Waters Corporation

Good morning. Welcome to the Waters Corporation third 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. The conference call is being recorded, and if you have any objections, you may disconnect at this time. It is now my pleasure to turn the call over to Mr. Casper Tudor, Manager of Investors Relations. Please go ahead, sir.

Thank you, Operator. Good morning, everyone, and welcome to the Waters Corporation third 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 potential market and business conditions that may impact Waters Corporation over the fourth quarter for year 2021 and 2022. We caution you that any and all such statements are only our present expectations and 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 31st, 2020 in part one under the caption risk factors. And in our most recent quarterly report on form 10Q for the quarter ended July 3rd, 2021 in part 1A under the caption risk factors, both of which are on file with the SEC, as well as the cautionary language included in this morning's press release, including with respect to risks related to the effects of the 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, whereas otherwise required by law. The next earnings release call and webcast is currently planned for February 1st, 2022. 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 issues this morning and in the appendix of our presentation, which are 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 and in the appendix of our presentation. Unless stated otherwise, references to quarterly results increasing or decreasing are in comparison to the third 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, Kasper, and good morning, everyone. Along with Kasper, joining me on this morning's call is Amol Chobal, Waters Senior Vice President and Chief Financial Officer. We have reported another quarter of strong, broad-based momentum across our portfolio and geographies. We first thank our over 7,000 colleagues around the globe who represent the indomitable spirit of Waters. Our teams have remained focused on supporting our customers and developing and delivering exciting new products despite the continuing impact of the pandemic. September 1st marked one year since I joined the company and what a year it has been. I'm often asked what is different. I would first like to talk about what is the same because that is what is giving us the ability to compete more effectively. Our brand stands for deep scientific expertise clear understanding of our customers' challenges and courage to invest in game-changing innovation. This remains the same. What we have injected with our new leadership team is a stronger focus on execution, a sense of urgency and accountability. We are a work in progress, but the trend is positive. Now moving to slide three, which summarizes where we are on our journey. Firstly, we're sustaining our commercial momentum with another strong quarter, delivering stacked sales growth of 6%, showing solid business performance with minimal COVID ailments. Meanwhile, our commercial initiatives and strong traction of new products like Premier Columns and Instruments and RKH PLC were well positioned to deliver market-class growth through 2022. Finally, we're building on this momentum by taking decisive steps in solving key problems that are present in higher growth adjacencies like biologics manufacturing. I will now provide a brief overview of our third quarter operating results as well as commentary on our end markets, geographies, and technologies. Amol will then review our financial results in detail and provide comments on our updated financial outlook. We will then open up the phone lines to take your questions. Moving now to slide four, In the third quarter, our revenue grew 11% as reported and on a constant currency basis, reflecting continued strength in our pharma and industrial end markets with balanced demand for our instruments and recurring revenue products. This translates to a 6% stacked CAGR for the quarter versus 2019 on a constant currency basis. Year-to-date, revenue has increased 21% with a constant currency stacked CAGR versus 2019 also above 6%. Our top line growth resulted in Q3 non-GAAP adjusted earnings per share of $2.66, growing 23% year over year. Year to date, non-GAAP adjusted earnings per share have grown 39% to $7.54. Looking more closely at our top line results for the quarter on slide five, in constant currency, first by operating segment, the water division grew 9%, while DA grew by 27%. By end market, our largest market category, pharma, grew 16%, industrial grew 9%, while academic and government declined by 11%. In pharma, we saw a broad-based, continued strength in sales across customer segments, geographies, and applications. Strength was both in small molecule and large molecule applications, which both grew in mid-teens for the quarter. Industrial growth was regionally broad and led by our TA business, which saw strong growth globally in thermal, microcalorimetry, and rheology. Turning to academic and government, which is about 10% of our business, continued strength in Europe was offset by software performance in China and other regions. Moving now to our sales performance by geography, on a constant currency basis, sales in the Americas grew 16%, with the U.S. growing 13%. Sales in Europe grew 8%, sales in Asia grew 8%, with India over 40%, and China sales were down 3%. Now to a bit of clarification on China. Demand remains very healthy, as does the execution of our initiative. A shipment of approximately $12 million got delayed at an airport in the last few days of the quarter due to a third-party shipping issue and has been delivered in the first few days of the fourth quarter. Looking, therefore, at China orders for the quarter, this was up mid-teens year over year, so really no challenge from a demand perspective. In the U.S., growth was led by a broad-based continued strength in our pharma and industrial air market. In pharma, we saw strength across our instrument and chemistry portfolios. In industrial, our waters and VA businesses both saw strong growth. In Europe, demand remains robust across all end markets with continued strength in pharma, industrial, and academic and government. For the quarter, India was our fastest growing market, driven by very strong growth in instrument sales to our pharma customers. As you know, India is primarily a small molecule and generic market for export, and this is indicative of continued strength in global pharmaceutical demand for small molecule drugs. By products and services, customer demand for our instruments remained strong after an impressive first half of the year, while recurring revenues also continued to see sustained growth. Overall, instrument sales grew 10% for the quarter, driven by robust demand, our improved commercial execution, new product contribution, and instrument replacement. In LC, the newly released ARC HPLC continue to see strong growth and uptake of our premier instruments, both ARC and Acuity, especially for applications in novel modalities like mRNA and biologics, remain solid. The strength we are seeing in our LC instrument portfolio remains a positive indicator for sustainable future growth in consumables and service. In mass spec, demand