Thank you for joining us here at the Citi Healthcare Conference. I'm Patrick Donnelly, the Citi Analyst covering tools and diagnostics. Happy to have in our last session here, Waters CFO Amol Chaubal. We're going to cover about 35 minutes or 40 minutes of Q&A. If investors, if you have any questions, feel free, you can email them over. I will try to get them asked. But I guess we can dive right in. You know, I think as we were talking a minute ago, I think you guys gave some great color for 2022 in terms of the building blocks and that algorithm of growth. Amol, maybe we can start on the instruments portfolio. You guys put up nice results last year. Can you just talk through, I guess, some of the growth drivers, the replacement initiative? Maybe we can start there.
Again, you guys kind of talk about continued opportunity in 2022. What does that look like? And then again, what's the sustainability as we look out towards that replacement cycle? How long will it last? And how long will it continue to be kind of a nice supplemental growth driver for you guys?
Thanks, Patrick, and thanks for having us here today. I mean, on the instruments, I mean, the growth was very broad-based, and there were sort of four main drivers for the excellent outcome that we managed for 2021. One, clearly there was very healthy demand in the market. Two, commercially we are really executing well. There's a lot of discipline around how we are approaching the market. Three, the new products that we've introduced, Arc HPLC, Arc Premier, ACQUITY Premier, those products are addressing a really good unmet need in the market, and that proposition is resonating well, and those products have had a great launch story in 2021, and then our initiatives between instrument replacement and how we are gaining ground in the CRO/CDMO space have all contributed, again, to this instrument growth story.
I mean, we had 12% instrument growth in Q4, and it was about 8% on a two-year stack basis. On a full-year basis, we also had robust growth on instrument, well over what we had historically seen in sort of healthy markets, right, and it's good for us because, you know, we are, as you know, a razor-razor blade model, and so instrument growth is sort of a very good indicator of what's to come on our recurring revenue, be it chemistry or service, and this, throughout the year, we see our commercial momentum accelerating because in the first half of the year, we were somewhere around 6% on a two-year stack basis. We ended Q4 at 7.5, so that gives us great confidence going into 2022.
And a lot of it's driven by the commercial initiatives we put in place about 12 months ago, one of them being our instrument replacement cycle. And there we had said, look, there are about 8,000 HPLCs, about 4,000 UPLCs, and about 1,000 tandem quads out there that had traditionally missed their replacement cycle. And we were sort of in a very disciplined way going after that. Most of the ground that we've covered in 2021 is largely on the HPLC side. So a lot of the UPLC portion is yet to come, which will start showing up in 2022. And we haven't even started in a meaningful way on the tandem quads. I think the focus there is more about building process and system discipline.
So what this initiative has done for us now is we have now very detailed processes and use of systems to track our entire installed base so that when it becomes a five, six-year-old instrument, it automatically goes in our CRM system as an opportunity that gets tracked and measured in the performance of the local territory manager. And that sort of puts the discipline in a way where, look, I mean, we operate in high-volume regulated settings in most of the cases. So that allows us to be in a place where these instruments naturally get replaced by our own instruments. So we now sort of have built the muscle and trained the organization to look at instruments also as recurring revenue because we have the first chance of replacing those instruments that belong to us.
I think that thing is really working well, and it's helping us drive instrument growth.
Yep, that's helpful. And then inside the instruments, obviously you guys have talked about Arc HPLC, ACQUITY Premier, the high-res mass spec platform. We're just going to talk about the contributions of those, not only to last year, obviously 4Q was really strong on the instrument side, but also as we look ahead to 2022 in terms of growth drivers, how we should think about that makeup.
Yeah, I mean, look, it's early days for MRT. It's a great instrument. Today it's focused on tissue imaging, and we'll over time increase the breadth of its application. So it's very early. But Arc HPLC, ACQUITY, and Arc Premier, they've hit it out of the park in 2021, and they will continue to do that in 2022 and years beyond. They saw a very unique sort of unmet need in the market, especially Arc HPLC, and in high-volume applications where we have a significant install base. It allows the customer to carry their existing workflows from their existing instruments to Arc HPLC and also benefit from additional functionalities and capabilities that Arc HPLC brings.
