Waters Corporation (WAT) Earnings Call Transcript & Summary

Yes. Look, I mean, as I go through them, maybe we can talk about the rank order. But if I were to sort of do it superficially right now, I'd say, look, the commercial excellence synergies are here and now. This is stuff that we've been doing at Waters for the last 5 years. We went from a spreadsheet-based instrument replacement protocol where there was a deficit of about 13,000 instruments that we had to replace at Waters. And mind you, the deficit is now 4,000. So we track it through a multiyear time frame initially starting with Excel spreadsheets, which I created on a weekend and had the team filled to now a CRM tool that is managed with Rob Carpio and his team and very, very sort of very careful management of replacement with different segments and propensity to replace across different customer segments. So huge confidence on the on the commercial side, on the strategic adjacencies, 2 out of 3 are almost cross-selling. Mass spec into diagnostics is basically just accessing the commercial infrastructure that BD has with molecular diagnostics for specialty labs and their service team that we currently don't have for mass spec will provide immediate expansion of service, but also allow us to improve the attachment on that front. And then on Flow and PCR, all we've modeled is taking flow and PCR into process development, using Waters resources and not necessarily moving them into QA/QC. Huge confidence across the 3 commercial ones, these 2, which are here and now. On the technical ones, especially taking the antibodies and attaching them to our columns. We have proof of concept as about between 15 and 20 programs that were stranded just waiting for access to antibodies, which will now start in earnest as soon as we get access to the full portfolio. And we feel that should hit in the 3- to 5-year time frame. That's the one that will take a bit of time to develop technologically. And then lastly, on cross-selling with access to DMPK or other segments. I mean, again, that's here and now, given that we have the best instrument in the industry with mass spec with TQ Absolute XR that belongs in DMPK, and we've already done a proof of concept with several customers there. But let me just go through it a little bit more systematically, but that gives you sort of a flavor of confidence across, which is pretty significant. And in all of these areas, we have backstops, right? So I mean we mapped out roughly what, $290 million in revenue synergies over 5 years, right? And it basically spans across these 3 defined and execution-ready areas. So $150 million from commercial excellence, $115 million from high-growth adjacencies, $60 million from cross-selling, right? And this is similar to what we had done back at Waters, especially on commercial excellence. I mean the BD business resembles what Waters looked like back in 2020, 30% of the installed base of instruments is due for replacement, right, 30%. 70% of the revenue comes from reagents, yet only a small percentage flows through e-commerce, right? And 40% of the installed base of instruments is on service coverage. And I went through earlier also on how we've improved service attachment rate over the last few years at Waters. So these are areas that we've just worked on, and we're getting just a larger portfolio to apply these capabilities on, right? So just take one of these, for example, by applying the same playbook, I mean, the $115 million, 1-1-5, $115 million is well within reach, right? So for example, e-commerce attachment, if you just increase it by 20% on BD's $1.8 billion reagent business, like we've achieved with Waters, it unlocks