Waters Q1 2023 Earnings Call Transcript

Presentation

[Operator]

Good morning, welcome to the Waters Corporation First Quarter 2023 Financial Results Conference Call. [Operator Instructions].

It is now my pleasure to turn the call over to Caspar Tudor, Head of Investor Relations. Sir, please go ahead.

[Caspar Tudor, Head of Investor Relations at Waters]

Thank you, Brad. Good morning, everyone, and welcome to the Waters Corporation First Quarter Earnings Call. Today, I'm joined by Dr. Udit Batra, Waters' President and Chief Executive Officer and Amol Chaubal, Waters' Senior Vice President and Chief Financial Officer.

Before we begin, I will cover the cautionary language. 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 on potential market and business conditions, including with respect to the close of the Wyatt transaction that impacts Waters Corporation over the second quarter of 2023 and full year 2023. 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 or Form 10Qs and the cautionary language included in this morning's earnings release.

During today's call we will refer to certain non-GAAP financial measures including - including in our discussions of the results of operations. Reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures are attached to our earnings release issued this morning and in the appendix of our presentation which are available on the company's website. Unless stated otherwise, references to quarterly results increasing or decreasing are in comparison to the first quarter of fiscal year 2022. In addition, unless stated otherwise all year-over-year 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 Udit to deliver our key messages for the quarter then Amol will provide a more detailed look at our financial results after we will open up the phone lines to take questions. Udit?

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

Thank you, Caspar and good morning, everyone. So this morning, I'll start by giving you color on our first quarter results as well as our updated guidance then I will cover some of our recent product launches including Alliance iS and I will also provide an update on Wyatt. Our first quarter results were below our expectations with revenue growth of 3% on a constant currency basis versus our expected 4% to 6% growth. This was largely driven by weaker-than-expected demand for instruments in biotech and pharma, which I will cover in a moment. As you know, we had an extraordinary Q1 last year with 16% constant currency growth, even though our first quarter this year was slower than expected, it still represents a very healthy 2-year stack growth of approximately 9.4%. We also saw overall - good overall strength in our recurring revenues, which continued to grow in the high single digits as well as mass spec and DA, both of which grew double digits.

Our end markets remain resilient and our leadership team continues to drive strong commercial execution. We have further strengthened our revitalized portfolio with a steady stream of innovative new products. Finally, we've added M&A to our growth strategy with our pending acquisition of Wyatt and we continue to invest organically in our high growth adjacencies which are also on track and are gaining momentum. Reviewing our first quarter results in more detail, our performance was impacted by a combination of three factors. First, China was weaker than anticipated as pharma customers scaled back purchases. Second, while we have limited exposure to pre-commercial biotech, we have seen it pronounced scaled back in demand from these customers as they have significantly reduced spending to conserve capital. And third, several of our large to medium size pharma customers delayed timing of instrument orders due to macroeconomic caution. Each of these dynamics occurred late in the quarter and led to instruments declining 3% after they grew over 25% in the first quarter of last year. By end market, the impact was to our pharma business, which declined 4% overall. This was offset by strength in the academic and government segment, which grew 45%, and industrial, which grew 3%, while our recurring revenues remained strong across service and chemistry.

As a result of this lower- than expected volume, our non-GAAP earnings per fully diluted shares also came below our expectations at $2.49 for the first quarter. On a GAAP basis, our earnings per fully diluted share was $2.38. As we look ahead, we are assuming that spending among pharma customers in China will remain scaled back for the balance of the year. And while our exposure to pre-commercial biotech is low, we also believe that the slowdown in this space is likely to persist for the remainder of the year, as a result we are lowering our 2023 guide due to these two factors. We now expect our full year organic constant currency growth to be in the range of 3% to 5%. We believe that large to medium pharma side budgets remain in place, we expect spending among these customers to catch up and be stronger in the second half of the year after delayed spending in the first half. Despite our revised revenue guide, our full year EPS guidance and free cash flow generation expectations remain unchanged. We intend to proactively manage our spend and working capital and Amol will cover this in more detail.

Even with short term market challenges, our sources for growth remain intact. Our end markets are robust with almost 80% of our business exposed to durable growth areas. This includes demand for QA/QC testing of commercialized medicines, increased scrutiny of PFAs in food and water and the testing of batteries used in applications such as electric vehicles. Our team has developed a strong commercial discipline that is supported by best in class innovative new products that address evolving customer unmet needs. We're also seeing high single digit growth in our recurring revenues, which are over 50% of our annual sales. Chemistry growth is supported by strong end market - end market activity, growth in biologic applications with our MaxPeak Premier columns and our e-commerce initiative.

For service, we're seeing strong pull through from our instrument sales and increased service plan attachment is supporting the growth. We expect service plan attachment for our instruments to increase by another 100 basis points this year, building on the 350 basis point expansion since 2019. Our revitalized portfolio has been further strengthened with the recent launch of Alliance iS which is our next generation intelligent HPLC system. We believe it is the most significant innovation to hit pharma QA/QC in the past decade and it provides a major leap forward in-lab productivity. Not only is the instrument easy to use with its large touchscreen interface but can eliminate common user errors by up to 40%, it does this by guiding users between steps with highly - with a intuitive interface. It intelligently conducted a number of real-time system checks before a sample is run. This helps - ensures that the instrument is configured correctly for the method that is being tested. Before now errors such as incorrect solvent or the wrong column being used which I usually discovered after the sample has been run with results in waste of time and a waste of sample.

