Waters Corporation (WAT) Q2 2021 Earnings Report, Transcript and Summary

Good morning. Welcome to the Waters Corporation's Second Quarter 2021 Financial Results Conference Call. All participants will be in a listen-only mode until the question and answer session of the conference call. This call is also being recorded. [Operator Instructions] It is now my pleasure to turn the call over to Mr. Caspar Tudor, Manager of Investor Relationships. Please go ahead, sir.

Thank you, operator. Good morning everyone, and welcome to the Waters Corporation second quarter earnings conference call. Before we begin, I will cover the cautionary language. During the course of this conference call, we will make various forward-looking statements regarding future events or future financial performance of the Company. In particular, we will provide guidance regarding possible future results of the Company and commentary on potential market and business conditions that may impact Waters Corporation over the third quarter and full year 2021. We caution you that any and all such statements are only our present expectations and that actual events or results may differ materially from those indicated in the forward-looking statements. For a detailed discussion of some of the risks and contingencies that could cause our actual performance to differ significantly from our present expectations, see the risk factors included in our Annual Reports on Form 10-K for the fiscal year ended December 31, 2020 in Part 1 under the caption Risk Factors and in our most recent quarterly reports on Form 10-Q for the quarter ended April 3, 2021 in Part 1A under the caption Risk Factors. Both of which are on file with the SEC as well as the cautionary language included in this morning's press release including with respect to risks related to the effects of the COVID-19 pandemic on our business. We further caution you that the Company does not intend to update any of its predictions or projections except during our regularly scheduled quarterly earnings release conference calls and webcast or otherwise required by law. The next earnings release call and webcast is currently planned for November 2, 2021. During today's call, we will be referring to certain non-GAAP financial measures. Reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures are attached to our earnings release issued this morning and in the appendix of our presentation, which are available on the Company's website. In our discussions of the results of operations, we may refer to non-GAAP results, which exclude the impact of items such as those outlined in our schedule titled Reconciliation of GAAP to Adjusted Non-GAAP Financials included in this morning's press release and in the appendix of our presentation. Unless stated otherwise, references to quarterly earnings, results increasing or decreasing are in comparison to the second quarter of fiscal year 2020. In addition, unless stated otherwise, all year-over-year revenue growth rates including revenue growth ranges given on today's call are given on a comparable constant currency basis. Now, I'd like to turn the call over to Dr. Udit Batra, Waters' President and CEO. Udit?

Thank you, Caspar, and good morning everyone. Along with Caspar joining me on this morning's call is Amol Chaubal, Waters' Senior Vice President and Chief Financial Officer; and John Lynch, Waters' Vice President and Corporate Treasurer. This is Amol's first conference call as Waters' CFO. Welcome, Amol.

Thanks, Udit.