strength from pharma customers continued, with strong demand for our single quads, led by users for oligo and biologics purification, as well as strength in our tandem quads used in late-stage product development. We're also encouraged by early interest in our select series MRT time-of-flight platform, which delivers highest quality resolution at fast speeds. Now for our recurring revenues, Chemistry sales grew 13%, driven by an increase in utilization of our pharma customers, as well as strength in our industrial end markets. Demand for our new premier columns remains strong, while our e-commerce initiative is progressing and making it easier for our customers to do business with us. So far this year, our chemistry consumables have grown almost double digits when compared to our 2019 base. We're pleased that our premier technology continuing to provide important benefits in separation and purification of mRNA and oligonucleotide molecules, given its unique ability to reduce selective binding of plasmids and mRNA to various surfaces. Service also grew double digits again this quarter, even as last year's comps have become tougher. On a two-year fact basis, service grew 7% in constant currency for the quarter and 6% year-to-date. By focusing on our value proposition and commercial execution, we have seen an increase in service plan attachment rates and plan renewals. Finally, TA had a great quarter, with sales up almost 30% as demand has rebounded, with strong growth across all regions. TA instrument sales have grown at 8% on a two-year stack basis so far this year, driven by strong demand for our thermal instruments used in the analysis of advanced materials, as well as microcalorie instrument demand for our pharma and academic customers. Moving now to slide six, let me now focus on why we believe that we will continue to deliver market-class growth. I think you are used to seeing these initiatives, so let me use the same frame. Starting from the left-hand side of the slide, in 2021, we expect our instrument replacement initiative to deliver over $30 million in revenue. In 2022, we expect this to become over 40 million, which means an incremental 10 million over 2021. Our focus on commercial execution is positively impacting our service business with planned coverage rates having increased by 2% so far this year compared to the first three quarters of 2019. In 2022, we think a further 100 basis points of expansion in service plan adoption is attainable. Growth in e-commerce adoption also remains strong with chemistry sales through our e-commerce channels approaching roughly 30% versus the 21% we saw in 2019. We expect this to continue reaching over 35% by the end of next year. So far, this year revenue from contract organizations has grown over 40% versus the comparable period in 2019. Next year, we expect this to grow low double digits for the year versus 2021. And new products continue to do well. We are just taking the example of ARK HPLC and Premier to illustrate the point here. Both ARK HPLC and Premier continue to be strong drivers with over 45 million revenue expected from these sources for this year in total, and separate to the replacement initiative. 2022, we are expecting this number to be over 60 million. So in all, these initiatives alone should give us approximately 1% over our base business growth for 2022, which reaffirms our belief in market-plus growth rates. Moving now to slide 7, we operate a strong core business in healthy and durable end markets. This strong foundation provides us a platform for solving critical problems facing our industry where we can bring our scientific expertise and product portfolio capabilities. In the biologics arena, on the reagent side and bioseparations, we believe there are significant problems to solve in separating and purifying these newer modalities. Having a deeper understanding of reagents coupled with our chemistry expertise will allow us to solve these problems. Second, in bioprocessing, The largest challenge I felt as an engineer in bioprocessing versus small molecule processing was that once you defined the process, you got stuck with it because it was in the drug master file. We have to decouple the process from the product. Separately, the process development timescales are longer versus small molecules given the sheer complexity of attributes you need to measure. A simple and robust tool that can measure multiple attributes is a potential solution. We believe that the BioCord is the right LC-MS tool that can begin to address this challenge. Third area is diagnostics, where we need a fast, unbiased detection of multiple biomarkers to enable early disease detection. We believe, again, mass spec has a significant role to play here. Moving now onto slide eight, let me illustrate what I mean by sharing what we are doing to solve some of the key problems in bioprocessing. Last week, we announced a partnership with Sartorius, a leader in bioprocessing, Our water biocore system has a bioprocess analyzer with Sartorius amber bioreactors, giving scientists both faster and at-line direct access to advanced quality characterization information. Scientists across Sartorius, Waters, and some of our customers have already shown that the combined offering will shorten product development timelines considerably, taking what currently takes six weeks to analyze down to only two days. It also lays the foundation for using the BioAccord as a bioprocess analyzer for process control and quality testing in the future. BioAccord is both versatile and easy to use, and we expect that process engineers will be able to master its operation within one to two weeks. In fact, one of our customers had summer interns use the BioAccord and gave raving reviews on how simple it is to use. I'm also an engineer who has been out of the lab for many years, and I was able to learn quickly. Resulting configuration will allow direct analysis of drug substance, not just cell culture media, by targeting over 250 cell culture media analytics. Separately, we also announced a multi-year collaboration with the University of Delaware to develop technology for analytical characterization of manufacturing processes for biologics and novel modalities. Through these partnerships, researchers from both Waters and the University of Delaware will identify and develop solutions that can provide better aseptic sampling, make sensor and analytical instrument improvements, and develop data analytics and process control. This partnership will help us expand our capabilities to characterize biological manufacturing processes in order to drive improvements in quality, yield, efficiency, and process control. 2021 so far has been a very successful year for Waters. We are laser focused on our commercial execution. The markets we serve are in a healthy state and our geographic regions have rebounded solidly from pandemic lows. Meanwhile, I'm convinced of the great opportunity that lies ahead of us in higher growth adjacencies to impact and deliver value by extending our scientific expertise, and product portfolio towards helping customers solve the most complex problems in our industry. With that, I'd like to pass the call over to Amol for a deeper view of third quarter financials and our outlook for the remainder of 2021.

