Earnings Call Transcript - WAT Q1 2024

Operator, Operator

Good morning. Welcome to the Waters Corporation First Quarter 2024 Financial Results Conference Call. This call is being recorded. If anyone has objections, please disconnect at this time. It is now my pleasure to turn the call over to Mr. Caspar Tudor, Head of Investor Relations. Please go ahead, sir.

Caspar Tudor, Head of Investor Relations

Thank you, Ivy. Good morning, everyone, and welcome to the Waters Corporation First 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. I would like to first point out that our earnings release and the slide presentation supplementing today's call are available on the Investor Relations section of our website. 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 second quarter of 2024 and full year 2024. 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, our Form 10-Qs and the cautionary language included in this morning's earnings 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 first quarter of fiscal year 2023 in organic constant currency terms. In addition, unless stated otherwise, all year-over-year revenue growth rates and ranges given on today's call, are given on a comparable organic constant currency basis. Finally, we do not intend to update our guidance, predictions or projections, except as part of a 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 remarks, then Amol will provide a more detailed look at our financial results. After, we will open the phone lines to take questions. Udit?

Udit Batra, CEO

Thank you, Caspar, and good morning, everyone. We had a strong start to the year with sales coming in at the high end of our expectations backed again by excellent operational performance. I want to begin today's call by thanking my colleagues for their continued focus on innovation and supporting our customers. These results reflect our drive to accelerate the benefits of pioneering science with our innovative portfolio. In the first quarter, market conditions were as expected, with cautious customer spending and later than typical budget releases. But as budgets opened up, we executed well with sales landing at the high end of our guide. We also continued to deliver outstanding operational results. Earnings were above our guidance and margins expanded even with volume and FX headwinds. This is a testament to our team, our resilient business model and our operational initiatives. Waters is well positioned for future growth in our attractive secular end markets. In the first quarter, we added to our revitalized portfolio with new products that serve high-growth areas. Turning now to our results. In the first quarter, sales landed at the high end of our guidance, declining 7% as reported and 9% in organic constant currency. Our non-GAAP earnings per share exceeded our guidance at $2.21. On a GAAP basis, EPS was $1.72. Outside of China, sales declined mid-single digits as expected. In China, sales declined just under 30%, which was better than expected. Growth remained weak as our prior year baseline does not reflect last year's deterioration in market conditions, which became more pronounced in the second half. While instruments declined 25% overall, LC sales were slightly better than expected, instrument weakness was led by mass spec, particularly for A&G-related applications, which had a tough prior year comparison from global funding and the China stimulus. Wyatt delivered a 3% M&A contribution to sales. We continue to see strong synergy performance and traction for our recently launched products such as ZetaStar. Now I will talk more about our operational performance. We believe the best reflection of good operational execution is effective margin management, particularly when things slow down. While facing significant headwinds from volume, FX and inflation, we delivered yet another strong margin result. Our gross margin expanded 40 basis points to 58.9%, and our operating margin expanded 20 basis points for the quarter to 27%. This was achieved through a combination of our operational management initiatives across pricing, productivity and proactive cost alignment. These initiatives position us well for resilience during lower volume periods and give longer-term opportunity when market conditions normalize. You can see further evidence of our operational performance and our free cash flow. We had an exceptional start to the year, generating free cash flow of USD 234 million in the first quarter, which was 37% of sales. With our excellent free cash flow profile, we made rapid progress in delevering from the Wyatt acquisition, as we approach its 1-year anniversary. We serve attractive secular end markets where testing volume plays a pivotal role in our business. This volume, which is correlated with global prescription consumption is expected to accelerate in the future, supporting our strong long-term growth outlook. Our distinct advantage in downstream applications lines with our full ecosystem of products that complement our innovative instrument portfolio. In addition, we have strategically aligned with high-growth opportunities that further enhance our core position. We had a busy quarter launching several new products that support a number of exciting, high-growth areas. At Analytica, last month, we launched the Alliance iS Bio, a version of our groundbreaking next-generation liquid chromatography platform suited for biologics applications. This new HPLC system combines advanced bioseparation technology, bioinert surfaces and built-in intelligence features. This helps Biopharma QC analysts boost efficiency and eliminate up to 40% of common lab errors. We believe that the Alliance iS is the most significant innovation to hit pharma QA/QC labs in over a decade. We're excited to bring this technology to routine testing applications for biologics. Supporting BioSeparations, we launched a new set of size exclusion chromatography columns called GTxResolve Premier. These columns enable scientists to quickly assess aggregate content, integrity and purity of larger biologic particles. It covers modalities such as lipid nanoparticles, nucleic acids, and viral vectors and gives scientists a significant improvement in sensitivity and sample consumption while accelerating run times. This launch supports the development of these modalities into downstream high-volume settings, where Waters has critical instrument technology like LC, mass spec and light scattering as well as highly innovative industry-leading software chemistry and service. To simplify the detection of PFAS, we launched Waters' Oasis dual-phase analysis cartridges. This consumable streamlines sample prep for PFAS workflows when detecting concentrations in water, soils, biosolids and tissues. It joins our comprehensive portfolio of solutions that support the surging demand for PFAS testing, which is a USD 300 million to USD 350 million global market, growing 20% annually. In an environment of increased scrutiny, the ability to accurately test for PFAS at very low levels is becoming a critical compliance need for a broad spectrum of industries. Our Xevo TQ absolute mass spec has leading sensitivity for detecting these anionic compounds. It can detect PFAS levels at as low as 1 part per quadrillion. Last month, in the United States, the EPA finalized and enforceable 4 parts per trillion limit of PFOA and PFOS in drinking water, which marks a significant regulatory milestone. Later this year, further regulations governing PFAS are expected across the globe. This includes the European Union, where REACH proposed chemicals regulation contemplates a PFAS ban on products manufactured as well as once imported. In our TA business, we launched the Rheo-IS, which serves battery testing applications when used with our hybrid rheometers. This Rheo-Impedance Spectroscopy accessory supports characterization of electrode studies, which can lead to more efficient battery production. I will now cover our 2024 full year guidance. With our first quarter results, we remain on track to achieve our full year revenue outlook, which is unchanged from our previous guidance at negative 0.5% to positive 1.5% growth in organic constant currency. We expect growth rates to improve over the remainder of the year and as our prior year comparisons, especially in China, get easier. We expect improving funnel activity to translate to orders as the year progresses. With our strong operational performance, we expect to build leverage in our P&L despite the flattish revenue guide and deliver 20 to 30 basis points of adjusted operating margin expansion while still reinvesting for growth. As a result, our adjusted EPS guidance is also unchanged at 0% to 3% growth in the range of $11.75 to $12.05.

