Waters Corporation (WAT) Earnings Call Transcript & Summary

Excellent. Okay. Moving to Diagnostics. Really strong performance there. I think 15% growth, and that was across both parts of the business. But Diagnostic Solutions, I think it sounds like the main issue you're having there was reagent rental non-compliance, and that's really what you've gone out to fix. Can you help explain that, what you're doing, if there's been any kind of pushback and maybe some of the other opportunities you see in the business, including the issues you're seeing in China?

So Diagnostic Solutions is basically 7 -- if I don't take the legacy Waters business, just take that out for a minute, that grew 15% in the quarter. Diagnostic Solutions, legacy BD business grew mid-single digits for the quarter. And microbiology in that grew 4%. Molecular diagnostics grew high single digits, okay? The drivers in the microbiology business were twofold. One, we -- threefold. One, we started to charge better pricing, 90 basis points of pricing versus what we've seen in the past, which was flat to sometimes even declining. Second, we saw better uptake of our BACTEC bottles, which were out of supply in the past. The theoretical maximum that the team had said is we would get back to about 85% of our -- we had a supply crisis before we acquired the business. And we basically went down to almost 50% of the volume that we used to supply in the past. They said the theoretical maximum will be 85%. We achieved that already sort of in the partial quarter that we had, this quarter, it was even higher, right? So theoretical maximum, we exceeded and we said, well, why shouldn't it be 100%? And so we're chasing the 100% penetration versus the past, right? And so those 2 alone were impacting the pricing of bottles and their volume. And the third piece was around instruments. FXI launch has been exceptionally good, right? It has already started to contribute. It's an instrument which is used as an incubator for microbiology. And it was launched in Japan and Europe first. In Japan, the customer feedback was exceptional. And one customer came back and said, we improved efficiency by 80%. So they used to have 10 people, they had 2 people to do that job after the instrument was installed. So really dramatic customer testimonials, and there are 12,000 such instruments globally that need replacement. And so we're sort of getting that moving. And then on the molecular side, we have launched this HPV assay with our BD COR. In Q2, we launched 14 instruments. Full year last year, we launched only 4, right? So rather a dramatic improvement in commercial excellence, right? So both parts of the business have started to accelerate. Now as you look at the second half of the year, remember, Q3 is the fiscal year-end for BD. It has severe dynamics also because it was a quarter before we signed the deal, right? So you can never quarterize things well enough. But the second half of the year, you'll see more momentum in our guide than you saw in the first half of the year. And Q4, you will see a nice acceleration.

Okay. Great. Maybe going to Analytical Sciences, your kind of legacy Waters business. I mean, 9% growth, I mean, that's probably the best in all tools, if I had to guess. But I mean, how much of the strength is LC replacement cycle versus idiosyncratic growth drivers? And then I know on the last call, you did have one slide where you continue to point out that the CAGR, 5-year CAGR is still just 2.5% versus historical 5%. So like where are we now in the cycle? And how much more runway do you think we have? Because I think it's been 2 years? 2-ish years? 3-ish years?

Yes. So it will be 2 years at the end of Q3 when the replacement cycle started. I think that's where your question is going. On the instrument side, look, qualitatively and quantitatively. Qualitatively, the funnels are super strong. We have nice visibility on orders. We see really good uptake of new products. And I'm just talking instruments for a minute. And when you look at it mathematically, the 6-year CAGR is still 2.5%. And in that, there are idiosyncratic growth drivers. There's better pricing. So from a volume perspective, it is way below average, which is 5% from the past, right? So we have a long way to go to catch up to the sort of average growth rate of instruments over a 20-year period for Waters. And now with better new products, with better pricing, with better innovation, we expect that to continue for a while, right? So it will continue at least until the end of 2027 is what we can say. And now in addition to pharma replacing and part of industrial replacing, we're starting to see biotech and CROs start to replace instruments as well, right? So about 90% of our installed base is now in the midst of a replacement cycle. There's 10%, which is branded generics in China, which has still not come to the table. But that's a pretty good step forward.

Okay. And I mean, also on the last call, you did talk about -- I mean, I think you kind of gave a similar time frame, '27, '28. But you talked about kind of an extension of that cycle because of reshoring, kind of that layering in on top of kind of maybe a fading replacement cycle. So I mean, you talked about $100 billion of CapEx, can you kind of help us frame what that means? Like how much of that is addressable by waters? And how -- when we think about '27, '28 and then how much longer could kind of reshoring add on top of that to kind of keep your...