the $75 million that we've signed up for there alone, right? And this math is based on what we've seen firsthand at Waters. This is not sort of consulting math. I mean this is stuff that we've seen ourselves where an incremental dollar is generated for every $5 that are shifted to digital channels. And at Sigma-Aldrich, we had roughly 75% of antibodies going through e-commerce, right? So this is far, far from what we will be signing up for. And in terms of bioanalytical characterization, bioseparations and mass spec and diagnostics, each sort of contribute between $35 million and $40 million. So as I said before, for Flow and PCR, we're just assuming that these get access and these are BDs products that get access to QA/QC laboratories and process development laboratories from Waters, initially only process development, and that sort of justifies the $40 million. And over time, we intend to take flow cytometry and PCR into QA/QC, like we have taken multi-angle light scattering from Wyatt into QA/QC. But the number, the $40 million only envisages access to process development. So the QA/QC move is an upside. Similarly, for bioseparations, as I mentioned, the $35 million basically just is based on concrete opportunities that we currently have stranded in our pipeline, which will be advanced with access to the antibodies. And on the diagnostics side, look, I mean, upstream proteomics is identifying new biomarkers for early disease detection, right? And mass spec is an essential tool that is now -- that is going to be used for multiplex diagnostic, right? So Roche's entry into the space with a high throughput platform validates this hypothesis. And so with BD, we gain immediate access to global specialty diagnostic labs, which we today don't have at Waters and the service infrastructure that gives us a 24-hour premium plan. So this channel and service capability alone gives us a $40 million upside. And this, again, does not include the development of a fully integrated mass spec platform like Roche has. We've done that already in China with KHV. We intend to do it here, but that's an upside, right? And on cross-selling, it's a significant revenue synergy where BD's strong presence in pharma clinical laboratories, which, again, where Waters doesn't have a lot of access today, gives us reach into those laboratories where we can place our TQ Absolute and TQ Absolute XR. And previously, we haven't had penetration there, and that is part of the cross-selling that we're signing up for roughly a $600-ish million TAM. We are assuming $60 million over the next few years. Now what this does not include is any contribution from mass spec for identification of microbes in microbiology labs or taking microbiology into pharma stability testing for QA/QC applications, right? And these 2 areas are -- can contribute quite a bit more. Each one of them is between $300 million to $500 million in TAM and our existing end markets where these products are relevant, but BD has not taken them there due to either lack of technical capabilities or commercial access. So in all, I feel very good about the $290 million that we have signed up for. It does not include the transformation that we intend to orchestrate with the microbiology business to get it back to sort of peer level growth. It does not include the revenue synergies that come from the microbiology business. And the $345 million does not include overachieving the cost synergies where the overall $345 million of EBITDA impact does not include the overachievement of cost synergies and bringing it in line with what we did with Sigma-Aldrich as well. So I feel very good that these are tactical here and now initiatives.