Amol Chaubal, CFO

Thank you, Udit, and good morning, everyone. In the first quarter, sales landed at the high end of our guidance range, declining 7% as reported and 9% in organic constant currency. As Udit mentioned, end market dynamics were consistent with our expectations. Ex-China declined mid-single digits as expected, while China declined close to 30%, which was slightly better than expected. In organic constant currency by end market, Pharma declined 6%, industrial declined 7% and academic and government declined 30%. In Pharma, sales outside of China declined low single digits as we executed well in this CapEx constrained environment. In China, sales declined almost 30% due to ongoing market challenges that are not reflected in our prior year baselines. In industrial, food and environmental applications grew mid-single digits with continued strong growth in PFAS related workflows globally. We also saw strong growth in battery testing within our TA business, which has been a consistent growth theme. However, this strength was more than offset by weakness in core industrial applications, which are more cyclical. Our TA business declined high single digits overall, while chemical analysis declined high teens. In academic and government, growth was weak against a 45% comparison as stimulus in China and elevated global funding in the prior year quarter drove lumpy spending patterns. By geography, sales in Asia declined 16%. The Americas declined 8% and Europe declined 3%. By products and services, instruments declined 25% with LC growth slightly better than expected. Within recurring revenues, chemistry grew low single digits and service grew mid-single digits, both of which were affected by low activity levels in China. The quarter had 1 fewer day compared to the first quarter of 2023, which translates to a growth headwind of approximately 1% for recurring revenues. Now I will comment on our first quarter non-GAAP financial performance versus the prior year. Despite headwinds from lower sales volumes, FX and inflation, our team continued to respond to these challenges with resilience and commitment. Our focus on operational excellence with pricing, productivity and proactive cost alignment allowed us to deliver first quarter gross margin of 58.9%, an expansion of 40 basis points, and first quarter adjusted operating margin of 27% and expansion of 20 basis points. Our effective operating tax rate for the quarter was 14.3% and our average share count was 59.4 million shares. Our non-GAAP earnings per fully diluted share were $2.21. On a GAAP basis, earnings per fully diluted share were $1.72. A reconciliation of our GAAP to non-GAAP earnings is attached to this morning's press release and in the appendix of our earnings call presentation. Turning now 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 first quarter of 2024, free cash flow was $234 million after funding $29 million of capital expenditures, which is approximately 37% of sales. We maintain a strong balance sheet, access to liquidity and well-structured debt maturity profile. This strength allows us 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. At the end of the quarter, our net debt position further declined to $1.7 billion, which is a net debt-to-EBITDA ratio of about 1.8x. This reflects a decrease of approximately $300 million, as we delivered the Wyatt acquisition. As previously disclosed, our share buyback program has been temporarily suspended to enable us to pay down debt incurred as part of the Wyatt acquisition last year. We will evaluate the resumption of our share repurchase program throughout 2024 as part of our balanced capital deployment objectives. Now I would like to share further commentary on our full year outlook and provide you with our second quarter guidance. We expect to see an improvement in sales growth over the course of 2024 as prior year comparisons, particularly in China, become easier, and as improved funnel activity translates to orders. Our full year guidance is unchanged with 2024 organic constant currency sales growth expected between negative 0.5% and positive 1.5%. At current exchange rates, currency translation is expected to result in a negative impact of just under 1% on a full year sales basis. We expect the Wyatt transaction to add just over 1% M&A contribution to our full year 2024 revenue for inorganic sales incurred in the