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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 For the quarterly period ended June 30, 2002
OR
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
and Exchange Act of 1934 for the transition period from _______to______.
Commission File Number: 01-14010
WATERS CORPORATION
(Exact name of registrant as specified in the charter)
Delaware 13-3668640
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
34 Maple Street
Milford, Massachusetts 01757
(Address of principal executive offices)
Registrant's telephone number, including area code: (508) 478-2000
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 and 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 ( )
Number of shares outstanding of the Registrant's common stock as of August 9,
2002: 131,180,503
1
WATERS CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
INDEX
Page
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2002 and December
31, 2001 3
Consolidated Statements of Operations for the three months
ended June 30, 2002 and 2001 4
Consolidated Statements of Operations for the six months ended
June 30, 2002 and 2001 5
Consolidated Statements of Cash Flows for the six months
ended June 30, 2002 and 2001 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
PART II OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 18
2
WATERS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
June 30, 2002 December 31, 2001
------------- -----------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 306,408 $ 226,798
Accounts receivable, less allowances for doubtful accounts and
sales returns of $4,056 and $3,812 at June 30, 2002 and
December 31, 2001, respectively 179,990 182,164
Inventories 119,341 102,718
Other current assets 13,047 11,064
------------ ---------
Total current assets 618,786 522,744
Property, plant and equipment, net of accumulated depreciation
of $100,086 and $86,421 at June 30, 2002 and December 31,
2001, respectively 116,452 114,207
Other assets, including intangibles 94,298 86,481
Goodwill 168,692 163,479
------------ ---------
Total assets $ 998,228 $ 886,911
============ =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 910 $ 1,140
Accounts payable 42,863 35,979
Accrued employee compensation 13,950 20,176
Deferred revenue and customer advances 51,625 46,014
Accrued retirement plan contributions 9,316 8,660
Accrued income taxes 42,456 41,643
Accrued other taxes 6,342 5,925
Accrued patent litigation 75,010 75,000
Other current liabilities 49,601 46,469
------------ ---------
Total current liabilities 292,073 281,006
Other liabilities 26,750 24,160
------------ ---------
Total liabilities 318,823 305,166
Stockholders' equity:
Common stock, par value $0.01 per share, 400,000 shares authorized,
131,948 and 130,918 shares issued and outstanding at June 30, 2002
and December 31, 2001, respectively 1,319 1,309
Additional paid-in capital 246,984 232,907
Retained earnings 428,371 359,926
Accumulated other comprehensive income (loss) 2,731 (12,397)
------------ ---------
Total stockholders' equity 679,405 581,745
------------ ---------
Total liabilities and stockholders' equity $ 998,228 $ 886,911
============ =========
The accompanying notes are an integral part of the consolidated financial
statements.
3
WATERS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(unaudited)
Three Months Ended June 30
-------------------------------
2002 2001
---- ----
Net sales $217,192 $206,803
Cost of sales 75,980 75,545
---------- --------
Gross profit 141,212 131,258
Selling, general and administrative expenses 80,041 67,169
Research and development expenses 12,643 11,741
Goodwill and purchased technology amortization 922 1,771
---------- --------
Operating income 47,606 50,577
Other income (expense), net (Note 4) 116 -
Interest income (expense), net 1,500 1,151
---------- --------
Income from operations before income taxes 49,222 51,728
Provision for income taxes 11,321 12,415
---------- --------
Net income $ 37,901 $ 39,313
========== ========
---------- --------
Net income per basic common share $ 0.29 $ 0.30
========== ========
Weighted average number of basic common shares 131,510 130,564
---------- --------
Net income per diluted common share $ 0.28 $ 0.29
========== ========
Weighted average number of diluted common shares and equivalents 136,778 137,564
The accompanying notes are an integral part of the consolidated financial
statements.
4
WATERS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(unaudited)
Six Months Ended June 30
------------------------------
2002 2001
---- ----
Net sales $ 417,533 $ 407,835
Cost of sales 147,412 148,843
--------- ---------
Gross profit 270,121 258,992
Selling, general and administrative expenses 148,959 133,076
Research and development expenses 24,923 22,779
Patent litigation provision (Note 11) 2,800 -
Goodwill and purchased technology amortization 1,837 3,519
--------- ---------
Operating income 91,602 99,618
Other income (expense), net (Note 4) 116 -
Interest income (expense), net 2,878 2,637
--------- ---------
Income from operations before income taxes 94,596 102,255
Provision for income taxes 21,645 24,542
--------- ---------
Income before cumulative effect of change in accounting principle 72,951 77,713
Cumulative effect of change in accounting principle, net of tax (Note 3) (4,506) -
--------- ---------
Net income $ 68,445 $ 77,713
========= =========
Income per basic common share:
Income before cumulative effect of change in accounting principle
per basic common share $ 0.56 $ 0.60
Cumulative effect of change in accounting principle (0.03) -
Net income per basic common share $ 0.52 $ 0.60
Weighted average number of basic common shares 131,264 130,363
Income per diluted common share:
Income before cumulative effect of change in accounting principle
per diluted common share $ 0.53 $ 0.56
Cumulative effect of change in accounting principle (0.03) -
Net income per diluted common share $ 0.50 $ 0.56
Weighted average number of diluted common shares and equivalents 137,004 137,785
The accompanying notes are an integral part of
the consolidated financial statements.
