Waters Corporation

Participants will be in a listen-only mode until the question and answer session of today's call. This conference call is being recorded. If anyone has any objections, please disconnect at this time. It is now my pleasure to turn the call over to Mr. Kaspar Tudor, Head of Investor Relations. Please go ahead, sir.

Thank you, Ivy. Good morning, everyone, and welcome to the Waters Corporation Third Quarter Earnings Call. Today, I'm joined by Dr. Udit Bhattra, Waters President and Chief Executive Officer. and Amol Chawal, Waters Senior Vice President and Chief Financial Officer. Before we begin, I will cover the cautionary language. I would first like to point out that our earnings release and the slide presentation supplementing today's call are available on the investor relations section of our website at ir.waters.com. In 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 and commentary on potential market and business conditions that may impact Waters Corporation over the fourth quarter of 2023, full year 2023, and 2024. These statements are only our present expectations, and actual events or results may differ materially. For more details, please see the risk factors included in our most recent annual report on Form 10Qs and the cautionary language included in this morning's earnings release. During today's call, we will refer to certain non-GAAP financial measures, including in our discussions of the results of operations. Reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures are attached to our earnings release issued this morning and in the appendix of our presentation, which are available on the company's website. Unless stated otherwise, references to quarterly results increasing or decreasing are in comparison to the third quarter of fiscal year 2022 in organic constant currency terms. In addition, unless stated otherwise, all year-over-year revenue growth rates and ranges given on today's call are given on a comparable organic constant currency basis. Finally, we do not intend to update our guidance, predictions, or projections except as part of a regularly scheduled quarterly earnings release or as otherwise required by law. Now, I'd like to turn the call over to Udit to deliver our key remarks for the quarter. Then Amol will provide a more detailed look at our financial results. After, we will open up the phone lines to take questions.

Udit.

