WAT - Waters Corporation (WAT) Presents at 42nd Annual J.P. Morgan Healthcare Conference (Transcript)

2024-01-09 12:21:05 ET

Waters Corporation (WAT)

42nd Annual J.P. Morgan Healthcare Conference

January 8, 2023 7:30 PM ET

Company Participants

Udit Batra - President, CEO & Director

Conference Call Participants

Rachel Vatnsdal - JPMorgan

Presentation

Rachel Vatnsdal

Good afternoon, everyone. This is Rachel Vatnsdal with the Life Science Tools and Diagnostics team at JPMorgan. We are here joined by Udit Batra, CEO of Waters. So this session will be as standard as you've seen earlier today, 20 minutes of presentation followed by 20 minutes of Q&A. [Operator Instructions]

And with that, Udit, I will let you take over. Thank you.

Udit Batra

Thank you, Rachel. Good afternoon, everyone. Thank you for taking the time for one of these last slots in the afternoon. Appreciate your interest. 2023 started with us having a lot of positivity in our business and in the markets. And little did we know, in Q1, biotech came to a screeching halt. The macroeconomic conditions made our customers slow down their purchasing cycles. And of course, in China, we saw an unprecedented economic slowdown. And despite all of this, for the first 9 months of the year, we've delivered really, really solid results. And for that, I'm really thankful to my team.

We're focused on delivering new products. The operational execution has been very, very good. And of course, we welcomed Wyatt Technology into our family, and that acquisition is going extremely well. But nothing works if you don't create an environment that is inclusive and embrace the differences that you have in your teams, and I'm incredibly proud of what we've done at Waters in the last few years.

And finally, our Board has been super supportive of the transformation. And I'm really thankful to our Board of Directors, which actually has been quite -- has been replenished over the last 3 years as well. So again, thank you for your interest.

I have 3 simple messages today, and I'll give you substantiation for each of these. Waters has a strong business model that operates in attractive markets. Over the last 3 years, we've transformed our business, and that has delivered strong results in a challenging environment, and I'll show you some proof of that. And finally, I'm incredibly excited about what we expect to see in the future. We have set our business up extremely well, entering into faster-growing adjacencies. So let's take each of these in turn.

We serve regulated markets that have large unmet needs. If you traverse your eye to the bottom of the slide, you see that our market size is roughly $12 billion, growing mid-single digits. And the largest -- and if you go to the middle of the chart, you see the largest market here is pharma, growing high single digits, really driven by the need for high-quality medicines where close to 50% of the late-stage pipeline of pharmaceutical companies these days is biologics and novel modalities, driving that growth even further.

Second, in the clinical space, again, we expect high single-digit growth. And our focus is on early disease detection to find biomarkers and move them into high-volume testing. If you traverse to the middle of the slide, food and environmental, this is a mid-single-digit grower, roughly proportional to the GDP growth globally. And that has lately been driven by the need for more and more sensitive testing, sensitive testing for PFAS and other impurities in food and the environment.

And finally, towards the right-hand side of the chart, you see the materials segment, again, growing mid-single digits. Classically, this segment has been polymers and material testing, but more recently, it's been driven by the need for safe and renewable energy, largely due to batteries and electric vehicles. So we serve these large attractive markets that have secular tailwinds.

We do this with a simple and repeatable business model. Let me walk you through this chart. We start by getting a deep understanding of our customers' unmet needs. And then we take highly complex instruments that usually start in discovery and turn them into a simple, yet sophisticated systems that are reliably used in high-volume applications to result in simple, compliant and efficient results. And this business model on the right-hand side, you see the flywheel has 4 parts.

First is instruments, where roughly 150,000 or so of these instruments planted globally. And these instruments then, the data that is generated is submitted to regulators using compliance software. And the prime example of this is our Empower software, which is the #1 chromatography data system in the world, roughly 80% of the drugs filed to the FDA. The Chinese NMPA, the EMA have used Empower in the past few years. In fact, in the genetics segment, virtually all molecules use Empower to submit data to regulators.

