Waters Corp (WAT) 2020 Q4 法說會逐字稿

Good morning. Welcome to the Waters Corporation Fourth Quarter 2020 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 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 and full year 2021. We caution you that all such statements are only our present expectations and that actual events or results may differ materially from those indicated in our 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, 2019, in Part 1 under the caption Risk Factors and our most recent quarterly report on Form 10-Q for the quarter ended September 26, 2020, in the Part 1 under the caption Risk Factors, both of which are on file with the SEC as well as cautionary language included in this morning's press release, 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 May 5, 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 fourth quarter of fiscal year 2019. 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?

Thank you, Bryan, and good morning, everyone. Along with Bryan joining me on this morning's call is Mike Silveira, Waters' Vice President, Controller and Interim CFO. Some of you may already know Mike, who has been a part of the Waters finance organization for 16 years. And I'm happy to have him joining me on this morning's call.

I would like to start by thanking our employees around the globe for their hard work and dedication through what has been an extraordinarily difficult year. It is one that has brought significant change and sacrifice. From navigating the pandemic and resulting short-term cost-saving initiatives earlier this year to changes in leadership, the Waters team has responded with drive, determination and an indomitable spirit. I am impressed by and grateful for our team's resilience and commitment to our customers and to each other.

During today's call, I will provide a brief overview of our fourth quarter and full year operating results as well as an update on the stabilization that we have seen in the LC market and a few factors influencing our thinking for 2021. Mike will then review our financial results in detail and provide comments on our first 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 fourth quarter, revenue grew 10% as reported, 7% on a constant currency basis, and adjusted earnings per share grew 14%. For the full year, revenue declined 2% and adjusted earnings per share was up 1%. This strong finish to the end of a challenging year was driven by the pharmaceutical market improvement, capital spending recovery in the second half of the year, strong execution and early contributions from our near-term growth initiatives.

Looking more closely at our top line results. First, from a customer perspective. Our largest market category, pharma, was the primary growth driver in the quarter with 15% growth. Our industrial market grew 5%, while academia and government declined 15%.

Now to geography. On a constant currency basis, sales in Asia were up 12%, with China up 19%. Meanwhile, sales in the Americas grew 3% with the U.S. growing 4%, and European sales grew at 6%.

From a product perspective, our Waters-branded products and services grew approximately 8%, while TA declined by around 1% on a constant currency basis.

While still navigating the global pandemic, we are seeing clear signs of improving customer activity, positive growth trends in our recurring revenues and an evidence of stabilization in LC instrument demand. Services grew 10%, while consumables business grew approximately 14%, driven largely by global pharma strength, including sales of our recently launched PREMIER Columns, which performed exceedingly well in the first quarter on the market.

LC instruments grew most -- grew across most of our major geographies with high single-digit growth. This improvement in capital equipment purchasing reflects the combination of the return of some of the planned capital spending that was delayed from the first half of the year, a normal pharma year-end budget flush and early contributions from our LC replacement initiative.

Following last June's release of the Arc HPLC System in the core HPLC market, with a particular focus on the small molecule development and QA/QC space, we look forward to the continued expansion of our liquid chromatography portfolio.

On February 10, we will launch ACQUITY PREMIER, a next-generation UPLC system that offers customers an extraordinary breakthrough in efficiency, sensitivity and overall capability. This new system will benefit both large and small molecule discovery and development as well as biomedical research. This new system has even more profound benefits when paired with our ACQUITY PREMIER Columns, which I mentioned earlier and were launched in the fourth quarter. The combined solution will alleviate nonspecific binding absorption losses and provide a significant leap forward with enhanced reproducibility, reduced passivation and an increased confidence in analytical results.

After a very strong third quarter, mass spec sales were about flat in Q4. As you know, the mass spec business can be lumpy, which we saw with biomedical research. There are -- there was also a general softness in clinical diagnostics as budgets were diverted to COVID-19 testing. Notably, however, mass spec sales to pharma customers grew double digits, driven by the strong double-digit growth of both BioAccord and the QDa.

Finally, QDa, revenues declined low single digits, which was much improved from earlier in the year. We saw the core thermal business start to pick up, driven by market improvement in Asia. In particular, life sciences, including pharma and medical devices, grew double digits. Combined, these comprised approximately 10% to 15% of TA's total revenues. However, this was not enough to offset declines from TA's industrial customers.

Looking now at our geographies, all major regions grew. The Americas grew low single digits, Europe grew mid-single digits, and Asia grew double digits. In the U.S., the growth was driven by pharma, which was partially offset by declines in material science, environmental and academic and government. Though Latin America continued to decline, it improved meaningfully relative to earlier in the year.

Europe also experienced strong pharma performance, partially offset by material science, food and academic and government. In both U.S. and Europe, pharma growth was broad-based, including strength in big pharma, large molecule customers, generics and contract labs.

China had an impressive quarter with strong double-digit growth, driven by continuing acceleration in pharma as well as strong environmental growth. The pharma growth was driven by both small and large molecule customers, including particularly strong growth at contract labs. India also continued to grow double digits.

In summary, overall, in the fourth quarter, we saw further relative strength in the market and benefited from strong year-end spending trends. Now for the year, our pharmaceutical market category achieved 1% growth with the U.S., Europe and India all seeing positive growth. Industrial declined 3% for the full year, and academic and government declined 16%. Notably, our pharma market category grew 10% in the second half compared to the first half decline of 8%, owed in part to strength in small molecules, the industry recovered from lockdowns. Industrial also grew in the second half at 4%, while academic and government declined 12% compared to the first half declines of 10% and 22%, respectively.