Thank you, Kasper, and good morning, everyone. I want to start today's call by thanking my colleagues for remaining focused on our customers, on developing new products, and supporting each other. Despite the challenging macro environment, our teams delivered a solid performance and did a great job capitalizing on the available opportunities through strong commercial execution. As headwinds from China and FX became greater, our indomitable teams rallied to drive productivity gains and margin expansion, resulting in strong adjusted earnings growth for the quarter. We launched innovative new products that address the critical unmet needs of our customers and further differentiate our revitalized portfolio in the attractive end markets that we serve. We also continued to make strong progress with Viat, including the launch of our first new light scattering instrument. Turning now to our results. In the third quarter, sales grew less than 1% as reported. Organic constant currency sales declined by 4%. Sales outside of China were largely at or above our expectations. However, demand in China fell beyond our expectations, which ultimately led to our sales landing at the lower end of our guide. With the U.S. dollar strengthening, the currency impact on sales for the quarter was flat, versus our expectations of a 1% tailwind. Wired continued its strong start, contributing 4% growth to the quarter as expected. Despite the market challenges and the adverse FX impact, we expanded our gross margin percentage by 240 basis points and adjusted operating margin percentage by 380 basis points. This allowed us to deliver non-GAAP earnings per fully diluted share above our expectations at $2.84, an 8% increase. On a GAAP basis, our earnings per fully diluted share were $2.27. Looking now at our organic constant currency results in more detail. In the pharma segment, US pharma grew 6% and Europe grew 5% with a strong continuing performance among our large to medium sized customers despite slow funnel velocity. In China, we saw continued weakness in pharma throughout the quarter. Market challenges in China have now broadened beyond pharma and impacted both our industrial and academic and government end market results in the quarter. Overall, sales in China declined approximately 30% as the demand environment further deteriorated as the quarter progressed. In the industrial segment, China declined low teens. Outside of China, industrial declined 6% as growth in the quarter was subdued by a tough prior year comparison of over 20%. While the most cyclical applications in industrial have continued to slow globally, we saw continued strong traction in PFAS and battery testing applications. In academic and government, we continued to see strong uptake of new products in Europe with low double digit growth and in the Americas with mid single digit growth. However, this trend was more than offset by pronounced weakening in China, which declined over 30% now that the shipments related to last year's stimulus program have concluded. In our core business, while the market environment has become more difficult, we continue to deliver strong commercial results. When looking at our third quarter results outside of China, our organic constant currency sales grew low single digits year over year and is a healthy 7% on a two and four year stack basis. On a year to date basis, our organic constant currency growth has been mid single digits year over year, excluding China and flat overall, including China. A key driver of performance for our business this year is mass spec, which is an area where we have gained share with our innovative new product portfolio. We're also managing our P&L very effectively through our focus on operational excellence that drove strong margin performance in the quarter and year to date. In the third quarter, Our gross margin was 59.1%, a year-over-year expansion of 240 basis points. Our adjusted operating margin was 31.5%, expanding 380 basis points. Year-to-date, our results also showed substantial margin expansion, with our gross margin up 160 basis points to 59%, and our adjusted operating margin up 60 basis points to 29.4%. Let me talk about what drove this. First, our commercial teams have continued to achieve strong pricing results at levels that were over 250 basis points for the quarter. Second, we're beginning to realize the productivity benefits of our focus on operational excellence and digitization. I'm excited that next month Waters will celebrate the opening of our new global capability center in Bangalore, India, which will further accelerate our pursuit of digitization and operational excellence. Third, through our proactive cost actions, we have rapidly aligned resources to our long-term growth strategy. While the current market environment is challenging, the long-term fundamentals of our end markets continue to be excellent. As I mentioned last quarter, There are incremental growth vectors to our historical 5% instrument growth that result in a great long-term growth profile for our business. This includes global prescription drug sales, which are expected to exceed historical growth rates, as well as measures we have put in place to improve pricing, where we expect to sustain a more than 100 basis point improvement versus historical levels. The growing adoption of analytical instruments in process development for large molecule therapeutics is a new growth vector for instruments such as mass spec and light scattering in our portfolio. This is only expected to strengthen as end users find value in these instruments for high volume and recurring applications such as process development, raw materials testing, and quality control. The competitive edge of our revitalized portfolio also positions us well for long-term growth. Our product portfolio has been renewed in the last few years with significant innovation that is answering the critical unmet needs of our customers. This includes new launches in LC, such as the Alliance IS, which we believe is the most significant innovation to hit Pharma QA QC labs in the past decade. In mass spec, the industry-leading sensitivity of Zevo TQ Absolute has allowed us to gain share in the food and environmental market for PFAS-related testing applications. In chemistry, our max peak premier columns have been the most successful launch in our company's history, serving the more complex needs of large molecule separation in our customers' labs. During the quarter, we announced two new product launches for bioanalytical characterization, including our first new instrument launch with WIAT. We launched a new bioprocess walk-up solution that combines our AndrewPlus liquid handling robot, OneLab software, and our BioQuad LC-MS system into a more automated setup that is even easier to use. Together, these new products help engineers capture high-quality bioprocess and drug product data directly from upstream bioreactors, such as those offered by Sartorius. It achieves this via simple workflows that automate sample prep, LC-MS analysis, and data capture. This accelerates the upstream development of MABs and other biologic drugs, providing more optimal clone selection that results in more effective titers and yields. Second, we launched our first new light scattering instrument within the WIAT portfolio. Zatastar is designed to precisely measure and analyze nanoparticles used in downstream biologics and material science applications. It combines three light scattering techniques into a single device, cutting measurement time by up to 10 times compared to other methods while using extremely low sample volumes. I would now like to cover our updated 2023 guidance. Growth rates in China have continued to deteriorate as the year has progressed. We expect this to decline further in the fourth quarter sequentially. We now expect China to decline approximately 25% for the year versus our prior expectations of low double digits. is an incremental headwind to our full-year organic constant currency growth of approximately 250 basis points versus our previous guidance. As a result, we now expect our revised full-year organic constant currency sales growth to be in the range of negative 2% to negative 1%. Despite the lower revenue guide, we're continuing to proactively manage our cost structure and drive productivity expansion, resulting in no change to our expected margin percentage performance versus our previous guide. We expect our full year adjusted operating margin to be 30.5%, which is 30 basis points of expansion versus 2022. Our updated full year adjusted EPS guidance is resultantly in the range of $11.65 to $11.75. Now I will pass the call over to Amol to continue covering our third quarter financial results in more detail and gave additional commentary on our guidance. Amol. Thank you, Udit, and good morning, everyone.

