Waters Corporation

Good morning, everyone, and welcome to the Waters Corporation Second Quarter Earnings Call. Today, I'm joined by Dr. Udit Batra, Waters President and Chief Executive Officer, and Amol Charbel, Waters Senior Vice President and Chief Financial Officer. Before we begin, I will cover the cautionary language. In this conference call, we will make various forward-looking statements regarding future events or future financial performance of the company. We will provide guidance regarding possible future results as well as commentary on potential market and business conditions that may impact Walters Corporation over the third quarter of 2024 and full year 2024. These statements are only our present expectations and actual events or results may differ materially. Please see the risk factors included within our Form 10-K, our Form 10-Qs, and the cautionary language included in this morning's earnings release. During today's call, we will refer to certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP measures are attached to our earnings release and in the appendix of the slide presentation accompanying today's call. Both are available on the investor relations section of our website. Unless stated otherwise, references to quarterly results increasing or decreasing are in comparison to the second quarter of fiscal year 2023. In addition, unless stated otherwise, all year-over-year revenue growth rates and ranges given on today's call are 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 earnings release as otherwise required by law. I'll hand it over to Udit to deliver our key remarks. Following that, Amol will present a more detailed overview of our results and guidance. After, we'll open up the phone lines for questions. Over to you, Udit.

Thank you, Kasper, and good morning, everyone. We achieved strong results in the second quarter that exceeded both our top line and bottom line reported guidance. I want to begin today's call by thanking my colleagues for their dedication to commercial execution, operational management, and innovation. This enables us to deliver differentiated performance and accelerate the benefits of pioneering science. In the quarter, year-over-year organic constant currency sales were 500 basis points better than Q1 levels. We saw a steady improvement in customer spending throughout the quarter with a strong finish in June. orders outpaced sales for the quarter as we built good momentum for the second half of the year. We again delivered resilient operational results with earnings surpassing our expectations. This reflects the strength of our downstream business model, progress on our strategic and operational initiatives, and our indomitable spirit. We also continued our steady stream of new product launches, releasing further innovations that address key customer needs. Waters now has a highly competitive portfolio serving attractive end markets. We expect this to benefit us as the market recovers and the instrument replacement cycle picks up pace. As we continue to build the Waters of the future, I would like to welcome Rob Carpio, who has joined us as the new head of the Waters division. Rob is a talented leader and a seasoned operator with a record of delivering strong financial results and transformation in life sciences. With his appointment, he will further enhance Waters' performance and long-term growth strategy. Turning now to our results. In the second quarter, sales declined 4% as reported and 4% in organic constant currency. Our non-GAAP earnings per share was $2.63. On a GAAP basis, EPS was $2.40. Excluding China, sales declined in low single digits. Growth was consistent with our expectations across each of our end markets. Customer capex spending is showing early signs of improvement. In China, sales declined in the low teens, which was better than expected. Growth rates improved in all end markets compared to the previous quarter, especially in pharma and in industrial. While the stimulus measures Measures announced by the Chinese government this year are still in the early stages of implementation. We are having active conversations with customers who stand to benefit from these initiatives. So far, this has led to improved quoting and funnel trends in the region. These opportunities are expected to begin converting to orders in 2025. Overall, instruments declined 17% and recurring revenue grew 5%. Wyatt delivered a 2% M&A contribution to sales, which was better than expected. It marks a strong close to the first year following the acquisition, where synergies were delivered well ahead of schedule. Wyatt operates in high-growth markets, serving large molecule applications, especially across cell, gene, and RNA therapies. Altogether, it should deliver 40 basis points of annualized accretion to the total company growth in the near to mid-term. I will talk about our operational performance. Margins remained resilient as we again successfully counteracted volume, FX, and inflationary headwinds with solid operational management. Our gross margin for the quarter was flat at 59.3%, and our adjusted operating margin was solid at 29.2%. Even with recent progress, our work is far from over. We have a runway towards further long-term margin expansion driven by our strategic and operational initiatives. This includes areas such as productivity enhancement where we have various programs that are still in the early stages. At the same time, our focus on pricing continues to yield contributions that is well ahead of historical levels. Looking forward, we feel very good about our future margin opportunity given our recent success in preserving and expanding our margins during challenging business conditions. Beyond 2024 levels, we expect to deliver a more pronounced impact on our long-term margin performance, particularly when more typical volume leverage returns. In the second quarter, we launched a steady stream of new products, solving the unmet needs of our customers. At ASMS in June, we unveiled the Zivo MRT, which is now our highest performing benchtop mass spectrometer. It builds on the multi-reflecting time-of-flight technology pioneered by the Select Series MRT, which has greater throughput and a more compact form factor. With up to six times greater resolution and two times better mass accuracy than competitive systems, the Zevo MRT sets new industry standards for high resolution at blazingly fast speeds. So far, our customers have been impressed by its capabilities. It will serve Discovery and other upstream pharma workflows where it will accelerate R&D times for new drugs. This includes areas such as metabolite identification, where resolution, accuracy, and speed are all critical value drivers. We also launched the latest evolution of our Acuity QDA mass detector, one of our all-time best-selling analytical instruments. The QDA2 provides a 20% enhancement in mass range, which benefits routine identification and analysis of large molecules. It also has excellent green credentials consuming up to 70% less energy than competing products. This is a benefit of increased importance to our customers. Most importantly, the QDA2 runs on Empower, which allows for seamless regulatory submission of compliance-related data for large molecules. As we look ahead, Waters is well positioned in attractive markets with secular growth drivers where testing volume plays a pivotal role in driving long-term growth. Our full ecosystem of instruments, informatics, advanced chemistry, and leading service positions us very well to help ensure the safety of medicine, food, and water, and batteries in electric vehicles. Along with our business model, the regulated and recurring nature of these applications results in excellent profitability and free cash flow generation. In recent years, we've made meaningful progress in aligning waters with faster-growing large molecule applications. Now over a third of our pharma revenues comes from large molecules and novel modalities. At the same time, future testing volume is expected to grow faster than historical levels with increased prescription volumes including GLP-1s and areas such as PFAS testing. With our revitalized portfolio, we are in an excellent position to capitalize on these growth opportunities. Over the past several years, we've launched multiple innovative new products that have enhanced our competitive edge and created better pricing levels. Serving our core, our next generation LC platform, Alliance IS serves routine QA-QC analysis for both large and small molecule workflows, where innovation helps to drive instrument replacement. It also includes our Zevo TQ absolute mass spectrometer, which is seeing rapid growth in areas such as PFAS testing. Within our high growth adjacencies, we've launched new products into bioanalytical characterization, battery testing, and clinical applications, all of which are gaining traction given the critical unmet needs that they solve. Finally, recent deferral of routine instrument replacement has created a catch-up opportunity that lies ahead of us. Weak macroeconomic conditions have put temporary constraints on customer capex spending for downstream instrumentation. Historically, this dynamic has lasted for four to seven quarters and has been followed by a catch-up. Looking at the facts, while no two macro environments are the same, Q2 marks the seventh consecutive quarter of ELSI instrument decline. Expected instrument growth for 2024 equates to a 1% CAGR versus 2019 levels. This is significantly below the 5% long-term average growth rate. Improving funnel trends are a positive leading indicator that we are approaching the early innings of a recovery and initiation of a new replacement cycle. I will now cover our 2024 full year guidance. While customer activity is showing signs of recovery, we're adding caution to our guide. Accordingly, we are revising our full year 2024 sales guidance to assume a more gradual pace of improvement in the second half of the year. As a result, our revised fully organic growth constant currency sales guidance is negative 2% to negative 0.5%. With our commitment to excellent operational performance, we expect to build leverage in our P&L and deliver an adjusted operating margin of around 31%. Therefore, our updated adjusted EPS guidance is in the range of $11.55 to $11.65. I will pass the call over to Amol to continue covering our financial results in more detail and to provide further details on our guidance.

