatility is the most appropriate indicator of expected volatility because it is generally reflective of historical volatility and expectations of how future volatility will differ from historical volatility. The expected life assumption for grants is based on historical experience for the population of non-qualified stock optionees. The risk-free interest rate is the yield currently available on U.S. Treasury zero-coupon issues with a remaining term approximating the expected term used as the input to the Black-Scholes model. The relevant data used to determine the value of the stock options granted during the three months ended April 4, 2015 and March 29, 2014 are as follows:
Options Issued and Significant Assumptions Used to Estimate Option Fair Values
Options issued in thousands
Risk-free interest rate
Expected life in years
Expected volatility
Expected dividends
Weighted-Average Exercise Price and Fair Value of Options on the Date of Grant
Exercise price
Fair value
The following table summarizes stock option activity for the plans for the three months ended April 4, 2015 (in thousands, except per share data):
Outstanding at December 31, 2014
Granted
Exercised
Canceled
Outstanding at April 4, 2015
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Restricted Stock
During the three months ended April 4, 2015, the Company granted ten thousand shares of restricted stock. The fair value of these awards on the grant date was $113.88 per share.
Restricted Stock Units
The following table summarizes the unvested restricted stock unit award activity for the three months ended April 4, 2015 (in thousands, except for per share amounts):
Unvested at December 31, 2014
Vested
Forfeited
Unvested at April 4, 2015
Restricted stock units are generally granted annually in February and vest in equal annual installments over a five-year period.
Basic and diluted earnings per share (“EPS”) calculations are detailed as follows (in thousands, except per share data):
Effect of dilutive stock option, restricted stock and restricted stock unit securities
For both the three months ended April 4, 2015 and March 29, 2014, the Company had 0.6 million stock options that were antidilutive due to having higher exercise prices than the Company’s average stock price during the period. These securities were not included in the computation of diluted EPS. The effect of dilutive securities was calculated using the treasury stock method.
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The Company sponsors various retirement plans. The summary of the components of net periodic pension costs for the plans for the three months ended April 4, 2015 and March 29, 2014 is as follows (in thousands):
Service cost
Interest cost
Expected return on plan assets
Net amortization:
Prior service cost (credit)
Net actuarial loss (gain)
Net periodic pension (benefit) cost
During fiscal year 2015, the Company expects to contribute a total of approximately $4 million to $11 million to the Company’s defined benefit plans.
The Company’s business activities, for which discrete financial information is available, are regularly reviewed and evaluated by the chief operating decision maker. As a result of this evaluation, the Company determined that it has two operating segments: Waters Division and TA Division.
Waters Division is primarily in the business of designing, manufacturing, distributing and servicing LC and MS instruments, columns and other chemistry consumables that can be integrated and used along with other analytical instruments. TA Division is primarily in the business of designing, manufacturing, distributing and servicing thermal analysis, rheometry and calorimetry instruments. The Company’s two divisions are its operating segments and each has similar economic characteristics; product processes; products and services; types and classes of customers; methods of distribution and regulatory environments. Because of these similarities, the two segments have been aggregated into one reporting segment for financial statement purposes. Please refer to the consolidated financial statements for financial information regarding the one reportable segment of the Company.
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Net sales for the Company’s products and services are as follows for the three months ended April 4, 2015 and March 29, 2014 (in thousands):
Product net sales:
Waters instrument systems
Chemistry
TA instrument systems
Total product sales
Service net sales:
Waters service
TA service
Total service sales
Recently Issued Accounting Standards
In May 2014, amended accounting guidance was issued regarding the recognition of revenue from contracts with customers. The objective of this guidance is to significantly enhance comparability and clarify principles of revenue recognition practices across entities, industries, jurisdictions and capital markets. This guidance is effective for annual and interim reporting periods beginning after December 15, 2016; however, there is currently a proposal to delay the effective period by one year. Adoption prior to December 15, 2016 is not permitted. The Company is currently evaluating the potential impact that the adoption of this standard will have on the Company’s financial position, results of operations or cash flows.