I would like to start the call on Slide 3 by paying our respects to the founder of our company, Jim Waters, who passed away on May 17. Jim was a brilliant and spirited scientist and a pioneer in liquid chromatography. I met Jim the first time in 2019, when he came to talk to me about the merits of a technology we had acquired in a previous company. We spent hours in front of a whiteboard debating how to manage innovation and in particular how the application of certain technology could deliver benefit. Jim continued reaching out to me, not just on technology, but also on our mutual love for science education and then more recently on Waters. Jim's legacy will live on with each and every one of our innovations as we continue to strive to deliver benefits. Our teams around the globe have continued to manage admittedly through the pandemic, which is still very much with us. Most of all, we've kept the working environment safer employees and have remained flexible and resourceful as we continue to support our customers. I remain grateful for the ongoing resilience, commitment and dedication that our team has shown. Moving on to Slide 4, during today's call, I will provide a brief overview of our second quarter operating results as well as some commentary on our end markets, geographies and technologies. I will also update you on the progress of our transformation plan. We continue to be focused on three primary objectives: number one, regaining our commercial momentum, number two, further strengthening our organization, and number three, building on a core – on a strong core to access even higher growth areas. Amol will then review our financial results in detail and provide comments on our updated third quarter and full year financial outlook. We will then open up the phone lines to take your questions. As outlined on Slide 5, in the second quarter, our revenue grew 31% as reported and 27% on a constant currency basis reflecting continued strength in our pharma and industrial end markets with strong demand for both our instrument systems and recurring revenue products across our major geographies. Sales for this quarter represent a 6% compounded average yearly growth versus our 2019 results on a constant currency basis. This translates to a 7% stacked CAGR versus 2019 for the first half of the year, again on a constant currency basis. Our strong top-line growth resulted in a year on – year-over-year Q2 non-GAAP adjusted earnings per share growth of 24% to $2.60 per share. Our top and bottom line performance translated into solid free cash flow performance and allowed us to strengthen our balance sheet. Looking more closely at our top-line results in the quarter on Slide 6, first by operating segment, our Waters' division grew 27% while TA grew by 32% on a constant currency basis. By end market, our largest market category pharma grew 31% in constant currency, industrial grew 28% and academia and government grew 7%. A continued strength in sales to pharma customers was broad-based across customer segments, geographies and applications. Late stage drug development activity drove sales of our tandem quad MS instrument systems such as the Xevo TQ-XS and TQ-S micro, small molecule applications in manufacturing QA and QC grew across Asia, Europe and North America and was particularly strong in India. Industrial end market growth was also broad-based across geographies and applications, continuing its recovery so far this year. Food testing and environmental demand grew nicely in the quarter as did our thermal and geometry portfolios. Turning into academic and government, which is less than 10% of our business. Growth in the U.S. and Europe was partially offset by lumpiness in China. Year-to-date, our primary geographies have all returned to growth versus last year. Moving now to our sales performance by geography on a constant currency basis. Sales in Asia grew 28% with China up almost 40% and India up almost 60%, sales in the Americas grew 28% with the U.S. growing 26% and sales in Europe grew 25%. In the U.S. all end markets had strong year-over-year performance led by pharma and industrial. Academic and governments saw a return to growth for the quarter as the market continues to recover. Europe's growth was also broad-based across end markets and sub-regions. Overall, pharma drove growth with strong demand with small molecule and large molecule applications. Industrial and academic and government markets continued their recovery with both having strong quarters and strong starts to the first half of the year. China sales were up sharply in our pharma business, and we had solid growth in our industrial and applied end market there as well. We're encouraged by our continued strength in the contract labs business due to strong execution of our growth initiatives. In India, sales for the quarter were again very strong even as the country continued to feel the effects from the pandemic. We're really grateful for the hard work and dedication of our colleagues, who persevered through these challenging and tragic conditions. Trends in Q2 and year-to-date for our LC instrument portfolio is a positive indicator for sustainable growth in consumables and service plans. In the second quarter, LC instruments grew across all major geographies at more than 40% growth driven by our instrument replacement initiative and new products, especially Arc HPLC and a strong uptake of our PREMIER instruments both Arc and ACQUITY lines. This week, I spent time with customers at our Immerse innovation lab in Cambridge, discussing the separation and purification of mRNA and oligonucleotide molecules. While mRNA vaccines have developed at a record pace, we are far from solving key issues such as aggregation and selective binding of plasmids and mRNA molecules to various surfaces, something that our PREMIER technology addresses really well. Further strengthening our UPLC portfolio, the Arc system was launched earlier this year for customers, who need ultimate sensitivity. The Arc PREMIER delivers fivefold improvement in detector sensitivity and tenfold improvement in asset to asset precision helping labs accelerate time to market. Mass spec sales grew in excess of 30% driven by demand from pharma research and development and food and environmental applications. This included high-resolution systems used for research applications such as the Xevo QTof, tandem quad led by our Xevo TQ-XS and TQ-S Microsystems and our SQD and QDa single quad detectors utilized in high-performance LCMs applications. We introduced the Waters' SELECT SERIES MRT, a high resolution mass spectrometer that combines Multi Reflecting Time-of-Flight, MRT technology with both enhanced DESI and new MALDI imaging sources. The MRT provides scientists with a unique combination of speed, resolution and mass accuracy, especially relevant for applications in proteomics. We have been in conversations with customers to see how we can collaborate using MRT to analyze libraries of samples to create a database of proteins and metabolites to further understand the impact of therapeutics on a variety of issues. Sales of precision chemistry columns, sample prep kits and reagents grew 28% driven by increased utilization by our pharma customers and improved industrial demand. Demand for our premier columns continues to be strong. The low double-digit two years stack growth of chemistry columns revenue in Q2 when compared to our 2019 base underscores the rebound and customer activity, the strong position of our portfolio and building momentum of our e-commerce initiative. Service also showed strong double-digit growth. Our service engineers continue to have good and improved access to our customer sites and I'm grateful for the way they have served customers while continuing to navigate the challenges of the pandemic. Finally, with respect to TA demand continues to rebound and was balanced across all major geographies and product lines with particular strength in the U.S. and Europe. Let me now give you some highlights on our progress with implementation of our transformation plan on Slide 7. Starting that our first priorities are gaining our commercial momentum. We continue to see progress in our instrument replacement initiative, a released Arc HPLC has played an important role in the LC replacement initiative. It's improved mechanical specs and ability to seamlessly transfer methods from alliance HPLC or other HPLC platforms have been very well received by our customers. We're already crossing the mid-single digit stack growth versus 2019 on a year-to-date basis in LC. With our CRO and CDMO customers, our ability to develop and provide method transfer support continues to be a strong driver of growth. This segment grew 60% on a year-to-date basis versus the comparable period in 2019. Early trends that we saw in China has now been replicated in Europe, as well as in the U.S. Our e-commerce and recurring revenue attachment initiatives are also starting to boost the momentum of drug in our year-to-date two years stacked CAGR for chemistry and service revenue. Moving on to our second priority on Slide 8. We have strengthened our organization with the addition of wage to our Board of Directors. They currently serve as President of their pharmaceuticals for China and APAC. As results driven experience will further – they further expand the perspective of the Board that directly aligns with what are the strategy to accelerate growth and innovation. I'm also pleased to welcome Dr. Daniel Rush to Water as Senior Vice President of Strategy and Transformation. Dan joins us from Bristol-Myers, where he was VP of Worldwide Commercialization Strategy and Innovation. Dan joined several of our technically trained executive committee members that experience in orchestrating transformations in M&A, in relevant to customer segments like pharma and diagnostics. This things need to our third priority of building our core to drive durable growth. As you will see on Slide 9, Waters' already has a strong foundation in large and going at markets with a leading position of science and innovation and a roughly $65 billion market. A high exposure – high exposure to end markets that go around mix single digits that has deep rooted presence in regulated end markets like QA-QC. A large installed base of instruments with over 50% recurring revenues, a diversified geographic race with over 40% – almost 40% sales in Asia and industry leading margins are the strong financial flexibility. So you'll agree with me that this is a solid base to build off? Now I'm on Slide 10. To build a team of leaders who have a strong track record of execution, both Jon Pratt and Jianqing Bennett, Heads of the Waters division, and the TA division respectively are highly experienced commercial leaders and are now very focused on building capabilities to sustain our commercial momentum. What gives me most pleasure is that we have started to hit our stride with new product introductions across the portfolio. And these are contributing to our sales momentum, already. Leadership that is focused on execution and innovation is preparing us well to further build our portfolio to access even faster, growing adjacencies. They are exploring and nurturing opportunities, both organic and inorganic to increase our exposure to biologics, be it bio-processing reagents are novel modalities. They are actively shaping the promise of LCMs and diagnostics and proteomics discovery applications and advancing lab connectivity applications to our informatics portfolio. High growth areas such as sustainable polymers and renewable energy are a focus of the TA division. In summary, we've had a strong start to the year with a broad base – with broad based contributions from our end markets, product portfolio and geographies to our revenue growth. In addition to the impressive growth versus our 2020 base of comparison, our business dynamics and customer demand look healthy on a two-year runway basis. Markets we serve are in a healthy state and our geographic regions are re-bonding solidly from pandemic lows. We remain focused on the continued progress and success of our short-term initiatives in that tactically strengthening our core business. We're confident in the opportunities ahead to bring LCMS products, separations expertise, and compliant data management experience into high-growth biopharma and diagnostic applications. I look forward to continuing to share more with you as we progress on these various fronts. With that, I'd like to pass the call over to Amol for a deeper review of the second quarter financials and our outlook for the remainder of 2021. Amol?