Thank you, Udit, and good morning, everyone. In the second quarter, sales exceeded our guidance range on a reported basis, declining 4%. Organic constant currency sales also declined 4%, which was a 5% improvement in growth compared with Q1 levels. We saw a steady improvement in customer spending throughout the quarter with orders outpacing sales. M&A contributed 2% to sales, covering Wyeth results in the first month and a half of the quarter. This was better than expected as we were able to accelerate revenue synergies as part of our integration. We are pleased that within the first year of the acquisition, Wyeth is already EPS and margin accretive, and our M&A execution remains well on track. Overall, FX was a 2% headwind to the second quarter sales. In organic constant currency terms, by end market, pharma declined 4%, industrial declined 4%, and academic and government declined 16%. In pharma, sales excluding China declined low single digits, while in China, sales declined low double digits. In both cases, this reflects an improvement in growth rates compared to the previous quarter. In industrial, sales declined 1% outside of China, led by low single-digit growth in the Americas. We again saw strong growth globally for PFAS-related applications, which has been a consistent tailwind for environmental testing. In China, sales declined low double digits, which was also an improvement in growth rates compared to the previous quarter. For our TA division, sales were flat, driven by improvement in segments such as electronics, advanced materials, and chemicals. In academic and government, growth remained weak as stimulus in China and elevated global funding drove lumpy spending patterns and a tough 21% comparison in the prior year's quarter. By geography, sales in Asia declined 3%, while sales in America and Europe both declined 7%. By products and services, instruments declined 17%. Chemistry and service both grew 5%. There was no change in the number of days versus the prior year quarter. Our commercial initiatives continue to support robust recurring revenue growth despite ongoing headwinds from China. Within our service business, we have already achieved our goal of increasing service plan attachment by a further 100 basis points this year with service plan revenue growing high single digits in the quarter we are now targeting an additional 50 to 100 basis points of service plan attachment over the remainder of the year now i will comment on our second quarter non-gap financial performance versus the prior year despite headwinds from lower sales volume fx and inflation our team continued to respond to these challenges with resilience and commitment Our focus on operational excellence with pricing, productivity, and prudent spend management allowed us to deliver a resilient margin performance in the quarter. Gross margin was flat at 59.3%, and our second quarter adjusted operating margin was 29.2%, as expected. Excluding FX, both gross margin and adjusted operating margin expanded 40 basis points year over year. Our effective operating tax rate for the quarter was 16.5%, and our average share count was 59.5 million shares. Our non-GAAP earnings per fully diluted share was $2.63. On a GAAP basis, earnings per fully diluted share was $2.40. A reconciliation of our GAAP to non-GAAP earnings is attached in 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 second quarter of 2024, free cash flow was $143 million after funding $36 million of capital expenditures. On a year-to-date basis, free cash flow is $377 million, or 28% of sales, resulting in free cash flow to adjusted net income conversion ratio of 131%. We maintain a strong balance sheet, access to liquidity, and a well-structured debt maturity profile. This trend allows us to prioritize investing in growth. We continue to evaluate M&A opportunities that will enhance value creation for our shareholders. In the second quarter, we continue to deliver while paying out this year's tax reform payment of $96 million and other items totaling 30 million. As expected, at the end of the quarter, our net debt position was approximately 1.7 billion, which is a net debt to EBITDA ratio of about 1.7 times. As we continue to deliver our balance sheet, we will evaluate the resumption of our share repurchase program throughout the remainder of the year. Now I would like to share further commentary on our full year outlook and provide you with our guidance for the third quarter. While business conditions showed signs of recovery in the second quarter, we are adding caution to our guide. As a result, we are revising our full year 2024 sales guidance to assume a more gradual pace of improvement in the second half of the year. Our updated guidance assumes relatively flat quarter over quarter revenue progression in Q3 versus Q2 It also implies a weaker than typical budget flush dynamics in the fourth quarter. Despite that caution, we are still expecting the business to return to growth in the second half of the year. Given these dynamics, our revised full year 2024 guidance is for organic constant currency sales growth between negative 2% and negative 0.5%. At current exchange rates, we anticipate the currency translation will negatively impact full year sales by approximately 1.5%. Meanwhile, M&A contribution from wire transaction has added 1.3% to our full year from inorganic sales incurred in the first four and a half months of the year. Therefore, our total full year 2024 reported sales growth guidance is in the range of negative 2.2% to negative 0.7%. With our commitment to excellent operational performance, we expect to build leverage in our P&L, even with the reduction in our guide. Consistent with our previous guidance, gross margin for the full year is expected to be approximately 59.8%, which is 20 basis points of expansion versus 2023. Adjusted operating margin is expected to be around 31%. Below the line, we expect full year net interest expense to be approximately 77 million. Our full year tax rate is expected to be 16.3%, and our average diluted 2024 share count is expected to be approximately 59.4 million. Rolling all this together on a non-GAAP basis, Our full year revised 2024 earnings per fully diluted share guidance is projected in the range of $11.55 to $11.65 and includes an estimated headwind of approximately 3% due to unfavorable foreign exchange. Looking to the third quarter of 2024, we anticipate that customer spending will remain cautious but show further signs of recovery. We expect an improvement in year-over-year growth compared to that in the second quarter as previous year comparisons, particularly in China, become easier and as continued improvement in funnel activity translates to orders. Given these dynamics, our third quarter organic constant currency sales growth guidance is projected in the range of positive 1% to positive 3%. At current rates, currency translation is expected to subtract approximately 1.5%. Therefore, our third quarter reported sales growth guidance is negative 0.5% to positive 1.5%. Based on these revenue expectations, third quarter non-GAAP earnings per fully diluted share are estimated to be in the range of $2.60 to $2.70. which includes a negative currency impact of approximately two percentage points at current FX rates. Now, I would like to turn the call back to Udit for our closing comments.