Amol? Thank you, Udit, and good morning, everyone. As Udit outlined, we recorded net sales of $659 million in the third quarter, an increase of 11% in constant in currency. reported sales growth was also 11%. Looking at product line growth, our recurring revenue, which represents the combination of chemistry and service revenue, increased by 11% for the quarter, while instrument sales increased 10%. Chemistry revenues were up 13%, and service revenues were up 10%. As we noted in our last earnings call, Recurring revenues were not impacted by a difference in calendar days this quarter. Looking ahead, there are six fewer days in fourth quarter of this year compared to 2020. Now I would like to comment on our third quarter non-GAAP financial performance versus the prior year. Gross margin for the quarter was 58.9% compared to 55.8% in the third quarter of 2020. improvement was driven primarily by volume leverage and revenue mix. The foreign exchange benefit in the quarter was about 1%. Moving down to P&L, operating expenses increased by approximately 17% on a constant currency basis and on a reported basis. The increase was primarily attributable to higher labor costs due to the normalization of prior year cost actions, as well as higher variable compensation on the higher sales volume. In the quarter, our effective operating tax rate was 11.7%, a decrease from last year due to some favorable quarter-specific discrete items. Excluding the impact of these discrete items, our year-to-date tax rate is consistent with the prior year. Our average share count came in at 61.9 million shares, or about 400,000 less than the third quarter of last year as a result of our share repurchase program. Our non-GAAP earnings per fully diluted share for the third quarter increased 23 percent to $2.66 in comparison to $2.16 last year. On a GAAP basis, our earnings per fully diluted share increased to $2.60 compared to $2.03 last year. A reconciliation of our GAAP to non-GAAP earnings is attached in the press release issued this morning and in the appendix of this presentation. Turning to free cash flow capital deployment in our balance sheet, we define free cash flow as cash from operations, less capital expenditures, and excludes special items. In the third quarter of 2021, free cash flow was $140 million after funding $40 million of capital expenditure. Excluded from the free cash flow was $12 million relating to investment in our content precision chemistry operations. Year-to-date, free cash flow has increased to $488 million and at approximately $0.25 of each dollar of sales converted into free cash flow. In the third quarter, accounts receivable, BSO, came in at 71 days, down five days compared to the third quarter of last year, and down two days compared to the last quarter. Inventory DIO decreased by 13 days compared to the third quarter of last year. Given the higher sales volume and our proactive measures to secure supply, inventory increased by 62 million in comparison to the prior year. We maintain a strong balance sheet, access to liquidity, and well-structured debt maturity profile. In terms of returning capital to shareholders, We repurchased approximately 369,000 shares of our common stock for 151 million in Q3. 958 million with net debt to EBITDA ratio of about one. Our capital deployment priorities are to invest in growth, maintain balance sheet strength and flexibility, return capital to shareholders, and to deploy capital to well thought out, attractive, and adjacent growth opportunities. As we look forward to the remainder of the year, I would like to provide you with some update on our thoughts for 2021 on slide 11. Throughout this year, we've seen good momentum driven by robust end market demand and strong commercial execution. We believe that this momentum will continue and expect our near-term growth initiatives to continue to contribute meaningfully to our performance. Looking at the fourth quarter, the comparison is more challenging, as it was the first quarter in our transformation journey and was further favorably impacted by post-lockdown elevated year-end budget plus spending. In addition, we have six fewer calendar days in the fourth quarter of this year. This dynamic supports raising full-year 2021 guidance to 15% to 16% constant currency sales growth. At current exchange rates, the positive currency translation is expected to add approximately one percentage point, resulting in full-year reported sales growth guidance of 16% to 17%. Gross margin for the full year is expected to be approximately 58% to 59%, and operating margin is expected to be approximately 29% We expect our full-year net interest expense to be $34 million and full-year tax rate to be 14% to 15%. Average diluted 2021 share count is expected to be approximately $62 million. Our share-rich purchase program will also continue into Q4 and will provide quarterly updates as appropriate. Rolling all this together on a non-GAAP basis, full year 2021 earnings per fully diluted share are now projected in the range of $10.94 to $11.04. This includes a positive currency impact of approximately 2 percentage points at today's rate and assumes no material adverse supply impact from COVID. Looking at the fourth quarter of 2021, we expect constant currency sales growth to be 5% to 7%. At today's rates, currency translation is expected to subtract approximately two percentage points, resulting in a fourth quarter reported sales growth guidance of 3% to 5%. Fourth quarter non-GAAP earnings for fully diluted share are estimated to be in the range $3.40 to $3.50. This includes a negative currency impact approximately 3 percentage points at today's rate and assumes no material adverse supply impact from COVID. Now, I would like to turn it back to Udit for summary comments. Udit?