Geographically, for the year, Asia sales were down 4%, with China sales down 8%. Sales in Americas were down 4%, with the U.S. down 2%. Europe sales were up 2%. Notably, all our major geographies grew in the second half of the year, with the U.S. up 4% and Europe up 6%, following first half declines if 9% and 3%, respectively. Our China market grew in the second half, up 11%, reversing much of its sharp 31% decline in the first half of the year.

Now I would like to share some of the progress we've made in our transformation program as several of the initiatives we're putting into action are starting to contribute to growth. First, I will talk about our instrument replacement initiative, then our progress in contract lab expansion, followed by e-commerce. And lastly, I'll give you a BioAccord update.

First, as it relates to our instrument replacement initiative, which is the most advanced initiative underway, we delivered our first quarterly LC instrument revenue growth in 2 years, and our LC instrument win/loss was the highest it has been in 3 years. Initial customer feedback has been very positive on the Arc HPLC as well.

Second, as part of our contract lab expansion initiative, we have made important progress in targeting this high-growth customer group. We have contacted a number of customers globally, particularly in China and have strengthened our value proposition with expanded alternative revenue and service offerings, which have been well received by this segment. It is still early days, but we're pleased with the progress we're making.

Third, our e-commerce initiative is still in the early stages, but waters.com traffic is up double digits, driven by search engine optimization and paid search. While there isn't a 1:1 relationship between traffic and revenue, increased traffic is an important first step in driving revenue growth through the e-commerce channel.

In tandem with our e-commerce actions, we've also enhanced our e-procurement platform, on which we have expanded our coverage of customers, leveraging this channel. This supported strong e-commerce -- strong e-procurement growth, indicating that it's now easier to work with Waters.

Fourth, driving launch excellence. BioAccord sales exceeded expectations in the quarter as our market development efforts and our specialist sales model have started to take effect, particularly in the U.S. and Europe. Many customers are increasingly adopting BioAccord for manufacturing and several have placed follow-on orders. Once we get BioAccord applications on an enterprise software platform, we believe we will be seeing more follow-on orders. More importantly, customer activity continues to be encouraging, which makes us optimistic about 2021.

Lastly, I'd like to highlight our efforts to help mitigate the public health crisis. In addition to the significant efforts by our innovation response team, we're encouraged to see Waters consumables specked in on QA/QC methods for COVID vaccines and therapeutics. We're also seeing an uptick in COVID-driven demand for our instruments and consumables. This peaked in the fourth quarter, where COVID revenues contributed an estimated 1 to 2 percentage points to the growth, driven by those pharmaceutical customers developing COVID vaccines and therapeutics, who saw meaningfully higher growth than manufacturers that don't have COVID-related programs.

In summary, as I wrap up for 2020, we've done a great job at keeping our employees safe and our operations running. Our teams are focused not only on getting products out the door, but we have also assisted our customers engaged in COVID-related efforts. Meanwhile, our base business is showing signs of recovery, and our transformation is well underway.

Turning to 2021. While the business environment remains uncertain, we look forward to building on the fourth quarter momentum. Mike will provide further details on our outlook for 2021, which is based on 3 key factors.

One, we're assuming a gradual improvement in customer activity led by the pharma market. Two, we expect all major geographies to perform better than they did in 2020 led by growth in China. Lastly, our near-term growth initiatives are expected to continue to ramp up, led by our LC replacement initiative, which we expect to increasingly contribute to performance.

With that, I'd like to turn the call over to Mike Silveira for a deeper review of the fourth quarter and 2020 financials and our outlook for 2021. Mike?

Thank you, Udit, and good morning, everyone. In the fourth quarter, we recorded net sales of $787 million, an increase of approximately 7% in constant currency. Currency translation increased sales growth by approximately 3%, resulting in sales growth of 10% as reported. For the full year, sales declined about 2% in constant currency and as reported.

Looking at product line growth. Our reoccurring revenue, which represents the combination of precision chemistry products and service revenue, increased by 11% in the quarter, while instrument sales increased 4%. For the full year, reoccurring revenue grew 3%, while instrument sales declined 9%. Chemistry revenue were up 14% in the quarter, driven by strong pharma growth. On the service side of our business, revenues were up 10% as customers continued to reopen labs, catch up on performance maintenance, professional services and repair visits.

As we noted last quarter, reoccurring sales were impacted by 2 calendar -- 2 additional calendar days in the quarter, which resulted in a slight increase in service revenue sales. Looking ahead, there are 5 additional calendar days in the first quarter and 6 fewer calendar days in the fourth quarter of 2021 compared to 2020.

Breaking fourth quarter product sales down further. Sales related to Waters-branded products and services grew 8%, while sales of TA branded products and services declined 1%. Combined LC and LC-MS instrument sales were up 5%, while TA system sales declined 4%.

Now I'd like to comment on our fourth quarter and full year non-GAAP financial performance versus the prior year. Gross margin for the quarter was 59.2%, an increase compared to the 58.2% in the fourth quarter of 2019, primarily due to the higher sales volume and FX. On a full year basis, gross margin was 57.4% compared to 58% in the prior year on lower overall sales volumes in 2020.