Given the strength of the Alliance brand and the significant new features that this - that this instrument offers, we had a strong reception at its launch. Since quality testing is such a critical component of pharmaceutical manufacturing, customer interest has been strong, including from Janssen Pharmaceuticals who noted that Alliance iS feels like the future is here and has already made plans to replace a large number of its LCs with this instrument. We now have not one but two new industry leading platforms for QA/QC applications in pharma, Arc HPLC and it's biocompatible equivalent Arc Premier and now higher-end Alliance iS, which sits at the top of the range.

Last month, we also launched our Xevo TQ absolute mass spec into clinical applications. Not only is this the most sensitive Triple Quad on the market for PFAs detection, where it has seen strong traction in food and environmental testing, but now within clinical it is up to five times more sensitive than other competing instrument in the segment. This sensitivity enables clinical labs to detect and measure trace level analytes at lower detection levels than was previously possible. It also enables clinical labs to expand their test menu to include multiplex panels. Meanwhile, our TA instruments business launched a new microcalorimeter for battery testing essential for electric vehicle, energy storage and electronics applications. This provides customers with a significant upgrade, as it accelerates validation of battery, safety, quality and performance testing by up to 75%, which while collecting up to six times more data than other calorimeters.

Lastly, we also recently launched a new system monitoring software product on Waters Connect first for us and unique to the industry. Developed in consultation with QA/QC scientist, it enables real-time monitoring of all chromatography instruments controlled by our Empower software. It helps increase productivity of QA/QC labs by allowing customers to analyze there instrument fleet at anytime from anywhere to monitor uptime usage levels and real time system availability. Each of these new products have been developed in close collaboration with our customers to address their most pressing unmet needs. They further support the strength of our revitalized portfolio.

Earlier this year, we announced our intent to acquire Wyatt Technology, the recognized leader in light scattering, but more than 80% of its revenue [Indecipherable] large molecule applications, Wyatt expands Waters' portfolio and - and increases our exposure to faster growth areas within biologics. It also increases our ability to build a business in bioanalytical characterization, which is a 1.8 billion US dollar total addressable market with a 10% to 12% projected annual growth rate. We remain on track to close in the second quarter of this year. We also expect the transition to deliver immediate growth and adjusted operating - operating margin accretion.

Now, I will pass the call over to Amol to continue covering our first quarter financial results and give additional commentary on our guidance. Amol?

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

Thank you, Udit, and good morning, everyone. In the first quarter, sales grew 3% in constant currency. This came below our expectations due to the demand dynamics in our pharma business which Udit outlined earlier. Waters division grew 2%, NTA grew 10%. By end market, pharma declined 4%, industrial grew 3% and academic and government was very strong at 45% growth. In pharma, weakness was led by China and the US. In China, we saw customers recalibrate their spending plans and in the US at large to medium pharma customers delayed spending due to macroeconomic caution. Our small biotech customers which is a small portion of our business scaled back spending to conserve capital in light of more pronounced funding concerns. In industrial, growth was led by Asia, which grew 6% and the Americas, which grew 2%. In our Waters business, we saw continued strong growth in PFAs testing applications. NTA growth was led by thermal analysis and rheology. We have seen continued strong demand in secular growth drivers such as batteries and electronic testing. Academic and government had a great start to the year as elevated funding resulted in strong demand for our refreshed mass spec portfolio. Strength was broad across all our geographies, by product strength was broad across our high-res mass specs, such as cyclic IMS and our tandem quads such as TQ Absolute.

Now, by geography, sales in Asia grew 6%, the Americas declined 1% and Europe grew 3%. In Asia, China declined mid single digits for the quarter. Excluding China, Asia grew mid-teens with broad strength across our end markets. In the Americas, pharma declined mid single digits given delayed spending against the tough comp of over 30%. Industrial grew 2% and academic and government grew over 25%. Europe grew 3% in the quarter with strength also led by academic and government, which grew over 40%. By products and services, instruments declined 3% overall, but both are mass spec and TA Instruments systems grew double digits. Recurring revenues grew 8% with chemistry up 10% and service up 8%. This quarter had one fewer day than the first quarter of 2022, which translates to a headwind of approximately 1% for our recurring revenues. Gross margin for the quarter was 58.5% compared to 58.6% in the first quarter of 2022, in line with our expectations.

