Earnings Call Transcript - WAT Q3 2022

Operator, Operator

Good morning and welcome to the Waters Corporation Third Quarter 2022 Financial Results Conference Call. All participants will be in a listen-only mode until the question-and-answer session of today’s call. This conference call is being recorded. If anyone has objections, please disconnect at this time. It is now my pleasure to turn the call over to Caspar Tudor, Head of Investor Relations. Please go ahead, sir.

Caspar Tudor, Head of Investor Relations

Thank you, operator. Good morning, everyone and welcome to the Waters Corporation third quarter earnings call. Today, I'm joined by Dr. Udit Batra, Waters President and Chief Executive Officer; and Amol Chaubal, Waters Senior Vice President and Chief Financial Officer. Before we begin, I will cover the cautionary language. In 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 and commentary on potential market and business conditions that may impact Waters Corporation over the fourth quarter of 2022, full-year 2022 and 2023. These statements are only our present expectations and actual events or results may differ materially. For more details please see the risk factors included in our most recent annual report on Form 10-K or Form 10-Qs and the cautionary language included in this morning’s press release. During today's call, we will refer to certain non-GAAP financial measures, including in our discussions of the results of operations. Reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures are attached to our earnings release issued this morning and in the appendix of our presentation, which are available on the company's website. Unless stated otherwise, references to quarterly results increasing or decreasing are in comparison to the third quarter of fiscal year 2021. In addition, unless stated otherwise, all year-over-year revenue growth rates and ranges given on today's call are given on a comparable constant currency basis. Finally, we do not intend to update our predictions all projections except as part of our regularly scheduled, quarterly earnings release or as otherwise required by law. Now, I'd like to turn the call over to Udit to deliver our key messages for the quarter, then Amol will provide a more detailed look at our financial results. After we will open the phone lines up to take questions.

