Waters Corporation (WAT) Earnings Call Transcript & Summary

Everyone, I'm Derik De Bruin, senior life science [indiscernible] analyst for Bank of America. Welcome to our conference. With us is [indiscernible] first company presenting. So we have Dr. Udit Batra, President and CEO of the company. Thank you, Udit. Thanks for being here. Thanks for making the trip over to [indiscernible] Just some basic background. I mean, do you want to make any -- you want to make an opening comments before we sort of begin the inquisition?

Firstly, thank you for that [indiscernible] start. But Derik, it's wonderful to see you in person. It's good to be here, and thank you for having us. Really been a terrific couple of years, lots of change. I'm sure we'll get into that. But a lot is constant, we're still in the middle of a anemic. There's still a macroeconomic challenge that we are confronted with every single day. Ecstatic to be as a company and we're starting to talk about what we're [indiscernible]

So you've been -- speaking of pandemic, you became CEO in the middle of it, which I'm sure is a challenging tasks to be in with, but you've executed quite well. The business has done very well. I would say the company had been underperforming your peers prior to your arrival, and it's certainly has not been. And since then, I guess, what were some of the major issues and challenges that you initially saw just to sort of the stage and we're going to go.

And I'll start with the market not has changed and not as the same. Very easy to talk about what we have done to change things and I'll get into that. But the deep technical focus and deep technical expertise and the customer closeness than what is obvious and that I experienced as a research or myself. So the lab, the PD store [indiscernible] lab is the U.S. and the best reps and the best service engineers were from DA and from Waters. And that still remains the case. And that was the case when I joined, right? So the basics success factors that made the company successful over several decades were still intact grade. What we had lost and like many companies, what we lost his focus or what has made a [indiscernible] a shiny object of the after the light and we wanted to pick up [indiscernible] that delivered software to SaaS, it would be so we want to be services, et cetera. So we have experiments going on in all directions. So we needed to focus back. And second, when you get produced with all of these things, time lines, right? [indiscernible] And the third and the most important is accountable, right? So when you have deals with a collaborative culture. It's not really clear on -- so we now have something called the donation experiment. What is going to be difficult right for the company. And I think that has changed the way we operate. And you can see it as a [indiscernible] can get into the transformation. But culturally, we just simply build on a very strong base of technical focus and customer closeness that I can tell you is very difficult growth. And that's why you got the transformation happened so far. We always said to people, today guys, we're good at replacing instruments. We're good at innovating products in bringing new products and deep unmet needs. We've always done that. Let's keep doing it, right? Let's continue.

So I mean, it's really a focus, I mean, unlike a lot of your life sciences peers, your business is highly concentrated. 60%, 70% of [indiscernible] 20% mass spec and business, roughly speaking. Certainly, in LC and MS, we've seen very strong markets [indiscernible] instruments for the last couple of years. I mean particularly for 2022, despite a really strong 2021, so I think there's a lot of concern about when will growth normalize, how sustainable is current demand of customers pull forward orders? Can you just sort of talk about the current [indiscernible] instrument plans.