The way to think about reshoring is, look, you're taking products that were developed somewhere else or being manufactured somewhere else, transferring them because there is a benefit in general to produce in the U.S. These are largely innovative products, right, where there's market access advantage. All told, when we looked at the customer set so far, there's about 77 customers who were bona fide producing new or breaking ground or plan to -- had plans to break ground for reshoring and not for just adding volume in their existing plants, right? And that was a pretty strict exercise that we made. We said, look, what is bona fide existing volume that is just increasing and what is reshoring. So we did a pretty rigorous exercise. We said 77 customers are breaking ground, and that number keeps increasing because as we look at the market, the number rises. More than half of them or about half of them have actually already started to build, right, and have broken ground. So 77 were going to break ground, about 36, 37 have already broken ground and 70% of those are primarily Waters' customers. That's an important fact, right? So we've done a pretty granular analysis. We are wherever people are having these discussions and the analysis suggests that 70% are Waters' customers. We're having pretty good discussions with them on what they want to order, when they want to order. The planning is there on paper. We know when the orders will come. We don't usually talk about concrete orders this far in advance, right? So we want to sort of wait until things become much more precise. Second, our market share in the U.S. is at least 10% higher than it is in Europe. And lastly, I think this is something I've talked about in the past, any time there is a new opportunity, our win rate is higher than our incumbent replacements or our incumbent customers, right? So it's a very good setup on reshoring. I wouldn't get too excited about it right now. I know folks are talking about concrete orders right now. I don't know, but I mean we are very sort of diligent about what we call reshoring versus not. So for instance, if Lilly expands their site, which they are, that could potentially have gone to Europe, but we're not counting that as reshoring. Unless there is a concrete cause and effect from a European site to the U.S. site or an ex-U.S. site or a U.S. site, we don't call it reshoring, right? So just so you understand the math. And at the end, just look at the results. I don't think the rest of it is all sort of conjecture.

Right, right. That's helpful. I mean I guess people are just trying to understand that if there as a replacement cycle, maybe peters out in 2028, how -- I guess, how long you can kind of continue -- potentially continue that...

I mean I think you can be sure that reshoring is a real event. It will dovetail into the replacement cycle. But let's not get too sort of precise about it. When it happens and it doesn't happen, I don't know. I think what is more important to realize on the replacement side on the base business is in 2021, coming out of the pandemic, we had a massive replacement year, right? And those instruments are coming due for replacement in 2028, '29, right? So in a strange way, you have a confluence of factors that keep the instrument growth rate higher. And I think what you also have to keep in mind, the replacement cycle generally started well before any of our peers started talking about it. Usually -- it's usually triggered by something that you're offering customers that they don't have. So innovation leads to a faster replacement cycle, a prolonged cycle. And now we're not just talking LC and LC-MS for us. We have a much broader portfolio that is benefiting from biologics, right? So I think if you want to do the mathematical exercise of instruments, which is roughly 20% of our portfolio, there are enough drivers to assume that the instrument growth rate will be high single digits for a while to come, including innovation, including new products, et cetera, including replacement, including reshoring. If that's sort of the mathematical exercise you're trying to do, I think you can be pretty safe that it's going to be high single digits for a while.

Pretty crazy. I was already talking about replacement cycle of COVID, COVID instruments. You put some perspective how long ago that was. It doesn't seem like it. Maybe looking at A&G, I mean, -- you guys 11% growth in A&G, double-digit growth in Asia. And you even saw -- you talked about 6% growth in the Americas. I think you mentioned semiconductor research as an area as one driver in the U.S. But what's driving your outperformance here relative to peers?

I mean, again, I cannot judge what others are seeing exactly. I mean what we're doing is pretty straightforward, right? So we sort of scour the funding landscape. We look at applications, and we go to specifically those customers. It doesn't matter if they were previous customers or not, right? So in the past, what we used to do is, okay, if you're selling to Harvard, we'll keep going to Harvard. But now we say, well, no, if Harvard doesn't have money for this application, somebody else does. And that's what the funding -- and the funding is pretty transparent in the U.S., by the way, right? The grants are pretty transparent. So if you have a database that is live and you're close to the customers, you know when this is happening. Usually, when it appears in the database, it's too late. You have to have enough contacts and enough other leading indicators to find out where the funding is going. So that's number one. Number two, no matter what end market, customers pay for innovation. When you have a new product like the Xevo MRT P10, which is a desktop mass spectrometer, high-resolution mass spectrometer that sets a standard in speed and resolution, and it is half the price of floor-standing high-resolution mass specs that our competitors supply, customers find money to pay for it for metabolomics applications as well as our other applications, right? So if there's an innovative product, the customers will find money to pay for it, right? So that's the second piece. The third is around the applications that you're talking about, it's semiconductors, it's battery testing, it's PFAS testing. When PFAS goes from environmental matrices to food matrices to textile, academic institutions lead the charge, public health institutions lead the charge. And knowing where that is, is part of the trick. And then, of course, having the Xevo TQ Absolute XR, which is, again, the most sensitive quantitative mass spec in the market, the customers will pay for it, right? So I think it's a lot of blocking and tackling. And this double-digit growth rate for the first half of the year is without a China stimulus. The stimulus, as you asked earlier, is anticipated in the second half of the year, and that's not in our guide, but we've grown outside of that in academia. Now I would caution in assuming that the academic market on average is going to be double digits. That's just simply not the case. It's a low single-digit grower over the long term, but we are very fortunate to have good commercial teams and good leading indicators.

