Waters Q3 2024 Earnings Call Transcript

Presentation

[Operator]

Good morning, and welcome to the Waters Corporation Third Quarter 2024 Financial Results Conference Call. [Operator Instructions]

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 at Waters]

Thank you, Julie. Good morning, everyone, and welcome to the Waters Corporation third 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. In this conference call, we will make various forward-looking statements regarding future events or future financial performance of the Company. We will provide guidance regarding possible future results as well as commentary on potential market and business conditions that may impact Waters Corporation over the fourth quarter of 2024, full-year 2024 and 2025. These statements are only our present expectations and actual events or results may differ materially. Please see the risk factors included within our Form 10-K, our Form 10-Qs and the cautionary language included in this morning's earnings release.

During today's call, we will refer to certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP measures are attached to our earnings release and in the appendix of the slide presentation accompanying today's call, both are available on the Investor Relations section of our website. Unless stated otherwise, references to quarterly results, increasing or decreasing, are in comparison to the third quarter of fiscal year 2023. In addition, unless stated otherwise, all year-over-year revenue growth rates and ranges given on today's call are on a comparable organic constant-currency basis. Finally, we do not intend to update our guidance, predictions or projections, except as part of a regularly scheduled earnings release or as otherwise required by law.

Now, I'll hand it over to Udit to deliver our key remarks. Amol will then present a more detailed overview of our results and guidance. After, we'll open the lines for questions. Over to you, Udit.

[Udit Batra, President and Chief Executive Officer at Waters]

Thank you, Caspar, and good morning, everyone.

Our team delivered very strong results, third -- very strong third quarter results with revenue, margin performance and earnings per share, all significantly ahead of our expectations. Sales were well above the high-end of our guidance range, as each of our three reported regions returned to positive growth. Strength was led by our pharma and industrial end markets, both of which saw liquid chromatography return to positive sales growth. Together, with an improvement in mass spec, instrument growth turned positive in the quarter, which exceeded our pace of recovery.

We also built excellence -- excellent momentum as we delivered mid-single-digit quarter-over-quarter revenue growth, while orders outpaced sales for the second quarter in a row. In addition to the positive strength in instruments, we saw an acceleration in recurring revenue growth, which grew a healthy high-single-digits. This was led by 8% growth in our chemistry consumables portfolio.

Within our P&L, our sustained focus on operational excellence led to better-than-expected gross margin and operating margin results. Coupled with the strong top-line performance, we achieved adjusted EPS growth, that was over 10% higher than the midpoint of our guide. Results like this in a dynamic market -- in dynamic market conditions take exceptional dedication from all our colleagues. I would like to take a moment to commend our team for their commitment to commercial execution, operational management and innovation. This enables us to deliver enhanced performance and accelerate the benefits of pioneering science.

On the subject of innovation, we too made excellent progress and further strengthened our alignment with higher growth testing areas, that will augment our future growth. We continue to expand our innovative portfolio with new product launches that solve customer unmet needs in both our core markets and in our high growth adjacencies.

Turning now to our results. In the third quarter, sales grew 4% as reported and 4% in constant currency. Our non-GAAP earnings per share was $2.93, up 3% year-over-year. On a GAAP basis, EPS was $2.71. In the quarter, market conditions and customer spending trends further improved. We continued our path of strong commercial execution and converted opportunities well. We drove strong results as customers were drawn to the innovative new products in our revitalized portfolio. After seven quarters of LC decline, instruments grew 1% as pharma and industrial LC growth turned positive. Mass spec also performed well in the quarter and grew low-single-digits, led by strength in industrial and applied applications, like PFAS testing. Recurring revenues grew 7%, led by 8% growth in our consumables business.

Breaking out our results by end market, we saw a broad improvement in sales growth, as each of our end markets turned to positive growth. In particular, we observed large pharma spending -- better large pharma spending, where our revenue is tied to QA/QC applications and capex spending trends. By geography, each of our reported regions grew. While China was a slight headwind to sales, we still grew mid-single-digits on a both China and ex-China basis as further stabilize -- further stabilization in China posed less of a headwind to our overall results, this is while not yet seeing sales contribution from stimulus.

I would like to share more in-depth commentary on what drove these strong results. Within LC, orders of Alliance iS significantly increased as our new flagship HPLC product grew to a greater percentage of our HPLC volume. This occurred not just within replacement, but within opportunities tied to installed base expansion, particularly among those in large pharma. We've continued to expand capabilities on Alliance iS by adding new detectors like the Photodiode Array, or PDA, and by introducing the Alliance iS Bio earlier this year. Alliance iS has already been trialed by most large pharma customers over the past 18 months. With the improvement in customer capex spending, we've noticed a notable upshift in the speed of adoption, indicating a promising future for this instrument system.

Within mass spec, the Xevo TQ Absolute saw a significant ramp-up in customer adoption. With unit sales growing more than 70% year-over-year, this system was our best-selling mass spectrometer in the quarter. Impressively, it exceeded the combined sales volume of our other tandem quad mass spectrometers for the very first time. The Xevo TQ Absolute's rapid success has been a three-fold dynamic. First, strength has been driven by continued rapid growth in PFAS applications. We see PFAS testing as a $300 million to $350 million global market opportunity, growing 20% annually. Meanwhile, our PFAS-related revenue has grown by over 40% this year. This is attributed to the competitive strength of this system, which is known for its sensitivity in the market.

Second, we've also seen strong adoption of Xevo TQ Absolute in quantitative pharma applications such as for impurity quantitation. This includes analysis of genotox, impurities, proteins and peptides. Similar to PFAS applications, its value proposition of leading sensitivity, together with its sustainable design, is resonating well with our customers. It is 45% smaller and uses 50% less nitrogen and electricity than comparable tandem quads. This has opened up new opportunities for us in this segment and enabled us to expand our market position.

