Good morning, and welcome to the Waters Corporation Second Quarter 2019 Financial Results Conference Call. All participants will be in a listen-only mode until the question-and-answer session of the conference call today. This conference is being recorded. If anyone has any objections, please disconnect at this time.

It is now my pleasure to turn the call over to Mr. Bryan Brokmeier, Head of Investor Relations. Please go ahead, sir..

Thank you, operator. Good morning, everyone, and welcome to the Waters Corporation second quarter earnings conference call. Before we begin, I will cover the cautionary language. During the course of this conference call, we will make various forward-looking statements regarding future events or future financial performance of the company.

In particular, we will provide guidance regarding possible future income statement results for the company for the third quarter and full year 2019. We caution you that all such statements are only predictions and that actual events or results may differ materially.

For a detailed discussion of some of the risks and contingencies that could cause our actual performance to differ significantly from our present expectations, see our annual report on Form 10-K for the fiscal year ended December 31, 2018, in Part 1 under the caption, Risk Factors, and the cautionary language included in this morning's press release and 8-K.

We further caution you that the company does not obligate or commit itself by providing this guidance to update predictions. We do not plan to update predictions regarding possible future income statement results, except during our regularly scheduled quarterly earnings release conference calls and webcasts.

The next earnings release call and webcast is currently planned for October 29, 2019. During today's call, we will be referring to certain non-GAAP financial measures. Reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures are attached to our earnings release issued this morning.

In our discussions of the results of operations, we may refer to pro forma results, which exclude the impact of items such as those outlined in our schedule titled Reconciliation of GAAP to Adjusted Non-GAAP Financials included in this morning's press release.

Unless stated otherwise, references to quarterly results increasing or decreasing are in comparison to the second quarter of fiscal year 2018. In addition, unless stated otherwise, all year-over-year revenue growth rates, including revenue growth ranges given on today's call, are given on a comparable constant currency basis.

Now, I'd like to turn the call over to Chris O’Connell, Waters' Chairman and Chief Executive Officer.

Chris?.

Thanks, Bryan, and good morning, everyone. Thank you for joining us today. Along with Bryan Brokmeier, joining me on this morning's call is Sherry Buck, Waters' Chief Financial Officer. During today's call, I will provide an overview of our second quarter operating results as well as some broader commentary on our business.

Sherry will then review our financial results in detail and provide comments on our third quarter and full year 2019 financial outlook. We will then open up the phone lines to take your questions. Briefly reviewing our financial highlights for the second quarter, revenues grew 2% and adjusted earnings per share grew 10%.

While sales in the quarter came in at the low end of our guidance range, we are encouraged by our progress in key areas of the business during the quarter, including achieving high-single digit growth in the U.S., growth in China and broad-based pharmaceutical strength across all major geographies.

With these positives and the stabilization in market trends that we saw during Q2 as well as the increasing impact of our new product launches, we are looking forward to continued improvement in the second half of 2019.

On our income statement, we demonstrated disciplined operating expense management during the quarter while protecting investment in key growth initiatives, particularly organic R&D. This operating control combined with our share repurchase program enabled us to deliver double-digit earnings per share growth in Q2.

Before I review our end market, geographic and product line performance, I’d like to provide an update on the three factors we cited in last quarter’s call that led to a slower start to 2019 than we expected; China, Europe and TA Instruments. First, on China.

As a reminder, China represents 18% of our global revenue and has reliably delivered strong double-digit growth for an extended period of time. Our business mix in China is unique within our global portfolio as well as within the industry with more concentration in generic pharma and food testing.

In the second quarter, our business in China grew 3% overall. Our pharmaceutical business in China grew nicely in the quarter with growth in both large and small molecule applications. We continue to watch the 4+7 program closely, especially given the likely expansion of this pilot program later this year.

That said, some generic customers that have withheld purchasing in Q1 resumed their purchasing of instruments in Q2, particularly those that were awarded tenders as part of the 4+7 pilot program. And we have a strong market position with this customer base.