In April 2015, accounting guidance was issued which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying value of the associated debt liability. This guidance is effective for annual and interim reporting periods beginning after December 15, 2015 and early adoption is permitted. The Company is currently evaluating the potential impact that the adoption of this standard will have on the Company’s financial position, results of operations or cash flows.
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Business and Financial Overview
The Company has two operating segments: the Waters Division and the TA Division (“TA®”). The Waters Division’s products and services primarily consist of high performance liquid chromatography (“HPLC”), ultra performance liquid chromatography (“UPLC®” and together with HPLC, referred to as “LC”), mass spectrometry (“MS”) and chemistry consumable products and related services. TA products and services primarily consist of thermal analysis, rheometry and calorimetry instrument systems and service sales. The Company’s products are used by life science (including pharmaceutical), biochemical, industrial, nutritional safety, environmental, academic and governmental customers. These customers use the Company’s products to detect, identify, monitor and measure the chemical, physical and biological composition of materials and to predict the suitability and stability of fine chemicals, pharmaceuticals, water, polymers and viscous liquids in various industrial, consumer goods and healthcare products.
The Company’s operating results for the three months ended April 4, 2015 and March 29, 2014 are as follows (in thousands):
Gross profit as a % of sales
Operating income as a % of sales
Interest expense, net
Sales in the first quarter of 2015 grew 7% despite the significant negative effect of foreign currency translation, which reduced sales growth by 8%. The 2015 sales growth benefited from strong demand from the Company’s life science, industrial chemical, nutritional safety and environmental customers, especially in the U.S., China and India. The 2015 sales growth also benefited by an estimated 4% from additional calendar days in the first quarter of 2015 as compared with the first quarter of 2014, as well as the relatively weak sales growth in the first quarter of 2014. The negative impact from foreign currency translation resulted primarily from the weakening of the Euro and Japanese yen against the U.S. dollar, which reduced Europe’s and Japan’s sales by 16% and 14%, respectively. Acquisitions had a minimal impact on sales for the quarter.
In the first quarter of 2015, both instrument system sales and recurring revenues (combined chemistry consumable and service sales) increased 7%, with foreign currency translation negatively impacting both by 8%. Sales to life science customers increased 9% for the quarter, with double-digit sales growth in all regions, except Europe and Japan, where the effects of foreign currency translation decreased sales 17% and 15%, respectively. Combined sales to industrial chemical, nutritional safety and environmental customers increased 5% for the quarter and combined global sales to governmental and academic customers decreased 3% for the quarter, with the effect of foreign currency translation negatively impacting sales to these customers by 6% and 7%, respectively.
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The increase in gross profit for the quarter was primarily a result of sales mix and leverage achieved on higher sales volumes, and the favorable effects of foreign currency translation on operating costs of the Company’s European manufacturing and distribution facilities. Based on current foreign currency exchange rates and forecasts, the Company estimates that the full year impact of foreign currency translation will negatively impact sales by approximately 6% and have a negative impact on gross profit.
Selling and administrative expenses decreased 5% for the quarter from the favorable effect of foreign currency translation and the impact of the $6 million of severance costs incurred in the first quarter of 2014 related to a reduction in workforce. The increase in research and development expenses in the quarter was primarily a result of additional headcount, merit compensation and costs associated with new product launches and the development of new product initiatives.
Net income per diluted share for the quarter benefited from an increase in sales and fewer shares outstanding due to additional share repurchases. Foreign currency translation decreased net income per diluted share by approximately $0.08 in 2015 as compared to 2014.
Net cash provided by operating activities for the quarter was $155 million and $116 million in 2015 and 2014, respectively. The $39 million increase was primarily a result of higher sales volumes and the timing of payments to vendors and collection of receivables from customers, as well as the additional days in the first quarter of 2015. Within cash flows used in investing activities, capital expenditures related to property, plant, equipment and software capitalization were $21 million for both 2015 and 2014.