So it's a good question. Just again, let's start with the facts, right? So take a step back. What is this quite diversified from a portfolio perspective, from a geography perspective, customers. And from a portfolio perspective, over 55% of our sales is regarding revenues provide a lot of the SKUs and quite a lot of customers. And on the instrument side, which is 45%, 46% of the business, LC is not. LC is many different many different types of a for small molecules for large molecules in development in R&D [indiscernible] into AC my spaces, many different days of money better than even the aspect and required now the bicar, is QAQC, SDA instruments have 5 to 6 different platforms as well. So it's not a mall of it, and our portfolio is quite diversified. Second, from a customer perspective, we are blessed to have exposure to highly resilient and attractive segments. It can get very diversified [indiscernible] of the business in part e highest little industry. Second, in the industrial investor couple segment, over 50%, 60% of that business is still in segments. The good environmental, increasingly battery testing. So close to 80% of our business is in the [indiscernible] But very nicely -- and geographically, we're 1 one the most diversified companies almost 20% in China, 40% of the business in APAC as a whole including China, U.S. Europe, right? So nicely diversified across forward. So actually quite diverse. Now to your question on cycles. Again, let's just look at the facts. It's -- there's no sense in just looking at 2021 in isolation, if you did. I mean, we'll look at the super we grew 16% at -- which is again at the top end of the analytical institutes peers. But on a stacked basis, if you just take out 2019, that growth was 7%. And that, again, is on the top end of the peer group, right? So if you now take the 7% and extract pricing is on a normalized basis. So 6% to 6.5% growth volume, which is nice. And this is Waters numbers, right? And there are some Waters-specific events, meaning commercial transformation, which adds about 100 basis points. Then new products, which also adds something, right? So that gives you a outperformance versus the market, which is roughly 5-ish percent volume percent better than what it has been historically but not double digit, right? So that base is reasonable. Then on that basis, first half of 2022 has really very great right? There, we grew 13% on constant currencies, but then you have to extract the pricing from it, which is 200 to 300 basis points that double-digit volume. Market is a little bit lower. And then again, there are a couple of water that explain our own performance. So it is -- there is an acceleration especially in the first half of 2022 versus historical numbers, but it's not a multiyear effect. And there are some specific events that have taken place in the market itself, right? Take pharma, for instance. Many of our customers focused all their energy and servicing corp, right? And during that time, some of their programs in development and launch has got delayed and how those programs have come through. So you're seeing a very nice sort of catch up. But on a normal basis, it's not a massive pull forward. We don't see a pull-forward add-ons through independent checks as well. In fact, I had my audit team go and do an independent check key customers. And I said, look, first, we can explain inside out of what the growth is, let's just do a check and see if anybody is pulling forward orders consumables. I think we don't hold $0.5 million worth of bio cards. I mean that's not something somewhat to do, but are they holding on to consumables, and we didn't find any evidence of that. And that said, the fact that orders are outpacing growth, it also tells you that the demand is very thin. So we don't see any slowdown in demand. We don't see any portfolio, especially in pharma, especially in the [indiscernible] segments that [indiscernible]

So with that sort of backdrop, and you've had your Analyst Day, when you think about sort of like the normalized go-forward grade, you still feel pretty confident in the 6% to 8%, right, numbers that you're sort of seeing there? And I guess, once again, tougher comps in '23, not trying to get you to guide in '23, but I would love some color on it. Because I think there's a big concern in the investor base is that all these tools companies are suddenly going to go to growth next year or negative growth on the business because the numbers are so strong and we're facing a recession, blah, blah, blah.

I mean, I guess let's go back to the and I can't speak about all those companies. I mean to say 80% of our business is in the Asia [indiscernible] where people don't stop taking medicines during recession. If anything, board and water testing has become much more stringent. I mean take PFAS, for example, right? I mean I was with 2 customers in Europe and 1 in the U.S. over the last week. I won't just want to understand the trends in that area. The regulations in some countries are already implemented. Manufacturers are required to demonstrate that the affluent Waters being term their plants have almost zero feedback. I mean that's unprecedented. You need highly sensitive instruments to detect that and zero absolutely. We just launched is the most sensitive MOSFET in sub in the market and customers are just picking it up really rapidly. So there are clear unmet needs in the markets that we're serving. New products are serving that needs. We don't see any fundamental reasons to believe that the demand is going to slow down, right? And we're not seeing any signals of it either. Now to your 6% to 8% question, the algorithm is pretty simple. There's market growth. And yes, the market is not pricing just partly due to the volume that I talked about earlier. But whatever it is, we have a clear algorithm that says that our commercial initiatives are adding about 100 basis points, a bit more over the last year or can change. And then on top of it, our growth including new products are adding 100 basis points. So that goes from 5% to 6% to 8%. The midterm of the market is a bit faster, you can add [indiscernible] right? So I think that for me is a simple algorithm of the market.

