Q3 2022 Waters Corp Earnings Call
Welcome to the Waters Corporation third quarter 2022 financial results Conference call all participants will be in a listen only mode until the question and answer session of today's call. The conference is being recorded if you have any objections. Please disconnect. At this time. It is now my pleasure to turn the call over to Casper to door.
<unk> of Investor Relations. Please go ahead Sir.
Thank you operator, good morning, everyone and welcome to the Waters Corporation third quarter earnings call today, I'm joined by Dr. <unk>, <unk>, President and Chief Executive Officer.
Our mobile travel, while Theres senior Vice President and Chief Financial Officer.
Before we begin I will cover the cautionary language.
In this conference call, we will make various forward looking statements regarding future events or future financial performance of the company.
In particular, we will provide guidance regarding possible future results and commentary.
Central market and business conditions that may impact waters Corporation over the fourth quarter of 2022 full year 2022 and 2023. These.
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 form 10, Qs and the cautionary language included in this morning's press release during.
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 in comparison to the third quarter of fiscal year 2021 and.
In addition, unless stated otherwise all year over year growth revenue growth rates and ranges given on today's call are given on a comparable constant currency basis.
Finally, we do not intend to update our predictions or projections, except as part of our regularly scheduled quarterly earnings release or as otherwise required by law.
Now I'd like to turn the call over to <unk> to deliver our key messages for the quarter then more will provide a more detailed look of our financial results. After we will open the phone lines up to take questions. Thank.
Thank you guys and good morning, everyone.
We continue to deliver excellent results in the third quarter with very strong growth across our product portfolio, our end markets and geographies. This was led by instrument growth of more than 20%.
Similar to previous quarters orders again outpaced sales.
It is unlike this takes an exceptional effort and dedication from all our colleagues.
Very proud of what our teams continue to consistently deliver.
Today, we have three key messages to share, which reflects the ongoing strength and exciting drivers of our business.
First we are consistently delivering strong commercial execution.
Transformation has become embedded in how we operate with a relentless focus on commercial excellence.
Can see this in our results.
Innovation at waters is back it's.
It's delivering across our portfolio and contributing meaningfully to our growth.
Refreshed product portfolio is answering our customers' unmet needs across a variety of applications adoption rates for new instruments have been impressive and are driving market share gains.
Thirdly, our growth initiatives are gaining traction we continue to make measurable progress on our high growth Adjacencies and have proof points that are giving us confidence.
Turning now to our third quarter results, our revenue grew 7% as reported and 15% on a constant currency basis, we saw broad strength across our end markets and geographies with robust demand from our customers growth in the quarter was led by industrial and academic and government, which both grew over <unk>.
80% and pharma, which grew 9%.
Each of our regions grew double digits, China grew over 20% India grew 20%.
Europe grew mid teens and the U S grew 11% instruments.
Instruments grew over 20% with our LC mass spec and da portfolios each growing double digits.
Mass spec growth was very strong at almost 40%.
Regarding revenues grew 10% supported by our growth initiatives and E Commerce and service attachment.
Our Q3 non-GAAP adjusted earnings per share was.
$2 64, this is roughly flat year over year, despite FX headwinds of 13%.
Now looking at our year to date performance, we're executing well throughout the organization despite a tough macroeconomic environment.
<unk> has been broad based across our geographies and end markets each of which are up double digit. This year pharma is up 12% industrial was up 15% and academic and government is up 16% instrument.
Instrument growth has been very strong throughout the year growing 19% year to date led by the U S at almost 30%.
We expect this to drive future growth in our recurring revenues.
Transformation has allowed us to consistently deliver excellent results our three year CAGR underscores the momentum we've built across our business year to date, we have delivered 9% three years stacked growth overall on a constant currency basis.
Moving on to our second key message innovation.
What does it what does has long been known as an innovation leader.
Our investments in innovation.
Driving results and contributing meaningfully to our growth.
Sales of arc, HPLC acuity Premier and Max Premier columns again doubled in the quarter versus the previous year.
Our new products are solving problems that matter to our customers supported by our technical strength and strong commercial execution arc HPLC is driving customers to upgrade their LTE fleets used for routine small molecule analysis. This is advancing customer lab capabilities and productivity by accelerating the cadence of.
And replacement IMAX.
IMAX speak Premier technology separates complex molecules like biologics.
By eliminating the need for activation Max peak Mcafee columns can get scientists answers up to 20 times faster.
Then theyre non premier equivalent. They also gave sharper peaks with 12 times the sensitivity when separating oligonucleotides as an example.
The customer benefits around premier are very compelling.
That resulted in significant large molecule growth in recent quarters, which now accounts for over 30% of our pharma revenues versus 20% just a few years ago.
Biologics represents 20% of the pharmaceutical market, but account for 40% of the R&D pipeline positioning us very well for future growth.
With our cyclic ion mobility separation high resolution mass spec cyclic IMS for shark.
Scientists can separate molecules by shape as well as mass due to the combination of iron mobility with time of flight. This is providing customers with amplified resolution and clarity demand has ramped up for cyclic within <unk> research for lipids proteins and metabolites all exciting areas within early disease detection and discovery.
As an example, the largest privately funded mass spec proteomics facility in Canada has been using cyclic for antibody sequencing in discovery, they're impressed with the quality of data. The cyclic has provided supporting their lab at the forefront of scientific discovery.