first 4.5 months of the year. Therefore, our total reported sales growth guidance is unchanged at approximately 0% to 2%. Despite guiding to flattish sales, we expect to deliver a gross margin of 59.8% for the full year, which is a 20 basis points of expansion versus 2023. We also expect to deliver 20 to 30 basis points of operating margin expansion versus 2023, resulting in an adjusted operating margin of slightly over 31%. We expect our full year net interest expense to be approximately $80 million. Our full year tax rate is expected to be 16.3%, and our average diluted 2024 share count is expected to be approximately 59.7 million. Rolling all this together, on a non-GAAP basis, our full year 2024 earnings per fully diluted share guidance is also unchanged and projected in the range of $11.75 to $12.05. This is approximately 0% to 3% growth and includes an estimated headwind of approximately 2% due to unfavorable foreign exchange. Looking to the second quarter 2024, we anticipate that cautious customer spending will persist. In addition, while the China Q2 baseline reflects the onset of weakness, it does not fully reflect the weakness we observed in the second half of the year. As a result, we expect China to decline mid-teens in Q2 versus the 28% decline we saw in Q1. Given these dynamics, we expect to see an improvement in year-over-year growth versus the first quarter and our second quarter organic constant currency sales growth guidance is projected in the range of negative 6% to negative 4%. At current rates, currency translation is expected to subtract approximately 2%. Wyatt is expected to add approximately 1.5% M&A contribution for sales incurred in the first 1.5 month of the quarter. Therefore, our total second quarter reported sales growth guidance is negative 6.5% to negative 4.5%. Based on these revenue expectations, second quarter non-GAAP earnings per fully diluted share are estimated to be in the range of $2.50 to $2.60, which includes a negative currency impact of approximately 4 percentage points at current FX rates.

Udit Batra, CEO

Thank you, Amol. I would like now to give you a brief update on our progress towards leaving the world better than we found it, which is how we think about ESG. We work alongside wonderful people here at Waters, and I'm always proud when others recognize their talent and hard work. Our colleagues were recognized in the quarter for their achievements and contributions to separation science, excellence in manufacturing and for being champions of LGBTQ and women's benefits in the workplace. I would also like to congratulate Dr. Philip Wyatt, the founder of Wyatt Technology for receiving the esteemed Pittcon Heritage Award earlier this year. Dr. Wyatt's groundbreaking contributions to laser light scattering technology have paved the way for industry-leading advancements. From a corporate standpoint, Waters has once again been honored by Barron's, earning a place on its list of the 100 most sustainable companies in 2024. Additionally, we are delighted to announce that S&P Global has included Waters in its 2024 sustainability yearbook. Separately, our commitment to robust governance practices was recently highlighted by the New England Chapter of the National Association of Corporate Directors. We were honored to have Massachusetts Governor, Maura Healey present Waters with the 2024 public company Board of the Year Award. After recently committing to SBTI, which is the science-based targets initiative, we are now building on the excellent progress we made in reducing our greenhouse gas emissions. We're in the process of setting new standards towards a long-term reduction in emissions and aligning our business with the 1.5 degree centigrade future. Now to summarize, we're pleased with how the first quarter landed versus our expectations, which supports our full year guidance. We remain on track to achieving the 2024 objectives and look forward to building on this strength as the year progresses. Our long-term growth profile remains excellent, and we are aligned to secular tailwinds that are stronger than ever in our attractive markets. With our robust financial profile and balanced capital allocation strategy, we have an excellent platform to deliver sustained value for our shareholders. 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. We are now ready to open the phone lines for questions.