Third, the IVD version of our Xevo TQ Absolute instrument has seen strong growth within clinical applications after we launched it into that space last year. With its ability to analyze trace-level analytes at lower detection limits, it has been an instant success. It has achieved notable traction across a number of testing areas, but especially in endocrinology and for the development of high-value complex tests. This is part of a very deliberate push as we expand the competitive position of our mass specs, consumables and software within clinical testing workflows. In the quarter, total clinical revenue grew low-double-digits, driven, in part, by strong sales of this system within the segment. Our results were supported by the strength of our innovation in chemistry.

In the quarter, MaxPeak Premier Columns, which are relevant for large and more complex molecules, grew over 40%. The benefits of our MaxPeak Premier technology are unique to the market and were a key driver of us winning multiple GLP-1 related opportunities. As we previously mentioned, our columns have been specked into methods for majority of the commercially available GLP-1 related injectables on the market today. We're extremely pleased with how well our chemistry portfolio aligns with the expected volume growth of large and small molecules.

Now, I will talk more about our operational performance. Margins remained resilient as we maintained a successful focus on operational management. Our gross margin expanded 20 basis points to 59.3% and our adjusted operating margin was a solid 30.8%. Looking forward, we feel very good about our future margin opportunity given our recent success in preserving and expanding our margins during a -- during challenging business conditions. We remain on-track to deliver adjusted operating margin expansion this year. We also expect our 2024 results to be a good base for future long-term margin expansion. We also have long-term margin expansion opportunities from our strategic operational initiatives, which are focused on areas such as productivity enhancement, cost management and pricing.

As we look ahead, Waters is well-positioned in attractive markets where testing plays a pivotal role in driving long-term growth. This volume growth is expected to accelerate in the future, led by: first, continued growth in GLP-1 adoption within pharma and PFAS-related testing within our non-pharma segments; second, new volume growth from an increased incidence of drug development and novel drug approvals as new molecules progress through the pharma pipeline; and third, future volume growth drivers for generic molecules are becoming more pronounced, particularly due to the aging global population. In addition, a number of key blockbuster drugs will soon be reaching patent expiration. So, this gives us a tremendous long-term opportunity for installed base expansion as we sell new testing capacity associated with these growth vectors in years to come.

Separately, customer fleets have aged after weak macroeconomic conditions have put temporary constraints on customer capex spending for downstream instrumentation. This deferral of routine instrument replacement within our existing installed base has created a catch-up opportunity that lies ahead of us. Expected instrument growth for 2024 still equates to a low-single-digit CAGR versus 2019 levels. This is significant -- significantly below the 5% long-term average growth rate that we've observed on a pre-COVID basis.

So, looking at the facts, while no two macro environments are the same, instrument down-cycles have lasted between four quarters to seven quarters. A catch-up in growth has then subsequently followed as new instrument replacement cycle emerges. As I mentioned earlier, last quarter marked the seventh consecutive quarter of LC instrument decline. Market conditions remain dynamic and it is still early days, but our third quarter results and improving funnel trends, especially conversion, indicate that we have taken a further step towards recovery. With our strong commercial execution, category-leading portfolio, better pricing levers and exposure to pharma QA/QC, we are in an excellent position to capitalize on these future growth opportunities.

Turning now to our new product launches in the quarter. We continued a steady stream of new product launches in our core markets, addressing top customer needs. This includes a high throughput rapid scan calorimeter, that enables precise thermal stability of high concentration biologic formulations. We also launched the TA Instruments Compact Discovery Rheometer. This expands our rheology portfolio with an easy-to-use product for routine quality-control testing within manufacturing test -- manufacturing settings such as batteries, pharmaceuticals and food. It offers similar performance to viscometers used in R&D settings, but at a price point that is competitive with those in downstream settings.

In our high growth adjacencies, we are actively shaping the Waters of the future and increasing our alignment with nascent, higher growth testing applications where we have a unique right to win. Today, I will share an update on bioseparations. Approximately 50% of the drugs in the pharma pipeline are now large molecules, which includes a wide range of novel modalities beyond monoclonal antibodies that each have their own unique challenges. Given the high future growth potential and significant unmet needs that exist within separating and purifying these molecules, we have directed organic investment to solve these challenges. With the initial progress we've made over the past few years aligning our overall chemistry business to biologics, approximately 40% of our pharma chemistry revenue now comes from large molecules. As we continue to gear our business towards future growth in novel modalities, we expect this number to rise further, particularly as we now spend approximately 70% of our chemistry R&D dollars on large molecule-related applications.

Last year, we launched our first set of in-house developed enzymes for antibodies in areas such as peptide mapping and antibody drug conjugates, which have achieved great initial success. Last month, we expanded our offering further launching our first enzymes and reagents for novel modality related applications. This includes areas like cell and gene therapy and RNA-based therapeutics such as CRISPR, oligonucleotides and mRNA. We continue to build key capabilities across each class of next-generation therapeutics with the objective of building a comprehensive portfolio that is molecule agnostic and can support the journey of any modality into high volume settings.

I will now cover our 2024 full-year guidance. While market conditions remain dynamic, customer capex spending has continued to improve, especially in pharma QA/QC. With our strong funnel, we expect these trends to progress into the fourth quarter and result in 5% to 7% constant currency growth. This is while still making prudent assumptions around fourth quarter seasonality at equivalent levels to last year and well below typical levels. Given our raised outlook for the fourth quarter and better-than-expected third quarter results, we are raising -- we're increasing our full-year guide. Our updated full-year 2024 organic constant currency sales growth guidance is now negative 0.9% to negative 0.3%. We are also increasing our full-year 2024 adjusted earnings per share guidance to reflect our improved sales growth expectations and continued strong margin performance. The midpoint of our full-year 2024 adjusted EPS guide is now $11.77, which is flat to slightly positive versus last year and is a 1.4% growth rate improvement compared to our previous guidance.

Now, I will pass the call over to Amol to continue covering our financial results in more detail and to provide further details on our guidance. Amol?

[Amol Chaubal, Senior Vice President, Chief Financial Officer at Waters]

Thank you, Udit, and good morning, everyone.

