Waters Corp (WAT) 2021 Q1 法說會逐字稿

Good morning. Welcome to the Waters Corporation First Quarter 2021 Financial Results Conference Call. (Operator Instructions) This conference call is being recorded. (Operator Instructions) It is now my pleasure to turn the call over to Mr. Bryan Brokmeier, Head of Investor Relations. Please go ahead, sir.

Thank you, operator. Good morning, everyone, and welcome to the Waters Corporation First 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'll provide guidance regarding possible future results of the company and commentary on the potential market and business conditions that may impact Waters Corporation over the second quarter and full year 2021.

We caution you that any and all such statements are only our present expectations 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 report on Form 10-K for the fiscal year ended December 31, 2020, and Part 1 under the caption Risk Factors and the cautionary language included in this morning's press release, included with respect -- including with respect to risks related to the effects of COVID-19 pandemic on our business.

We further caution you that the company does not intend to update any of its predictions or projections, except during our regularly scheduled quarterly earnings release conference calls and webcasts or as otherwise required by law. The next earnings release call and webcast is currently planned for August 3, 2021.

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 available on the company's website.

In 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. Unless stated otherwise, references to quarterly results increasing or decreasing are in comparison to the first 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, Water's President and CEO. Udit?

Thank you, Bryan, and good morning, everyone. Along with Bryan joining me on this morning's call is Michael Silveira, Waters' Vice President, Corporate Controller and Interim CFO.

I would like to start by expressing how grateful I am to our colleagues for their continued hard work and commitment, especially to those who are continuing to experience the devastating effects of the pandemic. We have not yet seen a uniform recovery as there are still many regions around the world that are being ravaged by the pandemic.

As many of you are aware, India is facing a particularly dire situation at the moment. Our colleagues and customers, they are very much on our minds, and we're working closely with our team in India to ensure safety of our employees and their families, and we're doing all we can to support our customers.

During today's call, I will provide you a brief overview of our first quarter operating results as well as an update on our 3-phase transformation plan focused on: Number one, regaining our commercial momentum; number two, further strengthening our organization with leadership and performance management; and number three, aligning our portfolio with growth areas.

Next, I will provide some thoughts on how our business is positioned to drive sustainable growth. Mike will then review our financial results in detail and provide comments on our updated second quarter -- on our updated second quarter and full year financial outlook. We will then open up the phone lines to take your questions.

Briefly reviewing our operating results. For the first quarter, revenue grew 31% as reported, 27% on a constant currency basis, and non-GAAP adjusted earnings per share grew 99% year-over-year. This strong start to the year was driven by growth across all end markets as we saw continued strength in pharma and earlier-than-expected recovery in non-pharma spending by our customers, new product traction and strong commercial execution by our team.

Looking more closely at our top line results. First, from a customer end market perspective, all our end markets grew double digits during the first quarter. Our largest market category, pharma, grew 28% in constant currency. Industrial grew 24% and academic and government grew 29%.

Moving now to our sales performance by geography. On a constant currency basis, sales in Asia grew 41%, with China up 109%. Sales in Americas grew 14%, with U.S. growing 13% and sales in Europe grew 25%.

From an operating segment perspective, our Waters division grew 26%, while TA grew by 28% on a constant currency basis.

Customer activity continued to improve in the first quarter with pharma leading the way, driving better-than-expected trends and recurring revenues, and a significant growth in instrument revenue. Recurring revenues grew 15%, with services growing 14% and chemistry consumables revenue growing 18%, driven by combined pharma strength and improved industrial demand.

LC instruments grew across all of our major geographies and market categories with more than 40% growth. It's encouraging to see both HPLC and UPLC instrument units grow double digits driven by pent-up demand, penetration of the Arc HPLC and strong execution of our LC replacement initiative.

The success of the launch of the Arc HPLC in the general purpose HPLC space cannot be understated, and the ACQUITY PREMIER has been received very well by customers since its February launch.

Mass spec sales were also strong in the first quarter with growth in excess of 50% as demand in the pharma market remained robust. In addition to rebounds, we saw in other markets, including clinical, food and environmental and biomedical research. Demand was solid for our tandem quads in Europe and China, particularly in pharma and in food.

Finally, to TA, revenue grew 28% as demand rebounded in the core industrial business and strength continued in pharma, medical devices and semiconductors. Growth was robust across all major geographies and product lines with particular strength in thermal and electro force.

Looking deeper at our sales performance by geography, all major regions grew double digits. China built further on last quarter's strength, more than doubling sales year-over-year. Results were strong across all end markets as China continued its recovery from last year's COVID disruptions.

Pharma was particularly strong in China, driven by triple-digit growth in both contract labs and traditional Chinese medicine.

Our food business in China also saw meaningful growth driven by a significant rebound in contract testing organizations to the level that were above those we saw in 2018 and in 2019. This is just one quarter and not indicative of a trend, but it demonstrates that the market is recovering and our execution has improved.

India sales grew double digits for the third consecutive quarter despite worsening conditions and continued pandemic challenges throughout the country.

Europe experienced broad-based strength across all customer end markets, including meaningful sequential improvements in both industrial and academic and government markets.

In the U.S., both pharma and industrial markets had strong growth in the quarter. While demand in our academic and government market remains soft, as it lags behind other markets in reopening.

