Earnings Call Transcript - WAT Q2 2024

Udit Batra, CEO

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. We will provide guidance regarding possible future results as well as commentary on potential market and business conditions that may impact Waters Corporation over the third quarter of 2024 and full year 2024. These statements are only our present expectations and actual events or results may differ materially. Please see the risk factors included within our 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. Reconciliations to the most directly comparable GAAP measures are attached to our earnings release and in the appendix of the slide presentation accompanying today's call. Both are available on the Investor Relations section of our website. Unless stated otherwise, references to quarterly results increasing or decreasing are in comparison to the second quarter of fiscal year 2023. In addition, unless stated otherwise, all year-over-year revenue growth rates and ranges given on today's call are 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 earnings release or as otherwise required by law. Now I'll hand over to Udit to deliver our key remarks. Following that, Amol will present a more detailed view of our results and guidance after we'll open up the phone lines for questions. Over to you, Udit.

Amol Chaubal, CFO

Udit Batra, CEO

Thank you, Caspar, and good morning, everyone. We achieved strong results in the second quarter that exceeded both our top-line and bottom-line reported guidance. I want to begin today's call by thanking my colleagues for their dedication to commercial execution, operational management and innovation. This enables us to deliver differentiated performance and accelerate the benefits of pioneering science. In the quarter, year-over-year organic constant currency sales were 500 basis points better than Q1 levels. We saw a steady improvement in customer spending throughout the quarter with a strong finish in June. Orders outpaced sales for the quarter as we built good momentum for the second half of the year. We again delivered resilient operational results with earnings surpassing our expectations. This reflects the strength of our downstream business model, progress on our strategic and operational initiatives, and our indomitable spirit. We also continued our steady stream of new product launches, releasing further innovations that address key customer needs.

Operator, Operator

Turning now to our results. In the second quarter, sales declined by 4% as reported and 4% in organic constant currency. Our non-GAAP earnings per share was $2.63, while on a GAAP basis, EPS was $2.40. Excluding China, sales decreased in low single digits. Growth was consistent with our expectations across each of our end markets, and we are seeing early signs of improvement in customer CapEx spending. In China, sales fell in the low teens, which was better than anticipated. Growth rates improved across all end markets compared to the previous quarter, particularly in pharmaceuticals and industrial sectors. The stimulus measures announced by the Chinese government this year are still in the early stages, but we are actively engaging with customers who could benefit from these initiatives. This has already led to better quoting and funnel trends in that region, with these opportunities expected to convert to orders in 2025. Overall, instruments experienced a 17% decline, while recurring revenue increased by 5%. Wyatt contributed 2% to sales through M&A, which exceeded expectations and marks a strong conclusion to the first year after the acquisition, with synergies materializing ahead of schedule. Wyatt operates in high-growth markets focused on large molecule applications, particularly in cell, gene, and RNA therapies, and should add 40 basis points of annualized growth to the total company in the near to midterm. Now, I will discuss our operational performance. Margins remained strong as we effectively navigated volume, foreign exchange, and inflationary pressures through solid operational management. Our gross margin for the quarter was steady at 59.3%, while our adjusted operating margin was a robust 29.2%. Despite recent advancements, our work is far from complete. We still have room for long-term margin expansion driven by our strategic and operational initiatives, particularly in productivity enhancements where several programs are in their early stages. Our continued focus on pricing is also yielding contributions well over historical levels. Looking ahead, we are optimistic about future margin opportunities, especially given our recent success in maintaining and expanding margins during challenging conditions. Beyond 2024, we anticipate a more significant impact on our long-term margin performance, especially as typical volume leverage returns. In the second quarter, we introduced several new products that address unmet customer needs. At ASMS in June, we launched the Xevo MRD, now our highest-performing bench-top mass spectrometer, which enhances throughput and is more compact. It offers up to 6x the resolution and 2x better mass accuracy than competing systems, setting new industry standards for high resolution at fast speeds. Customers have expressed enthusiasm for its capabilities, which will enhance discovery and other upstream pharmaceutical workflows by accelerating R&D for new drugs. This includes metabolite identification where resolution, accuracy, and speed are vital. We also released the next iteration of our Acquity QDa mass detector, one of our best-selling analytical instruments, which boasts a 20% increase in mass range benefiting the routine identification and analysis of large molecules. Additionally, it has excellent environmental credentials, consuming up to 70% less energy than competing products, which is increasingly important to our customers. Crucially, the QDA II operates on Empower, facilitating seamless regulatory submission of compliance-related data for large molecules. As we look forward, Waters is well positioned in appealing markets with long-term growth drivers where testing volume is essential for driving growth. Our comprehensive ecosystem of instruments, informatics, advanced chemistry, and exceptional service enables us to ensure the safety of medicine, food, water, and batteries in electric vehicles. Coupled with our business model, the regulated and recurring nature of these applications results in strong profitability and free cash flow generation. In recent years, we have made significant strides in aligning Waters with rapidly growing large molecule applications; now over a third of our pharmaceutical revenues derive from large molecules and novel modalities. Moreover, future testing volume is projected to increase faster than historical rates due to rising prescription volumes, including GLP-1s, and areas like PFAS testing. With our revitalized portfolio, we are well-placed to seize these growth opportunities. Over the past few years, we have introduced numerous innovative products that have bolstered our competitive position and provided better pricing levers. Serving our core needs, our next-generation LC platform, Alliance iS, facilitates routine QA/QC analysis for both large and small molecule workflows where innovation drives instrument replacement. Also included is our Xevo TQ absolute mass spectrometer, which is rapidly gaining traction in PFAS testing. Within our high-growth adjacent markets, we've introduced new products for bioanalytical characterization, battery testing, and clinical applications, all of which are gaining momentum due to the critical needs they address. Lastly, the recent deferral of routine instrument replacement presents a catch-up opportunity ahead of us. Weak macroeconomic conditions have temporarily impacted customer CapEx spending for downstream instrumentation. Historically, this trend lasts 4 to 7 quarters, usually followed by a catch-up phase. Examining the details, while every macro environment is unique, the second quarter marks the seventh consecutive quarter of LC instrument decline. Expected instrument growth for 2024 suggests a 1% CAGR compared to 2019 levels, considerably lower than the long-term average growth rate of 5%. Improving funnel trends are a positive leading indicator indicating we are entering the early stages of recovery and a new replacement cycle. Now I will discuss our guidance for the full year 2024. While customer activity shows signs of recovery, we are proceeding with caution in our guidance. Consequently, we are revising our full-year sales outlook for 2024 to reflect a more gradual improvement in the second half of the year. As a result, our updated full-year organic growth constant currency sales guidance is projected to be between negative 2% and negative 0.5%. With our commitment to strong operational performance, we expect to realize leverage in our P&L and achieve an adjusted operating margin of approximately 31%. Therefore, our updated adjusted EPS guidance is set in the range of $11.55 to $11.65. Now, I will turn the call over to Amol to continue discussing our financial results in greater detail and to provide additional guidance.