Thank you, Udit, and good morning, everyone. As Udit outline, we recorded next sales of $682 million in the second quarter, an increase of 27% in constant currency. Currency translation increased sales growth by approximately 4%, resulting in reported sales growth of 31%. Looking at the product line growth, our recurring revenue which represents combination of chemistry and service revenue increased by 18% for the quarter, while instrument sales increased 40%. Chemistry revenues went up 28%, and servicing revenues were up 13%. As we noted in our last earnings call, recurring revenues were not impacted by a difference in calendar days this quarter. Looking ahead, there is no year-over-year difference in the number of days for the third quarter either. However, please note there are six fewer days in the fourth quarter of this year, compared to 2020. Now, I would like to comment on our second quarter non-GAAP financial performance versus the prior year. Before I do so, a reminder that in the second quarter of 2020 we took decisive actions to manage our costs as part of our near-term cost savings plan in light of the pandemic, while our COVID cost savings plan was successful, totaling approximately $100 million for 2020; it does have some implications in not year-over-year comparisons as we normalize from an abnormally low expense base. Gross margin for the quarter was 58.9%, down 10 basis points compared to the second quarter of 2020 driven by 80 basis points foreign exchange headwinds. Excluding the impact of foreign exchange, gross margin improved by 70 basis points, despite higher instrument mix and COVID cost actions in 2020. This improvement was driven by volume leverage and productivity gains. Moving down to P&L, operating expenses increased by approximately 39% on a constant currency basis, and 42% on a reported basis. The increase was primarily attributable to higher labor costs and variable compensation, the majority of which relates to normalization of the prior year cost actions. In the quarter, our effective operating tax rate was 14.8%, a decrease from last year as the comparable period including some unfavorable discrete items. Our average share count came in at 60.2 million shares, approximately flat versus a second quarter of last year. Our non-GAAP earnings per fully diluted share for the second quarter increased 24% to $2.60 in comparison to $2.10 last year. On a GAAP basis, our earnings per fully diluted shares increased to $2.69 come back to $1.98 last year. A reconciliation of our GAAP to non-GAAP earnings is attached to the press release issued this morning and in the appendix of this presentation. Turning to free cash flow, capital deployment and our balance sheet. We define free cash flow as cash from operations, less capital expenditures and exclude's special items. In the second quarter of 2021 free cash flow declined 12% year-over-year to $155 million after funding $37 million of capital expenditures. Excluded from the free cash flow was $14 million related to the investment in our Taunton precision chemistry operation, a $38 million tax reform payment, and 3 million litigation's settlement receipt. In the second quarter this resulted in $0.23 of each $1 of sales converted into free cash flow. Year-to-date free cash flow has increased 17%, to $348 million. In the second quarter accounts receivable DSO came in at 73 days, down 14 days compared to the second quarter of last year. Inventories increased slightly by 5 million in comparison to the prior year. We maintain a strong balance sheet access to liquidity and well-structured debt maturity profile. In terms of returning capital to shareholders, repurchased approximately 535,000 shares of our common stock for $168 million in the second quarter. At the end of second quarter, our net debt position was $940 million and a net debt-to-EBITDA ratio of about 1. Our capital deployment priorities remain consistent, invest for growth, maintain balance sheet strength and flexibility, and return capital to shareholders. We remain committed to deploying capital against these priorities. In addition, we will evaluate deploying capital to well taught out attractive and adjacent growth opportunities. As we look forward to the remainder of the year, I would like to provide you some update on our parts for 2021 on Slide 11. In the first half of the year, we saw good momentum in our market segments, driven by robust demand and strong commercial execution. We believe that this momentum will continue in the second half of the year, but the comparisons are more challenging. Fourth quarter of 2020 was the first quarter in our transformation journey and was further favorably impacted by higher year end budget plus spending. In addition, we have six fewer calendar days in the fourth quarter of this year. We are also keeping a watchful eye on the potential impact of newer COVID variance and the likely disruption they may cause to both supply and demand. We expect our near-term growth initiatives and commercial momentum to contribute meaningfully to our performance. These dynamics support updated full-year 2021 guidance of 13% to 15% constant currency sales growth. At current rates the positive currency translation is expected to add approximately 1 to 2 percentage points resulting in a full-year reported sales growth guidance of 14% to 17%. Gross margin for the full year is expected to be approximately 58% and operating margin is expected to be approximately 29%. We expect our full year net interest expense to be $37 million and full year tax rate to be 15%. Average diluted 2021 share count is expected to be approximately 62 million. Throughout the year we'll evaluate our share repurchase program and provide quarterly updates as appropriate. Rolling all of these together and on a non-GAAP basis full-year 2021 earnings per fully diluted share are now projected in the range $10.50 to $10.70. This includes a positive currency impact of approximately 3 percentage points at today's rates and assumes no adverse demand or supply impact from COVID. Looking at the third quarter of 2021 we expect constant currency sales growth to be 7% to 9%. At today's rates currency translation is expected to add approximately 1 percentage point resulting in third-quarter reporting sales growth guidance of 8% to 10%. Third quarter non-GAAP earnings per fully diluted share are estimated to be in the range $2.25 to $2.35. This includes a positive currency impact of approximately 3 percentage point at today's rates and also assumes no worst demand or supplying back from COVID. Now, I would like to turn it back to Udit for some summary comments. Udit?