In summary, we had a great start to the year with strong year-on-year growth that was broadly based than last quarter, with impressive performance across all our regions, end markets and product categories. Pharma demand has not subsided and many of our nonpharma markets are now in the process of recovering, which gives us greater confidence as we look to the remainder of the year.

Now I would like to talk more broadly about our business and its overall direction moving forward, including the strength of the company, the attractiveness of the markets that we serve and our deep commitment to innovation as we look beyond this quarter into the longer term.

Our 3-phase transformation plan is: Number one, regaining our commercial momentum; number two, strengthening our organization with leadership and performance management; and number three, aligning our portfolio with growth areas.

Looking at our first priority of regaining our commercial momentum, let me review some initiatives I mentioned previously. First, our instrument replacement initiative. We delivered a significant acceleration in instrument revenue growth to 45%. In February, we launched the ACQUITY PREMIER system, augmenting the already solid placement of Arc HPLC launched in June of 2020, creating new opportunities for instrument replacements. Additionally, we have gained traction with customers to replace aging tandem quad, mass spec instruments with newer instruments.

Second, as part of our CRO CDMO expansion initiatives, we've seen revenue growth accelerate to strong double digits in both these customer segments. Customers continue to perceive us as a strong technical partner as they transfer methods from originators, and they see us as a strong collaborator rather than a competitor.

Third, our e-commerce initiative has begun to deliver tangible results. Search engine optimization and paid search have led to search impressions that are up more than 40% year-on-year. While not every click translates to immediate revenue, increasing traffic is an important first step in our e-commerce efforts.

Fourth, driving launch excellence. Let me start with liquid chromatography. While the Arc HPLC is a leader in general purpose HPLC space, I want to focus on the ACQUITY Premier. Last year, we launched the ACQUITY Premier Columns and followed that up with the ACQUITY Premier System last quarter. Though we're still in the early stages of the revenue ramp-up for both the Columns and the System, sales of ACQUITY Premier Columns, are significantly outpacing prior successful chemistry launches, including the original ACQUITY Columns.

Turning to mass spec. In 2019, we launched the BioAccord, Cyclic IMS, SYNAPT XS, TQ-S cronos and a next-generation version of our TQ-S micro. Pairing our tandem quads with ACQUITY Premier creates industry-leading reproducibility and sensitivity for challenging assays. With expanding applications of the BioAccord, we've maintained our focus on bringing a versatile, easy-to-use and robust LC-MS system to the QA/QC space.

During Q1, we launched a full workflow for peptide multi-attribute method on the new waters_connect platform to enable the monitoring of quality attributes at the peptide level. This adds to already existing simple-to-use applications of peptide mapping, impact subunit mass analysis, released glycan profiling and oligonucleotide mass confirmation.

Over the last year, we established a BioAccord into the workflows for characterizing mRNA molecules that have since become vaccines. In fact, BioNTech recognized Waters for our support of its COVID-19 vaccine development and release efforts.

Lastly, Cyclic was launched in September of 2019 and is targeted at the most advanced high-resolution mass spec users. Augmenting traditional LC-MS with high-resolution ion mobility, allows us to separate molecules with additional -- with identical molecular weight based on their different shapes. This is now especially relevant for monitoring structural changes in the sugar pattern of the spike protein of the SARS-CoV-2 virus.

We do recognize that we still have a bit of work to do on our mass spec informatics applications, and we're addressing this through the development and rollout of our waters_connect software platform across our full mass spec portfolio.

Today, waters_connect supports biopharma characterization and monitoring workflows with a range of capabilities on the BioAccord, Xevo, QTof and Vion and with the launch of our RDa BenchTOF in Q1, waters_connect also enables small molecule workflows. We're grateful to have earned the trust and partnership with our customers as we develop further applications and beta test upcoming products and software.

Next from our TA Instruments division. Last year, we launched the X3 DSC, which offers unique advantages for routine high-throughput labs and R&D, especially in pharma, electronics and advanced materials. The ability of the X3 DSC to deliver high sensitivity measurements of physical properties more quickly than comparable products is enabling these measurements to be more broadly deployed in manufacturing processes where scientists can evaluate multiple formulations in parallel reducing time to market.

More time I spent with my R&D colleagues together, with our customers, the more impressed I am with the strength of our deeply, deeply technical culture.

Moving on to our second priority. You've already seen the planned leadership transitions we announced last month. Amol Chaubal will join us as CFO on May 12. Amol has deep experience in pharma and diagnostics and has led many transformations in his prior roles through both organic and inorganic growth.

I would like to sincerely thank Mike Silveira for his 4 months of service as interim CFO. Mike will continue to serve as our Corporate Controller, and I'm pleased to add that Mike will also assume the role of Chief Accounting Officer.

Secondly, we've established a dedicated Innovation Board, which I will share that includes leaders from R&D, business development and marketing. The Innovation Board will review unmet needs in markets we serve, assess technology proof of concepts and monitor the execution of top R&D programs.

Thirdly, I'd like to thank Mike Harrington and Ian King, our SVPs of Global Markets and Global Products, respectively, for their decades of dedication to Waters. Though their retirements are effective July 2, they've graciously offered to service consultants for a period of time to ensure a smooth transition.

