Waters - Q1 2024

Transcript

Operator (participant)

Good morning. Welcome to the Waters Corporation first quarter 2024 financial results conference call. All participants will be in a listen-only mode until the question-and-answer session begins. This call is being recorded. If anyone has objections, please disconnect at this time. It is now my pleasure to turn the call over to Mr. Caspar Tudor, Head of Investor Relations. Please go ahead, sir.

Caspar Tudor (Head of Investor Relations)

Thank you, Ivy. Good morning, everyone, and welcome to the Waters Corporation first quarter earnings call. Today, I'm joined by Dr. Udit Batra, Waters' President and Chief Executive Officer, and Amol Chaubal, Waters' Senior Vice President and Chief Financial Officer. Before we begin, I will cover the cautionary language. I would like to first point out that our earnings release and the slide presentation supplementing today's call are available on the Investor Relations section, Investor Relations section of our website. In this conference call, we'll make various forward-looking statements regarding future events or future financial performance of the company. In particular, we will provide guidance regarding possible future results and commentary on potential market and business conditions that may impact Waters Corporation over the second quarter of 2024 and full-year 2024. These statements are only our present expectations, and actual events or results may differ materially.

For more details, please see the risk factors included in our most recent annual report on Form 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, including in our discussions of the results of operations. Reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures are attached to our earnings release issued this morning and in the appendix of our presentation, which are available on the company's website. Unless stated otherwise, references to quarterly results increasing or decreasing are in comparison to the first quarter of fiscal year 2023 in organic, constant currency terms. In addition, unless stated otherwise, all year-over-year revenue growth rates and ranges given on today's call are given on a comparable organic, constant currency basis.

Finally, we do not intend to update our guidance, predictions, or projections except as part of a regularly scheduled quarterly earnings release or as otherwise required by law. Now, I'd like to turn the call over to Udit to deliver our key remarks. Then Amol will provide a more detailed look at our financial results. After, we will open the phone lines to take questions. Udit?

Udit Batra (President and CEO)

Thank you, Caspar, and good morning, everyone. We had a strong start to the year, with sales coming in at the high end of our expectations, backed again by excellent operational performance. I want to begin today's call by thanking my colleagues for their continued focus on innovation and supporting our customers. These results reflect our drive to accelerate the benefits of pioneering science with our innovative portfolio. In the first quarter, market conditions were as expected, with cautious customer spending and later than typical budget releases. But as budgets opened up, we executed well with sales landing at the high end of our guide. We also continued to deliver outstanding operational results. Earnings were above our guidance and margins expanded, even with volume and FX headwinds. This is a testament to our team, our resilient business model, and our operational initiatives.

Waters is well-positioned for future growth in our attractive secular end markets. In the first quarter, we added to our revitalized portfolio with new products that serve high-growth areas. Turning now to our results. In the first quarter, sales landed at the high end of our guidance, declining 7% as reported and 9% in organic constant currency. Our non-GAAP earnings per share exceeded our guidance at $2.21. On a GAAP basis, EPS was $1.72. Outside of China, sales declined mid-single digits as expected. In China, sales declined just under 30%, which was better than expected. Growth remained weak as our prior year baseline does not reflect last year's deterioration in market conditions, which became more pronounced in the second half. While instruments declined 25% overall, LC sales were slightly better than expected.

Instruments, instrument weakness was led by mass spec, particularly for A&G-related applications, which had a tough prior year comparison from global funding and a China stimulus. Wyatt delivered a 3% M&A contribution to sales. We continue to see strong synergy, performance, and traction for our recently launched products, such as ZetaStar. Now, I will talk more about our operational performance. We believe the best reflection of good operational execution is effective margin management, particularly when things slow down. While facing significant headwinds from volume, FX, and inflation, we delivered yet another strong margin result. Our gross margin expanded 40 basis points to 58.9%, and our operating margin expanded 20 basis points for the quarter to 27%. This was achieved through a combination of our operational management initiatives across pricing, productivity, and proactive......

These initiatives position us well for resilience during lower volume periods and give longer-term opportunity when market conditions normalize. You can see further evidence of our operational performance in our free cash flow. We had an exceptional start to the year, generating free cash flow of $234 million in the first quarter, which was 37% of sales. With our excellent free cash flow profile, we made rapid progress in delevering from the Wyatt acquisition as we approach its one-year anniversary. We serve attractive secular end markets, where testing volume plays a pivotal, pivotal role in our business. This volume, which is correlated with global, global prescription consumption, is expected to accelerate in the future, supporting our strong long-term growth outlook. Our distinct advantage in downstream applications lies with our full ecosystem of products that complement our innovative instrument portfolio.

In addition, we have strategically aligned with high-growth opportunities that further enhance our core position. We had a busy quarter, launching several new products that support a number of exciting high-growth areas. At Analytica last month, we launched the Alliance iS Bio, a version of our groundbreaking next-generation liquid chromatography platform suited for biologics applications. The new HPLC system combines advanced bio-separation technology, bioinert surfaces, and built-in intelligence features. This helps biopharma QC analysts boost efficiency and eliminate up to 40% of common lab errors. We believe that the Alliance iS is the most significant innovation to hit pharma QA/QC labs in over a decade. We're excited to bring this technology to routine testing applications for biologics. Supporting bioseparations, we launched a new set of size exclusion chromatography columns called MaxPeak BioResolve Premier.