Within cash flows used in financing activities, the Company received $11 million and $35 million of proceeds from stock plans in 2015 and 2014, respectively. Fluctuations in these amounts were primarily attributable to changes in the Company’s stock price and the expiration of stock option grants. In May 2014, the Company’s Board of Directors authorized the Company to repurchase up to $750 million of its outstanding common stock over a three-year period and authorized the extension of the May 2012 program until May 2015. The Company repurchased $85 million and $86 million of the Company’s outstanding common stock in 2015 and 2014, respectively, under the May 2012 and May 2014 authorizations.
On April 23, 2015, Waters entered into an amendment to the credit agreement dated June 2013 (the “2013 Credit Agreement”). The amended credit agreement provides for an increase of the revolving commitments from $1.1 billion to $1.3 billion and extends the maturity of the original credit agreement from June 25, 2018 until April 23, 2020. The Company plans to use future proceeds from the revolving facility for general corporate purposes.
Results of Operations
Sales by Geography
Geographic sales information is presented below for the three months ended April 4, 2015 and March 29, 2014 (in thousands):
Net Sales:
United States
Europe
Asia:
China
Japan
Asia Other
Total Asia
Other
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The increase in sales in the U.S. for the quarter was broad-based across all product lines and customer classes. The 6% decrease in Europe’s sales for the quarter was primarily a result of the negative impact of foreign currency translation, which decreased sales in Europe by 16%. China’s sales growth for the quarter was driven by life science customers across all product lines. Japan’s sales were negatively impacted by foreign currency translation, which decreased sales by 14% for the quarter. The increase in sales in the quarter in the rest of Asia was broad-based across all products and driven primarily by an increase in India’s sales. The sales increase in the quarter for the rest of the world was driven by sales of instrument systems to life science customers.
Waters Division Net Sales
Net sales for the Waters Division’s products and services are as follows for the three months ended April 4, 2015 and March 29, 2014 (in thousands):
Total Waters Division product sales
Total Waters Division net sales
Waters instrument system sales (LC and LC-MS) increased in the quarter, primarily due to stronger demand for instrument systems from life science, industrial chemical, nutritional safety and environmental customers. The 7% increase in recurring revenues for the quarter primarily resulted from a combination of a higher utilization rate of installed instrument systems and a higher base of installed instruments. The effect of foreign currency translation decreased sales for the Waters Division by 8% and recent acquisitions had a minimal impact on sales.
Waters Division sales increased 21% in the U.S. for the quarter and decreased 5% in Europe, with foreign currency translation decreasing sales in Europe by 18%. Total Asia sales increased 7% for the quarter, with sales in China increasing 16%. Japan sales decreased 14%, primarily due to the effects of foreign currency, while sales in the rest of Asia increased 17% as a result of double-digit sales growth in India. Waters Division sales in the rest of the world increased 5% for the quarter.
TA Division Net Sales
Net sales for the TA Division’s products and services are as follows for the three months ended April 4, 2015 and March 29, 2014 (in thousands):
Total TA Division net sales
TA instrument system sales benefited in the quarter from stronger demand for TA’s core thermal analysis instruments. TA service sales increased in the quarter due to sales of service plans and billings to a higher installed base of customers. The effect of foreign currency translation decreased both instrument system and service sales for TA by 6%. For the quarter, TA’s sales increased 14% in the U.S. and decreased 17% in Europe, primarily due to the negative effects of foreign currency translation. TA’s total sales in Asia increased 22%, with 29% growth in China and a decreased of 12% in Japan, with the effect of foreign currency decreasing sales by 15% in Japan.
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Gross Profit
Gross profit increased 12% for the quarter, primarily as a result of benefits from sales mix, leverage achieved on higher sales volumes and the favorable effect of foreign currency translation on operating costs of the Company’s European manufacturing and distribution facilities. Gross profit as a percentage of sales for the quarter was also impacted by the factors discussed above.