Also within mass spec, we're seeing great traction for our recently launched vivo TQ absolute.
It has seen strong demand in food and environmental applications led by <unk> and policy Fluorinated compound testing the <unk> testing market has seen rapid growth in recent months driven by increased surveillance testing and newly added compounds of interest we see this as a multiyear growth opportunity.
In June of this year, the U S EPA announced new drinking water health advisories for the four most notorious b fast compounds setting measurement levels final than parts per billion.
<unk> absolute is so sensitive it can detect DFAST at one park per quadrillion.
This is less than a grain of sand in an Olympic sized swimming pool, DQ absolutes ability to quantitate lower bundles molecules is beyond anything on the market and gives us the right to win in this space.
Since launching <unk>, absolutely one competitive placements will be fast.
Across every region.
In one example, a large global testing organization is using it for infant food and water testing in southeast Asia. This customer is developing a new set of methods that are that can be used for routine testing across across workflows in their organization.
Within informatics waters connect is enabling exciting new analytical areas in large molecule analysis on instruments like the <unk> and bio CT. This includes cell culture media analysis peptide mapping an oligonucleotide characterization.
There is a lot of long term potential in these areas given demand for stability quality, an impurity analysis, the characterization of biologics and novel modalities allows these molecules to move downstream introducing QA QC workflows. Additionally at Ta we.
We have added new powder rheology capabilities to our portfolio. This is to support the strong growth. We're seeing in battery related applications. All of those are critical to anode and cathode manufacturing, allowing battery producers to better screen electric electric coatings and solvent free dry coatings helps ensure insurance optimal performance preventative.
FX and reduce sell failure rates.
According to industry sources.
And the next 10 years production of lithium ion batteries is expected to grow tenfold demand is expected to exceed 4000 gigawatt hours per year.
By 2032, driven by electric vehicles, and energy storage battery volume scale, our Ta instrument portfolio is well positioned to support an expanding set of testing demands within the battery development in safety analysis space.
One of our European customers, So fast drilling Scandinavian battery producer uses our <unk> test incoming materials for critical electrical components. This company has tripled its purchases of Ta instruments. This year, reflecting not only its own growth, but the confidence they have in our technology and support as they scale their operations.
I would now like to share some of the recent progress we've made.
Towards the high growth Adjacencies as our third key message since time is limited I will only focus on bioprocess characterization.
<unk> offers a compelling value proposition to bioprocess engineers. It provides a paradigm shift and analytical capabilities for biologics manufacturing, which which while being quick and easy to use through our collaboration with <unk>. We have expanded the capabilities of <unk> in this area. They can dramatically short term loan collection times.
We are also enabling improvements and tighter and yields which can reduce cogs our value proposition is resonating amongst industry leaders at.
At the recent Bioprocess International conference in Boston, which I attended Firstly Astrazeneca publicly highlighted the benefits of implementing online process analytical technology using.
The bio CT monitoring to monitor drug substance and cell culture media. Meanwhile, Janssen.
And other pharmaceutical companies are already using it to monitor vital components during cell culture production and full analysis of raw materials used in bio processing by fingerprinting components and cell culture media used using biochar theyre generating insights that can help streamline the manufacturing process. These adjust.
Few of the early proof points, we can share with you today for Biochar. We're encouraged by the long term opportunity we have to solve unmet needs in bioprocess characterization now I will pass the call over to our model to continue covering our third quarter financial performance and provide our guidance provided our guidance for the remainder of 2022.
Thank you and good morning, everyone.
We delivered another excellent quarter in Q3 with 15% constant currency growth.
Waters Division grew 14% and Ta grew 18%.
By end market pharma grew 9% industrial grew 22%.
Academic and government grew 29%.
In pharma, we saw growth in both large and small molecule with strength across segments applications and regions.
In industrial <unk>.
Each of our major regions grew mid teens on a BOE, China up almost 30%.
Europe up over 20% and U S growing 16%.
Growth was led by LC, Ms instrument sales, which grew 50% with our chemical analysis food and environmental businesses, all delivering strong growth.
In academic and government growth was also strong across all regions.
By geography sales in Asia grew 18%.
<unk> grew 11% and Europe grew 14%.
In Asia growth was led by China, where sales grew 23% as we executed well across all three classes.
<unk> the challenges posed by new Lockdowns.
In the Americas the U S.
<unk> grew 11% with growth across applications and end markets.
<unk> grew 14% in the quarter led by industrial which grew over 20% and pharma, which grew low double digits.
By products and services instruments grew 21% retail LC, Ms and Ta portfolios each growing double digits.
Recurring revenues grew 10% with chemistry up 10% and services up 9%. There was no change in the number of days versus the prior year's quarter.
Finally, <unk> had another great quarter with sales up 18% led by strong growth in thermal analysis and rheology.
Demand for <unk> products remain strong across all regions with sales in electronics and batteries continuing to ramp.
Gross margin for the quarter was 56, 7% compared to 58, 9% in the current quarter of 2021.
We had incredible growth in instrument sales this quarter with mass spec growing nearly 40%.
While this resulted in approximately 40 basis points of adverse mix impact for the quarter. It is expected to drive future margin accretive recurring revenue growth.
