Waters Corporation

Good morning. Welcome to the Waters Corporation First Quarter 2021 Financial Results Conference Call. All participants will be on a listen-only mode until the question and answer session of the conference call. This conference call is being recorded. If anyone has any objections, you may disconnect at this time. It is now my pleasure to turn the call over to Mr. Brian Brockmeyer, Head of Investor Relations. Please go ahead, sir.

Thank you, operator. Good morning, everyone, and welcome to the Waters Corporation first quarter earnings conference call. Before we begin, I will cover the cautionary language. During the course of this conference call, we will make various forward-looking statements regarding future events or future financial performance of the company. In particular, we will provide guidance regarding possible future results of the company and commentary on the potential market and business conditions that may impact Waters Corporation over the second quarter and full year 2021. We caution you that any and all such statements are only our present expectations, that actual events or results may differ materially from those indicated in the forward-looking statements. For a detailed discussion of some of the risks and contingencies that could cause our actual performance to differ significantly from our present expectations, see the risk factors included in our annual report on Form 10-K for the fiscal year ended December 31, 2020, in part one under the caption risk factors and the cautionary language included in this morning's press release, including with respect to risks related to the effects of COVID-19 pandemic on our business. We further caution you that the company does not intend to update any of its predictions or projections except during our regularly scheduled quarterly earnings release conference calls and webcasts or is otherwise required by law. The next earnings release call and webcast is currently planned for August 3rd, 2021. During today's call, we will be referring to certain non-GAAP financial measures, reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures are attached to our earnings release issued this morning and available on the company's website. In our discussions of the results of operations, we may refer to non-GAAP results, which exclude the impact of items such as those outlined in our schedule titled Reconciliation of GAAP to Adjusted Non-GAAP Financials, included in this morning's press release. Unless stated otherwise, references to quarterly results increasing or decreasing are in comparison to the first quarter of fiscal year 2020. In addition, unless stated otherwise, all year-over-year revenue growth rates, including revenue growth ranges given on today's call, are given on a comparable constant currency basis. Now, I'd like to turn the call over to Dr. Udit Batra, Waters President and CEO.