Gross profit as a percentage of sales is affected by many factors, including, but not limited to, foreign currency translation, product mix, price, product costs of instrument systems and amortization of software platforms. The Company expects that the impact of foreign currency translation will negatively affect gross profit for the remainder of 2015, based on current exchange rates.
Selling and Administrative Expenses
Selling and administrative expenses decreased 5% for the quarter from the favorable effect of foreign currency translation and the impact of the $6 million of severance costs incurred in the first quarter of 2014 related to a reduction in workforce. As a percentage of net sales, selling and administrative expenses were 26.0% and 29.4% for the 2015 and 2014 quarters, respectively.
Research and Development Expenses
Research and development expenses increased 17% for the quarter, primarily as a result of merit compensation increases and additional headcount and costs associated with new product launches and the development of new product initiatives.
Interest Expense, Net
The increase in interest expense for the three months ended April 4, 2015 was primarily attributable to an increase in average borrowings.
Provision for Income Taxes
The four principal jurisdictions in which the Company manufactures are the U.S., Ireland, the United Kingdom and Singapore, where the marginal effective tax rates were approximately 37.5%, 12.5%, 20.25% and 0%, respectively, as of April 4, 2015. The Company has a contractual tax rate in Singapore of 0% through March 2016, based upon achievement of contractual milestones that the Company expects to continue to meet, and the Company is currently attempting to negotiate an extension of this agreement. The current statutory tax rate in Singapore is 17%. The Company’s effective tax rate is influenced by many significant factors, including, but not limited to, the wide range of income tax rates in jurisdictions in which the Company operates; sales volumes and profit levels in each tax jurisdiction; changes in tax laws, tax rates and policies; the outcome of various ongoing tax audit examinations; and the impact of foreign currency transactions and translation. As a result of variability in these factors, the Company’s effective tax rates in the future may not be similar to the effective tax rates for the current or prior year. The Company’s effective tax rate for the quarter was 15.3% and 15.0% for 2015 and 2014, respectively.
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Liquidity and Capital Resources
Condensed Consolidated Statements of Cash Flows (in thousands):
Depreciation and amortization
Change in accounts receivable
Change in inventories
Change in accounts payable and other current liabilities
Change in deferred revenue and customer advances
Other changes
Cash Flow from Operating Activities
Net cash provided by operating activities was $155 million and $116 million in the three months ended April 4, 2015 and March 29, 2014, respectively. The changes within net cash provided by operating activities in 2015 as compared to 2014 include the following significant changes in the sources and uses of net cash provided by operating activities, aside from the increase in net income:
Cash Used in Investing Activities
Year-to-date, net cash used in investing activities totaled $56 million and $120 million in 2015 and 2014, respectively. Additions to fixed assets and capitalized software were $21 million in both 2015 and 2014. During 2015 and 2014, the Company purchased $794 million and $607 million of investments, while $759 million and $512 million of investments matured, respectively. Business acquisitions, net of cash acquired, were $4 million in 2014. There were no business acquisitions in 2015.
Cash Used in Financing Activities
During 2015 and 2014, the Company’s total debt borrowings increased by $20 million and $9 million, respectively. As of April 4, 2015, the Company had a total of $1,485 million in outstanding debt, which consisted of $500 million in outstanding senior unsecured notes, $300 million borrowed under the term loan facility under the 2013 Credit Agreement and $685 million borrowed under the revolving credit facility under the 2013 Credit Agreement. At April 4, 2015, $125 million of the outstanding portion of the revolving facility were classified as short-term
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liabilities in the consolidated balance sheet due to the fact that the Company expects to repay this portion of the borrowing under the revolving line of credit within the next twelve months. The remaining $560 million of the outstanding portion of the revolving facility were classified as long-term liabilities in the consolidated balance sheet, as this portion is not expected to be repaid within the next twelve months. As of April 4, 2015, the Company had a total amount available to borrow under the 2013 Credit Agreement of $413 million after outstanding letters of credit.