Operator, Operator

Our first question comes from Dan Brennan from TD Cowen.

Daniel Brennan, Analyst

Maybe the first one just on China. You guys were coming into the quarter expecting down 40, and I know it was certainly better than that, and you're talking about Q2 color. I'm just wondering, I know you guys gave some color on what was going on in the quarter. But could you just unpack it a little bit more like what deviated from the guide? How it's pacing in the quarter? And then is there any change to your full year down mid-teens, high-teens growth for China?

Udit Batra, CEO

China performed better than we anticipated, but it is still experiencing a decline in the high 20s. We expect this trend to continue through at least the first half of the year, with Q2 also showing a decline. However, we anticipate some growth in the second half of the year as the comparisons become less challenging. Referring back to Q1, when we discussed the changes, we noted last year that we believed there was a stabilization in volumes across all markets, particularly in pharma. Since then, we've witnessed improved activity, especially in replacing aging LCs within our Branded Generics segment, a topic we touched on last quarter as well. It's still early, but we're beginning to see customers start to replace this outdated LC fleet. As of late last year, we highlighted that the five-year growth for LC instruments in China is down nearly 10%, around 8% to 9% compared to last year and the past five years. With that context, we expect the replacement cycle to initiate, and we've already begun to see signs of this in Q1. Additionally, there's been considerable discussion around the new stimulus, which differs significantly from previous iterations. It appears to extend over a three-year period, is three times larger, and specifically mentions instrument replacement. While we haven't factored this into our full-year guidance, we now project a low double-digit decline instead of the previously discussed high teens decline. This suggests that China will likely perform better than we initially expected. Moving forward, although we haven't included the stimulus in our guidance, we should not underestimate its potential impact on the sentiment surrounding capital expenditures, particularly regarding the replacement cycle. As this begins to unfold in the latter half of the year and into 2024 and early 2025, we expect sentiment to improve and the replacement cycle to start in earnest.

Operator, Operator

Next, we'll go to the line of Vijay Kumar from Evercore ISI.

Vijay Kumar, Analyst

Udit, regarding your comment about China, you mentioned that there was improved funnel activity during the quarter as it progressed. Is that funnel activity being driven by China, or is it more of a global biopharma trend? Could you clarify what you mean by funnel activity? Also, concerning the guidance for the second half, which assumes high singles growth, what visibility do we have on the growth normalizing in that period?

Udit Batra, CEO

Thank you for your questions, Vijay. Let me provide some context. As you know, the first quarter is the most challenging for us to predict, as it tends to be the smallest quarter of the year and is when customers assess their total capital expenditure for the year and its timing. I took the opportunity to meet with several customers across Europe and the United States in various sectors such as pharmaceuticals, agriculture and government, industrial, and clinical. There are three main points to highlight. First, the quality of our sales funnel and orders is significantly better than it was a year ago across all segments, particularly in pharmaceuticals and biotech in both Europe and the U.S. Second, our new products are gaining a lot of traction and are being widely utilized by our customers, who are eager to fully adopt our Alliance iS platform. Lastly, regarding the timing of orders, while they are strong, capital expenditure decisions are often made in the later part of the first quarter. Thus, we expect to see the benefits of these orders starting late in the second quarter and more prominently in the latter half of the year. Consequently, our forecast is weighted towards the second half of the year. We have gained increased confidence in our full-year projections as a result of these discussions. Historically, over the past 15 years, the second quarter typically sees an 11% to 12% increase from the first quarter, so we are assuming a 10% increase this year. Additionally, looking at historical trends, the first half generally accounts for 45% of our revenues while the second half accounts for 55%. This historical data is what we used to guide our revenue projections. Overall, we feel more optimistic about our full-year guidance due to the strengthening of our sales funnel and conversations with customers globally, with our timing in line with historical patterns.

Vijay Kumar, Analyst

Fantastic. I'll let others jump in.

Operator, Operator

Next, we'll go to the line of Michael Ryskin from Bank of America.

Michael Ryskin, Analyst

Just following up on some of the end market commentary you talked about China a little about how you expect a low double-digit decline, so a little bit better than prior. You're maintaining the fiscal year. So what's sort of offsetting that? And maybe specifically honing on Americas, it looked like that came a little bit worse in the quarter. Anything changed in your outlook there for the year? And then I've got a quick follow-up.

