Waters Corporation's (WAT) CEO Udit Batra on Q4 2021 Results - Earnings Call Transcript

Feb. 01, 2022 1:56 PM ETWaters Corporation (WAT)
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Waters Corporation (NYSE:WAT) Q4 2021 Earnings Conference Call February 1, 2022 8:00 AM ET

Corporate Participants

Caspar Tudor - Director of Investor Relations

Udit Batra - President and Chief Executive Officer

Amol Chaubal - Senior Vice President and Chief Financial Officer

Conference Call Participants

Vijay Kumar - Evercore ISI

Dan Brennan - Cowen

Puneet Souda - SVB Leerink

Jack Meehan - Nephron Research

Josh Waldman - Cleveland Research

Mike Ryskin - Bank of America

Patrick Donnelly - Citi


Good morning. Welcome to the Waters Corporation Fourth Quarter 2021 Financial Results Conference Call. All participants will be in a listen-only mode until the question-and-answer session of the conference call begin. This conference call is being recorded. If anyone has objections, please disconnect at this time.

It is now my pleasure to turn the call over to Mr. Caspar Tudor, Director of Investor Relations. Please go ahead, sir.

Caspar Tudor

Thank you, operator. Good morning, everyone, and welcome to the Waters Corporation Fourth Quarter Earnings Conference Call. Before we begin, I will cover the cautionary language. During the course of this conference call, we will make various forward-looking statements regarding future events or future financial performance of the company. In particular, we will provide guidance regarding possible future results of the company and commentary on potential market and business conditions that may impact Waters Corporation over the first quarter of 2022 and full year 2022.

We caution you that any and all such statements are only our present expectations and that actual events or results may differ materially from those indicated in the forward-looking statements. For a detailed discussion of some of the risks and contingencies that could cause our actual performance to differ significantly from our present expectations see the risk factors included in our annual reports on Form 10-K for the fiscal year ended December 31, 2020, in Part 1 under the caption Risk Factors.

And in our most recent quarterly reports on Form 10-Q for the quarter ended October 2, 2021 in Part 1A under the caption Risk Factors. Both of which are on file with the SEC, as well as the cautionary language included in this morning's press release, including with respect to risks related to the effects of the COVID-19 pandemic on our business. We further caution you that the company does not intend to update any of these predictions or projections, except during our regularly scheduled quarterly earnings release conference calls and webcast, or as otherwise required by law.

The next earnings release call and webcast is currently planned for May 3rd, 2022. During today's call, we will be referring to certain non-GAAP financial measures, reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures are attached to our earnings release issued this morning and in the appendix of our presentation, which are available on the company's website.

And our discussions of the results of operations we may refer to non-GAAP results which exclude the impact of items such as those outlined in our schedule titled "Reconciliation of GAAP to Adjusted non-GAAP Financials" included in this morning's press release and in the appendix of our presentation. Unless stated otherwise, references to quarterly results, increasing or decreasing, are in comparison to the fourth quarter of fiscal year 2020.

In addition, unless stated otherwise, all year-over-year revenue growth rates, including revenue growth ranges given on today's call, are given on a comparable constant currency basis. Now, I'd like to turn the call over to Dr. Udit Batra, Waters President and CEO, Udit.

Udit Batra

Thank you, Caspar, and good morning, everyone. Along with Caspar joining me on this morning’s call is Amol Chaubal, Waters Senior Vice President and Chief Financial Officer.

We've ended a very successful year at Waters. In end markets with sustainable growth drivers, we have revived our resilient business and are now focused on growing our portfolio. Despite higher comparables, we saw strong growth continue with an acceleration on a stacked basis as the year went on. The strength we've seen in our instrument portfolio is a positive indicator for the future, as our new products have gained traction and this all supports the sustainable future growth we expect to see in our consumables and service.

Before summarizing the quarter and full year, let me start by thanking my colleagues around the globe who represented the indomitable spirit of Waters throughout 2021, remain focused on supporting our customers and delivering exciting new products despite the challenging conditions of the pandemic.

Achieving these results in a normal year would have been quite an accomplishment but to do so while balancing the continued ups and downs of the pandemic with a major transformation and a new leadership team is indeed quite remarkable.

Now I'm turning to Slide 3, we have three messages. We have a resilient and attractive portfolio of instruments systems, chemistry, consumables and services in end markets that are supported by sustainable growth drivers. We revitalize the score by engaging our customers progressing on a number of growth initiatives and continuing to innovate across our portfolio while launching exciting new products. And now we're focused on growth of our core business as well as accessing high-volume applications and faster-growing adjacencies.

I will now provide a brief overview of our fourth quarter and full year operating results as well as commentary on our end markets, geographies and technologies. Amol will then review our financial results in detail and provide comments on our financial outlook. We will then open up the phone line to take your questions.

Moving on to Slide 4. In the fourth quarter, our revenue grew 6% as reported and 8% on a constant currency basis, reflecting broad strength across our end markets and geographies with double-digit year-end demand for our instruments and continued growth in our recurring revenue products. This translates to a 7.5% two-year stacked CAGR for the quarter versus 2019 on a constant currency basis.