These columns enable scientists to quickly assess aggregate content, integrity, and purity of larger biologic particles. It covers modalities such as lipid nanoparticles, nucleic acids, and viral vectors, and gives scientists a significant improvement in sensitivity and sample consumption while accelerating runtimes. This launch supports the development of these modalities into downstream, high-volume settings, where Waters has critical instrument technology like LC, mass spec, and light scattering, as well as highly innovative, industry-leading software, chemistry, and service. To simplify the detection of PFAS, we launched Waters Oasis dual-phase analysis cartridges. This consumable streamlines sample prep for PFAS workflows when detecting concentrations in water, soils, biosolids, and tissues. It joins our comprehensive portfolio of solutions that support the surging demand for PFAS testing, which is a $300 million-$350 million global market, growing 20% annually.

In an environment of increased scrutiny, the ability to accurately test for PFAS at very low levels is becoming a critical compliance need for a broad spectrum of industries. Our Xevo TQ Absolute mass spec has leading sensitivity for detecting these anionic compounds. It can detect PFAS levels at as low as one part per quadrillion. Last month, in the United States, the EPA finalized an enforceable four parts per trillion limit of PFOA and PFOS in drinking water, which marks a significant regulatory milestone. Later this year, further regulations governing PFAS are expected across the globe. This includes the European Union, where REACH proposed chemicals regulation contemplates a PFAS ban on products manufactured, as well as ones imported. In our TA business, we launched the Rheo-IS, which serves battery testing applications when used with our hybrid rheometers.

This rheo impedance spectroscopy accessory supports characterization of electrode studies, which can lead to more efficient battery production. I will now cover our 2024 full-year guidance. With our first quarter results, we remain on track to achieve our full-year revenue outlook, which is unchanged from our previous guidance at -0.5% to +1.5% growth in organic constant currency. We expect growth rates to improve over the remainder of the year and as, and as our prior year comparisons, especially in China, get easier. We expect improving funnel activity to translate to orders as the year progresses. With our strong operational performance, we expect to build leverage in our PNL despite the flattish revenue guide, and deliver 20-30 basis points of adjusted operating margin expansion, while still reinvesting for growth.

As a result, our adjusted EPS guidance is also unchanged at 0%-3% growth in the range of $11.75-$12.05. Now I will pass the call over to Amol to continue covering our financial results in more detail and provide the rest of our guidance. Amol?

Amol Chaubal (SVP and CFO)

Thank you, Udit, and good morning, everyone. In the first quarter, sales landed at the high end of our guidance range, declining 7% as reported and 9% in organic constant currency. As Udit mentioned, end market dynamics were consistent with our expectations. Ex-China declined mid-single digits as expected, while China declined close to 30%, which was slightly better than expected. In organic constant currency, by end market, pharma declined 6%, industrial declined 7%, and academic and government declined 30%. In pharma, sales outside of China declined low single digits as we executed well in this CapEx-constrained environment. In China, sales declined almost 30% due to ongoing market challenges that are not reflected in our prior year baseline. In industrial, food and environmental applications grew mid-single digits, with continued strong growth in PFAS-related workflows globally.

We also saw strong growth in battery testing within our TA business, which has been a consistent growth theme. However, this strength was more than offset by weakness in core industrial applications, which are more cyclical. Our TA business declined high single digits overall, while chemical analysis declined high teens. In academic and government, growth was weak against a 45% comparison, as stimulus in China and elevated global funding in the prior year quarter drove lumpy spending patterns. By geography, sales in Asia declined 16%, the Americas declined 8%, and Europe declined 3%. By products and services, instruments declined 25%, with LC growth slightly better than expected. Within recurring revenues, chemistry grew low single digits, and service grew mid-single digits, both of which were affected by low activity levels in China.

The quarter had one fewer day versus first quarter of 2023, which translates to a growth headwind of approximately 1% for recurring revenues. Now, I will comment on our first quarter non-GAAP financial performance versus the prior year. Despite headwinds from lower sales volumes, FX, and inflation, our team continued to respond to these challenges with resilience and commitment. Our focus on operational excellence with pricing, productivity, and proactive cost alignment allowed us to deliver first quarter gross margin of 58.9%, an expansion of 40 basis points, and first quarter adjusted operating margin of 27%, an expansion of 20 basis points. Our effective operating tax rate for the quarter was 14.3%, and our average share count was 59.4 million shares. Our non-GAAP earnings per fully diluted share were $2.21.

On a GAAP basis, earnings per fully diluted share were $1.72. A reconciliation of our GAAP to non-GAAP earnings is attached to this morning's press release and in the appendix of our earnings call presentation. Turning now to free cash flow, capital deployment, and our balance sheet. We define free cash flow as cash from operation, less capital expenditures, and excludes special items. In the first quarter of 2024, free cash flow was $234 million, after funding $29 million of capital expenditures, which is approximately 37% of sales. We maintain a strong balance sheet, access to liquidity, and well-structured debt maturity profile. This strength allows us to prioritize investing in growth, including M&A, and returning capital to shareholders. We continue to evaluate M&A opportunities that will meaningfully accelerate value creation.