The strong U S. Dollar resulted in 120 basis points of FX headwind on gross margin in the quarter.
We have continued to offset the impact of inflation with pricing increases working with our customers. Our teams delivered over 350 basis points of net pricing gains in the corner.
While inflation had no net impact on our gross profit dollars. It does affect margin calculation as the revenue base is also higher.
These dynamics drove the remaining difference in the year over year gross margin for the quarter.
But again there was no net impact of inflation on gross profit dollars or earnings per share.
Incremental inflationary costs were offset by pricing increases.
Operating margin for the quarter was approximately 27, 8% compared to 29, 7% in the third quarter of 2020 131, primarily by foreign exchange headwinds and the gross margin dynamics.
Year to date operating margins have expanded 70 basis points before 110 basis points of foreign exchange headwind.
The expansion of 70 basis points includes the investments we have been making to merchant on a higher growth Adjacencies and includes the impact of higher instrument mix and the inflation dynamics I just discussed.
Our effective operating tax rate for the quarter was 15, 1%.
Average share count came in at $60 1 million shares, which is about $1 8 million less than the third quarter of last year.
Our non-GAAP earnings per fully diluted share for the third quarter was $2 64.
In comparison to $2 66.
Last year.
The foreign exchange headwinds lowered our non-GAAP EPS growth by 13%.
On a GAAP basis, our earnings per fully diluted share was $2 60.
A reconciliation of our GAAP to non-GAAP earnings is attached to the press release issued this morning and in the appendix of our earnings call presentation.
Turning to free cash flow capital deployment, and our balance sheet.
Defined free cash flow as cash from operations less capital expenditures and excludes special items.
In the third quarter of 2022 free cash flow was $126 million. After funding currently 2 million of capital expenditures.
Since last quarter.
Receivable have moved back in line with historical pattern.
Our sales volume.
We continue to build in Ramsey as a proactive measure to secure supply and build safety stock.
Strong instrument demand in the third quarter, our inventory balance increased by $32 million.
We maintain a strong balance sheet access to liquidity.
Well structured debt maturity profile.
This strength allows us the ability 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 in rail and port out attractive high growth adjacent markets.
In Q3 really purchased approximately 483000 shares of our common stock for $155 million.
At the end of the quarter.
Net debt position was approximately $1 1 billion with a net debt to EBITDA ratio of about one one.
Now as we look ahead to the remainder of the year I would like to provide some updated context on off talks for 2022.
We have seen continued strong performance. This year three one by robust end market demand excellent commercial execution across all our geographies and new product introductions, which are driving growth.
As we close the year, we expect our sales momentum to remain solid and that our refreshed portfolio and growth initiatives will continue to enhance our performance.
We also expect to successfully navigate supply chain constraints and inflationary pressures assuming these challenges do not worsen.
In light of the continued strong performance.
<unk>, our full year 2022 guidance to 11, 5% to 12% constant currency sales growth up from our prior guide of nine 5% to 10, 5%.
At current rates a negative currency translation is expected to subtract approximately six percentage points, resulting in a full year reported sales growth guidance of five 5% to 6%.
Gross margin for the full year is expected to be nearly 58% and includes 100 basis points of FX headwinds versus prior year.
Operating margin is expected to be 32%, which includes 120 basis points of underlying margin expansion offset by a 120 basis points of FX headwind.
We expect our full year net interest expense to be approximately $38 million and full year tax rate to be approximately 15, 5%.
Average diluted 2022 share count is expected to be approximately $63 million.
Our share repurchase program will continue as we progress through the rest of the year and we'll provide updates as appropriate.
Rolling all this together and on a non-GAAP basis full year 2022 earnings per fully diluted share.
Now projected in the range of $11 85 to.
To $11.95 reduced 6% to 7% growth versus last year, despite a negative currency impact of approximately 11 percentage points.
What is the previous guide.
<unk> guidance includes improved underlying business performance of <unk>.
Offset by <unk> 24 cents of higher FX headwind.
At current FX rates, we estimate the full year FX impact on 'twenty to 'twenty, three 2 billion year on year headwind of two 3% on sales and 4% to 5% on adjusted EPS.
The FX impact is expected to be largely concentrated in the first half of 'twenty 'twenty three at current rates looked.
Looking to the fourth quarter of 2022 we expect constant currency sales growth to be 6% to 8% at today's rates currency translation is expected to subtract approximately eight percentage points, resulting in a fourth quarter reported sales growth guidance of mine.
Is 2% two zero percent.
Fourth quarter non-GAAP earnings per fully diluted share are estimated to be in the range of $3 66.
The $3 76.
Which is flat to 3% higher than prior years quarter, despite negative currency impact of approximately 15 percentage points.
Now I would like to turn it.
Summary comments.
Thank you Rommel in summary, we're very pleased with our performance demand has continued to be robust across our resilient end markets and geographies.
Together with our strong commercial execution and refreshed portfolio is allowing us to consistently deliver excellent results once again, raising our full year sales guidance from our prior range of nine five to 10, 5%.
Now to 11%.
Percent.
In closing I would like to point out that our 2020 ESG report will be released.
Next week at waters, we are proud to have been widely recognized as an ESG leader. We believe that we all have a part to play in leading better than we found it from decreasing our environmental footprint to becoming more representative of the society. We live in this year. We made further progress towards our goal is delivering approximately 60% of our electric.