Udit Batra, CEO

Thank you, Caspar, and good morning, everyone. We are pleased to report excellent results for the third quarter, showcasing strong growth across our product portfolio, end markets, and geographic regions. This was primarily driven by instrument growth exceeding 20%. As in previous quarters, orders once again outpaced sales, reflecting the exceptional effort and dedication from all our colleagues. We take great pride in the consistent achievements of our teams. Today, I want to highlight three key messages that capture the ongoing strength and exciting drivers of our business: first, we are executing our commercial strategies effectively. Our transformation is now integral to our operations, characterized by an unwavering commitment to commercial excellence, as evidenced by our results. Second, Waters is reestablishing its reputation for innovation. Our refreshed product portfolio is meeting our customers' unmet needs across various applications, with impressive adoption rates for new instruments that are increasing our market share. Third, our growth initiatives are picking up momentum. We are making tangible progress in high-growth adjacent markets, providing us with confidence in our strategy. Regarding our third quarter results, our revenue increased by 7% as reported and 15% on a constant currency basis, driven by robust demand across our end markets and regions. The strongest growth came from the industrial and academic/government sectors, both exceeding 20%, followed by pharma at 9%. All regions experienced double-digit growth, with China and India growing over 20%, Europe in the mid-teens, and the U.S. at 11%. Instruments saw growth of over 20%, with our liquid chromatography, mass spectrometry, and TA portfolios achieving double-digit increases. Mass spectrometry, in particular, saw remarkable growth of nearly 40%. Recurring revenues grew by 10%, supported by our initiatives in e-commerce and service engagement. Our non-GAAP adjusted earnings per share for the third quarter was $2.64, remaining relatively unchanged year-over-year despite foreign exchange headwinds of 13%. Year-to-date, we have executed well across the organization despite challenging macroeconomic conditions, with broad-based strength across our geographies and end markets—each exhibiting double-digit growth this year. Pharma is up 12%, industrial is up 15%, and academic/government is up 16%. Instrument growth has been considerably strong throughout the year, totaling a 19% year-to-date increase, driven by outstanding performance in the U.S. at nearly 30%. We anticipate this trend to drive future growth in our recurring revenues. Our transformation has empowered us to reliably deliver excellent results, evident in our three-year compound annual growth rate, which highlights the momentum across our business. So far this year, we've achieved a 9% compound annual growth rate overall on a constant currency basis. Moving on to our second key message of innovation, Waters has a longstanding reputation as an innovation leader. Our investments in innovation are again yielding results and significantly contributing to our growth. Sales of Arc HPLC, ACQUITY Premier, and Max Premier columns doubled in the latest quarter compared to the previous year. Our new products are effectively addressing the challenges faced by our customers, bolstered by our technical strength and strong commercial execution. Arc HPLC is encouraging customers to upgrade their liquid chromatography fleets for routine small molecule analysis, enhancing lab capabilities and productivity while speeding up instrument replacements. Our MaxPeak Premier technology provides separation of complex molecules like biologics. By eliminating the need for passivation, MaxPeak columns enable scientists to obtain answers up to 20 times faster than traditional columns, with significantly sharper peaks and enhanced sensitivity, particularly for oligonucleotide separation. The benefits of the Premier technology have led to substantial large molecule growth in recent quarters, now representing over 30% of our pharma revenues, up from 20% just a few years ago. Currently, biologics constitute 20% of the pharmaceutical market and represent 40% of the research and development pipeline, positioning us well for future growth. With our cyclic ion mobility separation high-resolution mass spectrometry technology, scientists can separate molecules by their shape as well as mass, combining ion mobility and time of flight for enhanced resolution and clarity. Demand for this technology has increased significantly within Omics research, particularly for lipids, proteins, and metabolites, which are critical in early disease detection and discovery. For instance, the largest privately funded mass spectrometry trioromics facility in Canada utilizes our Cyclic technology for antibody sequencing and discovery, noting the exceptional quality of data obtained. Additionally, we are experiencing strong traction for our recently launched Xevo TQ Absolute, which has garnered significant demand in food and environmental testing, especially related to per- and polyfluorinated compound analysis. The testing market for PFAs has seen rapid growth driven by increased surveillance and the addition of new compounds of interest, representing a multi-year growth opportunity. Recently, the U.S. EPA released new drinking water health advisories for four major PFAs, specifying measurement levels finer than parts per billion. The TQ Absolute is so sensitive that it can detect PFAs at one part per quadrillion, equivalent to less than a grain of sand in an Olympic-sized swimming pool. Its unparalleled ability to measure lower molecule levels gives us a competitive advantage in this sector. Since the launch of TQ Absolute, we have secured competitive placements for PFAs testing across all regions. For example, a large global testing organization is using it for infant food and water analysis in Southeast Asia, developing new methods for routine testing within their operations. In the informatics space, Waters Connect is enabling exciting new analytical capabilities in large molecule analysis on instruments like the G3 QTOF and BioAccord. This encompasses areas such as cell culture media analysis, peptide mapping, and oligonucleotide characterization, which hold substantial long-term potential given the growing demand for stability, quality, and impurity analysis. The characterization of biologics and novel modalities facilitates their transition into routine quality assurance and quality control workflows. Furthermore, we have expanded our powder rheology capabilities within TA to support the burgeoning growth in battery-related applications. Powders are vital in manufacturing anodes and cathodes, enabling battery producers to effectively evaluate electrode coatings, while solvent-free dry coatings help ensure optimal performance, minimize defects, and reduce cell failure rates. Industry sources anticipate that lithium-ion battery production will increase tenfold over the next decade, with demand projected to surpass 4,000 gigawatt hours per year by 2032, driven by electric vehicles and energy storage. As battery production scales up, our TA instrument portfolio is well-suited to meet the emerging testing demands in battery development and safety analysis. One of our European clients, a rapidly growing Scandinavian battery manufacturer, relies on our rheometers to assess incoming materials for crucial electrode components and has tripled its orders of TA instruments this year, reflecting its growth and confidence in our technology and support as it expands its operations. I would now like to discuss some of the recent advancements we have made in our pursuit of high-growth adjacent markets, specifically in Bioprocess Characterization. BioAccord presents a compelling value proposition for Bioprocess Engineers, offering a significant enhancement in analytical capabilities for biologics manufacturing, while being user-friendly. Through our collaboration with Sartorius, we have broadened BioAccord’s capabilities in this area, effectively shortening clone selection times and enabling improvements in tighter yields, which can lower costs of goods sold. Our value proposition is gaining traction among industry leaders, with AstraZeneca publicly acknowledging the benefits of implementing online process analytical technology with BioAccord to monitor drug substance and cell culture media at the recent Bioprocess International Conference in Boston, which I attended. Companies like Janssen and others are already utilizing it to oversee critical components during cell culture production and analyze raw materials used in bioprocessing. By fingerprinting components in cell culture media with BioAccord, they are generating insights that can enhance the manufacturing process. These are just a few early success stories we can share regarding BioAccord. We are optimistic about our long-term opportunities to address unmet needs in Bioprocess Characterization. Now I will hand the call over to Amol to discuss our third quarter financial performance and provide guidance for the remainder of the year.

