We remain Neutral on The Cheesecake Factory Inc. (CAKE) over the long term. While second quarter 2011 earnings results, comparable sales growth, cost reduction initiatives and an increase in the share repurchase program are positives, a high unemployment rate, increased pre-opening expenses during the second half of 2011 and inflated commodity costs keep us on the sidelines.
The Cheesecake Factory’s second quarter 2011 earnings were in line with the Zacks Consensus Estimate. The company’s revenue spiked 2.8% year over year but missed the Zacks Consensus Estimate. The upside in the top line was attributable to higher comparable sales growth. The company is also focusing on sales-driven initiatives like new menu offerings, value-added services and improved food quality to attract customers. All dayparts were positive, with major increases in the mid-afternoon and late-night periods, and all key markets including California, Florida, the Midwest, the Southeast and Texas posted impressive results in the second quarter.
Cheesecake Factory also increased its share repurchases target in 2011 to a range of $125 million to $150 million. In the first half of 2011, the company spread investor cheer by repurchasing $95 million shares. During the second quarter of 2011, the company repurchased 1.5 million shares of its common stock at a total cost of approximately $44.4 million.
However, there are some causes of worry. Like all restaurant companies, Cheesecake is exposed to higher input costs. Management expects year-over-year food cost pressures to persist into the third quarter, pushing up total cost of sales by 70–90 basis points on a year-over-year basis. Management projects 4% commodity inflation for 2011. The related impact to total cost of sales will likely have an 11-cent drag on earnings per share this year relative to 2010.
Since the company is in an expansion mode, it will experience increased pre-opening expenses during the second half of 2011. Additionally, Cheesecake Factory’s labor expenses in fourth-quarter 2010 benefited 90–100 bps from the HIRE Act, which will not recur this year.
Cheesecake Factory, which competes with the likes of Panera Bread Co. (PNRA) currently, retains a Zacks #3 Rank, which translates into a short-term Hold rating.
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Rite Aid Corporation (RAD), the third largest retail drugstore in the U.S. based on revenues and number of stores, posted its second-quarter 2012 results. Street analysts had nearly a week to ponder on the news.
In the subsequent paragraphs, we cover the recent earnings announcement, analysts' estimate revisions as well as the Zacks Rank and long-term recommendation on the stock.
On September 22, 2011, Rite Aid reported a loss of 11 cents per share for the second quarter of 2012, which not only improved from the prior-year quarter loss of 23 cents, but also outshined the Zacks Consensus Estimate loss of 18 cents. Growth in same-store sales and reduced selling, general & administrative (SG&A) expenses had a positive influence on recent results.
Rite Aid's revenues came in at $6,271.1 million for the quarter compared with $6,161.8 million in the prior-year period. The marginal increase of 1.8% was mostly attributable to growth in same-store sales, partially offset by store closings. Same-store sales for the quarter witnessed an increase of 2.2%. Total revenue beats the Zacks Consensus Estimate of $6,207.0 million.
Management's Guidance for 2012
Looking ahead, Rite Aid expects fiscal 2012 revenue to be between $25.8 billion and $26.1 billion based on same-store sales increase of 0.75% to 2.0%. Net loss is now expected to be in the range of $345 million to $495 million (or 40 cents to 56 cents per share) instead of $370 million to $560 million (or 42 cents to 64 cents per share) forecasted earlier.
(Read our full coverage on this earnings report: Rite Aid Narrows Loss in 2Q)
Agreement of Analysts
Estimate revision trends for the upcoming third and fourth quarter of fiscal 2012 portrayed mixed sentiments among most of the analysts covering the stock. Over the last 7 days, 1 out of 6 analysts following the stock revisited its estimate and have upgraded the same for the upcoming third-quarter 2012. While for the fourth quarter of 2012, 1 analyst revisited its estimate and has downgraded the same.
Moreover, over the last 7 days, 1 analyst each revisited and upgraded its estimates for fiscals 2012 and 2013, respectively.
Magnitude of Estimate Revisions
The magnitude of estimate revisions for Rite Aid depicts an optimistic outlook for the third quarter of 2012 and for full fiscal 2012 and 2013. However, the magnitude of estimate revision for the fourth quarter of 2012 and full fiscal 2013 remains constant at an estimated loss of 13 cents and 34 cents per share, respectively, over the last 7 days.