<unk> from renewable or low carbon sources, we launched the water student Academy and are partnering with three historically black colleges and universities to provide stem education and career opportunities. We also conducted stakeholder engagement and a comprehensive materiality assessment.
We are proud that our new state of the art chemical manufacturing facility in Taunton, Massachusetts was recognized by the U S. Green building Council as the only LEED certified facility of its kind in the state and among a small number in the United States. While there is always more work to be done in ESG I'm proud of the progress we've made.
I'll turn the back call back over to Kasper.
That concludes our formal comments and we are now ready to open the phone lines for questions.
We are now ready to begin a formal question and answer session. As a reminder, please limit to one question and one follow up and the first question is coming from Vijay Kumar of Evercore ISI. Your line is open.
Hey, guys congrats on a really strong bench here.
Maybe my first one for you on that.
Revenue outperformance in the queue.
Big picture when you look at the state of end markets, whether it's pharma capex environment replacement cycle industrial perhaps.
Perhaps macro situations.
Talk about the big drivers here, what's happening in <unk>.
Whether any of these drivers should change for 2003.
Sure.
Firstly, thank you look.
From a demand perspective.
Our operating and very resilient end markets right I mean, starting with pharma, which is 60% of our business and I'll remind you that we are more levered to late stage development in QA QC.
Pharma continues to grow and even if there is a downturn people don't stop Congealing medicines. So I think that we believe is a very strong place to be.
Second is our industrial business, which over the years has transformed and it's heavily focused on our food and environmental and increasingly in the VA business on battery testing and the need for safe food clean water.
Especially with DFAST testing as well as battery testing is.
Salient driver, so roughly 80% of our business is levered towards I would say resilient end markets now in those.
Rather resilient drilling end markets I think that our water specific drivers that I'd like to point out that gave us confidence in continued outperformance.
So if you just simply starwood.
Start with.
With our commercial initiatives I mean, we see those continuing to add value over the next couple of years be it instrument replacement be it E Commerce, which is which has been over 30% now from a 20% starting point for our consumables revenue, but we think we're going to end up.
North of 55% over the next few years.
<unk> footprint has increased quite nicely over the on a stacked basis over the last two to three years that that portion of the business has grown double the rate of the overall business almost almost 20%. So we think our commercial initiatives have runway number one in these strong markets.
Second.
As I pointed out in my prepared remarks.
Ovation is really contributing well to our growth and that is a driver that will continue continue continue to contribute right I mean, starting with pharma.
Of course talked about arc HPLC, but then what gives me even more confidence is our increased focus on biologics site and that is one of the more salient drivers of.
Drivers of growth for pharma over 30% of our pharma business now is levered towards large molecules.
The launch of Max peak Premier columns.
Now increasingly focused on the mass spec business I remember when I joined <unk>.
Folks totally what what is what is going to do about their mass spec business.
Two years later, I mean, youll see strong strong outperformance in our mass spec business I mean instruments grew this quarter, 21% non spec almost touch 40% the zebra <unk> absolute really solving problems.
For our customers and detecting increasingly low quantities of DFAST.
So the mass spec portfolio is contributing very nicely to the growth of growth of the business.
I can go on on the innovation side, but I feel very good about where we stand from an innovation standpoint, and then finally, the third specific driver for waters as our Adjacencies.
Pointed out the increased traction we have for <unk> not just in <unk>, but upstream influence selection and selection of and detection of raw materials for bio processing and Theres a lot of traction for simplified as CMS in.
From our customers and finally.
Despite the sort of turbulent environment be it rolling.
Rolling shutdowns due to Covid in China, or the geopolitical challenges in Europe , we've been able to navigate through these extremely well so that gives me confidence that from.
From a macro perspective in these resilient end markets I mean, what are the commercial execution really now supported by strong innovation.
And.
Increased traction in our Adjacencies. It gives me a lot of confidence that in the future we will see even more even more robust performance and really I mean.
Ill.
I'll end here.
Foster instrument growth and don't ask me when.
Slows down it looks really good orders were again higher than sales this looks really good but it bodes well for what we see in the future for our for our consumables business, especially service, which we've been focusing on a lot.
So I hope that gives you clarity on why we have so much confidence and we've raised the full year full year guidance as well on constant currency growth.
Okay. That's helpful and maybe one quick one for you when you look at the margin performed.
Performance.
Inflation FX and mix were the main.
A key component when you look at 2018 should we expect any.
Perhaps some margin expansion I know FX is a headwind.
Not sure how to think about the impact of inflation on margins and mix.
Yeah. So Vijay look I mean on the gross margin line that are sort of all vectors that are playing out right.
There is FX.
There is a higher instrument mix that is new product launches and then there is the pricing inflation dynamics that I just discussed in each of these vectors are going to be creative in driving gross margin expansion in the times to come.
I mean on the FX side, we really feel excited about the fact that despite these headwinds the business has rallied to find ways to offset the impact of exchange rate and when the exchange rates normalize you will see a much more pronounced impact on the margin because of the resilience that has already played out in our 2020.
Two numbers.
On the instrument mix I mean, it's a great problem to have.
This instrument growth is creating somewhat of a headwind on the margin today it is going to drive.
Recurring.
Gross margin growth from chemistry and service in the future.
