Waters Corporation (NYSE:WAT) Q3 2023 Earnings Call Transcript

Waters Corporation (NYSE:WAT) Q3 2023 Earnings Call Transcript November 7, 2023

Waters Corporation beats earnings expectations. Reported EPS is $2.84, expectations were $2.56.

Operator: Good morning. Welcome to the Waters Corporation Third Quarter 2023 Financial Results Conference Call. All participants will be in a listen-only mode until the question-and-answer session of today’s call. This conference call is being recorded. If anyone has any 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 third quarter earnings call. Today, I’m joined by Dr. Udit Batra, Water’s President and Chief Executive Officer; and Amol Chaubal, Water’s Senior Vice President and Chief Financial Officer. Before we begin, I will cover the cautionary language. I would first like to point out that our earnings release and the slide presentation supplementing today’s call are available on the Investor Relations section of our website at ir.waters.com. 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 fourth quarter of 2023, full year 2023 and 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 third quarter of fiscal year 2022 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 for the quarter. Then Amol will provide a more detailed look at our financial results. After, we will open up the phone lines to take questions. Udit?

Udit Batra: Thank you, Caspar, and good morning, everyone. I want to start today’s call by thanking my colleagues for remaining focused on our customers, on developing new products and supporting each other. Despite the challenging macro environment, our teams delivered a solid performance and did a great job capitalizing on the available opportunities through strong commercial execution. As headwinds from China and FX became greater, our indomitable teams rallied to drive productivity gains and margin expansion, resulting in strong adjusted earnings growth for the quarter. We launched innovative new products that address the critical unmet needs of our customers and further differentiate our revitalized portfolio in the attractive end markets that we serve.

We also continue to make strong progress with Wyatt, including the launch of our first new light scattering instrument. Turning now to our results. In the third quarter, sales grew less than 1% as reported. Organic constant currency sales declined by 4%. Sales outside of China were largely at or above our expectations. However, demand in China fell beyond our expectations, which ultimately led to our sales landing at the lower end of our guide. With the U.S. dollar strengthening, the currency impact on sales for the quarter was flat versus our expectations of a 1% tailwind. Wyatt continued its strong start, contributing 4% growth to the quarter as expected. Despite the market challenges and the adverse FX impact, our expand – we expanded our gross margin percentage by 240 basis points and adjusted operating margin percentage by 380 basis points.

This allowed us to deliver non-GAAP earnings per fully diluted share above our expectations at $2.84, an 8% increase. On a GAAP basis, our earnings per fully diluted share were $2.27. Looking now at our organic constant currency results in more detail. In the Pharma segment, U.S. pharma grew 6% and Europe grew 5% with a strong continuing performance among our large to medium-sized customers despite slow funnel velocity. In China, we saw continued weakness in pharma throughout the quarter. Market challenges in China have now broadened beyond pharma and impacted both our industrial and academic and government end market results in the quarter. Overall sales in China declined approximately 30% as the demand environment further deteriorated as the quarter progressed.

In the Industrial segment, China declined low-teens. Outside of China, Industrial declined 6% as growth in the quarter was subdued by a tough prior year comparison of over 20%. While the more cyclical applications in Industrial have continued to slow globally, we saw continued strong traction in PFAS and battery testing applications. In academic and government, we continued to see strong uptake of new products in Europe with low-double digit growth, and in the Americas with mid-single digit growth. However, this strength was more than offset by pronounced weakening in China, which declined over 30% now that the shipments related to last year’s stimulus program have concluded. In our core business, while the market environment has become more difficult, we continue to deliver strong commercial results.

When looking at our third quarter results outside of China, our organic constant currency sales grew low-single digits year-over-year and is a healthy 7% on a two and four-year stacked basis. On a year-to-date basis, our organic constant currency growth has been mid-single digits year-over-year, excluding China and flat overall, including China. A key driver of performance for our business this year is mass spec, which is an area where we have gained share with our innovative new product portfolio. We’re also managing our P&L very effectively through focus – through our focus on operational excellence that drove strong margin performance in the quarter and year-to-date. In the third quarter, our gross margin was 59.1% a year-over-year expansion of 240 basis points.