Thank you, Amol. In summary, there is much to be pleased about the first half of the year driven by strong growth across our major end markets. Thanks to solid execution and double-digit growth in instrument sales we saw broad-based revenue growth across every region. Our transformation plan continues to progress the commercial momentum and strong leadership team in place. We now turn towards deploying our strategy in large and growing end markets. We operate through accelerating innovation to our portfolio as well as progressively aligning our portfolio with higher growth areas in adjacent markets. With that, we will now begin the Q&A session. Operator?

Thank you. [Operator Instructions] And our first question is from Tycho Peterson, JPMorgan and your line is open.

Hi, good morning. Nice quarter. Udit, I want to start with the replacement cycle. I know you talked about the Arc HPLC driving replacements on that side. I'm just wondering if you could share your latest thinking on how you're sizing that opportunity. I know last quarter you opened it up to competitive instruments. So if you could talk about the LC and MS side in terms of where we are in that replacement cycle and latest thinking on the size of that opportunity. That would be great.

So, thank you, Tycho, for the question. Look the LC placement cycle, last time I said we are in the third innings using a baseball analogy. I would say we're now in the seventh inning or so in terms of having tracked down all customers that are relevant for replacement, especially our own and to some extent our competitors. I would say we have reached out to almost 80% of our own customers and 20% to 30% of the competitive replacements, both across LC as well as mass spec. And we've recently, as I told you, added that UPLC segment to it as well. So really we start with the customers really solid, solid feedback, and especially with the introduction of Arc HPLC last year and now the promise of the Arc PREMIER, as well as the ACQUITY premier columns, which are really relevant for high-end separations. We're having very good luck with and very good performance with our LC replacement initiative. So from an overall contribution perspective, I would say we should think about it in terms of the stacked growth. So if you just look at our first half of the year, our organic constant currency stacked growth versus 2019 is roughly 7%. And if you compare it to our peer group over the same period on a stacked basis, and we've seen numbers anywhere ranging from about 2.5% to 3% to closer to 5-ish percent. So that if you take a weighted average gives you a lead of let's say 2% to 3% versus the roughly defined market. And I would say part of it is explained by our initiatives and part of it is explained – there's 2% to 3% lead versus the market, part of it is explained by outperformance of our initiatives and the LC replacement initiative being a strong contributor to it and part of it is replaced by really a strong uptake of our new products. I hope that gives you a bit of color and some quantification, and the best way to compare it is to just look at the stacked growth versus the overall market. And we are now trending, I think, probably second or third quarter in a row of our market plus organic performance.

Yes, that's very helpful. And then second question on that with the guidance increase, I am just wondering across kind of the three key end markets, pharma, industrial and academic, how you're thinking about transaction in the quarter sustainability as a moment you are seeing into the back of the year. Can you just provide some updated thoughts across each of those three groups?