Amol Chaubal, CFO

Thank you, Udit, and good morning, everyone. In the second quarter, sales surpassed our guidance range on a reported basis, declining by 4%. Organic constant currency sales also fell by 4%, which marked a 5% improvement in growth compared to Q1 levels. We noticed a steady increase in customer spending throughout the quarter, with orders exceeding sales. M&A added 2% to sales, reflecting results from the first 1.5 months of the quarter. This was better than anticipated, as we were able to accelerate revenue synergies during our integration. We are pleased that within the first year of the acquisition, it is already contributing positively to EPS and margins, and our M&A execution is on track. Overall, foreign exchange had a 2% negative impact on second quarter sales. In organic constant currency terms, by end market, Pharma sales declined by 4%, Industrial sales declined by 4%, and Academic and Government sales declined by 16%. In Pharma, sales excluding China decreased by low single digits, while in China, they fell by low double digits. In both situations, we saw an improvement in growth rates compared to the prior quarter. In Industrial, outside of China, sales dropped by 1%, with low single-digit growth in the Americas. We continued to see strong global growth for PFAS-related applications, consistently supporting environmental testing. In China, sales declined by low double digits, which also represented an improvement in growth rates compared to the previous quarter. For our TA division, sales remained stable, driven by growth in segments such as electronics, advanced materials, and chemicals. In Academic and Government, growth stayed weak as stimulus in China and high global funding led to unpredictable spending patterns and a tough 21% comparison from the same quarter last year. By geography, sales in Asia decreased by 3%, while sales in the Americas and Europe both fell by 7%. In terms of products and services, instruments dropped by 17%, while chemistry and service grew by 5%. There was no change in the number of days compared to the prior year's quarter. Our commercial initiatives continue to support strong recurring revenue growth despite ongoing challenges from China. Within our service business, we have already met our goal of increasing service plan attachment by another 100 basis points this year, with service plan revenue growing in the high single digits for the quarter. We are now aiming for an additional 50 to 100 basis points of service plan attachment for the remainder of the year. I will now address our second quarter non-GAAP financial performance in comparison to the previous year. Despite obstacles from lower sales volume, foreign exchange, and inflation, our team has shown resilience and commitment in facing these challenges. Our emphasis on operational excellence, pricing, productivity, and careful spending management enabled us to deliver a strong margin performance during the quarter. Gross margin remained flat at 59.3%, and our second quarter adjusted operating margin was 29.2%, as anticipated. Excluding foreign exchange, both gross margin and adjusted operating margin improved by 40 basis points year-over-year. Our effective operating tax rate for the quarter was 16.5%, and our average share count was 59.5 million shares. Our non-GAAP earnings per fully diluted share was $2.63. On a GAAP basis, earnings per fully diluted share stood at $2.40. A reconciliation of our GAAP to non-GAAP earnings is included in this morning's press release and the appendix of our earnings call presentation. Now turning to free cash flow, capital deployment, and our balance sheet. We define free cash flow as cash from operations, less capital expenditures, excluding special items. In the second quarter of 2024, free cash flow was $143 million after funding $36 million in capital expenditures. Year-to-date, free cash flow totals $377 million, or 28% of sales, resulting in a free cash flow to adjusted net income conversion ratio of 131%. We maintain a strong balance sheet, ample liquidity, and a well-structured debt maturity profile, allowing us to prioritize investments in growth. We are continually assessing M&A opportunities that will enhance value for our shareholders. In the second quarter, we continued to reduce leverage while managing this year's tax reform payment of $96 million and other expenses totaling $30 million. As expected, at the end of the quarter, our net debt position was around $1.7 billion, representing a net debt-to-EBITDA ratio of approximately 