Waters Corporation (NYSE:WAT) Q1 2024 Earnings Call Transcript

Waters Corporation (NYSE:WAT) Q1 2024 Earnings Call Transcript May 7, 2024

Waters Corporation misses on earnings expectations. Reported EPS is $1.72 EPS, expectations were $2.1. WAT isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. Welcome to the Waters Corporation First Quarter 2024 Financial Results Conference Call. [Operator Instructions]. This call is being recorded. If anyone has objections, please disconnect at this time. It is now my pleasure to turn the call over to Mr. Caspar Tudor, Head of Investor Relations. Please go ahead, sir.

Caspar Tudor: Thank you, Ivy. Good morning, everyone, and welcome to the Waters Corporation First Quarter Earnings Call. Today, I’m joined by Dr. Udit Batra, Waters’ President and Chief Executive Officer; and Amol Chaubal, Waters’ Senior Vice President and Chief Financial Officer. Before we begin, I will cover the cautionary language. I would like to first point out that our earnings release and the slide presentation supplementing today’s call are available on the Investor Relations section of our website. In this conference call, we will make various forward-looking statements regarding future events or future financial performance of the company. In particular, we will provide guidance regarding possible future results and commentary on potential market and business conditions that may impact Waters Corporation over the second quarter of 2024 and full year 2024.

These statements are only our present expectations and actual events or results may differ materially. For more details, please see the risk factors included in our most recent annual report on Form 10-K, our Form 10-Qs and the cautionary language included in this morning’s earnings release. During today’s call, we will refer to certain non-GAAP financial measures, including in our discussions of the results of operations. Reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures are attached to our earnings release issued this morning and in the appendix of our presentation, which are available on the company’s website. Unless stated otherwise, references to quarterly results increasing or decreasing are in comparison to the first quarter of fiscal year 2023 in organic constant currency terms.

In addition, unless stated otherwise, all year-over-year revenue growth rates and ranges given on today’s call, are given on a comparable organic constant currency basis. Finally, we do not intend to update our guidance, predictions or projections, except as part of a regularly scheduled quarterly earnings release or as otherwise required by law. Now I’d like to turn the call over to Udit to deliver our key remarks, then Amol will provide a more detailed look at our financial results. After, we will open the phone lines to take questions. Udit?

Udit Batra: Thank you, Caspar, and good morning, everyone. We had a strong start to the year with sales coming in at the high end of our expectations backed again by excellent operational performance. I want to begin today’s call by thanking my colleagues for their continued focus on innovation and supporting our customers. These results reflect our drive to accelerate the benefits of pioneering science with our innovative portfolio. In the first quarter, market conditions were as expected, with cautious customer spending and later than typical budget releases. But as budgets opened up, we executed well with sales landing at the high end of our guide. We also continued to deliver outstanding operational results. Earnings were above our guidance and margins expanded even with volume and FX headwinds.

This is a testament to our team, our resilient business model and our operational initiatives. Waters is well positioned for future growth in our attractive secular end markets. In the first quarter, we added to our revitalized portfolio with new products that serve high-growth areas. Turning now to our results. In the first quarter, sales landed at the high end of our guidance, declining 7% as reported and 9% in organic constant currency. Our non-GAAP earnings per share exceeded our guidance at $2.21. On a GAAP basis, EPS was $1.72. Outside of China, sales declined mid-single digits as expected. In China, sales declined just under 30%, which was better than expected. Growth remained weak as our prior year baseline does not reflect last year’s deterioration in market conditions, which became more pronounced in the second half.

While instruments declined 25% overall, LC sales were slightly better than expected, instrument weakness was led by mass spec, particularly for A&G-related applications, which had a tough prior year comparison from global funding and the China stimulus. Wyatt delivered a 3% M&A contribution to sales. We continue to see strong synergy performance and traction for our recently launched products such as ZetaStar. Now I will talk more about our operational performance. We believe the best reflection of good operational execution is effective margin management, particularly when things slow down. While facing significant headwinds from volume, FX and inflation, we delivered yet another strong margin result. Our gross margin expanded 40 basis points to 58.9%, and our operating margin expanded 20 basis points for the quarter to 27%.

