Waters Corporation (NYSE:WAT) Q4 2023 Earnings Call Transcript

Waters Corporation (NYSE:WAT) Q4 2023 Earnings Call Transcript February 6, 2024

Waters Corporation 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 Waters Corporation Fourth 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, Cedric. Good morning, everyone, and welcome to the Waters Corporation fourth 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 first 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 fourth 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. 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 would like to begin today’s call by expressing my gratitude to all my colleagues. 2023 was another transformative year for Waters. Throughout the year, our teams kept an unwavering focus on customers, launched innovative new products, and delivered strong business performance, all during highly eventful times with dynamic market conditions. As 2022 ended, the results of our transformation clearly showed on the top line, having delivered several years of very strong, above-average sales growth. Since then, in 2023, we’ve demonstrated our ability to manage exceptionally well through a downturn while continuing to make investments for growth. In 2023, we also initiated the next phase of our transformation with the acquisition of Wyatt.

This brings with it a new vector for value creation to our shareholders through M&A and we’re off to a great start. As an added benefit, it has accelerated our journey into high growth adjacent markets, where we made continued progress with our organic investments over the course of the year. We launched new and innovative products in 2023, including our Alliance iS next generation LC platform. We expanded our Xevo tQ mass spec into clinical applications and developed size exclusion columns for viral vectors that pair with Wyatt MALS instruments. We even had our first light scattering launch as a combined company with ZetaStar. Finally, we were recognized as one of the world’s most sustainable companies, achieving a variety of ESG awards. This includes our top five ranking on Barron’s Most Sustainable Companies list which scores over 1,000 publicly traded companies based on 230 ESG performance indicators.

We’re very proud of what we’ve achieved at Waters in 2023. Today, as I share our fourth quarter and full-year results, I have three key messages. First, we’ve continued to execute well. Second, our transformation is contributing to our results. And third, we are well positioned for future long-term growth. Turning now to our results. In the fourth quarter, sales declined 4.5% as reported, which was in line with our expectations. Our non-GAAP earnings per fully diluted share landed at the high end of our guidance at $3.62, driven by strong margin performance. On a GAAP basis, EPS was $3.65. For the full year, sales declined 0.5% as reported and 2% in organic constant currency. Even with a constrained CapEx environment, all our regions outside of China grew in 2023 in organic constant currency terms.

As expected, Wyatt successfully delivered on on-target M&A contribution of 2.5% to sales. And with a strong EPS result in Q4, non-GAAP earnings per fully diluted share came in at $11.75, which reflects underlying growth of approximately 2% before FX headwinds of 3% and 1% dilution from the Wyatt acquisition. I will now describe our sales results in more detail. The spending environment for instruments remained challenging into year-end. However, Q4 revenue increase increased Versus Q3 levels in all our geographies, even China as we continue to execute well in tough macro conditions. Reported sales were $108 million higher in the fourth quarter than the third quarter. This reflects a 15% ramp that was consistent with our guidance for a muted year-end budget flush.

For the full year, our organic constant currency sales grew 3% year-over-year, excluding China. As I mentioned earlier, the Americas, Europe and Asia excluding China all grew in 2023. This took a lot of effort from our sales team who did a fantastic job capitalizing on the available opportunities in the market with our competitive portfolio. As a result, on a full-year stack basis, our ex-China growth remains at a healthy high-single-digits. A key challenge in 2023 was the abrupt turn we saw in China where conditions deteriorated as the year progressed. This was particularly the case in the pharma market where our revenues are most heavily weighted. For the full year, China sales declined more than 20% overall, which was a 5% headwind to our total growth.

This brings us now to our margin performance. We believe that the best reflection of good operational execution is effective margin management when things slow down. During 2023, we saw volume and FX headwinds, while inflationary pressure continued. We responded with stronger pricing and added further discipline to our operational objectives. We redoubled our productivity efforts, including the opening of our global capability center in Bangalore, India. And we undertook proactive cost alignment as the slowdown began to emerge. This resilience, focus and commitment allowed us to deliver excellent operational results in our P&L. Our full-year gross margin was 59.6%, which is 160 basis points better than the previous year. Our full-year adjusted operating margin was 30.9%, which is 70 basis points of expansion.