We have seen also great growth from our new products, I think sort of underscores that innovation matters in this space, but as you can understand.
When you launch new products, they haven't gone through the typical value engineering cycle that they go like Walgreens like we've gone through with alliance and we will see that play out on the gross margin of these newer products in the coming years and then the last piece is the pricing inflation dynamics right in there.
<unk> gains a systemic.
Muscle in terms of systems and processes.
Pricing gains more than what we have historically, driven which was 50 to 75 basis points and on the.
The other had a lot of inflation is spot buys and as the electronic component market sort of normalizes. Some of the spot buy pressure will go away again relating tailwind there.
The gross margin. So overall I mean, we are still on track where do we say look I mean, we will have about 100 basis points of margin expansion in the underlying business between volume leverage mix and productivity gains and we will reinvest 70 to 80 basis points of those gains in nurturing on higher growth adjacencies in the knee.
Near term.
The next question is coming from Dan Brennan of Cowen Your line is open.
Great. Thanks, Thanks for taking the questions.
Maybe just as a.
But jumping off point as we kind of look ahead, you just kind of address a little bit.
Margin drivers I know at the Investor Day, you talked about 23.
So we feel good about mid single digit plus I'm just wondering it doesn't sound like anything has really changed but just wondering is that.
ZIP code as we sit here today, which would imply a three year stack acceleration from what Youre doing and then.
Related to the prior question given the FX headwind that you're talking about for next year three to four points.
It would imply kind of modest topline growth so in a modest topline growth environment kind of what's the ability to expand margins in 'twenty three if that's fair.
So sedan firstly. Thank you for your question look I'll start and then I'll bustle busler to them all.
5% to 7%.
We talked about goes in a different context site from a constant currency.
On a constant currency basis, I mean, we've been clocking well ahead of that as you know right. So.
Year to date, when you seed goes to 14, 14% growth on a three year stack basis.
Almost a double digit growth slightly shy of the double digit growth. So we're really really well ahead of that and thats not just strong end markets, but also really strong execution of our commercial initiatives, which still have some legs over the next next next next couple of years, we're seeing innovation really starting to contribute.
Meaningfully to this growth.
Of course, helping with the instrument replacement, but also improving our.
Biologics biologics footprint and then finally on Adjacencies are also starting to contribute especially the bioanalytical characterization in the battery testing battery testing initiatives. So we feel very good about where we sit today in terms of what we expect for 2023, there will be ample time to discuss that.
On our Q4 earnings and theirs.
A bit more data to be collected before the year ends as you can imagine in such a turbulent environment. We wanted to we wanted to take our time to think through think through what that will look like but sitting here today, we feel very good about what we've told you in the past in terms of drivers wherever the market is you can assume that on <unk>.
Execution will add on top of it.
Second our innovation is really meeting the unmet needs in the market and third on adjacencies or starting to contribute especially the biologics and the battery spot. So feel very good about where we sit more to more to come in Q4, yes.
<unk> coating on the margin right. So I think at this stage, we feel really good about.
Each of our initiatives are.
I mean, our volume level and just working with a strong instrument growth. This year, we think that will have an accretive impact on the recurring revenue, bringing better gross margin profile next year, we do see sort of the level of spot by slowing down and we have gained a lot of confidence.
And comfort in the systems and processes that we've implemented for pricing. So all of that will enable us to stay on the plan that we outlined at our Investor day, which is still roughly 100 basis points of underlying margin expansion with a 70 to 80 basis points of re enrichment.
In higher growth Adjacencies.
Great. Thank you and then maybe just a follow up on instruments, obviously spent a fair amount of time already but.
We'd love to expand the base of 40% mass spec growth exist.
Very very notable and.
The 21%.
10% three year stack is really strong so maybe could you just step back.
As you look at all of the adjacency opportunities new innovation opportunity.
What's the right way as we look ahead on the durability of kind of instrument growth for waters.
That's a fantastic question near and Dear to my Heart look I have made it a point to go to many of the conferences that that.
That many of the technical conferences like the Rps This as the American Association of pharmaceutical scientists when <unk>.
Recently, the bioprocess international the ACR just to talk to customers directly.
And not just drink our own Kool aid and I can tell you.
Our mass spec portfolio is solving fairly significant unmet needs across the portfolio, we've talked about LTE in the past Ark, HPLC and acuity premier what they do for especially acuity Premier and Mack speak Premier columns, what they do for biologics testing.
So on the mass spec side you.
You can go across the portfolio of high risk portfolios, our cyclic IMS as the only instrument that.
Is able to analyze molecules by shape and size, which is quite quite an important attribute to have as youre looking at looking at larger molecules and that's direct feedback from our from some of our top customers and cyclic has been doing very well recently.
The between launched recently, the multi reflecting golf is in its early innings. We've also got the licensed for charged protection mass spec.
And we feel very good about our portfolio as a consequence second.
The application of tandem quads. This is sort of the workhorse the workhorse instruments in the industry right I mean, I already talked about the vivo TQ absolute.
And the the waters connect black waters connect software that we developed for our <unk> TQ excess which is the food, which is never towards the food testing environment.
This is a very deliberate effort then right.
The challenges in environmental testing with increasingly sensitive increasing growing the sensitivity required for PFS testing is something thats known to all of us and it's an unmet need across all geographies and we are just seeing the start of that demand buildup. So we expect that to grow very nicely over the next couple of years second on the food testing side, our customers came to us and said.
