Waters Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 7, 2023

There are 12 speakers on the call.

Operator

Good morning. Welcome to the Waters Corporation Third Quarter 2023 Financial Results Conference Call. This conference call is being recorded. It is now my pleasure to turn the call over to Mr. Caspar Tudor, Head of Investor Relations.

Operator

Please go ahead, sir.

Speaker 1

Thank you, Ivy. Good morning, everyone, and welcome to the Waters Corporation Third Quarter Earnings Call. Today, I'm joined by Doctor. Uday Batra, WADA's President and Chief Executive Officer and Amol Charwal, WADA's Senior Vice President and Chief Financial Officer. Before we begin, I will cover the cautionary language.

Speaker 1

I would first like to point out that our earnings release and the slide presentation supplementing In this conference call,

Speaker 2

we

Speaker 1

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 questions that may impact Waters Corporation over the Q4 of 2023, full year 20232024. These statements are only our present expectations question comes from the line of David. For more details, please see the risk factors included in our most recent annual report on Form 10 ks, financial measures, including in our discussions of the results of operations. Reconciliations of the non GAAP financial measures to the most directly comparable GAAP measures References to quarterly results increasing or decreasing are in comparison to the Q3 of fiscal year 2022 We do not intend to update our guidance, predictions or projections except as part of a regularly scheduled quarterly earnings release or as otherwise required by law.

Speaker 1

Now, I'd like to turn the call over to Uddit to deliver our key remarks for the quarter, then Namor will provide a more detailed look at our financial results. After, we will open up the phone lines to take questions.

Speaker 3

Uday? Thank you, Casper, and good morning, everyone. I want to start today's call by thanking my colleagues for remaining focused on our customers on developing new products and supporting each other. Despite the challenging macro environment, our teams delivered a solid performance and did a great job capitalizing on the available opportunities drive productivity gains and margin expansion, resulting in strong adjusted earnings growth for the quarter. We launched innovative new products that address the critical unmet needs of our customers and further differentiate our revitalized portfolio In the attractive end markets that we serve, we also continued to make strong progress with Viatt, including The launch of our first new light scattering instrument.

Speaker 3

Turning now to our results. In the Q3, sales grew less than 1% as reported. Organic constant currency sales declined by 4%. Sales outside of China were largely at or above our expectations. However, demand in China fell beyond our expectations, which ultimately led to our sales landing at the lower end of our guide.

Speaker 3

With the U. S. Dollar strengthening, the currency impact Strong start contributing 4% growth to the quarter as expected. Despite the market challenges and the adverse FX impact, We expanded our gross margin percentage by 240 basis points and adjusted operating margin percentage by 3 80 basis points. This allowed us to deliver non GAAP earnings per fully diluted share In the Pharma segment, U.

Speaker 3

S. Pharma grew 6% and Europe grew 5% with a strong continuing performance among our large to medium sized customers despite slow funnel velocity. In China, we saw continued weakness in pharma throughout the quarter. Market challenges in China have now broadened beyond pharma and impacted both our industrial and academic and government end market results in the quarter. Overall, sales in China declined approximately 30% as the demand environment further deteriorated as the quarter progressed.

Speaker 3

In the Industrial segment, China declined low teens. Outside of China, Industrial declined 6% as growth in the quarter was subdued by a tough prior year comparison of over 20%. While the most cyclical applications in industrial have continued to slow globally, We saw continued strong traction in PFAS and battery testing applications. In academic and government, We continued to see strong uptake of new products in Europe with low double digit growth and in the Americas with mid single digit growth. However, this strength was more than offset by pronounced weakening in China, which declined over 30% now that the shipments related to last year's stimulus programs have concluded.

Speaker 3

In our core business, while the market environment has become more difficult, we continue to deliver strong commercial results. When looking at our 3rd quarter results outside of China, our organic constant currency sales grew low single digits year over year and is a healthy 7% on a 2 4 year stack basis. On a year to date basis, our organic constant currency growth has been mid single digits year over year excluding China and flat overall including China. A key driver of performance for our business this year is mass spec, which is an area where we have gained share with our innovative new product portfolio. We're also managing our P and L

Speaker 2

comes from the line of John. Thank you, John.

Speaker 3

Thank you, John. Thank you, John. Thank you, John. In the Q3, our gross margin was 59.1%, a year over year expansion of 240 basis points. Our adjusted operating margin was 31.5%, expanding 380 basis points.

Speaker 3

Year to date, our results also showed substantial margin expansion with our gross margin up 100 and 60 basis points to 59% and our adjusted operating margin up 60 basis points to 29.4%. Let me talk about what drove this. First, our commercial teams have continued to achieve strong pricing results to realize the productivity benefits of our focus on operational excellence and digitization. I'm excited that next month, 3rd, through our proactive cost actions, we have rapidly aligned resources to our long term growth strategy. While the current market environment is challenging, the long term fundamentals of our end markets continue to be excellent.