For the full year, revenue grew 18% as reported and 16% in constant currency as we saw strong growth in 2021 across all our regions led by pharma and industrial end markets. This translates to a 7% two years stacked CAGR for the year versus 2019 in constant currency. Our Q4 non-GAAP adjusted earnings per share was $3.67 per share, up 1% year-on-year and 7% stacked. Excluding the effect of our prior year COVID cost actions and FX, EPS grew 8% versus last year. For the full year, non-GAAP adjusted earnings per share grew 24% to $11.20 and 12% on a two-year stacked basis.

Now looking more closely at our top line results for the quarter on Slide 5. In constant currency first, by operating segment, the Waters division grew 7%, while TA grew 16%. The end market, our largest market category, pharma grew 8%, industrial grew 7% and academic and government grew at 5%.

In pharma, we saw continued broad-based strength in sales across segments, geographies and applications. Biopharma and contract organizations grew well above 20%. In industrial, growth was led by our TA business, which saw strong global strength in thermal as well as microcalorimetry and rheology. Within the Waters division, we saw broad demand for LC instruments across our geographies as well as our customers, as well as our customer segments who continue to invest in new capital equipment.

Turning to academic and government, we saw an improvement with growth across most of our geographies into the year-end. We're actively revitalizing our relationships with KOLs, which is an integral part of achieving long-term success in academic and government. While it takes some time for us to regain traction, Waters has familiarity and a fan base amongst KOLs, who have often used instruments throughout their careers.

Just last week, I was talking with the head of a leading core lab at one of our – one of the top medical institutions in the United States. He has worked closely with Waters for the better part of two decades to build up proteomics capabilities at this institution and currently has over 40 Waters LCs and 20 mass spec instruments from our company.

Moving now, to our sales performance by geography. On a constant currency basis, sales in Asia grew 9% with China up 13%, Americas 8%, with U.S. up 8% and Europe grew 5%. In China, we saw strong demand throughout the quarter with growth led by contractors, biopharma and a strong recovery in clinical. We also saw strong growth in food testing and chemical assays.

In the U.S. growth came from ongoing strength in our pharma and industrial end markets. In pharma, sales was strong in LC and mass spec, which combined grew in the mid-teens with chemistry up low double digits. In industrial, our TA business saw strong instrument placement across applications, led by advanced materials, chemicals and battery testing.

In Europe, all end markets continued to grow led by pharma and industrial with food and environmental businesses, resulting in strong demand for our Tandem Quads. Meanwhile, pharma sales remained solid with growth led by large molecule applications. By product and services, customer demand for our instruments finished the year strong, continuing the trend of instrument growth that we saw throughout the year, while demand for recurring revenue products remained strong.

Overall instrument sales grew 12% for the quarter with a robust demand driven by our commercial execution and new product contribution. In LC, Arc HPLC continued to see strong global growth in our core segments as demand continues to ramp. Meanwhile, our acuity and arc premier instruments continued to see strong adoption, driven by applications in large molecule and novel modality such as mRNA.

In mass spec, we saw growth in our high-end tandem quad portfolio, led by Xevo TQ-XS, Xevo TQ-XS micro. We also saw strong demand from our biopharma and CRO customers as well as for food safety applications. In our high risk mass spec portfolio, we saw the demand for cyclic with drug discovery applications. We're also encouraged by the early adoption of our new, SELECT SERIES MRT, Time-of-Fight platform, the customers using it for biopharma discovery and OMEX applications.

For recurring revenues, despite the quarter having six fewer days in the fourth quarter of 2020, chemistry sales grew 5%, led by continued high utilization biopharma customers. Our new MaxPeak, Premier Columns continued to provide incremental growth for our chemistry business. This technology provides important benefits in separation and purification of mRNA, oligonucleotides, peptides and glycans, which is effectively answering the needs of our customers as they work with more complex molecules.

Service grew to 2% despite a tough double-digit comparison a year ago with strong growth in both China and in India, which has been a theme throughout the year. Finally, TA had another great quarter, with sales up 16% led by strong growth in thermal analysis, microcalorimetry and rheology. Demand for TA products continues to be strong in all regions, the growth driven by advanced materials and chemicals including batteries and electronics.

Looking now, at our top line results for the full year on Slide 6, in constant currency, the Waters division grew 15%, while TA grew 25%. By end market, pharma grew 19% and industrial grew 15%, while academic and government came at 5% for the year. Pharma which is our largest market has grown 10% on a two-year stack basis driven by strong demand in our instruments and recurring revenues with strength in both large and small molecule applications. We've also seen ongoing strength in our industrial and applied market, which has grown 6% on a two-year stack basis led by China as well as North America and Europe.

In academic and government, which has been our slowest market to recover sales in Europe and the U.S. are close to pre-pandemic levels as China has further in its recovery as university spending continues to be constrained.

By geography, Asia grew 19%, China growing 25%, Americas grew at 16% with the U.S. growing at 14% and Europe also grew 14%. For the full year on a two-year stack basis, our three largest geographies, the U.S. China and Europe was 6%, 7% and 8% respectively. What is especially pleasing is that the demand is balanced across all geographies including a robust recovery in the U.S.

By products and services, instruments grew 23% for the year, chemistry 15% and service grew 9%. On a stack basis instruments grew 6%, chemistry 9% and service 6%, showing strong performance above our historical averages. The strength we've seen in our LC instrument portfolio throughout the year remains a positive indicator for sustainable future growth in consumables as well as service. Our growth in recurring revenues has also been supported by the progress we've made in ecommerce as well as delivering higher attachment rates in service. Given the global nature of our business, we're certainly not immune to the ongoing supply chain constraints and inflationary pressures. But we are proactively addressing these challenges, leveraging our global manufacturing footprint and working closely with our customers and suppliers.