In the third quarter, sales of $740 million grew 4% as reported and exceeded our guidance range. On a constant currency basis, sales increased 4%. We saw a steady improvement in customer spending throughout the quarter. This, coupled with our continued strong commercial execution, enabled us to deliver Q2 to Q3 sales step-up of $32 million or plus 4% versus typically a modest decline as we created good momentum. Funnel activity strengthened and orders outpaced sales for the second quarter in a row, enabling us to build backlog.

In constant currency terms, by end market, pharma grew 3%, industrial grew 7% and academic and government was flat. In pharma, sales returned to positive growth. Ex-China sales grew mid-single-digits, with 3% instrument growth and 7% recurring revenue growth. Both small and large molecule applications grew in the quarter as customer capex spending trends continued to gradually improve. In industrial, sales also returned to growth. Growth was led by food and environmental applications, which grew 5% and chemical analysis, which grew low-double-digits. We again saw strong growth from PFAS-related applications, which have been continued growth tailwind within food and environmental applications. For our TA division, sales grew 2%, led by growth in life sciences and advanced materials and chemical applications. In academic and government, growth was flat, reflecting an improvement versus the first-half of the year, now that last year's tough prior year comparisons are behind us.

By geography, all our three reported regions returned to growth, with mid-single-digit sales growth in Asia and Europe and low-single-digit growth in Americas. Excluding China, sales grew 5%, led by better-than-expected growth in both pharma and industrial applications. In China, sales declined mid-single-digits, reflecting continued sequential improvement versus almost 30% decline in Q1 and low-teens decline in Q2. Orders in the quarter were in-line with last year and we expect China sales to return to positive growth in the fourth quarter of this year. On the subject of China stimulus, we continue to have active dialogue with various customers who stand to benefit from the funding announcements made by the Chinese government earlier this year. So far, this has led to improved coating and funnel trends in the region. These opportunities are expected to begin converting into orders and sales in 2025.

By products and services, instruments grew 1%, chemistry grew 8% and service grew 6%. There was no change in number of days versus the prior year quarter. The fourth quarter of this year has two additional days compared with last year and three additional days compared with the third quarter of this year. Recurring revenues returned to-high-single-digit growth in the quarter, reflecting healthy customer activity levels and strong installed base utilization. Our commercial initiatives continue to support robust recurring revenue growth in areas such as service plan attachment, e-commerce adoption and launch of new bioseparation columns into high growth large molecule areas.

Now, I will comment on our third quarter non-GAAP financial performance versus the prior year. Despite the headwinds from FX, inflation and the return of annual incentive compensation, our team responded to these margin challenges with strength and commitment. Our focus on operational excellence with pricing, productivity and prudent spend management allowed us to deliver a resilient margin performance, again, [Technical Issues] in the quarter, with gross margin expanding 20 basis points to 59.3%. Excluding FX, gross margin expanded 50 basis points. Adjusted operating margin was 30.8%. Excluding FX, adjusted operating margin was 31.2%. Our year-over-year margin performance was impacted by last year's annual incentive compensation wash-back that benefited last year's Q3 result.

Our effective operating tax-rate for the quarter was 17.2% and our average shares count was 59.5 million shares. Our non-GAAP earnings per fully diluted share was $2.93. On a GAAP basis, earnings per fully diluted share was $2.71. A reconciliation of our GAAP to non-GAAP earnings is attached to this morning's press release and in the appendix of our earnings calls presentation.

Turning now to free cash flow, capital deployment and our balance sheet. We define free cash flow as cash from operations less capital expenditures and excludes special items. In the third quarter of 2024, free cash flow was $179 million after funding $26 million of capital expenditures. On a year-to-date basis, free cash flow is $556 million or 27% of sales, resulting in a free cash flow to adjusted net income conversion ratio of 120%. We maintain a strong balance sheet, access to liquidity and well-structured debt maturity profile. This strength allows us to prioritize investing in growth. We continue to evaluate M&A opportunities that will enhance value-creation for our shareholders.

With the strong free cash flow generation in our business model, we have made solid progress in deleveraging our balance sheet. In the third quarter, we reduced debt by approximately $180 million. At the end of the quarter, our net-debt position was approximately $1.5 billion, which is a net debt-to-EBITDA ratio of about 1.5 times. We will evaluate our priorities between further debt pay-down and the resumption of our share repurchase program throughout the remainder of the year.

Now, I would like to share further commentary on our fourth quarter and updated full-year outlook. While market conditions remain dynamic, customer spending has shown continued signs of recovery and our team has continued to execute well. We expect these trends to progress into the fourth quarter given our positive momentum and as increased funnel activity translates to orders. Looking to the fourth quarter of 2024, our constant currency sales growth guidance is projected in the range of positive 5% to positive 7%. This is an improvement in the growth rate expectation versus our previous guidance and calls for mid-single-digit instrument growth in the quarter. At current rates, currency translation is expected to subtract approximately 1.7%. Therefore, our total fourth quarter reported sales growth guidance is positive 3.3% to positive 5.3%. This guidance range prudently assumes a mid-teen quarter-over-quarter revenue ramp, implying below typical levels of ramp in the fourth quarter. It matches last year's Q3 to Q4 mid-teens ramp, during which we saw a much weaker than typical budget flush dynamics in Q4. Based on these revenue expectations, fourth quarter non-GAAP earnings per fully diluted share are estimated to be in the range of $3.90 to $4.10, which includes a negative currency impact of approximately 3 percentage points at current FX rates.

Turning now to our full-year guidance. Given our better-than-expected results in the third quarter and raised outlook for the fourth quarter, we are increasing our full-year sales and EPS guidance. Our updated full-year 2024 organic constant currency sales growth guidance is now between negative 0.9% and negative 0.3%. At current rates, currency translation is expected to subtract 1.2%. Meanwhile, M&A contributions from Wyatt transactions has added 1.3% to our full-year sales from inorganic revenue incurred in the first 4.5 months of the year. Therefore, our total full-year 2024 reported sales growth guidance is in the range of negative 0.8% to negative 0.2%. Consistent with our previous guidance, gross margin for the full-year is expected to be approximately 59.8%, which is a 20 basis points expansion versus 2023. Adjusted operating margin is expected to be around 31%.