In the third quarter, sales grew less than 1% as reported. Organic constant currency sales declined 4% against the mid-teens growth comparison last year. Waters Division and TA both declined 4%. We saw good results again from our Wyeth acquisition, which added 4% constant currency growth and performed in line with our expectations despite the challenging environment. The impact of FX was flat in the quarter, which came in below our expectations of a 1% tailwind to as reported sales. In organic constant currency, by end market, pharma declined 2%, industrial declined 8%, and academic and government declined 3%. In pharma, mid single digit positive growth outside of China, was more than offset by continued slowdown in China pharma, which declined over 30%. In industrial, our business declined high single digits, with a tough growth comparison of 22% in the prior year quarter, and due to China weakness now spilling over into non-pharma segments. We continued to see strong growth in global PFAS testing and battery testing applications. Academic and government declined 3%, Outside of China, overall A&G growth was up 8%. This was led by double-digit growth in Europe and mid-single-digit growth in the Americas. In China, A&G declined over 30% as demand fell rapidly after we completed shipments under the stimulus program in the first half of the year. By geography, sales in Asia declined 12%, the Americas was flat, and Europe grew 3%. In Asia, China broadly declined. Excluding China, Asia grew 3%, which was in line with our expectations. India grew low double digits, and Japan grew mid deans. In Americas, pharma grew 6%, which exceeded our expectations as we executed very well with our large to mid pharma customers. Academic and government also grew 6%. However, strength in these two segments was offset by contraction in industrial for the quarter. In Europe, growth exceeded our expectations in pharma, which grew mid-single digits, and academic and government, which grew 10%, while industrial declined mid-single digits. By products and segments, instruments declined 13%. Recurring revenues grew mid-single digits overall and high single digits outside of China. There was no change in number of days versus the prior year's quarter. Our continued focus on operational excellence with pricing, productivity, and proactive cost alignment, together with lower incentive compensation, drove continued margin expansion. Gross margin for the quarter was approximately 59.1%, an expansion of 240 basis points compared to 56.7% in the third quarter of 2022. Adjusted operating margin for the quarter was approximately 31.5%, an expansion of 380 basis points compared to 27.7% in the third quarter of 2022. Our effective operating tax rate for the quarter was 14.7% due to discrete items within the quarter. The average share count came in at 59.3 million shares, which is about 800,000 less than the third quarter of last year. Our non-GAAP earnings per fully diluted share were $2.84, an increase of 8% despite flat revenue. On GAAP basis, our earnings per fully diluted share were $2.27. A reconciliation of our GAAP to non-GAAP earnings is attached to this morning's press release and in the appendix of our earnings call presentation. Turning now to free cash flow capital deployment on our balance sheet, We define free cash flow as cash from operations, less capital expenditures, and excludes special items. In the third quarter of 2023, free cash flow was 123 million after funding 38 million of capital expenditures. Free cash flow was impacted by higher inventory balances. We maintain a strong balance sheet, access to liquidity, and a well-structured debt maturity profile. This strength allows us to prioritize investing in growth, including M&A, and returning capital to shareholders. We continue to evaluate M&A opportunities that will meaningfully accelerate value creation. At the end of third quarter, our net debt position further declined to $2.2 billion, a net debt to EBITDA ratio of about 2.2. This represents a decrease of $125 million during the quarter as we delivered the YF acquisition. As previously disclosed, Our share buyback program has been temporarily suspended to enable us to pay down the debt incurred as part of the Wyeth acquisition. We will evaluate the assumption of our share repurchase program through the quarter and into the first half of next year. Now I would like to provide our updated thoughts for 2023. As Udit outlined, growth rates in China have continued to deteriorate as the year has progressed. In addition, weakness in China has now broadened beyond pharma and into industrial and academic and government end markets. We expect China growth rates to sequentially decline further in the fourth quarter and now expect China to decline approximately 25% for the full year versus our prior expectations of low double-digit decline. This translates to a full year growth headwind of approximately 250 basis points versus our previous guide. As a result, we are updating our full year 2023 organic constant currency sales growth guidance to the range between negative 2% and negative 1%. At current exchange rates, where the US dollar has strengthened against most major currencies since our last earnings call, currency translation is now expected to have a 1.5% negative impact on our full year sales. which is a 150 basis points headwind versus our prior guide. Consistent with our prior expectations, we expect the wide transaction to add approximately 2.5% to our full year 2023 revenue growth. Therefore, our total reported sales growth guidance is now negative 1% to flat. As Udit covered, despite incremental headwinds from China and FX, our teams have rallied to drive pricing and productivity gains. We expect this will allow us to deliver a gross margin of approximately 59% for the year, which is in line with our previous guidance and is 100 basis points of expansion versus last year. Together with proactive cost alignment, we expect this will allow us to deliver an adjusted operating margin of approximately 30.5% for the year after funding investments in high growth adjacencies, which is also in line with our previous guide, and it's 30 basis points of expansion versus last year. We expect our full-year net interest expense to be approximately 80 million. The full-year tax rate is expected to remain at approximately 15.5%. our average diluted 2023 share count is expected to be approximately 59.2 million shares. Now rolling all this together on a non-GAAP basis, our full year 2023 earnings per fully diluted share guidance is projected in the range of $11.65 to $11.75, which includes a negative currency impact of approximately 3.5 percentage points at current FX rates. Looking to the fourth quarter of 2023, we expect further weakness in China and cautious spending from our customers throughout the quarter. Hence, we expect fourth quarter organic constant currency sales growth in the range of negative 8% to negative 5%. At today's rates, currency translation is expected to subtract approximately 1.5% while we expect WIAT to add approximately 3.5% to our fourth quarter revenue growth. Therefore, our total fourth quarter reported sales growth guidance is negative 6% to negative 3%. Fourth quarter non-GAAP earnings per fully diluted share are estimated to be in the range of $3.52 to $3.62, which includes a negative impact from currency of approximately 5% percentage points at current FX rates. Now I would like to turn it back to Udit for some summary comments. Udit.

Thank you, Amol. So to summarize, despite a macro environment that has progressively weakened this year, we have continued to deliver a solid performance through our execution. We're also driving strong outcomes in our margin and earnings performance and are maintaining our full year gross margin and adjusted operating margin guidance despite incremental headwinds from volume and FX. We have strengthened our product portfolio even further through innovation while continuing to make strong progress with our acquisition of IOT. Later this month, we look forward to issuing our 2023 ESG report, which is a transparent way to show our active progress each year on our commitment to leave the world better than we found it. Some key highlights to expect relate to our continued reduction of emissions, increased renewable energy use, increase of female representation in management roles, as well as the TCFD-related environmental disclosures we're initiating in this year's report. So with that, I'll turn the call back over to Casper.