The third part of this flywheel is really exciting. We are the only vendor that manufactures their own columns. And this allows us to work with our customers upstream when they're developing and discovering new molecules and new chemical species to develop exquisite separations. And this makes us a leader in the chemistry space.

And finally, this whole flywheel works only through the work of our service engineers, and these are folks that are not just servicing instruments, but they are helping our customers do their experiments. So really a simple business model that is repeatable and works in the later stages of development.

This simple business model is mostly focused on manufacturing in late stages of development. Roughly 50% of our revenues in the pharma space come from QA/QC, right? So this allows us to have a recurring revenue that is fairly significant, even our instruments are replaced every 7 to 10 years. The business model is so simple that the SG&A load is low, and that allows for an industry-leading profitability that you see on the right-hand side of this chart.

Let me just take my jacket off. I think it's a bit warm here. Sorry about that. So if you traverse your eye to the right-hand side of this chart, what you see is roughly $3 billion in total revenues. And as you go further down in the chart, you see roughly 60% gross margin, over 30% in operating margin, which is industry leading, and every $0.25 of $1 converts into cash. It's an incredible business. Our overall portfolio is focused on pharma, which is 60% of our revenues, 30% is in the industrial space, roughly half of it being food and environmental, the other half being materials, and then 10% to 12% in academic and government.

As you move to the middle of the chart, you'll see our geographic footprint. Now 37% of this is in Americas. This is also including now Wyatt, less -- slightly less than 30% in Europe and about 35-ish percent, 35-ish percent in APAC. And out of that 35%, 13% to 14% is China.

Move to the right-hand side of this chart, about 47%, 48% is instruments, and over 50% is recurring revenue, roughly 20-ish percent of that is chemistry and the balance is service. So high pharma exposure with a broad geographic and diverse footprint. So in a nutshell, a strong business model that has a repeatable -- it's a repeatable business with high margins and operating in highly attractive markets.

Over the last 3 years, we have transformed our business, and I want to take you through what we've been up to. So we said about 3 years ago, when I was standing here, we introduced our transformation, and it had 3 parts. We said we're going to strengthen our execution to deliver strong operating results, and we were able to do this even during this year when the environment got extremely challenging.

Second, we said we're going to revitalize our innovation. We've introduced new products that are meeting significant unmet needs for our customers. The whole portfolio is renewed, and I'll substantiate that in a minute. And we wanted to enter faster-growing segments to take our simple, repeatable business model into segments that look similar but grew faster. So let me give you proof of each of these.

So let's start with revenues. Traverse your eye to the bottom of this chart. Basically, this is year-to-date revenues. And all revenue data that I'll be presenting is year-to-date Q3 constant currency growth rates. So bottom right of this chart, you see the total growth of the company for the first 9 months of the year, roughly flat. Now this is incredible. This is incredible because it includes China.

China declined for the first 9 months of the year mid-teens. We were expecting it to grow high single digits. And despite that, we were able to manage -- we managed to keep our revenues flat. And this is largely due to the left-hand side of the chart, where we exclude China from the results. And what you see in the bottom row is that we grew mid-single digits. Where we have differentiated ourselves from the market is not just in the outside of pharma growth but in pharma.

In pharma, outside of China, we've grown roughly 4% year-to-date in the U.S., in Europe and in rest of APAC outside of China. And this is a differentiated performance in our industry. And this is largely, again, due to the fact that we're focused remember, on the -- in manufacturing, in QA/QC, where the revenues are repeatable. And even during a slowdown in the market, people don't stop purchasing and using pills, right? And you can see this more so if you look at the recurring revenues, which are growing 7%, even during a slowdown in growth.

So overall, strong execution, especially from a revenue perspective in a market that was quite challenging. Three years ago, I introduced to you these 5 commercial initiatives to transform our business. And every year, I've been providing you updates. Let me do the same this year.