Below the line, we expect our full-year net interest expense to be approximately $71 million. Our full-year tax-rate is expected to be 16.5% and our average diluted 2024 share count is expected to be approximately 59.5 million shares. Rolling all this together, on a non-GAAP basis, our updated full-year 2024 earnings per fully diluted share guidance is projected in the range of $11.67 to $11.87. At its midpoint, this updated EPS guidance reflects slight positive growth versus last year, which is 145 basis points growth rate improvement compared to our previous guide. It includes an estimated headwind of approximately 3% due to unfavorable foreign-exchange.

Now, I would like to turn the call back to Udit for our closing comments. Udit?

[Udit Batra, President and Chief Executive Officer at Waters]

Thank you, Amol. So, to summarize, we are very pleased with the faster-than-expected return to positive instrument growth. We're also delighted to have observed a notable upshift in new product adoption, which has contributed to our growth this quarter.

Our increased full-year guidance now has us at positive adjusted EPS growth versus last year at its midpoint, as we expect to build leverage in our P&L even with return of annual incentive compensation among the other headwinds of volume and FX that we've described. We're positioned well for the future with a long-term outlook that is above our historical average growth rate of 6%. This is driven by the associated new testing capacity needed for a compelling set of global volume growth drivers as well as other factors such as price contribution.

At the same time, we stand to benefit from a catch-up in deferred instrument replacement as customer capex spending recovers. The pace of this catch-up will depend on the speed at which the market continues to improve. We are in the early innings and the market remains dynamic, but we're off to a good start. With our teams' strong commercial execution, highly competitive product portfolio and strong margin story, we are confident in our future.

So, with that, I will turn the call back to Caspar.

[Caspar Tudor, Head of Investor Relations at Waters]

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

Questions and Answers

[Operator]

Thank you. [Operator Instructions]

Our first question comes from Tycho Peterson with Jefferies. Your line is open.

[Tycho Peterson, Analyst at Jefferies Financial Group]

Hey, thanks. Congrats on the quarter. Obviously, early innings on the replacement cycle, Udit, as you noted. I guess, a couple of questions here. Are you able to talk about the percentage of LCs that are going to customers that have Arc, or is it mostly labs that did not upgrade, so effectively a double upgrade here?

And then, you have the new PDA module. I guess, how much is that helping drive LC sales? And then, as we think about the next couple of years, I mean, you mentioned patent expirations. You also potentially have GLPs moving to orals. Like, what other drivers should we be thinking about that could potentially help this replacement cycle as it kicks off?

[Udit Batra, President and Chief Executive Officer at Waters]

Thanks, Tycho, and good morning. Look, I mean, very happy with the fact that instruments have returned to growth. And if you break it down into LC and mass spec. LC, after seven quarters of decline, and this is I think where your question on the replacement cycle is largely focused, after seven quarters of decline has returned to growth. This is, of course, on the back of continued strong growth in India, which -- where the generics segment is doing extremely well, but equally with return to growth in our large pharma QA/QC customer segment, where LC grew in the low-single-digits, both in Europe and in the United States.

And another sort of corroborating set of evidence for the replacement -- the beginning of the replacement cycle is when customers -- and we spent a ton of time and I personally did in this last quarter with large pharma customers to understand what we were seeing from a replacement cycle perspective. Look, when the customers start their replacement cycle, they bring cross-functional teams together, because this is a multi-year process. They bring in IT, they bring in the analytical labs, they bring in the procurement folks and sometimes finance folks, because this is a pretty large spend item. And we've seen more and more of those meetings.

Now, to your question on Arc versus Alliance, I mean, there is an increasing proportion of our LC fleet that is Arc HPLC and now increasing the Alliance iS, which, over the last 18 months, has been trialed by each and every large pharma customer. So, we feel extremely good with the feedback. And over the last few months, we've added the PDA, we've added the Alliance Bio System and we have several other ideas to continue to improve its performance. So, Alliance iS is indeed playing a part in the discussions. Our Arc HPLC remains a strong, strong contributor to the replacement discussions as well. We won't break it down any further than that at this point.

And to your question on patent expiration, I mean -- and I suspect that's referring to India. Look, India has been awesome for us for the last three years to four years, gone from 5% of our sales to 8%, largely driven by our strong presence in the generics segment. I mean, India supplies roughly 40% of the generics globally. And going forward, we expect at least $200 billion over the next three years, four years of patent -- sorry, the next four years to five years of about -- around $200 billion of revenues going off patent from originators in the next three years to four years, and more than half of that is small molecule. So, we are very well-positioned in that segment as well.

[Amol Chaubal, Senior Vice President, Chief Financial Officer at Waters]

And just to add to that, Tycho, right, as you correctly pointed out, I mean, Arc is at a meaningful price premium to legacy Alliance and that has been a very successful product and very accretive from being better priced. And with the value proposition of Alliance iS, it's able to justify even a higher price premium to Arc, because the unmet needs that it is solving is resonating with the customer. So, that sort of creates that double effect on the replacement cycle.

And very early days for PDA. So, the PDA version really hasn't produced accretion, because we're just launching it. So, we will see more of that in Q4.

[Udit Batra, President and Chief Executive Officer at Waters]

And so, in a nutshell, the replacement cycle -- definitely signals for the replacement cycle beginning, some impact already in the quarter. And our broader market-leading LC portfolio is absolutely playing a role in those discussions.

[Tycho Peterson, Analyst at Jefferies Financial Group]

And then, I guess, as we think about next year, are you willing to make any comments preliminarily? The Street is just under 5.5% organic. Obviously, there is a nice tailwind. [Speech Overlap]

[Udit Batra, President and Chief Executive Officer at Waters]

I was thinking that, that would be one of the more -- one of the questions later in the call, but I suspect it's one of the first ones. Look, you know that we won't make any comments on 2025 at this stage. I mean there's a lot that will play-out in the next few months. But -- so not to disappoint you, let me just sort of tell you how we are thinking about the puts and takes, right? So, you can start with our recurring revenue. And if you look at especially the last two years, it's like a Swiss clock, right? I mean while recurring revenues in different segments, especially in pharma research, has gone up and down. In QA/QC and late-stage for us, this has gone predictably well. So, you can assume a long-term historic average and that's 55% of our business. You start there.