Udit? Thank you, Brian, and good morning, everyone. Along with Brian, joining me on this morning's call is Mike Silvera, Waters' Vice President, Corporate Controller, and Interim CFO. I would like to start by expressing how grateful I am to our colleagues for their continued hard work and commitment, especially to those who are continuing to experience the devastating effects of the pandemic. We've not yet seen a uniform recovery as there are still many regions around the world that are being ravaged by the pandemic. As many of you are aware, India is facing a particularly dire situation at the moment. Our colleagues and customers there are very much on our minds and we're working closely with our team in India to ensure safety of our employees and their families and we're doing all we can to support our customers. During today's call, I will provide you a brief overview of our first quarter operating results as well as an update on our three-phase transformation plan focused on, number one, regaining our commercial momentum, number two, further strengthening our organization with leadership and performance management, and number three, aligning our portfolio with growth areas. Next, I will provide some thoughts on how our business is positioned to drive sustainable growth. Mike will then review our financial results in detail and provide comments on our updated second quarter and full year financial outlook. We will then open up the phone lines to take your questions. Briefly reviewing our operating results for the first quarter, revenue grew 31% as reported, 27% on a constant currency basis, and non-gap adjusted earnings per share grew 99% year over year. This strong start to the year was driven by growth across all end markets as we saw continued strength in pharma and earlier than expected recovery in non-pharma spending by our customers, new product correction, and strong commercial execution by our team. Looking more closely at our top line results, first, from a customer end market perspective, all our end markets grew double digits during the first quarter. Our largest market category, pharma, grew 28% in constant currency, industrial grew 24%, and academic and government grew 29%. Moving now to our sales performance by geography, On a constant currency basis, sales in Asia grew 41%, with China up 109%. Sales in America grew 14%, with U.S. growing 13%, and sales in Europe grew 25%. From an operating segment perspective, our waters division grew 26%, while TA grew by 28% on a constant currency basis. Customer activity continued to improve in the first quarter with pharma leading the way, driving better than expected trends in recurring revenues and a significant growth in instrument revenue. Recurring revenues grew 15% with services growing 14% and chemistry consumable revenue growing 18% driven by combined pharma strengths and improved industrial demand. LC instruments grew across all of our major geographies and market categories with more than 40% growth. It's encouraging to see both HPLC and UPLC instrument units grow double digits, driven by pent-up demand, penetration of the ARC HPLC, and strong execution of our LC replacement initiative. The success of the launch of the ARC HPLC in the general purpose HPLC space cannot be understated, and the acuity premier has been received very well by customers since its February launch. Mass spec sales were also strong in the first quarter with growth in excess of 50% as demand in the pharma market remained robust. In addition to rebounds, we saw in other markets including clinical, food, and environmental and biomedical research. Demand was solid for our tandem quads in Europe and China, particularly in pharma and in food. Finally, to TA, revenue grew 28% as demand rebounded in the core industrial business and strength continued in pharma medical devices and semiconductors. Growth was robust across all major geographies and product lines with particular strength in thermal and electroforce. Looking deeper at our sales performance by geography, all major regions grew double digits. China built further on last quarter's strength, more than doubling sales year over year. Results were strong across all end markets as China continued its recovery from last year's COVID disruptions. Pharma was particularly strong in China. driven by triple-digit growth in both contract labs and traditional Chinese medicine. Our food business in China also saw meaningful growth, driven by a significant rebound in contract testing organizations to the level that were above those we saw in 2018 and in 2019. This is just one quarter and not indicative of a trend, but it demonstrates that the market is recovering and our execution has improved. India's sales grew double digits for the third consecutive quarter despite worsening conditions and continued pandemic challenges throughout the country. Europe experienced broad-based strength across all customer and markets, including meaningful sequential improvements in both industrial and academic and government markets. In the U.S., both pharma and industrial markets had strong growth in the quarter, while demand in our academic and government market remained soft as it lags behind other markets in reopening. In summary, we had a great start to the year with strong year-on-year growth that was broadly based than last quarter with impressive performance across all our regions and markets and product categories. Pharma demand has not subsided and many of our non-pharma markets are now in the process of recovering, which gives us greater confidence as we look to the remainder of the year. Now, I would like to talk more broadly about our business and its overall direction moving forward. including the strength of the company, the attractiveness of the market that we serve, and our deep commitment to innovation as we look beyond this quarter into the longer term. Our three-phase transformation plan is number one, regaining our commercial momentum, number two, strengthening our organization with leadership and performance management, and number three, aligning our portfolio with growth areas. Looking at our first priority of regaining our commercial momentum, let me review some initiatives I mentioned previously. First, our instrument replacement initiative. We delivered a significant acceleration in instrument revenue growth to 45%. In February, we launched the Acuity Premier System, augmenting the already solid placement of RKH PLC launched in June of 2020, creating new opportunities for instrument replacements. Additionally, we have gained traction with customers to replace aging tandem quad mass spec instruments with newer instruments. As part of our CRO CDMO expansion initiative, we've seen revenue growth accelerate to strong double digits in both these customer segments. Customers continue to perceive us as a strong technical partner as they transfer methods from originators, and they see us as a strong collaborator rather than a competitor. Third, our e-commerce initiative has begun to deliver tangible results. Search engine optimization and paid search have led to search impressions that are up more than 40% year-on-year. While not every click translates to immediate revenue, increasing traffic is an important first step in our e-commerce efforts. Fourth, driving launch excellence. Let me start with liquid chromatography. While the ARK HPLC is a leader in general-purpose HPLC space, I want to focus on the Acuity Premier. Last year, we launched the Acuity Premier columns and followed that up with the Acuity Premier system last quarter. Though we're still In the early stages of the revenue ramp-up, for both the columns and the system, sales of Acuity premier columns are significantly outpacing prior successful chemistry launches, including the original Acuity columns. Turning to mass spec, in 2019, we launched the BioChord, Cyclic IMS, SynaptXS, TQS Kronos, and a next-generation version of our TQS Microbe. Pairing our tandem quads with Acuity Premier creates industry-leading reproducibility and sensitivity for challenging assays. With expanding applications of the BioQuad, we've maintained our focus on bringing a versatile, easy-to-use, and robust LC-MS system to the QA-QC space. During Q1, we launched a full workflow for peptide multi-attribute method on the new Waters Connect platform to enable the monitoring of quality attributes at the peptide level. This adds to already existing simple-to-use applications of peptide mapping, intact subunit mass analysis, released glycan profiling, and oligonucleotide mass confirmation. Over the last year, we established the BioAccord into the workflows for characterizing mRNA molecules that have since become vaccines. In fact, BioNTech recognized Waters for our support of its COVID-19 vaccine development and release efforts. Cyclic was launched in September of 2019 and is targeted at the most advanced high-resolution mass spec users. Augmenting traditional LC-MS with high-resolution ion mobility allows us to separate molecules with identical molecular weight based on their different shapes. This is now especially relevant for monitoring structural changes in the sugar pattern of the spike protein of the SARS-CoV-2 virus. We do recognize that we still have a bit of work to do on our mass spec informatics applications, and we're addressing this through the development and rollout of our Waters Connect software platform across our full mass spec portfolio. Today, Waters Connect supports biopharma characterization and monitoring workflows with a range of capabilities on the BioCord, VivoQ-TOF, and Bion, and with the launch of our RDA BenchTOF in Q1, Waters Connect also enables small molecule workflows. We're grateful to have earned the trust and partnership with our customers as we develop further applications and beta test upcoming products and software. Next, from our TA Instruments Division, last year we launched the X3 DSC, which offers unique advantages for routine high-throughput labs and R&D, especially in pharma, electronics, and advanced materials. The ability of the X3 DSC to deliver high-sensitivity measurements of physical properties more quickly than comparable products is is enabling these measurements to be more broadly deployed in manufacturing processes where scientists can evaluate multiple formulations in parallel, reducing time to market. The more time I spend with my R&D colleagues together with our customers, the more impressed I am with the strength of our deeply, deeply technical culture. Moving on to our second priority. You've already seen the planned leadership transitions we announced last month. Amol Chawbal will join us at CFO on May 12th. Amol has deep experience in pharma and diagnostics and has led many transformations in his prior roles, through both organic and inorganic roles. I would like to sincerely thank Mike Silvera for his four months of service as interim CFO. Mike will continue to serve as our corporate controller, and I'm pleased to add that Mike will also assume the role of chief accounting officer. Secondly, we've established a dedicated innovation board, which I will share, that includes leaders from R&D, business development, and marketing. The innovation board will review unmet needs in markets we serve, assess technology proof of concepts, and monitor the execution of top R&D programs. Thirdly, I'd like to thank Mike Harrington and Ian King, our SVPs of global markets and global products, respectively for their decades of dedication to waters. Though their retirements are effective July 2nd, they've graciously offered to serve as consultants for a period of time to ensure a smooth transition. Finally, we welcome our own John Pratt as the leaders of the Waters Division, while Jinqiang Bennett will succeed John at the TA Division. Both John and Jianqiang have deep commercial and transformation experience in global leadership roles in fast-growing markets, such as molecular diagnostics and bioprocessing. I'm really pleased with our new team, and I look forward to introducing them to you in the coming months. That brings us to our third priority, aligning our portfolio with high growth areas. While we won't take our eye off commercial execution, which remains our top priority, we have recently started our strategic planning process. Now I'd like to share with you some high-level thoughts on where we are today. Our number one priority is to continue strengthening the core, meaning LC, MS, and materials characterization instruments, informatics, service, and consumables. Second, is tapping into faster-growing adjacencies where we can bring our strength of managing compliant data without competing directly with our customers. These adjacencies include opportunities to increase our exposure to biologics, be it in reagents, other instrument technologies, or bioprocessing, or in accelerating LC-MS into diagnostics or other high-growth markets. Lastly, we will maintain our longstanding disciplined approach to financial management, capital structure, and capital deployment as we are focused on maintaining a top-tier ROIC. Over the coming year, I look forward to sharing more with you on our strategy as well as the data points that give us confidence that we have the foundation in place to sustainably grow in this attractive market. With that, I'd like to pass the call over to Mike Silvera for a deeper review of the first quarter financials and our outlook for the remainder of 2021.