Udit. Thank you, Amol. So now to summarize, with our strong commercial execution and continued resilient operational performance, our second quarter results demonstrate Waters' ability to deliver solid results in various market conditions. We're positioned well for the future with a long-term outlook that is above our historical growth rate of 6% as global testing volume growth remains on track and customer capex spending continues to recover. I am also proud of what our team has continued to accomplish on ESG and sustainability. Last month, we announced that Waters has become the first liquid chromatography column provider to receive the ACT Ecolabel certification from my green lab. This designation applies to more than 40 of our LC columns and makes it easier for scientists and procurement professionals to choose more sustainable lab products. So with that, I will now turn the call back over to Kasper.

Kasper Laundrieu Thanks, Udit. That concludes our formal comments. We are now ready to open the phone lines for questions.

Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star then 1. Please record your name at the prompt. If at any time your question has been answered, you can remove your request by pressing star 2. Please note that each person will get the opportunity for one question and one follow-up. Your first question for today will come from Vijay Kumar of Ibercor ISI.

Good morning, Odit, and thanks for taking my question. one maybe high level on your comments about the progression, the quarter, strong finish to June, orders above revenues. Help us square that with the guidance change, right? I don't think the guide change was a surprise. Is this just a conservatism in light of the strong June finish order momentum commentary or how should we interpret that in light of the guide change?