Then, you look at the puts and takes on the instrument side, right? And so, let's first talk about what is rather definite, right? So, the generics volume, as we just talked about, will continue to grow. Now, don't ask me exactly the percentage of growth, but it's pretty dynamic. Second, PFAS testing is accretive to our overall growth and we have a market-leading instrument that is helping us win more orders than we lose them. And GLP-1s, you already mentioned that. We have pole position in that with the two largest producers, and as it gets genericized and Indian producers come in, we think we are very well-positioned. So, those are things that you can assume are positive.

There are two variables that we really need to sort of watch and understand better. The first is how fast is the replacement cycle going to pick up, and I've given you enough clues in your first question that, it's already happening and the discussions are happening. And the second is the stimulus in China, right? And there, we feel that we are incredibly well-positioned given the expansion of distribution, given the expansion of our localized portfolio, we feel incredibly well-positioned to capitalize as the stimulus comes in. So, look, I think those are the only two variables that you need to watch over the next three months to four months, and there's plenty to happen in the next few months and we'll talk when we give the Q4.

[Amol Chaubal, Senior Vice President, Chief Financial Officer at Waters]

And there's one thing to add there is pricing, right? Even in this environment where we are seeing aggressive competitive pricing pressures, we are still delivering on our commitment of 100 basis points-plus versus the historic levels and the proof is in our gross margin.

[Tycho Peterson, Analyst at Jefferies Financial Group]

Okay. And then, just one last quick one on capital allocation. Amol, are you able to talk about preference for M&A versus buyback? You mentioned both in your comments.

[Udit Batra, President and Chief Executive Officer at Waters]

Look, Tycho, again, something that we won't get into a ton of detail on other than what we've said. Look, we're executing on what we told you probably three years, four years ago when the transformation started. We said we were going to learn how to play better with the hand we have. This is commercial execution and margin preservation that you saw all the way through in 2023. Then we said we're going to launch new products that are going to be first-in-class and best-in-class, and they're delivering the promise, be it Alliance iS, Xevo TQ Absolute or our chemistry columns. And third, we said we're going to start executing on M&A, which is aligned with our well stated and clearly stated strategic ambitions, and that's where Wyatt fit in.

So, from a capital allocation perspective, that's the sequence. We will spend more energy on organic growth. We think we have a ton of opportunities there. If a deal makes sense like it did with Wyatt and it's aligned with our strategy and it's financially very disciplined, we will do it. And, of course, we will continue to return value to our shareholders through buybacks. But it's a balanced capital allocation strategy.

[Operator]

Thank you. Our next question comes from Brandon Couillard with Wells Fargo. Your line is open.

[Brandon Couillard, Analyst at Wells Fargo & Company]

Hey, thanks. Good morning. Udit, you took down guidance last quarter, taking it back up now. Can you just talk about, like, which end markets actually beat your expectations? And it does feel like the LC replacement cycle may be coming back faster now than what your base case might have been two months or three months ago. Is that a fair assessment. And talk about just which region might be driving that?

[Udit Batra, President and Chief Executive Officer at Waters]

So, Brandon, good morning and thank you for your question. Look, I mean, everything across the board came ahead of expectations, right? So, I think, you can see that in the print as well. And as we go into Q4 and our sort of guidance philosophy, look, you need to look at it from two different perspectives.

One, all the positive drivers we expect that we've seen improve over the year will continue into Q4, right? So, through the year, sequentially, the growth has gone up and Q3 was 4%. Including the LC replacement, we see better signals for that. We see the generics market going pretty well, we see the PFAS testing, and I've just gone through that in the previous question as well. So, we see all of those trends continuing. And hence, we've raised the midpoint of our guidance for Q4 from a revenue perspective. So, it's now 6%, right? So, that has -- the trends have given us confidence to raise the guidance.

And so, on the other side, the second aspect, and Amol mentioned this in the prepared remarks as well, on the other side, it's one data point. We want to see more before we get more bullish. So, if you look at the top-end of the guidance, what we've done is, we've tried to keep the ramp from Q3 to Q4 the same as last year, right? So, let me just elaborate a little bit. Over the last 15 years from Q3 to Q4, the step-up in revenue from Q3 to Q4 usually is about 22%. Last year, we saw one of the most bid [Phonetic] ramps that we've seen in our history. And we felt it was prudent to keep that as the other book end of the guide. So, while trends are improving across the board, pharma, industrial, any of the portfolio segments, [Phonetic] we feel it's prudent at this point, sort of, put it on the book and then keep the ramp same as last year.

[Brandon Couillard, Analyst at Wells Fargo & Company]

Okay. That's helpful. And then, just on China, you have pretty mixed data points, I would say, so far from other peers this quarter. Is the signal to noise ratio from your point of view getting any better? And how do you think stimulus is, order activity, quoting is tracking relative to your expectations right now?

[Udit Batra, President and Chief Executive Officer at Waters]

So, I mean, that's a great question. I had a chance to visit China in September, and I have the same questions that you do and had a chance to visit a lot of customers, see some government officials across the country, not just in one city and across many customer segments, right? So, it was a pretty helpful visit. In all, I mean, if you just look at the numbers for a minute, China came in-line with our expectations. Orders are in-line with what we saw in the same time last year. Sales went down by 5% versus the same time last year, and that's largely due to ship -- one shipment moving in the TA business from Q3 to Q4. So, that impacted sales, but orders are in-line with last year as we expected.

Now, that said, as the market conditions -- and this is something I learned from our team, as the market conditions have worsened over the last two years, I mean, our team basically, first, of course, right-sized the organization to respond to the conditions. But then, we took a deliberate effort to expand our distribution to many more customer segments that we've been -- than we've been historically present in. Second, we localized our full portfolio. So, as and when the stimulus comes, we feel very well placed to capitalize on it.