Commercial and then the growth. I mean, look, I think our work on the market over the years, I mean things have definitely accelerated I mean the companies are better positioned. I mean this -- across the industry is much -- I mean, we first picked up coverage of Waters in 2001, if you can give you a old. But I mean, it's completely different from where it was. It was maybe 3% to 4%, maybe 3% to 5% if you were a bucking back that and now things have gotten better. The customers are stronger than [indiscernible] is stronger, but there is a sort of general. There's this original fear that the parties can leave a head, which is that we've been providing against but clearly reflected. Speaking of customers, currencies have moved pretty dramatically. I know that there had been some history with -- particularly with some of your Indian customers getting -- not having the budget as the group moves against the dollar and the -- are you seeing any sort of like delays because of people not having the budgets or [indiscernible]

Globally, the business is very strong the other is look at we sold and some geographies we still you don't see an impact on FX. Really an from a demand perspective has been impacted.

Got it. As you think about the business, I mean, you mentioned it was diversified amongst your geographies and certain product types in which you serve, is there a need to expand into, I don't know, increase citroscopy portfolio to better serve customers. I think it's a question as we think about what you need for doing biologics, as you sort of think about higher demand for food safety testing. There are other technologies besides LC-MS are there is like. So there that's a two-part question, like do you think you need incremental technologies and then this is going to segue into a bioprocessing question, which I have to ask.

[indiscernible] No, it's be some play if you didn't. Let's just again start with the facts and it's double click on pharma promenade. The pharma market as a whole commercialized products are 80% [indiscernible] some of our small molecule has become a bad word or not such a good word in the food industry. It's a terrific place to be, especially if you're in QA/QC, like we are. I mean, 85% of our portfolio is levered towards late-stage development in [indiscernible] In fact, when I joined the company 2 years ago in September 2020, One of the first things I installed is a small [indiscernible] It's getting commoditized and especially that's why you've got your part [indiscernible] in China because they have low-end instruments from some other competitors. Nothing could be further, right? We launched the have nothing to do with the development of that product, right? It's already the pipeline that it's just about met an unmet need in a regulatory frame that didn't have the customers the data the methods acquired because a sharper peaks, it's better carryover, faster experiments, better productivity and that product just took off, right? We gained tremendous tremendous share, contract manufacturers and large companies China business. Effect this year first half, while sort of other store started in the first half of the year or the first quarter here, we came out of the gate very strong. Second quarter, because we have done in Q1, we were a little bit slower. But first half of the year, 13%, 14% growth, well here we think it's going to be 15-ish percent. But the small molecule market was also really wanting innovation, right? And we showed with the launch of [indiscernible] that, that market is robust market. And then that product was launched in U.S. and Europe has done extremely. Now to your question on large, right? So 80% -- 80% of the market is small molecules, 20% of commercialized products is large. But it changes -- the ratio changes in development, 40% of it large monitor modalities. I think all of us know this, and that's why you asked the question. Waters has over the last 2 years, gone from this 2018 ratio in our product base in amount to a 30-70 relation. So we've gone from about 20% products. Certainly, the small molecule market -- large molecule market -- and that's been a very deliberate exercise. Now given that you're a [indiscernible] I'll take you through some specifics and talk me if I get to -- I love this stuff. I mean here by training I don't make any apologies for talking about science, right? Across the portfolio, start with LC, right? The -- let's start with the column, it's easier. The columns, we launched the max premier column. This is we quoted our columns with a -- to reduce the affinity of large molecules in our mistake to surfaces very easily. And that increased the experimental times from about 18 hours for some molecules to products that had to be fascinated, passivation that you have -- it means that you have to run the product before you -- it's like running a coffee machine. So I mean I don't know how many of you do this. But I -- usually, if I have to take an special, I usually run just through the machine so that the machine gets hot and my cup gets hot and then [indiscernible] on it. I see you nodding in the back. You do it as well. And the same thing you have to do with an LC color. You have to make sure all the surfaces are sort of ported and then when you have to separate the molecule is. It's doing what it's supposed to do that sometimes take 10, 12, 14, 18 hours. With the golf, you can just take it on box and on it, right? Imagine that you don't have to waste time in energy running at planes in the machine, right? So that is a very significant advancement in the industry. And no wonder this column has -- is the best launch for Waters and we've launched column since 1970. This is the best launch in history. That technology was then taken into -- and that's relevant for a large model. Then that was taken into the UBLC space with the acuity Premier launch. You talk about the mass spec portfolio. I don't know if that's your favorite for orders. It's mass spec, we have a very strong offering with specific instruments is the only instrument in the market that can distinguish shape of molecules, not just the sites. The MRT has been launched because it is an instrument that does does experiments to test or the orbit track can do, but does it much faster it's in early stages. It has to be simplified with software. But you go into the Tandem courts space as the excess line and the absolutely talked about earlier. And you have the [indiscernible] for the Acronis. It's a product that's the work cost for large molecules in development. The advancement here is software. Again, one of new liberate topics of waters what we've done with Empower, having a software that is used in development for small molecules allowing easier transfer for methods that are used to submit to regulators into QA/QC we've done from use. The water clinic platform. Our newest crop has the same sort of regulatory compliance capabilities that we for -- so I've gone on long about this, but I just wanted to demonstrate that across the portfolio, it's a very deliberate effort to move us in the direction of large molecule and you already see the rate debt increase from.