At the end of the quarter, our net debt position further declined to $1.7 billion, which is a net debt to EBITDA ratio of about 1.8x. This reflects a decrease of approximately $300 million as we delivered the Wyatt acquisition. As previously disclosed, our share buyback program has been temporarily suspended to enable us to pay down debt incurred as part of the Wyatt acquisition last year. We will evaluate the resumption of our share repurchase program throughout 2024 as part of our balanced capital deployment objective. Now, I would like to share further commentary on our full-year outlook and provide you with our second quarter guidance. We expect to see an improvement in sales growth over the course of 2024 as prior year comparisons, particularly in China, become easier and as improved funnel activity translates to orders.

Our full-year guidance is unchanged, with 2024 organic constant currency sales growth expected between -0.5% and +1.5%. At current exchange rates, currency translation is expected to result in a negative impact of just under 1% on a full-year sales basis. We expect Wyatt transaction to add just over 1% M&A contribution to our full-year 2024 revenue for inorganic sales incurred in the first 4.5 months of the year. Therefore, our total reported sales growth guidance is unchanged at approximately 0%-2%. Despite guiding to flattest sales, we expect to deliver a gross margin of 59.8% for the full-year, which is a 20 basis points of expansion versus 2023.

We also expect to deliver 20-30 basis points of operating margin expansion versus 2023, resulting in an adjusted operating margin of slightly over 31%. We expect our full-year net interest expense to be approximately $80 million. Our full-year tax rate is expected to be 16.3%, and our average diluted 2024 share count is expected to be approximately 59.7 million. Rolling all this together, on a non-GAAP basis, our full-year 2024 earnings per fully diluted share guidance is also unchanged and projected in the range of $11.75-$12.05. This is approximately 0%-3% growth and includes an estimated headwind of approximately 2% due to unfavorable foreign exchange. Looking to the second quarter of 2024, we anticipate that cautious customer spending will persist.

In addition, while the China Q2 baseline reflects the onset of weakness, it does not fully reflect the weakness we observed in the second half of the year. As a result, we expect China to decline mid-teens in Q2, versus 28% decline we saw in Q1. Given these dynamics, we expect to see an improvement in year-over-year growth versus the first quarter, and our second quarter organic constant currency sales growth guidance is projected in the range of -6% to -4%. At current rates, currency translation is expected to subtract approximately 2%. Wyatt is expected to add approximately 1.5% M&A contribution for sales incurred in the first 1.5 months of the quarter. Therefore, our total second quarter reported sales growth guidance is -6.5% to -4.5%.

Based on these revenue expectations, second quarter non-GAAP earnings per fully diluted share are estimated to be in the range of $2.50-$2.60, which includes a negative currency impact of approximately 4 percentage points at current FX rates. Now, I would like to turn the call back to Udit for some summary comments. Udit?

Udit Batra (President and CEO)

Thank you, Amol. I would like now to give you a brief update on our progress towards leaving the world better than we found it, which is how we think about ESG. We work alongside wonderful people here at Waters, and I'm always proud when others recognize their talent and hard work. Our colleagues were recognized in the quarter for their achievements and contributions to separation science, excellence in manufacturing, and for being champions of LGBTQ and women's benefits in the workplace. I would also like to congratulate Dr. Philip Wyatt, the founder of Wyatt Technology, for receiving the esteemed Pittcon Heritage Award earlier this year. Dr. Wyatt's groundbreaking contributions to laser light scattering technology have paved the way for industry-leading advancements. From a corporate standpoint, Waters has once again been honored by Barron's, earning a place on its list of the 100 most sustainable companies in 2024.

Additionally, we are delighted to announce that S&P Global has included Waters in its 2024 Sustainability Yearbook. Separately, our commitment to robust governance practices was recently highlighted by the New England chapter of the National Association of Corporate Directors. We were honored to have Massachusetts Governor Maura Healey present Waters with the 2024 Public Company Board of the Year award. After recently committing to SBTi, which is the Science Based Targets initiative, we are now building on the excellent progress we made in reducing our greenhouse gas emissions. We're in the process of setting new standards towards a long-term reduction in emissions and aligning our business with the 1.5-degree centigrade future. Now, to summarize, we're pleased with how the first quarter landed versus our expectations, which supports our full-year guidance.

We remain on track to achieving the 2024 objectives and look forward to building on this trend as the year progresses. Our long-term growth profile remains excellent, and we are aligned to secular tailwinds that are stronger than ever in our attractive markets. With our robust financial profile and balanced capital allocation strategy, we have an excellent platform to deliver sustained value for our shareholders. With that, I'll turn the call back over to Caspar.

Caspar Tudor (Head of Investor Relations)

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

Operator (participant)

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

Dan Brennan (Senior Equity Research Analyst and Managing Director)

Great. Thank you. Thanks for the questions. Maybe the first one just on China. You know, you guys were coming into the quarter expecting down 40, and it was, you know, certainly better than that. You're talking about, you know, Q2 color. I'm just wondering, I know you guys gave some color on what was going on in the quarter, but could you just unpack it a little bit more? Like, what deviated from the guide? How is pacing in the quarter? And then is there any change to your full-year down mid-teens, high teens growth for China?

Udit Batra (President and CEO)

Dan, and good morning. Look, China came in better than we expected, but I'll remind you, it's still declining in the high 20s. Now, we expect that to continue for at least the first half of the year. Q2 will also see a decline, and the second half of the year will start to see a little bit of growth, given the weakening comps as the year progresses.