Amol Chaubal, CFO

Yes. No. I mean, Mike, at this point, we are just derisking the remainder of the guide, right? We had better expectations of China, based on how we are executing in that market, and we're keeping our full year guide flat.

Udit Batra, CEO

Yes. And then I think you asked about the U.S., in particular, what are we seeing in the U.S. Look, I mean, as I said, I spent a fair amount of time with customers across the globe. And one of those was a large customer in the Midwest, where I spent a whole day with about 12 to 13 folks from the customer across many different departments, across development, manufacturing, QA/QC. And we talked deeply about what they envision for CapEx, which I sort of earlier commented on, and the CapEx is very robust. Second, we talked about the use of our new products, think about in-line testing with LCs, think about our columns, think about the upgrades for empower. The software, really, really well received. And we talked about the phasing of the spend, which also, again, is still sort of late Q2 and back half weighted. But to put it all in perspective, if you look at the U.S. itself, the 5 years stack, Michael, is still pretty healthy. It's in the mid- to high single digits, right? So there is really no drama outside of China. I mean we've had 2 exceptional years in ex-China sales. And now you have a little bit of a lull, but the activity looks extremely good, gives us confidence of what we are planning for the full year. So as I said, no drama, no new news, but just other than the fact that new products are gaining traction and customers have much more robust orders than they did a year ago.

Michael Ryskin, Analyst

Okay. If I could squeeze in a quick follow-up. On Wyatt, you had some commentary on how the quarter progressed? And if you could elaborate on that a little bit. And it looks like you tweaked down the M&A contribution for the year. I think it was $1.3 million prior. Now it's $1.1 billion. Is that instrument mix in Wyatt? Is that phased and phasing through the year? Just sort of how is that acquisition trending?

Amol Chaubal, CFO

Yes, look, I mean, on Wyatt, we're making fantastic progress, right? All the synergies that we laid out at the beginning of the acquisition, like cross-selling, like attaching our LC seamlessly to the instrument, like attaching our columns with their shipments have all progressed ahead of schedule, including sort of a beta version of bringing light scattering on Empower. Now keep in mind, right, Q1 is a really small quarter and for instruments, especially and when things sort of slip a couple of weeks here and there, it causes that distortion. And that's why we sort of tweaked down Wyatt to 1.1% versus 1.3% M&A contribution. But with the way that acquisition is going, we are super happy where we are in that journey and really look forward to bringing light scattering into QA/QC.

Udit Batra, CEO

Michael, to add to that, I met with one of our largest academic customers, which has an attached hospital, and we extensively discussed the characterization of lipid nanoparticles. As you know, these nanoparticles are used for mRNA delivery, including vaccines and therapeutics, an area of considerable focus in both academia and industry. This customer specializes in characterizing lipid nanoparticles, which often come in various sizes and shapes. They utilize SEC columns from Waters and light scattering equipment for this task. I also discovered that they are testing field flow fractionation, another instrument made by Wyatt, as a preliminary step before using SEC malls. The initial results are very promising, and if these tests prove successful, field flow fractionation could become a standard method for separating these aggregates. This concept similarly applies to AAVs, viral vectors utilized in cell and gene therapy, as well as other particles used in biologics. I am very excited about our progress with Waters; it is an excellent cultural fit, exceeding our synergy targets, and customer discussions are giving me greater confidence. In the mid- to long-term, we anticipate continued contributions to growth and margins.

Operator, Operator

Our next question comes from Matt Sykes from Goldman Sachs.

Matthew Sykes, Analyst

Maybe just revisiting the guide, just given the lower-than-expected guide in Q2, and you mentioned that you expect sort of funnel activity translate into some level of orders towards the end of Q2 into Q3. Have you changed sort of your view on the phasing for second half in terms of the growth you're going to achieve in Q3 versus Q4? Are you pushing more of that potential growth into Q4? Has that phasing at all changed for your full year guide?

Amol Chaubal, CFO

So Matt, thanks for your question. And look, I mean, we executed well to finish at the higher end of our Q1 guide, right? And that sort of keeps us on track for our full year sales guide. And as Udit discussed, our Q2 guide is essentially 10% higher than Q1, which has been sort of our historical trend pre-pandemic. And our second half guide is also very much consistent with how we've historically performed, which is a 45-55 split. So we generally expect the breakdown between Q3 and Q4 to also follow that historical trend for 2024.