Now moving on to Slide #7. We covered this in our Q3 earnings call and also at the recent JPMorgan conference. Our initiatives across instrument replacement, service attachment, contract organizations, ecommerce and new product launch excellence have all been important components for us to gaining our momentum and delivering strong performance in 2021.

We've continued to exceed expectations and milestones on these initiatives and believe that each has further one way not just in 2022 but in years beyond providing an average incremental growth impact of roughly 100 basis points annually across the base business in the next two to three years, as our transformation program is firmly on track.

Moving now on to Slide 8. The strength of our business is being supported by instrument innovation with recent product launches that have revitalized our core. Waters continues to build on its robust base with customer relationships. And importantly, it's highly technical team of scientists and engineers with deep understanding of our customers problems to solve.

For example, Arc HPLC which was launched in 2020, allows customers to increase the performance and capabilities for their high volume workhorse instruments without revalidating their existing methods. This is absolutely critical in compliant environments and helps us provide the benefits of newer technology to our customers while ensuring backwards compatibility. Meanwhile, our MaxPeak Premier technology provides important benefits and applications where sensitivity and reproducibility is key by virtually eliminating the metal binding affinity of compounds, like mRNAs, oligonucleotides, peptides and glycans.

On the instrument side, acuity Premier is a UPLC that was custom designed for biologics and novel modality applications, providing 100x better detection sensitivity than non-premier instruments and a 50% reduction in peak scaling.

Within our chemistry portfolio MaxPeak premier columns which also offer this high performance, surface coatings have set a record in terms of uptake for new columns as this technology continues to be well received by our final customers.

Turning to a mass spec portfolio, one additional example of innovation is our Select Series MRT, which is a high resolution multi reflecting time of flight instrument that provides remarkable accuracy at high speed with outstanding clarity. This instrument is setting the benchmark and mass accuracy. It's high throughput is enabling large sample studies of proteins and metabolites which previously would have taken too much time to conduct.

Additionally, you may have seen our announcement this morning of what is this acquisition of charge detection mass spec technology CDMS. CDMS overcomes limitations of conventional mass spec in characterizing, analyzing and quantifying complex large molecules. This investments will allow Waters to develop and commercialize CDMS technology to solve significant unmet needs and novel modality settings such as cell and gene therapy for drug development.

For the discipline my colleagues, Jon Pratt and Jianqing Bennett have brought into launches new products meaningfully grown in their contribution this year and with our product vitality index around 150 basis points up around 150 basis points to approximately 15% in Q4.

Turning now to Slide 9. A key element of our informatics strategy is to provide customers with tools that help them better manage their workflows and achieve faster, easier results with high quality compliant data.

Last month, we extended our next generation informatics platform Waters Connect to our Tandem Quad mass spectrometers for core quantitation starting with food testing. As any scientist who works in mass spec will tell you current software across the industry is powerful, but designed to fit all purposes and as a result can be complicated and difficult to use. A new software is built around the purpose and end market application for which it is being used. Delivering on our key principle of providing advanced technology that is fast, robust and easy to use. It reduces review times by up to 50% compared to the current market leading platform by allowing labs to meet their compliance and data integrity requirements.

The overriding benefit here is that analysts can reduce review time to a minimum which is one of the largest bottlenecks in the lab, improving workflows for quantitative LCMS and mass spec data review is critical for our customers as it helps improve the throughput and efficacy. I spent time with our launch team last week and the rollout has begun with food testing applications and the plan to extend it to other applications in the near future.

Now turning to Slide 10. Let me turn to the critical problems in higher growth adjacencies that we identified this year and believe we can solve overtime. First, in Bioseparations, we see an opportunity to take our chemistry expertise from small molecule separations and apply it to novel modalities and large molecule separation. Despite the rapid growth, there are significant challenges in characterizing and confirming the quality of these large complex molecules.

Take mRNA as an example. The industry has a key unmet need of sustaining analytical control when measuring molecular integrity. Current practices for newer modalities like this are not as reproducible as desired, because there is not enough precision. So by advancing a biologic capabilities, we can unleash our chemistry expertise and our engineering expertise to better characterize and separate these molecules and then identify items such as process related impurities and degradation that are critical in later stage development and high volume manufacturing.

In this area specifically, we're looking at bioseparations solutions for mRNA and other nucleic acids, proteins and lipid nanoparticles, as well as viral vector gene therapies and vaccines, and adeno associated viruses.

Second, in bioprocess characterization, one of the key differences in bioprocessing versus small molecule processing is that once you define the manufacturing process, you're effectively stuck with it and cannot optimize it without completely revalidating the process because it is tied to the drug master file. By providing analytical techniques that are powerful enough to characterize the product sufficiently, we believe that we can overcome this barrier and separate the process from the product. This is a significant need in the industry and has the potential to be a very attractive market.

Our partnership with Sartorius is a key step in this journey and as we bring the processing power of LCMS [outlines] [ph] the biocode in a workflow that is simple, powerful and fast and can be easily used on site by bioprocess engineers.