Thank you, Amol. Before I wrap things up, I would like to make a few comments on our ESG efforts and our core principles to fuel innovation and make a positive impact. It includes doing our part to reduce our environmental footprint and leave the world better than we found it, being representative of the diverse society we live in and providing effective governance that enhances long-term shareholder value. You will see more of our progress in each of these areas in our 2021 sustainability report coming out later this month. Turning to slide 10, I was particularly moved recently by the new internship program we developed with Team New England designed to increase access to STEM education for students of all backgrounds. Over the course of six weeks, we gave high school students a hands-on learning experience with a mix of science, business, and soft skills. Over 70 Waters employees were involved, who gave practical exposure and mentorship. We look forward to continuing these efforts in the future. In summary, we continue to be pleased with our performance this year. We're sustaining our commercial momentum with our initiatives, which continue to perform well and should provide a multi-year benefit as we continue to strengthen our core. We're continuing to track 6% on a two-year CAGR for our revenue in constant currency, showing that our core is strong. We're focused on accelerating innovation to our portfolio and reaching these higher growth rate areas in a case in mind. With that, we will now begin the Q&A answer session. Thank you.

Thank you. Our first question is from Dan Brennan. Alan, your line is open.

Great. Thanks, guys. Thanks for the call. Thanks for the questions here. Maybe first off, Udit, just on 2022, you provided some early look here with some of the drivers in terms of how they're going to impact. I'm just wondering, as we think ahead, given the comp you're coming off of for 2021, What's the right way to think about, you know, the early look for 2022 here? Consensus had you growing organically about 5%, which would imply a pretty nice acceleration on a two-year stock basis.

Thanks for the question, Dan. Look, first, just to this year, I mean, we're tracking at a 6-plus percent sort of stock growth rate. So, really, the base business is doing rather nicely. And we would feel that the transformation is now hitting its stride, so the base business should continue to track along those lines now. We've always said market plus, and what gives us conviction that it's going to be market plus is the initiatives that we've outlined, including the replacement, including additional penetration in different channels, and better launch of new products. So wherever the market is, we expect to be market plus given the initiatives And in terms of what you should expect for next year, again, the same logic applies, right? If the market is four, we should be four plus. If it's five, we should be five plus. And if it's six, we should be six plus. Now, there's no reason to believe that the market should slow down. All our end markets are doing super well. I mean, you saw that year to date, both pharma and industrial are tracking close to 20% on a two-year basis. They're well ahead of what we've seen over the history of water. So, We're going into the next year, and we have concrete initiatives that make us believe that we should be market-plus.

Great. And then just maybe as a follow-up, you've been at the helm about a year-plus right now. Obviously, you've outlined some areas for improvement, which you've actually cheated on in terms of new product, commercial execution, customer identification, where you were lagging. How do you think about the evolution of your impact on the business? Should we expect at some point here as we enter 2022, that there's going to be possibly a new wave of kind of initiatives, just kind of thinking through what the next leg is for Waters. And related to that, just wondering how M&A kind of fits into that. Thank you.