Amol Chaubal, CFO

Thank you, Udit, and good morning, everyone. We delivered another excellent quarter in Q3 with 15% constant currency growth. Waters division grew 14% and TA grew 18%. By end market, pharma grew 9%, industrial grew 22%, and academic and government grew 29%. In pharma, we saw growth in both large and small molecule with strength across segments, applications and regions. In industrial, each of our major regions grew mid-teens or above with China up almost 30%, Europe up over 20%, and U.S. growing 16%. Growth was led by LCMS instrument sales, which grew 50% with our chemical analysis, food and environmental businesses, all delivering strong growth. In academic and government, growth was also strong across all regions. Now by geography, sales in Asia grew 18%, the Americas grew 11% and Europe grew 14%. In Asia, growth was led by China where sales grew 23% as we executed well across all trade classes, despite the challenges posed by new lockdowns. In the Americas, the U.S. grew 11% with growth across applications and end markets. Europe grew 14% in the quarter, led by industrial, which grew over 20% and pharma, which grew low double digits. By products and services, instruments grew 21% with our LCMS and TA portfolios each growing double digits. Recurring revenues grew 10% with chemistry up 10% and service up 9%. There was no change in the number of days versus the prior year's quarter. Finally, TA had another great quarter with sales up 18%, led by strong growth in thermal analysis and rheology. Demand for TA products remained strong across all regions with sales in electronics, and batteries continuing to ramp. Gross margin for the quarter was 56.7%, compared to 58.9% in the third quarter of 2021. We had incredible growth in instrument sales this quarter with MassSpec growing nearly 40%. While this resulted in approximately 40 basis points of adverse mix impact for the quarter, it is expected to drive future margin accretive recurring revenue growth. The strong U.S. dollar resulted in 120 basis points of FX headwind on gross margin in the quarter. We have continued to offset the impact of inflation with pricing increases. Working with our customers, our teams delivered over 350 basis points of net pricing gains in the quarter. While inflation had no net impact on our gross profit dollars, it does affect margin calculation as the revenue base is also higher. This dynamics drove the remaining difference in the year-over-year gross margin for the quarter. But again, there was no net impact of inflation on gross profit dollars or earnings per share as the incremental inflationary costs were offset by pricing increases. Operating margin for the quarter was approximately 27.8%, compared to 29.7% in the third quarter of 2021, driven primarily by foreign exchange headwinds and the gross margin dynamics. Year-to-date operating margins have expanded 70 basis points before 110 basis points of foreign exchange headwind. The expansion of 70 basis points includes the investments we have been making to nurture our higher growth adjacencies and includes the impact of higher instrument mix and the inflation dynamics I just discussed. Our effective operating tax rate for the quarter was 15.1%, average share count came in at 60.1 million shares, which is about 1.8 million less than the third quarter of last year. Our non-GAAP earnings per fully diluted share for the third quarter was $2.64 in comparison to $2.66 last year. The foreign exchange headwind lowered our non-GAAP EPS growth by 13%. On a GAAP basis, our earnings per fully diluted share was $2.60. A reconciliation of our GAAP to non-GAAP earnings is attached to the press release issued this morning and in the appendix of our earnings call presentation. Turning to free cash flow, capital deployment and our balance sheet. We define free cash flow as cash from operations, less capital expenditures and excludes special items. In the third quarter of 2022, free cash flow was $126 million after funding $32 million of capital expenditures. Since last quarter, accounts receivable have moved back in line with historical pattern relative to our sales volume. However, we continue to build inventory as a proactive measure to secure supply and build safety stock given strong instrument demand. In the third quarter, our inventory balance increased by $32 million. We maintain a strong balance sheet, access to liquidity and a well-structured debt maturity profile. This strength allows us the ability to prioritize investing in growth, including M&A and returning capital to shareholders. We continue to evaluate M&A opportunities that will meaningfully accelerate value creation in well thought out attractive high growth adjacent markets. In Q3, we repurchased approximately 483,000 shares of our common stock for $155 million. At the end of the quarter, our net debt position was approximately $1.1 billion with a net debt to EBITDA ratio of about $1.1 billion. Now as we look ahead to the remainder of the year, I would like to provide some updated context on our thoughts for 2022. We have seen continued strong performance this year, driven by robust end market demand, excellent commercial execution across all our geographies and new product introductions, which are driving growth. As we close the year, we expect our sales momentum to remain solid and that our refreshed portfolio and growth initiatives will continue to enhance our performance. We also expect to successfully navigate supply chain constraints and inflationary pressures assuming these challenges do not worsen. In light of this continued strong performance, we are raising our full-year 2022 guidance to 11.5% to 12% constant currency sales growth, up from our prior guide of 9.5% to 10.5%. At current rates, a negative currency translation is expected to subtract approximately 6 percentage points, resulting in a full-year reported sales growth guidance of 5.5% to 6%. Gross margin for the full-year is expected to be nearly 58% and includes 100 basis points of FX headwinds versus prior year. Operating margin is expected to be 3.2%, which includes 120 basis points of underlying margin expansion offset by 120 basis points of FX headwind. We expect our full-year net interest expense to be approximately $38 million and full-year tax rate to be approximately 15.5%. Average diluted 2022 share count is expected to be approximately 60.3 million. Our share repurchase program will continue as we progress through the rest of the year and we’ll provide updates as appropriate. Rolling all these together and on a non-GAAP basis, full-year 2022 earnings per fully diluted share are now projected in the range of $11.85 to $11.95, which is 6% to 7% growth versus last year, despite a negative currency impact of approximately 11 percentage points. What is the previous guide, our updated guidance includes improved underlying business performance of $0.14 offset by $0.24 of higher FX headwind. At current FX rates, we estimate the full-year FX impact on 2023 to be a year-over-year headwind of 2% to 3% on sales and 4% to 5% on adjusted EPS. FX impact is expected to be largely concentrated in the first half of 2023 at current rates. Looking to the fourth quarter of 2022, we expect constant currency sales growth to be 6% to 8%. At today's rates, currency translation is expected to subtract approximately 8 percentage points resulting in a fourth quarter reported sales growth guidance of minus 2% to 0%. Fourth quarter non-GAAP earnings per fully diluted share are estimated to be in the range of $3.66 to $3.76, which is flat to 3% higher than prior year's quarter, despite negative currency impact of approximately 15 percentage points.