As we mentioned last quarter, we believe that over the long term, 4+7 will result in rising generic prescription volumes in China leading to attractive growth in demand for our instruments.

On the large molecule side of the business in China, we continue to see solid growth affirming the ongoing strength of innovation in China and our strong market position. We were also pleased to see our food business in China stabilize somewhat during the quarter, driven by stronger instrument demand from independent food labs.

While this development is encouraging, it is not yet sufficient to offset the continued soft demand we are experiencing from the governmental food labs in China.

As we have discussed before, the food safety testing market in China is in transition which will lead to strong, long-term growth opportunities even if we experience some bumps during the process.

Finally, in China, the progress we made in generic pharma and third party food testing was somewhat offset by weaker demand in academic and governmental markets. Second, with respect to Europe, sales declined 2% during the quarter as modest growth in Western Europe was insufficient to offset a double-digit decline in Eastern Europe.

Looking at Western Europe, we are encouraged by the solid pharmaceutical growth we experienced in Q2 as our large customers that had been more cautious in the first quarter increased their budget releases. However, that pharma growth was mostly offset by a decline in industrial and applied markets in Europe.

Third, our TA Instrument product line stabilized during the quarter with flat year-over-year revenue growth and all key product lines experiencing sequential improvement in year-over-year growth.

Though we remain appropriately cautious given industrial market headwinds, particularly in Europe, we are confident that our strong global TA team, our leading market position and our robust product pipeline position us very well competitively through these market cycles.

Taking a closer look at the business, starting with a review of our market categories at the corporate level, sales to our broadly defined pharmaceutical category increased 6% during the quarter with all major geographies growing. In China, we delivered solid growth in both small and large molecule applications.

Additionally, after a sluggish start to the year, our largest pharmaceutical companies in the U.S. and Europe began to release their 2019 budgets purchasing both LC and LC-MS instruments as well as our precision chemistries. Year-to-date, overall sales to our pharmaceutical category grew 3% including double-digit growth in large molecule pharma.

We remain excited about our market position and expanding product portfolio in large molecule pharma where we have seen consistent double-digit growth.

Sales to our worldwide industrial category, which include material science, food and environmental markets, declined 3% in the quarter due to weakness in industrial, chemicals and materials and soft demand in food testing markets, particularly in Europe. Year-to-date, our worldwide industrial category sales were down 3%.

We remain confident in our portfolio of growth opportunities in the industrial markets, particularly with our newly launched Tandem Quad Mass Spec products and strong TA product line.

Sales to our academic and governmental category were flat in Q2 as strong growth in biomedical research applications in the U.S., Europe and Korea were offset by softness in China. Year-to-date, our governmental and academic category was up 2%.

In general, we are seeing stable government funding patterns in most markets with the current exception of China. For the second half of the year, we are looking forward to the benefits of the recently launched Cyclic IMS and SYNAPT XS high resolution mass spec systems to serve the strong demand in biomedical research applications.

Next, I will review our sales performance by geography at the corporate level. Asia, our largest region in terms of revenue, grew 3% in the second quarter. As I noted earlier, China’s 3% growth performance was driven by solid pharmaceutical growth partially offset by weaker demand in academic and governmental markets.

In India, demand continued to stabilize with the completion of national elections and we anticipate solid growth in the back half of the year. Elsewhere in Asia Pacific, we were particularly pleased with our business in Japan and Korea where we expect continued stable trends.

Turning to the U.S., we are very pleased by our 8% growth in the second quarter. U.S. pharma grew mid-single digits as our largest pharmaceutical customers increased spending across both LC and LC-MS instruments. U.S.

pharma was led by strong growth in large molecule applications although it’s important to note that small molecule pharma returned to growth in the quarter driven by a healthier generic environment.

Overall, the Americas grew 5% in the second quarter as declines in Latin America resulting from political instability in Mexico and Brazil partially offset our strong U.S. growth. In Western Europe, as noted before, sales growth was positive in the quarter behind strong pharmaceutical growth mostly offset by broad industrial weakness.

