Waters Corporation (WAT) Earnings Call Transcript & Summary

Okay. Thank you, everybody. We're going to kick it off. I'm Tycho Peterson from Life Science team. I'm pleased to have Udit with me from Waters. Welcome.

Maybe we could -- I think, if we were sitting here a year ago, we'd be talking about the replacement cycle starting to kick off. We're a year into it. Maybe just talk a little bit about some of the trends you saw in 3Q, orders obviously outpacing revenues. So, talk about the momentum, the durability and how the pharma discussions are going now.

Yes. Firstly, thank you for having me here, Tycho, and it's great to be here. I'm not surprised the first question was on the replacement cycle. Look, it started about a year ago, as you said. Our instrument growth rate, this is LC-MS, remains in the high single-digit arena. And it's got three drivers. The first one is the instrument replacement cycle. We're still, I would say, probably not even midway through it, given that it's only been a year, and several of the customer segments have not even started to replace, right? So if you -- and another way to look at it is, to look at a 5-, 6-year CAGR. When you look at a 6-year CAGR, we're still in the low single digits for LC-MS growth, right? So that's quite an important indicator. So, we're far away from finishing the instrument replacement cycle. The funnels are good. So, the trends are very good there. The second driver were our idiosyncratic growth drivers, right? GLP-1 testing, the revenues doubled there. PFAS testing still 30% order growth. India growing again, high teens. So, everything that we had said sort of on track from the Investor Day last year. And then third and most enduring and the most important thing is our -- the products that we're developing are meeting significant unmet needs in the market, and they have incredible traction, right? So be it Alliance iS and you had the opportunity yesterday to visit our site, all the mass spec portfolio, including TQ Absolute XR for PFAS testing, for DMPK, and now CDMS is coming up for next year. Chemistry is doing extremely well. And then finally, informatics is at the table as well. So innovation across the board is contributing nicely. So, see good trends and nothing, sort of, is changing. In fact, a couple of new growth drivers have been added. Now yes, if you just look at pharma itself, there are two or three segments that are still not strong, right? CROs are starting to stabilize. Biotech, early-stage discovery is still sort of flattish, still declining a little bit. And China generics, which is a significant part of our China business is still declining, right? So, you have two or three segments in pharma that have not yet recovered.

And chemistry was up 13%, up double digits, low double digits year-to-date. You are well above the kind of pre-COVID run rate of typically 6%, 7%. So given new product cadence, is this the new norm?

Not 11%, not 13%, but trending in the right direction. Look, let's break it down a little bit, right? So, we started to invest in bioseparations 5 years ago quite significantly. Over 70% of our R&D spend in our columns is now towards biologic applications, right? So, that's a significant change from the past. And over the last 3 to 4 years, you've seen very significant innovations come to the market. First was -- were the MaxPeak Premier columns. This is a bio-inert surface, which is relevant for all large molecules, right? So large molecules are sticky. They stick to many surfaces. We created a bio-inert surface. And that then allowed us to build on it. We've launched SEC columns for size exclusion. The columns that did extremely well versus last year and this is where you saw incredible growth where some of the SEC columns, which are highly targeted, but also our protein A columns. Here we basically took antibodies and attach them to particles. And this is a very significant new platform. These products have grown faster than any products that we've launched in the history of Waters. And so, that's why you saw a spike in the growth, 13% this quarter, 11% year-to-date. Over the mid- to long term, I would expect our chemistry growth rate to go from 6% to 7% to high single digits, just given the amount of -- given the fraction of portfolio that is now targeted towards large molecules, which grow faster. Another way to think about it is the bioseparations -- the bioprocessing market. There, the consumables are proportional to biologics, biologics production, right? And the same thing will be true for bioseparations. So, that's another way to sort of anchor the logic. And so yes, the answer to your question, it's a long answer to your question. I wanted to give you all the caveats, so you don't start modeling 11% already. But over time, we expect the growth rate in chemistry to be high single digits to low double digits for sure. And with BD coming in, it unlocks several programs rather quickly. And so, you will probably see some of these spikes go up and down, and the slope of the line will continue to rise.

And then, we're going to hit on BD in a minute, but just maybe touch on the pricing opportunity on large molecule because that's very good for columns as well.

Yes. It's -- I mean, in general, chemistry, our pricing is pretty sticky, right? So generally 5%, 100% stick rate, and that's 20% of our business, so you get 200 basis points -- 100 basis points just like that. With biologics, the pricing opportunity is more significant if you're solving very difficult problems, be it in separating viral vectors, be it in separating antibody drug conjugates, be it in separating vaccines, right? So the pricing opportunity there is much more significant and much stickier than small molecules as well.