Number one, we said we're going to replace instruments that had not been replaced from 2018 to '20. There's still 25% of those left, right? So we're not done yet.

Second, we said we're going to increase our service attachment rates by 1,000 basis points. We're more than halfway done. We're at 550 basis points. Another 450 basis points to go.

Third, we said we're going to increase the adoption of our chemistry portfolio through e-commerce. This number used to be between 15% and 20% roughly 3 years ago, now that is in excess of 35%. We expect to reach about 55%. So still more room to go.

Number four, we said we're going to increase our footprint with faster-growing contract research and contract manufacturing customers. This number was close to 15% about 3 years ago, now it's in excess of 25%. In this particular segment, we don't expect the same level of dynamism, just the market has slowed down and there's overcapacity in contract manufacturing. But we've done extremely well in the last 3 years to gain traction in the area.

And number five, we said we're going to focus on innovation. Over the last 3 years, our innovation intensity has increased quite dramatically, and our product vitality index has increased by 500 basis points versus 2019. So you will agree with me from a revenue standpoint, even in a slowdown in the market, we've been doing quite well and continuing to execute our initiatives that we introduced about 3 years ago.

Let's shift to margins. I think the best reflection of good operational execution is cost management when things slow down. That's something that's within your control. And during 2023, we saw volume headwinds. We saw FX turn against us versus our assumptions. Inflationary pressures continued. We got strong -- we've introduced stronger pricing with better operational execution.

We redoubled our productivity efforts, including the opening of our Global Capability Center in Bangalore, where I was just a few weeks ago. And we took proactive cost actions well before we could see the -- we could see substantial slowdown. And this has resulted for the first 9 months of the year in 160 basis points of expansion in already one of the higher gross margins in the industry and a 60 basis points expansion in operating margin. So from an operational standpoint, revenue as well as cost, Waters has been doing quite well.

Second, we said we're going to revitalize our innovation. We decided to focus on areas where the need was significant. And Waters innovation has historically set new standards, and this year is no exception. Starting from the left-hand side of this chart is liquid chromatography.

The Alliance iS, which we introduced 1.5 years ago, is considered the most significant advancement in high-volume testing using liquid chromatography by many of our customers. It reduces errors by over 50% by reminding customers of any errors or stopping customers from making any errors before they start their experiments, including placing the wrong vial into their cassette, including using the wrong column or the wrong solvent. So this reduces errors by about 40%. And even in a slowing CapEx environment, some of our large customers have placed substantial orders this year for QA/QC.

Second, in mass spec, the Xevo TQ Absolute sets a new standard in the sensitivity of measurement of anionic compounds and PFAS is an example in that area.

Number three, in the TA segment, our team introduced the TAM IV battery cycler microcalorimeter, a mouthful. It basically is an instrument that detects the earliest signatures -- the earliest heat signatures of parasitic reactions that usually lead to explosions and fires in batteries, right? Something that is needed as electric vehicles use more and more batteries.

And number five is our precision chemistry segment. There are too many products here to name. Suffice it to say, 75% to 80% of our R&D today is spent on biologics and novel modalities to help our customers separate these very complex species. Our MaxPeak Premier Column is in its third year after launch, and it's still growing well into the 20%. So really game-changing innovation that is setting new standards. That was the second pillar in our transformation.

Number three, was to take our simple business model, in the flywheel that I showed you earlier, taking it from our core business into faster-growing adjacencies. And I highlighted 5 to you 3 years ago: bioseparations, bioanalytical characterization, early disease detection with LCMS in diagnostics, battery testing and sustainable polymers. All told, these added roughly $7 billion to our $12 billion TAM and they grow high single digits to double digits.