Firstly, good morning, Vijay, and thank you for the question. I think you sort of answered your own question. We're just sort of taking first just a step back and a 10,000-foot view. I mean, our approach to guidance, Vijay, has not changed as we've progressed through quarter on quarter, right? So we look at three different things. We, of course, look at the facts from the funnel, how the quarter is progressing, how it's ending, Then we spend a lot of time looking at history. I mean, there's not that many businesses that have 20 years of data on instruments, quarter on quarter. So we look at that. And the third thing we do is we talk to our customers and see what the sentiment is, how the orders are progressing, how the sales are progressing. So just to take you through that, and sorry for the long answer, but it'll give you context on our philosophy and the guide. On the facts, you're totally right. We saw, we've seen progressive improvement from Q1 to Q2. Sales have declined less in Q2 versus Q1. And as Q2 progressed, I mean, as you will know, June is a big month for us. We saw significant momentum in June. You'll remember in March, we talked about orders and quality of orders. And we said, we'll start to see them convert into sales towards the end of Q2 exactly the Well, that's exactly what happened. A lot of sales momentum at the end of the quarter in June and equally orders growing even faster than sales. So we feel very good about where we see the funnels and what we see with the facts. Now, historically, when you look at what is this business, we have the benefit of, as I said, 20 years of data, especially LC. If you just look at the LC business, when it goes through troughs, it is usually between four to seven quarters of negative growth. And Q2 was the seventh quarter of negative growth. So we are poised for a recovery. And we're operating at, if you just look at Q2 on a five-year CAGR basis, it's minus 2%. And we're seeing signs of recovery in LC. So we've factored that into our thinking. And then finally, talking to customers, both of those factual pieces of evidence are verified. I spent a lot of time in the quarter in Europe and in the U.S. with large pharma customers in particular, and China is improving. So as we look at the second half of the year, we're expecting to see improvement quarter on quarter as we go from one quarter to the other. The second half will see growth, as you rightly pointed out. We've just taken our our guidance down, especially in the fourth quarter, to assume a slightly lower ramp than we would see historically. So just a little bit of caution built into it. I think on a constant currency basis, it's not more than 50 million. So there's a bit of caution built into what we're seeing. And as more data emerges, you'll see us correct that. Sorry for the long answer, but I know I'm sure many people have the same question.

No, no, that's helpful. If I understand you correctly, What you're saying is, look, we're not seeing anything in the quarter. It's positive, a trend in the right direction. But from a guidance perspective, you're just de-risking it. And it's more from the perspective of being conservative versus having seen anything in the quarter. Is that a fair summary? Yes. Fantastic. You know, revenues, I think we're cut maybe 3% below street, the implied Q4 dollar revenues. EPS roughly in line with the street. So what change is the implied operating margins coming in better? Is there any below the line contribution that's driving Q4 EPS?

Yeah, look, I mean, as you've seen us through last year and this year, also back in 22 against inflationary pressures, Our team is super resilient and we are able to defend margin and even during down volume cycles, we're able to expand margin. As we've discussed before, we have a set of productivity initiatives that have a very long runway and we're able to accelerate some of them. And that reflects in sort of how we've been able to expand margin even last year. If you look at the embedded implied margin profile in our guide, our second half margin is relatively flat versus last year. So there is not any meaningful step up in the second half versus prior year. The only thing is, as we've sort of taken a more cautionary view on the guide, we will see some of the actions that we've put in place already show up in Q4, and that will help us a little bit in Q4. But other than that, second half is relatively flat versus last year.

The next question will come from Dan Brennan of TD Cowan. Your line is open.

great thanks uh thanks for taking the questions guys um maybe just on instruments uh q2 was about in line right with what your guide expected down 17 i think you were down mid-teens can you just flush out a little bit lc versus ms and how are we thinking about the updated instrument outlook for the back half of the year uh and kind of what's the math to support that

Yeah, so let me start and Amol can jump in, Dan. So instruments declined about 17% in the quarter. LC was a bit modest than that, mid teens. Mass spec declined a bit more and TA was around minus 2%, so minus 17% in the quarter. As I mentioned earlier, we're seeing steady improvement as we went through the quarter and the funnels look extremely strong, especially on the LC front. So for the back half of the year, we are assuming that the instrument growth rate will be flat versus the previous year. So overall, second half is flat. And just to sort of go a bit beyond the numbers, as I mentioned earlier, the LC replacement cycle now is in the seventh quarter of its decline. We're starting to see across the globe customers initiating their replacement cycle. So we expect a little bit of decline or flat growth in Q3 for ELSI, but in Q4 we expect the replacement cycle to start to kick in, which is consistent with what we see with the funnels. So quite an exciting time, just given the renewed portfolio across all the instruments. As the replacement cycle begins, we feel very good about where we are sitting today. Great.

Thank you. And then just China, anything change with the guide there? You were down, I think, mid-teens kind of in the quarter around what the guide was. So now what are you assuming for the full year? And is the commentary that orders on the kind of stimulus will start in 25? Is that a bit of a push? Like, I think... I thought I heard you guys say previously maybe orders come back half, and then it kind of kicks in in 20-packs. Any color on back half your China and then how we think about stimulus impact?