Now, coming back to Q1, to your question on what changed, I mean, you just have to go back to late 2023, when we basically said, "Look, we think across all end markets, especially pharma, we've seen a bottoming out of the volume." And from that baseline, we started to see better activity, especially on the replacement of LCs in our branded generics segment and something that we had talked about in the last quarter as well. Now, it's early days, right? We're starting to see a turn as customers start to replace this sort of highly aging LC fleet. So remember, we again talked about it at the end of last year.

When you look at the five-year stack growth of LC instruments for China in particular, it's down now almost, almost double digits, about 8%-9%, versus the five-year, versus five years. So with that as a baseline, we expect to see the replacement cycle initiate, and we started to see that already in Q1. Now, to put things in perspective, there's also a fair amount of talk on the new stimulus, and the stimulus itself is very different than the previous one. It appears it's gonna roll over a three-year period, it's three times in size, and it explicitly calls out instrument replacement, so which encourages us.

But we have not incorporated that into the guide for the full-year, which now we're basically saying is likely to be low double-digit decline, as opposed to the high teens decline that we had talked about, when we gave the full-year guidance. So China will likely be a little bit better than we had anticipated. And just coming back to the stimulus and looking ahead, I would not, while we have not incorporated that into our guidance, explicitly, I would not underestimate the importance of that on the psychology of CapEx spending, especially the replacement cycle. And as that sort of starts rolling out towards the latter half of the year and towards late 2024 and early 2025, we should see the sentiment improve and likely start of the replacement cycle in earnest.

Operator (participant)

Next, we'll go to the line of Vijay Kumar from Evercore ISI. Please go ahead.

Vijay Kumar (Senior Managing Director of Equity Research)

Hey, guys. Thanks for taking my question. Would it maybe on that comment around China, I think you mentioned improved funnel activity in the quarter as the quarter progressed. Is that funnel activity... Is that being sort of driven by this China, or is that a global biopharma? Any color on what you mean by the funnel activity? And I think for the back half guidance, which assumes, I think close to high singles growth, what visibility do we have, you know, in growth normalizing in back half?

Udit Batra (President and CEO)

Yeah, no, Vijay, thank you for the two questions. So let me just sort of take a step back and provide some context, right? I mean, as you know, Q1 is the toughest quarter for Waters to predict, right? It's our smallest quarter of the year, and this is when customers start to think through the total CapEx spend for the year and also think through the phasing of that CapEx. Right? So we took advantage of that, and I personally met several customers across Europe and in the United States, across pharma, across A&G, across our industrial segments, or across our clinical segments with our teams. And really, there are three main takeaways.

First, the quality of the funnel, the quality of the orders, is way higher than what we saw a year ago across all of the segments, especially in, in pharma, both in pharma and in biotech across Europe and the U.S.. Second, when you look at the traction of our new products, our new products are gaining a ton of traction and are being used heavily by our customers, and they're waiting to sort of adopt Alliance iS in earnest. You can go across the portfolio, it's being received extremely well. And third, the question on phasing. While the orders are firm and strong, the CapEx spending is firm.

Given that it is decided in the latter part of Q1, we think it's safe to assume that you'll only start to see the benefit late in Q2 and more so in the second half of the year. So the funnel is weighted towards later in Q2 and the second half of the year. So that's what sort of has gone into our overall thinking. Now, there are two big takeaways. One, we have increased confidence in our full-year guide as a consequence of these discussions. And second, on the phasing, we simply went back and said, "Okay, let's just look at the last 15 years." Over the last 15 years, the Q2 usually is a step up from Q1 of about 11%-12%, right? And so we assumed a 10% step up from Q1 to Q2.

And then first half versus second half, I mean, historically, it's basically, again, over the last 15 years, almost like clockwork. First half is 45%, and the second half is 55% of revenues. So that's basically what the algorithm we used to look at the phasing of the guide and from a revenue perspective. But overall, really increased confidence in the full-year guide, given the strengthening of the funnel and conversations across the globe and across customer segments. And second, the phasing is basically rooted in history.

Vijay Kumar (Senior Managing Director of Equity Research)

Fantastic. Thanks, guys. I'll let others jump in.

Operator (participant)

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

Michael Ryskin (Managing Director)

Hey, thanks for taking the question, guys. Just following up on some of the end market commentary. You talked about China, a lot about how you expect a low double-digit decline, sort of a better than prior. You're maintaining the fiscal year, so what's sort of offsetting that? And maybe specifically hone in on America, as it looked like that came a little bit worse in the quarter. Anything changing your outlook there for the year? And I got a quick follow-up.

Amol Chaubal (SVP and CFO)

Yeah, no, I mean, Mike, at this point, we are just de-risking the remainder of the guide, right? We have had better expectations of China based on how we are executing in that market, and we're keeping our full-year guide flat.

Udit Batra (President and CEO)

Yeah, and then I think you asked about the U.S. in particular, what are we seeing in the U.S.? Look, I mean, as I said, I spent a fair amount of time with customers across the globe, and one of those was a large customer in the Midwest, where I spent a whole day with about 12-13 folks from the customer across many different departments, across development, manufacturing, QA/QC. And we talked deeply about what they envision for CapEx, which I sort of earlier commented on, and the CapEx is very robust.