Got it. As much as I'd like to talk about technology, I'll get you all that. If I don't ask some mundane questions. So sort of a choppy macro environment you're facing and can you talk about your cyclical exposure, not to [indiscernible] cyclical exposure, your concerns, what -- how you sort of think about your exposure downturn.

That's a great question right. So the first is on the end market side. We've talked about the 80% of the end markets being in resilient attractive segments. So have sort of believable trends that will reverse through any sort of macroeconomic choppiness. So the macroeconomic environment is much relevant, right? Second, if we just look at the last down come back into the company grew orders contracted session, right? And that was way better than a menu the margin the gross margin expanded. So we're a cash machine. They had $0.25 or just cash on an average year. And that algorithm as long as we have resilient gen markets, differentiated products is still very much in right? And the reason I side [indiscernible] is just a relative debt that took place right on. So we did see it then, and the company is much more resilient now from an end market perspective also from a portfolio perspective, at that point, roughly 45% of our overseas instruments or so 45% is recurring revenue. That's were in excess of 6%. Now -- when you think of recurring revenue is also something that it requires a good decision. Shortage services regarding consumables are recurring and they have -- they are recurring every year. Instruments are recurring also 5 to 7 side [indiscernible] they were out. And just because people are not going to replace them during a capital downturn perhaps some customers might they get replaced next year. We have just demonstrated that with our placement not replaced for 3 to 5 years. And now we have a 3- to 5-year window that will replace all the instruments segment that we haven't replaced from a side. So it doesn't go away. And I think for long-term investors, that's something you really have to keep in mind. As long as the unmet need is there. roles just a question of time.

And it's also worth [indiscernible] that during the 2018 [indiscernible] acquired sharing being acquired, which typically historically has disrupted your business and some of the other deals.

And in there to you have to distinguish amongst the players, right? 85% of our business is now in pharma late-stage development in QA/QC. We have very low exposure to academia [indiscernible] which is where -- so when having spent most of my testing because that's when I left the scientific word that came into the business or as I used to be in R&D at ramped at the time. And when there is an acquisition or an integration research is sort of compressed. Yes, nobody touches late-stage development. I mean, that's why you're acquiring the company and definitely no one touches commercialized products in QA, right? So even during consolidation phase, quarters is likely to be given just where we are [indiscernible]

And certainly, I think that the commentary, I think there's a lot of concern about biotech finance that we've done. I think we think it's more of a red hearing on the group and on the CROs because of the fact that stuff doesn't get way stage. If you're -- yes, if you're very early, early stage there's clear examples of companies that are having issues with that because they're very early stage in it. But for most of the industry, it's not.