Thanks for the question. First, we have to make sure we do more of the same, right? I mean, and that I feel really good about, especially with the leadership of John Pratt and Jian Cheng really executing even further on our initiatives. Second, feel very good about our ability to bring in new products to the market. They have tremendous, tremendous traction, right, especially the products that we launched recently, RTHPLC, the Premier columns, both adding significantly to the top line. And the MRT, the Select Series MRT, has a lot of interest from our customers across proteomics, across imaging, and across many different segments. So feel very good about what our pipeline is contributing, and there is more to come there. And finally, to your question on M&A, look, I mean, we've outlined the areas of growth we are interested in, and I think what you will see is that we're not just interested in entering these areas willy-nilly. We are really thinking hard about what are the key problems to solve, right? So as an example, with bioprocessing, As an engineer and freshly minted after finishing my PhD, days into my new job, I was ushered into a manufacturing plant where we were still manufacturing vaccines using chick embryo eggs. So I sat with eggs, opening them up, and I won't tell you the rest of the process. The process was designed many, many years ago, probably decades ago. And that's how MMR vaccines are still manufactured today. why we have much better technology in cell culture to be able to manufacture the same type of vaccine. And the reason for that sort of conservatism is that the process and the product are indistinguishable in the drug master file that you file for biologics. And that's something that we really want to work on. We believe that our collaboration with the University of Delaware will help us make strides in that direction. And I'm super excited about what we just announced with Sartorius. I mean, Sartorius is a leader in bioprocessing, and they have probably the deepest penetration of small early-stage bioreactors that are used for clone selection. And that collaboration has two benefits. One, we're able to take the bio accord and improve a process that takes about six weeks from down to two days. And that's been shown in collaboration with Sartorius scientists and our scientists, as well as as well as customers, so very excited about that. There are several hundred amber bioreactors out there, and so we hope to be able to take advantage of that. And then secondly, it opens up for waters a higher growth area where we would have not otherwise entered. I mean, in this case, we want to enter with the capabilities that we possess, so feel extremely good about the initiative. So in summary, continuing the commercial momentum, second, recharging innovation, and third, looking to enter these faster growth areas through first partnerships and increasingly open to M&A if it makes sense. But I remind you that for M&A, we are a financially disciplined company, so you won't see us jumping in headfirst into something that doesn't make sense.

Thank you. Our next question is from Tycho Peterson, J.P. Morgan.

Thanks. Udit, maybe I'll start with China. You noted the $12 million shipment delay. It doesn't sound like you're flagging any demand issues, but I'm just curious if you could elaborate a little bit on what you're seeing in that market and then any comments on supply chain. Obviously, there's a lot of focus on that in the current environment.

So, Taiko, thanks for the question. Look, China year-to-date is over 30% growth, only second to India in organic growth. From a demand perspective, For the quarter, we were up mid-teens. And unfortunately, the shipment got stuck in the last few days of the quarter, which made it to our customers now. And if you included that into the Q3 numbers, it would be high single digits to low teens for China growth. So really nothing to flag from a China perspective. In fact, I would say I'm very happy with our new leader in China who's been implementing initiatives really, really well. RKHBLC has great traction. We have built really strong commercial momentum even in our food and environmental markets, smart specs doing super well. So we're extremely good about where we are in China. So nothing really to flag from a demand perspective. And on your question on supply chain, look, like everybody else, in fact, like everybody else, we are seeing constraints in shipping. in different ports that appear sporadically. We don't think it's a systemic issue, it's a sporadic issue. And we're not unique in experiencing those challenges. In fact, I was with a few colleagues from different industries last week, and virtually everyone is experiencing sort of a little bit of unpredictable changes in supply chain. So we're not immune to that, and I think if somebody tells you that they are, They're probably not shipping as much. And then the other two pieces of the supply chain that are being talked about a lot are inflation. We do see inflation specifically in U.S. labor, but nothing we haven't been able to offset by price increases with our customers. So hopefully that gives you enough color on how we feel. So China, really nothing to flag, no problem at all. From a demand perspective and from a supply chain perspective, feeling what everybody else feels, really happy with the way our teams are working to surmount these issues and passing on prices where it makes sense to our customers.

Okay. And then for the follow-up, academic government, it's only 10%, but it was down 11%. Can you maybe just touch on what you're seeing there, and do you expect that to turn into the fourth quarter with the budget flush?

I looked at it. For AMG, I mean, we grew year-to-date. We're growing roughly 6%. And if you look at the consumables revenue, that's tracking nicely. So there's activity across our customers that's tracking in double digits. So recurring revenues are still growing double digits like with other end markets. So nothing to sort of point out systemically overall if you look at the market. Now, the performance is a bit sort of... different by region. Europe's doing extremely well, whereas China and the U.S. are a bit slower. And that has to do with two reasons. One, as you pointed out, academic and government is a small portion of our business, and historically has not been a huge focus for Waters. We have, with John's arrival, we have started to increase our focus on that segment as well. And if you think about the instruments part of the business, that really depends on deep AOL relationships and customer relationships. And this, over time, has sort of slowed down in many markets. And in Europe, we've come out of the gates very well. We've started to reestablish those relationships, and you see the impact and the results here today. In the U.S. and China, that's a work in progress, and we'll give you updates as we go along. I'm optimistic with the activity I see, especially on e-commerce and e-procurement, and you see the results in our consumables business. And on the instrument side, with improving KOL relationships, I expect that to return as well.

And thank you. Our next question is DJ Kumar, Evercore.

Hey, guys. Good morning, and thanks for taking my question. Udit, one for you. The $12 million shipping delay in CQ, What segment did that impact? Was that instrument impact or government academia? And I'm curious, how do you risk this Q4 from any supply chain disruption? I'd be curious the visibility you have.