Speaker 3

As I mentioned last quarter, There are instrumental growth vectors to our historical 5% instrument growth that result in a great long term growth profile comes from our business. This includes global prescription drug sales, which are expected to exceed historical growth rates as well as measures we have put in place to improve pricing, comes from the

Speaker 2

line of David. Where we expect to

Speaker 3

sustain a more than 100 basis point improvement versus historical levels. In addition, the growing adoption of analytical instruments Inpus's development for large molecule therapeutics is a new growth vector for instruments such as mass spec and light scattering in our portfolio. This is only expected to strengthen as end users find value in these instruments for high volume and recurring applications such as process development, raw materials testing and quality control. The competitive edge of our revitalized portfolio also positions us well for long term growth. Our product portfolio has been renewed in the last few years with significant innovation that is answering the critical unmet needs of our customers.

Speaker 3

The past decade. In mass spec, the industry leading sensitivity of Xevo TQ Absolute has allowed us to gain share in the food and environmental market for PFAS related testing applications. In chemistry, our MaxPeak Premier columns have been the most successful launch in our company's history, serving the more complex needs of large molecule separation in our customers' labs. During the quarter, we announced comes from 2 new product launches for bioanalytical characterization, including our first new instrument launch with Viator. We launched a new Bioprocess walk up solution that combines our Andrew plus liquid handling robot, OneLab software and our BioAccord LC MS system into a more automated setup that is even easier to use.

Speaker 3

Together, These new products help engineers capture high quality bioprocess and drug product data directly from upstream bioreactors such as those offered by Sartorius. It achieves this via simple workflows that automate sample prep, LC MS analysis and data capture. This accelerates the upstream development of mAbs and other biologic drugs providing more optimal clone selection that results in more effective titers and yields. 2nd, we launched our 1st new light scattering instrument within the Viad portfolio. DataStar is designed to measure precisely measure and analyze nanoparticles used in downstream biologics and material science applications.

Speaker 3

It combines I would now like to cover our updated 2023 guidance. Growth rates in China have continued to deteriorate as the year has progressed. We expect this to decline further in the Q4 sequentially. We now expect China to decline approximately 25% for the year of approximately 250 basis points versus our previous guidance. As a result, we now expect our revised full year organic constant currency sales growth should be in the range of negative 2% to negative 1%.

Speaker 3

Despite the lower revenue guide, we're continuing To proactively manage our cost structure and drive productivity expansion, resulting in no change to our expected margin percentage performance versus our previous guide. We expect our full year adjusted operating margin to be 30.5%, which is 30 basis points of expansion versus 2022. Our updated full year adjusted EPS guidance is resultantly in the range of $11.65 to $11.75 Now I will pass the call over to Amol to continue covering our Q3 financial results in more detail and give additional commentary on our guidance. Thank you, Uddit, and good morning, everyone.

Speaker 4

In the Q3, sales grew less than 1% as reported. Organic constant currency sales declined 4% against the mid teens growth comparison last year. Waters division and TA both declined 4%. We saw good results again from our Via acquisition, which added 4% constant currency growth and performed in line with our expectations despite the challenging environment. The impact of FX was flat in the quarter, which came in below our expectations of a 1% tailwind to as reported sales.

Speaker 4

In organic constant currency by end market, pharma declined 2%, industrial declined 8% and academic and government declined 3%. In pharma, mid single digit positive growth outside of China high single digits with a tough growth comparison of 22% in the prior year quarter and due to China weakness now spilling over into non pharma segments. We continue to see strong growth in global PFAS testing and battery testing applications. Academic and government declined 3%. Outside of China, overall A and G growth was up 8%.

Speaker 4

This was led by double digit growth in Europe and mid single digit growth in the Americas. In China, A and G declined over 30% By geography, sales in Asia declined 12%, the Americas was flat and Europe grew 3%. In Asia, China broadly declined. Excluding China, Asia grew 3%, which was in line with our expectations. India grew low double digits and Japan grew mid teens.

Speaker 4

In Americas, Pharma grew 6%, We've exceeded our expectations as we executed very well with our large to mid pharma customers. Academic and government also grew 6%. However, strength in these two segments was offset by contraction in Industrial for the quarter. In Europe, Growth exceeded our expectations in Pharma, which grew mid single digits and Academic and Government, which grew 10%, while Industrial declined mid single digits. By Products and Segments, instruments declined 13%.

Speaker 4

Recurring revenues grew mid single digits overall and high single digits outside of China. There was no change in number of days versus the prior year's quarter. Our continued focus on operational excellence with pricing, productivity and proactive cost alignment together with lower incentive compensation continued margin expansion. Gross margin for the quarter was approximately 59.1%, an expansion of 240 basis points comes from the line of John Franzrebren, who is currently in the Q3 of 2022. Adjusted operating margin for the quarter was approximately 31.5%, comes from an expansion of 380 basis points compared to 27.7% in the Q3 of 2022.