I want to go back to the pharma performance and your comments earlier, trends are up 11% in the third quarter on pharma. You had a tougher comp. America, up low double, China up significantly. Maybe just touch a little bit on -- it doesn't seem like there's any slowdown in the cycle ahead of some of these CapEx developments here in the U.S.? And then on CROs, touch on that as well because that biotech funding that's driving that?

You promised no three questions in one. So -- but there are three questions in this one. So let's just take pharma and break it down a little bit. So double-digit growth in pharma yet again. U.S. and Europe, driven by the replacement cycle, the idiosyncratic growth drivers largely GLP-1 testing and DMPK in this case, and new products, right? So that's relevant for U.S. and Europe, and I went through that earlier as well. And this is large pharma and where the replacement cycle is driving the growth as well. You go to China. In China, the growth is driven by CDMOs, who are supporting the local biotech industry. And the local -- basically, the local biotech industry has rejuvenated quite dramatically, roughly 1/3 of the global in-licensing comes from China now, right? And that's a dual benefit for us. We have significant share in global CDMOs that are Chinese based. And as they transfer the -- as the biotechs gets sold or as the molecules get out-licensed, the CDMOs keep the molecule and they transfer the process from China to ex China facilities, right? So it's a long-term benefit for us as well. But in the short term, China has grown double digits in pharma, largely on the back of CDMO growth. Branded generics is still pretty slow, right, still negative. And then if you go to India, India is driven by genetics, right? So high teens growth, the generics demand remains pretty high, right? So different drivers geographically, so it's not a monolith, and it requires different ways to compete in the different markets. What was your second and third question?

Just the comments on CRO on the third quarter call and what's driving that? Is that all biotech funding or...

Yes. So, CRO is still pretty slow, Tycho, right? I mean -- but stabilized. It's not declining anymore, and we start to see a bit more stability in the biotech industry, even in the U.S. as a customer. But I wouldn't call it a victory yet, right? So, it's not going back to 2021, 2022, but it's starting to stabilize. It's not declining as rapidly anymore.

Any tailwind from anti-involution in China in terms of kind of bidding and regulatory quality pharmas in there?

Not in pharma. I think that's mostly relevant for the industrial markets. And even there, we don't see much of it, right? If anything, the need for high-quality producers is even higher as you start looking at different parts of the market, so no real impact.

Innovation, I want to spend a minute on. It was great to see some of that at your site yesterday. Talk a little bit about the CDMS opportunity? How are you thinking about that market?

It's fantastic. It's rare that -- I'm an engineer by training, so I get excited about these kinds of things. It's fair that you see something that looks so shabby when you start with it. It looked like my PhD experiments, where on the side of a wall we had the CDMS instrument with high-voltage signs and pumps. And I think you saw the previous version of it as well. And for those of you who have access to our Q3 earnings, there was a picture in there, and that's a real picture, from 2022. And customers had already started to -- started to look for that technology because it uses 100x less sample. It's 10x faster than analytical ultracentrifugation. It's nondestructive, it's a fantastic technology. And even in that pre-beta version, you could analyze large molecules and their molecular weight and their mass to charge ratio. It's not important what those characteristics are. It's just very difficult to measure them with small amounts of sample. And so this meets a very significant unmet need relevant for 40% of the biologics pipeline. And over the last 2 to 3 years, and you saw our Wilmslow site yesterday, the team there converted this Frankenstein experiment into a sleek-looking box that sits on a bench top and is able to analyze 40% of these large molecules and give you a mass and a mass to charge ratio, which is not possible to do with any other instrument. We have sized it and it's very difficult to size something like this when you're creating a new category, right? So it's a new category that's been created. The current techniques roughly captured $350 million sales annually. They grow high single digits to double digits. We think chances are we will take most of it over the next 5 to 10 years. I suspect others will come up with similar technologies as well. But over the next 5 years, I mean, the ambitions are pretty significant. So, I won't say more than that. Let's look at the facts as they roll out. Let's look at the customer adoption, and we'll share more as we go further, but it's a very significant opportunity. And it's a fantastic instrument. As I said, it's rare in your career. When you see an unmet need, you see a prototype instrument and you in-license it and within a reasonable period of time, it becomes a product that customers want. And the first shipment actually, by the way, occurred to a customer in China, right? So it's global demand, and it's just a fantastic product.

Maybe we could shift over to BD and curious thoughts on their 3Q results and how did that track relative to your own internal model?