Thanks, Udit. That concludes our four more comments. We're now ready to open the phone lines for questions.

Thank you. We will now begin the question and answer portion of today's conference. At this time, if you would like to ask a question, please press star one to be entered into the queue. We ask that you limit your questions to one question and one follow up question to allow ample time for questions from each analyst that may wish to participate in this portion of the call. Again, that is star one to ask a question and star two to withdraw your question. Our first question comes from Vijay Kumar from Evercore ISI. Please go ahead.

Hey, guys. Thanks for taking my question. Ulrich, maybe one on just how the quarter progressed here. What were the exit rates and what is the Q4 guidance implying? Because I think the sheet's looking at sequential numbers, the sequential step up on a dollar basis, Q3 versus Q4. But I think when you look at the growth rates here and here, I think your instrumentation growth is mid-teens. So I think it's just the way we look at year on year versus sequential. And I think, I think the streets look trying to make the comparison versus your peers and have some, some companies have guided sequential on a dollar basis. So maybe just talk about your exit rates in third quarter and what is Q4 is yaming for instrumentation.

So, so thank you. Uh, and good morning. Look, um, I'll give you some, some, somebody comments and I'm all, we'll talk to you about the ramp from Q3 to Q4. If I understand your question, uh, correct. When we look at the exit rates and ramp from Q3 to Q4, we of course look at the performance as we exit Q3. This includes detailed analytics on funnel velocities across the different customer segments, includes what we've seen over the last 15 years as we go from Q3 to Q4 and look at that statistically. And of course, a lot of conversations with our customers, and we continue to see strength relatively speaking, versus our peer group in pharma, especially outside of China. And I'll let Amol comment a little bit on the sequential ramp up.

Yeah. Hey, Vijay. Good morning. Look, Vijay, I mean, on the Q3 to Q4 ramp, if you look at our last five years, we've averaged roughly a 24% ramp from Q3 to Q4. And where our guide is is roughly 13% to 17% ramp from Q3 to Q4. So clearly, it's barely muted compared to historic levels. Also, if you look at last 15 years, there have been just a couple of years in those years which have come in towards the bottom end of our guide. So that's why we feel generally we've muted the ramp from Q3 to Q4. Also, Q3 baseline, which is in this ramp, reflects sort of the slower approval cycles that have been playing out throughout the year. And there's about one extra day in Q4 this year versus the previous year. And then the last piece is, I mean, it's based on the fact that, yes, there is pain in China at this point. But then when we look at pharma in the US, in Europe, in Japan, in India, especially mid to large pharma, our teams are doing a great job there and driving decent outcomes.

That's helpful comments. And one, maybe if Q4 jump off as the minus high signals organic, is China minus 25 for the year? Is that done for this year or is that going to spill over into fiscal 24? Can waters grow next year? I feel like when I look at the margins here, obviously leverage will be a question, but I saw that restructuring costed take-ups and anything on that. Any implications for 24 either on the COP and operating leverage?

Vijay, I'll comment on China. Before we get into any details, we will only comment on 2024 when we talk about next year, when we talk about Q4 earnings. That's generally been our policy. As you know, a lot has to evolve from now until the end of the year, especially in our business. We will not comment on 2024. But on China in particular, look, in the quarter, the business declined in excess of 30%, with pharma declining in line with what we had seen at the beginning of the year, right, with CDMOs sort of flushing out over capacity and responding to geopolitical tensions. We think that's towards the tail end of its development. We saw biotech come under pressure. We think that's also at the tail end of its pressure, just given that high-quality molecules are being funded also in China. And then the third piece was in pharma, the banded genetics segment, which is roughly 50 percent of our sales in the pharma segment in China. And this one here, there was an additional pressure that we learned about, which is the anti-corruption campaign that the Chinese government issued. While our customers are used to responding to value-based pricing cuts, this was a new headwind, so that is still in progress. So in all, pharma, two out of three vectors are starting to subside. The third one is new over the quarter, and this is something that I learned over the last couple of months when I visited China. When switching over to other segments, look, the industrial segment, we see great growth in batteries in China, but that was not enough to offset the macro sensitive food and environmental segments, which dropped further in this quarter. And then finally, the academic and government segment, as Amol commented in the prepared remarks, we're seeing the tail end of the benefit from the stimulus from last year. And that will sort of come out of the numbers now. Now, if you put it all together and put it in perspective, we started the year with about 19, 20% of water sales coming from China. With our current guide, we expect that to be about 12% to 13% of our overall sales. So while we remain super optimistic about what we expect in China in the future, and it has become a much smaller proportion of our business than at the beginning of the year.

Next, we'll go to the line of Dan Brennan from TD Cowan. Please go ahead.