Perfect. That's a lot of detail on the revenue synergies. So maybe I could just shift over to the cost synergy side of things that you just alluded to. You said that you expect to achieve $200 million in cost synergies and also expand the operating margin profile of the company by 500 basis points by 2030. So can you walk us through some of these key drivers and the confidence on the cost synergy side and then also on that margin expansion over the next 5 years here?

Yes. So on the cost side, Rachel, so like I said, it's $200 million by the end of year 3, right? $80 million comes from manufacturing and supply chain. About $40 million of that $80 million is from site rationalization and consolidation, right? So we've identified meaningful overlap across the combined manufacturing and distribution footprint, including specific sites where there are opportunities for rationalization and to consolidate. So this provides a very clear and actionable path forward. And Chris Ross, who is heading up the integration office now comes from operations. So I have immense confidence that we will achieve this rather rapidly. $30 million comes from direct procurement savings. Now this is highly conservative. It's just 2.5% of the combined material spend. Usually, from a benchmarking perspective, you'll see 5% achieved, right? So we're just signing up for half of it, $30 million. So there's a $30 million upside here. We've assumed $10 million from freight lane optimization. So this is basically just using the same freight lanes across a larger portfolio. So we can overachieve that, I'm quite certain. Both freight and direct procurement ramped up quickly within the first 3 years. Site rationalization will usually begin in year 2 with full benefits by the end of year 3. And again, application of supply chain rationalization, procurement leverage, workforce consolidation and overlapping areas is something we have not incorporated. So $80 million is quite straightforward and -- straightforward to achieve. Second, the $75 million coming from commercial infrastructure, service and technology. So 50% will come -- of this will come from consolidating regional management, inside sales, sales operations with 0 impact on quota-carrying sales reps, right? So that's the first part of it, where we will consolidate regional structures, which are -- which, of course, are going to be redundant across the 2 companies. 50% of it also comes from eliminating duplicative technology platforms. We don't need 2 CRM tools. We don't need 2 e-commercees. We don't need 2 analytics platforms and centrals -- and the central service oversight is there across the 2 companies, and we would want to make sure we consolidate that as well. Beyond the $75 million that we've modeled in commercial infrastructure, service and technology, there is significant opportunity as we examined the BD structure in improving spans and layers. So as a reminder, back in early 2023, we took out 5% of Waters' overall headcount given the slowdown in the market, and this was Q1 of 2023 when we implemented the program. This was largely done by reducing the number of layers from me all the way to the front line and increasing the span for each manager. So typically now at Waters, each manager has roughly 7 direct reports on average, some more, some less, and there's only 7 layers from me all the way to the front line. And this is very different at BD. Adding this would give us a much more significant number on -- and adding on to that $75 million. So that's manufacturing and supply chain and commercial and infrastructure. And the third is about $45 million from indirect procurement and a global -- and using our global capability center in Bangalore. So the $20 million from indirect procurement savings is less than 2% again of the indirect spend. And usually, I mean, even in the Sigma days, we did more than double of this. So this is well below any benchmark, but $20 million out of the $45 million comes from indirect procurement. The balance comes from in-sourcing outsourced services that BD today has to the Waters India Global Capability Centers where we already deliver equivalent output of $0.30 to $1. So whatever we can do in our in-house capability center is 70% cheaper versus going outside. And there's, of course, additional upside from rebalancing roles from high-cost geographies into India and something that we would treat as an upside. Finally, I mean, this Indirect procurement savings usually ramps up in year 1 and 2, so you should see it sooner than later. And the global capabilities organization requires us to renegotiate contracts with external IT vendors usually takes 2 to 3 years, right? So that's overall the $200 million in cost synergies, right? And again, I'll remind you, this is sort of grounded in what we already did back at Waters without sort of the benefit of an integration, which is also 5% of our overall headcount. So the 4.7% here of the total cost base with the cost synergies is imminently achievable even if you look at it from that perspective. And then secondly, of course, if I go back to my own experience and Chris Ross' experience at MilliporeSigma, when we combined those 2 organizations, we took out between 7.5% to 8% of the total cost base. And if you just take that alone, you get to $325 million in cost synergies. So significant upside potential here. So that's, I think, the first part of your question, just elaboration on the cost synergies. Now you also asked about our assumption on the margin going from 27% to 32%. I mean, let me sort of dimensionalize or give you just sort of a numerical -- a simple numerical way to look at it, right? Start with 27%, 250 basis points from -- will come from the $345 million synergies, of which 200 basis points are tied to margin benefit from cost synergies only at 4.7% of the combined company cost threshold. Remember, at Sigma, we did much, much larger. So this is sort of our lower end, 250 basis points on the $345 million in synergies, another 130 to 150 basis points from Waters stand-alone. Remember what we spoke about at the Investor Day, the trajectory that we have to get to closer to 35% by 2030. And this is a program that we will continue to implement. And that leaves between 50 and 100 basis points for BD stand-alone. Applying just our pricing discipline alone, including the resumption of, for instance, in the microbiology business of annual price increases on the [ BaTech ] platform, which has been constant for the last few years and greater volume leverage gets you that 100 basis points. So 27 plus 250 plus -- 250 from the overall synergies, 130 to 150 from Waters stand-alone and about 50 to 100 from BD stand-alone gets you to the 32%. So long answer, happy to pull any thread if you like.

Yes. Perfect. Maybe just in the interest of time, I think shifting over to 2026 and the discussion there because I've been getting some questions from investors on it. So if we look at your current guidance for the rest of this year, it really implies like a mid-single-digit organic growth for Waters in the fourth quarter. So how should we think about this exit rate in the context of the 2026 outlook for stand-alone Waters? And then also, how do we think about margins for stand-alone Waters as well as we look to next year?