Speaker 4

Our effective operating tax rate for the quarter was 14.7% due to discrete items within the quarter. The average share count came in at 59,300,000 shares, which is about 800,000 less than the Q3 of last year. Our non GAAP earnings per fully diluted share were $2.84 an increase of 8% despite flat revenue. On GAAP basis, our earnings per fully diluted share were $2.27 A reconciliation of our GAAP To non GAAP earnings is attached to this morning's press release and in the appendix of our earnings call presentation. Turning now to free cash flow capital deployment on our balance sheet.

Speaker 4

We define free cash flow as cash from operations less capital expenditures and exclude special items. Comes

Speaker 2

from the line of John. In the Q3 of 2023, free

Speaker 4

cash flow was $123,000,000 after funding $38,000,000 of capital expenditures. Free cash flow was impacted by higher inventory balances. We maintain a strong balance sheet, access to liquidity and a well structured debt maturity profile. This strength allows us to prioritize investing in growth, including M and A and returning capital to shareholders. We We continue to evaluate M and A opportunities that will meaningfully accelerate value creation.

Speaker 4

At the end of Q3, our net debt position further declined to 2,200,000,000 and net debt to EBITDA ratio of about 2.2. This represents a decrease of $125,000,000 during the quarter As we daily work the Wyeth acquisition. As previously disclosed, our share buyback program has been temporarily comes from the line of David. We will evaluate resumption of our share repurchase program through the quarter and into the first half of next year. Now I would like to provide our updated thoughts for 2023.

Speaker 4

As Ulit outlined, growth rates in China have continued to deteriorate as the year has progressed. In addition, weakness in China has now broadened is beyond pharma and into industrial and academic and government end markets. We expect China growth rates to sequentially decline further in the 4th quarter comes from the line of John This translates to a full year growth headwind of approximately 250 basis points versus our previous guide. As a result, we are updating our full year 2023 organic constant currency sales growth guidance Consistent with our prior expectations, we expect the Wyeth transaction to add approximately 2.5 percent to our full year 2023 revenue growth. Therefore, our total reported sales growth guidance is now negative 1% to flat.

Speaker 4

As Udi covered despite incremental headwinds from China and FX, Our teams have rallied to drive pricing and productivity gains. We expect this will allow us to deliver A gross margin of approximately 59% for the year, which is in line with our previous guidance and is 100 basis points of expansion versus last year. Together with proactive cost alignment, we expect this will allow us to deliver an adjusted operating margin of approximately 30.5 percent for the year after funding investments in high growth adjacencies, which is also in line with our previous guide And it's 30 basis points of expansion versus last year. We expect our full year net interest expense to be approximately $80,000,000 The full year tax rate is expected to remain at approximately 15.5%. Our average diluted 2023 share count is expected to be approximately 59,200,000 shares.

Speaker 4

Comes from the line of $11.65 to $11.75 which includes a negative currency impact of approximately question comes

Speaker 2

from the line of the call.

Speaker 4

Looking to the Q4 of 2023, We expect further weakness in China and cautious spending from our customers throughout the quarter. Hence, we expect 4th quarter organic constant currency Sales growth in the range of negative 8% to negative 5%. At today's rates, currency translation is expected to subtract comes from the line of sight. Approximately 1.5%, while we expect wired to add approximately 3.5% to our 4th quarter revenue growth. Therefore, our total 4th quarter reported sales growth guidance is negative 6% to negative 3%.

Speaker 4

4th quarter non GAAP earnings per fully diluted share are estimated to be in the range of $3.52 comes from the line of the call to $3.62 which includes a negative impact from currency of approximately 5 percentage points at current FX rates. Now I would like to turn it back to Udit for some summary comments. Udit?

Speaker 3

Thank you, Amol. So to summarize, despite a macro environment that has progressively weakened this year, we have continued to deliver a solid performance through our execution. We're also driving strong outcomes in our margin and earnings performance and are maintaining our full year gross margin and adjusted operating margin guidance despite incremental headwinds from volume and FX. We have strengthened our product portfolio even further through innovation, while continuing to make strong progress with our acquisition of Viatt. Later this month, we look forward to issuing our 2023 ESC report, which is a transparent way As well as the TCFD related environmental disclosures we are initiating in this year's report.

Speaker 3

So with that, I'll turn the call back over to Kasper.

Speaker 1

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

Operator

Our first question comes from Vijay Kumar from Evercore ISI. Please go ahead.

Speaker 5

Hey, guys. Thanks for taking my question. Uvekar, maybe one on just how the quarter progressed here. What were the exit rates and what is the Q4 guidance Implying, right, because I think the sheet is looking at sequential numbers, right, the sequential step up on a dollar basis, Q3 versus question comes from the line of Matthew McElroy from Barclays. I think when you look at the growth rates year on year, I think your instrumentation growth is mid teens.