Over the last 7 days, estimated loss for third quarter of fiscal 2012 has been decreased by a penny to 12 cents per share. Further, for fiscal 2012, estimated loss has been lowered by 2 cents to 44 cents, over the last 7 days.
Generic (non-brand) drugs are less expensive but generate higher gross margin. Recent trend in the U.S. is witnessing a growing demand for generic drugs. The company is expected to expand its generic drug portfolio in order to enhance its top-line as well as market share. Rite Aid has an edge over its competitors as it is the third largest retail drugstore in the U.S. based on revenues and number of stores.
Moreover, the company is in the process of various cost cutting initiatives including centralized indirect procurement of drugs, administrative headcounts requirement, reducing supply chain costs, reducing debt, etc. which will certainly benefit the company to improve its bottom-line.
However, in the United States, pharmacy sales growth has slowed down due to longer FDA approval process, drug safety concern, loss of individual health insurance resulting from unemployment and an increase in the use of non-branded drugs, which are less expensive but generate higher gross margin. Due to these factors, the company's same-store-sales are expected to remain weak. The company has reported losses for the last fourteen consecutive quarters.
Moreover, Rite Aid's generic drug sales are negatively affected by Wal-Mart Stores Inc.'s (WMT) strategy of entering the retail generic drug market. Due to Wal-Mart's broad array of manufacturers in India, Israel, and the U.S., the mass merchant can offer generic drugs at a discounted price compared with the average $10 generic drug co-pay.
Rite Aid, which competes with CVS Caremark Corporation (CVS) and Walgreen Co. (WAG), currently, holds a Zacks #2 Rank, implying a short-term Buy rating on the stock. Besides, the company retains a long-term Neutral recommendation on the stock.
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Two Harbors Investment Corp. (TWO) recently announced the appointment of Brad Farrell as the chief financial officer and treasurer, effective January 1, 2012. Two Harbors’ current CFO, Jeffrey Stolt, will hold his position till January 2012 and thereafter will serve as the partner and chief financial officer of Pine River Capital Management L.P.
Brad Farrell boasts an experience of 14 years in corporate financial management and business analysis for public financial service companies. Prior to joining Two Harbors, Brad Farrell held the post of vice president and executive director of external reporting at GMAC Res Cap, a diversified real estate finance company, and also served in a responsible position at XL Capital, Ltd, a global insurance underwriter.
On the other hand, Jeffrey Stolt made invaluable contributions toward Two Harbors during the formation years. Jeff hired Brad Farrell in 2009 as controller of Two Harbors, and together they have worked closely on Two Harbors’ capital market transactions, and developing Two Harbors’ finance and governance processes.
Management believes with exceptional financial service expertise, Brad Farrell will add further value and drive the company’s growth and profitability going forward.
Maryland-based Two Harbors Investment Corp. primarily focuses on investing, financing and managing residential mortgage-backed securities (RMBS) and mortgage loans. The company’s portfolio includes Agency RMBS and non-Agency RMBS.
Agency RMBS are those whose interest and principal payments carry guarantees from federally chartered entities such as Freddie Mac or government agencies while non-Agency RMBS are those that are not issued or guaranteed by such government entities.
Two Harbors currently retains a Zacks #1 Rank, which translates into a short-term Strong Buy rating. We are also maintaining our long-term Outperform recommendation on the stock. One of its competitors, Redwood Trust Inc. (RWT) holds a Zacks #3 Rank, which translates into a short-term Hold rating.
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The second-largest U.S. mobile service provider AT&T Inc. (T) is planning to acquire Montreal-based Superclick Networks for $15 million.
Superclick is an Internet provider for the hospitality industry. It designs, manages and deploys Internet services to top hotels and health care facilities such as Intercontinental Hotels Group plc (IHG), Marriott International, Inc. (MAR), Four Seasons, Jumeirah, Kimpton Hotels, Mandarin Oriental Hotels throughout North America, Canada, the Middle East and parts of Asia.
The deal received approval from the board of directors of Superclick and is awaiting shareholder approval. It is expected to be completed in the fourth quarter.
The acquisition will provide AT&T an opportunity to enter into the hotel WiFi (wireless broadband) business. The demand for hotel WiFi has been growing at a faster pace. Now a days, every hotel needs the Internet to attain the five-star status. AT&T is the leader in WiFi connectivity with over 24,000 WiFi hotspots in the U.S., and 135,000 globally.