Our adjusted operating margin was 31.5%, expanding 380 basis points. Year-to-date, our results also showed substantial margin expansion with our gross margin up 160 basis points to 59% and our adjusted operating margin up 60 basis points to 29.4%. Let me talk about what drove this. First, our commercial teams have continued to achieve strong pricing results at levels that were over 250 basis points for the quarter. Second, we’re beginning to realize the productivity benefits of our focus on operational excellence and digitization. I’m excited that next month Waters will celebrate the opening of our new Global Capability Center in Bangalore, India, which will further accelerate our pursuit of digitization and operational excellence. Third, through our proactive cost actions, we have rapidly aligned resources to our long-term growth strategy.

While the current market environment is challenging, the long-term fundamentals of our end markets continue to be excellent. As I mentioned last quarter, there are instrumental growth vectors to our historical 5% instrument growth that result in a great long-term growth profile for our business. This includes global prescription drug sales, which are expected to exceed historical growth rates, as well as measures we have put in place to improve pricing, where we expect to sustain a more than 100 basis point improvement versus historical levels. In addition, the growing adoption of analytical instruments in process development for large molecule therapeutics is a new growth vector for instruments such as mass spec and light scattering in our portfolio.

This is only expected to strengthen as end users find value in these instruments for high volume and recurring applications such as process development, raw materials testing and quality control. The competitive edge of our revitalized portfolio also positions us well for long-term growth. Our product portfolio has been renewed in the last few years with significant innovation that is answering the critical unmet needs of our customers. This includes new launches in LC such as the Alliance iS, which we believe is the most significant innovation to hit pharma QA/QC labs in the past decade. In mass spec, the industry leading sensitivity of Xevo TQ Absolute has allowed us to gain share in the food and environmental market for PFAS related testing applications.

In chemistry, our MaxPeak Premier columns have been the most successful launch in our company’s history, serving the more complex needs of large molecule separation in our customers’ labs. During the quarter, we announced two new product launches for bioanalytical characterization, including our first new instrument launch with Wyatt. We launched a new Bioprocess Walk-Up Solutions that combines our Andrew+ liquid handling robot, OneLab Software and our BioAccord LCMS system into a more automated setup that is even easier to use. Together, these new products help engineers capture high quality bioprocess and drug product data directly from upstream bioreactors such as those offered by Sartorius. It achieves this via simple workflows that automate sample prep LCMS analysis and data capture.

This accelerates the upstream development of MAbs and other biologic drugs, providing more optimal clone selection that results in more effective titles and yields. Second, we launched our first new light scattering instrument within the Wyatt portfolio. DataStar is designed to measure – to precisely measure and analyze nanoparticles used in downstream biologics and material science applications. It combines three light scattering techniques into a single device, cutting measurement time by up to ten times compared to other methods, while using extremely low sample volumes. I would now like to cover our updated 2023 guidance. Growth rates in China have continued to deteriorate as the year has progressed. We expect this to decline further in the fourth quarter sequentially.

We now expect China to decline approximately 25% for the year versus our prior expectations of low double digits. The result is an incremental headwind to our full year organic constant currency growth of approximately 250 basis points versus our previous guidance. As a result, we now expect our revised full year organic constant currency sales growth to be in the range of negative 2% to negative 1%. Despite the lower revenue guide, we’re continuing to proactively manage our cost structure and drive productivity expansion, resulting in no change to our expected margin percentage performance versus our previous guide. We expect our full year adjusted operating margin to be 30.5%, which is 30 basis points of expansion versus 2022. Our updated full year adjusted EPS guidance is resultantly in the range of $11.65 to $11.75.

Now, I will pass the call over to Amol to continue covering our third quarter financial results in more detail and give additional commentary on our guidance. Amol?

Amol Chaubal: Thank you, Udit, and good morning everyone. In the third quarter, sales grew less than 1% as reported. Organic constant currency sales declined 4% against a mid-teens growth comparison last year. Waters Division and TA both declined 4%. We saw good results again from our Wyatt acquisition, which added 4% constant currency growth and perform in line with our expectations despite the challenging environment. The impact of FX was flat in the quarter, which came in below our expectations of a 1% tailwind to as reported sales. In organic constant currency by end market, pharma declined 2%, industrial declined 8%, and academic and government declined 3%. In pharma, mid-single-digit positive growth outside of China was more than offset by continued slowdown in China pharma, which declined over 30%.