Hey, guys, thanks for the questions here. Maybe just on pharma, ex-China, obviously you kind of discussed positive trends in the quarter and kind of what you guys are expecting for the fourth quarter, but we've heard a lot of mixed comments in the quarter. So maybe can you just give us a flavor for, you know, maybe a little more details on instrument-signitable trends and kind of, you know, water specifically how you're doing, you think, versus the broader trends? And, again, maybe, Amal, I know you gave some color on fourth quarter, but just how should we be thinking about pharma in the fourth quarter ex-China?

Dan, thank you for the question. Look, pharma is almost a tale of two stories, right? I mean, overall, we saw the quarter decline low single digits, and in China, as expected, roughly 30% or so decline that I just commented on. If we look at ex-China, I mean, we've printed, I would say, amongst our peer group, probably the most positive numbers in growth in China. growing mid single digit. And this is across Europe, across Americas, and across the rest of APAC where we saw significant strength in India and Japan. And this is behind two factors. One, really our new product portfolio is gaining a lot of traction despite the slow funnel velocities that we see in mid to large pharma and additional approval levels. Despite the fact that biotech came under pressure at the beginning of the year, it's starting to become a little bit less pressured as we exit the year. So in pharma, our new product portfolio has done super well. Start with LC, the Alliance IS. We have had significant orders, and as I mentioned, despite the macro pressures, customers have placed large orders for Alliance IS, and the funnel looks really healthy. Masspec has been a real star for the year, and in pharma, we have specifically developed biologics applications. And you saw the recent launch of the walk-up solution for BioAccord, which should make process development even faster. The MaxPeak premier column, staying on the theme of biologics, is in its third year and still growing well into the 20% range. So it's been the strongest launch for us in columns for many, many years. And we recently introduced another column that is targeted towards AAV and cell and gene therapy. really excited about what we've seen in pharma this year despite a difficult environment and feel like we're gaining share. And over the long term, you know, pharma remains a source of strength. We don't expect to grow mid-single digits. We expect to grow high single digits and double digits as we look into the future. So I'm super excited about what we see in the pipelines from our customers. I mean, we are very well-spect in the GLP-1s and the Alzheimer's compounds. So really optimistic about the future and proud of the team's execution in, I would say, a challenging macro environment. Amol?

Yeah, just to sort of touch on your other question. Look, I mean, pharma overall declined low single digits for us in Q3. And then for Q4, what is embedded in the guide is sort of a mid-single-digit decline. Obviously, that includes China. When you strip China out for the rest of the markets, the rest of the markets grew a little under mid single digits in Q3. And then in Q4, we are expecting them to still grow, but not at the same level in Q3, a little bit less than what they grew in Q3.

Got it. No, thanks for that. And then just maybe on, you know, the instrument recurring revenue, just maybe can you just give us a little bit of an overview of kind of what you're seeing there? Obviously, trying to complicate things, but just wondering, the steadiness of that recurring revenue. Like, are you seeing any changes there? Just kind of any flavor about, you know, how the quarter went and kind of, you know, kind of what you're seeing in the outlook for Q. Thanks.

So let's start with recurring, and then I comment on instruments. So recurring revenue came in mid-single digits this quarter, around 4%. Chemistry, low single digits at 1%, service 5%. This is globally. Now, if you strip China out, recurring revenues are, again, high single digits, close to 7 plus percent. with chemistry in the high single digit range, service in the mid single digit range. So really healthy growth outside of China. And then China really impacted the chemistry piece, just given the less activity that we saw with our branded genetics customers. And then if I switch to instruments, look, I mean, instruments were dropped low teens globally, right? And similar drops across LC, mass spec and TA. So minus 14, minus 12%, something like this across the whole portfolio. But again, if you strip out China, which saw significant declines, and here I want to take it each in turn, right? LC, as we saw in the last quarter, low single digit growth outside of China. This year, this quarter, it was flat, right? So really hovering around, I would say, flattish growth for the last two quarters, just as we had talked about a few quarters ago when we saw mid-teens decline in LC. And customers will have to replace their fleets, and we're starting to see that happen with some large pharma customers. So you see LC is sort of hovering around flattish to low single-digit growth. Mass spec, ex-China came in at about 10% decline. Now, I will remind you that same time last quarter, mass spec grew almost 40%, almost 40%. Super excited about what we've seen with the MassSpec portfolio and its adoption. In virtually every account that we go and compete with the Xevo TQ Absolute, we win. If you go with our bio portfolio now, especially with BioAccord, Xevo TQ, Xevo G3 QDoF, we see significant seeding and adoption there. So MassSpec has gone from strength to strength and we see that continuing. And TA, again, also declined. high single digits, but again on a comp of about 20%. So if you again go back to mass spec, if you look at two-year, four-year CAGRs, I mean, we are well into the high teens with mass spec growth. So quite excited about what we've seen with instruments. And if you just again cast your eye to the longer-term trends, instruments grow roughly 5%, have grown over 5% over the long term, and we are seeing as we go forward, about 100 basis points of higher pricing. We see increased prescription rates with new molecules coming through, and our new product portfolio driving adoption across new segments like PFAS. So excited about what we are seeing, the execution we're seeing with instruments across the board, and what we expect in the future to be better growth than what we've seen also in the past.