5
WATERS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(unaudited)
Six Months Ended June 30
---------------------------------
2002 2001
---- ----
Cash flows from operating activities:
Net income $ 68,445 $ 77,713
Adjustments to reconcile net income to net cash provided by
operating activities:
Cumulative effect of accounting change for patent related costs 4,506 -
Loss provisions on accounts receivable and inventory 907 (830)
Impairment of investments 7,564 -
Deferred income taxes (805) (1,494)
Depreciation 13,773 9,781
Amortization of goodwill and other intangibles 5,218 6,131
Tax benefit related to stock option plans 5,871 1,181
Change in operating assets and liabilities, net of acquisitions:
Decrease (increase) in accounts receivable 9,675 (3,517)
(Increase) in inventories (14,864) (23,170)
(Increase) in other current assets (1,391) (4,127)
(Increase) in other assets (4,127) (4,026)
Increase in accounts payable and other current liabilities 6,026 13,454
Increase in deferred revenue and customer advances 7,100 6,531
(Decrease) increase in other liabilities (201) 481
--------- ---------
Net cash provided by operating activities 107,697 78,108
Cash flows from investing activities:
Additions to property, plant, equipment, software capitalization and
other intangibles (20,053) (22,907)
Investments in unaffiliated companies (14,500) (2,000)
Business acquisitions, net of cash acquired (5,851) (2,580)
Loan repayments from officers - 723
--------- ---------
Net cash (used in) investing activities (40,404) (26,764)
Cash flows from financing activities:
Net (repayment) of bank debt (230) (2,700)
Payments for debt issuance costs (827) -
Proceeds from stock plans 8,216 6,546
(Payments) proceeds from debt swaps (827) 6,526
--------- ---------
Net cash provided by financing activities 6,332 10,372
Effect of exchange rate changes on cash and cash equivalents 5,985 (2,711)
--------- ---------
Increase in cash and cash equivalents 79,610 59,005
Cash and cash equivalents at beginning of period 226,798 75,509
--------- ---------
Cash and cash equivalents at end of period $ 306,408 $ 134,514
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
6
WATERS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1. Organization and Basis of Presentation
Waters Corporation ("Waters" or the "Company"), an analytical instrument
manufacturer, is the world's largest manufacturer and distributor of high
performance liquid chromatography ("HPLC") instruments, chromatography columns
and other consumables, and related service. The Company believes it has the
largest HPLC market share in the United States, Europe and non-Japan Asia and
believes it has a leading position in Japan. HPLC, the largest product segment
of the analytical instrument market, 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. Through its
Micromass Limited ("Micromass") subsidiary, the Company believes it is a market
leader in the development, manufacture and distribution of mass spectrometry
("MS") instruments, which are complementary products that can be integrated and
used along with other analytical instruments, especially HPLC. Through its TA
Instruments, Inc. ("TAI") subsidiary, the Company believes it is also the
world's leader in thermal analysis, a prevalent and complementary technique used
in the analysis of polymers. As discussed in Note 9 to the consolidated
financial statements, these three operating segments have been aggregated into
one reporting segment for financial statement purposes.
The accompanying unaudited interim consolidated financial statements have
been prepared in accordance with generally accepted accounting principles
("GAAP") in the United States of America. The consolidated financial statements
include the accounts of the Company and its subsidiaries. All material
intercompany balances and transactions have been eliminated. Certain amounts
from prior years have been reclassified in the accompanying financial statements
in order to be consistent with the current year's classifications.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect (i) the reported
amounts of assets and liabilities, (ii) disclosure of contingent assets and
liabilities at the dates of the financial statements and (iii) the reported
amounts of revenues and expenses during the reporting periods. Actual results
could differ from those estimates.
It is management's opinion that the accompanying unaudited interim
consolidated financial statements reflect all adjustments (which are normal and
recurring) necessary for a fair presentation 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
Form 10-K filing with the Securities and Exchange Commission for the year ended
December 31, 2001.
2. Inventories
Inventories are classified as follows:
June 30, December 31,
2002 2001
-------- ------------
Raw materials $ 38,400 $ 31,965
Work in progress 21,309 26,305
Finished goods 59,632 44,448
-------- --------
Total inventories $119,341 $102,718
======== ========
7
WATERS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
3. Change in Accounting for Patent Related Costs
In the second quarter of 2002, the Company changed its method of accounting for
legal costs associated with litigating patents effective January 1, 2002. Prior
to the change, the Company capitalized these patent costs and amortized them
over the estimated remaining economic life of the patent. Under the new method,
these costs will be expensed as incurred. The Company believes that this change
is preferable because it will provide a better comparison with the Company's
industry peers, the majority of which expense these costs as incurred. The $4.5
million cumulative effect of the change on prior years (after reduction for
income taxes of $1.3 million) is included as a charge to net income as of
January 1, 2002. The effect of the change on the three months ended June 30,
2002 was to decrease net income by approximately $1.2 million or $0.01 per
diluted share. The effect of the change on the six months ended June 30, 2002
was to decrease income before cumulative effect of a change in accounting
principle approximately $1.4 million or $0.01 per diluted share and net income
$5.9 million or $0.04 per diluted share. The effect of the change on the three
months ended March 31, 2002, was to decrease income before cumulative effect of
a change in accounting principle approximately $0.2 million to $35.0 million and
net income $4.7 million to $30.5 million or $0.03 per diluted share. The change
in accounting principle had no effect on income before cumulative effect of a
change in accounting principle per diluted share for the three months ended
March 31, 2002.