Udit Batra, CEO

Thank you, Amol. In summary, we're very pleased with our performance. Demand has continued to be robust across our resilient end markets and geographies. This together with our strong commercial execution and refreshed portfolio is allowing us to consistently deliver excellent results. Once again, we're raising our full-year sales guidance from a prior range of 9.5% to 10%, now to 11.5% to 12%. In closing, I would like to point out that our 2022 ESG report will be released next week. At Waters, we're proud to have been widely recognized as an ESG leader. We believe that we all have a part to play in leading the world better than we found it from decreasing our environmental footprint to becoming more representative of the society we live in. This year we've made further progress towards our goals, delivering approximately 60% of our electricity from renewable or low carbon sources. We launched the Water Student Academy and are partnering with three historically black colleges and universities to provide STEM education and career opportunities. We also conducted broad stakeholder engagement in our comprehensive materiality assessment. We are proud that our new state-of-the-art chemical manufacturing facility in Taunton, Massachusetts was recognized by the U.S. Green Building Council as the only LEED certified facility of its kind in the state and among the small number in the United States. While there is always more work to be done in ESG, I'm proud of the progress we've made. So with that, I'll turn the call back over to Caspar.

Caspar Tudor, Head of Investor Relations

Thanks, Udit. That concludes our formal comments and we are now ready to open the phone lines for questions.

Operator, Operator

We are now ready to begin our formal question-and-answer session. The first question is coming from Vijay Kumar of Evercore ISI. Your line is open.

Vijay Kumar, Analyst

Hi, guys. Congrats on a really strong print share. Udit, maybe my first one for you on this revenue outperformance in the Q, big picture when you look at the state of end markets, whether it's a pharma CapEx environment, replacement cycle or industrial, you know, perhaps macro situation. Talk about the big drivers here on what's happening and whether any of these drivers should change for ‘23?