Let me show you some proof points on what's been going on in the last 3 years. From a biologics perspective, 3 years ago, less than 20% of Waters' revenue in pharma came from large molecules. Today, that number is in excess of 35%. Second, as we increased our focus on the clinical segment, we went from a low single-digit growth from 2017 to '19 to a double-digit growth from 2021 to '23, right? So more focus, more innovation spend and deeper collaboration with customers has led to a faster growth.

And finally, in the battery segment, we have managed to create some critical mass in that segment that is allowing us to grow tenfold versus what we used to 3 years ago. Granted that's a small segment, we are in early days. Our characterization is just getting embedded. But in all of these adjacencies, we've seen substantial progress in the last 3 years.

In addition, we added more impetus to the growth in these adjacencies by allocating M&A capital in this direction. And the prime example is the largest acquisition in the history of Waters, which is the acquisition of Wyatt Technology, which is a light scattering company.

I'm incredibly happy with where we are with our integration over the last 2 quarters. We have delivered against the commitments we had despite the fact that the CapEx environment in many of these customers had gotten more stringent. So this is a product that the customers like. These are a set of products that the customers like, and they meet a significant unmet need. We wouldn't have been able to meet these targets had it not been for us being highly focused on delivering the synergies. And the first piece was taking the broader commercial field force at Waters and our broader pharma access and taking those leads and bringing them to our Wyatt specialists. That was the first pillar in our synergies.

The second, we said we want to increase attachment rates of Waters' LCs with Wyatt's multi-angle light scattering equipment. We're well ahead of our target there, too. We created a data bridge, a software bridge where you can use Waters' instruments to control Wyatt instruments and Wyatt instruments to control Waters' instruments, allowing our customers to transfer data much more easily and control instruments much more easily.

And the third piece was, this is the #1 request from our customers. The third piece was to take multi-angle light scattering into QA/QC. Our customers said, "Well, it's a fantastic instrument. I want to use it in QA/QC to release products, but can you please move the data into Empower?" Remember, Empower is a software that is used to submit data to regulators for small molecules and large molecules, 80% or so. So this is the #1 request we got from customers. And again, we are well ahead of our software development there. Later this year, we are planning to introduce the first beta version of Empower that integrates data from light scattering. So this is a substantial step forward.

So overall, in attractive markets, a strong repeatable business model that allows us to have industry-leading margins, a transformation that is built on that simple business model that has brought the momentum back to the business, is allowing us to introduce new products, we've allocated capital towards M&A. So we feel extremely good about how well we are positioned for future growth.

And let me share some facts here. Our overall growth is very well aligned with secular tailwinds, and this is stronger than ever. So on the left-hand side of this chart, you see 6% average growth for Waters. Over the last 15 years or so, Waters has grown on average 6% in constant currency, right?

The top part of this chart on the left-hand side is instruments. And you see these bars fluctuating a lot. While the standard deviation is substantial, the average growth of instruments over the last 15 years has been 5%. Give me a business that is growing 5% with about 60% gross margin, very low SG&A, I'll take it any day. So instruments, replacement business for Waters is a very good business in its own right.

But if you turn your eye to the bottom of this chart, you see the recurring revenues, which are growing 7%. And there, the standard deviation is much less, right? So the average of the two being about 6-ish percent, really nice business, growing 6%, 30% margin, $0.25 of $1 going into cash, really good business to own.

It gets even better as you look ahead for 3 reasons. Number one, we believe there will be even faster volume growth for the segments that we serve, largely because over the next 10 years, IQVIA believes that prescription growth will be higher than it has been in the last 10 years. That's the number one driver for our business.

Second, you see there is an increased need for high-volume testing for more sensitive -- high-volume -- more sensitive, high-volume testing for compounds like PFAS. Second, newer applications, especially in biologics, require a much deeper and broader characterization of molecules. These are complex molecules, and they are currently in development in upstream processing, downstream processing. And when they move into QA/QC, we expect another vector for volume growth. And we are developing instruments for those needs.