Next, we'll go to the line of Matt Sykes from Goldman Sachs. Please go ahead.

Hi, good morning. Thanks for taking my questions. Maybe just first on pricing, just given the margin gains you saw this quarter in your comment about 250 basis points of price, we've heard from peers that pricing is starting to trend back towards normalized levels and probably less of a tailwind. Could you just maybe comment on what your expectations for price are in Q4? And then as we go into 24, how much of a tailwind do you believe pricing will continue to be for you?

Yeah, so Matt, good morning, and thanks for your question. Look, I mean, ever since we went through the inflationary cycle last year, that gave us opportunity to put good systems and processes around pricing. And if you look at Water's history, traditionally we've done 50 to 75 basis points, and last year was very different. And our teams have continued to execute on that sort of system and process pathway. So we started the year with about a little over 200 basis points, and it's only got stronger as we came into Q3 with a little over 250 basis points. And then we expect something similar in Q4, which then for the full year we will be a little over 250 basis points. And that's sort of driving a third of our operating margin expansion for the quarter.

And I think just to conclude on this, Matt, look, Pricing is dependent upon, as Amol said, good execution, good systems, good processes, but it's equally dependent on a differentiated portfolio. We've renewed our full portfolio across instruments, and it's got very high receptivity from customers. So customers are responding to good innovation across instruments, but also on the column side where the stick rates are tremendous, right? I mean, with the MaxWeek Premier, with new columns introduced for AAV, I mean, we are highly differentiated amongst the peer groups. So, we do expect pricing to stick at reasonably high levels.

Great. Thank you for that, Kolar. And then, just as a follow-up, just zeroing in on China, specifically on the industrial side, you talked about strength in batteries, but food and, I believe, environmental weakened in the quarter. Could you maybe talk about the dynamics there? I mean, I think that's relatively new information relative to what we've been hearing and just wanted to understand the dynamics within the industrial demand inside China and what your sort of expectations are for duration of that weakness.

Good one, Matt. Look, I mean, industrial came in below our expectations for the quarter in China and that drove the weakness across the globe. And you're right to divide it into two parts. I mean, there are the resilient segments like PFAS testing, as well as batteries, especially in China, where we're seeing very good uptake. The challenge is the more macro-dependent segments like materials, like food, which are also funded by the government, were impacted by the slowdown of the economy. And as you look ahead, I would simply model those in proportion to the economic recovery that we would expect in China. And that's how we're looking at it. Outside of China, of course, I mean, you didn't ask this, but outside of China, again, we saw a bit of a slowdown against very, very strong comps, right? On a long-term basis, outside of China, we're seeing mid to high single-digit growth in industrial. I mean, you should expect a mid-single-digit growth for the long term in industry. But in China, for sure, there was additional weakness largely related to the macro-sensitive segments like materials and food and the like.

Next, we'll go to the line of Derek DeBrown from Bank of America. Please go ahead.

Hi, good morning. Thank you for taking my questions. So the first one is looking at the Q3 to Q4 step down and operating expenses, how much of that was incentive comp that can come back? How much of that is going to be sustained as we look into 2024? Can you just sort of give us some thoughts on just how we should think about the operating expenses as we move in to Q4 and to next year.

Yeah, so, so, Derek, thanks for your question. And, I mean, as we had discussed in our last earnings call, right, we had to make some tough but necessary decisions to reduce our workforce by about 5%. And we did that at the beginning of Q3. And that resulted in approximately $10 million of savings in Q3, that is in our Q3 results. We expect for 2023, roughly $20 million, so another $10 million in Q4. And the annualized impact, which will play out next year, would be about $40 million. Again, you know, we may invest some of it to fund some of the high growth adjacencies, but before that annualized, it's $40 million. And we incurred about $27 million associated with severance expenses for this restructuring, which is in our gap to non-gap adjustment. Now, keep in mind, in Q3, the way it sort of played out is we had lower volume on our organic business. So we lost some volume leverage. And so essentially, the reduction in AIP plus the accretion for wire more or less offsetted the lack of volume leverage from the underlying business, and then the three factors which are pricing, these cost actions that I just talked about, and then the underlying productivity initiatives playing out on freight and procurement and the capability center, they each contributed roughly a third of the 380 basis points.

And just to conclude sort of rather qualitatively, I mean, this is in the DNA of Waters, right? I mean, we are one of the highest margin companies in the peer group. And back when I joined three years ago, people said, you can't expand your margins, you're maxed out. I mean, quarter on quarter, we continue to focus on, as Amol mentioned, really careful cost management, pricing, and difficult actions when we need to take them. And the exit for the full year is around 30.5, which is 30 basis points of margin expansion, despite the fact that volume went against what we had assumed. And FX was also a headwind, right? So, I mean, I'm extremely, extremely grateful to all my colleagues for putting their heads down and being super responsible with costs when the volume didn't come. And we had to respond rather rapidly, right? So I wanted to make that point.