That is a great value proposition for customers because a lot of times our customers are in regulated settings, and they don't want to change what they have because they think there would be implications on the regulatory setup that they operate in. But Arc HPLC solves this problem, which is why we are seeing great traction for the product in markets like India and China.
Right, right. And then maybe on the backlog, I know that's kind of an area you among others have started to talk about a little more. It seems like orders are outpacing revenue. I think you might have even said it was at kind of an all-time high recently. So what's the right way to think about the backlog? Any metrics you can give in terms of the build there and the visibility it gives you, I guess, kind of that confidence to guide the way you guys did for 2022?
Yeah, look, I mean, you know in Q4, the orders were ahead of our sales growth by a couple of percentage points, and that allowed us to build a little bit backlog, but not like we're sitting on quarters and quarters of backlog, right? We're not in the service industry. I think for Q1, when we guided what gave us a lot of confidence is the pipeline that we had in our CRM system across geographies, across end markets. The growth and the demand is very healthy, and we are executing really well. And that gives us a lot of confidence to sort of deliver on the guidance that we gave for Q1. And at this point, we don't see any indicators why that demand pattern would change over the year. So all in all, you know, there is great traction for new products that we've introduced.
There's a great deal of commercial discipline, and all our initiatives, commercial initiatives, are running ahead of our expectations.
Okay. And then one of the logical questions with backlog build is, is it caused by supply chain? And I know you guys have been kind of talking about supply chain, obviously, for a couple of quarters. It seems like you're managing well through it, but maybe just update us on where you are there. Is the worst behind us? Is it now just kind of, it's still there, but maybe a little bit in the background? Or is it still a pretty big issue? And then the visibility into maybe that alleviating at some point would be helpful.
Yeah, so as we're going through this, I mean, the supply chain situation hasn't changed meaningfully versus what it was, let's say, in Q3, Q4. Outside of that one shipment in Q3 that moved into Q4, we sort of proactively managed both supply chain as well as logistics issues, and so that really hasn't come in our way of delivering our sales numbers and hence hasn't materially gone and built the backlog in a way, let's say. Most of the issues on supply chain are predominantly in electronic components, to some degree on machining labor here in the U.S., and inflationary pressures are also in freight as well as electronic components.
I think over time we've built the right muscle strength to be proactive, to go deeper into our supply chain with secondary and tertiary suppliers and identify those issues early so that we can escalate those issues to the top management within our supplier base, explain to them the importance of our products, and seek better allocation of these components. Wherever possible, we've also built safety stock, and wherever possible, we've also paid premiums to get preferential treatments in allocation and supply. But all said, the electronic component situation hasn't changed. And it all comes down to knowing what is getting decommitted early, proactively working with engineering to see what replacement electronic components can be placed, also working proactively to see what other components are available in the market, and also leveraging opportunities to spot buy when we see there is limited solution on an existing component.
Okay, understood. And then maybe kind of following on the instrument side, obviously service attach rate is a big focus for you guys as well. It's been a nice story for the past year plus. Seems like there's more room there. Can you just talk about, I guess, where we are today? Again, the kind of visibility into the opportunity there as we go, obviously highlighted for 2022 kind of during the guidance, but this seems like a nice multi-year story as well. So maybe just talk a little bit about that initiative.
Yeah, no, service attachment is a great focus area for us, and there's part of it where there is a push from our side, and also there is a bit of pull from the customer base. I mean, if you look at it, we expanded our attachment by about 200 basis points, which is almost a 5% increase because our attachment rates are roughly around 40%, and we went up by two percentage points. In 2022, we would aspire to add another 100 basis points to that attachment rate. We think there is good, at least five-six percentage point attachment rate room in the U.S. and European markets.
But then when it comes to China, our attachment rates are at around 20% versus if you look at a comparable market like India where the attachment rates are 50% plus, that leaves a significant room in a market like China where the attachment rates can be increased. We're doing several things there where we are attaching service plans at the point of sale of the instrument because once an attached service plan is in place, there's a high degree of recurrence that the service plan will be extended. We are becoming a lot more proactive with our inside sales that when instruments are coming off warranty, these customers are followed up for a service plan.