Sure. Firstly, I mean, China came in ahead of expectations, right? I mean, that's part of the driver for the beat. I mean, just to give you a bit of the facts, I mean, in Q1, China declined 26%. In Q2, it was around 10% decline. And I mean, in the largest end market pharma, we went again from about a 25, 26% decline to what a 10% decline in Q2. So steady improvement in China and the second half of the year, it has a lower base, but we've kept the full year guide at a low double digit decline for China, just to sort of watch and see more data. So good things happening in China. And again, when you compare lc growth rate and this is sort of an interesting fact uh for the first time in a very long time china's lc decline was less than the rest of the world right so china declined uh in the high single digits whereas the overall decline for uh for lc was a bit higher than that now as you think of the stimulus nothing has really changed versus versus previous commentary uh we're spending a lot of time with uh with customers doing three things one helping them identify the age of instruments. You recall this particular stimulus is targeted towards instrument replacements, the age of the instruments, the eligibility for the stimulus, and helping them do the paperwork as they start to submit applications for funding. We think this is going to impact growth only in 2025, maybe a modest impact towards the end of the year, but we've not factored that in.

The next question will come from Tycho Peterson of Jefferies. Your line is open.

Hey, thanks. Maybe just diving in a little bit into the guidance in the back half of the year. So 3Q, you're guiding the revenues up sequentially from 2Q. That's, you know, kind of out of line with normal seasonality. So maybe just touch on visibility. And then for the fourth quarter, you're, I think, in flat operating margins are, you know, mid to high 30s to hit DPS guide. I know you said, you know, operating margins are flat in the back half of the year. But what drives that fourth quarter ramp in particular? that seems out of line with normal seasonality?

Yeah, so I mean, look, Q1Q, Q2 to Q3 is relatively flat. If you look at last 10 years, it has sort of oscillated between plus and minus 3%, right? So it's sort of within the range, and what gives us comfort and confidence on that is what we have in our funnel and the activity that is progressing, as well as the fact that, you know, we built some backlog in Q2, so that also helps. Going to your other question around second half margins, as I said, second half margins are relatively flat versus last year. There's a small difference between Q3 and Q4. One is the prudence in Q3. The second piece is, as we've sort of taken a more cautionary view on the guide, we've put in place certain cost measures that are already playing out, particularly around outside services spent, particularly around how we resource certain growth initiatives, and you will start to see some of that impact flow through more in Q4 than in Q3. So there is some plus minus between Q3, Q4, but overall second half operating margins are relatively flat versus last year.

Okay. And then to follow up, you know, Udi, academics are only 10% of the mix, I know, but, you know, it was down 16%. Can you maybe just talk on, you know, how much of that was U.S. versus Europe, and, you know, what are you thinking back half of the year as the comps ease there for academics? Yeah.

I think no change in assumption on the academic side. It's such a small portion of our business, Tyco. So really no change from the previous assumptions.

Yeah, and I mean, you look at it this way, right? Like first half of last year was super well-funded between the China stimulus and what was happening in US and Europe. If you look at it on a two-year stack basis, pretty much every quarter you will see is like 0.1% growth.

The next question comes from Matt Sykes of Goldman Sachs. Your line is open, sir.

Hi, good morning. Thanks for taking my question. Maybe just first, you guys have leaned into the CDMO channel in China over the past couple of years, and that's been an area of weakness recently due to overcapacity. Could you maybe kind of talk about what you're seeing in the CDMO channel in China, and is it part of sort of some of the inflection that you see maybe towards the back half of this year into next year, or is that going to remain fairly subdued? for the balance of this year and into 2025.

Matt, thank you for the question. I think we gave a lot of details around this time and probably even earlier than that last year on CDMOs in China in particular. So really no change from what we saw last quarter. Steady improvement on the recurring side as activity starts to pick up a bit from a very low base. You'll recall it's an extremely low base now. But CapEx is still subdued, and we have not assumed any improvement in CapEx in the CDMO segment. Now, overall, the genetics market in China is starting to get a bit better. I mean, this is why we exceeded our growth expectations in Q1 and now in Q2. So steady improvement in China as you go through the year. Especially on the LC side, we're starting to see some replacement cycles get initiated there. CDMO less, but genetics a bit more starting to see life there.

Got it. Thanks. Thanks, Ujit. And then, Amal, just on margins, you discussed sort of back half and your expectations. I'm just wondering, on a longer-term basis, you made some pretty positive commentary about some longer-term margin drivers going forward. How should we think about operating margin cadence over the longer term for the business, and where are some of the levers to kind of continue to expand those margins as we move through 25 or maybe on a longer term framework? Thanks.