This was achieved through a combination of our operational management initiatives across pricing, productivity and proactive cost alignment. These initiatives position us well for resilience during lower volume periods and give longer-term opportunity when market conditions normalize. You can see further evidence of our operational performance and our free cash flow. We had an exceptional start to the year, generating free cash flow of USD 234 million in the first quarter, which was 37% of sales. With our excellent free cash flow profile, we made rapid progress in delevering from the Wyatt acquisition, as we approach its 1-year anniversary. We serve attractive secular end markets where testing volume plays a pivotal role in our business. This volume, which is correlated with global prescription consumption is expected to accelerate in the future, supporting our strong long-term growth outlook.

Our distinct advantage in downstream applications lines with our full ecosystem of products that complement our innovative instrument portfolio. In addition, we have strategically aligned with high-growth opportunities that further enhance our core position. We had a busy quarter launching several new products that support a number of exciting, high-growth areas. At Analytica, last month, we launched the Alliance iS Bio, a version of our groundbreaking next-generation liquid chromatography platform suited for biologics applications. In the — the new HPLC system combines advanced bioseparation technology, bioinert surfaces and built-in intelligence features. This helps Biopharma QC analysts boost efficiency and eliminate up to 40% of common lab errors.

We believe that the Alliance iS is the most significant innovation to hit pharma QA/QC labs in over a decade. We’re excited to bring this technology to routine testing applications for biologics. Supporting BioSeparations, we launched a new set of size exclusion chromatography columns called GTxResolve Premier. These columns enable scientists to quickly assess aggregate content, integrity and purity of larger biologic particles. It covers modalities such as lipid nanoparticles, nucleic acids, and viral vectors and give scientists a significant improvement in sensitivity and sample consumption while accelerating run times. This launch supports the development of these modalities into downstream high-volume settings, where Waters has critical instrument technology like LC, mass spec and light scattering as well as highly innovative industry-leading software chemistry and service.

To simplify the detection of PFAS, we launched waters, Oasis, dual-phase analysis cartridges. This consumable streamline sample prep for PFAS workflows when detecting concentrations in water, soils, biosolids and tissues. It joins our comprehensive portfolio of solutions that support the surging demand for PFAS testing, which is a USD 300 million to USD 350 million global market, growing 20% annually. In an environment of increased scrutiny, the ability to accurately test for PFAS at very low levels is becoming a critical compliance need for a broad spectrum of industries. Our Xevo TQ absolute mass spec has leading sensitivity for detecting these anionic compounds. It can detect PFAS levels at as low as 1 part per quadrillion. Last month, in the United States, the EPA finalized and enforceable 4 parts per trillion limit of PFOA and PFOS in drinking water, which marks a significant regulatory milestone.

Later this year, further regulations governing PFAS are expected across the globe. This includes the European Union, where REACH proposed chemicals, regulation contemplates a PFAS ban on products manufactured as well as once imported. In our TA business, we launched the Rheo-IS, which serves battery testing applications when used with our hybrid rheometers. This Rheo-Impedance Spectroscopy accessory supports characterization of electrode studies, which can lead to more efficient battery production. I will now cover our 2024 full year guidance. With our first quarter results, we remain on track to achieve our full year revenue outlook, which is unchanged from our previous guidance at negative 0.5% to positive 1.5% growth in organic constant currency.

We expect growth rates to improve over the remainder of the year and as our prior year comparisons, especially in China get easier. We expect improving funnel activity to translate to orders as the year progresses. With our strong operational performance, we expect to build leverage in our P&L despite the flattish revenue guide and delivered 20 to 30 basis points of adjusted operating margin expansion while still reinvesting for growth. As a result, our adjusted EPS guidance is also unchanged at 0% to 3% growth in the range of $11.75 to $12.05. Now I will pass the call over to Amol to continue covering our financial results in more detail and provide the rest of our guidance. Amol?