Second, we talked about the use of our new products. Think about inline testing with LCs, think about our columns, think about the upgrades for Empower, the software. Really, really well received. We talked about the phasing of the spend, which also again, is still sort of late Q2 and back half weighted. But to put it all in perspective, if you look at the U.S. itself, the five-year stack, Michael, is still pretty, pretty healthy. It's in the mid- to high-single digits, right? So there is really no drama outside of China. I mean, we've had two exceptional years in ex-China sales, and now you have a little bit of a lull, but the activity looks extremely good, gives us confidence for what we are planning for the full-year.

As I said, no drama, no new news, but just other than the fact that new products are gaining traction, and customers have much more robust orders than they did a year ago.

Michael Ryskin (Managing Director)

Okay. Thanks. Can I, if I could squeeze in a quick follow-up, on Wyatt, you had some commentary on how the quarter progressed, and if you could elaborate on that a little bit. And it looks like you tweaked down the M&A contribution for the year. I think it was 1.3 prior, now it's 1.1. Is that instrument mix in Wyatt? Is that phase and phasing through the year? Just sort of how's that acquisition trending? Thanks.

Amol Chaubal (SVP and CFO)

Yeah, look, I mean, on Wyatt, we are making fantastic progress, right? All the synergies that we laid out at the beginning of the acquisition, like cross-selling, like attaching our LC seamlessly to the instrument, like attaching our columns with their shipments, have all progressed ahead of schedule, including sort of a beta version of bringing light scattering on Empower. Now, keep in mind, like, Q1 is a really small quarter, and, for instruments especially, and when things sort of slip a couple of weeks here and there, it causes that distortion, and that's why we sort of tweaked down Wyatt to 1.1% versus 1.3% M&A contribution. But the way that acquisition is going, we are super happy where we are in that journey and really look forward to bringing light scattering into QAQC.

Udit Batra (President and CEO)

And Michael, to build on it, again, from customer conversations, I had an opportunity to spend some time last week with one of our largest academic customers who has a hospital attached to it. And basically, we talked at length about characterization of lipid nanoparticles, which, as you well know, are used for delivery of mRNA, both vaccines and therapeutics as we go forward, an area of intense interest across academia and industry. These folks specialize in characterizing lipid nanoparticles, which can often be aggregated of different... and have different sizes and shapes. Like, they basically use SEC columns from Waters and light scattering equipment to characterize these aggregates.

In addition, what I learned is that they are piloting the use of field-flow fractionation, which is another instrument that Wyatt makes, as a precursor to using SEC-MALS, right? And field-flow fractionation, if and the early experiments indicate a really positive outcome, if those experiments work well, could become a mainstay for any experiment that is done to separate these aggregates. And the same idea then applies to AAVs, which are viral vectors used for cell and gene therapy or other particles that are used in biologics. So very excited about what we're seeing in Waters. Really a great cultural fit, well ahead of all synergy targets. Customer conversations even give me more confidence.

So in the mid to long term, we expect it to continue to be accretive to growth and to margins.

Operator (participant)

Thank you. Our next question comes from Matt Sykes from Goldman Sachs. Please go ahead.

Matt Sykes (Research Analyst and Managing Director)

Hey, good morning. Thanks for taking my questions. Maybe just revisiting the guide, just given the lower than expected guide in Q2, and you mentioned that you expect sort of funnel activity to translate into some level of orders towards the end of Q2 into Q3. Have you changed sort of your view on the phasing for a second half in terms of, the growth you're going to achieve in Q3 versus Q4? Are you pushing more of that potential growth, into Q4? Has that phasing at all changed for your full-year guide?

Amol Chaubal (SVP and CFO)

Yeah. So, Matt, thanks for your question. And look, I mean, we executed well to finish at higher end of our Q1 guide, right? And that sort of keeps us on track for our full-year sales guide. And as Udit discussed, our Q2 guide is essentially 10% higher than Q1, which has been sort of our historical trend pre-pandemic. And our second half guide is also very much consistent with how we've historically performed, which is a 45/55 split. So we generally expect the breakdown between Q3 and Q4 to also follow that historical trend for 2024.

Udit Batra (President and CEO)

I think, Matt, thanks for the question. Again, I'll remind you, we had the same discussion when we looked at Q3 versus Q4 of 2023, and there was a lot of discussion on the ramp, and I think we again landed at the higher end of what we were, what we were predicting. So difficult business overall to predict if you have high, high, average selling price instruments. But I think we have so much statistics from the history of Waters, it gives us a lot of confidence and couple that with discussions that we've had with customers, that we think the full-year guide is fully intact, and quarter-over-quarter, there's a lot more time to talk about it as we see how Q2 evolves on the ramp between Q3 and Q4.

But history should be a decent guide if you're really looking at that sort of modeling between quarters.

Amol Chaubal (SVP and CFO)

Yeah, and I mean, on a growth basis, it looks a little weird, but that's because of last year, right? The weakness progressively stepped into China, and pretty much Q3 and Q4, there was no incremental, meaningful bad news out of China, but a lot of that was not reflected in Q1 and Q2. That's why it sort of, it plays out in the growth purely from the baseline effect, mostly from China.

Udit Batra (President and CEO)

I think what Amol is saying is it's arithmetic, and customer conversations give us confidence that we have a pretty good set of visibility.