Finally, we welcome our own Jon Pratt, as the leader of the Waters Division; Y. Jianqing Bennett will succeed Jon at the TA division. Both Jon and Jianqing have deep commercial and transformation experience in global leadership roles in fast-growing markets such as molecular diagnostics and bioprocessing. I'm really pleased with our new team, and I look forward to introducing them to you in the coming months.

That brings us to our third priority, aligning our portfolio with high-growth areas. While we won't take our eye off commercial execution, which remains our top priority, we have recently started our strategic planning process.

Now I'd like to share you -- share with you some high-level thoughts on where we are today. Our #1 priority is to continue strengthening the core, meaning LC-MS and materials characterization, instruments, informatics, service and consumables.

Second, its tapping into faster-growing adjacencies where we can bring our strength of managing compliant data without competing directly with our customers. These adjacencies include opportunities to increase our exposure to biologics, be it in reagents, other instrument technologies or bioprocessing, all in accelerating LC-MS into diagnostics or other high-growth markets.

Lastly, we will maintain our long-standing disciplined approach to financial management, capital structure and capital deployment as we are focused on maintaining a top-tier ROIC.

Over the coming year, I look forward to sharing more with you on our strategy as well as the data points that give us confidence that we have the foundation in place to sustainably grow in this attractive market.

With that, I'd like to pass the call over to Mike Silveira for deeper review of the first quarter financials and our outlook for the remainder of 2021. Mike?

Thank you, Udit. Good morning, everyone.

In the first quarter, we recorded net sales of $609 million, an increase of approximately 27% in constant currency. Currency translation increased sales growth by approximately 4%, resulting in sales growth of 31% as reported.

Looking at product line growth. Our revenue -- our reoccurring revenue, which represents the combination of precision chemistry products and service revenue, increased by 15% for the quarter, while instrument sales increased 45%. Chemistry revenues were up 18% for the quarter, driven by strong pharma market growth and improving industrial demand.

On the service side of our business, revenues were up 14% as customers continue to reopen labs and catch up on performance maintenance, professional services and repair visits.

As we noted on our last earnings call, reoccurring sales were impacted by 5 additional calendar days in the quarter, which primarily impacted service revenues. Looking ahead compared to 2020, there is no year-over-year difference in the number of calendar days for this year's second or third quarter. However, there are 6 fewer calendar days in the fourth quarter of this year.

Breaking first quarter operating segment sales down further. Sales related to Waters Division sales grew 26%, while TA Instruments sales grew 28%. Combined, LC and LC-MS instrument sales were up 47%, while TA system sales grew 34%.

Now I'd like to comment on our first quarter non-GAAP financial performance versus the prior year. Gross margin for the quarter was 58.2%, a 350 basis point increase compared to 54.7% in the first quarter of 2020, primarily due to an increase in sales volume and favorable FX.

Moving down the first quarter P&L. Operating expenses increased by approximately 9% on a constant currency basis and 11% on a reported basis. The increase was primarily attributed to higher labor incentive compensation cost and higher depreciation from IT investments we made over the last few years.

In the first quarter, our effective operating tax rate was 14%, an increase from last year, as compared to the comparable period -- included some favorable discrete items in the prior year.

Net interest expense was $7 million for the quarter, a decrease of about $3 million as anticipated on lower average outstanding debt balances.

Our average share count came in at 62.6 million shares, flat with the first quarter of last year. Our non-GAAP earnings per fully diluted share for the first quarter increased 99% to $2.29 in comparison to the $1.15 last year.

On a GAAP basis, our earnings per fully diluted share increased to $2.37 compared to $0.86 last year. A reconciliation of our GAAP to non-GAAP earnings is attached to the press release issued this morning.

Turning to free cash flow, capital deployment and our balance sheet, I would like to summarize our first quarter results and activities. We define free cash flow as cash flow from operations less capital expenditures and excluding certain special items. In the first quarter of 2021, free cash flow grew 60% year-over-year to $193 million after funding $40 million of capital expenditures.

Excluded from free cash flow was $14 million related to the investment in our Taunton precision chemistry operation. In the first quarter, this resulted in $0.32 of each dollar of sales converted into free cash flow. Our increased free cash flow was primarily a result of sales growth and better operating margins compared to the prior year.

In the quarter, accounts receivable days sales outstanding came in at 84 days, down 15 days compared to the first quarter of last year. Inventory decreased by $16 million in comparison to the prior year quarter on higher sales volumes.

Waters maintains a strong balance sheet, access to liquidity and a well-structured debt maturity profile. In terms of returning capital to shareholders, we repurchased approximately 600,000 shares of common stock for $173 million in the first quarter. These capital allocation activities, along with our free cash flow, results in cash and short-term investments of $810 million and debt of $1.7 billion on our balance sheet at the end of the quarter. This resulted in a net debt position of $893 million and a net debt-to-EBITDA ratio of about 1x at the end of the first quarter.

Our capital deployment priorities remain consistent: Investment growth; maintain balance sheet strength and flexibility; and return capital to shareholders. We remain committed to deploying capital against these priorities. And as Udit commented earlier, we have begun a new strategic planning process. As we continue to execute against our priorities, we will evaluate deploying capital to open up attractive and adjacent markets.

As we look forward to the remainder of the year ahead, I would like to provide some updated context on our thoughts for 2021.

One, while the business environment remains subject to volatility, we are seeing good momentum in our market segments, which will help us exceed the 2019 levels.