Look we wanted to be able to do our testing faster and quantitate foster in the waters connect platform, especially with mask one with the Moscone application speeds up the process by 50% again, a very deliberate focus on unmet needs for our customers.
And then finally, we've talked about <unk>, which was initially launched in the QA QC environment of course, it has traction as I mentioned in my prepared remarks with several large pharmaceutical companies.
But not just in <unk> now for client selection with our collaboration with Sartorius, we've already placed several instruments and there is a very large number of seats out there and we think the seed conversion is going to be pretty high in this case for lone selection and we have seen increasingly customers use it to test raw materials against.
Something I pointed out in my in my prepared remarks and again.
The pipeline of pharmaceuticals is roughly 40% towards large molecules and.
The use of a simplified as CMS method would create great workflows is something that we expect to contribute to for many many years to come so across the portfolio and are really focused on elaborating on mass spec now we've talked about in the past we feel extremely extremely good.
About what it's doing in the pharma space for towards Biologics, but also how it's helping us revive the growth in food and environmental in the academic segments.
Thank you for the question I could go on Forever, I think being an engineer I can heck can get into more details, but I think this is I'll stop here and I hope that gives you some flavor of why we're so confident about what we're doing.
The next question is coming from Matt sites Goldman Sachs. Your line is open.
Hi, good morning, Thanks for taking my questions and congrats on the quarter.
Maybe first question just on China. It seems that for you and others that China Lockdowns have been less of less impactful. This time around than previously could you maybe talk about what has changed there is it just where the lockdowns are occurring or have you changed the way that you're managing that business over there to adjust to that type of.
So should we should expect maybe less volatile less volatility in China going forward.
It's an excellent question and something that would be something that we think about and talk about a lot in our team make no mistake that are rolling lockdowns across China going on even now.
That said.
We have as I mentioned previously we have a very strong we have very strong leadership in China that we brought in over the last couple of years.
And we managed to navigate these lockdowns really well.
And I hope and I think thats not going to change over the next few next few next few quarters. As this continues now just looking at the facts I mean year to date, China is growing roughly 16% this quarter was roughly 23% and <unk>.
And the growth and again I focus more on our water specific factors I mean, the growth is driven by our.
Strong commercial execution of the instrument replacement driven by <unk> and mass spec has contributed to the revival of the academic segment.
The business has almost doubled and the industrial segment as well so feel very good about what we're doing across end markets not just in pharma our contract manufacturing initiative has done extremely well.
And what started in China with strong strong growth with the biologics manufacture biologics contract manufacturer that the commercial execution has been going extremely well in China innovation is contributing like everybody else geographically the mass spec tandem quad portfolio has again helped us grow the food and environmental and the electronics testing market.
And then finally as we look ahead.
We feel that.
The fact that we've been able to navigate through these ups and downs.
Gives us a lot of confidence as things ease up that we will continue to accelerate in China. So China remains.
A strong growth market for us we feel very good with the leadership, we have had and the execution. We've had that we can manage the volatility that we've seen so far.
Got the math right for Q3.
Anna benefited with a lower baseline because of the 12 million shipment delay last year.
So that's about 10 percentage points of growth but.
But at the same time, they did have a headwind from some of the new urban Lockdowns.
One is to keep that in mind as.
Outline for us the team is executing really well and working towards a mid teens growth profile for the year.
Thanks for that and then just one quick one for your models.
On inventories, obviously, a lot of focus on the customer side inventories, but as you think about your own inventory. When you think about the potential visibility of demand as we go into 'twenty three and it still could be somewhat uncertain. How are you thinking about building your own inventories to solve for the supply chain constraints that still exist, but also from maybe a more uncertain demand environment in 'twenty three.
Hi.
Yes.
What we've done is we've looked at sort of our product profile and we've gone through bill of materials for pretty much every product and gone through secondary and tertiary supply chains.
Identified hotspots win.
<unk> component that travels through the supply chain is sort of in.
In shortage and there we've gone deep build relationships with the primary supplier and have secured.
Wanted to use that will last us.
For longer than usual tax rate.
Sure.
Possible, we have build ultimate of supplies, especially for electronic components, and where possible. We will also build.
Geographical diversification, so you're sort of not stuck in a lockdown in China.
Places, where you have a sole source.
Now that has put some pressure on inventory because we've sort of accumulated this inventory in preparation for the demand that we're seeing on the instrument side and in preparation for potential supply disruptions.
That may be caused by COVID-19 or other sort of macroeconomic events.
Point, we feel really good where supply chain stands right progressively a lot of the yellows are being resolved and things of sort of between green and yellow on most of the items.
The next question is coming from Scott <unk> of Barclays. Your line is open.
Hey, guys. Thanks for the question.
Our questions can you can you.
Dig in here, what Youre seeing on the <unk> side Theres been a lot of mixed signals coming from from peers and also the <unk> themselves can you just give us a sense of how you guys are seeing that market shake out and what your how you're factoring that in as you as you start planning for next year.
So look thanks for the question look I mean, let me just start with some context and then I'll answer your question right. I mean, when we started our transformation process <unk>, we're I would say less than 20% of our pharma business and we worked it and this is as you know one of the most dynamic segments.