Udit Batra, CEO

Thank you, Vijay. From a demand perspective, we are operating in resilient end markets, particularly in pharma, which makes up 60% of our business. Our focus is on late-stage development and QA/QC, and the pharmaceutical sector continues to grow. Even during downturns, the consumption of medicines does not cease, which positions us favorably. Additionally, our industrial business has evolved significantly, concentrating on food safety, environmental needs, and battery testing, especially regarding PFAs. Approximately 80% of our revenue comes from these stable markets. We are also confident due to specific water-related drivers that will contribute to our ongoing success, such as our commercial initiatives. We expect significant value from instrument replacements and e-commerce, which has already grown to over 30% of our consumables revenue from a starting point of 20%, and we anticipate it will exceed 55% in the coming years. Our CDMO footprint has expanded impressively, growing at double the rate of our overall business, indicating strong commercial initiatives in vibrant markets. Furthermore, innovation is a key contributor to our growth, especially in the pharma sector. Our focus on biologics is crucial, with over 30% of our pharma business tied to large molecules, bolstered by the launch of MaxPeak premier columns and a growing MassSpec business. The MassSpec segment has shown exceptional performance, with instruments growing by 21% this quarter and MassSpec nearing 40% growth, particularly with the Xevo TQ Absolute, which aids in detecting low PFAs levels. Additionally, we are gaining traction with BioAccord in QA/QC and upstream processes, showing significant customer interest in simplified LCMS. Despite challenges such as COVID-related shutdowns in China and geopolitical issues in Europe, we have navigated these obstacles effectively. This solid execution, alongside strong innovation and growth in our adjacent markets, gives me confidence in our future performance. We are experiencing robust instrument growth, orders have exceeded sales, and this positive trend is promising for our consumables business, especially in service areas we've prioritized. I hope this clarifies our confidence, leading us to raise our full-year guidance for constant currency growth.

Vijay Kumar, Analyst

Really that's helpful, Udit. And maybe one quick one for you, when you look at the margin performance, inflation, FX and mix were the main three components. When you look at ‘23, should we expect any perhaps some margin expansion? I know FX is a headwind not sure how to think about the impact of inflation on the margins and in mix?

Amol Chaubal, CFO

Yes. So, Vijay, look, I mean, on the gross margin line that are sort of four vectors that are playing out, right? There is FX, there is a higher instrument mix, there is new product launches, and then there is the pricing inflation dynamics that I just discussed. And each of these vectors are going to be accretive in driving gross margin expansion in the times to come. I mean, on the FX side, we really feel excited about the fact that despite this headwind, the business has rallied to find ways to offset the impact of exchange rate. And when the exchange rates normalize, you will see a much more pronounced impact on the margin, because of the resilience that has already played out in our 2022 numbers. On the instrument mix, I mean, it's a great problem to have. While this instrument growth is creating somewhat of a headwind on the margin today, it is going to drive accretive recurring gross margin growth from chemistry and service in the future. We've seen also great growth from our new products and it sort of underscores that innovation matters in this space. But as you can understand, anytime when you launch new products, they haven't gone through the typical value engineering cycle that they go at Waters like we've gone through with Alliance. And we will see that play out on the gross margin of these newer products in the coming years. And then the last piece is the pricing inflation dynamics, right? And there, the pricing gains are systemic, we've built muscle in terms of systems and processes to drive pricing gains more than what we have historically driven, which was 50 basis points to 75 basis points. And on the other hand, a lot of inflation is spot buys. And as the electronic component market, sort of, normalizes, some of this spot buy pressure will go away again providing tailwind to the gross margin. So overall, I mean, we are still on track where we say, look, I mean, we will have about 100 basis points of margin expansion in the underlying business between volume leverage, mix and productivity gains. And we will reinvest 70 basis points to 80 basis points of those gains in nurturing our higher growth adjacencies in the near-term.

Operator, Operator

The next question is coming from Dan Brennan of Cowen. Your line is open.

Dan Brennan, Analyst

Great. Thanks for Udit, thanks for taking the questions. Maybe just as a jumping off point as we kind of look ahead, you just kind of addressed a little bit of the margin drivers. I know at the Investor Day you talked about ’23, still feel good about mid single-digit plus. I'm just wondering, doesn't sound like anything has really changed, but just wondering is that still the right zip code as we sit here today, which would imply a three-year stack acceleration from what you're doing? And then kind of related to the prior question given the FX headwind that you're talking about for next year, three to four points, it would imply kind of modest top line growth. So in a modest top line growth environment, kind of, what's the ability to expand margin in ’23 if that's fair?

Udit Batra, CEO

Thank you for your question, Dan. I'll start and then hand it over to Amol. The 5% to 7% we previously mentioned refers to a different context. On a constant currency basis, we've been performing significantly better than that, nearly achieving 14% growth when looking at a three-year stack. We're just shy of double-digit growth, so we are well ahead of our expectations. This is due to not only strong end markets but also effective execution of our commercial initiatives, which still have room for growth in the coming years. Innovation is also playing a meaningful role in this growth, aiding in instrument replacement and improving our biologics footprint. Furthermore, our adjacent areas are starting to show contributions, particularly from bioanalytical characterization and battery testing initiatives. We are optimistic about our current position. Regarding our expectations for 2023, we will have more information to discuss in our Q4 earnings call, and we want to be thorough in our analysis given the current turbulent environment. However, at this moment, we feel confident about the drivers we've shared previously, regardless of market conditions. We anticipate that our commercial execution will be an additional positive factor, innovation will address unmet market needs, and our adjacent areas will contribute, particularly in biologics and batteries. We are pleased with our current situation and will provide more updates in Q4. Amol?