Now, let me share our progress with the acquisition of Wyatt Technology. The strong start to lead sharing between Wyatt and Waters allowed us to offset a slowdown in biotech spending, resulting in an on-target M&A contribution of 2.5% to our full year sales. I will now give some detail on how our revitalized portfolio and alignment with higher growth segments are contributing to growth as part of our transformation. Our strong results in 2023 was supported by our innovative portfolio, which helped drive customer spending on new products are gaining good traction in the market, including TQ Absolute, Alliance iS and MaxPeak Premier Columns, as well as several of our high res mass spec instruments such as Cycliq G3 and MRT. From an adoption perspective, this puts us in an excellent position when instrument budgets begin to normalize.

Turning now to our adjacencies. We have continued to invest and expand into adjacent high growth markets, where our business model of solving problems in downstream regulated applications can be deployed. For bioseparations and bioanalytical characterizations, we made organic investments, launched new products, and deployed capital to M&A. Large molecule applications are now 35% of our pharma revenues and expected to trend higher, up from around 20%, just a few years ago. For diagnostics, we have invested in our clinical business and added workflows for specialty applications of mass spec. This has transformed related revenue growth from that of low to mid-single-digits to double digits in the past several years. Finally, our focus on batteries is paying dividends where very strong growth has remained throughout the year.

Revenues from battery applications are now at over 10 times 2019 revenue levels and our TA business is increasingly aligned with their cyclical faster growing applications. Each of these exciting growth areas is delivering incremental revenue to the company. Now I will share some facts supporting the long term outlook for above average growth and provide our 2024 guidance. Since 2010, Waters has grown on average 6% in organic constant currency terms. For instruments, while the standard deviation is high, long term average growth has been 5%. For recurring revenues, the standard deviation is much lower and the average growth is 7%. As we look ahead, several vectors make us confident that this growth could be even higher. The first is even faster volume growth in segments that we serve, driven by global prescription drug sales and environmental regulations.

Second is increased use of analytical instruments for characterizing large molecules and novel modalities. And third, it’s about historic pricing where we expect to sustain 100 basis point long term tailwind in incremental growth. Let’s take each of these growth vectors in turn. There are at least two key drivers of testing volume acceleration. The first is related to the adoption of GLP-1 drugs, where Waters’ instruments and columns are specified into in-process testing and QA/QC testing at the two leading manufacturers. We expect our position to contribute an average additional revenue growth of 30 basis points per year between now and 2030. The second is PFAS testing where we’ve been gaining share in a rapidly expanding market, in part driven by the sensitivity and compact size of our Xevo tQ Absolute mass spec.

We expect PFAS testing to contribute an additional 30 basis points to our revenue growth for the foreseeable future. Finally, Wyatt light scattering is a high growth business, serving attractive large molecule applications. We expect it to contribute 40 basis points of core growth accretion to our business on an annualized basis. It also accelerates our ability to solve customer challenges at formulation development, bioanalytical characterization and QA/QC testing, which has positive repercussions for our Waters business as we increasingly tie our columns, LC and mass spec into these workflows. I will now cover our 2024 full-year guidance. We expect customer spending caution to continue in the first quarter of the year, with slow budget releases for downstream instrumentation.

We then expect to see a gradual improvement for the remainder of the year as budgets open up, market conditions improve and as prior-year comparisons become easier. We expect weakness in China to continue, particularly in the first half of the year, which also plays into the growth phasing of our guide. With this initial outlook for 2024, we expect full-year organic constant currency sales growth to be between negative 0.5% to positive 1.5%. We expect continued strong operational performance to build leverage in our P&L with 20 to 30 basis points of further operating margin expansion, while still reinvesting for growth. And we expect adjusted EPS growth of 0% to 3%, in the range of $11.75 to $12.05. Now, I will pass the call over to Amol to continue covering our fourth quarter financial results in more detail and give additional commentary on our guidance for 2024.

Amol?