Yes. Look, I mean we will not guide fully to all of next year, but I think I can give you sort of guidepost on a way to think about it. First half of the year, you saw us on the lower end of the high single-digit range, right, 7-ish percent growth. And I think your question is more around what should you assume when the company is combined? And what would be Waters stand-alone, what would be BD stand-alone, what would be synergies. Let me sort of take each of those and answer that question and it will give you the answer to the Waters question, right? BD stand-alone, we've assumed roughly 4.5%, right? And we can get into the details in a bit. But we've assumed in 2026, there will be a bit of recovery. It still doesn't recover to the '19 to '24 growth rate, but 4.5-ish percent. You add the revenue synergies in year 1 to it, and you basically then finally add the Waters growth rate, which I would be comfortable in saying that it is on the lower end of the high single-digit number, meaning say, between 6% and 7%. You add those 3 up to a weighted average, you come up with a company that's growing north of 6%. So I think that's how I would model it, yes. And there are, of course -- there can be deviations on one or the other of that. But overall, I think you can be quite sure that a 6-plus percent growth is within reach in 2026 for the combined company.

That's helpful. Just to follow up on that, though, any comments on margins? And then maybe more broadly, just given the timing of when the deal closes, when should we expect to actually receive formal 2026 guidance for you guys?

Yes. Look, I mean, it depends on when the deal closes, right? I mean if the deal closes at the end of Q1 and after our Q4, we usually give our full year guidance with our Q4 earnings. So it depends on the timing, Rachel. If it is before, we will do our best to try to give you an indication of what the full year will look like. I mean not much more to say at this point, but it's usually in that time frame that you should get guidance. I won't comment much more on the margin side at this stage.

Yes. Fair enough. Maybe shifting over then to some of the end market discussion. So pharma biotech, you guys grew 11% in that end market this quarter. It grew 8% in first quarter as well. So clearly, you're seeing some traction on the pharma side, especially. That said, we've had some crazy headlines at the start of the year with things like MFN, tariffs, so investor sentiment is pretty pressured on this pharma end market. So can you just reconcile that for us? What are you hearing from your pharma customers in regards to some of these headlines and their plans on the CapEx replacement cycle? And what gives you confidence that you're not going to experience some type of a delay in the instrument replacement cycle in the coming quarters here?

Yes. So 3 comments, Rachel. First, on the pharma -- overall pharma side, remember, we are mostly in late-stage development, QA/QC, sort of mostly CDMOs or generics, right? So that's the part of pharma that generally is preserved even through cycles, right? And we have a deficit on the replacement cycle, as I mentioned earlier, I mean, the 5-, 6-year CAGR is now still at 2%. We have very, very strong funnels. So analytically, no reason for anything to slow down, right? Then the qualitative -- second piece is the qualitative discussions. The qualitative discussions completely support it, meaning once we have planned the replacement cycle for LC-MS instruments in QA/QC laboratories with CDMO players, it's a multiyear process. And let me sort of explain how that becomes multiyear, right? The discussion to determine the exact portfolio you're going to use, exact sites that you're going to replace it at is a very large cross-functional discussion that starts with looking at IT and saying, okay, what version of Empower are you on? And what version of Windows are you on? So incidentally, Microsoft has just sort of upgraded to Windows 11. Many of our large pharma customers are adopting it. That then allows you to take the latest version of Empower that allows you to get Alliance iS into the mix, which our customers are extremely keen to get into the mix in QA/QC, right? So those 3 then determine what exact sort of portfolio you use for the replacement. And it's a multiyear process basically agreed upon across many different functions in these pharma customers. So analytically, I mean, the replacement cycle has a huge deficit still. quantitatively, the funnels are very strong, and we are still at 2% on a CAGR basis. So there's still more to go. And from a discussion perspective, we are not seeing any pressure from the customers in those categories. Now the story is a little bit different in drug discovery, in biotechs, to some extent, in CROs and also China genetics, which is a different type of pressure, but different type of discussion. But in all of these, there is still no start to replacing instruments, right? So no real change. And we are following the MFM discussions. We're having discussions with our customers. But where we sit today, there is really minimal to no impact on the change of trajectory.