Moving down the fourth quarter P&L. Operating expenses increased by approximately 6% on a constant currency basis and 8% on a reported basis. The increase was primarily attributed to variable expenses related to the strong sales performance. For the year, operating expenses were 1% lower before currency translation and flat after.

In the quarter and for the full year, our effective operating tax rate was 14.9% and 14.8%, respectively, an increase from last year as the comparable period included some favorable discrete items. Net interest expense was $7 million for the quarter, a decrease of about $3 million, as anticipated on lower outstanding debt balances.

Our average share count came in at 62.5 million shares, a reduction of approximately 3% or about 2 million shares lower than in the fourth quarter of last year. This is the result of shares repurchased through the end of the first quarter of 2020, subsequent to which we paused our share repurchase program.

Our non-GAAP earnings per fully diluted share for the fourth quarter increased 14% to $3.65 in comparison to the $3.20 last year. On a GAAP basis, our earnings per fully diluted share increased to $3.49 compared to $3.12 last year. For the full year, our non-GAAP earnings per fully diluted share were up 1% at $9.05 per share versus $8.99 and last year. On a GAAP basis, full year earnings per share were $8.36 versus $8.69 in 2019. 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 fourth quarter results and activities. We define free cash flow as cash from operations less capital expenditures and excluding special items. In the fourth quarter of 2020, free cash flow grew 52% year-over-year to $240 million after funding $47 million of capital expenditures. Excluded from free cash flow was $19 million related to the investment in our Taunton precision chemistry operation. In the fourth quarter, this resulted in $0.30 of each dollar of sales converted into free cash flow. For the full year in 2020, free cash flow generation was $726 million after funding $172 million of capital expenditures. This represents a 26% increase and $0.31 per dollar of sales converted into free cash flow.

Excluded from free cash flow was $70 million related to our investment in our Taunton chemistry operation and a $38 million transition tax payment related to the 2017 U.S. tax reform. Our increased free cash flow is primarily a result of our cost actions -- cost-saving actions and improvements in our cash conversion cycle.

In the fourth quarter, accounts receivable days sales outstanding came in at 70 days, down 7 days compared to the fourth quarter of last year. Inventories decreased by $16 million in comparison to the prior quarter -- prior year quarter, reflecting stronger revenue growth and revised production schedules.

Waters maintains a strong balance sheet, access to liquidity and a well-structured debt maturity profile. We ended the quarter with cash and short-term investments of $443 million and debt of $1.4 billion on our balance sheet at the end of the quarter. This resulted in a net debt position of $913 million and a net debt-to-EBITDA ratio of about 1.1x at the end of the fourth quarter.

Our capital deployment priorities remain consistent: invest for growth, balance sheet strength and flexibility and return of capital to shareholders. We remain committed to deploying capital against these priorities. As such, our Board of Directors has approved a 2-year extension of our January 2019 share repurchase authorization that was set to expire last month. As of today, we have $1.5 billion remains available under the program for share repurchases.

As we look forward to the year ahead, I'd like to provide some broader context on our thoughts for 2021. The business environment remains uncertain, and we are assuming a gradual improvement in customer activity led by the pharma market. We expect all major geographies to perform better than they did in 2020, led by growth in China. Our outlook does not anticipate a return of lockdown seen in 2020. We had a 1% tailwind from COVID-related revenue in 2020, 3 quarters of which was in the second half of the year. We expect a similar revenue impact in 2021, including a 1% to 2% growth tailwind in Q1. We anticipate the first half growth tailwind will moderate through the remainder of the year. Improved execution on our near-term growth initiatives contributed to our fourth quarter growth, but the quarter also benefited from capital spending that was delayed from the first half into the second half of the year, which we don't expect to continue in 2021.

The second half of 2021 will have to contend with a challenging comp resulting from a revenue shift that took place in 2020. These dynamics support full year 2021 guidance for constant currency sales growth of 5% to 8%. At current rates, the positive currency translation to 2021 sales growth is expected to be 1 to 2 percentage points.

Gross margin for the full year is expected to be in the range of 57.5% to 58.5%. Every year, we look to balance growth, investment and profitability. Accordingly, we expect 2021 operating margins of 28% to 29% based on a combination of growth investments, normalization of COVID-related cost actions and disciplined expense controls.

Moving now below the operating income line. Other key assumptions from our full year guidance are: net interest expense of $35 million to $38 million; a full year tax rate of between 15% and 16%, which includes our new 5-year tax agreement with Singapore that will expire in March 2026; a restart of our share repurchase program in 2021 that will result in an average diluted 2021 share count of 61 million to 61.5 million shares outstanding. Over the course of the year, we will evaluate share repurchase program and provide quarterly updates as appropriate.

Rolling all of this together, on a non-GAAP basis, full year 2021 earnings per fully diluted share are projected in the range of $9.32 to $9.57, which assumes a positive currency impact on full year earnings per share growth of approximately 3 percentage points.

Looking at the first quarter of 2021, we expect constant currency sales growth to be 7% to 10%. At today's rates, currency translation is expected to increase first quarter sales growth by approximately 3 percentage points. First quarter non-GAAP earnings per fully diluted share are estimated to be in the range of $1.50 to $1.60. At current rates, the positive currency impact on first quarter earnings per share growth is expected to be approximately 15 percentage points.