1.7 times. As we work to reduce our debt, we will consider resuming our share repurchase program during the remainder of the year. Now I'd like to share additional insights on our full-year outlook and provide guidance for the third quarter. While business conditions showed signs of improvement in the second quarter, we are approaching our guidance with caution. Consequently, we are revising our full-year 2024 sales guidance to reflect a more gradual pace of improvement in the latter half of the year. Our updated guidance assumes relatively flat quarter-over-quarter revenue progression in Q3 compared to Q2 and implies weaker than usual budget flush dynamics in the fourth quarter. Despite this caution, we expect the business to return to growth in the second half of the year. Accordingly, our revised full-year 2024 guidance is for organic constant currency sales growth between negative 2% and negative 0.5%. At current exchange rates, we expect currency translation to negatively impact full-year sales by roughly 1.5%. Furthermore, M&A contributions from wire transactions have added 1.3% to our full-year inorganic sales from the first four and a half months of the year. Thus, our total full-year 2024 reported sales growth guidance ranges from negative 2.2% to negative 0.7%. With our commitment to operational excellence, we expect to improve our P&L leverage, even with the adjusted guidance. As previously indicated, our full-year gross margin is forecasted to be around 59.8%, reflecting a 20 basis point expansion from 2023. We anticipate our adjusted operating margin to be approximately 31%. Below the line, we expect the full-year net interest expense to be about $77 million, with our full-year tax rate expected to be 16.3%, and our average diluted share count for 2024 is projected at around 59.4 million. Summarizing all of this, on a non-GAAP basis, our revised full-year 2024 earnings per fully diluted share guidance is projected to be between $11.55 and $11.65, which factors in an estimated negative impact of about 3% from unfavorable foreign exchange. Looking ahead to the third quarter of 2024, we anticipate that customer spending will remain cautious but will show further recovery signs. We expect year-over-year growth to improve compared to the second quarter as comparisons from the previous year, especially in China, become easier, and ongoing improvement in funnel activity leads to increased orders. Taking these factors into account, our guidance for third-quarter organic constant currency sales growth is projected to fall between positive 1% and positive 3%. At current rates, currency translation is expected to reduce sales by roughly 1.5%. Therefore, our third-quarter reported sales growth guidance is anticipated to range from negative 0.5% to positive 1.5%. Based on these revenue expectations, we estimate that third-quarter non-GAAP earnings per fully diluted share will be between $2.60 and $2.70, which includes a negative currency impact of about two percentage points at current FX rates. I would now like to turn the call back to Udit for our closing comments.

Udit Batra, CEO

Thank you, Amol. So now to summarize, with our strong commercial execution and continued resilient operational performance, our second quarter results demonstrate Waters' ability to deliver solid results in various market conditions. We're positioned well for the future with a long-term outlook that is above our historical growth rate of 6% as global testing volume growth remains on track and customer CapEx spending continues to recover. I am also proud of what our team has continued to accomplish on ESG and sustainability. Last month, we announced that Waters has become the first liquid chromatography column provider to receive the ACT Ecolabel certification from My Green Lab. This designation applies to more than 40 of our LC columns and makes it easier for scientists and procurement professionals to choose more sustainable lab products. So with that, I will now turn the call back over to Caspar.

Operator, Operator

Thanks, Udit. And that concludes our formal comments. We are now ready to open the phone lines for questions.

Vijay Kumar, Analyst

One maybe high level on your comments about the progression in the quarter, a strong finish to June, orders above revenues. Help us square what the guidance change, right? I don't think the guide change was a surprise. Is this just a conservatism in light of the strong June finish order momentum commentary? Or how should we inputting of the guide change?