Sure. So again, just first the facts, Tycho. For the second half of the year, stack growth would lead us to between slightly – north of 5% to slightly north of 6%, right. So that's, I mean, a year ago who would have thought that we would be here already. So, I mean, we're very happy with the ability to provide such a guidance. Across the three end markets, pharma goes from strength to strength and our strong presence in pharma benefits us as you can see disproportionately, so we expect that to continue. And on industrial, as you know, it can be quite a lumpy market, but if you again look at the fact growth of industrial, we are slightly higher than our overall average, which is closer to 5%, so we're closer to 6% on a stock basis for industrial growth on a year-to-date basis. So that again bodes well, I mean, again if you look at it over a longer period of time, it bodes well for what we're seeing on the industrial side, barring any sort of cyclicality due to the pandemic reemerging strongly. We think that trend should continue for the balance of the year. And then finally, academic and government, which is our smallest segment has backed quite an important one to place, especially our mass spec instruments, for the first half of the year was roughly on a stack base was roughly around 17% growth versus last year. And we expect that trend to start emerging even more strongly in the second half of the year. So we feel reasonably good across all three markets. I mean in the simplest way despite the pandemic, most of our customers and our teams have figured out how to work through the difficulties. I mean that's – there's not 100% access everywhere, but I feel they figured out a way to work through the ups and downs of the pandemic. I hope that gives you some color.

Thank you. Our next question is from Vijay Kumar with Evercore. Your line is open.

Hi, guys. Congrats on a good print this morning and thanks for taking my question. Udit and Amol maybe one on the Q in this guidance. If you at instruments, Udit, 40% growth. That is an impressive number and no doubt. But sequentially, we're just at 45% in Q1 perhaps a slight decal and I look at the segments, maybe academia a little bit soft. So I'm curious on the trends driving your instrument performance in the Q and what's implied in the back half? And Amol, on the back half, you mentioned six fewer selling days for Q4, can you quantify what the impact is?

Well, let me start with the instrument piece and then I'll pass over to Amol for the second part of the question. Under instrument piece, Vijay, I mean, we are really, really pleased with what we're seeing from – for three reasons. Number one, our initiatives are working extremely well, I mean, having a 40% to 45% growth versus last year, and then more impressively trending above our long-term average and we're already at mid single digits on instrument growth on a stack basis bodes very well. Second, it's equally important as you look at the recurring revenues and the impact on the recurring revenues, and you start to see some of that impact on the recurring revenues for the first half of the year already, the more – the larger the instrument placement, the larger the recurring revenues. And then finally, the third piece is around innovation. I mean our innovation across and this is probably the most enduring aspect of the transformation now. Our innovation is starting to hit its strides across the portfolio, right? You've talked – you asked about the instruments, so let me focus on that. We introduced Arc HPLC last year and I've talked several times about its benefit in China and the rest of the world for the workhorse – HPLC segment, we launched the Arc and the ACQUITY PREMIERE, which are also doing extremely well. In fact, ironically, the launch of ACQUITY PREMIERE has led to even increased demand for I-Class and H-Class – H-Class portfolio, which is meant for separating biologics and looking at high-end separations. So the portfolio across LC is really, really revitalized. And then on the mass spec side, having introduced new platforms for the tandem quads in 2019, the latest is the MRT, the multi-reflecting Tof and we have a lot of interest from our customers on that front. It's early days on where the sales will land on that. As you know, these are big ticket items, and they're also dependent upon capital outlays, but I feel very good about where we stand with our instrument initiative, the instrument replacement initiative, but even more importantly, how innovation is helping us to stay in that placement. Going forward, I mean, Jon Pratt and [indiscernible] thing will integrate this instrument replacement approach into our commercial execution. So this would not be new starting – starting late this year or early next year. So very happy with where we are. Amol, on the guide?

Yes, sure. And, Vijay, to follow on your question on six fewer days in Q4, I mean, that impacts our recurring revenue particularly service because service is accrued on a day-by-day basis for the annual contracts, as well as it impacts our chemistry revenue because of lesser utilization days in the quarter. And so at this point with six days it has roughly 3 percentage point impact in the sales realized in the quarter from six less days.

That's helpful, Amol. And, Udit, one follow-up. There's been some chatter about Alzheimer's is being a new opportunity for the entire life science tool space, but particularly for you guys in LT, historically, it hasn't been an instrument that's known for biologic area. Is there something different about this opportunity on the Alzheimer's side? That makes it different. Is this a meaningful opportunity for you guys? Thank you.

So, Vijay, we're very happy that there are additional therapies, so Alzheimer's coming out to the market and that was great news for patients. Look, it's very early to quantify and start thinking about exactly the impact of this therapy on our business. And it's suffice it to say we are well specked in most of the compounds that are in the late stages, especially in the QA-QC domain of large and small molecules. So, that's where I'll – that's as much as I will comment on it. I think it's too early to comment on the specifics and the quantification of such an opportunity.

And thank you. Our next question is from Doug Schenkel with Cowen. Your line is open.