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

Thank you, Mike. In summary, we're pleased with our resilience in the second half of 2020 and the strong finish to the year, which is a true testament to the determination of this team. Though the environment remains variable, pharma markets have shown resilience, and our transformation program is already demonstrating results and contributing to growth. Despite the challenging environment, the progress we've made as an organization over the last 5 months is nothing short of extraordinary. I remain ever more confident in the team, our portfolio and our market position. There remains a lot of work to do, but we have a tremendous opportunity in front of us to turn the business around.

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

(Operator Instructions) Our first question comes from Vijay Kumar from Evercore ISI.

Congrats on a good sprint here. Udit, I guess, when you look at the revenue guidance here, I appreciate the color on COVID tailwinds, what is -- I guess, on a go-forward basis, when you think about some of the growth initiatives that you guys are making, is Waters now 5% or 7%? Maybe perhaps talk about what the medium-term outlook would be for the company.

Thank you. Thank you, Vijay. And first, let me say I'm super pleased with how we've finished the year. Looking ahead, I think we've guided about -- we've guided, I think, more prudently than not. I think we have, I would say, we expect the basis of the guidance for the full year, which is about 5% to 8% is continuing strength in pharma. And if -- and there are 3 factors, if they go better, would tend towards the higher end of the guidance, both in the mid -- in the short and the midterm. First, recovery of the other markets beyond pharma. Second, continuing tailwind from our COVID -- from COVID-19 programs where we've seen our products specked in. And third, even more stronger contribution from our turnaround program.

So I think I would simply say the guidance is prudent, and we see several triggers that should allow us to get on the higher end, if they turn in the right direction.

Got you. And then one quick follow-up on margins, Udit. Will it -- I know there's been some debate, if you will, on the margin reset for the company. Is -- I guess, when you look at the -- and correct me if I'm wrong, I think I heard 28% to 29% margins for fiscal '21. Is that the new base? And now should Waters be expanding margins off of the new base?

So Vijay, I think you're looking at it probably much too closely. It's actually rather simple. The cost actions that we have taken in 2020 come back into the base, and then that should allow us to go from there further on. But Mike, did you want to provide more color on that?

Sure. I could. So definitely, our operating margins are being impacted by the normalization of those cost actions that were put in place in the second quarter as a result of the COVID-19 pandemic. These costs were temporary, and they included furloughs and salary reductions, but they have been restored already, and we're already seeing that benefit the sales growth. So it will put a drag on our 2021 operating margins. But as we return to growth and we return to more of our historical geographic and product mix in the future, we believe that our margins will get back to those historical levels and maybe even expand if we can get above the higher level of our guidance.

Fantastic, guys. Congrats on a nice sprint here.

And our next question comes from Derik De Bruin from Bank of America.

A couple of questions. I guess the first one, could you talk a little bit more about the LC cycle and some of the benefits of the PREMIER? And specifically, I'm also just curious about what of your pharma installed base is Alliance versus your various ACQUITY generations and what's actually potentially amenable to upgrade? I just -- basically just trying to get some sense of where you are in the process of a potential replacement cycle in this key group.

Sure. Thanks, Derik. Look, the LC replacement initiative, the one that I introduced in the call earlier, is off to a wonderful -- it's off to a wonderful start. If you look at the HPLC to UPLC mix of our installed bases, I would say, roughly 53% to 47% HPLC to UPLC. And in terms of dimensionalizing it, remember, we talked about Alliance, in particular, instruments that are now unlimited service. Assuming there are about 8,000 or so of them, we expect 10% to 15% of those to be replaced. The initiative in itself is off to an excellent start. I mean we've contacted over 60% of those customers already, received rather positive feedback.

And I would say a couple of facts. One, our HPLC is, of course, helping quite a bit in the replacement. But what we've seen in Q4 is the highest win/loss ratio that we've seen in over 3 years for our LC instruments. So this bodes well for the initiative, and we're seeing rather positive uptake.

Second, you asked the question on PREMIER. We launched our PREMIER Columns in Q4. And these are especially designed for molecules that are -- that have affinity for metals. And we've designed a nonabsorptive surface, which increases the efficiency of the separation.

And you'd say, well, what is the application? The application is actually squarely targeted towards larger molecules and oligonucleotides, and the uptake has been excellent. And I would say it's even -- it will get even more interesting when we take the technology and implement it across our UPLC instruments, which is ACQUITY PREMIER, and that's set to launch on February 10. The premarket work has been very, very good. And I expect that to do just as well. So I hope that gives you more clarity on LC and also on PREMIER.

Yes. No, I appreciate the detail on that one. That's very helpful. And just how should we think about the tax rate sort of beyond 2021?

Mike?

We're guiding to the 15% to 16%. We've obviously -- I mentioned that we actually have a new agreement in Singapore. So that will help maintain our current tax profile between 15% and 16%. But obviously, with all the new tax legislations that could possibly come down the pike, it would maybe be a different story. We are looking at it. Obviously, if there's a rate increase from 21% in the U.S. to 27%, we estimate that the impact would be about a 1% increase in the future to our tax rate overall worldwide if that were to happen, if that legislation passes.

And our next question comes from Tycho Peterson from JPMorgan.

Udit, I think one of the questions we're all going to get is just on the sustainability of the instrument strength and particularly the LC strength, especially after last quarter, you expected a moderation in the fourth quarter because you had talked about catch-up spending in 3Q.

It sounds like you mentioned normal budget flush, return on planned spending and the LC replacement initiative as the big driver. So why should we expect the moderation going forward on the instrument side if you're in early innings of the LC replacement cycle?