Amol Chaubal, CFO

Yes. And then covering on the margin, right? So I think at this stage, we feel really good about where each of our initiatives are? I mean, our volume leverage is working with a strong instrument growth this year, we think that will have an accretive mix impact on the recurring revenue, bringing better gross margin profile next year. We do see, sort of, the level of spot buys slowing down and we have gained a lot of confidence and comfort in the systems and processes that we've implemented for pricing. So all of that will enable us to stay on the track that we outlined at our Investor Day, which is still roughly 100 basis points of underlying margin expansion with a 70 basis points to 80 basis points of reinvestment in higher growth adjacencies.

Operator, Operator

The next question is coming from Luke Sergott of Barclays. Your line is open.

Luke Sergott, Analyst

Hey, thanks for the question. Can you share what you're seeing in the CDMO space? There have been various mixed signals from both peers and CDMOs themselves. Can you provide some insight into how you perceive the market developing and how you're considering that in your plans for next year?

Udit Batra, CEO

Thank you for your question, Luke. Let me provide some context before addressing your inquiry. When we began our transformation process, contract development and manufacturing organizations (CDMOs) constituted less than 20% of our pharmaceutical business. We have invested considerable effort in developing tools, systems, and processes to target this customer segment, which is among the most dynamic in the pharmaceutical industry. Over the past couple of years, we have seen growth in this segment that exceeds the overall dynamic growth in the industry. For clarity, our three-year stacked growth rate is nearly 9%, while CDMO growth is close to 20%. The market has recognized our overall demand and value proposition, which goes beyond pricing and improved lease terms to include a technical advantage. Our scientists collaborate closely with CDMO customers to facilitate the transfer of more complex molecules from companies like Pfizer, Merck, and AstraZeneca. This value proposition has been well acknowledged, and we have performed exceptionally well. Additionally, we are monitoring volatility in the CDMO market. For instance, global CDMOs now have international operations, and should geopolitical events occur in locations like China or the United States, we are observing that CDMO customers seeking to diversify are turning to us first. For example, some customers are choosing not to expand their facilities in China or the U.S., opting instead for countries like Ireland or Singapore. Our strong relationships with key customers in the CDMO sector have kept overall demand stable. While there may be shifts geographically due to geopolitical challenges and repatriation efforts, we continue to see significant growth in this segment. Thus far, none of our customers have indicated any desire to reduce their activities. It's a great question and personally important to me. I make it a priority to attend many technical conferences, like the American Association of Pharmaceutical Scientists, Bioprocess International, and AACR, where I engage directly with customers instead of just promoting our products. Our MassSpec portfolio is addressing significant unmet needs. We've discussed our LC products before, particularly the ACQUITY Premier and MaxPeak Premier columns and their benefits for biologics testing. On the MassSpec side, our high-resolution portfolio, including the cyclic IMS, stands out as the only instrument that analyzes molecules based on their shape and size, which is essential for larger molecules, according to feedback from our top customers. The Cyclic is performing well lately. The MRT, which we recently launched, is still in its early stages. We have also licensed Charge Detection MassSpec, which enhances our confidence in our IRS portfolio. Moreover, the tandem quartz instruments, such as Xevo TQ Absolute and Waters Connect software for Xevo TQXS aimed at food testing, have been part of our strategic efforts. The challenges in environmental testing, particularly for PFAs, are widely recognized, and there's significant demand for solutions across different regions. We anticipate strong growth in this area over the next few years. In food testing, our customers have expressed a need for quicker and more quantitative testing, and our Waters Connect platform, particularly with the MASK-1 application, accelerates these processes by 50%. Lastly, BioAccord, initially aimed at QA/QC, is gaining traction with major pharmaceutical companies, with applications expanding to clone selection in collaboration with Sartorius. We believe the conversion rate for clone selection will be high, and we have observed an increasing number of customers using it to test raw materials. The pharmaceutical pipeline is leaning towards large molecules, and we expect the simplified LCMS method to enhance workflows significantly for years to come. Overall, while we have previously discussed LC, I'm particularly excited about how MassSpec is contributing to growth in pharmaceutical, food, environmental, and academic segments.

Operator, Operator

The next question is coming from Matt Sykes, Goldman Sachs. Your line is open.