Similar to what I just said to Taiko, really nothing to be concerned about from a demand perspective in China. The 12 million have made it to the customers and it is a bit spread. It's basically all instruments. It's not any consumables. It's all instruments and it's made it to the customers. A bit spread across the different customer segments, pharma, industrial, as well as academic and government. So nothing sort of one segment feeling more pain. And in terms of how we're dealing with these issues, look, We have a superb supply chain department. We have extreme transparency on the shipments and the timing of the shipments. And we've started to build inventory where we see order spikes in the different regions. And so we feel that we should be able to manage to the volatility that we're seeing in different... It's helpful.

That's helpful. I did have one on gross margins. 2Q gross margins, very consistent with 2Q. But I recall FX has an impact on you guys at the gross margin line. Given the 200 basis points headwind in Q4, any comments on FX impact on gross margins either in Q4 or as we look to fiscal 22? Yeah, so

We do expect our cross margins in Q4 to be about 58% to 59%, right? And we've seen so far in Q3, as you said, 1% tailwind on the cross margin. Looking ahead, I mean, dollar has sort of strengthened, and we do have most currencies we are operationally hedged except pound, and that's the currency where we are exposed. But other than that, I mean, We sort of included that in our guide. And that's why you see we have close to a $0.10 headwind on EPS versus the last earnings call in our Q4 EPS guide.

And thank you. Our next question is from Jack Meehan with Nefron Research.

Thank you. Good morning. I wanted to just get a little bit more color on the shipment we flagged in China, the 12 million. So that was delivered in October. Obviously, the supply chain dynamic seems to be getting incrementally more challenging each week. So I was just curious how things are going there. And do you think, does your guidance contemplate any orders could slip from 4Q in 2022 as well?

Good morning, Jack. Nothing that we have visibility on that will go from Q4 to Q1. As I said, there is increased inventory in the different regions where we are seeing the demand going extremely, extremely well. And from an overall perspective, the $12 million was shipped rather promptly in Q4. It's just unfortunate the quarter ends on the day as it does. and the shipping clock occurred towards the end of the quarter. So I don't see anything that gives us visibility at this point that would tell us that there would be an impact in Q4. And in terms of what is within our hands, I mean, you heard me talk about earlier the extreme transparency that we have on supply chain, the processes that are much, much improved over the last year. Uh, and then finally, um, the increased inventory is a different, different reason. So feel reasonably comfortable that we should be able to manage a rather ambitious, uh, end of the year.

Great. And then, um, was just curious about, uh, labor trends. You called it out the, uh, the fact that you were now above the pre-pandemic recovering from the pre-pandemic levels. I was just curious if you felt like there was more spend coming in in 4Q and just maybe overall competition for labor, how you think you're managing in terms of retention?

Yeah, look, I mean, U.S. labor continues to be sort of a place where we are seeing inflationary pressures, right? I think with a strong HR function, we've put a lot of measures in place to reduce oppression and sustain talent, right? However, that doesn't play out so much in terms of cost and operating expenses into Q4. As you model Q4, what you have to keep in mind is Q4 is a heavy revenue quarter for us. And that results in a commission payment accrued heavily in Q4, which is why you typically see historically operating expenses, especially SG&A, are heavier in Q4. And that's reflected in our guidance.

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

Great. Thanks, guys. Maybe one on the 22 commentary. Certainly appreciate it. You're expecting to continue to grow above market. When we look at 21, it feels like one of the accelerants for you guys was the replacement cycle. I think last quarter you talked about maybe the sixth or seventh inning using the baseball analogy. How do you think about that in 22 kind of setting up as an opportunity for you guys to continue on that front? Or was that mainly condensed into 21 when we think about what the growth rate could look like there?

Patrick, thanks for the question. Unfortunately, I was learning baseball, so I kept using the baseball analogy, and people have talked sense into me to start talking in revenue numbers, so that's why we put that slide together, which is slide six in the prepared remarks. Look, we saw, say, one to one and a half percent acceleration on a stacked basis due to the initiatives, and the initiatives were not just the instrument replacement We saw service attachment increase of aftermarket. We saw e-commerce adoption go from 20% to 27%, 28%. Contract organizations grew, which was a new channel for us, grew roughly 40% on a two-year basis. And new product contribution also did extremely well. So across the board, 1% to 1.5% sort of benefit over what I would say the base growth and robust end markets. Next year we think that's roughly 1% versus the base market growth or whatever the base market growth will be. So for instrument replacement, this year we had roughly 30 million or so of benefit. Next year it will be 40 million, which is 10 million incremental, right? So that's how I would think about it, right? So for service, 200 basis points, another 100 basis points on top. So the 200 basis points already benefits us next year. And then e-commerce goes, and you can read the chart, so I think that for me is how I would think about 2022 and beyond, right? And as you think about what's happening beyond, this is now part of our CRM system. This is part of our execution that John Pratt and Jianqing are implementing, right? So we now have the full list of HPLC, UPLC, as well as the tandem quads in the CRM system that our reps are going through step by step and replacing. And this will continue next year and will go on into the year after. Same thing is true for our service attachment rates. We know where the attachment rates are. We're using that database to now go after it. So it has become part of the DNA of the organization. And I think that gives me confidence that we will be able to accelerate also next year. And then finally, new products. as I mentioned, are doing very well. MIT has just started to pick up a lot of interest. We've talked about our HPLC and Premier doing very well. So feel reasonably good about that 1% incremental over what would be any sort of market growth.