The third application is of LCMS and diagnostics, where we need a fast, unbiased detection of multiple biomarkers to enable early disease detection. We believe mass spec has a significant role to play here. They've already demonstrated a proof of concept that the U.K. government in characterizing the past CoV2 virus with excellent sensitivity and selectivity, leading to a lower false positive rate than many other techniques.

In review, our strong fourth quarter results cap a very successful year for Waters with broad based across our end markets and geographies. We sustained our momentum with strong two years stack revenue growth throughout the year, without transformation now embedded in how we operate. Our core business has been revitalized with growing contributions from innovative new products and initiatives.

We are laser focused on our commercial execution. The market we serve remain in a healthy state and our regions have rebounded solidly from pandemic lows. Meanwhile, we see opportunities in higher growth adjacencies that will raise our exposure to faster growing market segments as we start to solve the critical problems we've identified over time.

With that, I'd like to pass the call over to Amol for a deeper review of the fourth quarter and full year financials as well as our outlook for the first quarter and the full year of 2022. Amol?

Amol Chaubal

Thank you, Udit, and good morning, everyone.

As Udit outlined, we recorded net sales of 836 million in the fourth quarter, an increase of 8% in constant currency and an increase of 6% as reported. We had a record instrument sales this quarter, which increased 12% versus prior year and 8% on a two year stack basis. Despite six fewer calendar days, our recurring revenue, which represents the combination of chemistry and service revenue increased by 3% for the quarter. Chemistry revenues were up 5% and service revenues were up 2%, both of which had tough comparisons in the prior year.

The six fewer calendar days in the quarter, translated to a growth headwind of approximately 6% for recurring revenue and approximately 3% for total revenue. For the full year, sales grew by about 16% in constant currency and 18% as reported, recurring revenues grew 11% with chemistry up 15% and service up 9%, while instrument sales grew 23%, driven by strong customer demand and new product introductions. Our two-year stacked constant currency sales growth was 7.5% for Q4 and 7% for the second half of 2021 versus 6.5% for the first half. This acceleration underscores our good commercial momentum heading into 2022.

Looking ahead, comparing 2022 to 2021, there is one fewer day in the first quarter, no change in the second or third quarters and one additional day in the fourth quarter. Now I would like to comment on our fourth quarter and full year non-GAAP financial performance versus the prior year.

Gross margin for the quarter came in as expected at 58%. On a full year basis, gross margin was 58.5% compared to 57.4% in the prior year with improvements driven primarily by volume leverage and a 30 basis points tailwind from FX.

Moving down the P&L for Q4 operating expenses increased by approximately 12% on a constant currency basis and include an increase of approximately 7% due to the normalization of our prior year COVID-related cost actions. For the year, operating expenses were approximately 18% higher in constant currency and include an increase of 15% due to the normalization of prior year COVID-related cost actions.

In the quarter and for the full year, our effective operating tax rate was 14.4% and 13.8%, respectively. For the full year, our effective tax rate decreased by 100 basis points due to a favorable change in our income mix by jurisdiction.

Our average share count came in at 61.4 million shares, which is about 1.1 million less than the fourth quarter of last year. Our non-GAAP earnings per fully diluted share for the fourth quarter increased 1% to $3.67 in comparison to $3.65 last year, excluding the impact of foreign exchange and the normalization of prior year COVID-related cost reductions, non-GAAP EPS increased 8%.

On a GAAP basis, our earnings per fully diluted share increased to $3.52 compared to $3.49 last year. For the full year, our non-GAAP earnings per fully diluted share was up 24% at $11.20 versus $9.05 in the prior year. On a GAAP basis, full year earnings per share was $11.17 versus $8.36 a year ago, the increase was driven primarily by sales volume, partially offset by the normalization of our COVID-related cost action. A reconciliation of our GAAP to non-GAAP earnings is attached to the press release issued this morning and in the appendix of this presentation.

Turning to free cash flow capital deployment on our balance sheet, we define free cash flow as cash from operations, less capital expenditures and excludes special items. In the fourth quarter of 2021, free cash flow was 187 million after funding 45 million of capital expenditures, excluded from the free cash flow was 9 million related to the investments in our Taunton precision chemistry operations and 5 million in costs relating to one-time litigation settlement.

For the full year, free cash flow was 675 million, with approximately $0.24 of each dollar of sales converted into free cash flow. In the fourth quarter, accounts receivable DSOs came in at 66 days, down four days compared to the fourth quarter of last year and down five days compared to the last quarter. Inventory DIO decreased by nine days, compared to the fourth quarter of last year. Given higher sales volumes and our proactive measures to secure supply, inventory increased by 52 million in comparison to the prior year. We maintain a strong balance sheet access to liquidity and a well-structured debt maturity profile.

In terms of returning capital to shareholders, we repurchased approximately 448,000 shares of our common stock for 156 million in Q4. At the end of the quarter, our net debt position was 945 million with a net debt to EBITDA ratio of about one. Our capital deployment priorities are investing for growth, maintaining balance sheet strength and flexibility and returning capital to shareholders along with focus on deploying capital to well thought out attractive and adjacent growth opportunities.