Yes, look, Tycho, we're being prudent with what we are guiding at this stage, right? I mean so if you just look at -- let me start with the overall commentary, and then I'll comment more on LC and the instrument replacement and the other initiatives in particular.

Look, if you just look at how we've guided, we say, look, towards the end of the year, we should -- and Waters, as you know, underperformed in the last few years, we would want to reach market growth or above in the next 12 to 18 months, and these initiatives will help us, right? So if I just now break it down. If our initiatives do better than planned, if other end markets recover and we continue to see COVID tailwind, we believe that we will be on the higher end of the guide. And that should set us up very nicely for the future.

As far as the LC instrument replacement cycle is concerned, we're in the early stages of the innings. I mean it's a good start, but it's a start all the same. I don't want us to get overconfident with one data point. I believe the execution is very good. We have a good feedback. We have good feedback from our customers. I do believe, especially with Arc HPLC, the launch of PREMIER, we'll continue to see strength in LC, but I would still want to remain prudent. So as I said, it's one data point. It's a good data point, but I would not want to extrapolate just based on one data point at this stage.

Okay. And then one other question we've gotten is a lot of the turnaround plan is on kind of a refocused selling effort, whether it's penetrating CROs or pushing more of an attach rate or trying to drive the replacement cycle as you alluded to. The feedback in the market over the last couple of years is your competitors are selling better products cheaper. Now you highlighted the ACQUITY PREMIER, Arc and BioAccord. I'm just curious if you still think there's an innovation gap in the market or how you feel about the current suite of instruments as it stands today versus competition.

Yes. I think let's take it across the portfolio, right? So I've had a chance to examine the portfolio. I would say, again, if you remember the turnaround plan was the first focus is on the short-term commercial momentum. I think you would agree that, that gives us freedom to act, then we get our processes and systems right, and then we focus on the portfolio. So there would be more to say about the portfolio in the future, but the current assessment suggest the following, right?

First, if we just look at the instrument portfolio, our mass spec portfolio has been completely refreshed with 5 new launches in 2019 alone. And we've talked a lot about BioAccord, but also our tandem quad portfolio with the Xevo line has done quite well, especially if you look at the uptake for traditional Chinese medicine in China and small molecule organic testing with that portfolio. So the mass spec portfolio, both on tandem quad and high res, I feel good about. Of course, there's always more to do, but it's a very, very good start.

And if I move to LC, we talked a bit about Arc HPLC and PREMIER. Both are significant steps forward for our portfolio. And as I mentioned earlier, we are thinking of how to reimagine the LC instrument, especially in the QA/QC space, and there'll be more to say about that in the next few years. That program is well underway.

If I move into the consumables side, both for small and large molecule pharma, our portfolio is very well set. I won't speak much about the small molecule. I think that is well understood. But on the large molecule side, our ACQUITY Columns, in particular, have been designed for large molecules. And these are for proteins, for peptides, for oligos. And now with the launch of PREMIER, that even strengthens the position further.

So across the portfolio, on the instrument side, on the consumable side and with service, we continue to look for better options. I believe we're doing -- we've done a lot. We're doing a fair bit to continue to refresh the portfolio. And going forward, I mean, there are, of course, things to do to enhance the portfolio, but I don't feel for a second that we are disadvantaged versus competition in the market. So I think, for the short term, I believe with the hand that we have, we can fight pretty well.

Okay. That's helpful. One quick one before I hop off, just on the share repurchase. I'm curious as to the kind of the thought process there. Waters has been criticized in the past for buying back a lot of stock, especially as revenues are going along the way. I don't think you'd be penalized for reinvesting more. So just talk about that trade-off between repurchases and maybe investing more in the business.

Yes, yes. Look, I mean, we -- and I'll let Mike comment a bit more in a minute, but at the high level, we don't feel that there is any limitation for us to invest. Look, I mean, we just want to take it one step at a time. I mean Waters has industry-leading margins, has superb cash flow, so there is incredible flexibility to invest. We simply want to make sure that we do it in the right way and in the right areas, right? And again, coming back to the transformation program, the first focus is to get the sales momentum back, which are off to a good start. I mean 1 or 2 data points don't make a trend, so we'll keep at it. We'll focus on the processes and the systems, and then there will be enough time to think about enhancing the portfolio, both organically and inorganically. So there's no limitation on that front.

As far as the share repurchase program is concerned, it's part of our overall capital allocation philosophy. It is a lever, but don't assume that that's the only lever we have. Mike, do you want to comment on the priorities for a minute?

Sure. I would just add that we do have a strong flexible balance sheet, but we also generate a ton of free cash flow. Historically, we generate about 25% of each sales dollar that gets converted into free cash flow. But we can use that, and obviously, our debt capacity to both invest in growth, both organically and inorganically, but we can also return value to shareholders. We have our share repurchase program over the course of the year has been beneficial to our shareholders. We bought back -- it's been in place for about 18 years now, and we bought back close to $9 billion. So as we move forward through this year, certainly, we're still in a pandemic here, and we'll evaluate how much and when we actually will buy during the course of the year. But again, it's about being flexible, and we believe we do have that flexibility and strength to do a couple of different things with respect to capital.

Our next question comes from Doug Schenkel from Cowen.