Got it. That's helpful. Maybe digging into China, I think that's another area where we've gotten some questions on the line. This region returned to growth for Waters late last year. You posted 14% growth in China in the second quarter. But we've seen China performance from the broader Tools Group be a little bit mixed just given some of the macroeconomic pressures in the region still persist. So can you reconcile this for us? What is driving Waters performance in the region? What makes your portfolio different to some of your peers in China? And then, yes, what are you seeing in the region from a customer and product perspective here?

Yes. In China, China is not sort of one market, right, as much as we like to think of it as one sort of monolith, break it up into the 3 end markets, and we saw double-digit growth this quarter. Break it up into the 3 different end markets. I mean, in pharma, we saw high single-digit growth, while branded generics was still pressured. That's still sort of 50% of our pharma business. They were still pressured and declining, but CDMOs more than offset it, right? And you say, wow, CDMO is growing in China, what's the basis? Well, I mean, just read the headlines on biotech, 35% of in-licensing of global biotech molecules comes from China now. And there are structural advantages of doing early-stage trials and derisking large molecule development in China that this is a secular trend now, right, unless the U.S., Europe and other countries catch up in simplifying the early-stage development of large molecules, I mean, China has an advantage, and you will see this continue to grow. CDMOs support these companies, and it's fantastic, right? We're seeing some really nice dynamism both in service as well as in chemistry. On the instrument side, back during COVID, a lot of the CDMOs had purchased quite a large number of instruments. And when the demand slowed down, those instruments were not being utilized as much, but they're now starting to increase the utilization, which is what we see with service growth and with chemistry growth. So really robust trend, I would say, rather secular now unless real structural changes are made in biotech development in the rest of the world. And I think we telegraphed this about a year ago as well, but we're starting to see the impact of it. And we met 8 of our top customers in Wilford at our headquarters, and they were talking about the latest and the greatest technologies that they can bring in to support these biotech customers. So that's pharma. Industrial, TA is a paradoxical business for us, right? While in the U.S., we had a huge challenge with sort of classical materials customers in China with battery testing, was fantastic. It grew double digits. With chemical analysis, it grew double digits. The industrial segment did extremely well in China for us, grew nicely in the double-digit arena, largely driven by the TA strength. And third, in the academic and government segment, we worked extremely hard over the last few years to localize our portfolio and improve our distribution. This has benefited us, right? So this has benefited us in winning disproportionate share in -- with those customers and more recently also with the stimulus that came in -- a part of the stimulus that came in Q2. So China, I think overall, I mean, I'm not ready to sort of underwrite double-digit growth that we've seen in the first half of the year for a long period to come. The second half of the year, we have good visibility. We think it's going to be nice and dynamic. But we've just -- as we've done in the past, we've said low to mid-single-digit growth in our second half guidance, but all 3 end markets have different independent drivers, right? So pharma with CDMOs, industrial with battery testing and chemical analysis and A&G with a localized portfolio with some benefit from the stimulus. So I hope that gives you color on Waters is growth in China. I'm very happy with what the team is doing there. And I mean, I'll just take one more point. We usually -- you'll see us sort of -- and this is true with the BD acquisition as well. When we put a target on the table, we have multiple ways of achieving it, right? And so when we talk about guidance, there are geographies that we can pull and push faster or slower. There are portfolio pieces. And we feel very good about where now our China business sits competitively.

Perfect. Yes. Maybe following up on your comments there around the CDMO drivers within the Pharma segment in China. Can you just remind us what does your CDMO customer base look like in the region? Is it pretty broad-based? Or is it mainly focused on some of the larger players like Wuxi in the region?