Two, we believe this momentum will continue into the second quarter, but that a strong double-digit growth will mostly occur in the first half of the year due to more challenging comparisons in the second half of the year and the 6 fewer calendar days that we will have in the fourth quarter.

Three, we continue to expect that all major geographies will perform better this year than they did in 2020, led by growth in China.

Four, our near-term growth initiatives are expected to continue to ramp, led by our LC replacement initiative, which we expect to contribute increasingly through our performance. These dynamics support updated full year 2021 guidance for constant currency sales growth of 8% to 11%. At current rates, the positive currency translation to 2021 sales growth is expected to be approximately 1 to 2 percentage points.

Gross margin for the full year is expected to be between 57.5% and 58%. Every year, we look to balance growth, investment and profitability. Accordingly, we expect 2021 operating margins of between 28% and 29% based on a combination of investments, the normalization of COVID-related cost and disciplined expense controls.

Moving now below the operating income line. Other key assumptions for the full year guidance are as follows: Net interest expense of $35 million to $38 million, a full year tax rate in the range of 14.5% to 15.5%. The net impact of our share repurchase program in 2021 that will result in an average diluted 2021 share count of 61.5 million to 62 million shares outstanding. Over the course of the year, we will evaluate our share repurchase program and provide quarterly updates as appropriate.

Rolling all this together, and on a non-GAAP basis, full year 2021 earnings per fully diluted share are now projected in the range of $9.85 to $10.05, which assumes a positive currency impact on full year earnings per share growth of approximately 3 percentage points.

Looking at the second quarter of 2021, we expect constant currency sales growth to be 14% to 16%. At today's rates, currency translation is expected to increase second quarter sales growth by approximately 3 percentage points.

Second quarter non-GAAP earnings per fully diluted share are estimated to be in the range of $2.15 to $2.25 as a significant prior year COVID cost savings actions start to normalize. At current rate, the positive currency impact on second quarter earnings per share growth is expected to be approximately 1 percentage point.

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

Thank you, Mike. In summary, there is much to be pleased about -- with our first quarter results, driven by strong growth across each of the major end markets with pharma leading the way. Thanks to solid execution and double-digit growth. In instrument sales, we saw broad-based revenue growth across every region, with China sales more than doubling.

Our transformation plan is well underway with commercial momentum and a strong leadership team in place. We now turn towards developing a new strategy as we work more closely to align our portfolio with higher growth areas of the market.

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

And our first question comes from Dan Brennan, UBS.

And congrats, obviously, on the strong start to the year. Maybe just looking at the guidance, Udit, if you don't mind, I know you talked about 6 less days in the fourth quarter and tough comps, but nonetheless, after a strong start and a good second quarter guidance, your full year guidance does imply something on the order of 1% growth in the back half of the year.

So maybe could you just tease out a little bit like what's going on with the back half? Like how much are you still assuming the pandemic is with us? Just any further color there because I would expect that will be a question that we're going to be getting.

Firstly, thanks, Dan. Look, we're very pleased with the first quarter. And as we look at the rest of the year -- I mean, as Mike also mentioned, the pandemic is still ongoing. That's the first consideration.

Second, we saw pent-up demand be released in Q1, which had 5 extra days. So that grew our base quite nicely. And the second half has a higher comps, which makes us prudent as we guide towards the full year.

Now of course, if our initiatives continue to do what they're doing, and we see good execution there, and the other end markets continue to improve, we would be on the higher end of that guide. So I think to me, it's prudent or, to use another word, a wise guidance, which basically takes these factors into a comp.

And then you talked about new product launches, particularly on the LC side. Is it possible tease out a little bit in terms of what impacts these are actually having, again, really strong 27% organic growth. But could you give us a flavor for kind of the impacts from these new product launches in the quarter and kind of what you're assuming kind of for the full year?

And then, if you can also make any comments on what you're seeing from the relative market share trend across LC and LC-MS?

Sure. I think, first, on new products. I'm very excited about our whole portfolio across LC, across mass spec, across informatics.

In terms of overall quantitation, I mean, I think as we look at the contribution, it's probably 2% to 3%. Is it a bit higher? A bit lower? I think you'd have do very sophisticated math, but it's 2% to 3% contribution. And that's quite impressive, especially on the LC side, given the launch just took place, right? So Arc HPLC was launched only in June of last year, smack in the middle of the pandemic, and that has had great uptake, especially in China for general purpose HPLC.

And then the ACQUITY Premier, the Columns were launched last year, and we saw, I would say, absolutely terrific uptake. In fact, better than the ACQUITY launch originally.

And then finally as I look at the mass spec growth, I mean, our replacement initiative is doing well, especially with the launch of our renewed tandem quad portfolio. So really lot to be excited about on the new product side.

And maybe if I could sneak one more in, just China, obviously, you up against an easy comp, down 45% or thereabouts, but 100% growth is certainly significant. Just how do we think about -- you were facing some unique challenges in China over the past couple of years in food and pharma. How do we think about the door -- like what's kind of expected from here as you -- as we think about the full 2021 guidance for China?

Yes. So look, I mean, super happy with China, especially given the pandemic is still not over, and our colleagues have really done a great job of implementing our initiatives, and some of that is contributing to the growth. I mean it's terrific growth across all segments, especially pharma, which doubled and then you saw industrial also grew very nicely. And academic and government was in the mid-70 percentages, right?

