Waters Corporation (WAT)
January 09, 2012 6:00 pm ET
Douglas A. Berthiaume - Chairman, Chief Executive Officer and President
Tycho W. Peterson - JP Morgan Chase & Co, Research Division
Tycho W. Peterson - JP Morgan Chase & Co, Research Division
Okay. We're going to go ahead and get started. Thank you, everyone, for joining. I'm Tycho Peterson from the Life Sciences Tools and Diagnostics Group. It's my pleasure to introduce our next company this afternoon, Waters Corporation. If anyone's interested in the breakout, it's going to be across the hall in the Georgia room. So let me turn it over to Doug to tell you a little bit about Waters.
Douglas A. Berthiaume
Thank you, Tycho, and thanks for taking the time to hear the Waters story. Let's see. Sure, this is the first time you've been talked about the cautionary language that we point you to, understand the risks that are inherent in some of the statements that we're making. Please enjoy our 10-K to your heart's content, to learn more about that.
Let's make sure -- okay, for those of you who aren't totally familiar with Waters, we operate through 2 main operating divisions. The Waters Division, which comprises our liquid chromatography and mass spectrometry operations, it's about a $5 billion worldwide served market. And the smaller division of Waters, the TA Division, is focused on physical testing using thermal analysis, rheometry and relatively new endeavor in biocalorimetry. That's about a $400 million market, but it's been growing pretty rapidly.
If you look at the Waters Division, which is about 90% of our worldwide revenues, it has historically and consistently been about 63% of that business in the pharma and biotech arena; about 24% of what we call the industrial arena, really focused on industrial chemicals, food safety, food quality and environmental testing; and then about 13% in the academic and government marketplace.
The product line's breakdown into a little over 50% is hardware and software that goes along with the hardware, and about 46% is a combination of service and chemistry. That's what we call the consumables piece of the business and has been consistently operating at above that, nearly 50% of our business. That piece is also noteworthy in it's the most profitable piece of our business.
Historically, and you can see over the last 10 years or so, our compound topline growth has been in the high single digits, and most of that growth is organic. We haven't been aggressive acquirers. You'll see in the past 10 years or so, we've made roughly 10 acquisitions, and the largest ones have been in the $20 million arena. Most of them are focused niche opportunities or expansions that go along with our core product lines. So we haven't wandered dramatically outside of our core businesses, and we continue to believe that's the best use of our management time, to not wander too far outside of our core businesses.
That 8% organic growth rate has resulted in expanding operating margin. We've grown our operating income at a 9% compounded growth rate, including some tough times in there. And we've succeeded in leveraging our earnings at a 14% rate. So 8% organic sales growth, faster operating income growth and faster still earnings per share growth.
We've taken our free cash flow, and rather than make acquisitions, we've substantially lowered the flow to the company. We started with 135 million shares outstanding at the beginning of this period, and this year, we'll be down to around 91 million, 92 million shares outstanding. So we think that continues to be the wisest use of our free cash flow.
The -- we've optimized, I think, the operations of the company, both with a focus on making the best use of our manufacturing resources, as well as taking advantage of our opportunity to hedge some foreign currency exposure and to optimize our tax rate through our manufacturing resources. We have outsourced a great deal of our basic instrument manufacturing into Singapore and done it at a substantially -- substantially at a cost to benefit. At the same time, we've invested incremental resources in our mass spec manufacturing in the U.K. and in Ireland. So doing that has substantially lowered our net exposure to the euro during this period, at the same time optimizing our tax rate, which is in the mid-teens. So we've had better quality manufacturing, a natural hedge on foreign currency and an optimized tax rate. So it's worked very well over a long period of time.
If you look at our recent results, in the third quarter, finished in September, we saw organic growth from the top line of 9%. Earnings grew at 16%, up to $1.14. We continued strong free cash flow of $111 million, and we continued to buy back our stock aggressively and we bought back 1.8 million shares in the third quarter. That came together in 9-month operations, very similar organic revenue growth, 10%; earnings per share growth at 20%; free cash flow is $311 million through 9 months; and we've bought back 3.6 million shares of our stock, through this period.
So the bulk financial facts, I think, are pretty good, consistent with what we've generally produced over a long period of time. The key to that continues to be our rich new product process that continues to deliver organic growth rate that's higher than the industry is growing at.
Let's talk a little bit about some of the key new product introductions that have allowed us to grow faster than the marketplace. I think, as you all know, biopharmaceuticals is one of the fastest-growing parts of the overall pharmaceutical industry. Most of the big pharma companies are investing more disproportionately in the bio segment of their universe rather than the small molecule world. We introduced what we call our Biopharmaceuticals System, which utilizes our new unified platform and involves a new mass spectrometer that you can see here with the long tower in the time of flight configuration, and really focuses on this analysis of biopharmaceuticals. It's been very successful. It incorporates both our ACQUITY LC front end, as well as a new novel mass spec platform.