Operating margin for the quarter was approximately 26.8% compared to 30.3% in the first quarter of 2022, driven by sales mix and 120 basis-points of unfavorable FX. Our effective operating tax rate for the quarter was 15.4%. Average share count came in at 59.3 million shares, which is about 1.6 million less than the first quarter of last year. Our non-GAAP earnings per fully-diluted share for the first-quarter was $2.49 in comparison to $2.80 last year. Foreign exchange headwind lowered our non-GAAP EPS growth by 8%. On a GAAP basis, our earnings per fully diluted share was $2.38. 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. We define free cash flow as cash from operations, less capital expenditures and excludes special items. In the first quarter of 2023, free cash flow was $166 million after funding $34 million of capital expenditures, which represents approximately 24% of our sales. We maintain a strong balance sheet, access to liquidity and well structured debt maturity profile, this trend 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 well thought out attractive adjacent markets. In Q1, we repurchased approximately 173,000 shares of our common stock for $58 million early in the quarter. As we previously disclosed, we have since temporarily suspended our share buyback program for the remainder of the year so that we can use our free cash flow to fund the Wyatt acquisition. At the end of the quarter, our net debt position was approximately $990 million, which is a net debt to EBITDA ratio of about 1.

Now. I would like to provide our updated thoughts for 2023. Our end markets remained resilient and we expect our refreshed portfolio and growth initiatives to enhance our performance. However, as Udit covered earlier, we are revising our growth expectations to account for the scale back of purchases from our customers in China and the slowdown in small biotech. As a result, we are updating our full year 2023 organic constant currency sales growth guidance to 3% to 5% excluding Wyatt. At current rates, currency translation is expected to have a minimal impact on full year sales, resulting in full year reported organic sales growth guidance of 3% to 5%. Consistent with our prior expectations, we expect wired transaction to add approximately 2.5% to our full year 2023 revenue growth. Therefore, our total reported sales growth guidance is now 5.5% to 7.5% percent versus 2022 including Wyatt. We expect organic gross margins to be approximately 58.5% for the year and organic operating margins to be approximately 30.5%. This is higher than our previous guide due to anticipated cost savings in our core business and an improvement in FX. This now translates to 50 basis points of margin expansion. Net of investment in adjacencies partially offset by an FX headwind of 20 basis points.

As we previously mentioned, we anticipate the expected addition of Wyatt in Q2 of this year will be accretive to our full year 2023 adjusted operating margin by approximately 25 basis points. Excluding the Wyatt transaction, we expect our full year net interest expense to be approximately $40 million. Consistent with our prior expectations, the transaction is expected to add $40 million of additional interest expense for a total of $80 million interest expense. The full year tax rate is expected to remain at approximately 15.5%. Our average diluted 2023 share count is expected to be approximately 59.3 million given the temporary suspension of our share repurchase program. Rolling all this together, on a non-GAAP basis, our full year 2023 earnings per fully diluted share guidance excluding the Wyatt transaction is projected in the range of $12.70 to $12.90 which is unchanged from our previous guide and includes a negative currency impact of approximately one percentage point at current rates. Including Wyatt non-GAAP our full year 2023 earnings per fully diluted share is also unchanged projected in the range of $12.55 to $12.75.

Looking to the second quarter of 2023, we expect the current market dynamics to persist in China along with the slow down in pre-commercial biotech. We also expect cautious spending levels from our large pharma customers to continue until end of the second quarter before catching up in the second half of the year. Hence, we expect second quarter organic constant currency sales growth of 1% to 3%. At today's rates, currency translation is expected to subtract approximately one percentage point resulting in second-quarter reported organic sales growth guidance of 0% to 2%. Assuming a mid May close, we expect the Wyatt transaction to add approximately 1.5% to our second-quarter revenue growth. Therefore, our total second quarter reported sales growth guidance is 1.5% to 3.5% including Wyatt. Excluding the Wyatt transaction, second quarter non-GAAP earnings per fully diluted share are estimated to be in the range $2.60 to $2.70 with a negative currency impact of approximately three percentage points. Including Wyatt which is expected to result in an EPS headwind of $0.08 second quarter non GAAP earnings per fully diluted share is projected in the range of $2.52 to $2.62.

Now I would like to turn it back to Udit for some summary comments. Udit?

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

Thank you, Amol. So to summarize, despite a slower than expected start to the year our end markets are resilient and we expect to see increased strength in the second half of the year. While we have revised our revenue guide, we are maintaining our full year EPS guide due to our robust financial model and the acceleration of our growth strategy remains on track with continued progress on all of our high growth adjacencies and with our pending acquisition of Wyatt Technology. I would like to take this opportunity to thank our colleagues around the world who have continued to demonstrate the indomitable spirit of Waters with their focus on strong commercial execution and revitalized innovation. We also look forward to welcoming our future Wyatt colleagues.

Finally, I'm proud to share that Waters continues to be globally recognized for its strong ESG profile placing at number 5 on the balance 100 Most Sustainable Companies list for 2023. This is the second year that we've been placed in the top 10 after receiving more than 20 awards in 2022 recognizing the company for excellence and product innovation, leadership strength and commitment to social and environmental responsibility. We look forward to continuing to demonstrate our commitment to leave the world better than we found it. So with that, I'll turn the call back to Caspar.

[Caspar Tudor, Head of Investor Relations at Waters]

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

Questions and Answers

[Operator]

Thank you. [Operator Instructions]. And our first question today will come from Luke Sergott of Barclays. Your line is open sir.