Eastern Europe declined double digits leading to an overall decline of Europe sales of 2%. Eastern Europe was affected by very difficult comps and we expect growth will normalize over the course of the year. Finally, I will review product line dynamics within our Waters and TA brands.

Waters branded instrument sales stabilized in the quarter and increased 1% as strong instrument sales to pharmaceutical customers were mostly offset by general industrial softness as noted before. LC instruments grew modestly driven by demand in large molecule pharma, partially offset by soft industrial markets.

In mass spectrometry, our Q2 business grew modestly driven by strong pharmaceutical demand particularly for the QDa and high resolution mass spec systems.

In particular, our QTof mass spec portfolio sold well in the quarter setting the stage for even better high resolution mass spec sales in the second half when we expect to begin shipping our Cyclic IMS and SYNAPT XS systems and also see increasing contribution of BioAccord.

Waters branded recurring revenues, which reflect the combination of service and precision chemistries, grew 4% during the quarter. Pharmaceutical strength in chemistry was partially offset by softness in our academic and governmental category.

In particular, growth was strong within our application kits, UPLC columns and bioseparation columns including our recently launched BioResolve Reversed Phase Monoclonal Antibody columns.

I provided some color on TA earlier in the call, but to quickly recap, sales were flat in the second quarter with TA instrument sales down 2% and service sales up 5%. We are encouraged that our thermal, rheology and microcalorimetry product lines improved their growth rates sequentially.

Returning to the big picture, we remain steadfastly focused on executing on our five-point value-creating model. As we have consistently communicated, we aim to create shareholder value by first, holding a leading specialty position in structurally attractive markets; two, executing a focused growth strategy driven by organic innovation.

Three, seeking opportunities to continuous operational improvement in innovation, channel and our operations; four, maintaining capital discipline as we shift from being a capital accumulator to a capital deployer; and five, operating with a performance-oriented culture and management team.

We are truly excited about our significant new product cycle which is the result of our purposeful increases in R&D spending over the past three years. Halfway through the year, we have introduced a meaningful number of new products across a range of technology, market and application categories.

While we’ve launched a number of critical new platform extensions and product enhancements in LC and TA, I’d like to focus my comments here on several of our exciting new mass spec system launches.

In Q1, we launched a groundbreaking BioAccord system, a fit-for-purpose, a high-performance LC-MS system for routine monitoring of biomolecule attributes in regulated laboratories.

Customer feedback has been very positive and we are seeing an expanding pipeline of leads, opportunities and quotes which position us for a meaningful ramp over the next several years. At ASMS in June, we launched two new high resolution mass spec systems.

The first, the Select Series Cyclic IMS is a revolutionary next generation mass spectrometry instrument designed in collaboration with leading researchers with the aim of advancing their cutting-edge research.

It combines novel cyclic IM mobility separation with variable higher performance time-of-flight mass spectrometry to enable previously unattainable ion selection in fragmentation for advanced mass spec users across a very broad range of molecules.

The second high resolution mass spectrometer we launched at ASMS was the SYNAPT XS, a new high resolution instrument for research scientists with unprecedented flexibility of inlets and acquisition modes.

The system incorporates the StepWave XS ion guide from the Cyclic IMS providing the first example of Waters’ transferring leading-edge technology from our advanced mass spec program into the broader mass spec portfolio.

Customer interest in both systems has been very high and we’ve already received multiple orders for both the Cyclic IMS and SYNAPT XS. Most recently, we were pleased yesterday to announce the launch of two new mid-ranged Tandem Quad mass spec systems.

First is the Xevo TQ-S cronos, a new tandem quadrupole mass spectrometer that is purpose-built for routine quantitation of large numbers of small-molecule organic compounds over a wide concentration range.