Mike? Thank you, Udit. Good morning, everyone. In the first quarter, we recorded net sales of $609 million, an increase of approximately 27% in constant currency. Currency translation increased sales growth by approximately 4%, resulting in sales growth of 31% as reported. Looking at product line growth, our revenue, our reoccurring revenue, which represents the combination of precision chemistry products and service revenue, increased by 15% for the quarter, while instrument sales increased 45%. Chemistry revenues were up 18% for the quarter, driven by strong farmer market growth and improving industrial demand. On the service side of our business, revenues were up 14%, as customers continued to reopen labs and catch up on performance maintenance, professional services, and repair visits. As we noted on our last earnings call, reoccurring sales were impacted by five additional calendar days in the quarter, which primarily impacted service revenues. Looking ahead, compared to 2020, there is no year-over-year difference in the number of calendar days for this year's second or third quarter However, there are six fewer calendar days in the fourth quarter of this year. Breaking first quarter operating segment sales down further, sales related to water division sales grew 26%, while TA instrument sales grew 28%. Combined LC and LC-MS instrument sales were up 47%, while TA system sales grew 34%. Now I'd like to comment on our first quarter non-GAAP financial performance versus the prior year. Gross margin for the quarter was 58.2%, a 350 basis point increase compared to 54.7% in the first quarter of 2020, primarily due to an increase in sales volume and favorable effects. Moving down the first quarter P&L, operating expenses increased by approximately 9% on a constant currency basis. and 11% on a reported basis. The increase was primarily attributed to higher labor incentive compensation costs and higher depreciation from IT investments we made over the last few years. In the first quarter, our effective operating tax rate was 14%. An increase from last year as compared to the comparable period included some favorable discrete items in the prior year. Net interest expense was $7 million for the quarter, a decrease of about $3 million. as anticipated on lower average outstanding debt balances. Our average share count came in at 62.6 million shares, flat with the first quarter of last year. Our non-GAAP earnings per fully diluted share for the first quarter increased 99% to $2.29 in comparison to the $1.15 last year. On a GAAP basis, Our earnings per fully diluted share increased to $2.37 compared to $0.86 last year. A reconciliation of our GAAP to non-GAAP earnings is attached to the press release issued this morning. Turning to free cash flow, capital deployment, and our balance sheet, I would like to summarize our first quarter results and activities. We define free cash flow as cash flow from operations less capital expenditures and excluding certain special items. In the first quarter of 2021, free cash flow grew 60% year over year to $193 million after funding $40 million of capital expenditures. Excluded from free cash flow was $14 million related to the investment in our Taunton Precision Chemistry operation. In the first quarter, this resulted in $0.32 of each dollar of sales converted into free cash flow. Our increased free cash flow is primarily a result of sales growth and better operating margins compared to the prior year. In the quarter, accounts receivable day sale outstanding came in at 84 days, down 15 days compared to the first quarter of last year. Inventory decreased by $16 million in comparison to the prior year quarter on higher sales volumes. Orders maintains a strong balance sheet, access to liquidity, and a well-structured debt maturity profile. In terms of returning capital to shareholders, we repurchased approximately 600,000 shares of common stock for $173 million in the first quarter. These capital allocation activities, along with our free cash flow, results in cash and short-term investments of $810 million in debt of $1.7 billion on our balance sheet at the end of the quarter. This resulted in a net debt position of $893 million and a net debt to EBITDA ratio of about one time at the end of the first quarter. Our capital deployment priorities remain consistent. Invest for growth, maintain balance sheet strength and flexibility, and return capital to shareholders. We remain committed to deploying capital against these priorities, and as Udit commented earlier, we have begun a new strategic planning process. As we continue to execute against our priorities, we will evaluate deploying capital to open up attractive and adjacent markets. As we look forward to the remainder of the year ahead, I would like to provide some updated context on our thoughts for 2021. One, while the business environment remains subject to volatility, we are seeing good momentum in our market segments, which will help us exceed the 2019 levels. Two, we believe This momentum will continue until the second quarter, but that the strong double-digit growth will mostly occur in the first half of the year due to more challenging comparisons in the second half of the year and the six fewer calendar days that we will have in the fourth quarter. Three, we continue to expect that all major geographies will perform better this year than they did in 2020, led by growth in China. Four, our near-term growth initiatives are expected to continue to ramp led by our LC replacement initiative, which we expect to contribute increasingly to our performance. These dynamics support updated full-year 2021 guidance for constant currency sales growth of 8% to 11%. At current rates, the positive currency translation to 2021 sales growth is expected to be approximately 1% to 2%. Gross margin for the full year is expected to be between 57.5% and 58%. Every year we look to balance growth, investment and profitability. Accordingly, we expect 2021 operating margins of between 28 and 29% based on a combination of investments, the normalization of COVID related costs and discipline expense controls. Moving now below the operating income line, other key assumptions for the full year guidance are as follows. Net interest expense of 35 to $38 million. a full year tax rate in the range of 14.5 to 15.5%, the net impact of our share repurchase program in 2021 that will result in an average diluted 2021 share count of 61.5 to 62 million shares outstanding. Over the course of the year, we will evaluate our share repurchase program and provide quarterly updates as appropriate. Rolling all this together and on a non-GAAP basis, full-year 2021 earnings per fully diluted share are now projected in the range of $9.85 to $10.05, which assumes a positive currency impact on full-year earnings per share growth of approximately three percentage points. Looking at the second quarter of 2021, we expect constant currency sales growth to be 14% to 16%. At today's rates, currency translation is expected to increase second quarter sales growth by approximately three percentage points. Second quarter non-gap earnings per fully diluted share are estimated to be in the range of $2.15 to $2.25 as the significant prior year COVID cost savings actions start to normalize. At current rates, the positive currency impact on second quarter earnings per share growth is expected to be approximately one percentage point. Now I'd like to turn it Back to Udit for some summary comments. Udit.