Pro forma net income for the three months and six months ended June 30,
2001 would have been $39.0 million and $76.9 million, respectively, had the
change in accounting for patent related costs occurred at the beginning of 2001.
Pro forma net income per basic common share and pro forma net income per diluted
common share for the three months ended June 30, 2001 would have been $.30 and
$.28, respectively. Pro forma net income per basic common share and pro forma
net income per diluted common share for the six months ended June 30, 2001 would
have been $.59 and $.56, respectively. The pro forma amounts reflect the effect
of retroactive application of this change had the new method been in effect for
all periods presented.
4. Business Investments and Acquisitions
In November 2000, the Company entered into an agreement to make a minority
equity investment in GeneProt(TM), Inc. ("GeneProt") of $3.6 million Series B
Preferred Stock. In December 2001, the Company formed a strategic alliance with
GeneProt to collaborate on product development in the application of mass
spectrometry equipment to industrial-scale proteomics drug discovery. As part of
the strategic alliance, the Company purchased $10.0 million of Series B
Preferred Stock equity securities during the first quarter of 2002 as part of
Geneprot's second round of equity financing. The investment in Geneprot is
accounted for under the cost method of accounting. Due to changes in Geneprot's
business plan and financial condition, among other factors, the Company recorded
a pre-tax $6.5 million charge in the second quarter of 2002 to other income
(expense) in the consolidated statements of operations, for an
other-than-temporary impairment of its investment in Geneprot. The investment in
Geneprot was approximately $7.1 million and $3.6 million at June 30, 2002 and
December 31, 2001, respectively and is included in other assets. In connection
with Geneprot's canceled order of up to $20.0 million of mass spectrometry
equipment, related systems and services, the Company received approximately $7.7
million from Geneprot as a termination fee, which is recorded in other income
(expense) in the consolidated statements of operations for the three and six
months ended June 30, 2002. The Company collected $2.5 million of this fee in
June 2002 and the remainder, approximately $5.2 million, was collected in
December 2001 as a customer advance and is included in the consolidated balance
sheet at December 31, 2001.
The Company's equity investment in Variagenics, Inc. ("Variagenics") is
accounted for under Statement of Financial Accounting Standard ("SFAS") 115,
Accounting for Certain Investments in Debt and Equity Securities. During the
three and six months ended June 30, 2002, the Company recorded a $1.0 million
charge to other income (expense) in the consolidated statements of operations,
for further other-than-temporary impairment of its investment in Variagenics.
The Company recorded an other-than-temporary impairment charge of $5.9 million
for this investment in the fourth quarter of 2001. The investment in Variagenics
was approximately $.7 million and $1.7 million at June 30, 2002 and December 31,
2001, respectively. At June 30, 2002, no other investments and long-lived assets
were determined to be impaired.
During the six months ended June 30, 2002, the Company made a business
acquisition totaling approximately $5.9 million for the net assets of a foreign
distributor and other minority equity investments totaling $4.5 million.
8
WATERS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
5. Goodwill and Other Intangibles
Effective January 1, 2002, the Company adopted SFAS 142, Goodwill and Other
Intangible Assets. SFAS 142 requires that ratable amortization of goodwill be
replaced with periodic tests of the goodwill's impairment and that intangible
assets other than goodwill be amortized over their useful lives. Under the
transition provisions of SFAS 142, there was no impairment of goodwill at
January 1, 2002.
For the three months and six months ended June 30, 2001, the Company's
goodwill amortization expense was approximately $1.0 million and $2.0 million,
respectively. Pro forma net income for the three months and six months ended
June 30, 2001 would have been $40.1 million and $79.2 million, respectively,
excluding goodwill amortization expense at the Company's effective tax rate in
2001 of 24%. Pro forma net income per basic common share and pro forma net
income per diluted common share for the three months ended June 30, 2001 would
have been $.31 and $.29, respectively. Pro forma net income per basic common
share and pro forma net income per diluted common share for the six months ended
June 30, 2001 would have been $.61 and $.57, respectively.
The increase in the carrying amount of goodwill to $168.7 million at June
30, 2002 from $163.5 million at December 31, 2001 related to the acquisition of
a foreign distributor in the amount of approximately $4.0 million and currency
translation adjustments of approximately $1.2 million. As part of this
acquisition, the Company recorded approximately $2.2 million of other intangible
assets for customer contracts and non-compete covenants. These other intangibles
are being amortized over a period of two to fifteen years.