Superclick has a high margin business, and generated 66.3% in the last quarter. Coupled with high margin, consistent growth and global presence, the deal sounds to be healthy for AT&T.
Although Superclick does not have a stellar revenue track record, it seems to be growing rapidly. In the last quarter, revenue improved 54% year over year to $1.7 million. Year-to-date, revenue improved 58% to $4.4 million from the year-ago level of $2.8 million.
Hence, if the deal gets approved, it would provide a massive boost to AT&T’s revenue and its future growth. Talks between AT&T and Superclick were on since last year, when the former initially extended a proposal and was rejected by the latter due to the low bid price.
In addition, the proposed acquisition is very small compared to AT&T’s ambitious $39 billion purchase of T-Mobile, a Deutsche Telekom’s unit. The takeover of T-Mobile is facing a major roadblock with the Department of Justice filing an antitrust lawsuit to block the deal a month ago.
While waiting for AT&T to enter into the WiFibusiness, we are maintaining our long-term Neutral recommendation on the stock with the Zacks #3 Rank (Hold).
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Leading heart pump maker HeartWare International (HTWR) will present clinical data for the next-generation HeartWare Ventricular Assist System at the European Association for Cardio-Thoracic Surgery (“EACTS”) annual meet on October 2.
The Massachusetts-based company will present results from the critical ADVANCE bridge to transplant (“BTT”) trial at the EACTS meet which will be held in Lisbon, Portugal. ADVANCE is an Investigational Device Exemption (“IDE”) study intended to measure the effectiveness of the HeartWare Ventricular Assist System.
The HeartWare Ventricular Assist System is essentially a bridge to heart transplantation for patients suffering from end-stage heart failure (inability of the heart to pump enough blood). The device was cleared in the European Union in 2009 and in Australia in March 2011.
Currently, the HeartWare Ventricular Assist System is not available commercially in the U.S. The device is the subject of clinical trials in the U.S. for two indications, namely, BTT under continuous access protocol and destination therapy (“DT”).
HeartWare submitted a Pre-Market Approval (“PMA”) application with the U.S. Food and Drug Administration (“FDA”) for the device for BTT indication in December 2010. The PMA includes data from the ADVANCE trial.
Heart failure is a leading cause of deaths globally. The HeartWare Ventricular Assist System has been designed to specifically target the Class III and IV categories of advanced heart failure patients, an estimated 7 million patients globally. Roughly 20% of these patients are expected to benefit from the device, indicating a significant market opportunity.
The HeartWare Ventricular Assist System uses the HVAD pump, a small-sized complete-output circulatory support device intended to be transplanted adjacent to the heart thereby, obviating the abdominal surgery required for implanting certain devices offered by competing firms. The HVAD pump, which is at the core of the system, is a device capable of pumping up to 10 liters of blood per minute.
HeartWare makes miniaturized implantable heart pumps, also known as ventricular assist devices, which are used for the treatment of patients stricken by advanced heart failure. The company competes in the heart devices market with Thoratec Corporation (THOR) among others.
HeartWare’s sales more than doubled year over year in second-quarter 2011 to $20.4 million. The company sold 226 units of the HeartWare Ventricular Assist System globally in the quarter, up 95% year over year. Successful approval and commercialization of the device in the U.S. should further boost sales.
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Qualcomm Atheros Inc., the newly acquired arm of Qualcomm Inc. (QCOM), recently announced a collaboration with EDIMAX Technology, a leading provider of networking solutions, to provide a new carrier-grade video-over-wireless (VoW) bridge.
This VOW solution will be supported by Atheros AR9580 chipset, which supports multi-HD video streaming across homes and is ideal for glitch-free in-home video services distribution. This modern chipset allows error-free transmission, thus offering faster streaming and high quality service at reduced cost.
Qualcomm Atheros also launched another chipset called AR7420 that provides faster, wired networking connectivity supporting up to 500 mbps of power distribution across existing household electrical wiring for consumers and service providers who offer connectivity solutions. AR7420 chipset will be available from October, 2011 onwards.