Speaker 5

So I think it's just the way we look at year on year versus sequential. And I think the streets look trying to make the comparison versus your peers question Some companies have guided sequential on a dollar basis, so maybe just talk about your exit rates in 3rd quarter comes from the line

Speaker 2

of John. And what is Q4 presuming for instrumentation?

Speaker 3

So Vijay, thank you and good morning. Look, I'll give you some summary comments and Amol will talk to you about the ramp from Q3 to Q4, if I understand your question correct. When we look at the exit rates and ramp into from Q3 to Q4, we of course look at the performance As we exit Q3, this includes detailed analytics on funnel velocities across the different customer segments, includes what we've seen over the last 15 years as we go from Q3 to Q4 and look at that statistically. And of course, a lot of conversations with our customers. And we continue to see strength, Relatively speaking versus our peer group in pharma, especially outside of China.

Speaker 3

And I'll let Amol comment a little bit On the sequential ramp up.

Speaker 4

Vijay, good morning. Look Vijay, I mean, on the Q3 to Q4 ramp, if

Speaker 1

you look at our last

Speaker 4

5 years. We've averaged roughly a 24% ramp from Q3 to Q4. And where our guide is, is roughly 13% to 17% ramp from Q3 to Q4. So clearly, it's fairly muted compared to historic levels. Also, if you look at last 15 years.

Speaker 4

They've been just a couple of years in those years, which have come in towards the bottom end of our guide. So that's why we feel generally we've muted the ramp from Q3 to Q4. Also Q3 baseline, which is in this ramp, reflects Sort of the slower approval cycles that have been playing out throughout the year. And there's about one extra day in Q4 this year versus the previous year. And then the last piece is, I mean, it's based on the fact that, yes, there is pain in China at this point.

Speaker 4

But then when we look at pharma in the U. S, in Europe, In Japan, in India, especially mid to large pharma, our teams are doing a great job there and driving decent outcomes.

Speaker 5

That's helpful comments. And one maybe, if Q4 jump off as The minus high singles organic, is China minus 25 for the year? Is that done for this year or is that going to spill over into fiscal 2024? Can waters grow next year? I feel like when I look at the margins here, obviously, leverage will be a question, but I saw that Restructuring cost to tick ups, anything on that?

Speaker 5

Any implications for 2024 either on the comp and operating leverage?

Speaker 3

So, Vijaya, I'll comment on China and just I mean before we get into any details, I mean we will only comment on 2024 When we talk about next year, when we talk about Q4 earnings, right? And that's generally been our policy. As you know, a lot has to evolve comes from now until the end of the year, especially in our business. So we will not comment on 2024. But on China, in particular, look, In the quarter, the business declined about 30 percent in excess of 30%, with pharma declining in line with what we had seen at the beginning of the year, right, with CDMOs sort of flushing out overcapacity and responding to geopolitical tensions.

Speaker 3

We think that's towards the tail end of its being funded also in China. And then the 3rd piece was in pharma, the BANDED Genetics segment, which is roughly 50% of our sales in the pharma segment in China. And this one here, there was an additional pressure that we learned about, which is the anti corruption campaign that the Chinese government issued. So While our customers are used to value responding to value based pricing cuts, this was a new headwind. So that is still in progress.

Speaker 3

So in all pharma, 2 out of 3 vectors are starting to subside. The third one is new over the quarter. And This is something that I learned over the last couple of months when I visited China. When switching over to other segments, look, the Industrial segment, We see great growth in batteries in China, but that was not enough to offset the macro sensitive food and environmental segments, which dropped further in this quarter. And then finally, the academic and government segment, as Amol commented in the prepared remarks, We're seeing the tail end of the benefit from the stimulus from last year.

Speaker 3

And that will sort of come out of the numbers now. Now if you put it all together and put it in perspective, we started the year with about 19%, 20% of waterless sales coming from China. With our current guide, we expect that to be about 12% to 13% of our overall sales. So while We remain super optimistic about what we expect in China in the future, and it has become a much smaller proportion of

Operator

Next, we'll go to the line of Dan Brennan from TD Cowen. Please go ahead.

Speaker 6

Hey, guys. Thanks for the questions here. Maybe just on Pharma. Ex China, obviously, you kind of discussed positive trends in the quarter and kind of what you guys are expecting for the Q4, but We've heard a lot of mixed comments in the quarter. So maybe can you just give us a flavor for maybe a little more details on instrument segmenting mobile trends and kind of what specifically how you're doing You think first the broader trends?

Speaker 6

And again, maybe, Amal, I know you gave some color on Q4, but just how should we be thinking about pharma In the Q4 ex China.