Thanks for the clarity. Just wanted to follow up. I appreciate that Waters has a lot of new products and those are probably giving you a little bit more incremental growth. But I mean, I'm just a little bit surprised of your guidance outside of China. These are not normal market conditions. And, you know, and I know you're putting in some conservatism, but I haven't seen markets like this before in these swings that we're seeing. I just was wondering why you guided as aggressively as you did for the fourth quarter and your competence, because it just feels like you've got a little bit of a budget flush that's in there outside of China, and just a little bit more clarity on that. Thank you.

I think, Derek, this is what I'm all started with. First is the baseline and all the input that goes into Q4. So we look at how the funnel velocities are. I mean, if I just stay with pharma for a minute, And the quality of the orders is very high. Customers who place orders are actually buying. They've just bought over. The order to sales conversion is just a bit longer than it's been in the past. The new products have a lot to do with it. Customers are responding to innovation, especially in pharma. And you saw mid-single-digit growth this quarter. So that goes into our calculations. Second, we looked at historical ramp rates. And when you look at historical ramp rates, The lower end of our guide, which is 13% ramp from Q3 to Q4, is one of the lowest in the last 15 years, right? And I appreciate, I mean, both of us have been in this industry for a long time, and these are unprecedented times, but this is sort of the lowest, one of the lowest ramps that we've seen in many, many years. And then the third is customer conversations, right? So we're talking to customers, I'm spending a lot of time with them, and it's clear that we are seeing i would say asynchronous good execution in pharma uh that gives us the uh the confidence to sort of say okay q4 is going to be like we've like we've projected and you know um we have that's why we've and largely because of the uncertainty we've ranged the q4 guide um wider than we have in the past right so i appreciate your question and appreciate the historical context we took a lot of the facts into account in guiding wider than we have in the past. And as I said, look, new products, great execution with the hand that we have. I think we're doing extremely, extremely well, especially outside the U.S. Amol, anything else to add on the guide? Thank you, Derek.

Next, we'll go to Rachel Vattenstall from J.P. Morgan. Please go ahead.

Hi. Good morning, and thanks for taking the question. First, I just wanted to follow up on that answer to Derek's question around some of the order rates. You mentioned that the quality of orders have been high, but it's just that conversion to sales is taking a little bit longer. Can you give us any stats from order rates, book to bills, whether that's pharma, ex-pharma, and then looking at total world versus ex-China as well and kind of how that's trending into 4Q?

Yeah, I mean, look, if you sort of see how the year has played out, we did see funnel velocities slow down across all the trade classes, especially pharma in Q1. And then as we've gone through Q2 and Q3, the funnel velocity has sort of stayed where it is at a higher level. So it's taking more time for people to approve these orders. And we expect that to continue through Q4. What we haven't seen in pharma, which is good, is we haven't seen projects getting canceled. And so opportunities are landing. They're just taking more time to land. And in terms of sort of sales versus orders, I mean, they're going hand in hand. It's not that we are meaningfully drawing down backlog in any quarter or so. The one place where the the trajectory has changed somewhat is in the industrial trade class. And this is all outside of China I'm talking about. And there, you know, while the funnel velocity has progressively slowed in Q1 and Q2, we haven't seen any opportunities getting canceled. And what we are seeing in Q3 is, and again, don't confuse this with orders. No customers are canceling orders. But when the opportunity is in the CRM system from lead gen to conversion, we are seeing elevated levels of projects getting canceled for lack of funding or funding not available in the current year, particularly in testing labs. And that we saw sort of emerge in Q3. And then China, I mean, we've sort of covered that before, which is a different story, much more painful. That started in Q1 with Tier 1 CDMOs. and then sort of progressively went into tier two, tier three CDMOs and biotechs with investor funding, and then played out in branded generics with VBP and anti-corruption drives, which haven't bottomed yet, and then has spilled over into the industrial and ANG, especially as the stimulus money's done for ANG.

And Rachel, just one last comment on Q3 and the ramp to Q4. I mean, the trends we're seeing in Q3 what gives us confidence, especially in pharma, and with mass spec, with LC, that they'll persist as we saw exactly the same thing in Q2. And I think we probably had the same discussion. Why are we seeing better performance in pharma than the peer group? Why are we seeing LC sort of flatten out? It's the same reasoning, and we're seeing the same customer feedback. So I think it's reasonable to project that into Q4.

Next, we'll go to Eve Bernstein from Bernstein Research. Please go ahead.

Hi there. Good morning. Thanks for taking the question. Two questions. One, both high growth adjacency related. So for Wyatt, it seems not to have felt as much pressure as your core instruments. And it makes sense that there wouldn't have been as much COVID pull forward there as in LC, for example. But are you still seeing lengthening sales cycles and some of those same signs of demand weakness for Wyatt Technology. And then for the other high growth adjacencies, you've mentioned a couple of times about reinvesting, you know, funding investments affecting your adjusted operating margin. Can you talk about how the pressures in the industry and pressures on your top line have potentially lengthen some of the timelines that you're looking at to go after those high growth adjacencies?