Thank you, Mike. In summary, there is much to be pleased about with our first quarter results, driven by strong growth across each of the major end markets with pharma leading the way. Thanks to solid execution and double-digit growth in instrument sales, we saw broad-based revenue growth across every region, with China's sales more than doubling. Our transformation plan is well underway with commercial momentum and a strong leadership team in place. We now turn towards developing a new strategy as we work more closely to align our portfolio with higher growth areas of the market. With that, we will now begin the Q&A session. Operator?

And our first question comes from Dan Brennan, UBS. Sir, your line is open. You may go ahead.

Great, thank you. Thanks for the question, and congrats, obviously, on the strong start to the year. Maybe just looking at the guidance, Udit, if you don't mind, I know you talked about six less days in the fourth quarter and tough comps, but nonetheless, after a strong start and a good second quarter guidance, your full-year guidance doesn't apply, something on the order of 1% growth in the back half of the year. So maybe could you just tease out a little bit, like what's going on with the back half, like how much are you still assuming the pandemic is with us, Just any further color there, because I would expect that will be a question that we're going to be getting.

Firstly, thanks, Dan. And good morning. Look, we're very pleased with the first quarter. And as we look at the rest of the year, I mean, as Mike also mentioned, the pandemic is still ongoing. That's the first consideration. Second, we saw pent-up demand be released in Q1. which had five extra days. So that grew our base quite nicely. And the second half has higher comps, which makes us prudent as we guide towards the full year. Now, of course, if our initiatives continue to do what they're doing and we see good execution there and the other end markets continue to improve, we would be on the higher end of that guide. So I think, to me, it's a prudent, or to use another word, wise guidance, which basically takes these factors into account.

Great. And then you talked a lot about new product launches, particularly on the LLC side. Is it possible to tease out a little bit in terms of what impact these are actually having? Again, really strong, 27% organic growth. But could you give us a flavor for kind of the impact on these new product launches and in the quarter and kind of what you're assuming kind of for the full year. And then if you can also make any comments on what you're seeing from the relative market share trend across LC and LCMS.

Sure. I think first on new products, I'm very excited about our whole portfolio across LC, across MassTech, across informatics. In terms of overall quantitation, I mean, I think as we look at the contribution, it's probably 2% to 3%. Is it a bit higher, a bit lower? I think you'd have to do very sophisticated math, but it's a 2% to 3% contribution. And that's quite impressive, especially on the LC side, given the launch has just took place. So for our HPLC, it was launched only in June of last year, smack in the middle of the pandemic, and that has had great uptake, especially in China, for general purpose HPLC. And then the Acuity Premier, the columns were launched last year, and we saw, I would say, absolutely terrific uptake. In fact, better than the Acuity launch originally. And then finally, as I look at the mass spec growth, I mean, our replacement initiative is doing well, especially with the launch of our renewed Tandem Quad portfolio. So really a lot to be excited about on the new product side.

And if I could speak one more, and just trying to obviously, you're up against an EG comp down 45 or thereabouts, but 100% growth. is certainly significant. Because how do we think about, you know, you were facing some unique challenges in China over the past couple of years in food and pharma. How do we think about the door, like what's kind of expected from here as we think about their full 2021 diet for China?