Speaker 3

Dan, thank you for the question. Look, pharma is almost a tale of 2 stories, right? I mean, overall, We saw the quarter decline low single digits and in China as expected roughly 30% or so decline that I just commented on. If we look at ex China, I mean, we've printed, I would say, amongst our peer group, probably the most positive numbers in growth in China, question Significant strength in India and Japan. And this is behind 2 factors.

Speaker 3

1, really our new product portfolio is gaining a lot of traction despite The slow funnel velocities that we see in mid to large pharma and additional approval levels, despite the fact that biotech came under pressure at the beginning of the year, It's starting to become a little bit less pressured as we exit the year. So in pharma, our new product portfolio has done super well, start with LC, the Alliance We have had significant orders. And as I mentioned, despite the macro pressures, customers have placed large orders for Alliance IS and the funnel looks really healthy. MaSpeck has been a real star for the year. And in pharma, we have specifically developed biologics applications.

Speaker 3

And you saw the recent launch of the walk off solution for BioAccord, which should make process development even faster. The MaxPeak Premier Column staying on the theme of biologics, is in its 3rd year and still growing, well into the 20% range. So been the strongest launch for us in columns for many, many years. And we recently introduced another column that is targeted towards AAV and cell and gene therapy. So Really excited about what we've seen in pharma this year despite a difficult environment and feel like we're gaining share.

Speaker 3

And over the long term, pharma is remains a source of strength. We don't expect to grow mid single digits. We expect to grow high single digits and double digits as we look into the future. So I'm super excited about what we see in the pipelines from our customers. I mean, we are very well specked in the GLP-1s and the Alzheimer's compounds.

Speaker 3

So So really optimistic about the future and proud of the team's execution in a, and I would say, a challenging macro environment. Amol?

Speaker 4

Yes. Just to sort of touch on your other question. Look, I mean, Pharma overall declined low single digits for us in Q3. And then for Q4, what is embedded in the guide is sort of a mid single digit decline. Obviously, that includes China.

Speaker 4

When you strip China out for the rest of the markets, the rest of the markets grew a little under mid single digits in Q3. And then in Q4, we are expecting them to still grow, but not at the same level in Q3, little bit less than what they grew in Q3.

Speaker 6

Got it. No, thanks for that. And then just maybe on the instrument recurring revenue, just maybe can you just give us A little bit of an overview of kind of what you're seeing there. Obviously, trying to complicate things, but just wondering the steadiness of that recurring revenue, like Are you seeing any changes there? Just kind of any flavor about how the quarter went and kind of what you're seeing in the outlook for 4Q?

Speaker 6

Thanks.

Speaker 3

Let's start with recurring and then I comment on instruments. So recurring revenue came in mid single digits this quarter around 4%, chemistry low single digits at 1%, question 5%. This is globally. Now if you strip China out, recurring revenues are again high single digits, close to 7% plus With chemistry in the high single digit range, service in the mid single digit range. So really healthy growth outside of China and then China really impacted the chemistry piece just given the less activity that we saw with our branded genetics customers.

Speaker 3

And then if I switch to instruments, Instruments were dropped low teens globally, right? And similar drops across LC, mass spec and TA, so is minus 14%, minus 12%, something like this across the whole portfolio. But again, if you strip out China, which saw significant declines, And here, I want to take it each in turn, right? LC, as we saw in the last quarter, low single digit growth outside of China. This year This quarter, it was flat, right?

Speaker 3

So really hovering around, I would say, flattish growth for the last two quarters, just as we had talked about a few quarters ago when we saw mid teens decline in LC. And customers will have to replace their fleets, and we're starting to see that happen with some large pharma customers. So you see LC is sort of hovering around flattish to low single digit growth. Masspec ex China came in at about 10% decline. Now I will remind you that same time last quarter mass spec grew almost 40%, Almost 40%.

Speaker 3

Super excited about what we've seen with the mass spec portfolio and its adoption. In virtually every account that we go and compete with the Xevo TQ Absolute, we win. If you go with our If you go with our Bio portfolio now, especially with BioAccord, Xevo TQ, Xevo G3 Q TOF, we see Significant seeding and adoption there. So mass spec has gone from strength to strength, and we See that continuing. And TA again also declined high single digits, but again on a comp of about 20%.

Speaker 3

So If you again go back to mass spec, if you look at 2 year, 4 year CAGRs, I mean, we are well into the high teens with mass spec growth. So Quite excited about what we've seen with instruments. And if you just again cast your eye to the longer term trends, instruments grow roughly 5%, have grown over 5% over the long term, and we are seeing as we look as we go forward about 100 basis points of higher pricing. We see increased prescription rates with new molecules coming through and our new product portfolio driving adoption across new segments like PFAS. So excited about what we are seeing with what we are the execution we are seeing with instruments across the board and and what we expect in the future to be better growth than what we've seen also in the past.