I think -- look, I mean, it's an interesting question and one that we get a lot. One thing I would tell you is we don't run the business today. So whatever I say is with hesitation and also with not a ton of confidence, because we are not dug into everything, right? But that said, it's going according to our model, according to our plan, pluses and minuses, right? So the plus is being that the FACSDiscover S8, as I spoke to several customers, small pharma, academia, large pharma, universally, this is the best product in the market. And since it was launched, there's been a funding slowdown. So there's a lot of pent-up demand, right? And that started to pick up, especially in the U.S. and in Europe. So that's an upside, while on the diagnostics side in microbiology, BioMérieux reported as well, they were a bit slower as was BD's business. So puts and takes, but by and large, within error bars of what we had modeled. And don't expect it to be much different in the guidance either, right? So as I said, we are spending now more time doing integration planning, as opposed to going back to the model and saying, what did we get it? What do we get wrong? Right now, my entire focus is on day 1 planning, day 100 planning. So everybody who comes into the new company has a boss and has a seat and they go to a desk, they actually have a laptop. So we need to make sure that happens. So when the lights turn on, everybody's desktop turns on. Second, we're taking what we talked about with you externally as well on the synergies. We've broken them down into roughly 400 initiatives with individual owners, and those are now being populated, right? So that's where the time is spent, and I'm enjoying that a lot.

Maybe just touch on some of the innovation there too, new flow, new back tech. Talk a little bit about how you're thinking about those in the next year.

So, I think, I mean it's difficult to sort of take a wide portfolio and talk about everything, but let's pick three to four, right? So the FACSDiscover S8 is a flow cytometer that basically measures 50 parameters and has an imaging technology with it. It's the only one in the industry. So KOLs and key customers can't wait to get their hands on it. Second, the simpler version of it is going to be launched in 2026, that is relevant for cell therapy and clinical use, right? So there's a pipeline of products that are coming on that front. Second is the FXI, which is the incubator for microbiology. It is a product that's been in the pipeline for a while for BD. It's frankly speaking, they've been a bit slower than the only competitor who has a product there and the product is going to get launched in Q1, Q2 next year and slowly going to get rolled out across the globe, and there's roughly 20,000 of those instruments that need to be replaced. Right? So something that we know how to do at Waters, and we feel very good that we'll be able to accelerate that. So, those are two very significant innovations. The third one is BD COR. This is basically HPV testing. It's a high-throughput HPV testing, molecular high-throughput testing clinical diagnostic tool. And it is the only one with home collection, especially in the U.S. So, once that's been approved, we expect that to grow rather rapidly. So these are three pretty significant new platforms that are getting launched. And feel very good about what we're going to be able to do to get them moving.

Anywhere you've been most surprised on the integration planning front? You announced a deal in July, you'll close the end of March. So you have a long kind of runway here to plan it out.

Yes. I think more positive surprises than negative. Right? Significant opportunity on the microbiology workflow. Now there's an unmet need there to do rapid identification of microbes and determine the antibiotic that is needed to kill it, right? So, the workflow itself has a lot of improvements that one can bring. But equally, as we looked at where Waters can immediately add value. The first place is to take that workflow into QA/QC in sterile testing of pharmaceuticals, right? That's roughly a $300 million market, growing double digits. BioMérieux has most of that market, and we think we can enter that with our commercial footprint. And second is the MALDI-TOF that currently is sourced from a competitor. We have our own prototypes. It's already existing at Water. So there are three different work streams already in play to try and replace that over a certain period of time. So pretty excited about what we're seeing there. So I would say, learning more, not negative surprises, but more positive surprises on what else we can do. And then, of course, the market dynamics is the market dynamics, right? So academia, et cetera, a bit slower than one would have imagined early on, but nothing dramatic.

I want to make sure we spend some time on software, because that was certainly something we focused on, on the visit yesterday. And you've talked about the super highway for Empower, you've put it on light scattering technology from Wyatt now. Talk a little bit about the road map there and how you think about it? And we put a $1 billion target...