Yeah, Philip, I mean, super happy with China, especially given the pandemic is still not over. And our colleagues have really done a great job of implementing our initiatives, and some of that is contributing to the growth. I mean, it's terrific growth across all segments, especially pharma, which doubled, and then you saw industrial also grew very nicely. And academic and government was in the mid-70 percentages. So with that said, what I would argue is pharma is continuing to show strength. Industrial is also starting to get stronger, especially in the TA business. Academic and government on a stack basis still has some work to do, right? So we still want to make sure that we focus on it as the market recovers. And then I look at the portfolio side. Instruments grew very nicely, as you again saw from the prepared remarks. And the consumables portion of the business was in the mid-40s in terms of percentage growth. As I look at the implementation of our initiative that I mentioned earlier, they're contributing nicely. We singled out the food market in the past for commentary when we talked about transformation, so let me just comment on that. We saw incredible growth in the contract testing market for food, both in the government segment and with new customers. I remember I spoke about that when we talked about the transformation plan. And with the CDMO segment, some of our best performance is in China. And then finally, I have a lot to thank in terms of our leadership in China. We have a new leader in China and really a renewed focus on growth. That said, I would caution against taking two data points of recovery and saying that we have completely turned the business. We still remain focused, but I'm very happy with the start. Great. Thanks a lot. I didn't answer your question for the full year. For the full year, I think no reason to expect anything less than high teens in China, and that would be a very good stacked growth as well versus last year.

Excellent. Thank you. And thank you. Our next question is from Tyco Peterson, J.P. Morgan. Your line is open.

Hey, thanks. I want to follow up on the instrument growth. You know, 45% on a 90% confidence is pretty impressive. I'm just curious how much in your view was, you know, market heads up demand versus some of the stuff, you know, you're intentionally driving like the replacement cycle initiatives. You mentioned 2% to 3% from new products, so I get that. But how much came from new customer penetration, CROs, CDMOs? You know, the main question we're all going to get is kind of the sustainability of what you're seeing right now.

Yeah, yeah. So cycle, excellent point. And I think there are There are many things to be happy about on the instrument side, right? I mean, if we place more instruments, we get more consumer, we'll get more service down the line, and we saw a very nice recovery. It is a mix of everything, right? So we saw recovery with continued strength in pharma, but we also saw a nice recovery in industrials and also in academia. In terms of the contribution, our initiatives – have been doing extremely well. Our LC replacement initiative, and now we've added the mass spec initiative as well, is doing super well. And that is now being helped by the launch of RKH PLC and the QUT Premier, which are allowing us to focus both on the general purpose segment, but also on the UPLC segment. So it's very difficult to extract how much is coming from going and finding only replacement, and then how much is coming from the new products that are actually helping that conversation. So really added together, it's a very good performance. And also from a stacked comp basis, it's looking very good, as you've already commented. I mean, LC is doing very nicely from a 2019 basis, and Masspec is almost double digits on that front. So really, very happy with what we've been able to do with our initiatives. And then finally, on the CRO, CDMO area, I mean, we have had incredible, in fact, last Friday I was with incredible conversations with CDMOs, especially last Friday I was with the CEO of one of the leading CDMOs, and they perceive us as very strong partners to help them transfer methods for complex molecules. And this is something that has come more and more to the front and center globally as we talk to many of these customers. Of course, I mean, they're focused on cost, but even more importantly, they're focused on transferring these methods from originators. So I think the initiatives are doing well, but there's a lot more to do there. We've just – I mean, I would say in terms of penetration of our instrument space – We're 30% along the way on mass spec. I would say we're about slightly more than that on the LC side. So we still have fertile ground there to see more growth.

That's helpful. And then you mentioned the innovation board. I'm just curious, are there, you know, implications here in terms of how you're approaching R&D and what you want to spend at R&D? Should we assume kind of 6%, 6.5% sales is still the right bogey, or how do you think about that?

I think, Taiko, that question came up last time as well. We don't think of R&D in percentage terms. And being an engineer myself and now surrounded by people in the Innovation Board, we really look at the quality of the ideas. And if the quality of the ideas are good and we see a market opportunity, we will invest behind it. So let me give you an example. LCMS for diagnostics, right? worked very closely with the UK government on the COVID Moonshot Program, and we were able to develop LC-MS as a diagnostic tool for detecting pathogens. This is now going to be submitted as an RUO later mid-this year or later this year for research use only, at least initially, but we see incredible traction in that area, and we are investing behind it. So those are the kinds of examples that come to the Innovation Board, and if we see room to invest, we will. The second type of idea is where we invest our platforms, right? So I already mentioned from a commercial perspective e-commerce, but also taking the disparate data that exists in the organization and putting them into a data lake, right? So I would be loathe to tell you, hey, you know, this is the ratio that we're trying to manage. Of course, it's a cost-conscious organization, as you know, from the past. We will not do silly things. At the same time, if we see good ideas that have good bases, we will invest behind them. So I hope that's satisfactory.

okay yeah it is and then just lastly on the model i'm curious um five extra days could you quantify what that added in the quarter was that around 300 basis points and then as we look ahead to the second quarter you know given the uh you know tragedy unfolding in india i'm just curious how you're thinking about your exposure there uh in the second quarter let me comment on india and then i'll let mike comment on the the contribution of the extra days look i mean our heart goes out to everybody uh everybody who's going through the pandemic in india um

We have still seen our customers, as you can imagine, continue to produce small molecules and large molecules to address the challenges of the pandemic. And so our sales are tracking that. And we're heavily focused on the LC market in India, which is still the method of choice to release small molecules that India continues to produce. So we're seeing very good growth, very good access for our service engineers, despite the pandemic. I do expect it to be bumpy, but the underlying demand, as we look at the full year, I would expect to continue to rise. Mike, on the extra days?