And finally, we expect 100 basis points increase versus historical pricing, which was roughly 50 to 100 basis points. 100 basis points incremental versus historical pricing due to new products and better operational execution. So you can see the 6-ish percent average growth has 3 vectors that make us very confident that this growth could be even higher.

Let me substantiate some of these for you. For volume, we expect greater volume growth from new therapies and from PFAS testing as an example. In therapeutics, 55 new drugs were introduced by the FDA in 2023 -- were approved by the FDA in 2023. And this is the second largest in the history of approvals and the highest number of biologics ever in its history.

There are several new therapeutic areas that have come to the fore and GLP-1s are, of course, the one that we all talk about a lot. We are very well spec-ed in with our columns, with our HPLC instruments, with our in-process testing for -- with the 2 largest manufacturers of GLP-1s. And this should add at least 30 basis points incremental growth to our historical averages.

Second, on PFAS testing, the EPA now requires 100,000-fold increased sensitivity for PFAS testing in U.S. drinking water. And with the Xevo TQ Absolute that Waters has, we have the most sensitive instrument in the industry. So as standards drive or standards get even more exacting, we are in the front of -- we're in the front of the line. And PFAS testing should add roughly 30 basis points of incremental growth to our 6% that I showed you before.

So that's -- those are the first 2 vectors in volume. Second, I mentioned to you that biologics require more and more -- require a larger number of instruments and more and more complex testing to fully, fully characterize them.

On the left-hand side of this chart, you see HPLC and columns. Anytime you're trying to characterize something you need to first isolate it. And the best way to isolate the molecule and separate it is HPLC and columns at Waters manufacturers. Once you've done that, you have several detectors that are required to characterize the molecule starting with UV, then going into mass spec and then finally, multi-angle light scattering, which you just added to our armamentarium. All of these together give you a footprint of the biologic and novel modality that you're trying to characterize.

And if you -- at this point in time, these are used for characterization in early development, sometimes in late-stage development, but not yet in QA/QC. So there'll be an upstream characterization, downstream characterization of biologics but not yet in QA/QC. And over time, we expect this to move into QA/QC. And that was one of the big reasons why we acquired Wyatt Technology. Wyatt is adding 40 basis points of incremental growth to our long-term averages.

So I've given you some -- I think in the past, we've talked qualitatively about these trends, and I've given you some facts to substantiate what we've been up to in terms of incremental growth from all of these initiatives. So M&A is an additional vector for us, and we feel that we're uniquely positioned to continue to add to our portfolio. I've already talked about our free cash flow generation. We're focused on clear value creation really with, of course, sound industrial logic and a highly disciplined financial organization.

And finally, in the current environment, given our current portfolio and its narrow scope, we feel we have an advantaged position in the current regulatory environment. So we feel we're very well positioned to execute on M&A.

Now if I put it all together from an EPS perspective, for those of you who followed Waters for a long period of time, would know of our 6-2-2 algorithm, 6% from sales growth, 2% from margin expansion and 2% from capital deployment that has historically been share buybacks.

Now on each of those areas, we expect tailwinds. I've already taken you through the revenue side, increased volume from prescription, from PFAS, large molecule characterization, incremental pricing at about 100 basis points and entry into faster-growing adjacencies.

From a pricing -- from a productivity perspective, from a margin perspective, even in a difficult environment, we were able to expand our margins. So as the environment improves, we expect productivity, pricing and mix to add more significantly in the future.

And lastly, we've added M&A to our capital allocation armamentarium to improve our EPS growth in the future. So overall, very well positioned. I'm pretty excited about how we've set up the base. And as the environment improves, Waters is ready to execute even better.

Nothing works if you take more from the environment than you give back. So that's the ethos for our ESG strategy is leaving the world better than we found it. And I've just taken 3 examples from a lot of work that we do as a company.