Thanks, Matt, for the question. And look, I mean, there are sort of three to four broad levers here. One is our business is structured such that if we grow more than 5%, it produces 50 basis points of volume leverage. And that volume leverage largely shows up on the SG&A line versus on the gross margin line. Two, we have benefit from mix as we move to more recurring as well as with the discipline that we've put in pricing, we feel comfortable like we've seen even in these challenging market situations that we are able to do a little more than 100 basis points better than what we've historically done on pricing. And so mix and pricing sort of is a creative to our margin profile. Couple of years ago, we started various productivity and operational excellence initiatives that have started bearing fruit, right? Things like procurement excellence, operational excellence in manufacturing, setting up GCC in India. And these initiatives have a long runway. I mean, between these initiatives, we expect to cover approximately 300 basis points over a course of about eight years, right? So they add up to the profile. So overall, our goal is between the three vectors to put about 100 basis points of margin expansion on the board and use about 70 to 80 basis points from these gains to fund higher growth adjacencies. And then as we get into sixth, seventh, eighth year when some of these productivity initiatives will start to saturate, we expect these higher growth adjacencies to start to produce one, revenue growth, and two, margin accretion and that will then sort of take over the impact that productivity initiatives have saturated. Now, as we've gone through the last couple of years where the volume leverage was not there, in fact was a headwind, our teams were able to accelerate some of the benefits on these productivity initiatives as well as we took proactive cost actions and got benefit from pricing, which have allowed us to not just defend margin, but also expand margin during down volume cycles. And that's where the difference lies, right? Because people look at it and say, last 10 years, you know, water's margin has been always sticky at 30%. And so where was the volume leverage? And the answer to that is there was always a volume leverage, but we gave it up in a down cycle. And this time around, we're not giving up in a down cycle so that we come out much more stronger when the up cycle comes across.

Amol's given a comprehensive answer. Just two points to summarize the whole thing. One, the teams have great muscle now to expand margins during a down cycle, number one. And number two, the pricing that we see is very resilient. And I'm excited about the prospects as we come out of this down cycle, given the product portfolio that we have. I mean, it's been totally renewed. We have leading products across the board that customers have had a chance to test during the down cycle. So very excited about what we're about to see.

The next question will come from Rachel Vattenfall of JP Morgan. Your line is open.

Great. Good morning. Thank you for taking the questions, you guys. I wanted to follow up on Dan Brennan's question around China here. It sounds like LC was a little bit better than expected in the quarter, but can you unpack the performance by end market within China there? And then also on this China stimulus dynamic, we've heard from a few of your peers that they've called out an air pocket related to China stimulus as customers are really holding off on submitting orders. So can you clarify for us, have you seen any pause in orders from customers in the region? And if not, why have you guys kind of been more immune to that scenario? Thanks.

Thank you. Thank you, Rachel. China overall, as I said earlier, declined less than what we had thought it would this quarter. So went from 26% decline in Q1 to about 10% in Q2. Across the different markets, there was improvement across the board. Pharma went from about 26% decline in Q1 to 10% decline. Same thing with industrial, which was a 20-ish percent decline. Again, 11% decline in Q2. And academic and government, which still has very high comps, went from over 40% decline to slightly less than 30% decline. I mean, the most interesting thing here is that the replacement cycle is starting to show life in China already. We went from over a 40% decline in Q1 in LC, over 40% to now less than 10%, which was better than the rest of the world. So we're starting to see customer activity pick up in China. It's still negative growth versus previous years, but it's starting to get better quarter on quarter. And on your question on the stimulus, look, I mean, we are having a ton of conversations with our customers as the activity level remains consistent. So the activity level has remained consistent. It's actually improving quarter on quarter. From a stimulus perspective, as I said earlier, it's a broader stimulus. It's over a longer period of time, and it specifically targets instrument replacement. So we've been spending a lot of time with our customers identifying the age of their instruments, defining eligibility versus what the government has targeted, and helping them do the paperwork to submit proposals for funding that becomes available. We don't expect that to impact revenue this year, but surely it will impact what we see in 2025. So overall, improving conditions across all the markets, especially in pharma, especially in LC, no real sign of what you're calling an air pocket. Activities continuing at a baseline level, getting better, and customers are getting prepared to get funding from the stimulus.

Great, thank you. And then I did want to follow up on 2025 quickly. So can you walk us through your exit rates at 4Q? You've kind of talked about some of this replacement cycle starting to heat up in the back half. If we layer in some of the weaker comps and the China dynamics that you talked about as well, how are you really thinking about that exit rate underpinning 2025? It looks like the street is currently just shy of a 6% organic growth rate. So just at our early starting point, how comfortable are you with that?

Yeah, look, I mean, if we sort of extrapolate our guide and say where will Q4 and our 24 exit rates will be, will be a good, even for ex-China, for LC and MS, will be a good couple of hundred basis points below the historic average. And this is ex-China, right? So that gives us a lot of hope and comfort that we are at the bottom of this whole slowdown in the replacement cycle and the fleet out there has aged meaningfully beyond its life needing replacement, particularly for LC. And then China is a twofold equation of one, the fleet is aged far more than that. But then the question is, when does these generic companies feel comfortable with their status? And when do they start replacing? And we're seeing signs of that, right? We've had few generic companies in China already starting to replace their fleet. And we think others will follow over the course of next few quarters.