Now, talking about the stimulus in particular, I mean, you know that, the first one was on instrument replacement and the government is now thinking through releasing another one on fiscal stimulus, right? So, pretty broad-based encouragement for the economy. We feel very well-positioned to take advantage of it. And in the last quarter, I talked about one of the first discussions we had that looked like it could consummate into an order. This was discussions with customs agencies that are government run, that has indeed come through. So, that order has actually come through. If the sales -- don't ask me if it gets converted in Q4 or early next year, it's probably there or thereabouts. It's not in our guidance. And don't get too excited, it's low-single-digit millions. But it is the first signal that the stimulus is now converting into sales. And as I said, we feel incredibly well-positioned to take advantage of it.

So, in a nutshell, China came in as expected, improving conditions from the first-half of the year into Q3. And as we look ahead, we feel incredibly well-positioned to take advantage of the stimulus. And it's not just signals, it's actually turning into reality. I hope that helps.

[Operator]

Thank you. Our next question comes from Puneet Souda with Leerink Partners. Your line is open.

[Puneet Souda, Analyst at Leerink Partners]

Yeah. Hi, Udit. Thanks for taking my questions and congrats on the strong print here. First question, we're seeing varying numbers of instrumentation growth in the peers. You have instrumentation recovering in LC and also MS. An LC replacement cycle is happening, where some of the peers are still saying mid-single-digit decline. So, can you take a step back and elaborate a bit about the QA/QC position that Waters has when it comes to instrumentation growth? What do you think is misunderstood here?

And on the consumables side, the 8% chemistry and columns number, that was impressive. Could you maybe provide us your thoughts on the sustainability of that? And what gives you confidence why that recurring revenue should continue to sustain in 2025 despite the comps?

[Udit Batra, President and Chief Executive Officer at Waters]

Let's start with the simpler question, Puneet, and good morning. Recurring revenues for us are like the Swiss clock, okay? You go back in 2024 and you compare our recurring revenues to anybody in the peer group and you'll find that they are very stable, right, mid- to high-single-digits. And so, there's not much to say there other than the fact that this is going to continue and we are fueling it with new innovation, attachment rates and service are increasing. So, if anything, this starts to grow even more. And as we are at the cusp of the replacement cycle, you will see service revenues improve. So, there isn't -- there's nothing more to say there other than just look at the history and the facts and it's pretty clear.

On the instrument side, this is how I would think about it, and I'll try to sort of break it down from a customer segment as well, because your question had that piece. First, from a volume perspective, look, there are two obvious drivers, right? The first is generics in India, right? We have a strong position there and that continues to grow. And it's not just in India, it's also in Eastern Europe and parts of the U.S. that we continue to benefit disproportionately from our presence there. Second is the initiation of the replacement cycle. And here, I'll just take a slight detour and talk about pharma in particular, and that might explain some of the differentiated results here, right?

And basically for us, we are -- our instrument results, our consumable results are more proportional to the volume of high -- volume of testing in compliant conditions, be it pharma or be it non-pharma. In pharma, our stronger presence in QA/QC, testing for marketed drugs, both generics and originators, makes us slightly different than what you're seeing with the rest of the peer group, right? So, that segment is doing -- has been pretty resilient and now the replacement cycle benefits us there. If you now contrast that with upstream, in pharma research, we are not seeing the same level of dynamism, right? So, upstream where customers have been impacted by IRA, the funding is still not yet going. You can make the same argument for biotech. Biotech, while funding has improved, capex cycles have not improved. And finally, in CDMOs, we are again very well-positioned as we look at novel modalities in particular for our recurring revenues and increasingly for our instruments with ADCs and oligonucleotides. So, from a volume perspective, in instruments, we're very well-positioned.

Second, we've talked a lot about our best-in-class new products. I mean, we may took a deliberate -- we took on a deliberate effort three years to four years ago to revitalize our portfolio. And now, you can see the results. Alliance iS sets the standard in HPLC testing, augmenting our MaxPeak Premier supported ACQUITY Premier for UPLC. Go to mass spec, Xevo TQ Absolute sets the standard for PFAS testing for sensitivity. And we have just introduced the Xevo MRT and that is receiving very good feedback from customers for metabolomic testing where you don't have to give up speed if you want high-resolution and you get it all on a benchtop mass spec.

And finally, on pricing, given the differentiated portfolio and enhanced operational execution, we feel very confident that we will be able to extract at least 100 basis points improvement in pricing. So, I wanted to give you a comprehensive answer, because you've touched on end markets as well, but feel very good about where we are on our instrument portfolio.

[Amol Chaubal, Senior Vice President, Chief Financial Officer at Waters]

And just to add to your absolutely correct insight on the recurring revenues, right, no two recurring revenue portfolios are equal. And sometimes, we get penalized, because 45% of our portfolio is instruments, but people overlook the fact that the remaining 55%, which is recurring. When you contrast it with other recurring portfolios in the market, in this down economy, the other recurring portfolios have been flat or even negative growth. Our recurring revenue portfolio, as Udit says, is a Swiss clock. It has always been between 6% and 8%, typically 7%. And people typically overlook this fact, right? And when you put that together, it sort of gives you so much more stability in the equation.

[Puneet Souda, Analyst at Leerink Partners]

Got it. That's super helpful. Thanks for covering that. Just a follow-up on the GLP peptides, obviously, one of the largest categories in terms of volume. And Udit, you've talked about volume being an important driver. Can you just help us understand sort of how broad is your position there? And essentially, as new molecules are emerging, orals and improved injectables, can you elaborate what your position within those are and just given the volume growth that you can potentially expect in this market? And how to think about this in 2025? I know it's about 2025, but just wondering how to think about GLP-1s in 2025 context? Thank you.

[Udit Batra, President and Chief Executive Officer at Waters]

So, Puneet, you're going to be super popular with your peers because you're asking all the questions. But that said, look, it's a relevant question. GLP-1s are accretive to our growth. And when you look at our position in columns, we are the primary vendor specked in for both the two large injectable manufacturers for chemistry. Instruments are distributed between us and another vendor, but usually, it's 60-40 us or slightly more than that depending upon which one.