Amol Chaubal : Thank you, Udit. And good morning, everyone. We delivered a solid close to a tough year in the fourth quarter with sales that were in line with our expectations despite continued market challenges. In the quarter, sales declined 4.5% as reported, which aligned with our expectations for 15% increase in reported revenues versus Q3. Organic constant currency sales declined 8% against the high-single-digit growth comparison last year. We did observe a budget flush in the fourth quarter as sales grew across all geographies in Q4 versus Q3. However, this year’s budget flush was more muted than typical, consistent with our expectations. Our Wyatt acquisition delivered excellent results again, adding over 3% growth to the reported sales.

In organic constant currency by end market, pharma declined 11%, industrial declined 4% and academic and government declined 9%. In pharma, our results were impacted by a further weakening in China, which declined 45% for the quarter. Outside of China, pharma sales declined 4% as instruments sales were impacted by a muted budget flush, in line with our expectations. In industrial, growth was flat outside of China against a tough high-teens prior-year comparison. China declined approximately 20% as weakness has broadened into non-pharma segments due to weak economic conditions. Overall, we observed continued strong growth in PFAS and battery-related applications, which have continued to partially offset weakness in more cyclical areas. In academic and government, our ex-China Business continued to perform well with mid-single-digit growth.

However, this was more than offset by a decline of almost 40% in China, where demand has deteriorated after the benefits of stimulus ended in the second quarter. By geography, sales in Asia fell 16% as China weakness more than offset mid-single-digit growth in the rest of Asia. The Americas declined 2% and Europe declined 6%, driven by this year’s muted budget flush dynamics. By products and services, instruments declined 20%, recurring revenues grew mid-single-digits, with continued high-single-digit growth outside of China. There was one additional day in the quarter versus the prior year. Looking now at our full-year results, by end market, pharma declined 5%, industrial was flat, and academic and government grew 10%. Excluding China, pharma and industrial grew low-single-digits and A&G grew mid-teens for the year, each reflecting solid results against double-digit comps.

Now by geography, sales in Asia declined 7%, with China declining more than 20%, while Asia, ex-China, grew high-single-digits. The Americas grew 1% and Europe grew 2%. By products and services, instruments declined 10%, which was primarily driven by China. Excluding China, instruments declined low-single-digits in 2023, reflecting healthy high-single-digit four-year CAGR. Recurring revenues grew 6% overall and high-single-digits outside of China, with robust growth throughout the year. Chemistry growth has been supported by strong customer demand for MaxPeak Premier Columns, serving large molecule workflows, and adoption of ecommerce. For service, growth has been supported by expansion of plan attachment. In 2023, we exceeded our objective for a further 100 basis points of service plan attachment and delivered a 200 basis point increase for the year.

Now, I will comment on our fourth quarter and full-year non GAAP financial performance versus the prior year. Despite headwinds from lower sales volumes, FX and inflation, in 2023, our team responded to these challenges with resilience and commitment. Our continued focus on operational excellence with pricing, productivity, and proactive cost alignment, together with lower incentive compensation, allowed us to deliver a fourth quarter gross margin of 61.2%, an expansion of 170 basis points, and fourth quarter adjusted operating margin of 34.9%, an expansion of 120 basis points. For the full year, our focus and effort resulted in gross margin of 59.6%, an expansion of 160 basis points, and an adjusted operating margin of 30.9%, an expansion of 70 basis points, which is after reinvesting in our high growth adjacencies.

Our effective operating tax rate for the quarter was 17.1%, 50 basis points below prior-year quarter. For the full year, it was 16.2%. Our average share count came in at 59.3 million shares, which is about 300,000 less than the fourth quarter of last year. Our non-GAAP earnings per fully diluted share were $3.62. On a GAAP basis, our earnings per fully diluted share were $3.65. For the full year, our non-GAAP earnings per fully diluted share were $11.75. Foreign exchange headwinds lowered our non-GAAP EPS growth by 3% and there was a 1% dilution from the Wyatt acquisition. On a GAAP basis, EPS was $10.84. 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.