I just want to embellish a little bit on what we're seeing at the end of Q2 that starts to give us confidence. June is one of the largest months of the year for us. And it has surpassed our expectations, both in sales and in orders. So there's a lot of momentum that we've built going into Q3. So that gives us confidence in it. a lot in the areas that we've just discussed, right? So it's consistent with an improving trend in the industry. Second, as I said, I spent a fair amount of time with customers both in Europe and the U.S. in this last quarter. Especially in large pharma, customers are now used to the additional steps in the procurement process. In fact, one of the largest pharma companies had introduced several steps in the process, which their internal teams were also learning, and we were also learning about, and that sort of that gave a little bit of pause to how fast the orders were converting to sales. This time around, when we said in March, order quality is high, like clockwork, we've seen them convert into sales towards the end of June. So now the funnel predictability is way better than we've seen, especially in large pharma, and the order quality and the funnel strength is pretty good, as we said, looking into the back half of the year.

The next question will come from Dan Arias of Stifel. Your line is open.

Hey, good morning, guys. Thanks. Can you maybe just refresh us on the thinking around the upgrades within this replacement cycle that we're talking about taking place here? And what I mean by this is obviously things are still shaky out there on the CapEx side. So when these LC customers come back into the market, should we assume that there's maybe less HPLC to UPLC transitioning? and what you see during historical periods, or do you think these upsell dynamics and the conversion to UPLC can be fairly typical?

I think it's a great question, Dan, right? And I would look at it two ways. One, the HPLC to HPLC conversion, right? And that's a robust trend, and we have line of sight on what the fleet is. And there we offer our customers two options go to the arch HPLC which is done really, really well, even during the downturn. And then the alliance is which is now also available in for biologics with with our premier technology right and that has been received extremely well in a way, the slowdown in the market allowed many of our customers. to sample the benefits of Alliance IAS, which reduces errors in the QC environment by 40%, which is a significant advance, probably the most important advance in the last decade in the HPLC segment itself. So we feel very good on the like-for-like replacement already. Second, when you think of HPLC to UPLC transitions, we are seeing that as well. And GLP-1s are a case in point where we see that transition happening. And now on that, let me make Let me make two comments. One, you've seen that our biologics revenue as a fraction of overall pharma has gone from roughly 20% to over 35% in the last three to four years. So that has been a very deliberate effort, not just on the UPLC side, HPLC to UPLC side, but also in introducing what we call the premier technology, which is tailor-made for large molecules. That is now also available on the UPLC segment, which allows customers to transition the larger part of the pipeline, which is biologics, from HPLC to UPLC very comfortably, where now the experimental time is reduced dramatically with the premier technology. So we're seeing both, and we are well prepared if the customer decides to remain with HPLC, and equally we're seeing the trend continue as more and more large molecules and novel modalities come through the pipeline from people transitioning to HPLC to UPLC, but there again, On the receiving end, our UPLCs now have the premier technology, which basically reduce experimental time dramatically. I hope that gives you color into the transition.

And just to add to that, I mean, if you look at our historical instrument growth pattern, the 5% instrument growth has roughly about 50 to 70 basis points of price and 3% of volume. the remaining one and a half or so really comes from upsell, right? And when we quote our price numbers, they're like for like skew and like for like geography. So that doesn't include when a customer chooses, say, ARK HPLC or Alliance or Alliance IS or ARK HPLC. And in order to achieve that 1.5%, we only need about 7% of these customers to choose an upgrade, given the current innovation and the pricing that is out there. And 7%, we feel super comfortable with the huge unmet needs that some of our newer launches are directly addressing, which customers are appreciating.

The next question is from Punit Souda of Lyric Partners. Your line is open.

Yeah, hi. Amol, thanks for taking my questions. For you, if I could ask, the June order growth improvement, the significant momentum you talked about in June, has that continued into July as well? And could you elaborate if this momentum is mostly in pharma, North America and Europe? It seems like there's still some caution on China. It's improving. I just wanted to get some more details there.

a great question and as you know and i think we've been through this before we won't comment on on july trends um but you can assume that june was very robust uh customer activity has been uh has been very very good uh and that gives us confidence on what we're what we're seeing in what we're what we've guided for in q3 so june has a lot to do with the confidence that we built in the replacement cycle, the confidence that we built in Q3, the confidence we also built in the ramp towards ramp in Q4.

Got it. And then, you know, an Asia question for you. Just thinking about China, first of all, and then I want to cover just Japan and India. China, just wanted to understand in terms of retaliatory risks for tariffs, if you could elaborate, where is your manufacturing position? How much of the business is China for China in case if there are tariffs and sort of retaliatory tariffs in 2025? And then on Japan, I believe you grew. Sorry, Japan, you were down 11%. In India, you grew about 11% in the quarter. Could you talk a little bit about what happened in those geographies? Thank you.

Sure, so three questions. First on China, I think we used, we were in an interesting way, we used the downturn to improve our manufacturing footprint in China, and that is going to help us as the stimulus comes through. We also increased our commercial presence across China, so we feel very good about what the future holds for China, both in terms of local manufacturing, where bulk of our instrument portfolio now is either finished or manufactured in China, and on the commercial side, equally good. Now, on your question on India, India has been a star performer for us for many, many quarters. This quarter was no different. We grew in excess of 20%, largely on the back of Pharma, and there in Pharma, LC grew close to 50%, right? And you heard that right, close to 50%. And so that, India goes from strength to strength, and the Indian government is giving stimulus to, like many other countries, to their academic and government segments. And there too, we're benefiting a lot. That segment grew quite rapidly, where the funding is captured. And then on Japan, It was a 1% constant currency growth.