Earlier this year, Qualcomm acquired Atheros for roughly $3.3 billion, which is believed to be largest acquisition in the history of Qualcomm. The acquisition enables Qualcomm to diversify in the consumer electronics segment, particularly in the home networking market where Atheros manufactures Wi-Fi chips for televisions, video games, printers, and other home devices.
We believe that Qualcomm’s record-high earnings, strong balance sheet, accretive acquisition plans, product diversifications and solid management outlook for the current fiscal year will act as positive catalysts in the long run. Moreover, the growing popularity of smartphones and tablets coupled with increased deployment of 3G/4G networks will further drive the stock upward.
However, stiff competition from formidable rivals like Broadcom Corporation (BRCM) and Texas Instruments Inc. (TXN) as well as lower ASP of smartphones will negatively impact Qualcomm’s royalty business going forward.
We, thus, maintain our long-term Neutral recommendation on Qualcomm. Currently, Qualcomm has a Zacks #3 Rank, implying a short-term Hold rating on the stock.
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Micron Technology Inc. (MU) reported adjusted fourth quarter fiscal 2011 loss per share of 14 cents, as against the Zacks Consensus earnings estimate of 1 cent per share. Micron shares fell 3.41% in after market trade.
The miss was largely due to subdued PC sales, which adversely affected the demand for memory chips. Another aspect which affected the company’s fundamentals badly was the oversupply of DRAM (dynamic random access memory). Hence, the price of DRAM, which provides the main memory in PCs, dropped as demand from makers of laptops and desktop PCs remained sluggish.
Micron reported revenue of $2.14 billion, down 14.2% year over year. The reported revenue however surpassed the Zacks Consensus Estimate of $2.13 billion.
Revenue from sales of NAND products exceeded sales of DRAM. This had a favorable effect on the company's financial results. Apart from the shift to NAND, Micron continued to diversify its product portfolio within DRAM and NAND. Consequently, Micron has achieved comparatively higher average selling prices compared to industry averages.
The company's gross margin for the fourth quarter was 15.0%, down from 31.3% in the year-ago quarter. The decline was primarily due to significant drop in DRAM ASPs.
Selling, general and administrative expenses increased 9.9% year over year to $155.0 million. The improvement was due to higher legal costs associated with the pending Rambus Inc. (RMBS) lawsuit. Research and development expenses grew 6.1% year over year to $209.0 million, mainly due to higher labor costs. The operating margin was (2.4%) as against 17.4% in the year-ago quarter.
Net loss attributable to Micron was $135.0 million or 14 cents per share, compared to net income of $342.0 million or 30 cents in the year-ago quarter. Excluding the effect of the other income relate to gain on sale of facility, restructuring expense and gain on sale of property, plant and equipment and equity in net income (losses), adjusted net loss came at $87.0 million or 9 cents per share, compared to net income of $368.0 million or 32 cents in the prior-year quarter.
Balance Sheet & Cash Flow
Micron ended the fourth quarter with cash and short-term investments of $2.16 billion, up from $2.40 billion in the previous quarter. Receivables were $1.50 billion, unchanged from the previous quarter. Inventories increased 0.6% from the prior quarter to $2.1 billion. The company had $2.0 billion in long-term debt, up from $1.57 billion in the prior quarter.
Cash generated from operations was $354.0 million, compared to $589.0 million in the prior quarter. Capital expenditure increased $394.0 million from the prior quarter to $928.0 million.
Micron repurchased $150.0 million worth of its outstanding shares.
Micron’s fourth quarter results were disappointing as the bottom line badly missed the Zacks Consensus Estimate, while the top line managed to beat marginally. The quarter even saw declines in ASPs.
However, some analysts believe that ongoing cost reduction discipline could mitigate the adverse effect of ASP declines to some extent, going forward. Moreover, Micron’s shift in focus from traditional PC DRAM to specialty DRAM could also boost its fundamentals. The analysts are also positive about favorable DRAM pricing in the near term.
Competition from SanDisk Corp. (SNDK), the legal tussle with Rambus Inc. and weakening PC sales are concerns.
Micron Technology has a Zacks #3 Rank, implying a short-term Hold recommendation.
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Michigan-based Magna Seating of America Inc., a subsidiary of Magna International Inc. (MGA), recently received a preliminary approval for $8.5 million in state tax incentives from Kentucky Economic Development Finance Authority (KEDFA) in Frankfort for its Shepherdsville plant.