In industrial, our business declined high single digits with a tough growth comparison of 22% in the prior year quarter, and due to China weakness now spilling over into non-pharma segments. We continued to see strong growth in global PFAS testing and battery testing applications. Academic and government declined 3%. Outside of China, overall A&G growth was up 8%. This was led by double-digit growth in Europe and mid-single-digit growth in the Americas. In China, A&G declined over 30% as demand fell rapidly after we completed shipments under the stimulus program in the first half of the year. By geography, sales in Asia declined 12%, the Americas was flat and Europe grew 3%. In Asia, China broadly declined. Excluding China, Asia grew 3%, which was in line with our expectations.

India grew low double digits and Japan grew mid-teens. In Americas, pharma grew 6%, which exceeded our expectations as we executed very well with our large to mid pharma customers. Academic and government also grew 6%. However, strength in these two segments was offset by contraction in industrial for the quarter. In Europe, growth exceeded our expectations in pharma, which grew mid-single-digits, and academic and government, which grew 10%, while industrial decline mid-single-digits. By products and segments, instruments declined 13%. Recurring revenues grew mid-single-digits overall and high single digits outside of China. There was no change in number of days versus the prior year’s quarter. Our continued focus on operational excellence with pricing, productivity and proactive cost alignment, together with lower incentive compensation drove continued margin expansion.

Gross margin for the quarter was approximately 59.1%, an expansion of 240 basis points compared to 56.7% in the third quarter of 2022. Adjusted operating margin for the quarter was approximately 31.5%, an expansion of 380 basis points compared to 27.7% in the third quarter of 2022. Our effective operating tax rate for the quarter was 14.7% due to discrete items within the quarter. The average share count came in at 59.3 million shares, which is about 800,000 less than the third quarter of last year. Our non-GAAP earnings per fully diluted share were $2.84, an increase of 8% despite flat revenue. On GAAP basis, our earnings per fully diluted share were $2.27. 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 exclude special items. In the third quarter of 2023, free cash flow was $123 million, after funding $38 million of capital expenditures. Free cash flow was impacted by higher inventory balances. We maintain a strong balance sheet access to liquidity and a 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 third quarter, our net debt position further declined to $2.2 billion. Our net debt-to-EBITDA ratio of about 2.2. This represents a decrease of $125 million during the quarter, as we deal [ph] with the Wyatt acquisition.

As previously disclosed, our share buyback program has been temporarily suspended to enable us to pay down the debt incurred as part of the Wyatt acquisition. We will evaluate resumption of our share repurchase program through the quarter and into the first half of next year. Now, I would like to provide our updated thoughts for 2023. As Udit outlined, growth rates in China have continued to deteriorate as the year has progressed. In addition, weakness in China has now broadened beyond pharma and into industrial and academic and government end markets. We expect China growth rates to sequentially decline further in the fourth quarter and now expect China to decline approximately 25% for the full year versus our prior expectations of low double digit decline.

This translates to a full year growth headwind of approximately 250 basis points versus our previous guide. As a result, we are updating our full year 2023 organic constant currency sales growth guidance to the range between negative 2% and negative 1%. At current exchange rates where the U.S. dollar has strengthened against most major currencies since our last earnings call, currency translation is now expected to have a 1.5% negative impact on our full year sales, which is a 150 basis points headwind versus our prior guide. Consistent with our prior expectations, we expect the Wyatt transaction to add approximately 2.5% to our full year 2023 revenue growth. Therefore, our total reported sales growth guidance is now negative 1% to flat. As Udit covered despite incremental headwinds from China and FX, our teams have rallied to drive pricing and productivity gains.

We expect this will allow us to deliver a gross margin of approximately 59% for the year, which is in line with our previous guidance and is a 100 basis points of expansion versus last year. Together with proactive cost alignment, we expect this will allow us to deliver an adjusted operating margin of approximately 30.5% for the year after funding investments in high growth adjacencies, which is also in line with our previous guide and it’s 30 basis points of expansion versus last year, we expect our full year net interest expense to be approximately $80 million. The full year tax rate is expected to remain at approximately 15.5%. Our average diluted 2023 share count is expected to be approximately 59.2 million shares. Our rolling all this together on a non-GAAP basis, our full year 2023 earnings per fully diluted share guidance is projected in the range of $11.65 to $11.75, which includes a negative currency impact of approximately 3.5 percentage points at current FX rates.