I mean, look, Japan, you're looking at the reported number, right? And you know where Japanese yen has been over the last year. That's like a close to 11% headwind. So at constant currency, we're more or less flat. And that's also sort of the reason why the currency impact for us is somewhat higher. And we had to increase it to 1.5% driven by Japan because we have a reasonable Japan footprint. And our team is doing relatively well coming out of the March year end. So what you see progressing in Q2 and onwards is we see healthy demand and we see good funnel activity in Japan.

Yeah. And then just coming back to India, very excited about the prospects there. As with China, during a downturn, we've sort of figured out where to increase our commercial presence. In India, we go from strength to strength. The commercial presence has been increased across the board. We've increased our collaborations on the ground, and India has gone in the last two to three years from less than 6% of our sales to close to 8% of our sales. So it's becoming a more significant part of our business, and it's growing really, really well.

The next question will come from Jack Meehan of Nefron Research. Your line is open, sir.

Thank you. Good morning. So I wanted to ask about of this dynamic of instruments starting to recover but more looking at it from a margin perspective amal was curious like just um how a changing mix dynamic in the second half of the year and into 2025 um what that actually what that means for gross margin progression yeah great question jack as always uh look i mean there is going to be some um negative mix impact from more instruments when instruments start to come back but

As you look at our guide, that's sort of factored in the gross margin 20 basis points of expansion that we've outlined for the year. And as we go into next year, if the mix sort of returns back to, call it, say, 2019 levels, there will be 10-ish basis points adverse impact, but that's largely covered.

with the productivity initiatives we have in place so the margin algorithm of 20 to 30 basis points still remains intact got it okay and then uh two just uh housekeeping ones the first is any updated thoughts on buyback returning to that and second can you just remind us any selling day changes throughout the year in the third and the fourth quarter thanks

Yeah, so on the first one, right, I mean, we continue to pay down debt from the Wyeth acquisition. We are at 1.7 now. So we are at a point where we are actively considering the switch between paying down debt versus buying back shares. I mean, the intention is to gain strategic flexibility as much as possible. So we continue to review options. And on the number of days, I mean, the key thing to note is on q4 this year we have three more days than q3 of this year and that partly helps about one and a half percent in the ramp from q3 to q4 and then other than that i mean there are two more days in q4 of this year versus q4 of last year q3 is roughly the same the next question will come from catherine schulte of bear

Hey, guys. Thanks for the question. First, just maybe on Wyatt, great to see that coming in ahead of expectations. Are you seeing any different trends in terms of market improvement in that business, just given its exposure to large molecule and cell and gene therapy?

Yeah. Catherine, thank you for the question. Look, we're very happy with the way the integration has progressed. The synergies are being delivered well ahead of target. That's why you saw growth higher than what we had guided for Wyatt itself. And it's, as you know, focused on large-molecule applications, which are growing faster than the small-molecule applications, be it RNA therapy, be it MABS, be it viral vectors. We're working closely with customers on increasing applications. What's most exciting is that now the teams are working to take multi-angle light scattering, that is the wire technology, into QAQC with with basically our Empower software, right? And this is really exciting how you can imagine that large molecules don't have so many different analytical techniques that are in QAQC. It already has liquid chromatography, to some extent capillary electrophoresis, and now multi-angle light scattering. All of these now, if they are on, and now the RQDA2 gives us mass analysis, All of these now, if they talk to Empower, allow our customers to submit data to regulators. So very exciting, really good progress on that front. Even in a down market, we're seeing good demand for multi-angle light scattering.

Great. And then maybe just going back to the guidance update, can you just elaborate on if there were any specific areas of that conservatism that you added to your assumptions? Was it around China, pharma? Or is it really broader than that? Any further color would be appreciated.

Look, I mean, most of our guidance caution that we've put in place is around our ex-China business. We just put caution for a slower than anticipated pace of recovery. China, if anything, if you look at last two quarters, we've exceeded our expectations. We haven't just been bold enough to sort of then

improve the guidance for the rest of the year but we remain cautiously optimistic that our team will continue to positively surprise us like they've done in the first two quarters it's a it's a it's a great setup for for exceeding expectations as we go through the year um and it's just the guidance philosophy we talked about at the beginning of the call that we just started with and it's a great place to sort of end the call i mean it's basically what we've done all along. We look at a lot of data from customers, from funnels. Second, we spend a lot of time looking at history of LC replacement in particular, which bodes well. And third, talk to a lot of customers on how they're receiving our new products, how their spending is going. And all three point towards a more positive second half of the year than we've seen. So that's all been factored in, Catherine. Thank you for that question. Casper?

Thank you for joining us today and for your 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. Thanks. Have a great day. Thank you all for your participation on today's conference call.

At this time, all parties may disconnect their lines.