Udit Batra, CEO

Thank you for the question. I believe you have partly answered it yourself. Taking a step back, our approach to guidance has not changed as we move from quarter to quarter. We focus on three key areas: first, analyzing data from our funnel regarding the progress and conclusion of the quarter; second, reviewing historical data, which is valuable as we have 20 years of quarter-on-quarter data for our instruments; and third, engaging with our customers to gauge sentiment and assess how orders and sales are performing. To clarify, we have observed a gradual improvement from Q1 to Q2, with a smaller decline in sales during Q2 compared to Q1. Notably, June, a significant month for us, demonstrated considerable momentum. Back in March, we discussed the quality of orders and anticipated their conversion into sales by the end of Q2, and that indeed materialized, with a strong sales surge in June and orders outpacing sales growth. This gives us confidence in our sales funnel. Historically, based on Waters' data, the LC business typically goes through 4 to 7 quarters of negative growth, and Q2 marked the seventh quarter of decline, suggesting we are ready for recovery. Although Q2 is currently showing a 5-year CAGR of minus 2%, we see positive signs of recovery in LC. Discussions with customers validate both the data-driven insights we have. I have spent significant time with large pharma customers in Europe and the U.S., and we are seeing improvement in China as well. Looking ahead to the second half of the year, we expect quarter-on-quarter growth. We’ve lowered our guidance, particularly for the fourth quarter, to reflect a more conservative ramp-up than usual, which accounts for some caution. We anticipate this adjustment will not exceed $50 million on a constant currency basis. As more information becomes available, we will adjust our outlook accordingly. I apologize for the lengthy response, but I understand that many may have similar questions.

Vijay Kumar, Analyst

No, that's helpful. And if I understand you, what you're saying is, look, we're not seeing anything in the quarter. It's positive trends in the right direction. But from a guidance perspective, you're just derisking it. And it's more from the perspective of being conservative versus having seen anything in the quarter. Is that a fair summary?

Udit Batra, CEO

Yes.

Vijay Kumar, Analyst

Revenues were approximately 3% below expectations for Q4 dollar revenues, while EPS was roughly in line with expectations. The change appears to be in the implied operating margins, which are better than anticipated. Is there any non-operating contribution that is impacting Q4 EPS?

Amol Chaubal, CFO

Yes. Look, I mean, as you've seen us through last year and this year also back in '22 against inflationary pressures. Our team is super resilient, and we are able to defend margin and even during down volume cycles, we're able to expand margin. As we've discussed before, we have a set of productivity initiatives that have a very long runway, and we are able to accelerate some of them and that reflects in sort of how we've been able to expand margin even last year. If you look at the embedded implied margin profile in our guide. Our second half margin is relatively flat versus last year. So there is not any meaningful step-up in the second half versus prior year. The only thing is as we've sort of taken a more cautionary view on the guide, we will see some of the actions that we've put in place already show up in Q4, and that will help us a little bit in Q4. But other than that second half is relatively flat versus last year.

Operator, Operator

The next question will come from Dan Brennan of TD Cowen.

Dan Brennan, Analyst

Maybe just on instruments. Q2 was about in line, right, with what your guide expected down in '17. I think you were down mid-teens. Can you just flush out a little bit LC versus MS? And how are we thinking about the updated instrument outlook for the back half of the year and kind of what's the math to support that.

Udit Batra, CEO

Let me start and Amol can jump in. Instruments declined about 17% in the quarter, with LC showing a slightly more modest decline in the mid-teens. The spec category declined a bit more, and TA was down around 2%, resulting in a total decline of 17% for the quarter. However, we are observing steady improvement as we progress through the quarter, and the funnels look exceptionally strong, particularly for LC. For the second half of the year, we anticipate that the growth rate for instruments will be flat compared to the previous year. Overall, we expect the second half to remain flat. Furthermore, the LC replacement cycle is now in its seventh quarter of decline, but we are beginning to see customers globally start their replacement cycles. We anticipate a slight decline or flat growth in Q3 for LC, but expect the replacement cycle to begin picking up in Q4, aligning with our funnel observations. This is an exciting time as we prepare for a renewed portfolio across all instruments with the onset of the replacement cycle, and we feel confident about our current position.

Dan Brennan, Analyst

Great. And then just China, anything changed with the guide there you were down I think mid-teens kind of in the quarter around what the guide was. And now what are you assuming for the full year? And is the commentary that orders on the kind of stimulus will start in '25? Is that a bit of a push? Like I think I heard you guys say previously maybe orders come back half and then it kind of kicks in '25. Any color on back at our China and then how we think about stimulus impact.