In May 2014, the Company’s Board of Directors authorized the Company to repurchase up to $750 million of its outstanding common stock over a three-year period and authorized the extension of the May 2012 program until May 2015. During 2015 and 2014, the Company repurchased 0.7 million and 0.8 million shares of the Company’s outstanding common stock at a cost of $85 million and $86 million, respectively, under the May 2012 and May 2014 authorizations. As of April 4, 2015, the Company repurchased an aggregate of 7.6 million shares at a cost of $750 million under the May 2012 repurchase program, which is now completed. As of April 4, 2015, the Company had a total of $684 million authorized for future repurchases under the May 2014 plan. In addition, the Company repurchased $6 million and $7 million of common stock related to the vesting of restricted stock units during 2015 and 2014, respectively.
The Company received $11 million and $35 million of proceeds from the exercise of stock options and the purchase of shares pursuant to the Company’s employee stock purchase plan in 2015 and 2014, respectively.
In April 2015, Waters entered into an amendment to the 2013 Credit Agreement. The amended credit agreement provides for an increase of the revolving commitments from $1.1 billion to $1.3 billion and extends the maturity of the original credit agreement from June 25, 2018 until April 23, 2020. The Company plans to use future proceeds from the revolving facility for general corporate purposes.
The Company had cash, cash equivalents and investments of $2,109 million as of April 4, 2015. The majority of the Company’s cash, cash equivalents and investments are generated from foreign operations, with $2,067 million held by foreign subsidiaries at April 4, 2015. Due to the fact that most of the Company’s cash, cash equivalents and investments are held outside of the U.S., the Company must manage and maintain sufficient levels of cash flow in the U.S. to fund operations and capital expenditures, service debt interest, finance potential U.S. acquisitions and continue the authorized stock repurchase program in the U.S. These U.S. cash requirements are managed by the Company’s cash flow from U.S. operations and the use of the Company’s revolving credit facility.
Management believes, as of the date of this report, that its financial position, particularly in the U.S., along with expected future cash flows from earnings based on historical trends and the ability to raise funds from external sources and the borrowing capacity from existing, committed credit facilities, will be sufficient to service debt and fund working capital and capital spending requirements, authorized share repurchase amounts and potential acquisitions. In addition, there have been no recent significant changes to the Company’s financial position, nor are there any anticipated changes, to warrant a material adjustment related to indefinitely reinvested foreign earnings.
Contractual Obligations, Commercial Commitments, Contingent Liabilities and Dividends
A summary of the Company’s contractual obligations and commercial commitments is included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the U.S. Securities and Exchange Commission (“SEC”) on February 27, 2015. The Company reviewed its contractual obligations and commercial commitments as of April 4, 2015 and determined that there were no material changes from the information set forth in the Annual Report on Form 10-K.
From time to time, the Company and its subsidiaries are involved in various litigation matters arising in the ordinary course of business. The Company believes that it has meritorious arguments in its current litigation matters and that any outcome, either individually or in the aggregate, will not be material to the Company’s financial position or results of operations.
The Company has not paid any dividends and has no plans, at this time, to pay any dividends in the future.
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Critical Accounting Policies and Estimates
In the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the SEC on February 27, 2015, the Company’s most critical accounting policies and estimates upon which its financial status depends were identified as those relating to revenue recognition, loss provisions on accounts receivable and inventory, valuation of long-lived assets, intangible assets and goodwill, warranty, income taxes, pension and other postretirement benefit obligations, litigation, business combinations and asset acquisitions, valuation of contingent considerations and stock-based compensation. The Company reviewed its policies and determined that those policies remain the Company’s most critical accounting policies for the three months ended April 4, 2015. The Company did not make any changes in those policies during the three months ended April 4, 2015.
New Accounting Pronouncements
Please refer to Note 11, Recent Accounting Standards Changes and Developments, in the Condensed Notes to Consolidated Financial Statements.