On the five additional days, it added about 3% of growth to our reoccurring revenues in the quarter.

And thank you. Our next question is from DJ Kumar, Evercore. Your line's open.

Hey, guys. Congrats on a really strong friend this morning. A clue from me, and maybe on the first one, I look at the guidance, the 2Q, 14% to 16% constant currency. Comps actually get easier for 2Q. If I look at the 27% you guys did in Q1, X days, it was about 24. So can you maybe just walk us through the 24 to, you know, perhaps 15, 16 for 2Q? Was there any timing element which, you know, pulled forward from Q2? Or is this perhaps, like you said, prudent guidance?

Yeah, I think, Vijay, you answered your own question. It's actually prudent guidance. I mean, given that the pandemic is still not over yet, There was a bit of pent-up demand that came also from last year into Q1, not a pull forward from Q2. And then finally, I mean, our initiatives are ongoing. They've shown incredible traction. We're very happy with what's happening. However, I think they still are getting traction, right? I mean, despite the pandemic, we've seen good traction for our LC initiative. We've seen good traction for e-commerce, where As you know, the page views have increased quite dramatically. We're seeing good traction in reaching out to new customers, but two data points don't make a full trend. So we're just being wise to use another word. I think that would be the answer.

Understood. And then another guidance question. I guess simplistically, you guys beat Q1 EPS by about $0.70, and the annual guide was raised by about $0.50. Is there, I guess, you know, from an expense standpoint, is this also perhaps prudent, you know, from an OPEX perspective, or is there something else going on on the spend perspective? And, Mike, on the Q1, 300 basis points contribution from extra days, should this be a 300 basis headwind in Q4, given the fewer selling days? Thank you.

Mike, go ahead.

Yeah, so... From an EPS perspective, one thing to remember here is last year with the pandemic, we put in place many cost actions. For example, salaries were reduced, furloughs were put in place, spending was reduced against families throughout the corporation. We're going to experience a huge normalization the rest of this year that will mitigate the growth of the EPS. Said it another way, there's a ton of normalization that needs to happen this year. As far as the gross margins, this margin, there was so much volume that led to a ton of operating leverage. So that will mitigate itself the rest of the year because of that normalization that I mentioned. So I would expect for the full year, we're going to get back to the 57.5% to 58%, but I don't expect it to be inconsistent with the past.

Gotcha. Sorry, on the days, is that a 300 basis points headwind in Q4?

Headwind? That would be about a 3%.

Understood. Thanks, guys.

Thank you. Our next question is from Derek Dubron with Bank of America.

Hey, thanks. This is Mike Ruskin on for Derek. Appreciate you taking the question. I want to follow up on some of your comments earlier, Udit, on sort of the instrument growth you saw in the quarter, and you gave a lot of remarks on how you were able to drive some of those upgrades and replacements. I'm just wondering if you could comment, you know, how many of those were competitive or replacing existing products. And, you know, are you having a discounted drive upgrade there? Is there any bundling across the portfolio? Sort of what are the puts and takes of that program that's helping you make those gains besides the comps?

Yeah, sure. I think, look, it's virtually all of the above, but that said, look, let's start with, especially for LC, I mean, we have, we focus on solutions for our customers, and as we go in, the new products definitely help. Our KHPLC and the Acuity Premier especially help in having the conversation. Anything, and we started the program first with our own install base, then looking at the competitor install base, And the third step would be to look at everybody and anybody who's using Empower. So it's a pretty large pool, and we are just, I would say, one-third of the way with our own instruments in terms of getting that replacement cycle done. So there's a lot of room there. That said, the conversation is more straightforward. If you have new products, especially the RTH PLC, as well as the Acuity Premier, And then finally, given our reputation as a solid service company and our service engineers, absolutely help. So I think the answer is in your question. It's all of the above. For mass spec, we've also launched a similar program. And there, the success rates are absolutely terrific. We're going after our own installed base from a tandem quad perspective and replacing the older instruments with the newer generation of tandem quads that were introduced in 2019. Nice progress. Some of it is the market, but I think a significant amount is a renewed focus on the replacement cycle of older instruments, helped by new products, and a broader value proposition. As far as pricing and bundling, except pricing is concerned, we have not had to use a heck of a lot of pricing to make this happen. People trust the quality that Waters brings and the innovation that we're bringing to them to solve these problems.

Got it. Appreciate all that call. And then as a follow-up on the, you know, you mentioned the strategic review process, one of the areas you're thinking about is some of these faster growth adjacencies. Are there any opportunities here that you see organically, or is this sort of part of the strategic review that's only going to be handled through M&A? You know, obviously recognizing, again, the really good leverage position here.

All of the above, right? So we will have organic opportunities. We will have partnership opportunities, and we will look at inorganic options as well, right? So all of the above. From an organic standpoint, I can give you examples. We think the molecular diagnostics space is interesting, and LC-MS is right to get into that space. We've made really serious progress in working closely with many academics in the U.K. and the NHS. to take LC-MS into their diagnostic space for pathogens with COVID-19. We also worked with folks in Sweden on the same topic, and we will introduce LC-MS as a research-use-only technique rather in the near future. So organically, we see tremendous opportunity as well. And another example would be entering bioprocessing. We're looking at partnerships with leading academic institutions and many of our partners to take LC-MS into the bioprocessing suite and not just leave it in the QA, QC space where we still have room to grow. And then finally, on inorganic areas, we are looking at that very, very carefully, and there will be more to say about it as time progresses. All of the above.