Matt Sykes, Analyst

Hi, good morning. Thanks for taking my questions and congrats on the quarter. Udit maybe the first question just on China, it seems that for you and others that China lockdowns have been less impactful this time around than previously. Could you maybe talk about what has changed there? Is it just where the lockdowns are occurring? Or if you change the way that you're managing that business over there to adjust to that type of environment? So should we expect maybe less volatility in China going forward?

Udit Batra, CEO

It's a great question, and it's something we discuss frequently within our team. There are indeed rolling lockdowns occurring in China even now. However, we have established strong leadership in China over the last couple of years, which has helped us navigate these challenges effectively. I believe this will continue in the upcoming quarters. Currently, China is experiencing around 16% growth year-to-date, with this quarter showing approximately 23%. The growth is primarily due to our solid commercial execution and instrument replacements driven by our Arc HPLC. Moreover, our MassSpec offerings have revived the academic segment where business has nearly doubled, along with growth in the industrial sector. We are performing well across various markets, not just in pharmaceuticals. Our contract manufacturing initiative has been particularly successful, especially with a biologics contract manufacturer in China. Commercial execution is thriving, and innovation is making a significant impact everywhere. Our MassSpec tandem quad portfolio has boosted growth in the food, environmental, and electronics testing markets. Looking ahead, navigating through these fluctuations gives us confidence that as conditions improve, we will continue to accelerate in China. Therefore, we view China as a strong growth market and are optimistic about our leadership and execution to manage the volatility we have encountered.

Amol Chaubal, CFO

And good to add to that, Matt, right? For Q3, China benefited with a lower baseline, because of the $12 million shipment delay last year, so that's about 10 percentage points of growth. But at the same time, they did have a headwind from some of the newer lockdowns, so one has to keep that in mind. And as Udit outlined, you know, for us, the team is executing really well and working towards a mid-teens growth profile for the year.

Matt Sykes, Analyst

Great. And thanks for that, and then just one quick one for you, Amol. Just on inventory, there's obviously a lot of focus on the customer side inventories. But as you think about your own inventory, can you think about the potential visibility of demand as we go into ’23 and it still could be somewhat uncertain? How are you thinking about building your own inventories to solve for the supply chain constraints that still exist, but also for maybe a more uncertain demand environment in ‘23?

Amol Chaubal, CFO

Yes. So I mean, what we've done is we've looked at sort of our product profile and we've gone through bill of materials for pretty much every product and gone through secondary and tertiary supply chains and identified hotspots where a certain component that travels through the supply chain is sort of in shortage. And there, we've gone deep to build relationships with the primary supplier and have secured quantities that will last us for longer than usual times, right? And where possible we have built alternative supplies especially for electronic components and where possible we will also build geographical diversification. So you're sort of not stuck in a lockdown in China or in a place where you have a sole source. Now that has put some pressure on inventory, because we've sort of accumulated this inventory in preparation for the demand that we are seeing on the instrument side and in preparation for potential supply disruptions that may be caused by COVID or other sort of macroeconomic events. But at this point, we feel really good where supply chain stands, right, progressively a lot of the yellows have been resolved and things are sort of between green and yellow on most of the items.

Operator, Operator

The next question is coming from Rachel Vatnsdal of JPMorgan. Your line is open.

Rachel Vatnsdal, Analyst

Okay, thanks. Thanks for taking the questions. So first off here, I mean, we've had a few of your peers just talk about changing in ordering patterns from customers throughout various end markets. Just as supply chain constraints have slowed down, so you're seeing customers returning back to normalized ordering patterns. So just wondering if you've seen anything in line with that across any of your end markets, earning a no shift in those ordering patterns from your customers so far?

Udit Batra, CEO

Our orders have continued to grow at a rate that exceeds our sales this quarter. There hasn’t been any significant change in order patterns this year; the demand pipeline remains strong. Approximately 80% of our end markets are very resilient. Additionally, our products are innovative and meet unmet needs for our customers. For instance, we believe that there will be sustained demand for the Xevo TQ Absolute, as it is essential for testing PFAs, and the Xevo TQ XS with Waters Connect, which offers analysis that is 50% faster than competitors. The same goes for the ACQUITY Premier and Arc HPLC, given the advantages they provide. The strong demand for our innovative products in robust market segments does not appear to be affected by the trends you mentioned. We are also implementing specific strategies to enhance our customer engagement, particularly from an innovation perspective. Sure, Rachel. I mean, look, I'll just add, I mean, in many cases as we think through e-commerce, while there might be an initial demand, orders are becoming more normalized now, while we see that progressing positively and that's expected as demand stabilizes. However, given the strength of our portfolio and the needs that remain unmet overall, we don't expect any key disruptions in our growth profile, especially with the continued investment into new innovations and solutions. The end-market trends, driven by robust demand from industries we serve, remain favorable.