Now as we look towards the year ahead, I would like to provide you with our thoughts for 2022 which is on Slide 11. In 2021, our momentum has progressively accelerated, driven by a robust end market demand and strong commercial execution across our geographies. As we head into 2022, we expect our momentum to continue and that we will be able to address supply chain constraints and inflationary pressures and believe that our near-term growth initiatives will continue to contribute to our performance. These dynamics support full year 2022 guidance of 5% to 7% constant currency sales growth.

At current rates, a negative currency translation is expected to subtract approximately one percentage point, resulting in full year reported sales growth guidance of 4% to 6%. Gross margin for the full year is expected to be approximately 58% and operating margin is expected to be approximately 30% to 30.5%.

We expect our full year net interest expense to be approximately 35 million and full year tax rate to be approximately 15.5%. Average diluted 2022 share count is expected to be approximately 61 million. Our share repurchase program will continue into 2022 and we'll provide quarterly updates as appropriate. Rolling all this together and on a non-GAAP basis, full year 2022 earnings per fully diluted share have now projected in the range of $11.75 to $12. This includes a negative currency impact of approximately two percentage points at today's rates.

Looking at the first quarter of 2022, we expect constant currency sales growth to be 6% to 8%. At today's rates, currency translation is expected to subtract approximately three percentage points resulting in first quarter reported sales growth guidance of 3% to 5%. First quarter non-GAAP earnings per fully diluted share are estimated to be in the range $2.25 to $2.35. This includes a negative currency impact of approximately four percentage points at today's rates.

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

Udit Batra

Thank you, Amol. In summary, we are pleased with our performance this year. Our core business is reenergized, our transformation is on track. And we built really good commercial momentum going into 2022. And we are laser focused on our commercial execution and accelerating innovation through our portfolio while reaching higher growth, close adjacent markets. With a new leadership team in place and our transformation well underway, we're also expanding our focus on environmental, social and governance topics.

We've initiated a complete materiality assessment which will allow us to look at areas where Waters can contribute and ensuring we do our part to leave the world better than we found it. I look forward to sharing an update on this later this year.

With that, we will now begin the Q&A session. Operator?

Question-and-Answer Session


Thank you, sir. At this time, we'll begin our Q&A session. [Operator Instructions] Our first question is from Vijay Kumar with Evercore ISI. Your line is open.

Vijay Kumar

Hey, guys, thanks for taking my question. I had one on the Q and one on guidance. And maybe we'll start with the Q, Udit”. If I look at the instrument growth of 5%, 12% that came in well above expectations. Was there any year-end budget flush? Or is this the continuation of the execution momentum we've seen throughout the course of ’21? Maybe talk about what happened in Q4, why instruments came in so strong?

Udit Batra

Yes. So Vijay, thank you for the question and good morning. Look, we've seen strong instrument growth momentum throughout the year and Q4 is no exception. And this is largely attributed to our commercial. Our commercial initiatives, especially the replacement initiative and the successful launch of new products, especially the Arc HPLC, the Acuity Premier, and more recently, the high res mass spec platform.

The full year numbers from an instrument perspective, I would say even more interesting. I think their instruments have really led the growth with mid 20s sort of growth rate with LC coming around that range, mass spec a little bit slower and TA really endearing in the high 20s in growth rate. So instruments have really led the charge in terms of our recovery and that bodes, as you know, very well for the future for our service and recurring businesses.

So to summarize, really, it's commercial momentum, new products that we've seen throughout the year and nothing sort of dramatic that was taking place at the end of the year. That was very different from what we have seen throughout the year.

Vijay Kumar

That's helpful, Udit. And maybe one for Amol on the guidance. It looks like Q4 gross margin came in a little bit light. And I thought I heard you say it was in line with expectations. Is there anything on the gross margin line for fiscal '22? Because I look at your revenue growth -- reported revenue growth of the four to six, earnings growth of a five to seven, you do have some share repurchases going on. So that implies maybe perhaps margins were flat to down, what would cause margins to be down and is that a gross margin issue?

Amol Chaubal

Good morning, Vijay, and thanks for the question. So look, I mean, the gross margin for Q4 came in as we had guided. And if you compare it versus prior year, the gross margin is lower because of three factors. There is a 50 basis points headwind from exchange rate. But then there were also prior year COVID cost actions that normalize this year. And then, the quarter was heavier on instruments and instruments are lower margin compared to other elements of our portfolio.

So when you put those three things together, it sort of reconciles with the gross margin last year. Where we are guiding for 22 at approximately 58% is in line with what we did this year. And on the operating margin side, we are saying about 30% to 30.5%. So it's sort of slightly better than 30.2% on the top end of the range.

What is in there is also the tax rate, we are saying tax rate, we are expecting 15.5%. That's higher than the tax rate we had this year, primarily because the 2017 regs have a provision in place, which requires capitalization of R&D expenses, and our x-U.S. R&D expenses when capitalized will have an impact on the guilty provisions. So that has added about a little over a percentage point to the tax rate. That's included in our guidance.


Thank you so much for your question. Our next question is from Dan Brennan with Cowen. Your line is open.

Dan Brennan

Great. Thanks for the question, guys. Congrats on the quarter. Maybe just to start on -- just on the overall biopharma market. Just could you give us a sense, Udit, in terms of what the addressable market is growing at today? How Water is doing from a share perspective, particularly across your LCMS mass spec portfolios?