Hi, good morning guys. Thank you for taking my questions. So, clearly, The Street is giving Waters a lot of credit for the solid progress made over the past few quarters under your leadership, Udit, and I know you wouldn't take full credit. It's you and the team by one way or the other. You're doing a great job and the stock reflects that. That said, it's still hard from the outside to tell how much of this is favorable multi-year comparisons versus better execution keeping in mind that the company really struggled for a few years relative to peers heading into the pandemic. It's obviously a bit of both and you tried to help to cut through this by providing stacked growth figures relative to 2019. But again, even that's noisy given how the company was performing heading into the pandemic? So cutting through all of that, what arguably matters most is how we should think about the future outlook for Waters' growth at the top line? Your stacked analysis that you talked about in your prepared remarks pointed to 6% to 7% growth at the top-line. As we sit here today, based on the progress you've made and just cutting through the comps, are you comfortable asserting that Waters has built to compound revenue growth annually at 6% to 7% moving forward?

Thank you, Doug. I can't help, but laugh about the overall question, not that I'm making fun of the question, I just – it's a long – it's a serious progress in a year. But to answer your question legitimately, I would say it has to – if you look at the long-term growth, I won't give you a number. I think it's very difficult to do it. What you can safely assume is our ambition is to remain a top-tier performer, especially when you look at the organic growth, right. So we've now for the last two or three quarters on a stacked basis have been market plus and our margins remain at the high-end of the industry. So that's our ambitions, right. So, I mean, that's what I'll tell you. Is it 4%, 5%, 6%? I don't know, but if it's 4%, we have the ambition to be higher than 4%, if it's 5%, it's higher, and you can go on from there. But there are two drivers that make me confident, actually three drivers that make me confident that we can be at the higher-end of the market. Number one, we've put a very solid team together with experienced leaders, who have shown in the past that they can execute very well above market – on the above market growth and they have experience in of course conducting transformations and integrations. So I feel very good about the team we've put together. Second, we're starting to develop a rhythm in our execution and you end up seeing the results, but we see a lot of leading indicators. And I've tried to give you some color around the different initiatives. And these are initiatives should – that should help us in longer-term. The LC replacement initiative has changed the way we work at Waters or probably brought us back to where Waters started long time ago, and looking at each and every replacement initiative and diligently going after through our CRM channel. That's a long-term improvement and execution. E-commerce, last year, at the same time we were less – less than 20% of our consumables went through the e-commerce channel. Today that number is in excess of 25%, that's in less than a year. And there is a long runway ahead of us in seeing the benefit of that execution. We've started to tap into newer customer segments. And again, I mean, I was pretty open about how underweighted we were in the CRO, CDMO, food testing segments in China. And there we've just started to hit the side. And you can see on a two year stack basis that's 60% growth, on a one year stacked basis that's a 40% growth in the same channel. And we are seeing our value proposition resonate very well with our customers. Our sales teams are super excited about what we're hearing from our customers. So these – the execution platforms that we've built, and I've just gone through three of these are going to help us for many, many years to come. And the last piece is innovation, which is most endearing to me. I mean, we have really been very precise about identifying unmet needs, and this is something definitely I don't take credit for. This has been going on at Waters for a long period of time. It was just starting to rekindle it and focusing us on the right problems to solve. We've seen already the impact of the recent launches in LC, the MRC is strengthening our high-res mass spec portfolio, the PREMIERE launch for the PREMIER – the PREMIER technology for columns as – could not have come at a better timing given the need for continued separation of more complex modalities, which have a higher affinity to metal. So I feel very good that there is a team in place that has a strong execution track record both organic and inorganic execution and the pipeline is starting to hit its stride. And I think that gives me confidence that wherever the market is, we can have the ambition to be a market class. Okay, I hope that gives you color.

Yes, that's helpful. And maybe just as a follow-up kind of along the same lines, recognizing higher instrument mix and the impact that has margin some of your comments on FX having a negative impact on margin in the quarter. I think the incremental margin was only 21%, 22%. And I think guidance for the year implies a high 20s incremental margin on really strong top-line growth. I think two of the big questions as it relates to Waters are the longer-term growth outlook at the top-line, which is why I asked the first question. The other question continues to be where margins can go from here. Recognizing mix, recognizing FX, recognizing you're investing in long-term initiatives over time, do you think the incrementals can get into the 30s over the next few years?

Thanks. Thanks again, Doug. I'll let Amol comment on how we're thinking about margin progression in a second. But I mean you should also look at the impact of additional instrument placement on the recurring revenues. And then when I talk about innovation and sustainability, the recurring revenues on a two year stack basis are double digits, right? Especially – our two year stack basis – sorry, chemistry is double digits and recurring revenues are high single digits on a two year stack basis, on a one year stack basis it's a double digit performance. So instrument placement helps with consumables placement, which are, of course, higher margin part of the business. I'll let Amol comment on your – on the breakdown of the margin.

Yes. Now, let me look from a longer-term outlook point of view from our margin profile, as you know, we have one of the best margins within the industry. We have a very disciplined sort of margin management profile within the company. And then as you step back, there are so many opportunities in terms of margins, right. One, as Udit mentioned, there is a huge opportunity in increasing our recurring revenue attachment rates and recurring revenue is a higher margin product or between chemistry and service, and that helps expand margin. As you look into operations, I mean, there's a huge effort underway on operational excellence and our procurement programs, which are starting to deliver and that would help our margin profile. We have a similar program underway on our service productivity initiatives, and that will expand margin and then there is the whole area around capability centers, and we haven't really invested in capability centers so far, and that will bring margin expansion. Now at the same time, as Udit outlined we continue to explore and nurture really fantastic adjacent growth opportunities, and those opportunities will need some investment. So the general plan is to use this margin expansion in some way to fund some of these investment opportunities and yet to deliver part of a steady margin profile. And as these programs deliver growth, you will see margin expansion show up over time.