Previously, KEDFA granted a $6 million tax incentive for the plant due to its original plans and proposals. But, earlier in March this year, the company made changes to its plans and announced that the proposed plant would be much bigger than what was previously estimated. Thus, KEDFA increased its tax incentive for the plant.
As per the previous estimates, the Shepherdsville plant would have covered an area of 90,000 square feet nearly and would have accommodated 234 workers at an average hourly wage of $20.
However, as per the changed plan, the plant will now cover an area of 140,000 square feet and will have 450 workers working in it at an average hourly rate of $23. Thus, the company’s investment in the project has also increased to $19.8 million from $15.5 million.
According to the company, the Magna plant is expected to manufacture and supply seats and seating components for Ford Motor Co.’s (F) Louisville Assembly Plant, which is scheduled to open later this year after a $600 million retooling. Magna also expects its plant to become operational soon. However, the opening date is yet to be finalized.
Magna Seating, an operating group of Magna International, develops and manufactures complete seating solutions and mechanisms for the global automotive industry. Its product offerings range from consumer and market research, full concept development, design and engineering, testing and validation to manufacturing of seating components and complete seat assemblies.
Magna International Inc., based in Aurora, Canada, is a leading manufacturer and supplier of automotive components. The company designs, develops and manufactures automotive systems, assemblies, modules and components, besides engineering and assembling complete vehicles, primarily for sale to original equipment manufacturers (OEMs) of cars and light trucks.
The product portfolio includes automotive interior and exterior systems, seating systems, body and chassis systems, electronic systems, powertrain systems and roof systems.
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Paychex Inc. (PAYX) reported first-quarter fiscal 2012 earnings of 41 cents per share, fairly ahead the Zacks Consensus Estimate of 38 cents. Though the quarter’s results indicate an improving client retention rate and higher checks per client, lower sale of new units remains an overhang. Shares increased 1.91% in after-market trade.
Paychex reported first-quarter 2012 revenues of $563.1 million, up 8.6% from $518.3 million reported in the year-ago quarter. The upside can be attributed to year-over-year growth in both checks processed per client and the HR services client base.
Payroll Service segment revenue increased 6.0% from the year-ago quarter to $382.3 million, attributable to the contribution from SurePayroll Inc., acquired in February. Excluding the SurePayroll contribution, Payroll revenue would have grown only 4.0%.
Continued growth in checks processed per client as well as revenue per checks also aided the growth. However, the increase in new unit sales was sluggish, due to the limited number of new companies commencing business during the quarter.
The Human Resource Services segment generated $169.7 million in revenues, up 16.6% from the prior-year quarter. The improvement was partly due to the contribution from ePlan Services, which was acquired in May. Excluding ePlan, Human Resource Services’ revenue growth would have been 14%.
The number of client employees served and the number of clients grew during the quarter, contributing to the improvement. Moreover, demand for a new product, HR Essentials, also added to the segment’s revenue growth.
In the first quarter, Paychex incurred total operating expense of $333.4 million, up 5.0% from the year-ago quarter. The increase was mainly due to acquisition-related costs as well as the company’s continued efforts to train sales personnel, provide better customer service and enhance technological infrastructure.
Operating income was $229.7 million, up 14.4% from the year-ago period, attributable to modest revenue growth and better cost management. Operating margin grew 340 basis points year over year to 43.9%.
Net income of $148.9 million in the reported quarter reflected a 12.9% increase from $131.9 million in the prior-year quarter. Net income per diluted share was 41 cents compared with 36 cents in the year-ago quarter. There was no one-time item during the quarter.
Balance Sheet & Cash Flow
Paychex exited the first quarter with cash and cash equivalents of $113.1 million, down from $119.0 million at the end of the prior quarter. The lower cash balance was due to cash used up in investing and financing activities. Corporate investments increased $27.0 million sequentially to $372.0 million.
Additionally, interest on funds held for clients decreased 8.3% year over year to $11.1 million as a result of lower average interest rates earned, partially offset by an increase in average investment balances. Paychex has no long-term debt.
Cash from operations was $187.2 million compared to $162.4 million in the prior quarter. Capital expenditures were $20.2 million compared to $21.5 million in the prior quarter.
Keeping in view the current market and economic condition, Paychex believes that checks per client will moderate through fiscal 2012, impacting quarterly comparisons for both Payroll Service and Human Resource Services revenues.