The Company's intangible assets included in other assets in the
consolidated balance sheets are detailed as follows:
At June 30, 2002 At December 31, 2001
------------------------------------ ------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
------------------ ----------------- ------------------ ----------------
Purchased technology $ 43,595 $ 21,145 $ 43,595 $ 19,308
Capitalized software 39,557 16,067 34,762 13,177
Patents, intellectual property
and other intangibles 20,634 6,623 21,711 7,026
------------------ ---------------- ------------------ ----------------
Total $103,786 $ 43,835 $100,068 $ 39,511
================== ================= ================== ================
Purchased technology is amortized over a period ranging from four to
fifteen years. Capitalized software is amortized over a period ranging from
three to five years. Patents, intellectual property, such as licenses, and other
intangibles are amortized over a period ranging from two to fifteen years. At
June 30, 2002, intangible assets above reflect the change in accounting for
patent related costs as discussed in Note 3. All intangible assets are amortized
on a straight-line basis. Amortization expense for intangible assets is
estimated to be approximately $10.6 million for each of the next five years.
6. Income Taxes
The Company's effective tax rate for the three months ended June 30, 2002 and
2001, was 23% and 24%, respectively. The Company's effective tax rate for the
six months ended June 30, 2002 and 2001, was 22.9% and 24%, respectively.
9
WATERS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
7. Earnings Per Share
Basic and diluted earnings per share ("EPS") calculations are detailed as
follows:
------------------------------------------------
Three Months Ended June 30, 2002
------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------- --------------- -----------
Net income per basic common share $ 37,901 131,510 $ 0.29
============= =============== ===========
Effect of dilutive securities:
Options outstanding 5,050
Options exercised and cancellations 218
------------- --------------- -----------
Net income per diluted common share $ 37,901 136,778 $ 0.28
============= =============== ===========
------------------------------------------------
Three Months Ended June 30, 2001
------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------- --------------- -----------
Net income per basic common share $ 39,313 130,564 $ 0.30
============= =============== ===========
Effect of dilutive securities:
Options outstanding 6,899
Options exercised and cancellations 101
------------- --------------- -----------
Net income per diluted common share $ 39,313 137,564 $ 0.29
============= =============== ===========
------------------------------------------------
Six Months Ended June 30, 2002
------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------- --------------- -----------
Income before cumulative effect of change in accounting
principle per basic common share $ 72,951 131,264 $ 0.56
============= =============== ===========
Effect of dilutive securities:
Options outstanding 5,390
Options exercised and cancellations 350
Income before cumulative effect of change in accounting ------------- --------------- -----------
principle per diluted common share $ 72,951 137,004 $ 0.53
============= =============== ===========
------------------------------------------------
Six Months Ended June 30, 2001
------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------- --------------- -----------
Income before cumulative effect of change in accounting
principle per basic common share $ 77,713 130,363 $ 0.60
============= =============== ===========
Effect of dilutive securities:
Options outstanding 7,193
Options exercised and cancellations 229
Income before cumulative effect of change in accounting ------------- --------------- -----------
principle per diluted common share $ 77,713 137,785 $ 0.56
============= =============== ===========
10
WATERS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
For the three months and six months ended June 30, 2002, the Company had
3,874 and 3,823 stock option securities that were antidilutive, respectively.
For the three months and six months ended June 30, 2001, the Company had 1,688
and 1,643 stock option securities that were antidilutive, respectively. These
securities were not included in the computation of diluted EPS. The effect of
dilutive securities was calculated using the treasury stock method.
8. Comprehensive Income
Comprehensive income details follow:
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001
---------------------------------------------------------------------
Net income $37,901 $ 39,313 $ 68,445 $ 77,713
Other comprehensive income (loss):
Foreign currency translation adjustments, net of
tax 24,091 (4,245) 18,016 (13,044)
Appreciation (depreciation) and realized
gains (losses) on derivative instruments (3,859) 1,983 (2,888) 6,526
Unrealized (loss) on investments, net of tax 192 (479) -- (2,929)
---------------------------------------------------------------------
Comprehensive income $58,325 $ 36,572 $ 83,573 $ 68,266
=====================================================================
As described in Note 4 of these financial statements, the Company
reclassified the unrealized loss on its investment in Variagenics to other
income (expense) in the consolidated statements of operations during the six
months ended June 30, 2002. The $192 unrealized loss on investments, net of tax,
in Variagenics for the three months ended March 31, 2002 has been included in
the asset impairment charge recorded in other income (expense) in the
consolidated statements of operations for the six months ended June 30, 2002.
9. Business Segment Information
SFAS 131, Disclosures about Segments of an Enterprise and Related Information,
establishes standards for reporting information about operating segments in
annual financial statements of public business enterprises. The Company
evaluated its business activities that are regularly reviewed by the Chief
Executive Officer for which discrete financial information is available. As a
result of this evaluation, the Company determined that it has three operating
segments: Waters, Micromass and TAI.
Waters is in the business of manufacturing and distributing HPLC
instruments, chromatography columns and other consumables, and related service;
Micromass is in the business of manufacturing and distributing mass spectrometry
instruments that can be integrated and used along with other analytical
instruments, particularly HPLC; and TAI is in the business of manufacturing and
distributing thermal analysis and rheology instruments. For all three of these
operating segments within the analytical instrument industry; economic
characteristics, production processes, products and services, types and classes
of customers, methods of distribution, and regulatory environments are similar.