[Luke Sergott, Director at Waters]

Great, thanks. Good morning, everybody. So I want to start off on the academic and government strength that you guys saw in the quarter particularly in China, you guys called that out, but it was strong across every region. So, did you guys see any push outs in there from - from the 4Q. Just talk about what -what you are seeing there is that kind of goes forward. So, this isn't just a one time thing.

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

Sure. Thanks, Luke, and good morning. Look, it's a great start to the year with about 45% growth and this is largely due to the elevated global funding that we're seeing - seeing - seeing across - across the globe and the strong demand for our high rise mass spec portfolio. This growth was of course led by China, which grew over 80% versus previous year and of course we saw the same thing happening, not to that same extent in magnitude, but in the US, in India and in Europe all had a - had a nice growth well into the double digit territory. So, academic and government, as you know is a segment that's rather lumpy, so I would rather not extrapolate Q1 to the rest of the year. So we assume that we will see the second half that will become more normalized and the full year will be more in the low double digit to teen range given such a strong start to the year.

[Luke Sergott, Director at Waters]

Okay, great and then when you guys talked about the - on the guide down part being from biotech customers and part being from large pharma kind of pushing out their spending, can you help size what those actually were and contributed to the guidance cut for the year.

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

So Luke, look I mean, if just to sort of take a step back, the full year guide - for the full year guide we have assumed 3% to 5% in constant currency, right. And on a 2-year stacked basis, this is still high single digits. We like to - we think like the first quarter the spending at Chinese CDMO customers and the pre-commercial biotech customers remained constrained for the balance of the year and to remind you on the - on the China upside we've grown the CDMO presence over the last two years, we've actually tripled that business, right. So, it's gone - it's gone dramatically up. So we think like the first quarter, the spending in the Chinese CDMO customers and the pre-commercial biotech customers will remain sort of muted. On the other hand, we're assuming that the large pharma customers with delayed orders for instruments will come in the second half of the year. And here over the last two weeks, I've personally spoken to several large customers, both in the US and Europe to understand the situation and the funding remains very much intact and the [Indecipherable] were simply delayed, so we're expecting those to come largely in the second half of the year. So then the 3% to 5% guide would then imply that for the full year, China will grow in the low single digits versus our previous assumption of high single digits. Pharma will also remain in the low single digit category with combined pressure from China, CDMO and pre-commercial biotech. And instruments for the year will grow flat to low single digits and recurring revenues in the high single digits, right. So I hope that gives you a flavor for the drivers of the full year guide and how we stepped it down. Amol, do you want to comment - comment on the quantitative aspects?

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

No. I think you covered it well, yeah.

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

Thank you.

[Operator]

The next question will come from Vijay Kumar of Evercore ISI. Your line is open.

[Vijay Kumar, Senior Managing Director at Waters]

Hey guys, thanks for taking my question. Udit, back to some of your comments here. What is Waters exposure to this emerging biopharma, was that down in 50%, any directional sense and what the business did and in - in this Wyatt, I understand they have exposure to large pharma. Is there any risk here on Wyatt's - what is Wyatt's exposure to emerging biopharma?

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

So let me - so Vijay, thank you for the question. First on the biotech exposure, our biotech customers broadly speaking constitute between 10% to 15% of our pharma business and with more heavier weighting in the US and China, where the biotech industry is even more developed. Pre-commercial biotech, which is where we saw the slowdown is a subset of this and it's roughly half of it, right. So if you do the math, that's roughly 5% to 7% of our pharma business, right, and largely focused on the US and in China. So during Q1, pre-commercial biotech companies of course got extremely cautious and virtually halted the instrument purchases, especially later in March. We're starting to see some relaxation but we've assumed that this situation will persist for the balance of the year. So and over the long - and over the long term I don't need to remind you the biotech industry plays an extremely important role in the innovation that we see across healthcare and they remain our very-very strong customers. Now to your question on Wyatt, roughly 80% of the Wyatt business is focused on -on biologics - on biologics applications. Wyatt has historically been very strong in academic and government and for biologics applications for characterizing large molecules like cell and gene therapy and proteins and monoclonal antibodies. We expect this business for the balance of the year once the close happens to remain in the low double digit category and as Amol said this would add roughly 2.5% to our incremental revenue for Waters for the rest of the year. So we expect this to continue to remain extremely strong for the balance of the year.

[Vijay Kumar, Senior Managing Director at Waters]

Understand and then Amol, one for you. The second quarter EPS guidance implies I think the operating margins in 2Q to be roughly similar to Q1. [Indecipherable] trace of the annual EPS guidance, it looks like back half has to be like low 30s operating margins, that's a massive step up, I think 500 basis points or 600 basis points from doing the math correctly. What is driving the second half margin expansion versus first half, is there any synergies being baked in from this Wyatt transaction or perhaps is Waters contemplating any restructuring actions.

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

So there a couple of things Vijay that play into the second half of the year, right. One is the volume in the second half is typically higher than the first half and that produces some degree of volume leverage and our gross margin profile in the second half is slightly better than that in the first half. Two, we also benefit from exchange rate in the second half. Remember in the first-half, FX is still a headwind in the second half FX is a tailwind. And three, given the revise sort of the demand outlook we plan to proactively manage our costs and intend to keep our operating expenses relatively flat in the second half versus the first half and if we are able to do that, then it allows us to produce the kind of margin expansion and EPS that we've guided from the second half.