Looking to the fourth quarter of 2023, we expect further weakness in China and cautious spending from our customers throughout the quarter. Hence, we expect fourth quarter organic constant currency sales growth in the range of negative 8% to negative 5%. At today’s rates currency translation is expected to subtract approximately 1.5%. While we expect Wyatt to add approximately 3.5% to our fourth quarter revenue growth. Therefore, our total fourth quarter reported sales growth guidance is negative 6% to negative 3%. Fourth quarter non-GAAP earnings per fully diluted share are estimated to be in the range of $3.52 to $3.62, which includes a negative impact from currency of approximately five percentage points at current FX rates. Now, I would like to turn it back to Udit for some summary comments.

Udit?

Udit Batra: Thank you, Amol. So to summarize, despite a macro environment that has progressively weakened this year, we have continued to deliver a solid performance through our execution. We are also driving strong outcomes in our margin and earnings performance and are maintaining our full year gross margin and adjusted operating margin guidance, despite incremental headwinds from volume and FX. We have strengthened our product portfolio even further through innovation while continuing to make strong progress with our acquisition of Wyatt. Later this month, we look forward to issuing our 2023 ESG report, which is a transparent way to show our active progress each year on our commitment to leave the world better than we found it.

Some key highlights to expect, relate to our continued reduction of emissions, increased renewable energy use, increase of female representation in management roles, as well as the TCFD related environmental disclosures we are initiating in this year’s report. So with that, I’ll turn the call back over to Caspar.

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

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer portion of today’s conference. [Operator Instructions] Our first question comes from Vijay Kumar from Evercore ISI. Please go ahead.

Vijay Kumar: Hey guys. Thanks for taking my question. Udit maybe one on just have the quarter progressed here. What were the exit rates and what is the Q4 guidance implying, right? Because I think the Street’s looking at sequential numbers, rate the sequential step up on a dollar basis Q3 versus Q4, where I think when you look at the growth rates year-on-year, I think your instrumentation growth is mid-teens. So I think it’s just the way we look at year-on-year versus sequential. And I think the Street’s look trying to make the comparison versus your peers and have some companies have guided sequential on a dollar basis and maybe just talk about your exit rates in third quarter? And what is Q4 as you are aiming for instrumentation?

Udit Batra: So, Vijay, thank you, and good morning. Look, I’ll give you some summary comments and Amol will talk to you about the ramp from Q3 to Q4 if I understand your question correct. When we look at the exit rates and ramp into from Q3 to Q4, we of course look at the performance as we exit Q3. This includes detailed analytics on funnel velocities across the different customer segments, includes what we’ve seen over the last 15 years as we go from Q3 to Q4, and look at that statistically. And of course, a lot of conversations with our customers and we continue to see strength relatively speaking versus our peer group in pharma, especially outside of China. And I’ll let Amol comment a little bit on the sequential ramp up.

Amol Chaubal: Yes. Hey, Vijay. Good morning. Look, Vijay, I mean, on the Q3 to Q4 ramp, if you look at our last five years, we averaged roughly a 24% ramp from Q3 to Q4. And where our guide is roughly 13% to 17% ramp from Q3 to Q4. So clearly it’s fairly muted compared to historical levels. Also, if you look at last 15 years, there’ve been just a couple of years in those years, which have come in towards the bottom end of our guide. So that’s why, we feel, generally we’ve muted the ramp from Q3 to Q4. Also, Q3 baseline, which is in this ramp, reflects sort of the slower approval cycles that have been playing out throughout the year. And there’s about one extra day in Q4 this year versus the previous year. And then the last piece is, I mean, it’s based on the fact that yes, there is pain in China at this point.

But then when we look at pharma in the U.S., in Europe, in Japan, in India, especially mid to large pharma, our teams are doing a great job there and driving decent outcomes.

Vijay Kumar: That’s helpful comments Udit and Amol. And one maybe, if Q4 jump off as the minus high singles organic, is China minus 25 for the year, is that done for this year or is that going to spill over into fiscal 2024? Can Waters grow next year? I feel like when I look at the margins here, obviously, leverage will be a question. But I saw that restructuring cost did tick up, so anything on – any implications for 2024 either on the top and operating leverage?