Because of these similarities, the three 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.
10. Recent Accounting Standards Pronouncements
In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS 146,
Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146
addresses significant issues regarding the recognition, measurement, and
reporting of costs that are associated with exit and disposal activities,
including restructuring activities that are currently accounted for pursuant to
the guidance that the Emerging Issues Task Force ("EITF") has set forth in EITF
Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). The scope of SFAS 146 also includes (1) costs related to
terminating a contract that is not a capital lease, (2)
11
WATERS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
termination benefits that employees who are involuntarily terminated receive
under the terms of a one-time benefit arrangement that is not an ongoing benefit
arrangement or an individual deferred-compensation contract and (3) costs to
consolidate facilities or relocate employees. SFAS 146 will be effective for
exit or disposal activities that are initiated after December 31, 2002. Early
application is encouraged. While management has not determined the impact of the
new standard, it is not expected to be material to the Company.
11. Patent Litigation
Applera Corporation:
PE Corporation (since renamed Applera Corporation), MDS Inc. and Applied
Biosystems/MDS Sciex ("the plaintiffs") have filed a civil action against
Micromass UK Limited and Micromass, Inc., wholly owned subsidiaries of the
Company, in the U.S. District Court for the District of Delaware. The plaintiffs
allege that the Quattro Ultima triple quadrupole mass spectrometer infringes
U.S. Patent No. 4,963,736 ("the patent"). The patent is owned by MDS Inc. and
licensed to a joint venture with Applied Biosystems/MDS Sciex. The Company
believes that it does not infringe the patent and alleges the patent is invalid
and unenforceable based on inequitable conduct in the course of obtaining the
patent and the Reexamination Certificate therefore.
In March 2002, the Company was informed of a jury's finding that the
Quattro Ultima with Mass Transit ion tunnel technology infringes the patent. The
same jury has found that the infringement was not willful and determined damages
in the amount of $47.5 million. The Court has entered an injunction in which the
Company is enjoined from making, using and selling the Quattro Ultima triple
quadrupole mass spectrometer incorporating features of the patent. These
instruments are manufactured in the United Kingdom and shipments to the rest of
the world outside of the United States are not subject to the present
litigation. There is a possibility that similar claims may be asserted against
the Company in other countries and for other products in the mass spectrometry
product line. Based on the facts available to management, the Company believes
the outcome of any such claims should they be brought, cannot be predicted with
certainty, but could be material to the Company's financial position, results of
operations and liquidity.
The Company intends to contest both the jury's verdict and the district
court's underlying patent claim construction vigorously by way of an appeal to
the United States Court of Appeals for the Federal Circuit. Management, after
reviewing available information relating to this matter, has determined that it
is probable some liability has been incurred. The Company believes that any
liability ultimately incurred will not likely exceed the provisions recorded in
the periods ended December 31, 2001 and June 30, 2002, respectively, including
interest, court costs, legal fees and other charges. However, in the event of an
unanticipated adverse final determination in respect of certain matters, the
Company's consolidated net income for the period in which such determination
occurs could be materially affected. Although sufficient uncertainties exist to
preclude the Company from precisely determining the amount of its liability, the
accrued patent litigation of $74.2 million recorded as of June 30, 2002 in the
consolidated balance sheets, is the Company's best estimate of its exposure for
this contingent liability based on information currently available. During the
six month period ended June 30, 2002, the Company recorded a $3.0 million
pre-tax charge for additional liabilities associated with interest costs and
related product sales made in the period prior to the day of the jury's verdict.
Approximately $3.8 million of legal fees were paid or accrued and charged
against the patent litigation accrual in the six months ended June 30, 2002.
Hewlett-Packard Company:
The Company filed suit in the U.S. against Hewlett-Packard Company and
Hewlett-Packard GmbH ("HP"), seeking a declaration that certain products sold
under the mark Alliance do not constitute an infringement of one or more patents
owned by HP or its foreign subsidiaries ("the HP patents"). The action in the
U.S. was dismissed for lack of controversy. Actions seeking revocation or
nullification of foreign HP patents were filed by the Company in Germany, France
and England. A German patent tribunal found the HP German patent to be valid.
The Company is appealing the German decision. In Germany, France and England, HP
and its successor, Agilent Technologies Deutschland GmbH, have brought an action
alleging certain features of the Alliance pump may infringe the HP patent. In
England, the Court of Appeal and in France, the Paris District Court, has found
the HP patent valid and infringed by the Alliance pump. The Company intends to
appeal both decisions. During the six months ended June 30, 2002, the Company
recorded a provision for estimated damages incurred with respect to this ongoing
litigation which was charged to selling, general and administrative
expenses and was not considered material to the Company. The provision recorded
represents management's best estimate of the probable and reasonably estimable
loss related to this litigation.