Another instrument that we introduced in this year is our Regulated Bioanalysis System. Regulated Bioanalysis is the highest served market for mass spectrometers in the world. These are drug metabolism studies, typically in drug metabolism labs and big pharma and CROs around the world. We have traditionally not been as strong a competitor in this segment of the marketplace, but we launched a new high-sensitivity mass spectrometer. Here, you see on the right of this model, our new TQ-S, combined with ACQUITY LC and has been very successful in penetrating into Regulated Bioanalysis markets. So that we saw a midyear introduction in 2011, and that should benefit us going forward.
That new system takes advantage of the newly introduced state-of-the-art I-Class ACQUITY, which in drug metabolism studies in particular, sensitivity is all important, and the I-Class ACQUITY is the most sensitive front end to a mass spectrometer that's now available on the market. So it's been bringing together this liquid chromatography and mass spectrometry technology that's been key to penetrating and producing fast growth in these markets.
The ACQUITY family consists of traditional ACQUITY high-sensitivity front ends and the H-Class ACQUITY platform. We introduced this in 2010, and it was introduced as a way to bring high-performance ultra chromatography to the benchtop liquid chromatography platform. So it allows them to migrate applications that are done on HPLC into the UPLC world. It's been very successful in going into laboratories who might be a little squeamish about jumping to a new technology, but they can run their own methods and the new methods on the same system. So the H-Class has been very successful on this and has been particularly successful in beginning to penetrate into new QC applications and pharmaceutical labs. That is a major application. And with the traditional ACQUITY, we were very successful in penetrating research applications. We found that the H-Class has been very successful and now penetrating into QC laboratories.
Another key introduction to us this year is a high-end, high-sensitivity mass spectrometer, the SYNAPT G2-S, which combines a number of different mass spec technologies, including high-sensitivity analyses. The G2-S was introduced at ASMS in the middle of the year. We saw very strong response to it and shipments began late in the third quarter, so we've got like a quarter and a 1/3 of shipments for this year. And that will benefit us for the full year in 2012.
So we've got a long-term financial history of growing our top line in consistent year-in and year-out rates, a management mythology that takes advantage of that consistent growth, invests in cost reduction to optimize the return on that. It delivers pound-for-pound, some of the best free cash flow per dollar sales in the industry and some of the best return on invested capital in the industry.
We look forward to what's in front of us, and we're still confident that the factors that gave rise to the kind of last 10-year performance are still in front of us as we look forward. There's no question that some of the fiscal concerns that are in front of all of our geographies as we go into 2012 raise some level of caution. We are looking at that and seeing how, and if it should, modify how we look at 2012, particularly coming out in 2011. But at this time, we are optimistic albeit entering 2012 a little more cautiously, probably, than we entered 2011. But long term, the fact that our emerging marketplace continued to show the kind of growth opportunity that they have for the past 4 or 5 years. China continues to show very strong growth, very good strong underlying dynamics. Places like Brazil, Taiwan, Korea continue to grow in the strong double digits and continue to show the kind of underlying opportunities that, I think, make us confident that we can continue to penetrate those kinds of markets and continue to produce the growth. There's no question that probably the most concern right now is in Western Europe, but the Western Europe that we do business in is not heavily concerned with government spending. There's no question that to some extent, it affects all of us in those territories. But as I said, less than 15% of our worldwide revenues are in the government and academic marketplace. The piece that's in Western Europe is even smaller than our worldwide concerns.
So while we continue to monitor that, we continue to make sure that we're not overly resourced for that piece of the marketplace. We don't think in the long run, it's going to have a major impact on how we view our long-term growth and our opportunity to maintain our organic growth rate. We think the strength of our new product cycle, the opportunity in the life science marketplace, the very fast emerging markets of China, Brazil, Mexico, Taiwan, Russia, and Russia is having a record year for us, continue to -- they continue to invest in new healthcare. They continue to invest in the pharmaceutical segments, the environmental segments. Food safety is a fast -- and continuing to take resources in those countries and continue to be an area that we're putting more resources. We continue to believe that, that new product pipeline, our position in those markets, and importantly, our ability to produce free cash flow and continue to invest in ourselves. We'll continue to produce the long-term results that we have seen over the past 10 years or so.
So thank you very much. That is the Waters story, and I'd like to invite you all to the breakout room and have any questions.