[indiscernible] biotech funding, it's a question that's [indiscernible] less than 5% [indiscernible] 5% of our revenue base. And that doesn't mean that these companies are relevant do work with them to develop methods, but [indiscernible] such as 1% of our business and they buy an LCO they were the CRO that they don't have big capital needs. So they're not part of our customers.

Can we talk a little bit -- I mean, you touched on it briefly, but can we talk a little bit about how margins progress from here? And then you mentioned your strong free cash flow. Obviously, there is always the question of capital returns and share buybacks, dividends and there was a tax rate question embedded in there. So once again, let's stick with all the boring stuff talk margins.

And I was going to invite my CFO, to come up and talk to you about tax rate, he gives a good lesson on tax rates. But on taxes, just to address that question. no change medal give you any more detail on the calculations we're doing based what would come -- what could come in a whole bunch of scenario planning [indiscernible] Now on margins, I think what one has to keep in mind is just the algorithm, right? So again, just taking a step back and looking at water as a P&L as an overall company, we grow 5% we usually have about a 15 basis points in it gross margins should expand -- given that we have one of the highest margins in the industry, people come and see productivity back. And if you could invest more in R&D, you guys will [indiscernible] margin. That was the first question. I think you would also asked us. [indiscernible] I think you've demonstrated over the last couple of years, we can maintain the expand margins while growing the top line and investing in the base. And that's because we should have ways to go on productivity, right? The interesting thing about Waters is we were so technically focused and so sort of dispersed that we didn't implement many of the productivity initiatives. The margin [indiscernible] a large company itself, right? So we never built a capability center like many companies have in India or in some other locations, we're doing that. We had a sort of consolidated recur when we have been implemented the ambition tartar for many of our peers. We have implemented and started [indiscernible] and if you take that into account, you take new products into account, there's another 50 basis points of margin there. So that's about 100 basis points on an organic basis on a constant currency base. We believe over the next couple of years, we want to invest 70 to 80 basis points in R&D. So that's why you don't see any dilution in solution coming from that because we're investing heavily in our [indiscernible] and we still have 20 to 30 basis points that -- now this year, with the FX headwinds, if you take the FX segments into account, and this is quite important, right? The actual [indiscernible] we've committed to 20 to 30 basis points even this year. That's 160 basis points [indiscernible], that there's about -- sorry, there's 130 basis points of FX headwind. If you remove that 60 basis points of margin. If you just look at the numbers right. So that means once FX goes away, just going to water right -- and you just have to be in the onion I take you through the math, and I think it's worthwhile just look at it, analyzing it. And what you find is the companies are very, very good, right? And the headwinds will cause contents [indiscernible] relatively speaking, western what was coming out at a very, very good -- and you see this in the EPS as well full year, when you look at our numbers, the top line is 1.5% -- but the EPS on a constant currency basis is IP growth. So it's a very healthy business at a very good time where a whole bunch of things are working, and we're able to offset pretty significant headwinds from [indiscernible]

And on the capital deployment, I mean, you talked about maybe looking at things and things that we're sort of still within the core competency waters in the diagnostics space. Can you talk about share buybacks given that some of the loss are change there? There's always the dividend question.

Growth for capital allocation growth is bad, right? [indiscernible] organic growth by far. We believe that we have tons of opportunities to reinvest in the business. It's not just in the LC and the mass back in the consumables space, the informatics space. But it's also in the adjacencies we the newer SG and reagent in activation of mycosis capital mass spec into that batteries. It's very attractive areas. But to grow at. And there's still stuff that done share buybacks. We have great and the orders is completely that we have extremely good growth areas as what in these adjacencies. And we're open to M&A, right? [indiscernible] I want to give you any specifics [indiscernible]

No, given that we cover for you [indiscernible] is going to make some suggestions. Just [indiscernible]