Udit, in recent discussions, you acknowledged that Waters over the last several quarters has in certain instances been losing market share. And we've talked about this being a function of strong competitors really targeting Waters for a long time and finally making some progress, especially in disrupting typical replacement cycles where you would kind of have the home field advantage in placing the replacement box. I'm just wondering, where do you think you are in the process of taking steps to reverse these trends? How much investment in time is required pursuant to the reversal? And then keeping in mind that it was a pretty strong quarter, should we put much weight on Q4 results in the context of assessing your progress with these efforts?

Thanks, Doug. Look, it's a good quarter. It's a strong start to our initiatives and especially the LC initiative, which we've talked about a fair bit. The basic assumption is, and as you mentioned, is that there is a replacement cycle. And our replacement cycle of our instruments in the past is -- I mean, we knew about it, and we've been at it for a while, but I think the focus that we have now, and you'd say, "Well, what are you doing differently?" I think what we're doing differently from the past, which starts to show -- starts to pay dividends, is that we are using -- we know exactly where these instruments are. We've taken a look at the database. We've targeted our reps to those exact channels -- to those exact customers.

And in addition, armed with Arc HPLC as a new product, in addition to a value proposition with PREMIER, we feel our full portfolio with the LC, with PREMIER, with our service offering is off to a good start in this replacement cycle. I don't want to get too far ahead of ourselves, and I won't speculate too much on the future, but this data point looks good. And leading indicators in terms of orders also look rather good.

Now in terms of how you should think about it in the future, I think I'd rather share the fact after we're done rather than speculating, but all I can say is the data points we have at this point in time look positive, both in terms of how the customers are receiving our value proposition and how we're targeting the customers. So I mean, in general, I would remind you that Waters is an LC company, right? Any time we do something on LC, our whole team, our sales team, our service team, gets super enthusiastic. And we're seeing some of that in the results. So I'll stop there. And of course, happy to answer any follow-ups.

Okay. That was super helpful, Udit. And then I guess, this has kind of been touched on in some of the earlier questions, but I still think it's worth revisiting. If we just think about what we've heard in terms of some of the early updates from some of the other larger tools companies, they are significantly accelerating investment in the current environment, essentially taking the COVID-19 related windfalls and reinvesting a lot of that cash flow into growth initiatives. In response to that, do you see the need to increase investment to essentially help maintain your competitive position, kind of building off of the last question? Or do you think that's not necessary and not something that drove you to kind of be reactionary in terms of how you looked at your investment plan for 2021?

Doug, again, a very perceptive question. And look, it's -- you somehow answered your question in the last comment. I mean we will not be reactionary to anything. I mean, I think R&D, and having been a researcher myself for a good part of my career, I mean, we want to focus on fundamentals. We want to focus on technology development. And Waters is a technology-oriented company, so we'll stay true to the problem-solving that we have to do.

Now to some facts, right, if you look at the R&D productivity in recent times, the mass spec portfolio has been completely renewed, both on the high-res side as well as on the tandem quad side. And to provide you more color on the tandem quads, we're seeing very good uptake of those, in particular, as I mentioned earlier. In China, we wanted to continue to work on our software on those tandem quads to even increase the uptake in pharma DMPK sort of areas as well. So I feel we have done a good job in refreshing the mass spec portfolio. And we also know what we need to get done specifically, and we are funding those programs very well, especially on the informatics side for mass spec.

BioAccord is another case in point. I mean, as you know, LC-MS and QA/QC is somehow the holy grail in the industry to be able to take large molecules to the same place where small molecules are in release testing. And we have a robust and reliable instrument, BioAccord, which is starting to see very good uptake. And we have a really clear road map in increasing applications and improving the software on that front as well, and that's very well funded.

If I now turn to the LC side. I mean we've redoubled our effort on that front, both on the commercial side, but also on the R&D side and it's a question of turning dollars to the right to the right programs. And there, on the consumables, in particular, I mean, the launch of PREMIER has been received very well in the market. We're expanding that technology into our full instrument space. And that should be -- that is something that the market is, I think, looking forward to have a nonabsorptive surface for full instruments. And there, again, there is a strong effort on the software side as well to take Empower into the cloud and expand the applications there.

And then finally, if I turn to the service side, there, we are always looking at better value propositions. And here, it's not necessarily a product-based innovation, but it's a service-based innovation. Many of our customers are asking us for more flexible value propositions, especially when it comes to, I would say, almost a la carte service if based on their utilization, and we are offering those value propositions as well.

So I've gone on long, but just to give you a flavor that the R&D programs are based on specifics and not what appears to be popular. And we will not be shy in increasing that funding, and you'll hear more about that as we go forward.

And our next question comes from Dan Arias from Stifel.

Udit, on the specialty selling efforts that you've kind of honed in on as a need, can you just sort of share some thoughts on how we should think about the scale and the magnitude of that push? I mean is there a percentage of reps years from now that we might be thinking about as focused on either a particular product or a particular application?

Sure. I use that as an example, Dan, when we were talking about talking about BioAccord in particular, right? I mean products that require a deeper explanation, products that could benefit from our customers being coached on how to use it, how to develop methods on them. And for BioAccord, in particular, and I'll just use that as an example, that's off to an excellent start, right? So we have our -- we have turned specialty reps, and we've created a specialty reps team and turned them towards specific customers, especially ones with large molecule and oligonucleotide applications. And they've gone in and developed methods with these customers. And in many cases, we have follow-on orders as well.