Operator

Next, we'll go to the line of Matt Sykes from Goldman Sachs. Please go ahead.

Speaker 7

Hi, good morning. Thanks for taking my questions. Maybe just first on pricing, just given the margin gains you saw this quarter in In your comment about 250 basis points of price, we've heard from peers that sort of pricing is starting to trend back towards normalized levels and probably less of a tailwind. Could you just maybe comment on what your expectations for price are in Q4? And then as we go into 'twenty four, how much of a tailwind Do you believe pricing will continue to be for you?

Speaker 4

Yes. So Matt, good morning and thanks for your question. Look, I mean, ever since we went through the inflationary cycle last year, that gave us opportunity to put good systems and processes around pricing. And if you look at water's history, traditionally, we've done 50 to 75 basis points, and last year was very different. And our teams have continued to execute on that sort of system and process pathway.

Speaker 4

So we started the year with about little over 200 basis points and it's only got stronger as we came into Q3 with little over 250 basis points. And then we expect something similar in Q4, which then for the full year, we will be a little over to 50 basis points. And that's sort of driving a third of our operating margin expansion for the quarter.

Speaker 3

And I think just to conclude on this, Matt, look, pricing is dependent upon, as Amol said, good execution, good systems, good processes, But it's equally dependent on a differentiated portfolio. We've renewed our full portfolio across instruments, and it's got very high receptivity from customers. So customers are responding to good innovation across instruments, but also on the column side where the stick rates are tremendous, right? I I mean with the MaxPeak Premier, with new columns introduced for AAV applications, I mean we are highly differentiated amongst the peer group. So We do expect pricing to stick at reasonably high levels.

Speaker 7

Great. Thank you for that color. And then This is a follow-up. Just zeroing in on China, specifically on the industrial side, you talked about strength in batteries, but Food and I believe environmental weakened in the quarter. Could you maybe talk about the dynamics there?

Speaker 7

I mean, I think, that's relatively new information relative to what we've been hearing and just Wanted to understand the dynamics within the industrial demand inside China and what your sort of expectations are for duration of that weakness?

Speaker 3

Good one, Matt. Look, I mean, Industrial came in below our expectations for the quarter In China and that drove the weakness across the globe. And you're right to divide it into 2 parts. I mean there are the resilient segments like PFAS testing as well as batteries, especially in China, where we're seeing very good uptake. The challenge is the more macro dependent segments like Materials like food, which are also funded by the government, were impacted by the slowdown of the economy.

Speaker 3

And as you look ahead, I would simply model those in proportion to the economic recovery that we would expect in China and that's how we're looking at it. Now Outside of China, of course, I mean, you didn't ask this, but outside of China, again, we saw a bit of a slowdown against very, very strong comps, Right. On a long term basis outside of China, we're seeing mid to high single digit growth in industrial. I mean, you should expect a mid single digit growth For the long term in the industry, but in China for sure, there was additional weakness largely related to the macro sensitive segments like materials and food and the like.

Operator

Next, we'll go to the line of Derik De Bruin from Bank of America. Please go ahead.

Speaker 8

Hi, good morning. Thank you for taking my questions. So, first one is Looking at the Q3 to Q4 step down in operating expenses, how much of that was incentive comp that can come back? How much of that is going to be sustained As we look into 2024, can you just sort of give us some thoughts on just how we should think about the operating expenses as we move in

Speaker 4

Yes. So, Derek, thanks for your question. And I mean, as we had discussed in our last earnings call, right, We had to make some tough but necessary decisions to reduce our workforce by about 5%. And we did that at the beginning of Q3, and that resulted in approximately $10,000,000 of savings in Q3 that is We expect for 2023, roughly $20,000,000 so another $10,000,000 in And the annualized impact, which will play out next year, would be about $40,000,000 Again, we may invest some of it to fund some of the high growth adjacencies, but before that annualized, it's $40,000,000 And we incurred about $27,000,000 Now keep in mind, in Q3, the way it sort of played out is we had lower volume on our organic business. So we lost some volume leverage.

Speaker 4

And so essentially, the reduction in AIP plus the accretion for wire More or less offset the lack of volume leverage from the underlying business and then the three factors, which are pricing, These cost actions that I just talked about and then the underlying productivity initiatives playing out on freight and procurement And the capability center, they each contributed roughly a third of the 3 80 basis points.

Speaker 3

And Derek, just to conclude sort of Rather qualitatively, I mean this is in the DNA of Waters, right? I mean we are one of the highest margin companies in the peer group. And back when I joined 3 years ago, people said you can't expand your margins, you're maxed out. I mean quarter on quarter, we continue to focus on, as Amol mentioned, question margin expansion despite the fact that volume went against what we had assumed and FX was also a headwind, right? So I mean, I'm extremely, extremely grateful to all my colleagues for putting the heads down and being super responsible with costs When the volume didn't come and we had to respond rather rapidly, right?