Thank you. Our next question is from Doug Schenkel with Cohen. Your line is open.

Hey, good morning, everybody, and thank you for taking my questions. I want to ask one end market question and then one guidance question on the end markets, specifically industrial cyclical. Recognizing all end markets were pretty solid, I'd love to hear more about what you're seeing in terms of the pickup in cyclical demand and How does that evolve over the course of Q1, and are there signs that demand is picking up in a sustainable way that, you know, meaning this just isn't a catch-up, it is actually a function of global economic improvement? And if you're seeing signs of that as exemplified by things like backlog, you know, are there certain geographies where this is more or less notable? So that's the first topic. A second topic is just, again, sorry to go back to guidance, but specifically below the top line as we think about operating spend. When I look at our model for Q1, R&D and SG&A together were about $10 million below our forecast. And I think we were the high on the street for revenue, and you came in $50 million above our forecast. So that was really nice leverage in the model. I'm just wondering, was there any holdback on investment in the early part of the year just given all the uncertainty, because it doesn't seem like you're looking at this as the new normal. I say that because it seems like guidance assumes there's going to be an increase in operating investment moving forward over the balance of the year, which I think makes sense given the strength in your business and some of the initiatives you talked about in your prepared remarks. So I guess I'm just hoping you can provide some clarity there. It seems like Q1 operating leverage isn't the new normal just because you want to invest. I just want to make sure we got that right. Thank you.

Excellent questions, Doug. First, on the other two end markets, industrial and academic and government, I think you rightly note that it is one quarter, and we are seeing a nice rebound. I'm cautious here, right? So we're seeing good conversations with our customers, but the industrial end markets are disparate, right? I mean, They go from polymers to semiconductors and other areas which inherently are cyclical. We're seeing good demand for hardware, especially on the CA side. But that said, I would say it's one quarter. We're seeing good conversations. I would not start to immediately extrapolate, and this is why we're a bit cautious on the guidance. On a stacked growth basis, when you look at specific regions, I mean, China is almost 20%. Europe is in the mid-teens in industrial, and the U.S. is mid-single digits. So even on a stack basis, this is a good performance on the industrial end market, but largely driven by a lot of hardware spend. Now, on academic and government, which is also cyclical, I know you were not asking in particular, but I'll take the opportunity to comment on this already. We saw very good growth, I mean, 29% growth overall, largely driven by what we saw in China. And Europe continued its strength, close to 70% growth. The U.S. is still spotty and recovering on a stacked basis. There's still work to do on China and the U.S. I mean, both are still not positive versus 2019. Europe is. So I think industrial, a little bit more confidence in the overall trend. The academic and government were seeing slow return back into the different labs, more so in Europe. definitely in China, but still a bit of a hill to climb, and U.S. is probably across the country. If I move to your guidance question, I'll first give you the qualitative remark, and then Mike can comment on the numbers as well. We're not holding back any investment, Doug. I mean, in fact, if you look at... how much we have approved in terms of operating investment. It's fairly significant in Q1 to start to support our initiative that we already mentioned, so expanding our field force in contract testing, having more informatics folks to build up Waters Connect even further, and to invest behind our R&D programs. I mentioned LCMS already, and there are several others. It's just a question of the recruiting cycle taking a bit of time and people finding the right people and getting them into the system. So really not holding back there at all. Mike, do you want to comment on the numbers?

Sure. I will just add, you know, with the strong customer demand that we're actually seeing, we have started to make the investment into the P&L, but all of those expenses just haven't hit our Q1 P&L. So you are going to see some increased in-expense as we move through the rest of the year that catches up with these initiatives that Udit was referring to. This is a gated process. We do look at each of the products' initiatives, depending on what it is, and we have a gated process that we make sure it makes sense before we actually start the process. So it is a gated process, and we will expect the leverage to be not as good as it was in Q1 the rest of the year.

And then I think one closing remark on that, Doug, just reminding you how we talked about the transformation plan. We said, look, we want to get our top line growth back first. This is such a great business and such a good install base. There's tons of leverage in the P&L that allows us to invest without any dilution. And you're seeing the sustainability of the business as we recover our top line. And it's not just Versus last year, Q1, it's also on a stacked basis across many different segments and geographies.

Thank you. Our next question is from Brandon Creelard with Jefferies. Your line is open.

Hey, thanks. Good morning. In terms of some of your e-commerce initiatives, are you starting to see any incremental pull-through in terms of consumables revenue that – that you have quantified and kind of what's next in terms of the e-commerce strategy and some of those initiatives over the balance of the year.