And to just come back to the facts, I mean, for BioAccord, Q4 was the best quarter since its launch by severalfold. So we think this approach is working. Now in terms of what fraction of the total field force is specialty versus generalist, look, most of our reps have a technical training. And the reason Waters has been successful in the market for so long is because of our technical capabilities and how we are able to partner with our customers. And now we basically trained a few of them on specific methods. I would say we will continue to expand it. If it works more, we'll continue to expand that specialty field force for more complex applications, and BioAccord is just a start. I hope that gives you a bit more clarity. I don't want to quantify the fraction of field force that are on specialty. We will basically -- it's a pilot that seems to be showing results, and we'll continue to expand as there are a larger number of customers and targets.

Yes. Okay. That's helpful. Okay. And then maybe just one on margins as it relates to product mix. When you look at the collective gross margin profile for this last tranche of new products that's been developed, BioAccord, Cyclic IMS, SYNAPT XS, Arc HPLC, is there a different profile attached to that in aggregate relative to the rest of the portfolio, such that if you guys are successful and we do see some new product acceleration there, we should think of that as a mix factor that works in your favor? And then along those lines, Udit, you have mentioned that there are some other new things that you have in the hopper. Is there a conscious effort to design and add things to the portfolio that are at a higher level of profitability than, say, the predecessor platforms?

Thanks. Excellent questions. I mean I'll give you a general answer to your second question and then let Mike give you a bit of specifics on how we're seeing the margin evolution.

In general, look, a simple way to think about it is consumables and recurring revenues have a bit of a higher margin than instruments. And over time, instruments, as the demand rises, you can see more leverage in the P&L and you have higher units. So hence -- and you'll start to see better and better margins over time, so you start off with a slightly lower margin with instruments, and that goes up over time. And with consumables and informatics, you already see a nice starting point. And so launch of PREMIER, more informatics solutions, better service definitely gave a lift. And instruments at the beginning might start off at a lower starting point, but then would go up rather rapidly as the demand goes up, and we're seeing that already in many of our platforms. So Mike, do you want to comment a bit more on the margins and the evolution, especially on the gross margins?

Sure. Well, what I will add is that, obviously, when a new product gets introduced, we don't have the advantage of taking costs out. So over time, over the next couple of years after a product is introduced, we're typically able to lower the cost to produce the product, which will help the margin significantly. Also, obviously, the more units that we had alluded to that we pushed through the plans will also help margins. So the combination of those 2 generally improves, especially on the instrument side, as we move out from 1 to 2 years after we launched.

But in general, I mean, just to expound on your question earlier and give you something specific. In general, it's a good assumption that we are introducing products that have a higher-margin profile than we have in the past. I think that's a reasonable assumption.

And our next question comes from Steve Willoughby from Cleveland Research.

I had a couple, maybe just 1 or 2, starting for Mike. Mike, just wanted to double check that we heard you correctly as it relates to some of the guidance for the first quarter. Did you say that you expect a 15%, 1-5 percent, benefit to EPS from FX in the first quarter?

15%.

Wow. Okay. And then I guess to...

Sorry. To expand upon that, the number is very small. So it's the power of the denominator a little bit. So that's what caused that to be impacted.

Okay. Very good. Just to Udit, 2 questions for you then as it relates to sort of looking forward. One, how are you thinking about instrument growth versus reoccurring growth in 2021? And maybe if you -- if there's any comments on the strong 14% chemicals growth you saw in the fourth quarter, if that was -- how sustainable that sort of growth is?

And then the second question is just you previously have made some comments about seeing some of the largest orders in company history here recently. Was just wondering if you could provide any more color on if that was something you think is a change or sustainable? Or does it just happened to be kind of a one-off here in the most recent couple of months?

Steve, thank you for both of those questions. First, on instrument growth versus recurring. You saw in the fourth quarter that recurring revenues were double digits. Instruments were mid-single digits. And I think, going forward, also, we -- I mean, if you just think through what we are thinking, what we are hoping to see in the future, I mean we expect that pharma continues, and you should see a similar sort of mix going forward as well if pharma continues its strength. And as other end markets recover, we expect a bit of upside to it. And if you just turn a bit towards -- I think rather than giving you a ratio, let me give you a bit of specifics on how one could think about it. If you just take -- think of our applications in pharma for both small and large molecules, and let me just give you a bit of the portfolio that goes towards that, right? So for small molecules, I mean, as that rises, especially as generic consumption and products for COVID, especially therapeutics, small molecule therapeutics rise, we see our LC portfolio with the Arc HPLC, in particular, going up. Then if you turn to large molecules, you can start with consumables. And then the reason I'm giving you the specifics is just to give you color that on both fronts, there is reason to believe that we should see some optimistic development.

And on the consumable side, for large molecules first, I mean, our ACQUITY Columns for UPLC have been designed, in particular, for large molecules. This starts with proteins, with peptides, glycans and also oligos. With PREMIER getting launched first as a column, the technology has got very good traction, especially for oligonucleotide applications, and now it goes into the instrument space. So it's rather broad-based if I just take the LC example, both on the UPLC side and the HPLC side.

And for mass spec, as you already know, BioAccord and our QDa have done pretty well for large molecule applications in Q4. So really, really broad-based. I would not speculate on one or the other, but I would say, Q4 gives you a good indication of what we should see even going forward, if not better.