Over 75% of our electricity comes from renewable low-carbon sources in 2022 and 2023. And this is over a 30% increase versus 2 years before. We again scored 100 out of 100 in the Corporate Equality Index from the Human Rights Campaign Foundation again in 2023 and '24. And then finally, from a governance standpoint, our Board was selected as the 2024 Public Company Board of the Year by National Academy of Corporate Directors in New England. This is a very prestigious award, and we're very excited to receive it. And there's a whole set of awards at the bottom of the chart that I won't read. But suffice it to say, this is in the ethos of the company to leave the world better than we found it.

So as I close, I hope I've given you enough evidence to suggest that Waters has a strong business model that operates in attractive markets. It's a repeatable business model that allows us to command industry-leading margins. We've orchestrated a transformation that sets us up very well for future growth.

And at this point, I want to thank you for your attention, and happy to answer any questions.

Question-and-Answer Session

A - Rachel Vatnsdal

Perfect. Thank you, Udit. So first up, I just want to kick it off by talking about your ex China growth for the year. So you've grown mid-single digits year-to-date. Can you spend a minute just talking about what's specifically driving that performance? You've talked about some of this commercial execution, the new product launches. So how would you parse out contribution from both of those areas?

Udit Batra

So thank you, Rachel, and thank you for having us. And as I showed in the presentation, for the first 9 months of the year, I mean, the revenues were flat. This is despite the fact that, as you mentioned, China really went down quite dramatically, mid-teens.

Ex China, the growth was as expected, to some extent, right? Pharma grew roughly 4% for the first 9 months of the year. And this is largely behind -- and then the ex China growth is largely behind. As I mentioned, strong, strong operational execution, introduction of new products, but also equally the fact that we are focused on manufacturing and QA/QC.

Even during a slowdown, people don't stop purchasing pills, right? Our customers don't stop servicing that part of their business. And you can see this especially in our recurring revenue. where we grew 7-ish percent even with the slowdown, and this reflects the activity that we're seeing in the later part of development and QA/QC.

Rachel Vatnsdal

Helpful. And then just given how many markets Waters plays in. I was wondering if you could spend a minute talking about the health of those underlying markets. How much of the weakness that we've seen this year is really driven by more cyclical pullback, like we've seen in prior cycles versus something more structurally and could something be structurally lost?

Udit Batra

Yes. Look, I mean, it's a good question. It's a very difficult one to parse out when things are volatile and the visibility is not that high. But let's start with the overall global business, and then let's take China first, and then we'll do ex China after.

In China, we saw the business go down quite dramatically, roughly 15%, 16% year-to-date. And within pharma, what we saw is biotech went down about 80%, right? And CDMOs also at the beginning of the year, that spending went down, and it has started to bottom out.

And the third thing we saw is on the branded generic side, we -- due to the anticorruption campaign in China, that part of the business went down quite dramatically as well. But as you look ahead within pharma, we think biotech has bottomed out. We think from a CDMO perspective, activity has returned while CapEx will take a little bit longer to come back.

And in the branded generics segment, while in the large cities, the anticorruption campaign has gone through, it's not yet made its way through the rest of the country, right? So with China, we think within pharma, it's almost bottomed out, a little bit to go in branded generics. That's our best guess.

Outside of pharma in China, the industrial segment will -- basically, it slowed down a little bit in the latter part of the year, especially in Q3. And that's largely going to come back when the economy recovers. And the academic and government segment is dependent upon stimuli. We had a stimulus last year. We don't have any line of sight on when the next stimulus is coming.

So now outside of China, things have gone largely as expected, right? Pharma, basically, for us, especially pharma is more levered towards late stage, and that's gone as expected. We've been able to execute pretty well. And when you talk about cyclical parts of the business, I mean, our business is roughly 60% pharma. And when you talk about cycles, it's really customers delaying purchases of LC instruments. I think that's the question behind the question. And that delay, I mean, as we had said, has been roughly 2 quarters, right?