That's super helpful. Maybe going back to BD. I mean, I think you're well ahead on the cost synergy side of things. I mean you talked about run rate $200 million by the end of this year, which I think is -- was your expectation for year 3, if I'm not mistaken. I mean that's pretty impressive. So where -- are you finding more opportunities? Or are you just finding it easier to attack them? And how...

Nothing is easy, man.

Yes. But it's been only 1.5 quarters or so, a quarter, and you're clearly either finding more or you're just finding it quicker. So like how should we think about the ultimate opportunity here?

I think, firstly, the teams are doing an incredible job, right? I mean this is hard work anytime you do an integration, and I have the dubious distinction of doing 2 large ones like this, one at MilliporeSigma and the other one here. On the cost side, I think you'll recall us saying, look, I mean, the average in general is 7% to 8% of the cost base, at least in Sigma, which we did 7.5% and we have signed up for 4%. So therein gives you already the indicator. We came out of the gates very fast. And I believe that whenever you have to do restructuring in an organization, you're better off doing it as fast as possible so that the teams have stability and then they can just build from there. And that was the intent, and you see the result of that on the $200 million on a run rate basis that's already been delivered, but we're far from done. We haven't even started the manufacturing footprint optimization, which is a very significant component, the distribution optimization, the direct and indirect procurement that is a long way to go, right? So there's a lot more here. Now the question behind the question is the margin progression, right? And I think there, there are puts and takes. The $200 million plus all the other pieces will show up in the margin, but we also want to invest for growth for the future. And we'll talk more about that as the year progresses, and we have even more data by the time we guide for next year. But we're well ahead of the model, and I think we'll remain ahead of the model for a while to come.

Okay. Maybe -- and just moving to -- you've talked about organic growth for the base business. It sounds like high single digits is a decent place to think about things. But I mean, BD is also now at mid-single digits. And that's just only after really one full quarter of being in your hands. And then on top of that, you have new products there. You've talked about replacement cycles in BD. So I mean, like -- I mean, how -- when you kind of put these 2 things together and BD becomes organic next year, I mean, what is the potential for Waters from a top line perspective?

So I think -- I mean, go back to sort of the deal model and our earlier thoughts on this, right? On average, the acquired businesses grow faster than our base Waters business historically, over a 20-year period, the base business grew between 5% and 6%, closer to 6%. The acquired businesses grew north of that, right? So if you keep that in mind as a starting point and say history can be used as a way to sort of project the future after this sort of perturbation of the acquisition, right? And now we've taken that 6% to the high single-digit domain for the Analytical Science business. The ambition is similar for the BD business. It won't happen overnight. The levers are pretty clear, right? The levers are operational improvement, 180-day plan, and then you have the revenue synergies with instrument replacement, service, e-commerce, pricing and the like. And then you have the strategic synergies where you're basically going into the industrial facility segment, and I can go on repeating what I've said in the past, but that then allows you to take the business from where we inherited it already at mid-single digits. We'll exit Q4 closer to 6%. I'm not saying that's a jump-off point for the next year. But the answer is between that and what we inherited it, right? And we'll have enough time to have looked at the full year and then guide beyond that. But midterm, you should absolutely expect Waters to make this whole thing a high single-digit business pro forma. And we are absolutely confident just given the number of drivers we have, given the market structure that we have. I mean, the market structure in the acquired businesses is even better. You have 1 to 2 competitors in every segment. You have a differentiated value proposition. The unmet needs are significant. The R&D spend has always been high. The question is, can you direct it in the right places, right? So really good setup for the future.

Sounds great. I have a bunch more questions, but we're out of time. It was really great to talk to you, and thank you so much for your time.

Thank you, Evan. Good to see you.

Good to see you, too.