And then in general, as market is moving through newer modalities and sort of complex molecules, they are needing a service partner that sort of understands their problem, brings a lot of scientific expertise, enables them to navigate their situation so that they can leave those situations from a premium service provider to deal with, right? And that's where we excel. I mean, our service offering is premium in the marketplace, and more and more customers are valuing that. So there is naturally a pull that is helping our pursuit to increase the attach rates.
Perfect. And then e-commerce, kind of right on the back of that, another initiative seems like good traction. I think you guys are maybe 20% or so there in terms of the penetration, I guess. Can you talk about the progress to date and then again, kind of future plans on that initiative would be helpful.
Yeah, so look, when we started about a year or so ago on the e-commerce journey, only 20% of our chemistry business went through e-commerce. As we've invested in that, we've moved to about 27% by the end of 2021. We think we'll be at about 35% by end of 2022. The general thinking there is if you look at market benchmarks for every $5-$10 of revenue that you move from brick and mortar to e-commerce or digital platform, you get an extra dollar of revenue because it's easier for the customer to order. You're able to showcase your broader portfolio to the customer, and you're able to make it easier for them to navigate the entire process. When we look at our 2021 numbers, our outcomes are somewhere within that bracket.
That gives us a lot of confidence that it's just not moving customers from brick and mortar to digital commerce. It's actually driving incremental revenue, and that also shows up in the growth of our chemistry business. Page search traffic has gone up almost 70% versus before. When we look at the market, we generally feel market median is around 55%. Market median e-commerce platforms have 55% of their consumables or chemistry business moving through digital commerce. Some of the best participants in the market are as high as 75%-80%. We aspire to at least be at 55%, and if we end the year at 35% on 2022, it still leaves a significant runway for us in 2023 and 2024 to cover ground.
Okay, great. And then, kind of putting that all together, it kind of leads to the growth, the guidance you guys gave: 5%-7%. Again, I think it came in a little bit ahead of expectations. I guess, can you just talk about the underlying market? Obviously, those pieces give you kind of a little bit of a boost, but what are you seeing in kind of the biopharma market first? Obviously, your exposure to kind of maybe that more emerging biotech is a little bit smaller and less of a concern, but curious in terms of the conversations on the pharma side, what you're seeing as a market growth right there? And again, the general outlook there, I mean, it certainly seems pretty healthy, but would love your perspective.
Yeah, look, I mean, the guidance was based on, if you look at historically, this market has grown 4%-6%, say midpoint 5%, and we think our initiatives will allow us to deliver one additional point of growth, and that's why we said 5%-7%, midpoint 6%. But if you look at how sort of our commercial momentum has come together over the course of 2021, we delivered a 7% two-year stacked growth versus 2019, and that momentum only accelerated in the second half versus the first half, so that gives us great confidence going into 2022. As we look at our pipeline in our CRM system, that gave us confidence to guide 6%-8% for Q1, which is ahead of our full-year guide, but again, those two things are not fully related.
One is based on what we have in the pipeline, and the other is based on where we think market could be. But we don't see any signs of market slowing down. The demand continues to be very healthy, and we continue to have great opportunities in our pipeline that we pursue. Coming to your other point on biologics and large molecule, I mean, we already have a good presence in the large molecule market. It's just not there as much in QA/QC as we are present in the small molecule. But when it comes to late-stage clinical, Phase 2, Phase 3, Phase 4, we have a really solid presence in the large molecule setting. And in fact, the large molecule business has grown much faster than our small molecule business.
A couple of years ago, 20% of our pharma business was large molecule, and now almost 30% of our business is large molecule. There again, I mean, there are various vectors that we continue to work on. I mean, you would have seen our partnership with Sartorius and our focus to deploy mass spec as a bioprocess analyzer. We think there is a lot of merit in separating process from the product in large molecule, just like we have in small molecule. I mean, today small molecule product is approved, large molecule product is not approved. It's the process. And why, right? I mean, why should it be that way? Mass spec can allow us to characterize a bioprocess so that you don't need to approve the process as long as it produces the same end product.