Thanks for the question, Eve. I'll start with the Wyatt question. Look, I mean, we're very pleased with the way the integration is going. I mean, that should be the general takeaway. And you can see that in the facts, right? Basically a 4% contribution this quarter and 2.5% for the year. So we think we're going to deliver that. And when you look at the drivers, the integration is going faster than we had initially even imagined. There are exactly the same headwinds. The funnel velocities are longer. It is taking more time for customers to place orders. But number one, given the larger commercial field force that Waters had, we were able to use that to generate a lot more leads. for our light scattering instruments from WIAT, which are highly differentiated in the market. So as we got more leads, we got more conversions, and the funnel's moving nicely through. Second, we've spent a lot of time in making it easier for customers to connect waters as LCEs to multi-angle light scattering instruments from WIAT, and that's well ahead of target. We had talked earlier, when we talked about the synergy contributions, we talked about columns from Waters being substituted for other competitors' columns, and that's gone extremely well. So every light scattering equipment that is sold now is sold with a Waters SEC column, which are the best in class. So integration going very well, but the largest driver, I would say, of short-term results and overcoming the obvious headwinds is the larger number of leads that our Waters account managers have provided the WIAT specialists. And as you look ahead, I mean, really optimistic about what we are seeing with the collaboration across the two organizations. Our WIAT colleagues were present at the Innovation Summit recently, which basically invites over 300 or so R&D scientists around the globe for a hybrid session. We had many posters from WIAT colleagues looking at collaborations across the organization. So I'm extremely pleased with where things are going. And we recently launched the Zetastar, which combines three light scattering technologies into one. So it's going extremely well, and thank you for the opportunity to expound on that. Now on the high growth adjacencies, the 30.5% operating margin that we are committing to for the full year includes the 70 to 80 basis points that we had said that we would invest. We had started to invest that early in the year. We are seeing very nice outcomes of that, especially in our clinical business where the team has developed many, many assays, simplified workflows for difficult to do experiments with LC-MS and making it a much more easier experiment for customers who want to use LC-MS in specialty diagnostics areas like for testing antibodies for Alzheimer's as just a case in point. the high growth adjacencies are delivering. Now, we will look at the next picture as we look at the full year and how it lands, and we will talk about how we're going to invest and continue to invest in the high growth adjacencies as we give guidance at the beginning of next year.

Next, we'll go to the line of Catherine Schulte from Bayard. Please go ahead.

Hey guys, thanks for the questions. Maybe first just to touch on some of your commercial initiatives here. Any comments on service attachment rates and e-commerce trends and how those are tracking relative to your expectations?

Yeah, so service attachment rates, so Catherine, thank you for the question. Service attachment rates are well ahead of target. You'll remember that we committed to 100 basis points of increase in attachment rates. We're well ahead of that, so we'll likely exit the year with 200 basis points of increase in service attachment rates, and you would see that in the growth that is being seen, especially outside of China for service, which is basically high single digit growth for year to date and the balance of the year. So service is going quite well. On e-commerce as well, we've gone from about 20, 25% of products going through e-commerce to well in excess of 30%, closer to 35% now. The team is highly focused on that. I mean, as you can imagine, given the slowdown in the overall market, our chemistry portfolio has still done pretty well. And the chemistry portfolio is benefiting from additional products going through e-commerce. So chemistry is currently going high single digits. and benefiting from the additional focus on e-commerce.

Okay, great. And then you had impressive operating margin results in the third quarter. I think to get to your 30.5 for the full year, that implies somewhere between 33% and 34% in the fourth quarter. You know, I know fourth quarter margins are often seasonally high, but should we think of the 31.5 that we saw in the third quarter as a jumping off point for 24, or just walk through the moving pieces there? Thanks.

Yeah, I mean, look, if you look at how we've performed in adversity, like last year, there was tremendous inflationary pressure and dollar kept becoming stronger and stronger, right? And despite all of that, our teams rallied to find pricing gains and productivity gains and sort of land the margin equal or better than the prior year. And then this year, again, you know, we've sort of gone through demand challenges and then also further strengthening of US dollar. And despite that, we found ways to defend margin through pricing, through productivity, through cost alignment. So we really feel good about how our teams have responded in these situations. Now, as you look at 2024, I mean, as Udit outlined, right, it's a little early because we want to see how the next two months play out. They are a big part of our year. We are also just rolling up our bottoms up AOP and we want to sort of review that before we sort of talk about 2024. So, like we always do at our Q4 earnings call, we will provide more details and guidance for 2024.

Thank you. And that is all the time we have for questions.

Thank you for joining us today and for your continued support and interest in waters. A replay of this call will be available in the investor relations section of our website. This concludes our call and we look forward to seeing you at future events and conferences.

Thank you all for joining. That concludes the Waters Corporation third quarter 2023 financial results conference call. You may disconnect at this time and have a great rest of your day.