Now turning to free cash flow, capital deployment and our balance sheet. We define free cash flows as cash from operation less capital expenditures and exclude special items. In the fourth quarter of 2023, free cash flow was $192 million after funding $42 million of capital expenditures. For the full year, free cash flow was $554 million after funding $161 million of capital expenditures. Excluded from the free cash flow were payments of $72 million related to tax reform, $26 million for Wyatt assumed liabilities, and $16 million related to investment in our Taunton Precision Chemistry operations. We maintain a strong balance sheet, access to liquidity and well-structured debt maturity profile. This trend 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 $2 billion, a net debt to EBITDA ratio of about 2 times. This represents a decrease of approximately $150 million during the quarter 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 transaction. We will evaluate the resumption of our share repurchase program throughout 2024 as part of our balanced capital deployment objective. Now as we look towards the year ahead, I would like to provide you with our high level thoughts for 2024. Similar to others in the industry, our growth in 2023 was slower than usual, driven by unprecedented weakness in China and cautious spending from customers in other regions.

We view these market conditions as temporary and anticipate a gradual recovery in sales growth throughout 2024. While our customers remain healthy, market uncertainty still remains and necessitates prudence in our guide. These dynamics support full year 2024 organic constant currency sales growth guidance of negative 0.5% to positive 1.5%. At current exchange rates, currency translation is expected to result in a negative impact of just under 1% on full-year sales. We expect Wyatt transaction to add approximately 1.3% M&A contribution to our full year 2024 revenues from inorganic sales incurred in the first four and half months of the year. Therefore, our total reported sales growth guidance is approximately 0% to 2%. We expect to extend our strong margin performance into 2024 and deliver a gross margin of 59.8% for the full year, which is 20 basis points of expansion versus 2023.

We also expect to deliver 20 to 30 basis points of additional 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 remain largely consistent with 2023 levels at 16.3%. Our average diluted 2024 share count is expected to be approximately 59.7 million. Now rolling all this together, on a non-GAAP basis, our full year 2024 earnings per fully diluted share guidance is projected in the range of $11.75 to $12.05, which is approximately 0% to 3% growth and includes an estimated headwind of approximately 2% due to unfavorable foreign exchange. Turning now to our expectations for the first quarter of 2024.

We believe that customer budget release timing will be slower than typical in the first quarter. In addition, current levels of market weakness in China are not fully reflected in last year’s first quarter comparison. Last year’s deterioration picked up significantly in the second quarter and thereafter. The first quarter also last year benefited from A&G stimulus in China. As a result, we expect our China business to decline approximately 40% year-over-year in Q1. Given these dynamics, we expect organic constant currency sales growth in the range of negative 11% to negative 9%. At current rates, currency translation is expected to subtract approximately 1%, while Wyatt is expected to add approximately 3.5% to sales for the quarter. Therefore, our total first quarter reported sales growth guidance is negative 8.5% to negative 6.5%.

Based on these revenue expectations, first quarter non-GAAP earnings per fully diluted share are estimated to be in the range $2.05 to $2.15, 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 Batra : Thank you, Amol. So, in summary, another transformative year for Waters. We will continue to navigate the current market environment well and deliver earnings growth for our shareholders in 2024. Before I close, I would like to share a few updates on our ESG efforts. We’ve made strong progress towards our environmental goals with 77% of our electricity now sourced from renewable or low carbon sources. In 2023, we started working with the Science Based Targets initiative to build on this progress and develop further emissions reduction targets. We’ve also enhanced our climate related disclosure with our TCFD related reporting. Waters was recognized as one of the best companies to work for but by the US News and World Report, and we achieved a perfect score of 100 on the Human Rights Campaign Foundation’s Corporate Equality Index.

We’re also proud that our governance has been recognized. Waters Board of Directors was named the 2024 Public Company Board of the Year by National Association of Corporate Directors, New England chapter. 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.

See also 10 Highest Quality Egg Brands in the US and 15 Highest Quality Creatine Supplements of 2024.

Q&A Session

Operator: Our first question comes from Vijay Kumar with Evercore ISI.

Vijay Kumar: Udit, just on the annual guidance here, at the midpoint, I think it’s about 50 basis points growth. What is the guide you’re assuming zooming for price? And can you talk about end markets, pharma, government and academia, and industrial sort of assumptions? I know you gave the China assumption. China is expected to be down. But could you just parse out between China versus non-China for those end markets?