We've started that journey by going upstream in process development, which is where we think a highly simplified workflow, yet a highly comprehensive mass spec like BioAccord can make a meaningful difference for bioprocess developers and can expedite the pathway to develop the process, and over time, as mass spec gets adopted as a bioprocess analyzer, process control parameters and QA/QC parameters start relying on that instrument in large molecule setting, and it finds applications in higher volume settings in large-scale manufacturing.
At the same time, you also probably would have seen we recently licensed in the CDMS technology, and that's fantastic because today, while mass spec is the tool to go when you're characterizing small and large molecules, mass spec cannot characterize a very large molecule easily just because the molecule is too heavy to fly through a mass spec, and you end up sort of dissecting or digesting the molecule into small pieces and trying to sort of replicate and use libraries to build back what that molecule was, and that creates lots of inaccuracies, and it doesn't work really well in practice.
But with CDMS, you're able to impart a charge to the molecule that allows the molecule to be detected, and you're able to keep the molecule intact, which is a great unmet need in the market, and we'll be developing that instrument which will serve that need across discovery research as well as late-stage clinical. So we are slowly but surely making our way into other applications of large molecule beyond late-stage clinical, and we are starting to see traction, especially on bioprocess analytics and bioprocess characterization with BioAccord.
Okay. And then another part of the guidance, obviously, the margins, they were kind of implied, the margins at least a little more flat, maybe slightly up at the top end. Clearly, some growth investments going on. Can you just talk about, I guess, the levers on the up margin side, how we should think about that? It seems like the growth investments will go in 2022 implied in the guidance. That'd be helpful.
Yeah, I mean, there are three parts to this. Let me start with pricing, and there, I mean, we firmly believe that our products are highly differentiated, and they cater to a significant unmet need, and customers understand this. We've fortified our instruments with robust informatics platforms. On chemistry, we are clearly the leading-edge innovator who brings differentiated chemistry to the market, and our service offering is premium, so across all this, customers have valued our partnership with them, which allows us to have very transparent conversations with customers on what's happening on inflation, what's happening on supply chain.
What we've done is whatever we face on the operation side, be it with electronic components, be it with freight, we've educated our commercial teams to understand that and how that is impacting the products that they are selling so that they can have very transparent conversations about these with our customers. That's allowing us to have a big part of this impact passed on to our customers. When we guided gross margin to 58%, market sometimes thinks too much about it. What we implied was, hey, the gross margin is going to be somewhere in line with 2021. On the operating margin side, we have several initiatives in place that drive productivity. I mean, just the volume leverage of it, when we grow 5%, we generally [audio distortion] have 50 basis points of volume leverage.
On top of it, we have several initiatives like productivity in our service organization, operational excellence in manufacturing, procurement programs [audio distortion]
So sorry about that couple of technical difficulties. So Amol, you were talking about the margin gives and takes. I think you were just wrapping up on the pricing and getting to the second point. So I'll turn it back to you. Sorry about that.
Yeah, no problem. So look, I mean, we covered pricing. On the operating margin side, when we grow 5%, we get about 50 basis points of volume leverage. And all the productivity initiatives we have in place would add another 50, 60 basis points. But we're going to invest, call it about 60- 70 basis points of that gain in funding our high-growth adjacencies across bioseparations, across bioprocessing analytics, across LC-MS and diagnostics, batteries, and sustainable polymers. And that's why when we communicated, we said we'll do about 20- 30 basis points of margin expansion at the J.P. Morgan conference. And the guide is somewhat in line with that. It's about 30%-30.5% operating margin. But the intention is to deliver at least 20- 30 basis points margin expansion. As we go through 2022 and 2023, that would be roughly how it will play out.
As we go beyond 2023, you will see a much more pronounced impact on the margin as some of this reinvestment comes out and some of these adjacencies start to produce revenue and growth.
Okay, perfect. Yeah. And I guess that's kind of the question we've got, is the growth investments clearly make sense? They're going to drive growth in the future. I guess, is it about a two-year period? Is that the right way to think about kind of the less margin expansion that kind of should inflect a little higher once that growth initiatives kind of take off? Is that the right way to think about it?