So with that said, what I would argue is, pharma is continuing to show strength. Industrial is also starting to get stronger, especially in the TA business. Academic and government on a stack basis still has some work to do, right? So we still want to make sure that we focus on it as the market recovers.

And then, I look at the portfolio side, instruments grew very nicely as you again saw from the prepared remarks. And the consumables portion of the business was in the mid-40s in terms of percentage growth.

Look, as I look at our -- the implementation of our initiatives that I mentioned earlier, they're contributing nicely. We singled out the food market in the past for commentary when we talked about transformation. So let me just comment on that.

We saw incredible growth in the contract testing market for food, both in the government segment and with new customers, right? Remember, I spoke about that when we talked about the transformation plan. And with the CDMO segment, some of our best performance is in China.

And then finally, I have a lot to thank in terms of our -- in terms of our leadership in China. We have a new leader in China and have really a renewed focus on growth. That said, I would caution against taking 2 data points of recovery and saying that we have completely turned the business. We still remain focused, but I'm very happy with the stock.

I think for you -- I didn't answer your question for the full year. Full year, I think no reason to expect anything less than high teens in China, and that will be a very good stacked growth as well versus last year.

Our next question is from Tycho Peterson, JPMorgan.

I want to follow up on the instrument growth, 45% on a 90% comp is just pretty impressive. I'm just curious, how much in your view was market pent-up demand versus some of the stuff you're intentionally driving the replacement cycle initiatives. You mentioned 2% to 3% from new products, so I get that. But how much came from new customer penetration, CROs, CDMOs? The main question we're all going to get is kind of the sustainability of what you're seeing right now?

Yes, yes. So Tycho, excellent point. I mean and I think there are many things to be happy about on the instrument side, right? I mean if we place more instruments, we get more consumables and more services down the line, and we saw a very nice recovery. It is a mix of everything, right? So we saw a recovery -- we've seen continued strength in pharma, but we also saw a nice recovery in industrials and also in academia.

In terms of the contribution, our initiatives have been doing extremely well. Our LC replacement initiative. And now we've added the mass spec initiative as well, is doing super well. And that is now being helped by the launch of Arc HPLC and the ACQUITY Premier, which are allowing us to focus both on the general purpose segment, but also on the UPLC segment.

So it's very difficult to extract how much is coming from -- going and finding only replacement and then how much is coming from the new products that are actually helping that conversation. So really added together, it's a very good performance.

And also, from a stacked comp basis, it's looking very good as you've already commented, I mean, LC is doing very nicely on a -- from a 29 basis -- from 2019 basis, and mass spec is almost double digits on that front. So really very happy with what we've been able to do on -- do with our initiatives.

And then finally, on the CRO, CDMO area, I mean, we have had incredible -- in fact, last Friday, I was with incredible conversations with CDMOs, especially, last Friday, I was with the CEO of one of the leading CDMOs. And they perceive us as very strong partners to help them transfer methods for complex molecules.

And this is something that has come more and more to the front and center globally as we talk to many of these customers. Of course, I mean, they're focused on costs. But even more importantly, they're focused on transferring these methods from originators.

So I think the initiatives are doing well, but there's a lot more to do there. We've just -- I mean, I would say, in terms of penetration of our instrument space, we're 30% along the way on mass spec. I would say, we're about slightly more than that on the LC side. So we still have fertile ground there to see more growth.

That's helpful. And then you mentioned the Innovation Board. I'm just curious, are there implications here in terms of how you're approaching R&D and what you want to spend in R&D. Should we assume kind of 6% or 6.5% sales are still the right bogey? Or how do you think about that?

Yes. I think Tycho, that question came up last time as well. We don't think of R&D in percentage terms. And being an engineer myself, and now surrounded by people in the Innovation Board, we really look at the quality of the ideas. And if the quality of the ideas are good and we see a market opportunity, we will invest behind it. So let me give you an example.

LC-MS for diagnostics, right? So we work very closely with the U.K. government on the COVID Moon Shot programme, and we were able to develop LC-MS for -- as a diagnostic tool for detecting pathogens. This is not going to be submitted as an IUO later -- mid this year or later this year. For research use only, at least, initially, but we see incredible traction in that area, and we are investing behind it. So those are the kinds of examples that come to the Innovation Board. And if we see room to invest, we will.

Second type of ideas where we invest our platforms, right? So I already mentioned from a commercial perspective, e-commerce, but also taking the disparate data that exists in the organization and putting them into a data lake, right?

So I would be loathed to tell you, hey, this is the ratio that we're trying to manage. Of course, it's a cost-conscious organization, as you know, from the past. We will not do silly things. At the same time, if we see good ideas that have good basis, we will invest behind them. So I hope that's satisfactory.

Okay. Yes, it is. And then just lastly on the model, I'm curious 5 extra days, could you quantify with that had in the quarter, was that around 300 basis points?

And then as we look ahead to the second quarter, given the tragedy on COVID in India, just curious how you're thinking about your exposure there in the second quarter?

Let me comment on India, and then I'll let Mike comment on the contribution of the extra days.

Look, I mean, our heart goes out to everybody who's going through the pandemic in India. We have still seen our customers, as you can imagine, continue to produce small molecules and large molecules to address the challenges of the pandemic. And so our sales are tracking that, and we're heavily focused on the LC market in India, which is still the method of choice to release small molecules that India continues to produce.