Moreover, the favorability in expenses realized in the first quarter may not be realized throughout fiscal 2012 due to the planned investments in its business. Hence, Paychex reaffirmed its full-year guidance.
For fiscal 2012, Paychex expects a 5–7% increase in Payroll Service revenues compared to the year-ago quarter. Human Resource Services revenues are expected to increase in the range of 12.0% to 15.0%.
Total service revenue is likely to grow in the range of 7% to 9%. The company expects a 12–14% decline in interest on funds held for clients and a roughly 2% increase in net investment income.
Interest on funds held for clients and investment income for fiscal 2012 are expected to be impacted by the low interest rate environment. However, investment of cash generated from operations is expected to continue, so investment income will increase.
Net operating income is expected in the range of 35–36% of total service revenue. The effective tax rate is expected to be in line with the first quarter and net margin is projected at between 5% and 7%.
The guidance for fiscal 2012 includes anticipated results from Paychex’ recent acquisition of SurePayroll Inc. and its ePlan Services. The acquisitions are expected to have approximately a 2% positive impact on revenue, nonetheless resulting in earnings dilution of around 1 cent per share due to amortization on acquired intangible assets and some one-time acquisition costs.
Paychex’ first quarter results were encouraging, with the bottom line exceeding the Zacks Consensus Estimate. We are also positive on management’s positive commentary regarding continued investments in product development and synergies from the recent acquisition. We also believe that cost control will remain a catalyst for Paychex, going forward.
The market is losing confidence on the growth of the small and medium business (SMB) group. The sector is being hit hard by lackluster demand due to high unemployment and inflation rates. Outsourcing companies like Paychex are highly dependent on the performance of the SMB sector and this is the reason why the company may not see much revenue growth.
Moreover, we are slightly concerned about growing competition in the outsourcing space from big players such as Automated Data Processing Inc. (ADP) and Administaff Inc., as well as limited margin expansion due to continuous investments in diverse fields.
Paychex has a Zacks # 3 Rank, implying a short-term Hold recommendation.
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Waters Corporation (WAT) launched a new line of low-adsorption sample vials called TruView™ LCMS Certified Vials, which are certified for LC/MS/MS analyses. These vials are effective in analysis of LC/MS/MS with analyte concentrations of ng/mL or pg/mL, where analytical sensitivity and accuracy are critical.
There has been a rise in demand for low adsorption vials that provide accurate results with the LC/MS/MS technology evolving and levels of detection approaching or exceeding the part-per-trillion range. As per Waters, TruView glass vials are a certified effective and superior alternate to glass autosampler vial in the market.
These vials from Waters substantially lower analyte adsorption by limiting the concentration of free ions on the surface of the glass. Waters TruView LCMS Certified Vials has been launched globally by Waters.
Waters enjoys a solid footing in the chromatography instrument market, which we believe will be a prime benefactor for the company. A strong customer demand in mass spectrometry and HPLC will help the company to sustain a healthy performance in its organic sales growth over the next few years.
Further, a significant portion of Waters’ revenue is derived from recurring revenue sources, including consumables and services, which are expected to continue to increase over the longer term.
However, the analytical instrument and systems market is highly competitive. Major competitors of Waters are Agilent Technologies Inc. (A), Life Technologies Corporation (LIFE) and Thermo Fisher Scientific Inc. (TMO). Waters competes in its markets primarily based on instrument performance, reliability, service, and to a lesser extent, price.
Some competitors have instrument businesses that are generally more diversified, but are typically less focused on the company’s chosen markets. Some other competitors have greater financial and other resources compared to Waters.
In the recent period, the company experienced lower business growth in US Government academic market performance, which also suffered due to a difficult funding environment. Moving ahead in 2011, the company continues to see relevant stability in its end markets and continued momentum in the acceptance of new products.
Waters Corporation, an analytical instrument manufacturer, designs, manufactures, sells and services, through its Waters Division, high performance liquid chromatography, ultra performance liquid chromatography (LC) and mass spectrometry (MS) instrument systems and support products, including chromatography columns, other consumable products and comprehensive post-warranty service plans.
We currently maintain our Neutral rating on Waters, with a Zacks #3 Rank (short-term Hold recommendation) over the next one-to-three months.
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