Udit Batra

Sure. Good morning, Dan. Look, overall, the best way to look at this is to look at stacked growth rates, right? If you just look at the stacked growth rates, we finished the year around 7% overall in the business where pharma came in higher at double-digit. And what we've seen on the pharma side is really strong uptake, not just the demand, not just the increasing demand in the market. So it's slightly higher than historical averages, but also water specific execution. First, from a commercial perspective, across our five commercial initiatives, as well as new product introduction which has had very good uptake, especially in pharma, arc HPLC has done very well, especially in China. And increasingly in the U.S. and Europe, the acuity premier with the MaxPeak technology has really hit a real sweet spot with novel modalities, which have higher affinity to metal surfaces.

So new products, especially on the instrument side. And now we have introduced our next generation of informatics platform for mass spec. So we expect new products to continue to do well. So to summarize, the pharma end market has been a bit more robust than historical averages. But in that robust market, we have been executing extremely well from a commercial perspective, as well as with new product introductions. So that bodes well for what we think about in the future for this largest end market.

Dan Brennan

Great. Thank you for that. And then maybe if I can ask a two-parter, just one on China, obviously, Q4 was a really nice stack acceleration. You had some color in the prepared remarks. Just wondering what to assume for '22 in China? And then on an unrelated base, just bioproduction, you did the deal today, which is likely a very small tuck-in, you have the Sartorius deal, but how do we think about your organic and inorganic investments going forward over the next year in bioproduction? Thank you.

Udit Batra

Dan, I mean, China, thanks for the question, really excited. I mean, it all starts with leadership. We have a new leader in China who's really executing what I've talked about at a global level from a commercial perspective. Overall, I mean, as the overall business grew 16% for the year, China was in the mid-20s, driven again, by very, very strong instrument growth rates, well in excess of 30% growth where LC is doing very well.

From an end market perspective in China, pharma, and/or especially our focus on CDMOS there has grown the business in excess of 40%. So excited about what we're seeing in China. New products are doing extremely well. And there's no reason to believe that that should slow down going into the New Year. If anything, we expect newer products to gain even more traction. And there's a lot more to do in China, by the way, increasing penetration across the board.

And then, turning to your question on bioproduction, look, in general, the two growth initiatives that we've highlighted, that are focused on biologics and novel modalities are number one on bioseparations, and number two on bioproduction. On bioseparations, we are a world leader in separating small molecules. And with our chemistry and engineering expertise, we're simply turning that to larger molecules, like mRNA oligonucleotides proteins. And then from a bioproduction perspective, we've talked about first, the collaboration, we have Sartorius, where we first focused on characterizing the process for a high volume application called clone selection, where we took the workflow from about six weeks to less than a week. And that has a lot of traction with our customers, we are now adding on other attributes that we want to measure for the process, creating a seamless software bridge between the [indiscernible] of Sartorius as well as the biocode that we have.

And then looking at other applications, be it scale up to larger bio reactors, or other modalities like again, oligonucleotides and more complex protein. So a lot of runway on the bioproduction side, and the deal that we announced a small tuck-in as you know, CDMS, thanks for asking about it. It's something that's good and dear to my heart. And I must admit, I started off as a skeptic. When I first heard about the technology, the team sent me some publications and said, hey, it's a technology. And I thought it's another hobby, but it's a really good fit, right. So basically, the CDMS technology takes mass spec to larger molecules, where we can now separate mRNA as well as viral vectors, which are larger proteins, intact proteins where mass spec reaches its limits.

And what excited us the most is a demonstration we did with our customers several months ago, where we expected roughly 20 customers to come in Kendall Square, where we have our immerse lab roughly 40 showed up, I was so excited, I asked them all and our Head of Strategy. Dan Welch to join me to listen to the customers that sealed the deal, right? So we basically said, look, this is a technology that our customers really, really want. It's going to allow them to analyze more complex molecules much more carefully. And now we have the development, commercialization manufacturing rights for the technology. So super excited about what we are seeing in the bioproduction, bioseparations area.


Our next question is from Puneet Souda with SVB Leerink.

Puneet Souda

So first of all, congrats on the strong quarter here. Really strong in instrumentation growth. So have a bit of a question on the guide. First, 5% to 7% full year guide, how much are you expecting in terms of contribution from the replacement initiative here? I mean, is this still a 40 million or so replacement initiative for 2022 as you were expecting before or is it more now? And how much contribution in the full year guide from maybe new growth initiative with the separations and bioprocessing clone selection the diagnostics?

Yes, contribution overall from -- in the guide from the replacement initiatives and these new initiatives that you have in place now because I mean, Udit you joined them in 2020. It's been one full year of lift that we're seeing in the replacement cycle, and just wanting to get as to sort of how should we think about this year and maybe even into next year for the replacement initiatives in these new efforts that you have underway?

Udit Batra

Puneet, the way I would think about the contribution across the five initiatives instrumental placement, service attach ecommerce, CDMO is about 100 basis points of acceleration beyond what we see in the market. So that's how I would look at that piece, sort of lump it all together and it's about 100 basis points give or take.

Second, on the new growth initiatives, as I commented in the previous quarter, as well as at a recent conference. This is something that we expect to meaningfully contribute in the mid to long term. We are very excited about the traction we have on bioprocessing with our collaboration with Sartorius. We're doing very well on the early stages of adapting SCMS for specialty applications in diagnostics. And we have a very good start on bioseparations as well as some other initiatives. So you should expect that to contribute in the midterm.