Special Note Regarding Forward-Looking Statements
Certain of the statements in this Quarterly Report on Form 10-Q, including the information incorporated by reference herein, may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with respect to future results and events, including any statements regarding, among other items, anticipated trends or growth in the Company’s business, including, but not limited to, the impact of foreign currency translation on financial results; the growth rate of sales and research and development expenses; the impact costs associated with developing new technologies and bringing these new technologies to market; the impact of new product launches and the associated costs, such as the amortization expense related to software platforms; geographic sales mix of business; development of products by acquired businesses and the amount of contingent payments to the sellers of an acquired business; anticipated expenses, including interest expense, capitalized software costs and effective tax rates; the impact and outcome of the Company’s various ongoing tax audit examinations; the achievement of contractual milestones to preserve foreign tax rates; the impact and outcome of litigation matters; the impact of the loss of intellectual property protection; the impact of new accounting standards and pronouncements; the adequacy of the Company’s supply chain and manufacturing capabilities and facilities; the impact of regulatory compliance; the Company’s expected cash flow, borrowing capacity, debt repayment and refinancing; the Company’s ability to fund working capital, capital expenditures, service debt, repay outstanding lines of credit, make authorized share repurchases, fund potential acquisitions and pay any adverse litigation or tax audit liabilities, particularly in the U.S.; future impairment charges; the Company’s contributions to defined benefit plans; the Company’s expectations regarding changes to its financial position; compliance with applicable environmental laws; and the impact of recent acquisitions on sales and earnings.
Many of these statements appear, in particular, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2 of this Quarterly Report on Form 10-Q. Statements that are not statements of historical fact may be deemed forward-looking statements. You can identify these forward-looking statements by the use of the words “feels”, “believes”, “anticipates”, “plans”, “expects”, “may”, “will”, “would”, “intends”, “suggests”, “appears”, “estimates”, “projects”, “should” and similar expressions, whether in the negative or affirmative. These statements are subject to various risks and uncertainties, many of which are outside the control of the Company, including, and without limitation:
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Certain of these and other factors are discussed under the heading “Risk Factors” under Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the SEC on February 27, 2015. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements, whether because of these factors or for other reasons. All forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q and are expressly qualified in their entirety by the cautionary statements included in this report. The Company does not assume any obligation to update any forward-looking statements.
There have been no material changes in the Company’s market risk during the three months ended April 4, 2015. For information regarding the Company’s market risk, refer to Item 7A of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the SEC on February 27, 2015.
Evaluation of Disclosure Controls and Procedures
The Company’s chief executive officer and chief financial officer (principal executive and principal financial officer), with the participation of management, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, the Company’s chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures were effective as of April 4, 2015 (1) to ensure that information required to be disclosed by the Company, including its consolidated subsidiaries, in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its chief executive officer and chief financial officer, to allow timely decisions regarding the required disclosure and (2) to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
Changes in Internal Controls Over Financial Reporting
No change was identified in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended April 4, 2015 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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There have been no material changes in the Company’s legal proceedings during the three months ended April 4, 2015 as described in Item 3 of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the SEC on February 27, 2015.
Information regarding risk factors of the Company is set forth under the heading “Risk Factors” under Part I, Item 1A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the SEC on February 27, 2015. The Company reviewed its risk factors as of April 4, 2015 and determined that there were no material changes from the ones set forth in the Form 10-K. Note, however, the discussion under the subheading “Special Note Regarding Forward-Looking Statements” in Part I, Item 2 of this quarterly report on Form 10-Q. These risks are not the only ones facing the Company. Additional risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially adversely affect the Company’s business, financial condition and operating results.
Purchases of Equity Securities by the Issuer
The following table provides information about purchases by the Company during the three months ended April 4, 2015 of equity securities registered by the Company under the Exchange Act (in thousands, except per share data):
Period
January 1 to January 31, 2015
February 1 to February 28, 2015
March 1 to April 4, 2015
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ExhibitNumber
Description of Document
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
/s/ EUGENE G. CASSIS
Date: May 8, 2015
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