The TQ-S cronos system is paired with a next generation version of the popular Xevo TQ-S micro bolstering our Tandem Quad line of mass spectrometers that is perfectly suited for the applied markets, including pesticide residue analysis, contaminants monitoring in processed foods, identifying drugs of abuse and performing impurity profiling of pharmaceuticals.

To recap where we stand midway through 2019, while we started the year facing a number of unanticipated headwinds, particularly in China and Europe, we have focused on managing through these challenges to sequentially improve our growth.

During Q2, key areas of our business improved, including achieving high-single digit growth in the U.S., growth in China and pharmaceutical strength across all major geographies. This progress is encouraging.

Stabilizing end markets as well as our accelerating cadence of new product introductions provide us with the confidence that we will be able to achieve continued improvement over the course of the year. With that, I’d like to pass the call over to Sherry Buck for a deeper review of the second quarter financials.

Sherry?.

Thank you, Chris, and good morning, everyone. In the second quarter, we recorded net sales of $599 million, an increase of approximately 2% in constant currency. Currency translation decreased sales growth by approximately 2% resulting in flat sales as reported. In the quarter, sales into our pharmaceutical market grew 6%.

Sales into our industrial market declined 3%, while academic and governmental markets were flat. Looking at product line growth, our recurring revenue, which represents the combination of precision chemistries products and service revenue, grew 4% in the quarter, while instrument sales were flat.

As we noted last quarter, there is no year-over-year difference in the number of calendar days during the second or third quarters, but there is one additional calendar day in the fourth quarter of 2019 compared to 2018.

Breaking second quarter product sales down further, sales related to Waters branded products and services grew 3%, while sales of TA-branded products and services were flat. Combined LC and LC-MS instrument platform sales were up 1% and TA's instrumentation system sales decreased by 2%.

Looking at our growth rates in the second quarter geographically and on a constant currency basis, sales in Asia were up 3% with China growing at 3%. Sales in the Americas were up 5% driven by 8% growth in U.S. and European sales were down 2%. Now, I’d like to comment on our second quarter non-GAAP financial performance versus the prior year.

Gross margin for the quarter was 58.4% compared to 59.2% in the second quarter of 2018. The lower gross margin relative to the prior-year quarter was primarily the result of FX.

Moving down the second quarter P&L, operating expenses increased by approximately 1% on a constant currency basis and foreign currency translation decreased operating expense growth by approximately 3% on a reported basis. In the quarter, our effective operating tax rate was about 16%.

Year-to-date, the tax rate is approximately 14%, which is in line with our full year guidance. Net interest expense was $6 million, an increase of about 3 million from the prior year as anticipated as we shifted to a net debt position during the quarter.

Our average share count came in at 69.5 million shares, a share count reduction of approximately 11% or about 9 million shares lower than in the second quarter of last year. This is a net effect of our ongoing share repurchase program.

Our non-GAAP earnings per fully diluted share for the second quarter increased to $2.14 in comparison to $1.95 last year. On a GAAP basis, our earnings per fully diluted share increased to $2.08 compared to $1.98 last year. A reconciliation of our GAAP to non-GAAP earnings is attached to the press release issued this morning.

Turning to free cash flow, capital deployment and our balance sheet, I'd like to summarize our second quarter results and activities. We define free cash flow as cash from operations less capital expenditures and excluding special items.

In the second quarter of 2019, free cash flow came in at $136 million after funding $20 million of capital expenditures. Excluded from free cash flow were $29 million for U.S. tax reform-related payments and $20 million related to the investment in our Taunton precision chemistry operation.

In the second quarter, this resulted in $0.23 of each dollar sales converted into free cash flow and $0.26 year-to-date.

Now, I’d like to provide an update on our second quarter activities related to capital deployment, which we categorize into three areas; investing for growth, balance sheet strength and flexibility, and the return of capital to shareholders.

During the quarter, R&D grew 6% on a constant currency basis as we continue to invest in bringing innovative new products to market. In terms of returning capital to shareholders, we repurchased 2.7 million shares of our common stock for $577 million in the second quarter.