Four.
For the pharma business over the last couple of years, we've worked extremely hard to build dune systems processes and go after that customer segment and the growth in that segment over the last two years has been doubled the dynamic growth that youll see right. So if youll see two year stacked growth number.
As almost double digits about 9%.
<unk> growth has been close to 20% type so the overall demand for us and our value proposition in that market has been recognized very widely and the value proposition I would remind you is not just one off pricing and giving better lease terms, it's actually a technical value proposition, meaning as more complex molecules that transfer.
From pharma and others into CDM O R.
Our scientists are working hand in hand, with our CMO customers to help them transfer those processes from the Pfizer and the merits of the Astra then it goes to the world.
Value proposition is recognized we've done extremely well so far and yes. They are following the volatility in the <unk> market now I'll give you. An example, so global CDN malls like any other like any other multinationals.
A multinational that have global footprints now right and if there is a geopolitical geopolitically driven volatility for instance, either in China or in the United States.
What we're seeing is if any of our customers see the ammo customers starting to look at diversifying their footprint, they're coming to us and saying, Hey, I'm no longer going to expand my facility. As an example in China are no longer going to do it in the U S I'm going to actually diversify to Ireland or diversify the Singapore.
They come to us first and so for us the overall demand given our deep relationships with our top customers in the <unk> space.
Has not fluctuated right. So we find that to be a very strong growth segment for us. It might just you would shift geographically given all the geopolitical changes challenges that are cutting and with a lot of repatriation RFC demo customers and diversifying so I hope that clarifies why we still remain confident that while.
Individual geographies might might suffer a little bit.
We pick up we pick up the volume in other geographies and by and large none of our customers have come back so far and said hey.
We wanted to we wanted to.
Wanted to slow down.
Okay great.
And then you talked about service a little bit.
As you guys continue to drive a lot of strong instrument growth can you update us on how.
Much you've expanded your installed base and then talk about the service attach rates and what's driving part of your strong service growth is it more about just placing new boxes or is it also driving that incremental service revenue per instrument.
So let me start and then ill.
I'll hand over to hand, it over to Omar.
So we had started with the aspiration.
Increasing our service attachment rates by and it is already industry, leading wanted to expanded by about a 1000 basis points, meaning 10% 10 percentage points.
You've already done 200 basis points, so far in the last year and a half or so and we still see a long runway of increasing our attach rates and this is due this is.
Too many different tactics right. So.
Quoting at the point of sale.
Having automated renewable and several other tactics that I won't discuss openly due to competitive reasons we.
We feel extremely good about the increasing attach rates for any installed base. The installed base that we have now with such terrific instrument growth.
<unk> LTE with mass spec double digits on a stacked basis, 21% year to date.
So 19% year to date to 21% for the quarter, we feel very good that we.
We should see that flow through in the service business over the next few years I know them all Super enthusiastic about this and he gets very analytical without deems since as you've grown your instrument based as much or service should go up this one so I'll, let him comment a little bit yes.
Question in the way we look at it is let's say when you grow instruments by 21% of your installed base doesn't grow by 21% rate because the installed base on on average, let's say seven years and so you get a 3% bump if all these instruments are new placements.
Close to 70% or 80% of them are replacement. So they are sort of not.
Adding to the installed base the new ones are.
But also on the ones that you replace you will expect higher utilization at least on chemistry. So all of these become available to what you can drive recurring revenue on and as we pointed out on salaries. We've been very successful 200 basis points last year and this year. We said, we would do 100 and we already did 100 in the first half of the year.
And again Theyre one has to think not all of it is incremental revenue because these customers are already buying spare parts from us outside of the plants.
Rental revenue.
Sort of a fraction of what the attachment rate will bring but overall with this great instrument growth, we feel really excited how much recurring revenue we can drive both on chemistry as well as on service in the years to come.
And just to sort of summarize look the simplest way to think about it is if you would.
Placed 100 instruments 20 to 30 closer to 30. These days are new customers and new users right and they will then convert into service revenue de Novo service revenue add on top better service performance with increased attachment rates gives us confidence that the increased.
Increased installed base, especially the newer ones that go to add incrementally to service growth over the coming years and of course consumables attachment is an added benefit.
Yes.
The next question.
<unk> is coming from Rachel <unk> of Jpmorgan. Your line is open.
Okay. Thanks for taking my question so.
So first off here, we've had a few here.
Your peers is talking about changing ordering patterns from customers throughout various end markets.
Supply chain constraints that slowed down.
Seeing customers returning back to normalized ordering pattern. So just wondering if you've seen anything in line with that across any of your end markets.
Second ordering patterns from your customers so far.
Rachel.
On the orders to sales ratio right. So autos again.
One more than the sales.
This particular quarter. So orders were higher than sales again, we have not seen I would say any sort of significant change in order patterns.
So far this year I mean, it's a very robust pipeline we're very.
And again I'll remind you I mean, we're not dealing with volatile end markets close to 80% of our end markets are highly highly resilient second our products are very innovative right. I mean, we are now meeting unmet needs for our customers. So we don't expect customers to stop at auditing.
<unk> absolute because they need it and it's the more sensitive instrument.
In the.
In the in the space for testing DFAST, we don't expect customers to stop ordering.
<unk> access with waters connect because its 50% faster than any competitive instrument in terms of analysis, we don't expect them to stop ordering acuity Premier arc.