12
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations
Net Sales:
Net sales for the three month period ended June 30, 2002 (the "2002 Quarter")
and the six month period ended June 30, 2002 the ("2002 Period") were $217.2
million and $417.5 million, respectively, compared to $206.8 million for the
three month period ended June 30, 2001 (the "2001 Quarter") and $407.8 million
for the six month period ended June 30, 2001 (the "2001 Period"), an increase of
5% for the quarter and 2% for the period. Excluding the effects of currency
translation, net sales increased by 3% for both the 2002 Quarter and 2002
Period. The Company's HPLC product line continued to perform well with sales
growth in the high-single digits for the 2002 Quarter, excluding currency
effects. HPLC sales growth in North America was near mid-single digits while
shipments in Europe were at a strong double-digit rate, excluding the effects of
currency translation. HPLC order backlog grew approximately $5.7 million with
increases across most major territories and product lines. The Company's mass
spectrometry product line continued to be affected in the U.S. by the March 2002
unfavorable patent litigation ruling involving sales of certain mass
spectrometry products. Overall mass spectrometry sales decreased at a mid-single
digit rate in the 2002 Quarter. Sales in the 2002 Quarter of the Company's
thermal analysis product line were relatively flat compared to the 2001 Quarter.
Order backlog for thermal analysis products grew modestly in the 2002 Quarter.
Currency increased reported sales growth in the 2002 Quarter by two percentage
points primarily due to the strengthening of the euro and British pound.
Gross Profit:
Gross profit for the 2002 Quarter and the 2002 Period was $141.2 million and
$270.1 million, respectively, compared to $131.2 million for the 2001 Quarter
and $259.0 million for the 2001 Period, an increase of $10.0 million or 8% for
the quarter and $11.1 million or 4% for the period. Gross profit as a percentage
of sales increased to 65.0% in the 2002 Quarter from 63.5% in the 2001 Quarter.
Gross profit as a percentage of sales increased to 64.7% in the 2002 Period from
63.5% in the 2001 Period. Gross profit as a percentage of sales has increased
steadily from the beginning of 2002. This is attributed to many factors
including price increases, a higher mix of more profitable consumables and
services and continued manufacturing cost savings initiatives. In addition, the
Company acquired the businesses of its Irish and Korean distributors in early
2002 and mid- 2001, respectively. As such, the incremental profit from direct
billings have increased gross profit and gross profit percentages and will
continue to do so for the remainder of 2002, as well as operating expenses. This
incremental profit was not in the 2001 Quarter and 2001 Period.
Selling, General, and Administrative Expenses:
Selling, general and administrative expenses for the 2002 Quarter and the 2002
Period were $80.0 million and $149.0 million, respectively, compared to $67.2
million for the 2001 Quarter and $133.1 million for the 2001 Period. Selling,
general and administrative expenses increased to 36.9% for the 2002 Quarter from
32.5% for the 2001 Quarter and 35.7% for the 2002 Period from 32.6%. The $12.8
million or 19% increase for the quarter and $15.9 million or 12% increase for
the period in total expenditures primarily resulted from increased headcount and
related costs required to support increased current and future sales levels,
including the acquisitions of Irish and Korean distributor businesses. In
addition, the Company recorded an increase of $1.5 million in patent related
costs during the 2002 Period. The Company changed its method of accounting for
legal costs associated with litigating patents effective January 1, 2002 and
current year patent related expenses are recorded in selling, general and
administrative expenses. The Company also recorded a provision of $1.5 million
for estimated damages incurred with respect to ongoing patent infringement
litigation.
The Company recently announced it will fully integrate the worldwide sales,
service and distribution groups of the Micromass division with the Waters HPLC
division. The objective of this strategy is to leverage the strengths of both
divisions and align operating expenses to a more rational historical level as a
percentage of sales. It is expected operating expense growth will continue to be
just over 10% for the rest of 2002 before the benefits of the combination will
be realized. Also, as a result of this ongoing process, the Company will be
identifying certain service labor and related costs associated with revenue
producing activities that are currently classified as operating expenses and
will be reclassifying them to cost of sales for the years ended December 31,
2002, 2001 and 2000.
13
Research and Development Expenses:
Research and development expenses were $12.6 million for the 2002 Quarter and
$24.9 million for the 2002 Period, compared to $11.7 million for the 2001
Quarter and $22.8 million for the 2001 Period, an increase of $.9 million or 8%
for the 2001 Quarter and $2.1 million or 9% for the 2001 Period, respectively.
The Company continued to invest significantly in the development of new and
improved HPLC, mass spectrometry, thermal analysis and rheology products.
Patent Litigation Provision:
The Company recorded a $2.8 million pre-tax charge for Applera patent litigation
in the 2002 Period for additional liabilities associated with related product
sales made in 2002 prior to the day of the jury's verdict in March 2002. There
was no such charge in the 2001.
Goodwill and Purchased Technology Amortization:
Goodwill and purchased technology amortization for the 2002 Quarter and the 2002
Period was $.9 million and $1.8 million, respectively, compared to $1.8 million
for the 2001 Quarter and $3.5 million for the 2001 Period, a decrease of $.9
million or 48% for the quarter and $1.7 million or 48% for the period. The
change was primarily related to the elimination of goodwill amortization in 2002
in accordance with recently adopted accounting standards.