Udit Batra, CEO

Sure. Firstly, China performed better than expected, which contributed to the positive results. To give you some details, in Q1, China saw a 26% decline, while in Q2, the decline was around 10%. In the pharma sector, the decline improved from about 25% to 26% down to 10% in Q2. We expect steady improvement in China during the second half of the year, although we maintained our full-year guidance at a low double-digit decline for China as we want to see more data. There are positive developments in China. Interestingly, for the first time in a long while, the decline in China's LC was less than that of the rest of the world, with China's decline being in the high single digits, while the overall LC decline was slightly higher. Regarding the stimulus, our approach remains unchanged from earlier discussions. We are focusing on three main areas: helping customers assess the age of their instruments, as this stimulus targets instrument replacements, ensuring they understand the stimulus, and assisting them with the paperwork for funding applications. We believe this will influence growth only in 2025, perhaps having a modest effect towards the end of the year, but we are not factoring that into our current guidance.

Operator, Operator

The next question will come from Tycho Peterson of Jefferies.

Tycho Peterson, Analyst

Let's discuss the guidance for the latter half of the year. You are expecting revenues to increase sequentially from the second quarter, which seems atypical for normal seasonality. Can you provide some clarity on your visibility? Furthermore, for the fourth quarter, you anticipate plant operating margins to be in the mid- to high 30s to meet the earnings per share target. Although you mentioned that operating margins will remain flat in the second half of the year, what specifically contributes to the increase in the fourth quarter? Does this align with typical seasonal patterns?

Amol Chaubal, CFO

Yes. So I mean, look, Q-on-Q, Q2 to Q3 is relatively flat. If you look at last 10 years, it has sort of oscillated between plus and minus 3%, right? So it's sort of within the range. And what gives us comfort and confidence on that is what we have in our funnel and the activity that is progressing as well as the fact that we built some backlog in Q2. So that also helps. Going to your other question around second half margins. As I said, second half margins are relatively flat versus last year. There's a small difference between Q3 and Q4, one is the prudence in Q3, the second piece is, as we've sort of taken a more cautionary view on the guide, we've put in place certain cost measures that are already playing out particularly around outside services spend, particularly around how we resource certain growth initiatives and you will start to see some of that impact flow through more in Q4 than in Q3. So there is some plus/minus between Q3, Q4, but overall, second half operating margins are relatively flat versus last year.

Tycho Peterson, Analyst

Okay. And then the follow-up, academics is only 10% of the mix, I know, but it was down 16%. Can you maybe just talk on how much of that was U.S. versus Europe? And what are you thinking back half of the year as the comps ease there for academic.

Udit Batra, CEO

I think no change in assumption on the academic side. It's such a small portion of our business, Tycho. So really no change from the previous assumptions.

Amol Chaubal, CFO

Yes. And I mean you look at it this way, right? Like first half of last year was super well funded between the China stimulus and what was happening in U.S. and Europe. If you look at it on a two-year stack basis, pretty much every quarter you will see is like 0.1% growth.

Operator, Operator

The next question comes from Matt Sykes of Goldman Sachs.

Matt Sykes, Analyst

Maybe just first, you guys have leaned into the CDMO channel in China over the past couple of years, and that's been an area of weakness recently due to overcapacity. Could you maybe kind of talk about what you're seeing in the CDMO channel in China? And is it part of sort of some of the inflection that you see maybe towards the back half of this year into next year or is that going to remain fairly subdued for the balance of this year and into '25?

Udit Batra, CEO

Thank you for your question, Matt. We've provided a lot of details about the CDMO sector in China recently, and there hasn't been much change since last quarter. We're seeing steady improvement in recurring activities from a very low starting point. However, capital expenditures remain low, and we haven't anticipated any improvement in CapEx for the CDMO segment. Overall, the generics market in China's pharmaceutical industry is showing some signs of recovery, which is reflected in our performance exceeding growth expectations in both Q1 and Q2. As the year progresses, we're seeing steady improvement in China, particularly in the licensing side, where replacement cycles are beginning to emerge. While CDMO is still weak, generics are starting to regain some momentum.

Amol Chaubal, CFO

Thank you for the question, Matt. There are about three to four main factors at play here. First, our business is set up so that if we grow more than 5%, it generates 50 basis points of volume leverage, which primarily affects the SG&A line rather than the gross margin. Second, we've benefited from a better mix as we transition to more recurring revenue, along with the discipline we've maintained in pricing. We are comfortable reporting that even in challenging market conditions, we are achieving over 100 basis points better on pricing compared to our historical performance. Therefore, the mix and pricing positively contribute to our margin profile. Additionally, a couple of years ago, we initiated various productivity and operational excellence projects that are starting to show results. Initiatives such as procurement and operational excellence in manufacturing, along with establishing a Global Capability Center in India, have a long-term impact; we expect these efforts to cumulatively provide about 300 basis points over the next eight years. Altogether, we aim for around 100 basis points of margin expansion from these three areas, with 70 to 80 basis points of those gains being reinvested into higher growth areas. As we reach the sixth, seventh, and eighth year, when some of these productivity initiatives might begin to plateau, we anticipate these growth areas will generate increased revenue and margin improvement, compensating for the saturation of productivity initiatives. In the past couple of years, when volume leverage was lacking and even acted as a headwind, our teams managed to accelerate the benefits from these productivity initiatives. We also took proactive cost actions and benefited from pricing, enabling us to not only defend our margins but also expand them during times of decreased volume. This distinction is important because, historically, Waters' margins have remained stable around 30%, and one might wonder about the volume leverage. The reality is that while there has always been volume leverage, we chose to forfeit it during downturns. This time, we are committed to preserving that leverage during difficult periods, which will position us much stronger for growth when the market improves.