So we're seeing very good growth, very good access for our service engineers despite the pandemic. I do expect it to be bumpy, but the underlying demand, as we look at the full year, I would continue to rise. Mike, on the extra days?

Yes. On the 5 additional days, it added about 3% of growth to our reoccurring revenues in the quarter.

Our next question is from Vijay Kumar, Evercore.

Congrats on a really strong thing this morning. 2 from me, and maybe on the first one, I look at the guidance to 2Q, 14% to 16% constant currency, I mean, comps actually get easier for 2Q. If I look at the 27% you guys did in Q1, x days, it was about 24%. So can you maybe just walk us through the 24% to perhaps 15%, 16% for 2Q. Was there any timing element, which pulled forward from Q2? Or is this perhaps, like you said, prudent guidance?

Yes. I think, Vijay, you answered your own question. It's actually prudent guidance. I mean given that -- for the pandemic is still not over, there was a bit of pent-up demand that came also from last year into Q1, not a pull forward from Q2.

And then finally, I mean, our initiatives are ongoing. They've shown incredible traction. We're very happy with what's happening. However, I think they still are getting traction, right? I mean, despite the pandemic, we've seen good traction for our LC initiatives. We've seen good traction for e-commerce, where as you know, the page views have increased quite dramatically. We're seeing good traction and reaching out to new customers. But 2 data points don't make a full trend. So we're just being wise, to use another word. I think that would be the answer.

Understood. And then another guidance question. I guess simplistically, you guys feel Q1 EPS by about $0.70, right, and the annual guide was raised by about $0.50. Is there, I guess, from an expense standpoint, is this also perhaps prudent from an OpEx perspective? Or is there something else going on, on the spend perspective?

And Mike, on the Q1 300 basis points contribution from extra days. Should we assume a 300 basis headwind in Q4 given the fewer selling days?

Mike, go ahead on the EPS...

So from an EPS perspective, one thing to remember here is last year with the pandemic, we put in place many cost actions. For example, salaries were reduced, furloughs were put in place, spending was reduced throughout the corporation. We're going to experience a huge normalization for the rest of this year that will mitigate the growth of EPS.

I guess, say it another way, there's a ton of normalization that needs to happen this year.

As far as the gross margins, this margin, there was so much volume that led to a ton of operating leverage. So that will mitigate itself the rest of the year because of that normalization that I mentioned. So I would expect for the full year, we're going to get back to the 57.5% to 58%, but I don't expect it to be inconsistent with the past.

Got you. Sorry, on the days, is that a 300 basis points headwind in Q4?

Headwind? No. It'd be about a 3%.

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

This is Mike Ryskin on for Derik. I want to follow up on some of your comments earlier, Udit, on sort of the big instrument growth you saw in the quarter, and you gave a lot of prepared remarks on how you're able to drive some of the upgrades and replacements. I'm just wondering, if you could comment, how many of those were competitive? Or are replacing existing product? And you having a discount to drive upgrade there. Is there's any bundling across the portfolio? Sort of what are the puts and takes of that program that's helping you make those games besides the unit comps?

Yes. Sure. I think, look, it's virtually all of the above. But that said, look, let's start with -- especially for LC. I mean we have -- we focus on solutions for our customers. And as we go in, the new products definitely help. Our HPLC and the ACQUITY Premier, especially helped in having the conversation. Anything -- and we started the program first with our own installed base, then looking at the competitor installed base. And the third step would be to look at everybody and anybody who's using Empower, right?

So it's a pretty large pool and we have -- we are just, I would say, 1/3 of the way with our own instruments in terms of getting that replacement cycle done. So there's a lot of room there. That said, the conversation is more straightforward. If you have new products, especially the Arc HPLC as well as the ACQUITY Premier.

And then finally, given our reputation as a solid service company and our service engineers absolutely help. So I think the answer is in your question. It's all of the above.

For mass spec, we also -- we've also launched a similar program. And there, the success rates are absolutely terrific. We're going after our own installed base from a tandem quad perspective and replacing the older instruments with the newer generation of tandem quads that were introduced in 2019. So nice progress.

Some of it is the market, but I think a significant amount is our renewed focus on the replacement cycle of older instruments, helped by new products and a broader value proposition.

As far as pricing and bundling, except pricing is concerned, we have not had to use heck of a lot of pricing to make this happen. People trust the quality that Waters brings and the innovation that we're bringing to them to solve these problems.

Got it. I appreciate all the color. And then as a follow-up, on the -- you mentioned the strategic review process, one of the areas you're thinking about is some of these faster growth adjacencies. Are there any opportunities here that you see organically? Or is this sort of part of the strategic review the volume is going to be handled through M&A, obviously recognizing again the really good leverage position you're in?

All of the above, right? So we will have organic initiatives, we will have partnership opportunities, and we will look at inorganic options as well, right? So all of the above.

From an organic standpoint, I can give you examples. We think the molecular diagnostics space is interesting, and LC-MS is ripe to get into that space. We've made really serious progress in working closely with many academics in the U.K. and the NHS to take LC-MS into the diagnostic space for pathogens with COVID-19.

We also worked with folks in Sweden on the same topic. And we will introduce LC-MS as a research-use only technique rather in the near future. So organically, we see tremendous opportunity as well.