[Operator]

The next question will come from Daniel Brennan of TD Cowen. Your line is open.

[Daniel Brennan, Managing Director at Waters]

Great, thanks. Thanks, guys, for the question. Maybe the first one, just on the guide, just wondering, was there a discussion maybe to cut beyond the 3 to 5, just wondering, you kind of ripping the band aid off here, given some of the factors you pointed to, but do you feel that guide provides still healthy cushion given all the uncertainties you flagging, it's still as you pointed out, you did, it's still kind of in high single digit to your stack, which is above your long-term LLP and you do have these factors and your banking on a recovery in the back half of the year for large pharma.

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

Yeah, so - so, Dan, thank you for the question. Look, I mean, we spend a lot of time clinically dissecting what happened in Q1, and why it came below our - below our expectations with a 3% or so growth, right, and the reasons that I outlined the slowdown in Chinese CDMO customers - slowdown on purchasing of Chinese CDMO customers who largely serve US - US and European pharma customers, we think that will persist for the balance of the year. We think the pre-commercial Biotech spending will remain muted and that is that's what we've assumed even though we see some signs of that improving, we've assumed that - that remains muted. And then thirdly, we expect the deferral of purchases of instruments in large pharma customers to come back and we looked at it super carefully and I personally spoke to some large pharma customers, they have the budget, they have the funding, it simply was caution to delay the purchases and now with a very strong revitalized portfolio, we feel very good about being able to compete for - for orders across the instrument portfolio. So you put it all - you put it altogether, you basically see that the instruments are - instrument growth will be flat or low single digit at most for the full year. Recurring revenues, which have gone from strength to strength is over 50% of our business, gets into the high single digit category. Pharma, which has been our sort of strongest grower in many - for many-many years, we also assume in aggregate will be back to low single digit. And China, again a strong growth driver, will end up flat to low single digits. So I think we've been we've been rather cautious about our guidance and we've taken all the factors into account. And as you said, I mean, the full year stack looks very good, just given the strength we've built from a commercial perspective, and the strong innovative portfolio that we have put forth in the market and with the close of Wyatt that should add a little bit of more - little bit more momentum.

[Daniel Brennan, Managing Director at Waters]

Great, thanks Udit. And maybe sort of follow-up just on instruments. So flat to low single, that's kind of high single digit stack against what you guys did, you've obviously had tremendous growth there. Can you just unpack that a little bit, it sounds like a mass spec doing terrific. Could you just give us a flavor for the relative contribution between NASDAQ and LC and if you want to give us any regional, I don't know how far down the whole you want to go, but just give us a sense of what's incorporated into that low single. Thank you.

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

The instrument sales for this quarter declined roughly 4%, right. And as you rightly pointed out, this is on the base - on the back of a 26% growth in 1Q22, right, so pretty strong comp. Now mass spec grew high-teens so strength to strength and on a multiyear basis, it's a high-teen growth. DA grew double-digits, while LC declined in teens. Now to your question on LC or deeper question on LC, the sales were impacted disproportionately by the decline that we saw in the purchase by pharma customers and these are - these are Chinese CDMO serving US and European customers as I mentioned the pre-commercial Biotech and also the delayed orders that I talked about for large pharma so disproportionately impacting LC. Now just to put this all in a bit of perspective and you've seen an instrument business we will always see fluctuations but what is important to remember is that over the long-term our instrument business has grown in a 4% to 5% range with a gross margin of roughly 60%, right, it's a pretty attractive area to be in.

We during this time looked at our instrument growth rates for the last 20 years, starting 2004, we basically looked at every year and you come away with just two very simple insights. First the average growth hovers around 4% to 5%. Second, there is a fluctuation around this mean which generally gets exaggerated around economic slowdowns, like in 2008 and 2009, 2011 and 2012, but the volume always returns within one to two quarters. So whenever there is a delay, especially in the case of LC, which is over 70% of replacement business. This fluctuation always subsides and you return to your average of about 4% to 5%. So we're pretty positive and we feel very confident about the deferred business is coming back, especially now, given our terrific commercial execution that you pointed out, and our renewed portfolio, especially in the small molecule LC segment where Arc HPLC now is augmented by Alliance iS. We should see the instrument growth returning back to normal before long as for the full year than we basically assume still a flat to low single digit instrument growth in aggregate and recurring revenues at the high single digit range. Wherein the second half of the year, you'll start to see trends that are more like pre-COVID times, right. So I hope that gives you a bit of flavor on - on what the assumptions are and how you probably have thought about it.

[Operator]

The next question will come from Matt Sykes of Goldman Sachs. Your line is open.

[Matthew Sykes, Research Analyst at Waters]

Hi, good morning. Thanks for taking my questions. So maybe just to dig a little bit more on the large pharma side, it's quite clear, your expectations for the second half recovery and this is a delay. I'm just wondering just given some of the news we've seen from some of the larger pharma about rationalizing their R&D spend, has there been any kind of re-prioritizing those R&D budgets, whether it's inflation reduction act prompting them to move into large molecule or anything like that, are you truly see this is sort of a temporary delay in terms of ordering.