Speaker 3

So I wanted to make that point.

Speaker 8

Thanks for the clarity. Just wanted to follow-up. I appreciate that Waters has a lot of new products and those are probably giving you a little bit more incremental growth. But Udi, I mean, I'm just a little bit surprised of your guidance outside of China. These are not normal market conditions.

Speaker 8

Question comes from the line of John. And I know you're putting in some conservatism, but I haven't seen markets like this before and these swings that we're seeing. So I just was wondering why you guided as aggressively as you did for the Q4, and your confidence because it just feels like you've got a little bit of a budget flush question comes in there outside of China. And just a little bit more clarity on that. Thank you.

Speaker 3

I think, Derek, this is what Amol started with. Like, first is the baseline from and all the input that goes into Q4, right? So we look at how the funnel velocities are. I mean, if I just stay with pharma for a minute, The quality of the orders is very high, right? Customers who place orders are actually buying.

Speaker 3

They just bought over Yes. They've just the order to sales conversion is just a bit longer than it's been in the past, right? The new products and the new products have a lot to do with it. Customers are

Speaker 2

comes from the line of the line of the line of the line of the line of the line of the

Speaker 3

line of the line of the line of the line of the line of the line of the line of the line of

Speaker 2

the line of the line of the line of the line of the line of the line of the line of the

Speaker 3

line of the line of the line of Ramp rates. And when you look at historical ramp rates, the lower end of our guide, which is 13% ramp from Q3 to Q4, is one of the lowest in the last 15 years, Right. And I appreciate, I mean, both of us have been in this industry for a long time and these are unprecedented times. But this is sort of the lowest 1 of the lowest ramps that we've seen in many, many years. And then the third is customer conversations, Right.

Speaker 3

So we're talking to customers. I'm spending a lot of time with them. And it's clear that we are seeing, I would say, Asynchronous good execution in pharma. That gives us the confidence to sort of say, okay, Q4 is going to be like we have projected. And we have that's why we have and largely because of the uncertainty, we have ranged Q4 guide wider than we have in the past, right?

Speaker 3

So I appreciate your question and I appreciate the historical context. We took a lot of the facts into account in guiding wider than we have in the past. And as I said, look, new products, great execution With the hand that we have, I think we're doing extremely, extremely well, especially outside the U. S. Amol, anything else to add on the guide?

Speaker 3

Question. Thank you, Derek.

Operator

Next, we'll go to Rachel Vatinstell from JPMorgan. Please go ahead. Hi, good morning and thanks for taking the questions. First, I

Speaker 9

just wanted to follow-up on that answer to Derek's question around some of the order rates. You mentioned that Quality of orders have been high, but it's just that conversion to sales is taking a little bit longer. Can you give us any stats from order rates, book to bills, whether that's question comes from the line of Pharma, ex Pharma and then looking at total world versus ex China as well and kind of how that's trending into 4Q?

Speaker 4

Yes. I mean, look, if you sort of see how the year has played out, we did see funnel velocity slowdown across All the trade classes, especially pharma in Q1. And then as we've gone through Q2 and Q3, The funnel velocity has sort of stayed where it is at a higher level. So it's taking more time for people to approve these orders. And we expect that to continue through Q4.

Speaker 4

What we haven't seen in Pharma, which is good, is we haven't seen projects getting canceled. And so opportunities are landing, they're just taking more time to land. And in terms of sort of sales versus orders, I mean, We are going hand in hand. It's not that we are meaningfully drawing down backlog in any quarter or so. The one place where The trajectory has changed somewhat is in the industrial trade class.

Speaker 4

And this is all outside of China I'm talking about. And there, while the funnel velocity has progressively slowed in Q1 and Q2, we haven't seen Any opportunities getting canceled. And what we are seeing in Q3 is and again, don't confuse this with orders, no customers are canceling orders. But when the opportunity is in the CRM system from lead gen to conversion, we are seeing elevated levels of Projects getting canceled for lack of funding or funding not available in the current year, particularly in testing labs. And that we saw sort of emerge in Q3.

Speaker 4

And then China, I mean, we've sort of covered that And then sort of progressively went into Tier 2, Tier 3 CDMOs and biotechs with investor funding and then played out in branded generics With VBP and anti corruption drives, which haven't bottomed yet and then has spilled over into the industrial

Speaker 3

And then Rachel, just one last comment On Q3 and the ramp to Q4, I mean the trends we're seeing in Q3, what gives us confidence especially in pharma comments in pharma. Then the peer group, why are we seeing LCs sort of flatten out? It's the same reasoning and we're seeing the same customer feedback. So I think it's reasonable to project that into Q4.

Operator

Next, we'll go to Eve Bernstein from Bernstein Research. Please go ahead.