So after a very substantial increase when we came out of -- came through our transformation, LC went down double digits. And then for the last 2 quarters, it's been roughly flat and outside of China, actually low single digits. So as the economy recovers and as the CapEx cycles come back, we expect LC to come back quite substantially. And you can substantiate that even further if you look at our 4-year CAGR. For liquid chomatography, that number is now low single digits. That's below historical averages, right? So we expect that to come back.

But as for mass spec, it's the opposite. It's well above historical averages, right? Historical averages for mass spec of 5% to 6%. And right now, we're traversing high single digits to low double digits. So from a cycle perspective, instrument cycle perspective, LC, we believe, is almost ready to come back as the CapEx [relieves].

But overall, to put it all together, China slowed down, not a lot of visibility on exactly when we see the inflection outside of China. Things have gone as expected, not -- at least given our portfolio and given our focus on the late stages of the customers.

Rachel Vatnsdal

Got it. That's really helpful. Then just given your portfolio, I was wondering if you could kind of walk us through why does Waters typically see such a much larger step-up sequentially from 3Q to 4Q relative to peers? You've touched on some of it being related to your portfolio being more focused on downstream. And then yes, really, how should we think about that step-up right now?

Udit Batra

Yes. So it's -- I mean, I won't give you any intra-quarter comments. But in terms of historical averages, given the fact that we are focused more on pharma and given the fact that we're more focused on QA/QC, those type of customers, usually when they have CapEx and place an order, that order consummates. We've had no cancellations of orders outside of China, while the funnel velocities have been slower, right?

Customers have taken a bit longer to decide, there's been 0 cancellations, right? And in the QA/QC segment, customers once they get CapEx, they usually have a chance to spend it and they take a bit longer. And you see this in the quarter and you see this in the year. Purchases in the last 2 weeks of the quarter are higher. Purchases in the last quarter of the year are higher. So this is the vagary of the customers that we serve pharma and QA/QC.

In academic and government, it's a use it and lose it sort of philosophy, use it or lose it sort of philosophy. You have CapEx, you don't spend it, it's gone. In research, you have CapEx, you don't spend it, it's gone. Whereas in QA/QC, once you have CapEx, you can spend it and customers tend to take a bit longer. They wait until the end of the quarter, they place their orders and they consummate sales then and same thing for the year.

Rachel Vatnsdal

Got it. That's helpful. Maybe just as a follow-up, I understand that you're going to give us full numbers for 4Q in a few weeks here. But can you just talk about, did you see any of those budget flush dynamics that were implied within your guide? And then can you talk specifically about China performance in the last few weeks as well and how that trended?

Udit Batra

Rachel, I won't comment on intra-quarter trends, as I mentioned earlier. And I think you expected this just knowing me.

Rachel Vatnsdal

Fair enough. I had to try.

Udit Batra

Good try.

Rachel Vatnsdal

Maybe just shifting over to the long-term outlook then. So Waters was one of the few companies in the sector that actually lifted long-term guidance during 2022. And so just given how dynamic the market has been really the last 12 to 18 months here, a lot of investors are wondering how do we think about these LRPs that were raised during when times were great. So can you kind of spend a minute talking about is Waters' long-term guidance still intact on top line and on that margin expansion profile?

Udit Batra

So I mean that's why I spent a fair bit of time in the prepared remarks substantiating what we've seen in the past. I can't talk about next year, I can't talk about the year after next. But I can tell you in the mid- to long term, we see incredible tailwinds, right? Historically, Waters has grown roughly 6%, right, where instruments are 5-ish percent and recurring revenues are 7%. Year-on-year, these numbers fluctuate because just given how much of our portfolio is instruments. But for long-term investors, it's fantastic, right?

6% growth, 30-plus percent margins, $0.25 of $1 as cash. It's incredible as it stands already if we can do our job, but now we see better growth vectors for our revenue growth in the future. We see higher volume in prescription drugs, right, over the next 5 to 10 years than we've seen in the past. We see PFAS testing emerging as a new vector for volume growth. We see biocharacterization where there is a substantial need for new techniques, and we're adding to our portfolio there in faster-growing adjacencies.