And another example would be entering bioprocessing. We're looking at partnerships with leading academic institutions and many of our partners to take LC-MS into the bioprocessing suite and not just leave it in the QA/QC space where we still have room to grow.

And then finally, on inorganic areas, we're looking at that very, very carefully, and there'll be more to say about it as time progresses. So all of the above.

Our next question is from Doug Schenkel with Cowen.

I want to ask one end market question and then one guidance question. On the end markets, specifically industrial cyclical, recognizing all end markets were pretty solid, I'd love to hear more about what you're seeing in terms of the pickup in cyclical demand. How does that evolve over the course of Q1? And are there signs that demand is picking up in a sustainable way that -- meaning this just isn't a catch-up. It is actually a function of global economic improvement. And if you're seeing signs of that as exemplified for things I think like backlog, are there certain geographies where this is more or less notable? So that's the first topic.

A second topic is just, again, sorry to go back to guidance, but specifically, below the top line as we think about operating spend. When I look at our model for Q1, R&D and SG&A, together, were about $10 million below our forecast. And I think we were at the high on The Street for revenue, and it came in $50 million above our forecast. So that was really nice leverage in the model.

I'm just wondering, was there any holdback on investment in the early part of the year, just given all the uncertainty because it doesn't seem like you're looking at this as the new normal. I say that because it seems like guidance assumes there's going to be an increase in operating investment moving forward over the balance of the year, which I think makes sense, given the strength in your business and some of the initiatives you talked about in your prepared remarks, Udit.

So I guess I'm just hoping you can provide some clarity there. It seems like Q1 operating leverage isn't the new normal just because you want to invest. I just want to make sure we got that right.

Excellent questions, Doug. First, on the other 2 end markets, industrial and academic and government, I think you rightly note that it is one quarter, and we are seeing a nice rebound. I'm cautious here, right? So we're seeing good conversations with our customers, but the industrial end markets are disparate, right?

I mean, they go from polymers to semiconductors and other areas, which inherently are cyclical. We're seeing good demand for hardware, especially on the TA side. But that said, I would say it's one quarter. We're seeing good conversations. I would not start to immediately extrapolate, and this is why we're a bit cautious on prudent on the guidance.

On a stacked growth basis, when you look at specific regions, I think, China is almost 20%. Europe is in the mid-teens in industrial, and the U.S. is mid-single digits. So even on a stacked basis, this is a good performance on the industrial end market, but largely driven by a lot of hardware spend.

Now on academic and government, which is also cyclical, I know you were not asking in particular, but I'll take the opportunity to comment on this already.

We saw very good growth, I mean, 29% growth overall, largely driven by what we saw in China. And Europe continued its strength, close to 70% growth. The U.S. is still spotty and recovering. On a stack basis, there's still work to do on China and the U.S. I mean both are still not positive versus 2019. Europe is. So I think industrial, a little bit more confidence in the overall trend.

With academic and government, we're seeing slow return back into the different labs more so in Europe. Definitely in China, but still a bit of hill to climb, and Europe is spotty -- and U.S. is spotty across the country.

If I move to your guidance question, I will first give you the qualitative remark and then Mike can comment on the numbers as well. We're not holding back any investment, Doug. And in fact, if you look at how much we have approved in terms of operating investment, it's fairly significant in Q1 to start -- to support our initiatives that we already mentioned. So expanding our field force and contract testing, having more informatics folks to build up waters_connect even further and to invest behind our R&D programs. I mentioned, LC-MS already, and there are several others. It's just a question of the recruiting cycle taking a bit of time and people finding the right people and getting them into the system. So really not holding back there at all.

Mike, do you want to comment on the numbers?

Sure. I will just add with the strong customer demand that we're actually seeing, we have started to make the investment into the P&L, but all of those expenses haven't hit our Q1 P&L. So you are going to see some increase in expense as we move through the rest of the year, that catches up with these initiatives that Udit was referring to. This is gated process. And we do look at the projects one on -- we do look at each of the products' initiatives, and depending on what it is, and we navigate the process, we make sure it makes sense before we actually start the process. So it is a gated process, and we will expect not -- the leverage to be not as good as it was in Q1 the rest of this year.

And then I think one closing remark on that, Doug, just reminding you how we talked about the transformation plan. We said, look, we want to get our top line growth back first. This is such a great business and such a good installed base. There's tons of leverage in the P&L that allows us to invest without any dilution. And you're seeing the sustainability of the business as we recover our top line. And it's not just versus last year, Q1. It's also on a stacked basis across many different segments and geographies.

Our next question is from Brandon Couillard with Jefferies.

In terms of some of your e-commerce initiatives, are you starting to see any incremental pull-through in terms of consumables revenue that you quantified? And kind of what's next in terms of the e-commerce strategy and some of those initiatives over the balance of the year?

Brandon, thank you. From an e-commerce, basically, with just engine optimization and paid search, we saw a 45% increase according to our own numbers, and I know you look at it independently as well on the number of eyeballs coming on to our site. It's very difficult to translate that, as you know, into the exact impact on revenues. So I won't attempt that, but it's -- you can imagine the largest impact is on the consumables side. And especially with newer products, it's worked out extremely well, having the ability to drive more people on to the channel, find out more information, leading to purchase and a great uptake for our ACQUITY Premier launch.