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

So Matt, great question, right. And so, I personally then decided to speak to several of the large pharma customers both in the US and in Europe, and basically we find that the budgets are still very much intact. Like many companies like us as well we are being more cautious with - with capital spend, and we are taking longer to approve capital spend and that's what's happened in large pharma as well. So there is no talk of not doing replacements or not - not adding instrument fleets that they had planned altogether. Second, what I'll remind you is that our business is more heavily weighted towards the QA/QC segment, which is more proportional to manufacturing volumes, right, and so R&D spend if it comes under pressure does not impact especially our LC business which is more weighted towards QC and especially on the small molecule sites, so really no - no real indicator there that - that would - that would slow down. And finally, Matt feel extremely good about our commercial execution that has demonstrated what we've been able to do over the last 2 to 2.5 years. Where we have really grown rather nicely with all the instrument replacement initiatives, also on the consumable side, which remains extremely strong and consumables I'll remind you is an indicator of pharma activity, right. If that is glowing high single digits, what you find is that significant activity still occurring with the pharmaceutical customers. So we believe it's just a matter of time that the instrument - the instrument orders that were delayed in large pharma will come back. So we have a lot of corroborating evidence that suggests that this is coming back, but we've been rather cautious - even though we see some indicators of it coming back already we've been rather cautious to assume that most of the spend will come in the second half of the year.

[Matthew Sykes, Research Analyst at Waters]

Great, thanks. That's very helpful color. And then just my follow-up would just be on the industrial end market, you've done a really good job in the past of kind of decomposed into sub-segments there and you talked about strength in batteries and PFAs, but maybe could you talk a little bit more about the sub-segments where you're seeing some maybe softness and where you're seeing continued strength.

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

Yeah. Yeah, so I mean, just taking a step-back, Matt, the Industrial segment on Waters has dramatically changed over the last 15 years or so, right. I mean, basically it's now constituted heavily of food and environmental and the TA business has 40% of it is in the more resilient segments like batteries, also serving some parts on life science right out of TA. Now to just decompose the results for the quarter, the industrial business grew roughly 3%, it was led by TA again, which grew almost 10% and PFAs testing, which we've talked about several times in our previous discussions, which continues to grow really-really rapidly. And in TA, roughly 40% of the business is now in the more resilient segments with batteries really continuing to grow nicely. So when I double click on TA, I mean it has the same sort of dynamics that the Waters division does, right. So, we've really increased our focus on commercial execution, new products, especially the ones relevant for high growth areas for thermal analysis and rheology and we just talked about our new battery calorimeter that sets a new standard in testing batteries and their efficiency and effectiveness, it's just been launched. So we feel very good about where the TA business stands going forward. So if I just put all of that together for the full year we're assuming a mid single digit growth in our industrial - in our industrial business led by the strength that we continue to see in TA and PFAs testing.

[Operator]

The next question will come from Derek Brown of Bank of America Merrill Lynch. Your line is open.

[Derek Brown, Project Manager at Waters]

Hi, good morning, everyone.

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

Morning, Derek.

[Derek Brown, Project Manager at Waters]

Hey Udit. I have a question for you. I mean, I've been covering Waters for a long time, and we've seen some of the spending patterns before and historically farmers have delayed their budget releases in Q1, thinks pickup in 2Q but otherwise [Indecipherable], if we're going back to sort of like historical seasonality, 3Q then is always a crapshoot in terms of what spending is because you won't have any real visibility until - until September. So I'm just - I'm just sort of why are we not back to somebody sort of seasonal patterns and then in - and everything essentially end up right on the fourth-quarter and like this. I'm just very curious. Are we - is there anything more different going on here than just return to normal seasonality.

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

It's a fantastic question, Derek, and expected you to ask something that relates to the history of Waters in general. Look, you're totally right. We think the second half of the year will start to approximate what we've seen in the past, right. That's why if you just look at the growth rate on the second half of the year, it's between 4% and 7%. Instruments now starting to traverse into the low to mid single digits and consumables, well-above our historical averages traversing at the high single digit, right. So, it does start to look like historical patterns. And if you just now look at the specifics, right, as I said - we basically said, look, the CDMO spending in China, the pre-commercial biotech is not coming back. Now, you can call that super conservative or not up to you, but we just said, look, that's not coming back for the balance of the year. That's what we want to assume for now. But pharma, we have said, based on the visibility we have with those customers and I personally spoken to several of them as well to just gain confidence, we're already starting to see the orders release now, it's anyone's guess If it comes in Q2, Q3 or Q4, but again we've been cautious and said, look, it will come in Q3 and Q4 rather than in Q2, right. So I think that's the dynamics, but it does return, the second half of the year starts looking awfully like pre-COVID times and then when you do the full-year math, right, you look at Waters, I mean, you'll see us on a stack 2 year 4-year stack basis traversing high single digits and Amol already talked to you about the margins, the margins are 330.5%. That's a pretty good business right high single digit 30.5% margin. So we expect to be able to overcome these challenges for the balance of the year and, I mean, this is the best visibility that - that we had at that point in time given the conditions.