Yeah, that's helpful. I appreciate that. And then just a quick one on the industrial market. You guys put up pretty good results there. It's been a little more mixed across the sector. So can you just talk about what you're seeing there and expectations going forward?

Look, I mean, across all end markets, right? I mean, you look at pharma and now you look at industrial. Industrial, it's roughly 6% to 6.5% stacked growth, right? Historically, that's been 4% to 5%. So we're seeing even a bigger acceleration, relatively speaking, in industrial versus we've seen with pharma. And, you know, I must say, we're seeing extremely, extremely good performance out of the DA business, right? So nice performance across The different customer segments, be it in advanced materials, be it batteries, where we test slurries for renewable batteries, and I don't need to tell you why that's important these days. Electronics, that's growing in the high team, double digits. The life science part of our PA business is also growing nicely. So in PA, we're seeing really, really good momentum, and again, on a stacked basis, even outpacing the overall business, roughly 8% or so growth. I think industrial, we feel that our customers have found a way to work despite the pandemic. Our service engineers and our sales teams have access to many of these customers, initially virtually, but in many regions, increasingly also physically. Our service engineers, both across Waters and TA, are actually more welcome at our customer site. Europe, rest of Asia also doing quite well. It's a real area of strength, and we're lucky to have a business like DA that's kind of pointed in that direction.

And thank you. Our next question is from Derek Dubron from Bank of America.

Thanks for taking the question. This is Mike Riskin on for Derek. I want to talk a little bit on the instrument performance you saw in the quarter. I was wondering if you could break out anything you saw different in terms of the LC versus the mass spec, and particularly sort of tying it back to the academic and government question. I'm wondering if that was more on the mass spec side and just sort of how you see some of those new product introductions playing out this quarter and going forward.

Firstly, overall, and again, I talk more in terms of stack growth. I mean, instrument growth for the year is roughly 30%. Both LC and MassSpec are doing extremely well. LC, even higher than 30%, MassSpec is actually shy of 30%. So nothing to choose between the two sort of product platforms. But I think it makes more sense to talk about it on a stack basis. Historically, waters have seen instrument growth between 3% and 4%. We've kind of steadily now, year-to-date, stacked growth is steadily around 5%, 5-ish percent. So really nice momentum. And this is true both across LC as well as mass spec. So nothing really to sort of differentiate the two. Now, you asked about mass spec. In particular, in mass spec, the demand is driven by demand across all our portfolios, across uses in high-res mass spec, across our tandem quads, which are both used, the single quads are used for intact mass, and also our tandem quads that are used in development as well as food and environmental. And then, of course, as I mentioned, the BioQuad, we see renewed momentum and a lot of interest in the bioprocessing arena. So mass spec is going from strength to strength. Now turning to the second part of your question on new products, as I pointed out in the prepared remarks on HPL, just focusing on HPLC for a minute, ARC HPLC as well as the premier technology which includes columns as well as the application of this unique technology to our instruments has led to roughly 45 million in sales in 2021. We expect that to go up to 60 plus million, so about 15 million or so incremental. That's in the LC space on mass spec. New applications for BioAccord. I already mentioned that in the prepared remarks. And the MRT has a lot of interest from many of our customers, especially ones who want to use it in the proteomic space and for imaging with our DESI technology which can be used under ambient conditions, which is quite unique. So, again, new products. I mean, Waters has had a history of introducing game-changing new products. I think what we are doing differently is just making sure that there is a lot of traction once we launch these products and they're not just... Okay, good.

A quick follow-up, actually, on the OpEx side. SG&A and R&D both came in a little bit better than we expected in our model. I was just wondering if there's any one-time effect there. I know effects probably played a role there as well, being less of a tailwind. Just wondering if you could comment on any trends there. And the 12 million shipment that got delayed to 4Q in China, how should that pull through the model? Is that about a $0.05 to $0.10 benefit to 4QPS?

Yeah, so on the two questions, the first one, there was no one-time effect. activity in R&D or SCNA, so it's pretty straightforward there. On the 12 million shipment that got delayed, I mean, you know, you can assume it's largely instruments, and modulate that instrument gross margin, that would have been

Thank you. Our next question is from Praneet Sutta with SBB Learing. Your line's open.