Udit Batra, CEO

Amol has provided a detailed answer. To summarize, the teams are now well-equipped to improve margins during a downturn, and the pricing we are seeing remains strong. I'm looking forward to the opportunities that will arise as we emerge from this downturn, especially considering the renewed product portfolio we have. Our leading products have been tested by customers during the downturn, and I'm very optimistic about the developments ahead.

Operator, Operator

The next question will come from Rachel Vatnsdal of JPMorgan.

Rachel Vatnsdal, Analyst

I wanted to follow up on Brennan's question regarding China. It seems that LC performed slightly better than expected this quarter, but could you elaborate on the performance by end market within China? Additionally, concerning the China stimulus situation, we've heard from some peers that there is a slowdown due to customers hesitating to place orders. Can you clarify whether you’ve noticed any decrease in orders from customers in that region? If you haven’t, what has contributed to your resilience in this situation?

Udit Batra, CEO

Thank you, Rachel. In China, overall, the decline was less than we anticipated for this quarter, decreasing from a 26% decline in Q1 to about a 10% decline in Q2. There was improvement across various end markets: Pharma dropped from around a 26% decline in Q1 to 10% in Q2; Industrial reduced from about a 20% decline to 11% in Q2; and Academic and Government saw a decline improve from over 40% to just under 30%. The most notable development is that the replacement cycle is beginning to gain traction in China. We moved from an over 40% decline in Q1 for LC to less than 10% now, which is better than the global trend. We're starting to observe increased customer activity in China. Although growth remains negative compared to previous years, it is improving on a quarterly basis. Regarding your question on the stimulus, we are engaged in extensive discussions with our customers as the activity level remains steady and is actually improving quarter-on-quarter. The stimulus is broad, lasts over a longer period, and specifically focuses on instrument replacement. We have been working closely with our customers to assess the age of their instruments, determine eligibility based on government criteria, and assist them in completing the necessary paperwork for funding proposals. While we don't expect this to affect revenue this year, it should positively influence what we see in 2025. Overall, conditions are improving across all end markets, particularly in Pharma and LC, with no indication of what you refer to as an air pocket. Activity remains consistent, improving gradually, and customers are preparing to access the stimulus funding.

Rachel Vatnsdal, Analyst

Great. And then I did want to follow up on 2025 quickly. So can you walk us through your exit rates at 4Q? You've kind of talked about some of this replacement cycle starting to heat up in the back half. If we learn some of the weaker comps on the China dynamics that you talked about as well, how are you really thinking about that exit rate underpinning 2025? It looks like the Street is currently just shy of a 6% organic growth rate. So just at an early starting point, how comfortable are you with that?

Amol Chaubal, CFO

Yes. If we look ahead and consider our guidance, the exit rates for the fourth quarter and for 2024 will likely be a couple of hundred basis points below the historical average, even excluding China. This provides us with optimism that we are at the lowest point of this slowdown in the replacement cycle. The current fleet has significantly surpassed its expected lifespan and is in need of replacement, especially for light commercial vehicles. In China, the situation is more complex; the fleet has aged even more. The key question is when the generic companies will feel confident enough to start replacements, and we are beginning to see that happen. Some generic companies in China have already started replacing their fleets, and we anticipate that more will follow in the coming quarters.

Udit Batra, CEO

I want to elaborate on what we're observing at the end of Q2 that gives us confidence. June is one of our biggest months, and it has exceeded our expectations in both sales and orders. We have generated significant momentum going into Q3, which reinforces our confidence in several areas we've discussed. This aligns with an improving trend in the industry. Additionally, I spent considerable time with customers in both Europe and the U.S. this past quarter, particularly in large pharma. Customers are now accustomed to the additional steps in the procurement process. One of the major pharma companies introduced several new steps, which their internal teams were learning along with us, causing some delay in converting orders to sales. However, as we mentioned in March, the order quality has been high, and we've seen them convert into sales toward the end of June. The predictability of our funnel has greatly improved, especially in large pharma, and both order quality and funnel strength appear solid as we look into the latter half of the year.

Operator, Operator

The next question will come from Dan Arias of Stifel.