[Derek Brown, Project Manager at Waters]

Yeah. I mean, absolutely. I mean, just sort of looking at it historically gone through a couple of years like double digit growth in the business and then it goes to mid singles and it comes back double digits and then it goes there, it goes to these processes, so I mean it seems like the trajectory as was the exit 23 would be back to that 3% to 5% growth in instrumentation business, than whatever your augment is on the consumables business, right. So 7% to 8% that way, so that's probably the best way we think about next year. I think, I mean, I can't give you [Indecipherable] next year, but just to give you sort of broad strokes at this point we think that our instrument business is super healthy right, though is it 3% or is it 5%, I cannot judge but it's a good starting point. We think our consumables business has been traversing on a stacked and a double stack meaning two to - two and four years stack basis on high single digits now. It seems a bit higher than previous - previous growth rates. Now we've augmented our business with Wyatt which would add more to the growth rate, right. So, that's a low double digit grower and exposed more to biologics. And you put it all together, I mean instruments are mid single digit, recurring revenues are high single digit, you sort of end-up at a weighted average which is mid to high single digits, right, that's what we are seeing and remember, we said 5% to 7% growth in the midterm starting to and with more move towards high-growth adjacencies that growth even expands and we are able to maintain our margins because we are rather careful about how we invest in the business and it's about a 30ish percent or 30.5% margin, right. So you start to see the algorithm come back, but with a bit more - a bit more strength given what we've done on the commercial side and how been adding - adding, adding strength on the consumables, placement through e-commerce, service attachment rates which are higher than ever and then new product - the new product portfolio, which is completely revitalize. So we think it will be a - it will be in there or thereabouts, but probably a little bit better given commercial - commercial success given innovation and the fact that we have Wyatt which is the faster-growing businesses in the - in the segment.

[Operator]

The next question will come from Joshua Waldman of Cleveland Research. Your line is open.

[Joshua Waldman, Senior Equity Research Analyst at Waters]

Hey guys, thanks for taking my questions. A couple for you. Udit I guess, just another follow-up on your comments on large pharma. I think you said you have orders or quotes in hand at this point. I guess, just curious if you could comment on the magnitude of these orders and then maybe what customers are telling you with respect to a year-over-year growth in their budget and then I guess reference - in reference to the full year guide if the opportunities do convert that it sounds like you're starting to see. Do you think there's upside to the guide and then on the flip side, if - i f they don't, do you think you have to trim the guide going through the year.

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

So maybe I'll start with the very end and then work - work towards the front on the pharma customers. Look Josh, we've done a very clinical analysis on the drivers of what's happened in Q1, right, and we have been super transparent about where they've come from, right, the Chinese CDMOs, the emerging - the pre-commercial biotech and those, those two, we don't expect to see coming back for the balance of the year, even if there are indications that starts to relax towards the later part of the year. On the pharma spend, we have a significant amount of corroborating evidence that from the field, from my personal conversations, from looking at the data, especially in - in what we're seeing on a commercial - from a commercial perspective, and I'll remind you that, that we are - we are still very much QA/QC focused company. So the commercial volumes continue - to continue to rise as they are in pharma and new products keep coming through, we expect to see that spend - spend continue in the way that it has. So we feel reasonably comfortable that - that spending will come back for the balance of the year. Again, how it's distributed in Q2, Q3, Q4, it's not straightforward but we are assuming that it's in the second half of the year. And that brings us to the full year guide, which is 3% to 5% or 2-year stacked growth rate of high single digits. So, I hope that gives you color on - on how we are thinking about the full year and where we see strengths and where we are sort of analyzed it and said, look, we are not bringing this back into the equation.

[Joshua Waldman, Senior Equity Research Analyst at Waters]

Got it, then we [Indecipherable] wondering if you could comment on how prices tracking year-to-date versus your expectations. I think you previously said 200 basis points this year, is that still the right way to think about it or does the softer demand environment here in the near term put pressure on that.

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

I mean at this point Josh price is reducing little above 200 basis points based on dynamics we are seeing in the market our teams are doing an excellent job of holding onto that. And that's what we're thinking for the rest of the year.

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

Yeah, and Josh, to build-on the price comment. We expect that the strength that we've built in execution of implementing pricing changes will stay with us. Second, our portfolio, which is really reinvigorated across the board, right. So we've talked enough about the mass spec business in the Boston, Xevo TQ Absolute, the G3 Qtof which now helps customers transfer their methods much better from development into QA/QC or to the BioAccord. We've talked about the impact of our MaxPeak Premier columns, so innovation across the board and now more recently with LC with the Alliance iS and also in DA for battery applications, we see innovation across the board and this customers do want these products, they meet very significant unmet needs and they're willing to pay a premium to access these products. So the commercial strength that we've built over the last two years plus revitalized portfolio makes us confident that we can continue to pass on price in a very significant way.

[Operator]

The next question will come from Rachel Vatnsdal of JPMorgan. Your line is open.