Udit Batra: So, Vijay, I’ll comment on China and just, I mean, before we get into any details, I mean, we will only comment on 2024 when we talk about next year, when we talk about Q4 earnings, right. And that’s generally been our policy. As you know, a lot has to evolve from now until the end of the year, especially in our business. So we will not comment on 2024. But on China in particular, look, the quarter – in the quarter, the business declined about 30% – in excess of 30% with pharma declining in line with what we had seen at the beginning of the year, right, with CDMOs sort of flushing out over capacity and responding to geopolitical tensions. We think that’s towards the tail end of its development. We saw biotech come under pressure.

We think that’s also at the tail end of its pressure just given that high quality molecules are being funded also in China. And then the third piece was in pharma, the Branded Generic segment, which is roughly 50% of our sales in the Pharma segment in China. And this one here, there was an additional pressure that we learned about, which is the anti-corruption campaign that the Chinese government issued. So while our customers are used to value – responding to value-based pricing cuts this was a new headwind. So that is still in progress. So in all pharma, two out of three vectors are starting to subside. The third one is new over the quarter. And this is something that I learned over the last couple of months when I visited China. When switching over to other segments, look the Industrial segment, we see great growth in batteries in China, but that was not enough to offset the macro sensitive Food and Environmental segments, which dropped further in this quarter.

And then finally, the Academic and Government segment, as Amol commented in the prepared remarks, we’re seeing the tail end of the benefit from the stimulus from last year and that will sort of come out of the numbers now. Now, if you put it all together and put it in perspective, we started the year with about 19%, 20% of Waters’ sales coming from China. With our current guide, we expect that to be about 12% to 13% of our overall sales. So while we remain super optimistic about what we expect in China in the future and it has become a much smaller proportion of our business than at the beginning of the – then at the beginning of the year.

Operator: Next, we’ll go to the line of Dan Brennan from TD Cowen. Please go ahead.

Dan Brennan: Hey guys. Thanks for the questions here. Maybe just on pharma, ex-China, obviously you kind of discussed positive trends in the quarter and kind of what you guys are expecting for the fourth quarter. But we’ve heard a lot of mixed comments in the quarter. So maybe can you just give us a flavor for maybe a little more details on [indiscernible] trends and kind of water specifically how you’re doing, you think first to [ph] broader trends. And again, maybe Amol, I know you gave some color in fourth quarter, but just how should we be thinking about pharma in the fourth quarter ex-China?

Udit Batra: So Dan, thank you for the question. Look pharma is almost a tale of two stories, right? I mean, overall, we saw the quarter decline low single digits. And in China as expected, roughly 30% or so decline that I just commented on. If we look at ex-China I mean, we’ve printed, I would say amongst our peer group, probably the most positive numbers in growth in China growing mid-single digit. And this is across Europe, across Americas and across the rest of APAC where we saw significant strength in India and Japan. And this is behind two factors. One really our new product portfolio is gaining a lot of traction, despite the slow funnel velocities that we see in mid to large pharma and additional approval levels, despite the fact that biotech came under pressure at the beginning of the year, it’s starting to see – it’s starting to become a little bit less pressured as we exit the year.

So in pharma, our new product portfolio has done super well start with LC. The Alliance iS we have had significant orders. And as I mentioned, despite the macro pressures, customers have placed large orders for Alliance iS. And the funnel looks really healthy. Mass spec has been a real star for the year. And in pharma, we have specifically developed biologics applications, and you saw the recent launch of the walk-up solution for BioAccord, which should make process development even faster. The MaxPeak Premier column staying on the theme of biologics is in its third year and still growing in well into the 20% range. So been the strongest launch for us in columns for many, many years. And we recently introduced another column that is targeted towards AAV and cell and gene therapy.

So really excited about what we’ve seen in pharma this year, despite a difficult environment and feel like we’re gaining share. And over the long term, pharma is – remains a source of strength. We don’t expect to grow mid-single digits. We expect to grow high single digits and double digits as we look into the future. So I’m super excited about what we are seeing in the pipelines from our customers. I mean, we are very well specked in the GLP-1s and the Alzheimer’s compounds. So really optimistic about the future and proud of the team’s execution and I would say a challenging macro environment. Amol?