But look, I mean there's -- the dual industry is a terrific, terrific what has happened to be in 1 of the best places with a very sort of recurring revenue base late-stage in development QA/QC. And a simple business model been perfected over many years. It gives us high margins and gives us the ability to sort of see at the rest space and saying, what do we want to pick off to accelerate our growth that is consistent with our business model. And our business model is very simple at the end, right? If you are structured come, we take complex instruments that start off looking like a fitting and we simplified into little elegant boxes without losing the sophistication. We are deeply embedded in QA/QC. So the informatics developed really assure the regulators and our customers the [indiscernible] of the analysis to me. So nobody can press the rebate without everyone knowing that you've done it. right? And the chemistry is sort of customized to the molecule we're trying to test and our service engineers and our service teams are rated the highest in the industry year in, year out. And that's no mystery because these folks have developed the instruments, and they have very often worked on the instruments as customers. So they go to help our customers do the experiments in these regulated settings, right? It's a very simple business model. And we want to apply it in spaces like bioprocess in reagents in bioanalytical testing and bioseparations. We want to do the same thing in battery testing as regulations. So it's -- and there are many opportunities to accelerate, right? So we have pieces of the puzzle. If you just take bio separations for a second, we have the capability of functionalizing services with a for small molecule separation. We want to do the same thing for large molecules -- so it's a very logical extension. But that's as much as I would say about what we have.

Right. I mean it's interesting. The industry is so resilient. Even if I talk with many investors, they -- as I said, it's -- I think a lot of people can relate to what Pfizer does or what United does or CVS does. But if you look at life science tools companies, nobody know what PCR was prior to the COVID pandemic, right? And so -- I do think the fact that these tend to be a little bit more niche for most people. I mean, you and I are geeks because we spent years in the lab and doing things. So we have a certain approach for this. But I think the industry is a lot more resilient than anybody appreciates. I think we're coming towards the end here. Is there any specific questions from the audience?

I think I want to pick up on the thread unless there's a question that some people asked where you ended your last statement on the under appreciation of what the tools industry does people who are not experts. I think it's also consistent with how we're trying to describe what we do internally and to make sure everyone is inspired. We don't talk about platforms. and scientists don't be excited about, hey, I'm going to become a big service meet will have become a big LC manufacturer or a mass segment. Nobody gets excited about that. We get excited about solving problems, right? I mean [indiscernible] company that is looking to detect diseases in the very early stages of an infant's life. In the first 6 months of an infant's life, there are biomarkers that you can measure, largely using techniques to the assets is aspect. And those biomarkers are predictors of diseases that relate which I have to want to know in the first 6 months of the life of the child of what I can do help them grow up healthy and so on. The same thing in cell gene therapy, analytical methods are one of the single largest tools that will reduce the cost of [indiscernible] I hope those [indiscernible] cell and gene therapy because if you have better analytics you don't have to have so much QA in modifying and then tracing cells. That is exciting. I want to go home and tell your man your kids that, a, I'm working on techniques that are going to take this therapy that's available to 3 kids to 300 kids. That's amazing. And that's how we talk about science and the company right? And I'm certain hopefully, within my career, we're able to talk to the general audience about the value range it's unfortunate that we talk about just the breadth of the portfolio and serving the customers' needs. I mean, yes, that's all cool. But at the end, we are we will serve the customers [indiscernible] we will not be in business. That's sort of expected. But it's much more expiring to talk about solving an unmet need in a specific area. Battery testing is another one, right? I mean, if we're all going to drive electric vehicles, so many of us driving is we want to be sure that these batteries are not going to explore it [indiscernible] How do you it? You basically look for in vaginitis in composition in these little cells of the format you can do that in a lab. And when you're driving electric vehicles, you can talk to your kids or family and say, "Hey, I'm working at a company that tests these things to make sure that when we're driving this thing doesn't catch higher." Isn't that cool? I think we just have to change the narrative a little bit and not just either be too geeky as you and I are or be commercial have medium directly focused on the needs [indiscernible]

And I think that's a fabulous way to end. Thank you, Udit. Thanks, everybody, for listening and have a great conference. Thank you.

Thank you.