I think that's probably a good way to look at it. I mean, 2022, 2023, we'll clearly reinvest. Late 2023, 2024, some of these adjacencies will start to produce revenue and margin. And then the question becomes, do you have other adjacencies or other growth opportunities that need further investment? And that would likely delay when you see a more pronounced impact on margin. But if you sort of come out of these three and there are no other investment opportunities that are as meaningful, then you will start to see some of the reinvestment rewind. And you will see the impact of higher revenue come in. But strategically, that will position us to higher growth in markets, which is the intention of these adjacencies.
Okay. All makes sense. Okay. Maybe we can bounce around the portfolio a little bit. China is always an area of interest for investors. I guess you guys have put up pretty good results there. I think you have new leadership in the region. Maybe just talk about your outlook there in terms of growth, your presence. Obviously, it's a big piece of revenue for you guys. Any expectation for kind of momentum to change at all? Obviously, the comps have made it a little hard to tell what the underlying business is actually doing. But what are you seeing in China, and what are the expectations going forward there?
Yeah, look, I mean, internally, we always looked at 2021 on a two-year stack basis, right, because it didn't make sense to compare what was 2020. China is a big part of our business. It's about 20% of our business. We have a new leader in China, and under her leadership, the business is executing really well. We delivered 13% stack growth in pharma on a two-year basis. We delivered 17% stack growth on the industrial business, again, on a two-year stack basis. The CDMO part of the business in China is really thriving. That's where we made our first headway in the CRO CDMO space, and we've since replicated that blueprint in other geographies. Food and environmental and industrial applications are really doing well in China. The one place that dragged the numbers down in China is the academics and government business.
And clearly, there we need to improve our commercial execution, and it's clearly our priority going into 2022. So if anything, we feel good because there is an upside there. If we continue to execute pharma and industrial like we have and we fix our ANG business, we will see even better numbers coming out of China. And a big part of the ANG issue is our own commercial execution, but a part of the issue is also the VAT reimbursement issue. And hopefully, as we go through 2022, that issue should resolve, and we'll unlock a whole bunch of demand that is stranded because of the issue.
Okay. And then maybe we'll talk about different end markets as well. Obviously, we touched on pharma. Industrial, you guys put up pretty healthy growth last quarter. Again, the cyclical pieces of the market seem like they're in a good place. TA, maybe talk a little bit about what you're seeing in that market. Again, expectations going forward, it seems pretty healthy, but curious as to what you guys are seeing and the expectations going forward.
Yeah, for us, I mean, on the industrial side, the growth on the Waters division was led by our China business. But across the geographies, we are seeing a healthy trend there. And then on the TA side, we are seeing a great momentum. I mean, we have a new leader who started about nine, 12 months ago, and she's brought a lot of discipline and focus to that business, and that's showing up in the results of our TA business across geographies. And on top of that, that business has great tailwinds coming out of two secular growth drivers, one across batteries and two across sustainable polymers. And in both those cases, we have an instrument portfolio that has direct applications to the needs of those businesses, particularly thermal analysis and microcalorimetry in the batteries business, and then rheology and thermal analysis on the sustainable polymers business.
So we're seeing a great demand tailwind that is augmenting the discipline and the commercial focus brought together by Jianqing, and it's translating into really solid numbers coming out of TA. And we think that trend will continue because we are seeing nothing change on that front when we look at demand and our pipeline.
Okay. Perfect. And then academic, it's been one of the more mixed end markets. Obviously, not the biggest for you guys, and it tends to move around a little bit, I guess, given the size. But it seems to be kind of a laggard coming out of COVID for the group. I guess, what have you guys seen there? And again, maybe expectations for 2022. It seems like things are improving, but just wondering what you guys are seeing.
Yeah, look, I mean, for us, academics is about 10% of our business. It also tends to be lumpy because most of the buy in that market is happening on high-resolution mass spec, which are large orders, but they are a little bit sporadic orders. Look, where we are looking at, we think we still have a distance to go in how we are commercially executing in that market. I think Waters for a long time has had a great KOL following. But in the recent years, we haven't done as much as we should have to nurture our KOL base. I think in certain markets like Europe, we do a good job of nurturing the KOLs and managing that business. We haven't done that in places like U.S. and Europe and broadly in Americas and APAC.