Matt Sykes (Research Analyst and Managing Director)

Great. Thanks for that color. And then just one quick follow-up. Just in the academic end market in the quarter, I know you were facing a really challenging comp. I think you grew academic, like, 45% constant currency in Q1 of last year. So was there any incremental weakness in that academic end market, or was it just purely facing difficult comps?

Udit Batra (President and CEO)

Yeah, I think you, you nailed it. It's really difficult comps. I mean, it is our smallest segment in particular anyway, so you see an exaggerated drop if you just look at year-on-year. And again, if you look at sort of the long-term trend, and which is sort of the best way to look at Waters in any case, even in A&G, what you find is the five-year comp is at the low single-digit. Five-year CAGR is at the low single-digit range. And ex-China, as I keep saying, there's really no drama. Ex-China, you're at almost 2%-3% growth versus what we saw five years ago on a CAGR basis.

China is down about sort of low to mid single digits in the academic segment, again, given the comps from last year, but also a little bit more exaggerated weakness.

Operator (participant)

Thank you. Next, we'll go to Rachel Vatnsdal from JPMorgan. Please go ahead.

Rachel Vatnsdal (Executive Director of Equity Research)

Hi, good morning. Thanks so much for taking the question. So I wanted to dig into the pharma performance in China a little bit. I believe you said that was down 30% this quarter versus rest of world, down low single digits. So can you unpack that China performance within pharma for us a little bit? Obviously, we've seen the headlines related to BioSecure Act. Last year, at 1Q, you guys called out your overexposure to CDMOs in the region. So can you quantify for us how much of this was driven by those Tier 1 CDMOs in the region this quarter? And then you previously have kind of broken out those trends between Tier 1 versus Tier 2 and 3 CDMOs. So could you do that for this quarter as well? Thank you.

Amol Chaubal (SVP and CFO)

So look, I mean, great question. As you sort of travel through last year, Q2, Q3, Q4, we saw weakness creep in on different elements of the pharma business in China. But as I said earlier, in Q3 and Q4, there was no incremental bad news out of China, and that trend sort of has continued into Q1. And so in a way, what played out, what you see in terms of the decline is largely baseline related, where China, from a pharma point of view, has bottomed out, and there is no incremental headwind coming into the business. But we are also not seeing sort of growth in activity, both in CDMOs or in branded generics or in biotechs in China. So if anything, let's call it stable.

Now, on your second point, which is around the BioSecure Act, I mean, look, with the weakness that we observed in 2023, the baseline is largely corrected in China for submarkets like CDMOs, right? Including WuXi. What we are seeing in the market is customers are taking proactive measures to secure their supply chain. And when they are doing that, our service organization, which is really well respected in the industry and plays a pivotal role in these tech transfers, are deeply embedded when these moves happen, right? I mean, our role is to support customers in their pursuits, and our customers really value our support when they go through situations like this and move products from one site to another.

Udit Batra (President and CEO)

Yeah, and then Rachel, just to embellish on this, and that's a very good, sort of insightful question. Just to embellish on what Amol said, on the -30% for Q1, it came out -28%. Q1, it came above our expectations, largely because we started to see customers who have aging LC fleets in branded generics start to move, right? So we started to see that signal, which is a positive sign. And as I commented earlier, as the stimulus starts to roll in towards the latter part of the year, that should have a positive impact on the psychology for spending CapEx. And I'll remind you that we're sort of almost 50% delinquent on these replacements in branded generics, in the branded generics segment, which is the largest segment for LCs in China.

We expect that to turn at some point, and the psychology will have a lot to do with it. On BioSecure, I mean, it's a net neutral for us at the end, right? I mean, we've already bottomed out on CDMOs at in China. I think as customers look for help in transferring from one vendor to another, we stand ready to help them.

Rachel Vatnsdal (Executive Director of Equity Research)

Great. And then my follow-up, I wanted to push on that China stimulus dynamic a little bit more. We've heard from some of your peers that are working on proposals for customers at this point. So can you talk about the conversations you're having on your end with customers and if you're working on proposals as well? And specifically, what types of instruments and then which industries do you really expect to benefit from within China's stimulus? You know, we've heard some rumors around this being a little bit more industrial-focused. So are you seeing that in your, you know, proposal funnel as well? And then when do you think that this could eventually translate into orders and revenue? You mentioned back half of the year, some of the psychological impacts, so any color on timing expectations would be helpful as well. Thank you.

Udit Batra (President and CEO)

... everything and anything about the stimulus, Rachel. Look, the timing, I don't have much more to add than what I said earlier. I think latter half of the year, we are indeed working with several customers on their plans for the stimulus as they hear more across the country. And it is a broad stimulus. I mean, this time around, it's a three-year stimulus. It's three times in size. It's quite broad across virtually every customer segment, not just limited to A&G. And frankly speaking, I don't know what people, if they got extra money in academia, what they would do with it, because they've sort of been chock full.

I remember I commented, sort of in Q3 last year, about how many instruments they bought, high-res instruments and how many are still in boxes. So I don't expect much of it to go to high-end R&D customers, but definitely beyond that, there is a lot of conversation across many different customer segments as they plan, and they learn more about the details of the stimulus. But I would not, and so we've not incorporated that into the guide, and I would not expect that impact sooner than sort of later this year and in earnest, first part of next year. So, good conversations with customers, planning going on, like you've heard with...

from others, but a broader one, not just limited to academia, across industry, across pharma, and the psychological impact, I would not underestimate, as I said before, because I think we're operating at a significant deficit on LC instruments and branded generics.