Yes, I'll leave it to you to set public targets. Look, it's just to sort of set the current context. It's a $300 million business. And Empower is used to submit 80% -- the dossiers for 80% of QA/QC data for 80% of the drugs that are filed to the FDA, EMA and NMPA. So it's a very significant part of Waters' portfolio but also significant part of QA/QC for the pharma industry, right? There are three areas where we are trying to add value, right? The first is to add other instruments to the Empower super highway as we call it. So today in the bioanalytical lab, not many instruments are compatible with Empower, right? So basically, we took multi-angle light scattering and made it compatible with Empower in the past. We've done capillary electrophoresis. Mass spec is in progress. LC has already been done T.he next step would be flow cytometry, right? So that's the first piece of the initiative. The second is adding -- today, roughly 450,000 users have access to Empower. So imagine how much data exists in our customers databases, both on instruments and on the product. Both of those can be mined for insights, right? So we're basically building apps that access that data and give customers utilization data, give customers data on integration of peak, so they can have better anomaly detection. And in some cases, we've seen customers who used to have 90 out of 100 errors, now have 5 out of 100 errors in first-time integrations, right? So really significant advancement that customers are deriving value from. So second initiative is basically launching new applications just using the existing data that we have access to. And the third and the most important one is changing the commercial model from what is called an on-prem model where a customer pays for a -- pays capital on day 1 and then has charged a service fee to maintain the software. The challenge with that sort of model is that, if you sell 500 licenses to a customer, they can easily substitute one user for another, and we found a few customers. In fact, one who had bought 500 licenses but had 1,000 users, right? So, there is no chance to go back and inspect what's happening. What we've decided to do is move towards a subscription model, meaning each individual user is an individual unique subscriber, each instrument is a unique subscriber. So, any time now you change the instrument version, you have to pay up. Any time you change the user, you have pay up, right? And basically, you go from, say, $1 and then $0.20 for service all the way through and covering all upgrades for Empower now to a $0.35 or $0.40 per subscriber charge in perpetuity, right? So that's a significant change in the commercial model. And we've had quite a bit of success with small to medium pharma already. They don't have large networks of instruments. They have transitioned and most customers prefer a non-CapEx model. They like it in their OpEx. So it's much easier for them to manage. We are in late-stage conversations with two very large pharma companies where it could be a very significant outlay. Now so, if you add all that up, it's not unreasonable to think that the Empower business could be doubled in the next 5 years and to your target probably in a 10-year time frame. Yes. So it's -- because you're adding bioanalytical instruments, that's equally -- that is just about the same size of small molecules. The subscription model gives you a revenue uplift and so do the application. So you've put the target out there, but it's not unreasonable.

We gave you 10 to 15 years. Is your win rate in large molecule comparable to small molecule? I mean, it's been dominant for a small molecule. I mean, does that competitive advantage translate?

I think it depends in the area, right? So, where you have a unique value proposition, so for chemistry for sure, right? I mean, chemistry, each time, I think it's each time we have a head-to-head with anyone I think we usually win. So, if you're at the table because our chemistry and engineering teams usually customize for the user, right? So, for instance, one customer wanted to reduce the pore size in these SEC columns and the commercially available one was 250 angstroms, our guys built up 125 angstroms -- sorry, 125-micron pore size SEC column. So, the customization allows us to win a lot of share. So, it depends in the area. Now where you have a unique value proposition like flow, like multi-angle light scattering, the win rates are pretty significant, right? So when you think about in-line testing, multi-angle light scattering compatible with Empower, BioAccord connected to bioreactors are two areas that are also starting to gain traction. And this was after the MFN deals were starting to be signed. Basically, pharma companies have started to become a little bit more relaxed about their CapEx even in R&D, right? And that has allowed them to buy these instruments.

There's another bucket for you. We kind of call it idiosyncratic growth drivers, right? It's PFAS. It's GLP. Talk about how these markets, I guess, have evolved relative to expectation. And if we're sitting here a year or 2 years from now, are there new ones that are popping up?

Very early days on PFAS, right? It's grown 40% again year-to-date of a $55 million or $56 million base from last year. We had signed up for half of that. The market is growing half of that rate. So, ahead of target on PFAS testing. The unmet needs are still pretty significant. The TQ Absolute XR wins more than it loses, given its sensitivity and there, I think you probably saw it in Wilmslow as well, instead of having to service the instrument after 2 weeks, you can now service it after 20 weeks, just the enhancement that was made recently on that particular product. GLP-1 testing revenue, think of it in three different dimensions: the columns. We are specked into the two largest GLP-1 providers, we are specked into the late-stage oral compound, we are specked into generics. So you can see on the GLP-1 testing, on the columns, on instruments, on in-line testing, it's a very significant share there. And that revenue doubled from last year, right? And India, in our model at the Investor Day, we had said 70 to 100 basis points of accretive -- accretion on our baseline growth. It's been growing well ahead of that. That was a mid-teens growth. We've been growing high teens with India. So, all three going in the right direction. I think at some point, you'll see these get into the baseline. And at that point, the new initiatives with the BD acquisition, with bioanalytical, bioseparations, and LC-MS in diagnostics will start to kick in and create the sustainable growth rate to be at a higher level.

Great. Maybe in the last minute, and Amol is not here, so I can push you on '26. I think 6% to 8% is kind of the framework on the top line. Talk a little bit about some of the other dynamics that you can for next year.

I mean, the setup is good, right? The growth drivers remain the same, right? So the replacement cycle is still in its, as I said, middle innings. The idiosyncratic growth drivers, we just went through new products. Now you add -- you have Alliance iS, TQ Absolute XR, you have the chemistry that we sort of saw benefits already in this past quarter, add on -- add to that informatics, there will be some significant releases next year. On that front, CDMS will start to pick up. BioAccord and multi-angle light scattering on innovation are starting to catch up on the biologics side. So, feel very good about the setup on the business, right? So, I won't give you a number, but the setup is very good.

Great. We're out of time. I'll leave it at that. Thanks.

Thank you. Thank you, Tycho.