Yeah, hi. Thanks for taking my question. So first one is just I wanted to clarify, obviously, instrumentation was strong last quarter. And if you pull in this $12 million order back into 3Q, that would be strong this quarter as well. So I just wanted to understand if there's you know, sort of application wise, what is, you know, driving the instrumentation sale. And maybe just if you could elaborate a little bit, if there was any, you know, in terms of QA, QC of vaccines, maybe the analysis of mRNA cap structure, there were some applications notes published by Waters teams around that. So just wanted to understand if you are working on QAQC side of the proteins or mRNA vaccines, or what are the applications that are driving the instrumentation growth that we have seen here over the last two quarters?

First, I mean, the instrument growth is driven by strong, robust end markets. better commercial execution. Second, it's our initiatives, be it replacement, be it newer products. And your question is increased applications, and I would break it into two parts. One, we are indeed seeing increased application of our technologies in oligonucleotides, in mRNAs. So, for instance, I met somebody from a leading mRNA company in Cambridge recently, and they basically said, look, There are huge aggregation problems with plasmids, with the mRNA molecule itself, as well as with the lipid-encapsulated mRNA molecules. So they are turning to us to help them solve these problems, one, by retaining more samples by using Premier, and two, by using LC-MS to elucidate the structures of the molecules themselves. So good application there. a lot of them being in development and discovery and hopefully increasingly in QAQC. The second area that I would comment on is the wider application of the BioAccord. You'll recall the product was initially launched really focused on LC-MS, which we still, in QAQC, we still believe LC-MS has a strong place in QAQC, provided the instrument that you have is simple, robust, and fast. and give you faster results. But that same value proposition is equally relevant in development of, in early stage development of complex biologics. And we're seeing really good application there. We demonstrated with Sartorius that some experiments that take six weeks can now be turned around within two days. And this has been replicated in Sartorius' labs, our labs, and in several customer labs. So as you can imagine, there's a ton of excitement on that front. And the BioPort is rather unique here. The results are fast. It's a simple-to-use instrument. Even somebody like me can use it. And it provides you... a wide range of results, not just on cell culture media applications, where it's much wider than any sort of application used today, but also on the drug substance. So seeing wider application of our technologies, I'm really excited about where LC-MS is going, especially the BioCord, with its simplicity, robustness, and speed in early-stage development and bioprocessing.

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

Good morning. Thanks for taking my questions. Wondered if you could provide a breakout of growth in LC and MS separately here in the quarter. I don't think you provided those numbers. I missed them if you did. And I guess, you know, broadly, it seems like the Waters Instrument business was a bit lighter than expected. I mean, any additional color you can provide on maybe what drove this would be helpful. Was it largely timing-related, or is it more a reflection of possibly a normalization in orders?

Firstly, to your second question, I mean, year-to-date instrument growth is roughly 30% quite good about that. So I don't know either. In Q3, we saw nice growth, double-digit again on instruments with stronger comps in Q3 from last year already. So double-digit growth across the two lines of instruments, or even three lines of instruments, LC, mass spec, and VA. As I mentioned earlier, on a year-to-date basis, and supporter is the same, LC grew in excess of 30% mass spec in the mid-20s, So really nothing to choose between the two sort of instrument platforms. It makes less sense to look at it quarter by quarter given the instrument trajectory. But again, nothing to choose between the two fields that both LC and MassTech have significant momentum in Q3 and year-to-date. And also going into Q4, we feel very good about where we are with that.

Thank you. Our next question is from Catherine Schulte with Baird. Your line's open.

Hey, guys. Thanks for the questions. I guess just first on the instrument side of the business, you know, revenue was down about 8% constant currency last year. Do you think you've largely recaptured that revenue at this point, or is there still some to make up, or do you think there's some that is just lost revenue that won't be recaptured? I'd just be curious how you'd allocate across those three buckets.

Catherine, thanks for the question. I think on the instrument side, we really feel that we are on a very, very good track. I mean, if you just look at historical averages, right, I mean, 2020 can confound, given all the COVID impact. But on a stacked basis, we're traversing nicely in excess of 5%, close to 6% in some cases for our instrument business. And historically, that average is for waters and across the industries between 4%. So really nicely clear of the historical averages. And in terms of how much have we clawed back, we think that just looking at three sort of data points, one, comparing our stacked growth rates, both instrument and consumables, with the rest of the industry, wherever there are comparable products. We feel very good that we are operating well ahead of the market, so it's market plus performance on performance. That's the first data point that makes us feel that we're clawing back rather nicely. Second, we have been lost ratios that we measured internally. Those have been tracking ahead of historical averages for the last four quarters, and Finally, there are public reports that are available, which are rather idiosyncratic because they change the definitions every quarter, but according to those also, we're doing pretty well on our market share. So we're very good about how we are traversing with gaining our footing. Now, we are a work in progress. There's a lot more to do, a lot more opportunity as well, a lot of applications for our instruments, a lot more penetration to be had, but be really good so far.

Thank you. That concludes the session of today's call.

Thank you very much for your participation and questions. And on behalf of our entire 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 fourth quarter 2021 call, which is going to be on February 1st, 2021. Thank you.

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