And thank you. Our next question is from Derik De Bruin, Bank of America.

Hello, good morning.

Good morning.

So a couple of questions. So the constant currency number in 2Q, it didn't include any acquisitions, I don't think. And I guess, can we talk a little bit about capital deployment and sort of like how you're thinking about balancing share buy backs with M&A opportunities. And it also, I know you're talking about investing in certain new initiatives and diagnostics in so many other areas, because as you put a little bit more clarity on where you sort of see some of the more likely near term opportunities for bolt-ons?

Yes. So thanks Derik. I think off the bat, I mean, of course we can't be specific on where the immediate M&A opportunity or the midterm M&A opportunity is for obvious reasons. But from a capital deployment perspective, I mean, we remain flexible, right? I think that's been our – that's been our approach and disciplined, right? So this is basically something that you've heard us say many, many times. Now, in terms of the specific – in terms of the specific areas where we're interested, of course, given our very strong core, I mean we want to continue to invest in our core. If there are better technologies to perform separations that are dedicated to novel modalities to biologics, I mean we are very well placed to nurture those and capture those. And that's an area that we're looking at cheaply. We're looking at augmenting our instruments with automation. We continue to chase that space rather carefully. If I move to informatics, Empower is the leader in chromatography data that we also have the concept of creating a connected lab. And there too, we look for partnerships and expanding our portfolio, that's in the core. If you look outside the core, really where we see our technology is growing and some of the attractive data that we see our technology is going of course one of them is bioprocessing where we think step decoupling the process from the product is an imperative, and we believe technologies such as LCMS and technologies such as BioAccord in particular can help us help us achieve that objective. And we're seeing very good traction on that front, especially as we seed instruments earlier and earlier with our customers. So I feel very good about that. And then secondly, in and I've talked about LCMs in particular, and I'll let Amol comment on this as he gives you this view on capital deployment as well. On LCMs in particular we feel it's a technology that belongs in diagnostics and enhancing our ability to examine proteins in addition to – in addition to being genomics into that segment. So I feel very good about what we are doing on the LSMs front its early days, but we've done some pilots. We think we can do a fair bit organically, but we also might require partnerships. So that hopefully gives you a flavor of the areas we're thinking off. Amol, did you want to comment a bit on how we are thinking about.

I think you've covered it well, and Derik as we outlined in our prepared remarks, right, our priority with the clear product there is growth and the team work there is well thoughtout as we look at, I guess in growth opportunities, and that's how we will look at capital deployment, right? We will pursue growth, remain flexible, but be well thought out in what we choose.

Okay. One follow-up if I may; what was the percentage of new products – percentage of revenues from new products? I mean, do you have a vitality index and was there any COVID either you would call out COVID related sales in prior quarters, and just curious, do you have an update on that? Thanks.

Sure. So we do track our product vitality index and we look at it as products on the instrument side launched in the last three years and products on the chemistry side launched in the last five years. On our product quality index was close to 12% in the second quarter. We had very little, over to be nothing in terms of COVID impact on our Q2 revenue.

Thank you. Our next question is from Patrick Donnelly with Citi. Your lines are open.

Great. Thanks for taking my questions guys. Maybe one on China, the performance there, obviously 1Q, I think you had up over 100% growth and then the very easy comp. This is around 40% this quarter, obviously still very strong. Can you just talk about what you saw there sequentially, I mean, was 1Q kind of a bit of a catch-up on the span and this quarter a little more normalized, it seems to be we are going out what's going on in space, but we'd love your take on China here?

Yes. Thanks, Patrick for the question. I'm super excited about what's happening in China. We have a new leader for the last few months, and she's been making a tremendous changes that I've lead to acceleration. In the first quarter you'll remember that, that the pandemic hit China first. So the first quarter also actually weaker than the second quarter in China until you'll see a bit of a comp effect, but fundamentally all the initiatives that we've launched at global level are on China speed in China, right? So let me explain. From a factual perspective, right, so the second quarter growth was roughly 40% versus the previous year driving that instruments, the Arc HPLC was the design for the China market, and it's done very well, especially given its better performance in any of the – any of the other instruments available in the market. Second, from a consumables perspective we've seen really good progress on in China, in – mostly in the – even in excess of the instrument growth in some cases. And then finally on the CRO, CDMO and CTO sort of initiative; remember we talked about the food market in the past and we've said we were underweight in the food market. In China we've seen very good growth there; almost doubling of the business versus the same period last year. And then sort of CRO and the CDMO piece are -- the growth that I've mentioned was a global growth meaning 60% on a full year – on a two year stack basis. This in China is – this turnaround of growth for CRO, CDMO segment started in China. So feel very good about what's happening in China. And we'll just, I would say we've just begun on looking at newer segments, like the contract testing segments, both in food and pharma. We've started to work really efficiently and effectively on our presence and placement of instruments. And I feel very good about what we're going to do on the consumer growth side as well. So I hope that gives you a bit of color on what we see in China.

And thank you. Our next question is from Puneet Souda with SVB Leerink. Your line is open.