Operating Income:
Operating income for the 2002 Quarter and the 2002 Period was $47.6 million and
$91.6 million, respectively, compared to $50.6 million for the 2001 Quarter and
$99.6 million for the 2001 Period, a decrease of $3.0 million or 6% for the
quarter and $8.0 million or 8% for the period. Waters operating income levels
decreased due to an increase in operating expenses, including an increase in
current year patent related costs, offset by the impact of improved profit
margins and the elimination of goodwill amortization in 2002.
Other Income (Expense), Net:
In the 2002 Quarter and 2002 Period, the Company recorded a $7.6 million pre-tax
charge for other-than-temporary impairments to the carrying amounts of certain
equity investments, including investments in Geneprot and Variagenics. The
impairment charges were offset by a $7.7 million termination fee received from
Geneprot for cancellation of its $20.0 million order. There were no such items
in 2001.
Interest Income (Expense), Net:
Net interest income for the 2002 Quarter and the 2002 Period was $1.5 million
and $2.9 million, respectively, compared to $1.2 million for the 2001 Quarter
and $2.6 million for the 2001 Period. The change primarily reflected
considerably higher cash balances in 2002, offset by lower yields on
investments.
Provision for Income Taxes:
The Company's effective income tax rate was 23% in the 2002 Quarter and 22.9% in
the 2002 Period compared to 24% in the 2001 Quarter and 2001 Period. The 2002
tax rate decreased primarily due to the continued favorable shift in the mix of
taxable income to lower tax rate jurisdictions.
Income before Cumulative Effect of Change in Accounting Principle:
Net income for the 2002 Quarter and income before the cumulative effect of
change in accounting principle for the 2002 Period was $37.9 million and $73.0
million, respectively, compared to $39.3 million for the 2001 Quarter and $77.7
million for the 2001 Period, a decrease of $1.4 million or 4% from the 2001
Quarter and $4.7 million or 6% from the 2001 Period, respectively. The decline
in 2002 was due to an increase in operating expenses, including an increase in
current year patent related costs. These were offset by the impact of improved
profit margins, a decrease in the Company's effective income tax rate and the
elimination of goodwill amortization in 2002.
Change in Patent Accounting:
In the 2002 Quarter, the method of accounting for patent related costs
associated with patent litigation was changed effective January 1, 2002 from a
method of capitalizing the patent related costs and amortizing them over their
estimated remaining economic life, to expensing the costs as incurred. The
Company believes that this change is preferable because it will provide a better
comparison with the Company's industry peers, the majority of which expense
these costs as incurred. The $4.5 million cumulative effect of the change on
prior years (after reduction for income taxes of $1.3 million) is included as a
charge to net income for the six months ended June 30, 2002.
14
Liquidity and Capital Resources
During the 2002 Period, net cash provided by the Company's operating activities
was $107.7 million, primarily as a result of net income for the year after
adding back depreciation, amortization and a decrease in working capital needs.
In terms of working capital and after excluding the effects of currency
translation, $9.7 million was provided as accounts receivable decreased due to
lower sales volume in the 2002 Period compared to the second half of 2001.
Approximately $14.9 million was used for inventory growth related to sales
expectations, including the canceled Geneprot order in June 2002. Both accounts
receivable days-sales-outstanding (75 days versus 67 days) and inventory were
seasonably higher as expected versus December 31, 2001. Within liabilities, an
increase in accounts payable and other current liabilities, and deferred revenue
and customer advances provided $13.1 million. In addition, the Company received
$8.2 million of proceeds from the exercise of stock options and its employee
stock purchase plan. Primary uses of cash flow during the period were $20.4
million for investments in unaffiliated companies and business acquisitions and
$20.1 million of property, plant and equipment and software capitalization
investments.
The Company believes that the existing cash and cash equivalent balance of
$306.4 million and expected cash flow from operating activities together with
borrowings available from its credit facility will be sufficient to fund working
capital, capital spending requirements and other cash outlays in the foreseeable
future. Beginning in July 2002, the Company commenced repurchases of its
outstanding common shares. The Board of Directors authorized the Company to
repurchase up to $200.0 million of its outstanding common shares over the next
twelve months. As of August 9, 2002, approximately $26.8 million of common stock
had been repurchased.
In connection with the unfavorable judgment against the Company in the
Applera patent litigation, the Company is required to extend a financial
guarantee for the amount of the damages awarded plus interest. A letter of
credit is expected to be finalized in the third quarter of 2002, at which time
approximately $55.0 million of cash used as collateral will be reclassed to
other assets as restricted cash. As a publicly held company, the Company has not
paid any dividends and does not plan to pay any dividends in the foreseeable
future.
Environmental Matters
The Company is currently working with the Massachusetts Department of
Environmental Protection regarding alleged noncompliance with state
environmental laws at its Taunton, Massachusetts facility. The Company does not
currently anticipate any material adverse effect on its operations, financial
condition or competitive position as a result of its efforts to comply with
environmental laws.