Rachel Vatnsdal, Analyst

Great. And then just a follow-up here on M&A, can you just talk about how the pipeline is looking? And then anecdotally, we've heard that those private valuations on the private side of things have still remained high? So what have you seen from that and kind of what's the latest timeline for when you think that you could maybe get a deal done here? And then finally, what type of leverage range would you be willing to reach for the right size deal in any of those high growth adjacent markets that you flagged?

Udit Batra, CEO

Sure, Rachel. I mean, M&A is something we're thinking about quite regularly, right? I mean, but I’ll just remind you sort of our overall capital allocation priorities, right? I mean growth is the imperative, we're seeing tremendous organic growth and that remains the number one priority. I mean, we'll invest in CapEx and OpEx as Amol mentioned earlier about 80 basis points even in this environment to support our growth ambitions. We feel extremely good about that. Second, to support the growth, we're looking at M&A opportunities and the pipeline is very robust, not just in the adjacencies, but also in the coal. In some areas they are richer than others, of course, you can imagine I can't comment more specifically on it. And if we don't find something that is financially reasonable and sensible, will of course continue to do buybacks as we've done in the past. But growth remains the priority. As far as timing is concerned, that's always better to comment in the rearview mirror. Amol, do you want to talk about the leverage ratios?

Amol Chaubal, CFO

Yes. I mean, in general, our thinking is, first of all, we want to be absolutely financially disciplined and make sure that on a risk adjusted basis any transaction creates value for our shareholders. And then in terms of financing, we want to stay investment grade as much as possible or even lower. So that the interest rates have gone up and that can create a dilutive impact on EPS accretion. But as long as we are sort of within investment grade, we should be able to thread the needle.

Operator, Operator

The next question is coming from Derik De Bruin, Bank of America. Your line is open.

Mike Ryskin, Analyst

Thank you for taking my question. This is Mike Ryskin stepping in for Derik. Udit, you mentioned the timing of a slowdown, but I would like to delve into the factors driving growth. We recognize the role of innovation and strong markets, yet these results are consistently impressive quarter after quarter. Could you provide further breakdowns of the growth components? Specifically, how do share gains, the replacement cycle, new lab construction, and emerging markets compare? You also highlighted the increasing significance of PFAs. Could you clarify what you see as the main contributors to this growth surge, which may offer insights into its sustainability moving forward?

Udit Batra, CEO

Michael, I can share the algorithm with you, but I won’t be able to provide very deep specifics on each item. To recap the drivers, the end markets we serve are resilient and robust. About 80% are performing well, and we are confident in the strength of these end markets. Historically, that number has been X, and now it’s improved to X plus delta X, driven in part by both volume increases and higher pricing. From a Water-specific standpoint, we identified three contributors. We noted at our Analyst Day that you can expect about 100 basis points from our commercial initiatives, instrument replacements, CDMO, service, and e-commerce, all of which are contributing significantly, so definitely more than 100 basis points this year. Additionally, innovation is another key driver. I took some time today to discuss its importance, given your questions about the sustainability of growth. Innovation is already making a substantial impact. For instance, MaxPeak Premier is the fastest launch in Waters' history for columns. We've been launching columns since 1970, and this one has outperformed all previous launches. Furthermore, our MassSpec portfolio has been completely revitalized, and we are just beginning to tap into the extraction market. There's a strong need for PFAs testing in water analysis, and we have the best instruments available. While we didn't discuss TA much today, it has also seen innovation with our powder rheology instrument, which tests powders for coatings and battery components. I’m very optimistic about these developments, but I won't provide a specific number. We may be able to provide insights in Q4 regarding how innovation has contributed. The adjacencies you inquired about are also showing promise. I mentioned BioAccord and similar trends emerging in LCMS. I recently attended the American Association of Clinical Research in Chicago and noted strong demand for early disease detection in clinical settings. These different adjacencies are starting to contribute, and while we expect more meaningful contributions beyond 2024, we’re already observing positive results. Overall, this explains our outperformance. We took time to present a three-year stacked growth rate because short-term quarter-on-quarter changes can obscure our achievements. Examining our growth over two to three years clearly shows we are outperforming our peers. I hope this clarifies how demand is expected to evolve in the coming years.

Operator, Operator

This will conclude our question-and-answer session for today's call.

Udit Batra, CEO

Thank you.

Operator, Operator

And this will conclude our conference for today. All parties may disconnect at this time.