Arc HPLC given the benefits that they get so innovative products in resilient demand segments don't seem to be impacted by what you're pointing out. So we're not seeing any of that and I think it could be a water specific thing I mean, as I mentioned earlier.
The demand overall is good but we also think we are doing some specific things which are deliberately.
Proving our traction with our with our customers, especially from an innovation standpoint.
Great and then just a follow up here on M&A can you just talk about how the pipeline's looking and then anecdotally.
Anecdotally, we've heard that the private valuations on the private side of things, let's start I mean high. So what are you seeing from that kind of what's the latest timeline for when you think you could maybe get it.
Yes, John here and then finally, what type of leverage range would you be willing to reach.
The rates on any of those hi, Jason Hi high growth adjacent markets that you flag sure Rachel.
M&A is something that we're thinking about.
Quite regularly right I mean, but I can.
Just remind you of sort of our overall capital allocation priorities and growth is the embedded we're seeing tremendous organic growth.
That remains the number one priority and we will invest in Capex and Opex as I mentioned earlier about 80 basis points, even in this environment to support our growth ambitions, we feel extremely good about that.
Second two suppliers to support the growth we're looking at M&A opportunities in the pipeline is very robust not just in the adjacencies, but also in the core in some areas the richer than others of course, you can imagine I cannot comment more specifically on it and if we don't find something that is financially reasonable and sensible we'll of course continue to do.
<unk> as we've done in the past, but growth remains the remains the priority as far as timing is concerned that's always better to comment in the rearview mirror I Wonder do you want to talk about the leverage ratios.
In general our thinking is first of all we want to be absolutely financially disciplined and make sure that.
On a risk adjusted basis any transaction creates value for our shareholders and then in terms of financing we want to stay investment grade as much as possible or even lower.
So that.
The interest rates have gone up and that can create a dilutive impact on EPS accretion.
As long as we are sort of within investment grade, we should be able to thread that needle.
The next question is coming from Derik de Bruin Bank of America. Your line is open.
Great. Thanks for taking the question. This is micro scan on for Derek.
Want to ask with one for you.
Specifically said.
One asked me when this is going to slow down, but I still kind of have to go there first.
Can you can you can you maybe try to parse out some of the components of the growth I mean, we hear you on the innovation here you on sort of the robust markets, but still these are really impressive results quarter after quarter. So any additional clarity you could get maybe a rank ordering.
<unk> gains versus replacement cycle versus how much is new lab construction of our new end markets. You spent a lot of time talking about P fast and how thats, becoming more and more prominent.
Just maybe going through and saying what are you seeing the biggest contributors to the step up in growth and that will hopefully put more clarity in how durable this will be going forward.
So Michael I can give you the algorithm.
And then I'm going to disappoint, you that I'm not going to give you a very very deep specifics on each of these so just to review the drivers right.
First I mean, the end markets that we serve are resilient and robust as you know right.
So 80% as Ive talked repeatedly are pretty robust and we feel good about the resiliency of these end markets.
Whatever that number is has historically been X and now it's definitely extra delta ex some of it driven by volume and some of it also driven by increased pricing right. So take that as a starting point then from a water specific standpoint.
There are three different different contributors, we had said at our analyst day about 100 basis points you can expect.
Probably a bit higher this particular year.
From our commercial initiatives instrument replacement CMO.
Service as well as e-commerce all of those are contributing quite handsomely and so definitely north of 100 basis points. This year.
What we are seeing very nicely now dovetail into that is the second independent driver, which is innovation.
And I took some time today.
And we had a big debate internally how much we should we should elaborate but I felt it was necessary given the questions that I think you guys have asked on the durability of growth.
Innovation is really really contributing already significantly late next week premier fastest launch in Waters' history.
In terms of columns and we have been launching column since 1970, and some of them are still in the market and this one has done better than anything we have launched.
Second the mass spec portfolio is totally revived and we're definitely in the early innings of extraction DFAST.
Testing is a significant need for water testing and we have the best instrument in class.
We really feel good about that and we didn't talk much about the day to day right, but.
Has has also revitalized innovation with our powder rheology.
Although the allergy instrument.
That's debt that's photos that go into quoting anode and cathode battery testing so feel extremely good about it.
I won't I won't give you give you a number I mean likely in Q4, we can comment looking backwards on what the contribution has been from innovation, but innovation is contributing in some adjacencies now again a question that I think several of your last album.
Does the traction I took some time today to talk about <unk> I mean, the same thing we see with batteries. We are starting to see with CMS I was at the ACR. This at the American Association of clinical research.
Chicago with the team and there is a strong demand from our spec for early disease detection.
In.
In the clinical space. So again, the different adjacencies are starting to contribute and remember we said that they will more meaningfully contribute beyond 2024, where we're already starting to see them contribute and that I think overall explains the beyond market performance and I think again, we took some time to give you the three year stack.
Right, because I mean short term changes quarter on quarter, Ken can sort of dilute the outperformance, but if you look at it on a stack basis on a two to three year basis outperforming quite significantly the peer group. So I hope that gives you clarity.
And helps you to think through how the demand is going to shape up for the coming years.
This will conclude our question and answer session for today's call.
Thank you.
And this will conclude our conference for today all parties may disconnect at this time.