Dan Arias, Analyst

Can you maybe just refresh us on the picking around the upgrades within this replacement cycle that we're talking about taking place here? And what I mean by this is, obviously, things are still shaky out there on the CapEx side. So when these LCE customers come back into the market, should we assume that there's maybe less HPLC to UPLC transitioning and what you see during historical periods or do you think these upsell dynamics and the conversion to UPLC could be fairly typical.

Udit Batra, CEO

I think it's a great question, Dan, right? And I would look at it two ways. One, the HPLC-to-HPLC conversion, right? And that's a robust trend and we have a line of sight on what the fleet is. And there, we offer our customers two options, go to the ARC HPLC, which is done really, really well, even during the downturn. And then the Alliance iS, which is now also available for biologics with our premier technology, right? And that has been received extremely well. In a way, the slowdown in the market allowed many of our customers to sample the benefits of Alliance iS, which reduces errors in the QC environment by 40%, which is a significant advance probably the most important advance in the last decade in the HPLC segment itself. So we feel very good on the like-for-like replacement already. Second, when you think of HPLC to UPLC transitions, we are seeing that as well and GLP-1s are a case in point where we see that transition happening. And now on that, let me make two comments. One, you've seen that our Biologics revenue as a fraction of overall pharma has gone from roughly 20% to over 35% in the last 3 to 4 years, right? So that has been a very deliberate effort, not just on the UPLC side, HPLC to UPLC side but also in introducing what we call the premier technology, which is tailor-made for large molecules. That is now also available on the UPLC segment, which allows customers to transition the larger part of the pipeline, which is Biologics from HPLC to UPLC very comfortably where now the experimental time is reduced dramatically with the premier technology. So we're seeing both and we are well prepared if the customer decides to remain with HPLC. And equally, we are seeing the trend continue as more and more large molecules and novel modalities come through the pipeline from people transitioning to HPLC to UPLC but there, again, on the receiving end, our UPLCs now have the premier technology, which basically reduce experimental time dramatically. I hope that gives you color into the transition.

Amol Chaubal, CFO

And just to add to that, right, I mean, if you look at our historical instrument growth pattern, the 5% instrument growth has roughly about 50 to 70 basis points of price and 3% of volume, the remaining 1.5 or so really comes from upsell, right? And when we quote our price numbers, their like-for-like SKU and like-for-like geography. So that doesn't include when a customer chooses say, ARC HPLC or Alliance or Alliance iS or ARC UPLC. And in order to achieve that 1.5%, we only need about 7% of these customers to choose an upgrade given the current innovation and the pricing that is out there. And 7%, we feel super comfortable with huge unmet needs that some of our newer launches are directly addressing, which customers are appreciating.

Operator, Operator

The next question is from Puneet Souda of Leerink Partners.

Puneet Souda, Analyst

Udit, could you provide an update on the growth improvement in orders from June? You mentioned significant momentum during that month. Has that continued into July? Also, can you clarify if this momentum is mainly in the pharmaceutical sector in North America and Europe? It seems there is still some caution regarding China, but I would like to hear more details on that.

Udit Batra, CEO

Great question. As you know, we won't discuss July trends, but you can assume that June was very strong. Customer activity has been excellent, which gives us confidence in our guidance for Q3. June contributes significantly to the confidence we have in the replacement cycle, our expectations for Q3, and the momentum we anticipate for Q4.

Puneet Souda, Analyst

Got it. I have a question about Asia. Let's start with China, and then I'll touch on Japan and India. Regarding China, I'm interested in understanding the potential risks related to tariffs. Could you clarify your manufacturing position there? How much of your business in China is specifically for the Chinese market, especially with the possibility of tariffs or retaliatory tariffs in 2025? Moving on to Japan, I saw that you were down 11%. However, in India, you experienced growth of about 11% this quarter. Can you provide some insight into what occurred in those regions?

Udit Batra, CEO

Sure. There are three questions. First, regarding China, we utilized the downturn to enhance our manufacturing capabilities there, which will benefit us as the stimulus is implemented. We also expanded our commercial presence in China, and we are optimistic about the future there, especially since a significant portion of our instrument portfolio is now either completed or produced in China. On the commercial front, we feel equally positive. Moving to India, it has consistently been a strong performer for us, and this quarter was no exception, with growth exceeding 20%, primarily driven by the pharmaceutical sector, where we saw close to 50% growth. The Indian government is providing stimulus for its academic and government sectors as well, and we are reaping the benefits with rapid growth in that area. Lastly, regarding Japan, we experienced a 1% growth in constant currency.

Amol Chaubal, CFO

Yes. I mean, look, Japan unit likely are looking at the reported number, right? And you know where Japanese yen has been over the last year, that's like close to 11% headwind so at constant currency we're more or less flat, and that's also sort of the reason why the currency impact for us is somewhat higher and we had to increase it to 1.5% driven by Japan because we have a reasonable Japan footprint. And our team is doing relatively well coming out of the March year-end. So what you see progressing in Q2 and onwards we see healthy demand, and we see good funnel activity in Japan.