And from a pricing perspective, we think there's going to be more robust pricing in the future, just given our portfolio and given the operational excellence that we've been able to implement in our company. So very happy with what I see in the future. And then when I put it all together from an EPS standpoint, it's not just the focus on the revenues.

From a cost perspective, we've launched new productivity initiatives that have not yet started to pay off. Despite that, you see that the incredible discipline that we have from a cost perspective has allowed us to expand margins in such a difficult year.

And then finally, from a capital allocation standpoint, accretive M&A is part of our capital allocation philosophy now. So we feel very good about where we're heading. And again, that's why I spent a fair bit of time not just building the base, but showing why we are excited about where we are taking the company in the future.

Rachel Vatnsdal

Got it. That's really helpful. Then maybe just a question on 2024. You've had a few of your peers have given guidance that it's implying market declines and then really on top line flat to no growth in some scenarios. So can you give us any type of framework on how should we think about Waters in the context of some of the market growth expectations we've gotten for your peers?

Udit Batra

So again, same thing, right? I mean I know you would ask, but I have to say, look, there's time to give the 2024 guidance, which will be with the full year results. You just got to wait a couple of months and it will be there.

Rachel Vatnsdal

Fair enough. Maybe just a follow-up on China then. So one of the comments that you mentioned earlier to one of my questions was just around any corruption and some of the impacts there. So I wanted to dig into a little bit of that. How much of an impact has that really been? You mentioned some of the Tier 1 leadership versus Tier 2, Tier 3. So how should investors think about that piece?

Udit Batra

Yes. It's a good question, right? I mean it's -- there's not a ton of visibility, but as you now think about the anticorruption campaign, it's flown through already in the large cities. We start to see those recovering and we start to see our customers being able to go to the hospitals, to the customers. We're starting to see the volume in Q3. We started to see it come back already. But in the smaller cities, we're far from done, right?

The -- and then this impacts the branded generics segment, which I'll remind you is about 50% of our pharma business in China. So there is still a bit of time to go until that recovers. And on China, a simple way to think about it, Rachel, is we were -- we had a $550 million or so business at the beginning of the year. We think, as we said in Q3, the year could end roughly $400-ish million. It's a substantial drop. Roughly $50-ish million is structured. There's $100 million or so that we expect to come back, plus the secular trends in China are pretty attractive in the future.

So the $100 million or so that will come back is in the biotech segment, is in the CDMO segment, is in the branded generics segment and the other segments where things have slowed down.

Rachel Vatnsdal

Okay. And then just one question here on pharma. So can you spend a minute talking about pharma? And the potential impact that we're seeing from IRA here is some pharma companies are really reprioritizing pipelines. What inning are we in that within the reprioritization and how long until you think it's really running its course?

Udit Batra

It's a good point. I mean at the CEO level, at the C-suite level, there is a discussion, right? So when I talk to my colleagues and friends there, it's pretty clear that they are concerned. But on the front lines in procurement, we've not seen any such discussion. At the lab manager level, we've seen no discussion, especially where we are playing, which is QA/QC and late-stage development, customers are not pulling back on purchases for columns, for software.

Some of the CapEx in LC has been sort of delayed a couple of quarters, and that's starting to come back, especially in the U.S. and in Europe. So really no substantial impact on the front lines.

At the C-suite level, people are thinking through it. And now if you project that forward, the first place where the reprioritization will occur is in R&D, not in QA/QC and not in development. Nobody in the right mind is going to stop selling drugs that are selling just because they believe something is coming down the line, right? So I think that's a reasonable way of thinking about it.

Rachel Vatnsdal

Perfect. And with that, we are actually out of time. So Udit, thank you so much for joining us today. And I hope everyone has a great rest of their evening.

Udit Batra

Thank you, Rachel.

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Waters Corporation (WAT) Presents at 42nd Annual J.P. Morgan Healthcare Conference (Transcript)