Udit Batra, CEO

I think, Matt, thanks for the question. And again, I'll remind you, we had the same discussion when we looked at Q3 versus Q4 of 2023, and there was a lot of discussion on the ramp. And I think we, again, landed at the higher end of what we were predicting. So a difficult business overall to predict if you have high average selling price instruments. But I think we have so much statistics from the history of Waters, gives us a lot of confidence and couple that with discussions that we've had with customers that we think the full year guide is fully intact. And quarter-on-quarter, there's a lot more time to talk about it as we see how Q2 evolves on the ramp between Q3 and Q4. But history should be a decent guide if you're really looking at that sort of modeling between quarters.

Amol Chaubal, CFO

Yes. I mean on a growth basis, it looks a little weird, but that's because of last year, right? The weakness progressively stepped in China and pretty much Q3 and Q4, there was no incremental meaningful bad news out of China, but a lot of that was not reflected in Q1 and Q2. And that's why it sort of it plays out in the growth purely from the baseline effect mostly from China.

Udit Batra, CEO

I think what Amol is saying is it's arithmetic, and customer conversations give us confidence that we have a pretty good set of visibility.

Operator, Operator

Next, we'll go to Rachel Vatnsdal from JPMorgan.

Rachel Vatnsdal Olson, Analyst

So I wanted to dig into the pharma performance in China a little bit. I believe you said that was down 30% this quarter versus rest of world down low single digits. So can you impact that China performance within Pharma for us a little bit? Obviously, we've seen the headlines related to the BIOSECURE Act. Last year at 1Q, you guys called out your overexposure to CDMOs in the region. So can you quantify for us how much of this was driven by those Tier 1 CDMOs in the region this quarter? And then you previously have kind of broken out those trends between Tier 1 versus Tier 2 and 3 CDMOs. So could you do that for this quarter as well?

Amol Chaubal, CFO

Great question. Over the past year, in the second, third, and fourth quarters, we noticed some weakness in various areas of the pharma business in China. However, as I mentioned earlier in the third and fourth quarters, there was no new negative news from China, and that pattern has continued into the first quarter. Essentially, the decline you're observing is primarily related to baseline factors, indicating that the pharma sector in China has likely reached its lowest point, and there are no new challenges impacting the business. At the same time, we are not witnessing growth in activities related to CDMOs, branded generics, or biotechs in China, so the situation can be described as stable. Regarding your second point on the BIOSECURE Act, in light of the weaknesses we observed in 2023, the baseline in China for submarkets like CDMOs, including Wuxi, has largely stabilized. We are observing that customers are taking proactive steps to secure their supply chains. In these instances, our service organization, which is highly regarded in the industry and plays a crucial role in technology transfers, becomes actively involved when these changes take place. Our role is to assist customers during these transitions, and they truly appreciate our support as they relocate products from one site to another.

Udit Batra, CEO

And Rachel, just to embellish on this, and that's a very good sort of insightful question, just to embellish on what Amol said, on the minus 30% for Q1, it came minus 28%, Q1, it came above our expectations, largely because we started to see customers who have aging LC fleets in branded generics start to move, right? So we started to see that signal, which is a positive sign. And as I commented earlier, as the stimulus starts to roll in towards the latter part of the year, that should have a positive impact on the psychology for spending CapEx. And I'll remind you that we're sort of almost 50% delinquent on these replacements in the Branded Generics segment, which is the largest segment for LCs in China. So we expect that to turn at some point, and the psychology will have a lot to do with it. And on BIOSECURE, I mean, it's a net neutral for us at the end, right? I mean we've already bottomed out on CDMOs in China, and I think as customers look for help in transferring from one vendor to another, we stand ready to help them.

Rachel Vatnsdal Olson, Analyst

Great. And then my follow-up. I want to push on that China stimulus dynamic a little bit more in terms of some of your peers that are working on proposals for customers at this point, so can you talk about the conversations you're having on your end with customers and if you're working on proposals as well? And specifically, what types of instruments and then which industries do you really expect to benefit from within China stimulus? We've heard some rumors around this being a little bit more industrial-focused or you seeing down in your proposal funnel as well? And then when do you think that this could eventually translate into orders and revenue? You mentioned back half of the year, some of the psychological impact. So any color on timing expectations that would be helpful as well.