Udit Batra, CEO

Yes. And then just coming back to India. Very excited about the prospects there. As with China, during a downturn, we've sort of figured out where to increase our commercial presence in India, we go from strength to strength. The commercial presence has been increased across the board. We've decreased our collaborations on the ground. And India has gone in the last 2 to 3 years from less than 6% of our sales to close to 8% of our sales. right? So it's becoming a more significant part of our business, and it's growing really, really well.

Operator, Operator

The next question will come from Jack Meehan of Nephron Research.

Jack Meehan, Analyst

I wanted to ask about the recovery of instruments, specifically looking at it from a margin perspective. Amol, I'm interested in how the changing mix in the second half of the year and into 2025 will impact gross margin progression.

Amol Chaubal, CFO

Yes. Great question, Jack, as always. Look, I mean, there is going to be some negative mix impact from more instruments when instruments start to come back. But as you look at our guide, that's sort of factored in the gross margin, 20 basis points of expansion that we've outlined for the year. And as we go into next year, if the mix sort of returns back to, call it, say, 2019 levels there will be 10-ish basis points adverse impact, but that's largely covered with the productivity initiatives we have in place so the marginal have got to 20 to 30 basis points still remains intact.

Jack Meehan, Analyst

Got it. Okay. And then two just housekeeping ones. The first is any updated thoughts on buyback returning to that. And second, can you just remind us any selling day changes throughout the year in the third and the fourth quarter?

Amol Chaubal, CFO

Yes. So on the first one, right, I mean we continue to pay down debt from the Wyatt acquisition. We are at 1.7 now. So we are at a point where we are actively considering the switch between paying down debt versus buying back shares. I mean, the intention is to gain strategic flexibility as much as possible. So we continue to review options. And on the number of days, I mean, the key thing to note is on Q4 this year, we have three more days than Q3 of this year and that partly helps about 1.5% in the ramp from Q3 to Q4. And then other than that, I mean, there are two more days in Q4 of this year versus Q4 of last year. Q3 is roughly the same.

Operator, Operator

The next question will come from Catherine Schulte of Baird.

Catherine Schulte, Analyst

First, just maybe on Wyatt, it's great to see that coming in ahead of expectations. Are you seeing any different trends in terms of market improvement in that business, just given the exposure to large molecule in cell and gene therapy?

Udit Batra, CEO

Yes, Catherine, thank you for the question. We are very pleased with the progress of the integration. The synergies are being realized much faster than anticipated, which is why we experienced growth exceeding our expectations for Wyatt. As you know, this area is focused on large molecule applications, which are growing more rapidly than small molecule applications, including RNA therapy, monoclonal antibodies, and viral vectors. We are collaborating closely with customers to expand applications. What’s particularly exciting is that our teams are working on integrating multi-angle light scattering technology into quality assurance and quality control using our Empower software. This is a significant development. Large molecules typically have limited analytical techniques in QA/QC; they usually involve liquid chromatography and, to some extent, capillary electrophoresis, and now we are adding multi-angle light scattering to the mix. With the QDA providing mass analysis, this integration will allow our customers to submit data to regulators, which represents substantial progress, especially in a challenging market where we are seeing solid demand for multi-angle light scattering.

Catherine Schulte, Analyst

Great. And then maybe just going back to the guidance update. Can you just elaborate on if there are any specific areas of that conservatism that you added to your assumptions? Was it around China, pharma or is it really broader than that? Any further color would be appreciated.

Amol Chaubal, CFO

No. Look, I mean, most of our guidance caution that we've put in place is around our ex-China business. we just caution for a slower-than-anticipated pace of recovery. China, if anything, if you look at last two quarters, we've exceeded our expectations. We haven't just been bold enough to sort of then improve the guidance for the rest of the year, but we remain cautiously optimistic that our team will continue to positively surprise us like they have done in the first two quarters.

Udit Batra, CEO

It's a great setup for exceeding expectations as we go through the year and it's just the guidance philosophy we talked about at the beginning of the call that Vijay started with, and it's a great place to sort of end the call. I mean it's basically what we've done all along. We look at a lot of data from customers, from funnels. Second, we spend a lot of time looking at history of LC replacement, in particular, which bodes well. And third, talk to a lot of customers on how they're receiving our new products, how their spending and growing and all three point towards a more positive second half of the year than we've seen. So that's all been factored in, Catherine. Thank you for that question. Caspar?

Operator, Operator

Thank you for joining us today and for your 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. Thanks. Have a great day.

Operator, Operator

Thank you all for your participation on today's conference call. At this time, all parties may disconnect your lines.