Operator (participant)

Next, we'll go to the line of Dan Leonard from UBS. Please go ahead.

Dan Leonard (Managing Director and Research Analyst of Life Science Tools, Services, and Diagnostics)

Thank you. One question on your gross margin expansion in the quarter. How much did better-than-expected product mix contribute to that? You mentioned that liquid chromatography did a bit better than planned, and mass spec was a bit worse. I'm curious how much of the contribution that was. Thank you.

Amol Chaubal (SVP and CFO)

Dan, yeah. I mean, look, the product mix is helping at this point, especially given a lower instrument mix, that's contributing about 30 basis points. But keep in mind, there was also a good 70-80 basis points of FX headwind that we offset it, right? So, the remaining delta is favorably coming from price, and some of the productivity initiatives in manufacturing.

Dan Leonard (Managing Director and Research Analyst of Life Science Tools, Services, and Diagnostics)

Thanks, Amol.

Operator (participant)

Next, we'll go to the line of Patrick Donnelly from Citi. Please go ahead.

Patrick Donnelly (Managing Director)

Hey, guys. Thanks for taking the questions. Udit, I guess in terms of some of these conversations you're having, I'm just wondering, you know, what stage do you think we're in? You know, it sounds like, again, the conversations have funneled to your point, maybe improving a little bit, specifically with China, it sounds like maybe you're expecting the actual revs to show up, you know, late this year at the earliest. So how do you think about just the progression of these conversations into orders, into revs? And again, is there a potential for a bit of an air pocket as these conversations pick up and the dollars, you know, materialize a little later in the year? How do you think about just the progression there?

Udit Batra (President and CEO)

It's a great question. Look, Patrick, let's just take a full step back on Waters, right? As you know, and many on the call know, we've grown instruments roughly 5%, and I know your question is targeted towards instruments. Instruments have grown on average 5% over the last 15 years, right? And those statistics are sort of easily available, given that we've not done a lot of M&A. You can look at our longitudinal history on instruments, right? So about 5% on average, but no year is actually 5% on the dot, right? There are five that are well below, five that are well above, and five close to the average, right?

So you start with that, and since I've been at the company the last three and a half years, we've seen a microcosm of that already, right? So two years of 20%+ growth and now a bit of decline in instrument growth rate. We didn't get too excited when things were at 20%+ growth for several quarters in a row, and we said, "This is not going to last, just given the long-term averages." And we're not so fazed when we look at what we are seeing now. And now let me sort of address your question, just that with that as context, it's very difficult to predict a quarter-on-quarter rollout of instruments for Waters. But I think it's more instructive to look at the five-year average, especially when you think about LC.

A five-year CAGR for LC is operating now at the low single-digit level. In China, it's almost double-digit decline. So we are due for a replacement cycle to begin very soon, in LC instrumentation. And remember, these are used in QA, QC, so you can't forever defer these replacements. And the conversations that we've had with customers, and as I said, I spent a whole day with one of our largest customers, especially in QA, QC, they are raring to go and start their replacement cycles, right, on LCs. The aging fleet is not something that they want to have, especially for new launches, which are going to be high volume and of course, marketed compounds. So I think things are trending in the right direction.

But again, I mean, just put this all in context, there's really, again, one shouldn't get too excited when you see high growths and declines, especially for our instrument portfolio. And when you look at the full-year, again, I'll remind you, that it's a 45%, 55% average, for the overall business, right? First half, 45%, second half, 55%, and that's what we presumed for the full-year phasing overall, and the step up in the second quarter is, roughly 10%. So just sort of give you broad, broad sort of signpost, but the conversations were with the QA, with the heavy focus on QA/QC, and we see replacement, signs of replacement cycles beginning both in China, which we commented on earlier, and ex-China.

Patrick Donnelly (Managing Director)

Yeah, that makes a lot of sense. Thanks, Udit. And then, Amol, maybe just quickly on the margin side, can you just talk about, you know, the progression as we work our way through the year? I know you guys had some kind of cost initiatives working with the way through the year, last year. So I'm just trying to think on the cadence there and any moving pieces you want to call out as we work our way through 2024 here. Thank you, guys.

Amol Chaubal (SVP and CFO)

Yeah, look, I mean, already in Q1, we put good numbers on board and continued our good financial performance. As you get into second half of the year, keep in mind, the proactive cost actions that we took are already in the baseline, and there'll be some headwind, as we accrue for bonuses. So you may not see meaningful margin expansion in the second half, net of those two effects, but we would have mostly covered our ground for the 20-30 basis points of margin expansion, mostly in the first half. So we will still end up delivering an adjusted operating margin expansion of 20-30 basis points.

Operator (participant)

Next, we'll go to the line of Doug Schenkel from Wolfe Research. Please go ahead.