Udit Batra, CEO

Everything related to the stimulus, Rachel. As for timing, I don't have much more to add to what I previously mentioned. In the latter half of the year, we are indeed collaborating with several customers regarding their stimulus plans as they receive more information nationwide. This is a broad stimulus, lasting three years and three times the size of previous ones. It affects nearly all customer segments, not just A&G. Honestly, I’m not sure what academia would do with extra funds considering they have already invested heavily, evidenced by the high number of high-resolution instruments they purchased last year that remain unopened. Therefore, I don’t anticipate much of this funding going to high-tier A&G customers, but there are many discussions happening across various segments as customers strategize and learn more about the stimulus details. However, we have not included this in our guidance and I wouldn't expect its impact until later this year or early next year. We are having constructive dialogues with customers and planning is underway, similar to what you’ve heard from others, but it's broader than just academia, reaching into industrial and pharmaceutical sectors. I would also not underestimate the psychological impact, as I mentioned before, since we are operating at a significant deficit in LC instruments and Branded Generics.

Operator, Operator

Next, we'll go to the line of Daniel Leonard from UBS.

Daniel Leonard, Analyst

One question on your gross margin expansion in the quarter. How much did better-than-expected product mix contribute to that? You mentioned that liquid chromatography did a bit better than planned and mass spec was a bit worse. So I'm curious how much of the contribution that was.

Amol Chaubal, CFO

Dan, yes, I mean, look, the product mix is helping at this point, especially given lower instrument mix, that's contributing about 30 basis points. But keep in mind, there was also a good 70 to 80 basis points of FX headwind that we offset, right? So the remaining delta is favorably coming from price and some of the productivity initiatives in manufacturing.

Operator, Operator

Next, we'll go to the line of Patrick Donnelly from Citi.

Patrick Donnelly, Analyst

I guess in terms of some of these conversations you're having, I'm wondering what stage do you think we're in? It sounds like again, the conversations with the funnel to your point, maybe improving a little bit, specifically with China, it sounds like maybe you're expecting the actual revs to show up late this year at the earliest. So how do you think about just the progression of these conversations into orders, into revs? And again, is there a potential for a bit of an air pocket as these conversations pick up and the dollars materialize a little later in the year? How do you think about just the progression there?

Udit Batra, CEO

It's a great question. Let's take a moment to consider Waters overall. As many of you know, our instruments have grown by approximately 5%. Your question focuses on instruments, which have shown an average growth of 5% over the last 15 years. This information is readily available, particularly since we haven't engaged in much M&A activity. Looking at our historical performance with instruments, the average growth is indeed around 5%, but it’s important to note that no single year exactly matches that figure. Some years are significantly lower, while others exceed the average, and some hover close to it. Since I joined the company 3.5 years ago, we've observed a snapshot of this trend. For instance, we had two years of over 20% growth followed by a slight decline in the growth rate for instruments. We remained cautious during the periods of high growth, recognizing they wouldn’t be sustainable given the long-term averages. Similarly, we are not overly concerned with the current trends we are seeing now. Now, to directly answer your question within that context, predicting quarter-to-quarter instrument rollout for Waters is quite challenging. A more useful approach is to consider the five-year average, especially for liquid chromatography (LC). Currently, the five-year compound annual growth rate for LC is in the low single digits, with China experiencing nearly double-digit declines. We anticipate a replacement cycle for LC instrumentation to start soon because these instruments are essential for quality assurance and control; these replacements can't be delayed indefinitely. Based on our discussions with customers, including a full day spent with one of our largest clients focused on QA/QC, there is significant eagerness to initiate these replacement cycles for LCs. They are keen to update their aging equipment, especially with new product launches expected to be high volume and involve marketed compounds. Overall, while there are positive trends, it's important to remain cautious about getting too excited about high growth followed by a decline in our instrument portfolio. For the full year, it's worth noting that we follow a 45-55 split for our overall business, with 45% in the first half and 55% in the second half, which is how we plan for the year. The anticipated increase in the second quarter is about 10%. This provides a broad overview of our expectations. Our discussions have heavily focused on QA/QC, and we are seeing signs of replacement cycles beginning in both China and outside China.

Patrick Donnelly, Analyst

And then Amol, maybe just quickly on the margin side. Can you just talk about the progression as we work our way through the year? I know you guys have some kind of cost initiatives working their way through the year last year. So I'm just trying to think on the cadence there and any moving pieces you want to call out as you work our way through '24 here.

Amol Chaubal, CFO

Yes, look, I mean, already in Q1, we put good numbers on board and continued our good financial performance. As you get into the second half of the year, keep in mind, the proactive cost actions that we took are already in the baseline, and there will be some headwind as we accrue for bonuses. So you may not see meaningful margin expansion in the second half, net of those 2 effects, but we would have mostly covered our ground for the 20 to 30 basis points of margin expansion mostly in the first half. So we will still end up delivering an adjusted operating margin expansion of 20 to 30 basis points.