Okay. Great. Thanks for that. And Amol, welcome to the world of LCs and mass specs from amino acids. Really great to have you on board here. So first one is a bit, it is really around the instrument replacement cycle. My main question there is you pointed to arc replacement being in the seventh inning, correct me if I'm wrong about 8,000 instruments or so. So my question is absolutely first of all, it's great to see the replacements cycle, but in terms of when we think about next year, this does create tougher compares for 2022. You are replacing your own legacy LT Alliance here. So I'm just trying to understand what are some other initiatives that you have ongoing, including acuity replacement, tandem triple quads, replacements that you've talked about before. So just should we think about this level of growth continuing into next year with further replacement cycles? Because obviously, mass spec at Tandem Quads and liquidities are – there's a, maybe a smaller install base there than the Arc one. So if you could clarify that for next year, that'd be great? Thank you

Just to first quantify a little bit, right, so we said there are about 8,000 or so alliance instruments that that required a placement at our own 4,000-ish which is half the number for UPLC Acuity, and about 1,000 Tandem Quads, right? So varying degrees of progress on all of those, they should continue for a little bit of time, while we work through our own portfolio and then turn our attention to the competitive portfolio as well. Which especially on the LC side, whatever is plugged into Empower with gold, our reps that any time there's a replacement there, we want to be – we want to be in competition, especially if it's a competitive instrument. So your question is more around what challenges it creates for the future. First, let me start with the opportunity; the opportunity is that as you have more instruments base, you start to see a better recording revenue. I think that is the first and the most important piece. The second is on the placement cycle. This will become modus operandi as soon as we brought to our own installed base, and as we moved to our competitors installed base are playbook, which has been honed over the last six months or so is now becoming standard operating procedure for our reps around the globe. So it will be – of course, I mean from a mathematical perspective the growth on the instrument side has been terrific. I mean, we think it's a benefit for our recurring revenues both service and consumables. But it's becoming our modus operandi as we go forward. So Waters will no longer be letting instruments and perhaps even competitors go off our install base.

And thank you. Our next question is from Josh Waldman with Cleveland Research. Your line is open.

Hi, thanks for taking my questions. Previously you've talked about benefiting from customers investing in all go capabilities. I wondered if you could talk through the opportunity you see here, and I guess what is your, I guess current level of conviction that investments continue to serve as a growth catalyst for waters in the 2022 and beyond. And is it maybe just a one-time bolus that hits here in 2021?

Yes. I think Josh, it's a very good question. And last week I was at our Immerse site, Immerse Innovation site in Cambridge Mass, and had an opportunity to talk to several customers, especially ones who are now working in the mRNA space and the SiRNA space. And I would say universally, we're far from having solved the challenges for separating oligonucleotides and mRNA molecules, right. And if you just think of the progression there, number one, large number of large – very large number of compounds in the pipeline that are now leveraging the mRNA technology. And you must've seen some recent acquisitions in this space as well. But if you break the problem down from a separation standpoint, there's the plasmid, there is the mRNA molecule, and then there's also the lipid nanoparticle. For all three of these [indiscernible] we are far from having solved the aggregation problem, the problem with affinity to metal surfaces. And as I said earlier, the introduction of the premiere technology couldn't have come at a better time. So I believe given the further investment in the pipeline of molecules in this space, basically oligo-based compounds, our technological focus especially on separations of these complex molecules. First with the premier technology and others that we're working on bodes very well for what we see in the future. And I can tell you that I mean customers, while we have delivered – while the customers and us working together have delivered vaccines in record times, they're very far from having native and efficient process. So something that is a significant opportunity for Waters from an innovation standpoint, as you go forward.

And thank you. And our last question for today comes from Jack Meehan with Nephron Research. Your line is open.

Thank you. Good morning. My question is focused on gross margins. Udit, I was curious if we could start and just give us an update on the supply chain and how you're managing through any constraints you might be seeing? And then just looking at the full year guidance at 58%, it implies that the second half gross margins are below what you did in the first half. How much of this is related to the selling days, or is there some other dynamic related to investments kind of weighing on the seasonality this year?

So thanks for your question, Jack. Look from a supply chain perspective we have so far managed really rally with our suppliers and we are monitoring any dynamics in the supply chain, including ships that are stranded on the West Coast of the U.S. So we're very closely monitoring all those changes. We are in constant conversation with our suppliers so far so good. But I mean we are monitoring s things change, especially on electronic box. Let me also we're to Amol, to talk about the gross margin.

Yes. So on the gross margin, right, I mean, usually, typically in the March month, we take merit increases up. But that merit increase doesn't travel into the P&L because the inventory turns right on the gross margin side. And if you assume sort of a 3% merit increase, that will only travel into the P&L second half of the year with the inventory turns. So that sort of explains why gross margin is lower in the second half versus the first time.

Thank you.

And thank you. That concludes today's conference. I'll go ahead and turn it back over to the speakers at this time.

Thank you all for your participation and questions. And on behalf of our entire management team, I'd like to thank you for your support and interest in Waters. We look forward to updating you on our progress during our third quarter of 2021 call, which we currently anticipate holding on November 2, 2021. Thank you.

And thank you. You may disconnect your lines and thank you for your participation.