I think that's going to be our commercial focus. That's sort of the last leg of our commercial excellence journey because that's one piece of the market where we haven't gained as much momentum as we should have. And it's an important market. I mean, while in most cases, we play downstream in the value chain, which is usually high volume and regulated and allows a lot of repeat business, academics and government is typically not that way. But it's critical because that's where the publication flows come out of, and that's where initial adoption happens. So as we bring new technology in the market, it's absolutely a critical part of the market for us to drive sort of downstream application and usage.
Okay. And then maybe just on kind of. I know we talked a little bit about biologics, large molecule. Can you just talk about your strategy there? You obviously have the Sartorius partnership, CDMS acquisition, small but still notable. I guess, what's your strategy there in terms of internal investments versus is it something you pursue inorganically to get larger? Just kind of it would be great to hear a bit more about the strategy, kind of getting into that high-growth area.
Yeah. I mean, look, there are three or four plays, right? I mean, we already are present in a very meaningful way in large molecule, late-stage clinical, Phase 2, Phase 3, Phase 4 applications. And that business continues to grow and is very accretive to our growth profile. We are clearly focused on deploying BioAccord and mass spec as a bioprocess analyzer, first at-line and then eventually in-line. And there the partnership with Sartorius, as well as the collaboration with the University of Delaware, where we now started our in-process or we'll soon start our in-process facility, would be very critical towards developing a more comprehensive solution towards characterizing a bioprocess so that eventually, slowly but surely, we'll move to a place where the bioproduct is approved and not a process.
Outside of that, we are also focused on bioseparations, and we do a fantastic job of using our chemistry expertise in separating small molecules. We don't have a meaningful presence in affinity columns and biologic separations as much as we have presence in small molecule settings. And there, some of the gaps that we have are around our expertise and capabilities on the biologic side. And we are continuing to build those organically in-house. But there, again, if we find the right partner, like we found Sartorius on the bioprocess analysis side, it will materially accelerate our journey to get into that market and deploy meaningful solutions on the large molecule side.
Okay. That makes sense and maybe last one, I know we're almost up on time, but just on capital deployment overall, how are you thinking about your M&A strategy, what you would go to in terms of size, whether it's leverage, whatever it may be, and then obviously focus areas. Obviously, large molecule sounds like one of them, but just curious on the overall strategy on that front.
Yeah. Look, I mean, historically, we have deployed capital towards returning capital back to the shareholders. I think as we now look at our capital deployment priorities, we want to be balanced, but growth by far is high in priority list versus anything else, and there, again, the focus is what are the most complex problems facing our industry that we have capabilities and technology in-house to solve, and on that journey, we've identified significant problems across bioseparations, across bioprocess analysis and characterization, across taking mass spec into diagnostics of batteries or sustainable polymers. In each of these pursuits, there are various capabilities that we have in-house, but there are also a set of capabilities that we don't have in-house, and we are investing in building those capabilities.
If we do find assets that have those capabilities, those complementary capabilities, which when coming on board will materially accelerate our journey towards getting into these adjacencies and would accelerate value creation for our shareholders, we'll absolutely use capital on such assets to accelerate our pursuits. Broadly speaking, we've said we are open to going up to two and a half times net debt to EBITDA. If the asset is very strategic and financially makes sense, we will go even further. What's critical for us is having an asset that delivers good ROIC by year five and is accretive from an EPS point of view, year two, year three. And that's where our focus is, right? It begins with the science. It begins with the problem we are trying to solve, and then it has to make financial sense.
In this market, and even if when the market has come down, people still sometimes tag on to the prices they were trading six, seven months ago, and we remain extremely disciplined in how we continue to look at these assets. I mean, as a company, we've had a great track record of being financially disciplined, which is one of the reasons why we have the top margins within the industry, and we plan to continue that disciplined approach looking at the assets.
Okay. Perfect. I know we're up on time, Amol. Thanks so much for this session. That actually wraps up the entire conference. This was the last one. So I want to thank investors for staying with us for a couple of days. A bunch of great meetings. This was certainly one of them. So Amol, thanks so much for the time, and appreciate it. And we'll talk soon.
Thank you very much for having me.
Take care. Thanks.
Thanks. Take care. Bye.