Amol Chaubal: Thank you, Udit, and good morning, everyone. In the first quarter, sales landed at the high end of our guidance range, declining 7% as reported and 9% in organic constant currency. As Udit mentioned, end market dynamics were consistent with our expectations. Ex-China declined mid-single digits as expected, while China declined close to 30%, which was slightly better than expected. In organic constant currency by end market, Pharma declined 6%, industrial declined 7% and academic and government declined 30%. In Pharma, sales outside of China declined low single digits as we executed well in this CapEx constrained environment. In China, sales declined almost 30% due to ongoing market challenges that are not reflected in our prior year baselines.

In industrial, food and environmental applications grew mid-single digits with continued strong growth in PFAS related workflows globally. We also saw strong growth in battery testing within our TA business, which has been a consistent growth theme. However, this strength was more than offset by weakness in core industrial applications, which are more cyclical. Our TA business declined high single digits overall, while chemical analysis declined high teens. In academic and government, growth was weak against a 45% comparison as stimulus in China and elevated global funding in the prior year quarter drove lumpy spending patterns. By geography, sales in Asia declined 16%. The Americas declined 8% and Europe declined 3%. By products and services, instruments declined 25% with LC growth slightly better than expected.

Within recurring revenues, chemistry grew low single digits and service grew mid-single digits, both of which were affected by low activity levels in China. The quarter had 1 fewer day versus first quarter of 2023, which translates to a growth headwind of approximately 1% for recurring revenues. Now I will comment on our first quarter non-GAAP financial performance versus the prior year. Despite headwinds from lower sales volumes, FX and inflation, our team continued to respond to these challenges with resilience and commitment. Our focus on operational excellence with pricing, productivity and proactive cost alignment allowed us to deliver first quarter gross margin of 58.9%, an expansion of 40 basis points and first quarter adjusted operating margin of 27% and expansion of 20 basis points.

Our effective operating tax rate for the quarter was 14.3% and our average share count was 59.4 million shares. Our non-GAAP earnings per fully diluted share were $2.21. On a GAAP basis, earnings per fully diluted share were $1.72. A reconciliation of our GAAP to non-GAAP earnings is attached to this morning’s press release and in the appendix of our earnings call presentation. Turning now to free cash flow, capital deployment and our balance sheet. We define free cash flow as cash from operations, less capital expenditures and excludes special items. In the first quarter of 2024, free cash flow was $234 million after funding $29 million of capital expenditures, which is approximately 37% of sales. We maintain a strong balance sheet, access to liquidity and well-structured debt maturity profile.

This strength allows us to prioritize investing in growth, including M&A and returning capital to shareholders. We continue to evaluate M&A opportunities that will meaningfully accelerate value creation. At the end of the quarter, our net debt position further declined to $1.7 billion, which is a net debt-to-EBITDA ratio of about 1.8x. This reflects a decrease of approximately $300 million, as we delivered the Wyatt acquisition. As previously disclosed, our share buyback program has been temporarily suspended to enable us to pay down debt incurred as part of the Wyatt acquisition last year. We will evaluate the resumption of our share repurchase program throughout 2024 as part of our balanced capital deployment objectives. Now I would like to share further commentary on our full year outlook and provide you with our second quarter guidance.

We expect to see an improvement in sales growth over the course of 2024 as prior year comparisons, particularly in China, become easier, and has improved funnel activity translates to orders. Our full year guidance is unchanged with 2024 organic constant currency sales growth expected between negative 0.5% and positive 1.5%. At current exchange rates, currency translation is expected to result in a negative impact of just under 1% on a full year sales basis. We expect Wyatt transaction to add just over 1% M&A contribution to our full year 2024 revenue for inorganic sales incurred in the first 4.5 months of the year. Therefore, our total reported sales growth guidance is unchanged at approximately 0% to 2%. Despite guiding to flattish sales, we expect to deliver a gross margin of 59.8% for the full year, which is a 20 basis points of expansion versus 2023.

We also expect to deliver 20 to 30 basis points of operating margin expansion versus 2023, resulting in an adjusted operating margin of slightly over 31%. We expect our full year net interest expense to be approximately $80 million. Our full year tax rate is expected to be 16.3%, and our average diluted 2024 share count is expected to be approximately 59.7 million. Rolling all this together, on a non-GAAP basis, our full year 2024 earnings per fully diluted share guidance is also unchanged and projected in the range of $11.75 to $12.05. This is approximately 0% to 3% growth and includes an estimated headwind of approximately 2% due to unfavorable foreign exchange. Looking to the second quarter 2024, we anticipate that cautious customer spending will persist.