Operator, Operator

Next, we'll go to the line of Doug Schenkel from Wolfe Research.

Douglas Schenkel, Analyst

Udit, I appreciate your insights on the quality of the funnel and the historical context you provided regarding seasonal patterns over the last 15 years. However, while recognizing those points and considering the year-over-year comparisons throughout the year, I find your guidance does not appear conservative from my perspective as I analyze the model. I'm having some difficulty understanding how you arrived at that conclusion despite your valuable commentary. To clarify my viewpoint, regarding revenue, the 45, 55 split for the first and second halves aligns with long-term norms, but it does not reflect recent trends. Additionally, it seems you would need to transition from over a 6% decline organically in the first half to achieving more than a 7% increase in the second half. Regarding margins, if my calculations are accurate, your forecast suggests an operating margin target of approximately 33.5% in the second half, indicating a larger ramp-up than typical from the first to the second half. Therefore, I have a few questions: first, how reliant are you on a recovery in instruments and a return to normal trends in the fourth quarter to meet these targets? Second, if you are assuming a normalization, how does that align with your margin guidance? Lastly, considering investor concerns and the current market environment, especially since none of your peers seem optimistic about China or instruments at this time, did you think about adjusting your guidance downward? That’s quite a lot to unpack, so I’ll step back and listen.

Udit Batra, CEO

Let's start with Amol, and then I'll join in.

Amol Chaubal, CFO

Yes, look, I mean, where we stand at this point, one may say, look, your Q2 guidance is conservative given there was some delay in budget releases in Q1. And we've been prudent there just to stay with our historical norm, right? Q3, Q4, we have some visibility in CRM. But the sales cycle, as you know, is 6, 9 months, so you don't have all the visibility, but it's still in line with the historical pattern, and we are seeing increased activity at early stages in our pipeline, which we think will convert into orders as the year progresses. If you look at ex-China pretty much across these quarters, it is on a 5-year stack basis, a little lower, mid-single digits. So again, as Udit said, there is no noise ex-China. And really what plays out in the growth guide is how progressively the decline in China translates to a modest increase in the second half of the year, and that's what we are modeling. There could be upside on China if China performs well. And we did some of that in our guide where we saw a little bit better China, and we derisk the remainder of the guide.

Udit Batra, CEO

Yes. To elaborate and summarize, the discussions with customers have become increasingly positive, but we want to wait for these discussions to yield tangible results before making any assumptions. Given the unpredictability of instrument businesses from year to year, predicting quarter-to-quarter is even more challenging. The conversations are indeed positive, but we need to see results, and then hopefully we can have a more optimistic discussion at the end of Q2. Regarding China, the situation is straightforward; the year has begun better than anticipated, but the second half is where we expect to see the previous weaknesses reflected in the overall numbers. Therefore, we anticipate the second half to be relatively flat or show slight growth. However, if you look at the broader picture, excluding China, we are forecasting low single-digit growth for the full year across various customer segments, particularly in pharmaceuticals and academia. In China, we expect a low double-digit decline after a significant drop last year. Overall, I don't see substantial risk based on the recent conversations we've had with customers and the visibility we possess.

Operator, Operator

And our final question comes from Catherine Schulte from Baird.

Catherine Ramsey, Analyst

Maybe just on pharma. I think you said down low single digits ex-China. And you talked about budgets opening up throughout the quarter. So can you just talk through the health of that end market outside of China exiting the quarter and your expectations for the second quarter for that end market?

Udit Batra, CEO

Thank you for the question, Catherine. Overall, the pharmaceutical sector grew at low single digits for us last year, and our forecast for this year remains the same. While Q1 showed a slight decline, our discussions with customers lead us to believe that we are still on track for low single-digit growth in pharma for the full year. Orders appear more stable than they were last year in both biotech and pharma. Additionally, our products, particularly those designed for large molecules, are gaining significant traction, whether in column applications or in analyses involving light scattering, mass spectrometry, and liquid chromatography. Regarding the timing, Q1 performed as expected for pharma, and as we progress through the year, we anticipate easier comparisons, allowing us to achieve low single-digit growth by year-end.

Caspar Tudor, Head of Investor Relations

Thank you for joining us today and for your continued support and interest in Waters. A replay of this call will be available in the Investor Relations section of our website. This concludes our call, and we look forward to seeing you at future events and conferences.

Operator, Operator

Thank you all for joining. That concludes the Waters Corporation First Quarter 2024 Financial Results Conference Call. You may disconnect at this time, and have a great rest of your day.