[Rachel Vatnsdal, Senior Equity Research Analyst at Waters]

Great, thanks for taking the question. And so one here on instrument declined 3% during the quarter, you made a comment of how the dynamics really sort of late on in the quarter. So can you walk us through what was the exit-rate for instruments and then how orders look during April-May timeframe and then as a follow-up, you mentioned that instruments are expected to be flat or low single digits for the year. So what's embedded in that guidance for instrument growth during TQ.

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

Sure, Rachel. Thanks for your question. Look, instrument sales declined by 4% for this quarter, right, and on the back of the 26% in 1Q22, mass spec as I mentioned earlier grew high teens and TA grew double digits, while LC is the one that declined in teens and for your question on how these were and where this came from, I mean, it's the same drivers that I mentioned earlier they were impacted disproportionately by the decline in the Chinese CDMO customers were serving US and European pharma companies, pre-commercial biotech and some delayed orders in large pharma. And as we - we think about the full year, we feel quite confident that the deferred business is going to come back, given what I mentioned in response to the previous questions and also the fact that we have an excellent commercial organization and the new portfolio that basically allows us to place these instruments. For the full year - for the full year, we are assuming a flat to low single digit growth in instruments and of course high single digits for consumables and you'll start to see Derek's question earlier, the second half of the year look awfully like pre-COVID - pre-COVID times. I hope that gives you clarity.

[Rachel Vatnsdal, Senior Equity Research Analyst at Waters]

Yeah, and then just a follow-up here on - on biological analytical characterization. Can you talk about what the adoption of that portfolio with BioAccord and then also how Wyatt adoption rate has trended in recent months and talked about the opportunity here for bioanalytical characterization is that - adoption rates will increase over time, but just given that characterization is that required for bioprocessing right now, is there a risk that could be an area where pharma really start to rationalize spending and that could pressure new customer wins and then ultimately looking back to you for growth rates and BioAccord and Wyatt this year. Thank you.

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

So, Rachel, thanks for that question. Look I mean about 40% to 50% of the pharma pipeline is now biologics. A good portion of that is cell and gene therapy molecules which are curative not just - not just treatments. These are fantastic drugs and we're doing all we can to help our customers take these to the market. Unfortunately the characterization techniques for these have not moved at the pace that they should have historically. Now we have the tools like LCMS, like LCUE, like light scattering and like our MaxPeak Premier columns that will allow our customers to characterize these molecules much better to move them faster through the pipeline and reduce costs dramatically. So we see that demand really-really picking-up, right. So, when we did the analysis we said, look, this is about a 1.8 billion market that is growing well into the double digits, now with the addition of Wyatt we now have a world-class portfolio with the simplest LCMS instrument in BioAccord that has very good adoption for raw material testing, for in-process characterization of [Indecipherable] lines and now rapidly moving into - into QA/QC and I had given some examples of that also in the past. Second, LCUV remains a characterization technique that many of our customers use to release biologics. And thirdly, now with Wyatt multiannual light scattering that we now intend to attach to our SEC - SEC columns as well as our LCs, we think this has very-very good prospects going forward. And when you talk about Wyatt, Wyatt has historically grown in the 20% range and our assumption is as we look at the balance of the year and the rest and after the deal is closed we - our assumption is still that it's a low single - low double digit grower with a 40% margin for the foreseeable future. So we feel very good about this area and biologics in general and bio and the business that we're building in bioanalytical characterization.

[Operator]

The next question comes from Patrick Donnelly of Citi. Your line is open.

[Patrick Donnelly, Director at Waters]

Good morning, I am Lizzie on for Patrick. Thanks for taking my question. So, I guess first on pre-commercial biotech, can you talk a little bit about how that trended throughout the quarter to the weakness mostly stemmed later on in the quarter in February and March, or was it kind of you know even throughout and then I have one follow-up. Thanks.

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

Sure, look, I mean, this - this really came in the month of March, right. I mean our pre-commercial biotech, as I've said before, is roughly 5% to 7% of our overall pharma business and largely focused in the US and in China, now to double click on the US, these companies are mostly in the Cambridge and San Diego, San Francisco area, right, and we saw really their spending almost halt in March given the financial crisis that many of the companies were going through, some of that has started to relieve but we saw that - that segment really slow-down quite dramatically in the month of March and then that has - and that has persisted into, we are assuming that, that is persisting into Q2, especially for that particular segment.

[Operator]

And that was our final question for today. I'll turn it back over to the speakers for closing remarks.

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

Sure thank you very much for your participation and questions today and on behalf of the entire management team at Waters I would like to thank you for your continued support and interest in the company. Thank you and have a wonderful day.

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

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

Analysts

• Luke Sergott, Barclays PLC
• Vijay Kumar, Evercore ISI
• Daniel Brennan, TD Cowen
• Matthew Sykes, The Goldman Sachs Group, Inc.
• Derek Brown, Bank of America Merrill Lynch
• Joshua Waldman, Cleveland Research
• Rachel Vatnsdal, JPMorgan Chase & Co.
• Patrick Donnelly, Smith Barney Citigroup