And third, there are at-line testing HPLC and UPLC instruments, where we have the lion's share and these are called PATROL Systems for those of you who've been following Waters will be very well familiar with it. They are adopted in each and every manufacturing site and each and every line of both Novo Nordisk and Eli Lilly.

Now, to your question on orals, we are -- we feel very good about where we are. It's early days in terms of talking about exactly what's specked and what's not, but we are very well-positioned, not just with these two, but with many others who are working on it.

Third piece is around GLP-1s in the generics segment. As I mentioned earlier, we are -- we have a good position with the generics manufacturers in India and in Eastern Europe. And as they start to bring the older GLP-1s and start to geneticize them, we again feel very good about our position there.

2025, I won't say more, especially on the specifics of what's -- what will happen with GLP-1s, but there is no reason to believe that this does -- the trend doesn't follow the overall volume growth that we assume so far.

[Operator]

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

[Vijay Kumar, Analyst at Evercore ISI]

Hi, Udit. Good morning to you and congrats on a nice print here. Maybe one on the competitive dynamics here. Do you believe Waters is gaining market share, or is this a broader sort of end market recovery? How would you characterize your competitive position?

[Udit Batra, President and Chief Executive Officer at Waters]

Vijay, thanks for the question. And I mean, having been in the industry over a decade, I mean, this is -- a question on market share is always puzzling [Phonetic], right? And we [Technical Issues] using two things when we discuss market share, share of wallet, market share. Given that most of our peers have different portfolios in different segments, it's very difficult to have direct comment other than your own information, which is longitudinal. So, we have information for many years. And I can tell you we are winning more than we're losing across different segments.

And just to sort of shed some more light why that's happening. First, I mean, basically, [Technical Issues] what we said four years ago, improved our commercial execution and basically follow each and every opportunity. The CRM system gives us an incredible, incredible exposure and our teams have worked really hard in the last two years to maintain and win in very difficult environment. Second, we have a market-leading portfolio. We have podium position in LC, we have podium position in quantitative mass spec, which is [Technical Issues] segments that [Technical Issues] very hard, increasingly developing a position [Phonetic] in high-resolution mass spec in Xevo MRT for metabolomic testing, and we set standards for column testing for chemistry. So, feel very good about the portfolio going forward.

So, I think from a competitive standpoint, I can confidently say that we win more than we lose. But if you pin me down and say what exactly is the market share point by point gain, I would need very trustworthy information from each of our competitors to add and subtract. And I'm surprised that people are able to [Technical Issues] comments with so much confidence. I think we're confusing two issues, share of wallet and market share.

[Amol Chaubal, Senior Vice President, Chief Financial Officer at Waters]

And just to add [Technical Issues], we don't have IMAX-like [Phonetic] data in our sector as you know, right? The only place where you can sort of gauge this is, if our growth is outsized versus market. [Technical Issues] And for us, there are three vectors where we clearly see that. PFAS, we are growing twice the market. India, which we are doing so much more better than the market. [Technical Issues]

[Vijay Kumar, Analyst at Evercore ISI]

Understood. And maybe Amol, one for you on this guidance here. You beat the quarter by $25 million, annual was raised roughly by $25 million. When you look at the sequential revenue math, while I understand it's consistent with last year, I think you have extra days in Q4. So, maybe just talk about the guidance assumptions here in Q4, is that conservatism or any pull-forward of revenues from Q4 into 3Q? Thank you.

[Amol Chaubal, Senior Vice President, Chief Financial Officer at Waters]

Yeah, no, look, I mean, we wanted to be prudent, right? I mean, we wanted to be in line with the ramp we saw last year. Last year, we saw about 15% ramp, which is far lower than typical. What we have guided is 15.5%. We have two extra days in the ramp this year versus last year and that adds 2% more recurring revenue or 1% overall, right? So, call it, 16%. So, maybe it's a tad conservative and prudent at this stage in the equation. So, that's on the sales side.

On the EPS side, our full-year raise is slightly lower than our Q3 beat, and that's to do with the fact with timing of spend, right? I mean, we had pulled back spend because September is a big month and we wanted to make sure it checks out to our assumptions, which it did. And plus, we want to be ready as market starts to recover. And so, that's purely timing of spend. We're still raising our full-year EPS guide. And now, the full-year EPS guide is slightly positive versus last year.

[Udit Batra, President and Chief Executive Officer at Waters]

And then, I think there's two embellishments. One on the spend. Look, I mean, we are seeing dynamic growth in generics in India, in Eastern Europe. We're seeing very good growth with the Alliance iS, as it's -- as the adoption improves. We're seeing great growth in PFAS. We're not pulling back spending. And so, as teams come in, we are really making sure that they have the resources to grow in the future.

And on the -- and your question on pull-forward, none -- no pull-forward. You just need to look at the orders and sales. Orders grew again faster than sales and backlog has been building. So, no pull-forward at all.

[Operator]

Thank you. Our next question comes from Dan Brennan with TD Cowen. Your line is open.

[Daniel Brennan, Analyst at TD Cowen]

Great. Thank you. Thanks for the questions. Congrats on the quarter. Maybe just on -- just to start on China. So, in the quarter, what, China instruments may be down around 10% is our math. I'm just wondering, did you say what you're implied or kind of what your guide is for China in the fourth quarter and for instruments? And Udit, you talked about the stimulus, like, any way to size what that might be for '25? We come up with $70 billion in monetary stimulus being allocated broadly to instruments in kind of science and tech. Is that the number? And any sense of what percent the sector could capture of that?

[Amol Chaubal, Senior Vice President, Chief Financial Officer at Waters]

Yeah. So, look, I mean, China for the quarter was minus 5%. Instruments were down sort of high-single-digits. For Q4 -- and again, lot of it, as Udit mentioned, has to do with the fact that -- orders were in-line with last year. It was just timing of some of the TA-related shipments. As we get into Q4, we are expecting growth to return to China. So, it will be sort of low-single-digit to mid-single-digit growth in China and instruments will be somewhere around low- to mid-single-digit decline. But again, as we said, we have had no major incremental negative news from China since Q3 of last year. And because we had finished shipping last stimulus in Q2 of last year, Q3, Q4 base-line for us in China is pretty corrected.