In addition, while the China Q2 baseline reflects the onset of weakness, it does not fully reflect the weakness we observed in the second half of the year. As a result, we expect China to decline mid-teens in Q2 versus 28% decline we saw in Q1. Given these dynamics, we expect to see an improvement in year-over-year growth versus the first quarter and our second quarter organic constant currency sales growth guidance is projected in the range of negative 6% to negative 4%. At current rates, currency translation is expected to subtract approximately 2%. Wyatt is expected to add approximately 1.5% M&A contribution for sales incurred in the first 1.5 month of the quarter. Therefore, our total second quarter reported sales growth guidance is negative 6.5% to negative 4.5%.

Based on these revenue expectations, second quarter non-GAAP earnings per fully diluted share are estimated to be in the range of $2.50 to $2.60, which includes a negative currency impact of approximately 4 percentage points at current FX rates. Now I would like to turn the call back to Udit for some summary comments. Udit?

Udit Batra: Thank you, Amol. I would like now to give you a brief update on our progress towards leaving the world better than we found it, which is how we think about ESG. We work alongside wonderful people here at Waters, and I’m always proud when others recognize their talent and hard work. Our colleagues were recognized in the quarter for their achievements and contributions to separation science, excellence in manufacturing and for being champions of LGBTQ and women’s benefits in the workplace. I would also like to congratulate Dr. Philip Wyatt, the founder of Wyatt Technology for receiving the esteemed Pittcon Heritage Award earlier this year. Dr. Wyatt’s groundbreaking contributions to laser light scattering technology have paved the way for industry-leading advancements.

From a corporate standpoint, Waters has once again been honored by Barron’s, earning a place on its list of the 100 most sustainable companies in 2024. Additionally, we are delighted to announce that S&P Global has included Waters in its 2024 sustainability yearbook. Separately, our commitment to robust governance practices was recently highlighted by the New England Chapter of the National Association of Corporate Directors. We were honored to have Massachusetts Governor, Maura Healey present Waters with the 2024 public company Board of the Year Award. After recently committing to SBTI, which is the science-based targets initiative, we are now building on the excellent progress we made in reducing our greenhouse gas emissions. We’re in the process of setting new standards towards a long-term reduction in emissions and aligning our business with the 1.5 degree centigrade future.

Now to summarize, we’re pleased with how the first quarter landed versus our expectations, which supports our full year guidance. We remain on track to achieving the 2024 objectives and look forward to building on this strength as the year progresses. Our long-term growth profile remains excellent, and we are aligned to secular tailwinds that are stronger than ever in our attractive markets. With our robust financial profile and balanced capital allocation strategy, we have an excellent platform to deliver sustained value for our shareholders. So with that, I’ll turn the call back over to Caspar.

Caspar Tudor: Thanks, Udit. That concludes our formal comments. We are now ready to open the phone lines for questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question comes from Dan Brennan from TD Cowen.

Daniel Brennan: Maybe the first 1 just on China. You guys were coming into the quarter expecting down 40 and I know it was certainly better than that, and you’re talking about Q2 color. I’m just wondering, I know you guys gave some color on what was going on in the quarter. But could you just unpack it a little bit more like what deviated from the guide? How it’s pacing in the quarter? And then is there any change to your full year down mid-teens, high-teens growth for China?

Udit Batra: Look, China came in better than we expected. But I’ll remind you, it’s still declining in the high 20s. Now we expect that to continue for at least the first half of the year. Q2 will also see a decline and the second half of the year, we’ll start to see a little bit of growth given the weakening comps as the year progresses. Now coming back to Q1, to your question on what changed? I mean you just have to go back to late 2023 when we basically said, look, we think across all end markets, especially pharma, we’ve seen a bottoming out of the volume. And from that baseline, we started to see better activity especially on the replacement of LCs in our Branded Generics segment and something that we had talked about in the last quarter as well.