Now in terms of the overall plan for e-commerce, I mean, this is just the start, right? So remember, I said early on, that we want to take the hand we have and do the best we can with it at the beginning as we make our plans to revitalize our platforms. And I mentioned a couple of those investments in the previous question as well.

So we do believe that investing in a data lake that takes all unstructured and structured data from different parts of the organization and putting that into an easily accessible middle layer will help us service our e-commerce customers better.

We do believe investing in content even more is going to lead to better conversion on the e-commerce channel. We do believe investing in mobile is going to lead to a better conversion. So you can see that there are some infrastructural investments that we have started to look at. And as the organization becomes stronger and stronger, we'll start -- you'll start to see us invest in those. So the e-commerce plan as a few phases, the first one was just to get the quick wins, and we're not done with that yet. That's just a start. And there is a long-term plan that will build a world-class e-commerce platform for Waters. Hope that helps.

Our next question is from Patrick Donnelly with Citi.

Great. Udit, just want to follow up on one of your earlier questions about the capital deployment side. It seems you're a bit more open about pursuing some inorganic opportunities. Can you just talk about size that we should be thinking about how large you guys will go? And then again, what verticals make the most sense for you guys to pursue inorganically versus the organic investments you reckon?

Patrick, you know that I won't take -- I won't talk too much about the size and the exact ideas and the exact domains. I mean in general, you can assume that the part of the market we're in is a good mid-single-digit grower. I mean we have a bit of catch-up to do. So you'll see us doing better than that in the short to midterm, given the initiatives we've put in place and the market share we've had to -- we want to climb back and gain, right? So I think that will be the first lift.

As you look at adjacencies, there are ones that fundamentally grow faster, like molecular diagnostics, like bioprocessing and bio reagents. And we're looking at each of those categories to see how we can organically enter those, how we can do partnerships and also looking at inorganic ideas. I mean the process has begun and you'll hear more about it as we progress further with concrete ideas.

Our next question is from Josh Waldman with Cleveland Research. .

Wondered if you could provide more color on the replacement initiative. I guess, what inning do you think we're in here? And I think I remember you previously saying there were about 8,000 systems that you're targeting. Is this still how you're thinking about the opportunity? Or has that number gone up?

And then, I guess, lastly, do you think it's driving replacement of only your systems? Or at this point, are you seeing it replace maybe competitor systems? It just seems like growth of 40% in the LC business is probably representing share gains.

Yes. Thanks for picking that up, Josh. Look, LC -- the 8,000 number was HPLC and UPLC only, and especially only Waters instrument. And when you talk about innings, if you're talking about baseball, probably we're in the third inning. There's a lot more work to do and lot more to pick up there.

And we haven't done that in the past. We haven't replaced our own instruments. So I mean, we are going in, and it's working out super well, especially with the new products being available as well, both on the HPLC side and UPLC side. So we're very happy with where we are there.

To your question on competitor instruments, definitely, that's the second step. And then there's a third step, everybody and anybody who's using Empower, that probably also hits the competitors there. So there's a large installed base. And any time somebody is trying to replace an HPLC or UPLC, you should expect Waters to be in that conversation, especially -- and this is especially important given that Empower is installed as the most ubiquitous CDS system. So we are going to leverage the strength of Empower to try and make sure that we have a seat at the table virtually everywhere.

The second thing that I wanted to add is from an instrument perspective, I mean, don't forget mass spec. Mass spec also has an older army of instruments that we've sold over many years. And there, too, we completely renewed our tandem quad portfolio in 2019, and we're using that to get in and have conversations with our customers. So that also -- that probably is in your baseball analogy in the first innings. And that's also started off very well.

So expect to hear more as the year progresses, and we do intend to make sure that, that continues and gets tracked very carefully.

And the last piece on that, that I'll add, this is also to a previous question on the areas we're investing in. We've invested in basically collecting all the data that we have on the installed base, be it Empower-based, be it instrument-based and of course, to automate it and to make it readily usable, you need to invest in technology, and that's what we're doing. So I hope that gives you more color.

And our last question today comes from Catherine Schulte with Baird.

Congrats on the quarter. I guess, first, Udit, you made a comment in your prepared remarks on the CRO and CDMO side that your customers view you as a collaborator rather than a competitor. Now just given some of the M&A we've seen in the space, do you think that's a concern among customers that some of the analytical instrument providers are increasingly becoming customers? And do you see this as a competitive advantage that you can take advantage of?

Yes. I mean, we are definitely hearing that. I mentioned conversations I've had with heads of CDMO organizations. This is front and center. I mean they view us as a collaborator who they can trust with their methods, with their ideas. And I think this is something that we're definitely hearing, and we intend to take -- we intend to service our customers accordingly, right? So I think you heard right.

And especially, I would even argue, especially given Waters' technical strength and unique focus on science and technology. I mean they view us as people who can help them transfer methods, get deeper into the -- deeper with them into technical conversations and are not worried about us competing or using their technology for our own purposes.

So I would say, quite a benefit, but 2 drivers. One might be what's happening in the competitor universe, but the other is our own reputation as strong scientifically based organization.

At this point, I want to thank you for your participation and questions. And on behalf of our full 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 Q2 2021 call, which we currently anticipate to hold on August 3, 2021. Thank you all.

And thank you. This does conclude today's conference. You may disconnect your lines. And thank you for your participation.