Udit Batra: Look, a couple of high level comments, and then I’ll go to the end markets and let Amol comment on the pricing question. The 2024 guidance in general assumes that the trends that we saw in 2023 continue in large part. So, you start off just looking at what happened in 2023. outside of China, all end markets and geographies grew low-single-digits or thereabouts. So all geographies were low-single-digits, and we assumed the same trend for the balance of the year. And all end markets are in the similar sort of zip code. And in China, we assume roughly sort of mid-teens to high-teens decline for 2024. Now when you do the arithmetic, you basically look at the comps. The first half of the year will be slower than the second half, right?

The first half of the year has significantly higher comps. When you look at the academic and government stimulus, especially in China, and then the second half of the year, that alleviates, so you’ll start to see a bit of a growth. So now to your question on the full year and the assumption for different end markets. For the full year, pharma, we are expecting to grow low-single-digits. And this is again on the back of what we saw in 2023. Industrial was flat in 2023 for the full year, expect to be there or thereabouts, low-single-digit growth. And A&G with a very strong year, roughly 10%, 12% for 2023. We expect it to be a low double-digit decline, basically in China declining quite significantly because of high comps, and the rest of the world, you sort of go back to the long term trends of low single-digit growth.

So really, overall, expecting the same execution that we saw in 2023, basically really nice performance in markets outside of China with low single-digit growth in China, mid-teens decline. And by end market, sort of similar trends. Strength continuing in pharma due to our QA/QC focus. Amol, on the pricing.

Amol Chaubal: On pricing, when we started 2023, we started with an assumption of 200 basis points, 250 basis points. But as the year panned out, our team gathered strength quarter after quarter, and you see full year, we finished about 300 basis points on price side. Now, long term, we’ve said we’ll do about 100 basis points better than what we’ve historically done. And historically, we had done 50 to 75 basis points. So that’s where our current assumption is starting, roughly around 200 basis points of pricing gains in 2024. But, again, the underlying trend is we’re doing better than that. And where better to see it, right? It reflects loud and clear in our gross margin expansion, which is where it should show up.

Udit Batra: I think just to sort of emphasize that point even more, what gives me sort of a lot of confidence is what we saw on our gross margin and our operating margin. In such an environment, we took proactive cost actions. Operating margin for the full year expanded by 70 basis points and gross margin by 160 basis points. You can talk a good game on pricing, but at the end, it has to show up in the P&L, and that’s what we’re really proud off.

Vijay Kumar: Amol, one for you. Operating margin expansion, that’s really pretty impressive considering revenues are almost flat this year organically. Is that all being driven by gross margins. I think in the past, you noted FX could have an impact on gross margins. Maybe just talk about what’s driving [indiscernible] and FX assumptions on margins.

Amol Chaubal: We expanded our full year margins by 70 basis points. And on a constant currency basis, that’s 120 basis points of expansion because we had a good 50 basis points of FX headwind during the year. The negative leverage from volume was partially offset by mix and AIP. So net-net, it was negative 40 basis points. Pricing added 110 basis points, freight and material savings another 60 basis points, cost actions added another 60 basis points. And then we invested about 70 basis points in nurturing higher growth adjacencies. So that’s roughly the breakdown.

Udit Batra: All hands on deck basically.

Operator: My next question comes from Matt Sykes with Goldman Sachs.

Matthew Sykes: Maybe just the first one, a higher level question. Udit, just on the replacement cycle impact, just given the outsized growth we saw in instruments during this sort of COVID period, what kind of impact do you think this has had on replacement cycles, particularly in biopharma, given a lot of the spend was concentrated there? Do you think the replacement cycle has been pushed out? Or do you think that you’ll see that impact of that coming back in this year? Or is it more of a 2025 impact?

Udit Batra: Let me start by first just talking about what we have seen in Q4. You would have seen that, Q4, our sales ramped from Q3 to Q4 by about 15%. And this is typical in a QA/QC driven business. It’s muted versus historical trends, which are roughly 24% for Waters. But in a QA/QC driven business, you do see a ramp in replacement towards the end of the year. That trend is very much intact, especially outside of China. I think it’s naive to think that replacement cycles have suddenly stopped. This Q4 ramp tells us that replacement cycles are still ongoing. Now the underlying question is, what are driving these replacement cycles and how do you trigger them? In a muted CapEx environment, the conversations we’ve had with customers on replacements have largely centered around new products, Arc HPLC and Alliance iS, which have both gained a lot of nice receptivity.