In the short-term, about 100 basis points from our initiatives that are already ongoing. And in the midterm, these other initiatives will start to contribute meaningfully. It’s a great start. But I would say the midterm starting '23, '24 is when you should start seeing an impact of these initiatives.

Puneet Souda

Got it. And then on the order book and overall demand. Just maybe could you update us where the backlog stands? I think that's fairly strong in the fourth quarter, even in third quarter, maybe just give us, how do you see that conversion in the first quarter and through the year? And just update us if you could on the supply chain, obviously, that's impacting number of companies. But how should we bounce that order conversion versus the supply chain and any other inflation concerns that you're seeing in the market? Thank you.

Udit Batra

Puneet, you asked two maybe three questions in one, I'll try to take them each in turn. First, in terms of the order book, it's extremely strong. We don't get specific numbers on the backlog. But it's higher than it's been in the past, you can safely assume that orders are growing faster than sales.

Now in terms of challenges that we're facing on supply chain on pricing, let's take a step back. We're not immune to those challenges like anybody else. Especially on the material side, where there are material constraints, what I would say on that front, having now extreme transparency into the primary, secondary, tertiary suppliers, deep sort of discussions with those colleagues in different companies. And the fact that we have a nimble organization here our size and our simple portfolio is a huge advantage. We're able to communicate any sort of changes rapidly through the organization through supply chain into commercial and be able to deal with it. And we've dealt successfully with any sort of disruption in Q3 and Q4. I'm not saying it was easy, but we've dealt with it, given the transparency and given the communication we have internally and externally with stakeholders. And by contrast, I think Q1 is like summer vacation versus Q4. So I'm not diminishing the topic, it's still with us. But we have developed that muscle.

And in terms of pricing and freight. Look, we've had about 100 basis points or so of pricing in 2021, you should expect, say 150 basis points give or take. But what I would like to emphasize here, this is not a willy-nilly transfer of pricing to our customers. We have, as I said many times very, very strong relationship with our customers, we have open discussions and wherever we see challenges, we discuss them. And there's a lot of understanding as we pass on some of the increases in pricing that we see. So I think I've addressed several of your questions. And Amol, do you to –

Amol Chaubal

I mean just to build on it, Puneet, as you know, I mean, our products are differentiated. And that's not just instruments. I mean, we have very innovative chemistry portfolio that the customers like. We have a great track record and a seamless service. And we have an informatics platform that's really valued by our customers. So that puts us in a great spot to have these discussions to with our customers walk them through what's happening in the market. And then internally, what we've done is, we're keeping a close eye on how prices are moving in the market, especially labor freight and electronic components. We are constantly training and educating our sales teams so that they are aware about what's happening on the operation side so that they can have productive dialogue with our customers. And through Q4. we've navigated that well and that gives us a lot of confidence going into 2022.


Our next question is from Jack Meehan with Nephron Research.

Jack Meehan

So strong end to the year on the chemistry front, was hoping you could comment more on customer ordering trends. Do you think there was any stocking benefit in the quarter or any quantifiable budget flush across the portfolio?

Udit Batra

Not really didn't see, I would say what we saw, of course, there's always a run up at the end of the year in this business. But I would say it's nothing unusual. And the way -- the reason I say that we're seeing similar trends persist into the year as well. So we're seeing really a continuation of what we saw towards the year end. And the orders, as we commented earlier, orders are outpacing the sales. So that gives us confidence that this is not sort of a big pull forward of any sort of products.

And when you look at Waters are specific reasons, right, so we can, and again, I'll draw your attention to the overall stacked growth numbers. We've basically ended the year with the second half being stronger than the first half of the year, overall for the year, it's roughly 7% stacked growth. Where instruments are roughly 6% growth, which is well above our historical averages. And, again, the same thing for consumables which are close to double-digit growth. This is, again, above historical averages, but there are Waters specific reasons driving both of those. So in both cases, we have commercial initiatives that have driven that and new products that have contributed.

So nothing really that one should look at as a blip. I mean, this is something that we expect to continue both the commercial as well as the new product momentum.

Jack Meehan

Great. And then just was hoping either you or Amol could comment on expectations for operating expenses in 2022. So gross margins of 58%, it'd be down something like 50 bps year-over-year, the op margin is more like flat. So just talk about the investments in R&D, and sales and marketing for 2022. What's the plan there?

Amol Chaubal

Yes, thanks. That's a great question. So as we get into 2022, our focus is to drive productivity gains through various different initiatives that are in place across service productivity, operational excellence in manufacturing, both direct and indirect procurement programs, as well as things like digitization and building capability center in India. And those will provide a great amount of space for us to fund the high growth adjacencies that we've talked about. And so net of that we think, as we've said at JPMorgan conference, allows us to deliver 20 to 30 basis points of year-over-year margin expansion. And that's what is embedded in our guide. So we've guided at 30% to 30.5% versus 30.2% for 2021. So at the higher end of the guide, you do get the 20 to 30 basis points that we had –

Udit Batra

I think just to sort of conclude the formula is very simple. I mean, we drive the top line with our initiatives, there's a lot of leverage in the P&L. And with the productivity initiatives, we make a bit more room. We're not skimping on the investments. We believe that these are really necessary and helpful for us to set up the future. And hence we deliver a 20 to 30 basis points increase in margin. So the idea is very simple.