Doug Schenkel (Managing Director of Life Science Tools and Diagnostics)

Hey, good morning, and thank you for taking my question. Udit, thank you for the commentary on the quality of the funnel and also providing context, looking back, you know, 15 years at seasonal patterns. That, that's helpful. That said, recognizing those points and, you know, even being mindful of the year-over-year comparisons and how they progress over the course of the year, your guidance, it doesn't seem conservative to me to be direct. At least as I look at the model, I'm struggling a little bit to kinda see how you get there, in spite of all the helpful commentary you provided. To explain where I'm coming from, you know, starting on revenue, the 45/55 H1, H2 revenue split, it's a long-term norm, but it certainly isn't the recent norm.

And then looking at things a different way, I, I think you would need to go down, you know, go from being down more than 6% organic in the first half to being up more than 7% positive in the second half. And for margins, if I'm doing the math right, I, I think you're, you know, essentially implying a targeted second half operating margin of around 33.5%, which is a bigger first half to second half ramp than normal. So with all of that in mind, you know, my, my questions are really the following: One, how dependent are you on an instrument recovery and in fact, a normalization to trend in the fourth quarter to get to these targets? Two, if the answer is you are assuming a normalization, how do we put that with the margin guidance?

And then third, given investor concern and just the market backdrop, you know, keeping in mind, none of your peers sound good on China or instruments right now, did you contemplate cutting guidance a bit? I know that was a lot, so I'll get back in the queue and listen. Thank you.

Udit Batra (President and CEO)

Go ahead. Let Amol start, and then I'll, I'll jump in.

Amol Chaubal (SVP and CFO)

Yeah, look, I mean, where we stand at this point, one may say, look, your Q2 guidance is conservative, given there was some delay in budget releases in Q1. We've been prudent there just to stay with our historical norm, right? Q3, Q4, we have some visibility in CRM, but the sales cycle, as you know, is six, nine months, so you don't have all the visibility. But it's still in line with the historical pattern, and we are seeing increased activity at early stages in our pipeline, which we think will convert into orders as the year progresses, right? If you look at ex-China, pretty much across these quarters, it is on a five-year stack basis, little lower, mid-single digits. So again, as Udit said, there is no noise ex-China.

Really, what plays out in the growth guide is how progressively the decline in China translates to a modest increase in the second half of the year, and that's what we are modeling. There could be upside on China if China performs well. And we did some of that in our guide, where we saw a little bit better China, and we de-risked the remainder of the guide. On your second question on the margin, I mean, as I said earlier, right, a lot of the cost work we did last year is in the second half baseline, so you're gonna see very modest, if any, margin expansion in the second half, but we would have covered most of the ground on the 20-30 basis points of full-year margin expansion in the first half.

China, I mean, you know, stimulus is not in our guide. We expect very little towards the end of the year, if any, because a lot of things need to be worked out there. But we are super encouraged by what the government is doing, both in terms of the size and the tenure of the stimulus and the secondary effect it'll have on the local mentality and purchase patterns.

Udit Batra (President and CEO)

Yeah, and then just to sort of, again, embellish just a little bit, Doug, and summarize. First, yeah, I mean, the discussions with customers are increasingly positive, but we felt we want to see that land first before we start assuming that it has come, right? So you can imagine, given how difficult it is to predict instrument businesses year-over-year, quarter-over-quarter is even a trickier exercise. So yes, the conversations are positive, but we want to see it land, and then we'll have a, hopefully, you're right, and then we can have another discussion at the end of Q2 that looks a little bit different. Second, on China, it's a pure math issue, right?

I mean, it's the year has started better than we expected, but the second half of the year is when all the weakness was plugged in into the overall numbers. So you see second half being slightly basically flattish to a slight growth. But you put it all together, I mean. There is no drama ex-China. It's low single-digit growth prediction for the full-year across the different customer segments, especially pharma and academia. And in China, it's a low double-digit decline after a very significant decline the previous year. So really, there's not a lot of risk as I look at it after the conversations that we've recently had with customers, the visibility we currently have.

Operator (participant)

Thank you. Our final question comes from Catherine Schulte from Baird. Please go ahead.

Catherine Schulte (Senior Research Analyst and Director)

Hey, guys. Thanks for the question. Maybe just on pharma, you know, I think you said down low single digits ex-China, and you talked about budgets opening up throughout the quarter. So can you just talk through the health of that end market outside of China exiting the quarter and your expectations for the second quarter for that end market?

Udit Batra (President and CEO)

Yeah. So, so Catherine, thank you. Thank you for the question. Look, pharma overall, even last year, grew, low single digits for us, for the full-year. And the full-year guide, again, is low single-digit growth. Q1 was, sort of a low single-digit decliner, but the conversations with customers make us even more confident that the full-year guide is very much intact for, a low single-digit growth in pharma. And as I said before, look, first, the orders look much more firm than they did a year ago across biotech and across pharma.

Second, when I look at what traction our products have, especially the products that are meant to solve problems for large molecules, be it in columns, and I talked about that in the prepared remarks, be it in analysis using light scattering or using mass spec and LC, the products have extremely, extremely good traction. And in that, as far as phasing is concerned, it's the same commentary that I provided overall. Look, Q1 came in as we expected for pharma, and as we roll through the year, basically the comps get a little bit easier, and so you see us landing the full-year with a low single-digit growth for pharma.

Caspar Tudor (Head of Investor Relations)

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

Operator (participant)

Thank you all for joining. That concludes the Waters Corporation first quarter 2024 financial results conference call. You may disconnect at this time, and have a great rest of your day.