Now in terms of large orders and to give you color on my comment on large orders previously, you see with the LC replacement initiatives we've had some customers come in and ask us to replace their full fleet, and that has resulted in some of the largest orders. And this is why I'm rather optimistic about this initiative. So that gives you more color.

On the chemicals piece, I'm not sure what you're referring to on the 14%. So I don't know, Mike, if you have any comments on that, I don't know what that is referring to, the chemicals growth of 14%.

I'm not sure either. Sorry.

Steve, I hope that gives you color.

And our next question comes from Puneet Souda from SVB Leerink.

Udit, first of all, congratulations. This is an impressive quarter. And thanks for all the work that you've put in, in these few months here. So first one, based on what you were saying here, and correct me if I'm wrong, it appears to me that the China pharma recurring revenue sales and especially columns and small molecules and then services grew very strongly in the quarter. Obviously, you've highlighted the growth in China. So wondering what has changed in your approach in China in terms of commercial execution? Or is it largely market-driven growth that we are seeing from across the peers as well? So correct me if I'm wrong on any of those assumptions as to what I'm seeing.

And then that light also, were there any incentives in the fourth quarter that drove this growth in that geography?

So thanks for your question, Puneet. On China, look, I mean, we're extremely happy with the quarter. I mean it grew slightly shy of 20% after, I would say, a very difficult first half of the year. And so we're very happy with the momentum, and largely led by pharma, both on the small molecule and large molecule side and a very broad-based growth across the portfolio or across instruments, both mass spec as well as LC consumables and service, especially recurring revenues did super well in -- especially in the pharma -- especially in the pharma segment. So I feel really good about that.

In terms of changes, I mean, it goes back to what we talked about earlier, really focusing the field on what matters. And as I mentioned earlier, as soon as we utter the words LC at Waters, we have a genuine enthusiasm across the organization. I mean we have not just our portfolio, but our service teams are state-of-the-art. So I think having the organization focus on LC, giving them Arc HPLC as a new product, and it was especially designed for China, in particular, right? So giving them Arc HPLC and PREMIER to go out and have these conversations with the LC customers has been a terrific initiative.

Secondly, I also mentioned our CXO or our contract testing and contract research organization initiative. That's also done rather well in China. Our team has gone out to meet contract manufacturers. We've increased our penetration in contact testing organizations in the food segment. It's, again, one data point, but it's a good data point. I'm reluctant to start extrapolating too much, but it's a good data point that it gives us confidence that activity is at a higher level.

Now as far as incentives are concerned, they are no different than they have been in the past. It's just a question of focus. But given the team's new products, giving them clarity on which customers to go after and working with them to succeed, I think, are the key success factors I would point to.

And operator, we have time for one more question.

And our final question comes from Dan Brennan from UBS.

Great. I kind of hopped on late, but I was hoping -- I know you spoke a lot about Asia and China, but I was hoping to dig in a little bit more there, if you don't mind. Could you just kind of break apart kind of China because there was a lot going on in the last couple of years for Waters there, particularly on the food and the pharma side, which -- and I know you've addressed that a little bit. But can you just walk us through a little bit how you think about the opportunity going forward for Waters in China, maybe some of what are the strategic initiatives that you have ongoing? I know you're talking about a bigger push into the contract research organization, but I'm just wondering if you can kind of maybe peel the onion a bit more on China for us.

Sure, sure. Dan, a very, very good question. And on China, look, we talked a bit about in the past about what had caused the slowdown, right? I mean the slowdown was led by the food segment, but also a bit of a slowdown in pharma and our focus on pharma. So again, let me break it down a bit across the different initiatives with pharma. We expect our focus with LC with Arc HPLC, with the launch of Arc HPLC and PREMIER and the replacement initiative should give us good tailwinds in pharma going forward.

Second, for the food segment, we have really focused on expanding our coverage for the contract testing organizations. You remember, I mentioned we were a little bit late in following that trend. The team has gone and reached out to each and every one of those customers. And now we have to make sure that our value propositions work before we start to see meaningful growth in that area.

And then across clinical, China is one of those markets that in the past grew very well in that segment. I mean, this year, we've seen some headwinds, especially on -- especially due to the diversion towards COVID-19 testing. So I expect that to come back. So across the board, we see some good opportunities in China.

Now talking at a bit of a higher level, in the pharma industry in China, if you look at the latest 5-year plan, it calls for having roughly 45% or so of the production for biopharmaceuticals occurring locally in China for China use. And today, that number is around 20 -- between 20% and 25%. So there's a commitment in the Chinese government and the Chinese economy to increase pharma consumption. So we feel rather well placed with our portfolio, with our commercial focus to go after the opportunity in pharma as well as in food.

And from a portfolio perspective, our Arc HPLC was specifically designed for the Chinese LC market. Our tandem quad portfolio is doing rather well for traditional Chinese medicine and food testing and environmental testing in China. So I feel very good from a portfolio perspective and from a commercial perspective on the base we've set, but it's -- as I said, it's a good start. It's a start all the same. So we're a bit prudent about what we want to see in the future.

And that was the final question.

Thank you very much. So as we conclude, thank you all for joining today. I want to thank our team for doing such a stellar job in the first -- in the fourth quarter. And we're looking forward to continuing the effort and the strength as we go forward. I'd like to thank you for your continued support and interest in Waters, and we look forward to updating you on our progress on Q1 in the Q1 2021 call, which is currently anticipated on May 5, 2021. Thank you, and have a great day.