Thank you. I mean, e-commerce basically with just search engine optimization and paid search, we saw a 45% increase according to our own numbers, and I know you look at it independently as well, on the number of eyeballs coming onto our site. It's very difficult to translate that, as you know, into the exact numbers. impact on revenues, so I won't attempt that, but you can imagine the largest impact is on the consumable side. And especially with newer products, it's worked out extremely well having the ability to drive more people onto the channel, find out more information, leading to purchase and a great uptake for our Acuity Premier launch. Now, in terms of the overall plan for e-commerce, I mean, this is just the start, right? So remember I said early on that we want to take the hand we have and do the best we can with it at the beginning as we make our plans to revitalize our platforms. And I mentioned a couple of those investments in the previous question as well. So we do believe that investing in a data lake that takes all unstructured and structured data from different parts of the organization and putting that into an easily accessible middle layer will help us service our e-commerce customers better. We do believe investing in content even more is going to lead to better conversion on the e-commerce channel. We do believe investing in mobile is going to lead to a better conversion. So you can see that there are some infrastructural investments that we have started to look at. And as the organization becomes stronger and stronger, you'll start to see us invest in those. So the e-commerce plan, as a few phases, the first one was just to get the quick wins, and we're not done with that yet. That's just a start. And there is a long-term plan that will build a world-class e-commerce platform for waters. Hope that helps.

And thank you. Our next question is from Patrick Donnelly with Citi. Your line's open.

Great, thanks. Just wanted to follow up on one of the earlier questions about the capital deployment side. it seems you're a bit more open about pursuing some inorganic opportunities. Can you just talk about the size that we should be thinking about, how large you guys would go, and then, again, what verticals make the most sense for you guys to pursue inorganically versus the organic investments you recommend?

Patrick, you know that I won't talk too much about the size and the exact ideas and the exact domains. I mean, in general, you can assume that – The part of the market we are in is a good mid-single-digit grower. I mean, we have a bit of catch-up to do, so you'll see us doing better than that in the short to mid-term, given the initiatives we've put in place and the market share we want to climb back and gain. So I think that will be the first lift. As you look at adjacencies, there are ones that fundamentally go faster, like molecular diagnostics, like bioprocessing and bioreagents, and we are looking at each of those categories to see how we can organically enter those, how we can do partnerships, and also looking at inorganic ideas. I mean, the process has begun, and we will hear more about it as we progress further with concrete ideas.

Thank you. Our next question is from Josh Waldman with Cleveland Research.

Hey, guys. I wondered if you could provide more color on the replacement initiative. I guess, you know, one inning, do you think we're in here? And I think I remember you previously saying there were about 8,000 systems that you were targeting. Is this still how you're thinking about the opportunity, or has that number gone up? And then I guess lastly, do you think it's driving replacement of only your systems, or at this point are you seeing it replace maybe competitor systems? It just seems like growth of 40% in the LC business is probably representing share gains.

Yeah, thanks for picking that up, Josh. Look, LC, the 8,000 number was, HPLC and UPLC only, and especially only Waters instrument. And when you talk about innings, if you're talking about baseball, probably we're in the third inning. There's a lot more work to do and a lot more to pick up there. And we haven't done that in the past. We haven't replaced our own instrument. So, I mean, we are going in and it's working out super well, especially with the new products. being available as well, both on the HPLC side and the UPLC side. So we're very happy with where we are there. To your question on competitor instruments, definitely that's the second step. And then there's a third step. Everybody and anybody who's using Empower, that probably also hits the competitor side. So there's a large installed base, and any time somebody's trying to replace an HPLC or UPLC, you should expect Waters to be in that conversation And this is especially important given that Empower is installed as the most ubiquitous CDS system. So we are going to leverage the strength of Empower to try and make sure that we have a seat at the table virtually everywhere. The second thing that I wanted to add is from an instrument perspective, don't forget Masspec. Masspec also has an older army of instruments that we've sold over many years. And there, too, we completely renewed our tandem quad portfolio in 2019, and we're using that to get in and have conversations with our customers. So that probably is in your baseball analogy in the first innings, and that's also started off very well. So expect to hear more as the year progresses, and we do intend to make sure that that continues and gets tracked very carefully. And the last piece on that that I'll add, this is also to a previous question on the areas we're investing in, We've been invested in basically collecting all the data that we have on the install base, be it power-based, be it instrument-based, and, of course, to automate it and to make it readily usable, you need to invest in technology, and that's what we're doing. So I hope that gives you more knowledge.

And thank you. And our last question today comes from Catherine Schulte with Baird. Your line is open.

Hey, guys. Congrats on the quarter, and thanks for the questions. I guess first, Uta, you made a comment in your prepared remarks on the CRO and CDMO side that your customers view you as a collaborator rather than a competitor. Now, just given some of the M&A we've seen in this space, do you think that's a concern among customers that some of the analytical instrument providers are increasingly becoming customers, and do you see this as a competitive advantage that you can take advantage of?

Yeah, I mean, we're definitely hearing that. I mentioned conversations I've had with heads of CDMO organizations. This is front and center. I mean, they view us as a collaborator who they can trust with their methods, with their ideas. And I think this is something that we're definitely hearing. And we intend to take, we intend to service our customers accordingly, right? So I think you heard right. And I mean, especially I would even argue, especially given Waters' technical strength and unique focus on science and technology, they view us as people who can help them transfer methods, get deeper with them into technical conversations and are not worried about us competing or using their technology for our own purposes. I would say quite a benefit, but two drivers. One might be what's happening in the competitor universe, but The other is our own reputation as a strong, scientifically-based organization. At this point, I want to thank you for your participation and questions. And on behalf of our full management team, I'd like to thank you for your continued support and interest in waters. We look forward to updating you on our progress during our Q2 2021 call, which we currently anticipate to hold on August 3rd, 2021. Thank you all.

And thank you. This does conclude today's conference. You may disconnect your lines and thank you for your participation.