Now it’s early days, right? We’re starting to see a turn as customers start to replace this sort of highly aging LC fleet. So remember, we again talked about it at the end of last year. When you look at the 5-year stack growth of LC instruments for China, in particular, it’s down now almost double digits, about 8% to 9% versus a year versus 5 years. So with that as a baseline, we expect to see the replacement cycle initiate and we’ve started to see that already in Q1. Now to put things in perspective, there’s also a fair amount of talk on the new stimulus and the stimulus itself is very different than the previous one. It appears it’s going to roll over a 3-year period. It’s 3x in size, and it explicitly calls out instrument replacement, so which encourages us, but we have not incorporated that into the guide for the full year, which now we’re basically saying is likely to be low double-digit decline as opposed to the high teens decline that we had talked about when we gave the full year guidance.

So China will likely be a little bit better than we had anticipated. And just coming back to the stimulus and looking ahead, I would not — while we have not incorporated that into our guidance explicitly, I would not underestimate the importance of that on the psychology of CapEx spending, especially the replacement cycle. And as that sort of starts rolling out towards the latter half of the year and towards late 2024 and early 2025, we should see the sentiment improve and likely start of the replacement cycle in earnest.

Operator: Next, we’ll go to the line of Vijay Kumar from Evercore ISI.

Vijay Kumar: Udit, maybe on that comment around China. I think you mentioned improved funnel activity in the quarter as the quarter progressed. Is that funnel activity — is that being sort of driven by this China? Or is that a global biopharma? Any color on what you mean by the funnel activity, and I think for the back half guidance, which assumes I think, close to high singles growth. What visibility do we have in growth normalizing in the back half?

Udit Batra: Vijay, thank you for the 2 questions. So let me just sort of take a step back and provide some context, right? I mean, as you know, Q1 is the toughest quarter for Waters to predict, right? It’s our smallest quarter of the year, and this is when customers start to think through the total CapEx spend for the year and also think through the phasing of that CapEx right? So we took advantage of that. And I personally met several customers across Europe and in the United States, across pharma, across A&G, across our industrial segments, across our clinical segments with our teams. And really, there are 3 main takeaways. First, the quality of the funnel, the quality of the orders is way higher than what we saw a year ago across all of the segments, especially in pharma — both in pharma and in biotech across Europe and the U.S. Second, when you look at the traction of our new products, our new products are gaining a ton of traction and are being used heavily by our customers.

And they’re waiting to sort of adopt Alliance iS in earnest, you can go across the portfolio. It’s being received extremely well. And third, the question on phasing, while the orders are firm and strong, the CapEx spending is firm, given that it is decided in the late — in the latter part of Q1, we think it’s safe to assume that you’ll only start to see the benefit late in Q2 and more so in the second half of the year. So the funnel is weighted towards later in Q2 and the second half of the year. So that’s what sort of has gone into our overall thinking. Now there are 2 big takeaways. One, we have increased confidence in our full year guide as a consequence of these discussions. And second, on the phasing, we simply went back and said, okay, let’s just look at the last 15 years.

Over the last 15 years, the Q2 usually is a step-up from Q1 of about 11% to 12%, right? And so we assumed a 10% step-up from Q1 to Q2. And then first half versus second half, I mean, historically, it’s basically, again, over the last 15 years, almost like clockwork. First half is 45% and the second half is 55% of revenues. So that’s basically what the algorithm we used to look at the phasing of the guide from a revenue perspective. But overall, really increased confidence in the full year guide given the strengthening of the funnel and conversations across the globe and across customer segments and second, the phasing is basically rooted in history.

Vijay Kumar: Fantastic. I’ll let others jump in.

Operator: Next, we’ll go to the line of Michael Ryskin from Bank of America.

Michael Ryskin: Just following up on some of the end market commentary you talked about China a little about how you expect a low double-digit decline, so a little bit better than prior. You’re maintaining the fiscal year. So what’s sort of offsetting that? And maybe specifically honing on Americas, it looked like that came a little bit worse in the quarter. Anything changed in your outlook there for the year? And then I’ve got a quick follow-up.

Amol Chaubal: Yes. No. I mean, Mike, at this point, we are just derisking the remainder of the guide, right? We had better expectations of China, based on how we are executing in that market, and we’re keeping our full year guide flat.