Speaker 10

Hi there. Good morning. Thanks for taking the question. Two questions. One, both high Growth adjacency related.

Speaker 10

So for Wyatt, it seems not to have felt as much pressure as your core instruments. And it makes sense that there wouldn't have been as much COVID pull forward there as in LC, for example. But Are you still seeing lengthening sales cycles and some of those same signs of demand weakness Funding investments affecting your adjusted operating margin. Can you talk about how the pressures in the industry and pressures on your top line have

Speaker 3

Thanks for the question, Ziv. I'll start with the Viad question. Look, I mean, we're very pleased with the way the integration is going. I mean, that should be The general takeaway, and you can see that in the facts, right, basically a 4% contribution this quarter and 2.5% for the year. So we are going to deliver we think we're going to deliver that.

Speaker 3

And when you look at the drivers, the integration is going faster than We had initially even imagined, right, there are exactly the same headwinds. The funnel velocities are longer. It is taking more time for customers to place orders. But number 1, given the larger commercial field force that Waters had, We were able to use that to generate a lot more leads for our light scattering instruments that from Wyatt, which are highly differentiated in the market. So as we got more leads, We got more conversions and the funnel is moving nicely through.

Speaker 3

2nd, we've spent a lot of time in making it easier for customers to connect Waters' LCs to multi angle light scattering instruments from Wyatt, and that's well ahead of target. And third, We had talked earlier, when we talked about the synergy contributions, we talked about columns for what is So integration going very well, but the largest driver, I would say, of short term results and overcoming the obvious headwinds is the larger number of leads that our Waters account managers have provided the Viator specialists. And as you look ahead, I mean, really optimistic about what we are seeing with the collaboration across the 2 organizations. Our Viad colleagues were present at the Innovation Summit recently, which basically invites over 300 or so R and D scientists Extremely pleased with where things are going. And we recently launched the Zeta Star, which combines 3 light scattering technologies into 1.

Speaker 3

So why it's going extremely well? And thank you for comes from the line of the line of John. Now on the high growth adjacencies, the 30.5% operating margin that we are Committing to for the full year includes the 70 to 80 basis points that we had said that we would invest. We had started to invest that early in the year. We are seeing very nice outcomes of that, especially in our clinical business where the team has developed many, many assays, simplified workflows for customers who want to use LC MS in specialty diagnostics areas like for Alzheimer testing like for testing antibodies for Alzheimer's As just a case in point.

Speaker 3

So the high growth adjacencies are delivering. Now we will look at the net

Operator

question comes from the line of Catherine Schulte from Baird. Please go ahead.

Speaker 11

Hey, guys. Thanks for the questions. Maybe first just to touch on some of your commercial initiatives here. Any comments on service attachment rates and e commerce trends and how those are tracking relative to your expectations?

Speaker 3

Yes. So service attachment rates, so Catherine, thank you for the question. Service attachment rates are well ahead of target. You'll remember that we committed to 100 basis points question comes from the line of Chris. Please go ahead.

Speaker 3

We're well ahead of that. So we'll likely exit the year with 200 basis points of increase in service attachment rates and you would see that in The growth that is being seen especially outside of China for service, which is basically high single digit growth For year to date and the balance of the year. So service is going quite well. On e commerce as well, we've gone From about 20%, 25% of products going through e commerce to well in excess of 30%, closer to 35% now. The team is highly focused on that.

Speaker 3

I mean, as you can imagine, given the slowdown in the overall market, our chemistry portfolio has still done pretty well, And the chemistry portfolio is benefiting from additional products going through e commerce. So chemistry is currently growing high single digits

Speaker 11

the Q3. I think to get to your 30.5% for the full year that implies somewhere between 33% and 34% in the 4th quarter. Question I know 4th quarter margins are often seasonally high, but should we think of the 31.5% that we saw in the Q3 as a jumping off question is answered.

Speaker 1

Yes. I mean, look,

Speaker 4

if you look at how we've performed in Adversity like last year, there was tremendous inflationary pressure and dollar kept becoming stronger and stronger, right? And despite all of that, our teams rallied to find pricing gains and productivity gains and sort of land the margin And then also further strengthening of U. S. Dollar. And despite that, we found ways to defend margin through pricing, through productivity, So we really feel good about how our teams have responded in these situations.

Speaker 4

Now as we look at 2024, I mean, as Udi outlined, right, it's a little early because we want to see how the next 2 months play out. They are a big part of our year. We are also just rolling up our bottoms up AOP, and we want to sort of review that before we sort of Talk about 2024. So like we always do at our Q4 earnings call, we will provide more details and guidance for 2024.

Operator

Thank you. And that is all the time we have for questions.

Speaker 1

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

Operator

Thank you all for joining. That concludes the Waters Corporation Third Quarter 2023 Financial Results Conference Call. You may disconnect at this time and have a great rest of your day.

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Waters Q3 2023
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