A mix, but mostly large now, right? It used to be large and small, but with the Biosecure Act, I mean the small on sort of were not viable anymore, but it's mostly large ones. We have deep relationships with the names that you mentioned. I mean there's also Pharmaron, there's Wuxi. There's also some large pharma who do -- a large pharma in China who do contract manufacturing themselves. So very, very good relationships. And again, remember, I think back in 2021, early 2021, we had flipped Wuxi from a competitor to us. It went from 80-20 of a competitor to 80-20 Waters, and we've maintained that share. So we feel extremely good about it.

Okay. That's helpful context. Maybe shifting to India. India grew double digits in the second quarter. It grew roughly 20% in the first quarter as well. You've talked about how you expect that the generics opportunity in India will contribute 70 to 100 basis points annually that you mentioned at the Analyst Day. So with this in mind, can you discuss some of the competitive dynamics in India for the generics opportunity? And then how should we think about the tariff dynamic in India impacting this opportunity, if at all?

Yes. I mean, again, quantitative and qualitative. So let me start with the qualitative this time. We have deep relationships with the top generics players in India. I mean -- and these folks have, of course, some of them have sites in the United States and Canada as well. They're very close to the tariff discussion between the U.S. and India. There is no impact on this industry per se, especially the export generics industry, and they are very confident in their CapEx investment. So we're very close to these customers. And I would say, I mean, our GM talks to them on a weekly basis, I talk to them on a monthly basis, and I have a first-time view that we are not seeing any pressure on CapEx investments for generics to support the upcoming patent cliffs. So that's the first piece. The second quantitatively, yes, India has been growing in the high teens for a while now. And we don't see the funnel support strong growth for the back half of the year as well. So quantitatively, we don't see any challenge. Now we're very close to all the discussions that are taking place between the U.S. and India. I think the discussion largely, Rachel, focuses on the agriculture and dairy segments and not as much the pharma and generics segment. The pharma discussion is largely taking place with the U.S. and large pharmaceutical companies with MFN, not with the generics industry per se in mind, right? So I think we sometimes sort of lump pharma into one. It's a different discussion with large pharma, different discussion with generics, which are not being sort of -- not being impacted. With India and the U.S., it's largely a discussion on agriculture and dairy products and both of which are politically important for both countries given the population that is involved, right? So I think just important to be specific on that front, but we're very close to the details there. So I feel very good about our position and our forecast in India.

Great. That's helpful. Maybe in the final minute or 2 here, Udit, can you just provide us with any final takeaways? And what do you think is the most underappreciated aspect of the Waters story here?

Look, I mean -- thank you, firstly, for giving us the time to talk about it today. I think firstly, we feel very fortunate in terms of where we stand as Waters stand-alone. How our strategy is working, how the execution is really now kicking into good gear, and we're able to sort of offset any challenges that we see geopolitically, geographically, and this has a lot to do with the team's resilience. So I think that has been understood reasonably well. And yes, we discussed the replacement cycle, chemistry, et cetera, again and again, but I think overall, that's well understood. The potential of the BD transaction, I think, is getting better and better appreciated. I feel good about the discussions we've had with several investors and several of our large investors. As we provide more detail and as people get more comfortable with the -- as time passes and people get more comfortable with their own analysis, I mean, there is a tremendous value creation potential here to create a leading innovation-driven life science tools and diagnostics company, which basically is able to withstand even more turbulence than what a stand-alone has been able to do. So I feel very good about the discussions we've had. And as the story gets appreciated, I'm sure more and more folks will see an opportunity to come in and support us. So I want to again thank you for the opportunity. Thank you for the forum, and thank you for your questions. I hope it was helpful.

Perfect. Yes. With that, we are unfortunately out of time. So thank you so much again, Udit, for joining us today, and thank you for everyone on the line as well. Please feel free to reach out if you have any follow-up questions.

Thank you, Rachel. Thanks, everyone. Bye-bye.

Bye.

This concludes today's call. Thank you for joining. You may now disconnect your lines.