Our next question is from Josh Waldman with Cleveland Research.

Josh Waldman

Hi, guys, thanks for taking my questions. First, Amol, I wonder if you could comment on how you're thinking about growth across instruments, consumables and service for 2022 or within your 2022 guide.

Amol Chaubal

Yes. Look, I mean, as we've traditionally seen, you would see service growth at the midpoint of the guide. Instrument growth is slightly lower than that and chemistry growth is slightly about that about two percentage points spread plus or minus.

Udit Batra

And Josh, not much different than what you would have seen in and how we exited 2021. So 7% stack rose with consumables being closer to double-digit, instrument being slightly lower at 6%, but well above historical averages.


Our next question is from Derik De Bruin with Bank of America.

Mike Ryskin

This is Mike Ryskin on for Derek. I'm going to ask two quick ones. First on the academic and government markets. didn't really touch on the prepared remarks. You guys had a little bit of a bounce back to end the year. But I know that can be super volatile and 2020 was an easy comp. So could you give us an update on what you're seeing in that probably more than the mass spec portfolio. But still is that end market across geographies, starting to come back to normal, or is there still some choppiness there?

And then, the quick follow is on M&A, the Megadalton deal. Most technology tuck-in, is that, something like that technology or an underlying platform deal, something we should expect going forward. Just given your leverage in the balance sheet, are you willing to look at bigger assets? Thanks.

Udit Batra

Thanks, Mike. On academic and government look, we're pleased with how we ended the year with a 5% growth. But it's still very choppy across the geographies and across the portfolio. We saw nice recovery in Europe, very much driven by our mass spec portfolio like so and there the businesses rather lumpy. So that said, what I'd rather focus on in that end market is what we're trying to do to establish a basis is reviving our KOL relationships. And recently I was with a KOL, who's been with Waters for a very long time, Head of our Proteomics Institute at one of the top medical schools in the U.S. And he basically said in no uncertain terms that have careers been sort of built together with Waters, especially on the mass spec side. So we are very optimistic on what we will be able to do in that market. But it's early days, right on the academic and government market.

And then on M&A, on the Megadalton deal, this is a very good fit. So for large novel modalities to characterize them better with mass spec, and we know mass spec really, really well. You should expect us to continue to look for such technology accelerators. But also, we're open to building our portfolio, as I mentioned earlier, both on the floor as well as the faster growth adjacencies wherever we find something relevant. But I will remind you that look, our core business is performing extremely well. And that is the number one focus to continue the commercial momentum, to continue delivering new products across our base portfolio. And as you noticed, across the LC portfolio, across the mass spec portfolio now informatics, we're seeing a drumbeat of new products that are adding on to the field. So the focus is on the core. And we are very open to looking at M&A that accelerates and sentence our position. Amol?

Amol Chaubal

I just wanted to add on the previous question, so on the academics and government, China is one area of focus for us because if you look at China, we grew on a stack basis in [indiscernible] constant currency, industrial stack 16%. But what brought it down was academics and government. And we are laser focused on revitalizing growth in that business. There are two parts to the problem, part of it is our own commercial execution, which we are focused on. But there's also drag from the VAT reimbursement issue, which we think will progressively resolve over the course of 2022.


Our next question is from Patrick Donnelly with Citi.

Patrick Donnelly

Udit, maybe just a follow up on Mike's question there in terms of M&A. You've mentioned the large [mall] [ph] strategy a few times, obviously, one, where you see investment [indiscernible]? I mean, how do you think about balancing organic versus inorganic investments in that segment? I mean, is the base business, do you feel like the technology isn't a good enough place to kind of go after some of those high growth areas? Or do you feel like it really needs to be supplemented in organically with some deals just curious on the strategy on that front?

Udit Batra

Patrick, I mean, it's a great question. I mean, we don't have a dogma there. But it always starts with what we know how to do. So we know how to do analytical measurements. And we've turned that focus towards larger molecules and more complex molecules both in the bioseparations arena, where there are significant challenges. Even if you take mRNA as an example, in aggregation and separation of these molecules. Lipid nanoparticles or plasmids, and there, we are perfectly capable of making a difference with our internal focus and collaborations with reagents companies and people who know how to do sample prep for biologics. So I think that for me, is the perfect combination. And on the bioprocessing side, we started with a partnership where we wanted our organization to learn the whole bioprocessing domain. And now we -- as we get a better understanding, we will surely be looking at augmenting our capabilities in Indiana on the analytical front. So you will not see us going and buying a bioreactor or a filtration company but you will see us looking at better analytical techniques to elucidate the structure and properties of these complex molecules, but it's a mix. So it's a heavy focus on organic investments, where relevant partnerships and where we see opportunities that beat up the separations of these molecules or as was characterized bioprocessing better, we will be active in the M&A space.


That does conclude our Q&A portion of today's conference. I will now turn our call back over to Mr. Udit Batra.

Udit Batra

Thank you. Thank you all for your participation and your questions. And on behalf of our entire management team, I'd like to thank you for your continued support and interest in Waters. We look forward to updating you on our progress during our first quarter 2022 call which is currently anticipated on May 3, 2022. Thank you and have a wonderful day.


This does concludes today's conference call. We thank you all for participating. You may now disconnect and have a great rest of your day.

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