Stimulus, I mean, it's hard to say at this stage, because the biggest challenge is timing. Unlike last time, this is being rolled-out through different provinces. And based on our read, every province is in different part of its journey in terms of getting all the paperworks and approvals together. So, still very early days in sort of timing the stimulus as it will happen next year. I mean, it's inevitable, it's going to be a great tailwind for the sector, but hard to put time on.

[Udit Batra, President and Chief Executive Officer at Waters]

And then, just to embellish this on the China piece, we were in China September, as I mentioned earlier. I mean, the general sense is, yes, the stimulus is coming. We have many conversations with each individual customer who is looking to qualify. We expanded our distribution as a result to make sure we were in every place where there was a discussion going on. This one would be very dispersed. It's not one that will be concentrated in two or three big academic institutions. So, we've prepared ourselves. We've localized the portfolio.

As I mentioned, we already see all the first set of orders consummate, and as I said, I don't know if it lands this year in sales or early next year, it's low-single-digit millions, but it's a good signal that it's happening. Very difficult to talk about timing at this stage. I mean, let the next three months pass, we'll find out a lot more until that time. And I think you talked about the $70 billion, but there's an equally important fiscal stimulus that will create confidence in the overall economy and that will influence the sector as well. So, don't forget that piece of it as well.

[Daniel Brennan, Analyst at TD Cowen]

Got it. And then, maybe just as a follow-up. Just I know, you've touched on PFAS and GLP-1 several times throughout. Would you be -- I know you talked about the long-term opportunity in terms of contribution to your growth rate. Would you be willing to size how big those businesses are today and kind of how much they're contributing today to your growth?

[Amol Chaubal, Senior Vice President, Chief Financial Officer at Waters]

Yeah. I mean, what we've said is, both those businesses will contribute about 30 basis points to 40 basis points of accretive growth. And that's based on purely the environmental side of PFAS. What we are seeing on PFAS is, it's now spilling into things such as food and consumer products and that would be incremental upside to that 30 basis points to 40 basis points of accretive growth on PFAS.

On GLP-1, that assumption is based on what percentage of prescription volumes GLP-1 will be, say, around 2030 based on analyst reports. If you look at it in an alternative way, which is what percentage of capex GLP-1 would be over the next decade, you get to a much larger number. But at this stage, we would want to stay prudent.

[Udit Batra, President and Chief Executive Officer at Waters]

Yeah. And I mean, I think the other way to look at this is, you take a visit to Copenhagen, I highly recommend it, or go around Indianapolis, and the number of cranes per square foot is higher than Cambridge, Mass, where the biotech -- and Cambridge, Mass at its height as well when the biotech boom was going. So, it's pretty serious activity towns [Phonetic].

[Operator]

Thank you. Our last question comes from Matt Sykes with Goldman Sachs. Your line is open.

[Matthew Sykes, Analyst at The Goldman Sachs Group]

Hi, good morning. Thanks for taking my questions. Congrats on the quarter. Maybe just going back to instruments, and Udit, the comment you made about a catch-up opportunity, how do you see the slope of recovery as we kind of move into next year? And do you have expectations that it could outgrow that 5% historical average? I think it's interesting to see the replacement cycle kicking-in for you and I think there's still a lot of questions about how gradual that recovery will be and your comments around catch-up opportunities suggest there might be some pent-up demand. So, maybe you could just kind of contextualize how you see this potential recovery taking place?

[Udit Batra, President and Chief Executive Officer at Waters]

So, I think -- thanks, Matt. I mean, I think the magnitude is pretty clear, right? I mean, you can just look at historical numbers, do the CAGRs that we've been doing for so much time and you can see the magnitude is pretty significant, especially for LC catch-up opportunity.

In terms of the slope, I mean, just being fact-based, that can go anywhere from 0.5% to 11% growth quarter -- one quarter to the other for the recovery. So, it's very difficult to predict based on facts. Now, you can then rely on two other features. One is the funnels that we have. And there, I can tell you, since March, June and now September, the last quarter of -- the last month of every quarter tells you a lot about funnel conversion, it has been improving, right? So, we've been seeing, people say they're going to do something, they do it. And they say they're going to do large stuff, they do large stuff; they're going to do small stuff, they do small stuff. So, it's -- the funnel conversion rates have been getting much more robust as we've gone through. So, the predictions become way better.

And the last piece is customer conversations, and I delve into the qualitative part of the conversation. We're having increasing number of cross-functional collaboration, construction -- cross-functional discussions with our customers where IT will also show-up and procurement will show-up, finance will show-up. So, those are the start of a multi-year replacement discussion where the capex is pretty significant for our large pharma customers. And I'm talking here about non -- also non-GLTP-1 customers. So, I think that's as much as I can say right now. And as I said, more will reveal itself in the next few months and we'll share it at the full-year numbers.

[Matthew Sykes, Analyst at The Goldman Sachs Group]

Great. Very helpful. And then, just when you look at sort of medium-term views on China, just given where the GDP growth has gone from where it's been historically, how are you thinking about sort of medium- to long-term growth in China, given your portfolio and your exposure there?

[Udit Batra, President and Chief Executive Officer at Waters]

Well, lots of people way smarter than us have been speculating on this. I think the general sense at this point is it's a mid-single-digit grower, and if -- because it's a developed economy. But if you have an advantaged portfolio, in some cases where we do and you have better execution, you can outgrow that number. So, I think that's as much as we can say about that at this stage. And again, more will reveal itself, Matt, as time goes on.

[Caspar Tudor, Head of Investor Relations at Waters]

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

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

• Caspar Tudor, Head of Investor Relations
• Udit Batra, President and Chief Executive Officer
• Amol Chaubal, Senior Vice President, Chief Financial Officer

Analysts

• Tycho Peterson, Jefferies Financial Group Inc.
• Brandon Couillard, Wells Fargo & Company
• Puneet Souda, Leerink Partners
• Vijay Kumar, Evercore ISI
• Daniel Brennan, TD Cowen
• Matthew Sykes, The Goldman Sachs Group, Inc.