Critical Accounting Policies and Estimates
In the Company's Form 10-K for the year ended December 31, 2001, the Company's
most critical accounting policies and estimates upon which our financial status
depends upon were identified as those relating to revenue recognition, loss
provisions on accounts receivable and inventory, valuation of equity
investments, long-lived assets, intangible assets and goodwill, warranty, income
taxes and litigation. We reviewed our policies and determined that those
policies remain our most critical accounting policies for the 2002 Period. We
did not make any changes in those policies during the period, except for the
change in accounting for legal costs associated with litigating patents and the
adoption of SFAS 142, Goodwill and Other Intangible Assets.
Forward-Looking Information
Safe Harbor Statement under Private Securities Litigation Reform Act of 1995
Certain statements contained herein are forward looking. These statements are
subject to various risks and uncertainties, many of which are outside the
control of the Company, including (i) changes in the HPLC, mass spectrometry and
thermal analysis portions of the analytical instrument marketplace as a result
of economic or regulatory influences, (ii) changes in the competitive
marketplace, including new products and pricing changes by the Company's
competitors, (iii) the ability of the Company to generate increased sales and
profitability from new product introductions and (iv) the short term effect on
sales and operating expenses as a result of the recently announced combination
of the HPLC and Micromass sales, service and distribution organizations, as well
as additional risk factors set forth in the Company's Form 10-K for the year
ended December 31, 2001. Actual results or events could differ materially from
the plans, intentions and expectations disclosed in
the forward-looking statements we make, whether because of these factors or for
other reasons. We do not assume any obligations to update any forward-looking
statement we make.
15
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the Company's market risk during the six
months ended June 30, 2002. For additional information, refer to the Company's
Form 10-K, Item 7a for the year ended December 31, 2001.
Part II: Other Information
Item 1. Legal Proceedings
Applera Corporation:
Reference regarding the Applera patent litigation against the Company is
contained in Note 11, Patent Litigation on page 12 of this Form, included in
Part I, Item 1, Financial Statements.
Hewlett-Packard Company:
Reference regarding the Hewlett-Packard Company and Hewlett-Packard GmbH ("HP")
patent litigation is contained in Note 11, Patent Litigation on page 12 of this
Form, included in Part I, Item 1, Financial Statements.
Other:
In June 2002, Varian, Inc. filed a civil action against the Company alleging
trademark infringement with respect to a Company product sold under the mark
Polarity. The Company has not answered the complaint as of the date this Form
10-Q was filed, however the Company does not believe the trademark Polarity
infringes the trademark rights of Varian, Inc. The Company believes it has
meritorious arguments and should prevail, although the outcome is not certain.
The Company believes that any outcome will not be material to the Company.
In July 2002, the Company filed suit against Applera Corporation in a
civil action alleging patent infringement on U.S. Patent No. 5,304,798 owned by
the Company. The Company believes it has a meritorious claim and should prevail,
although the outcome is uncertain.
Item 2. Changes in Securities
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
The Waters Corporation annual meeting of stockholders was held on May 7, 2002,
at which the following matters were submitted to a vote of security holders: the
election of directors of the Company as previously reported to the Commission
and the approval of an amendment to the Company's Second Amended and Restated
1996 Long-Term Performance Incentive Plan ("Stock Plan") to increase the number
of shares of common stock reserved for issuance from 12,000,000 to 17,750,000
shares.
As of March 19, 2002, the record date for said meeting, there were
131,098,061 shares of Waters Corporation common stock entitled to vote at the
meeting. At such meeting, the holders of 113,985,823 shares were represented in
person or by proxy, constituting a quorum. At such meeting, the vote with
respect to the matters proposed to the stockholders was as follows:
16
Matter For Withheld Against Abstain
------ --- --------- ------- -------
Election of Directors:
For Joshua Bekenstein 112,273,643 1,712,180
For Michael J. Berendt, Ph.D. 112,281,922 1,703,901
For Douglas A. Berthiaume 112,278,523 1,707,300
For Philip Caldwell 112,255,825 1,729,998
For Edward Conard 112,281,111 1,704,712
For Laurie H. Glimcher, M.D. 112,282,421 1,703,402
For William J. Miller 112,280,422 1,705,401
For Thomas P. Salice 112,274,733 1,711,090
Amendment to increase reserved shares of Stock Plan 101,526,844 11,973,773 485,206
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8-K
A. Exhibit 10.31 First Amendment to the Waters Corporation
Second Amended and Restated 1996 Long-Term
Performance Incentive Plan.
Exhibit 18.1 Change in accounting principle preferability
letter from PricewaterhouseCoopers LLP
Exhibit 99.1 Chief Executive Officer Certification
Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
Exhibit 99.2 Chief Financial Officer Certification
Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
B. The Registrant filed reports on Form 8-K on each of the
following dates during the quarter for which this report is
filed:
A report on Form 8-K was filed by the Company on June 3, 2002
to report material modifications to the Company's technology
contract with GeneProt.
A report on Form 8-K was filed by the Company on June 26, 2002
to report the Company's stock repurchase plan.
17
WATERS CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: August 12, 2002 Waters Corporation
/s/ John Ornell
-----------------------------------
John Ornell
Vice President, Finance and
Administration and Chief Financial Officer
18