These capital allocation activities, along with our free cash flow, resulted in cash and short-term investments of $676 million and debt of $1.1 billion on our balance sheet at the end of the quarter, resulting in a shift to a net debt position of $473 million.

Looking ahead, we remain committed to deploying capital against these three priorities and continue working towards a near-term capital structure of up to 2.5x net debt to EBITDA ratio.

Our current plans are to repurchase approximately $600 million in shares during the third quarter and consistent with our previous communications, about $2.5 billion for the full year. These assumptions are reflected in our 2019 guidance.

We will continue to evaluate our share repurchase plans over the remainder of the year and provide quarterly updates. Turning to working capital. Accounts receivable days sales outstanding stood at 79 days this quarter, up slightly compared to the second quarter of last year.

In the quarter, inventories increased by $52 million in comparison to the prior-year quarter, driven by planned inventory build related to Brexit contingency planning, quarterly sales volumes and inventory build for new product launches. As we look forward to the balance of the year, I’d like to comment on our full year 2019 guidance.

As Chris previously mentioned, we continue to expect improved second half revenue performance versus the first half.

That said, when factoring in our actual results for the first half, we are updating our full year 2019 constant currency sales growth guidance to a range of 1% to 3% from our prior guidance range of 2% to 4% constant currency sales growth. At current rates, currency translation is assumed to decrease 2019 sales growth by 1 to 2 percentage point.

Net interest expense guidance for the full year is now expected to be in a range of $30 million to $32 million which is lower than our prior guidance of $30 million to $35 million. Our other key assumptions for the full year guidance are unchanged.

Gross margin of 58.5% to 59%, operating expense growth at a rate that is below our sales growth rate, full year effective tax rate of 14% to 15% and lastly an average diluted share count of 68.5 million to 69 million shares outstanding.

Rolling all of this together, and on a non-GAAP basis, full year 2019 earnings per fully diluted share are now projected in the range of $8.95 to $9.10, a decrease from our prior range of $9.05 to $9.25. At current rates, the negative currency impact on full year earnings per share growth is expected to be 2 to 3 percentage points.

Looking at the third quarter of 2019, we expect 2% to 4% constant currency sales growth. At today's rates, currency translation is expected to decrease third quarter sales growth by approximately 1 percentage point.

Combining these top line factors with a moderate increase in expenses, we estimate third quarter non-GAAP earnings per fully diluted share in the range of $2.05 to $2.15. At current rates, the negative currency impact on third quarter earnings per share growth is expected to be 2 to 3 percentage points. Chris will now make a few summary comments.

Chris?.

Great. Thank you, Sherry. In summary, while our first half of 2019 was slower than we expected, we did see improvement in the second quarter, particularly in key growth drivers of our business, namely our two largest geographies; U.S. and China, and in our largest market category, pharmaceuticals.

In total, we expect a better second half than our first half based on the improving end market conditions we saw in the second quarter as well as our accelerating cadence of new product introductions. With that, we will now begin the question-and-answer session.

As we are not always able to get to everyone's questions, please limit yourself to one question and one follow up. And if you have additional questions, please contact the Waters Investor Relations team after the call.

Operator?.

Thank you. Our first question comes from Derik De Bruin of Bank of America. Your line is open..

Hi. Good morning..

Good morning, Derik..

Hi. Can you just clarify on the margins for a little bit? How did FX help? I know the pound obviously has been tanking. So how does that flow through? I know that benefits you.

Can you just talk about the impact on the margin?.

Yes. Hi, Derik. This is Sherry. In the quarter, our FX on the top line kind of came in as expected and on gross margin it was unfavorable, about 60 basis points – impacted about 60 basis points. And then we – as it flowed through to EPS, it was a little bit more unfavorable than what we had expected.

And basically it’s due to the weaker euro and the pound and yen movement wasn’t able to be offset..

Got it. Obviously, there’s a lot of questions on China and one of your competitors in the tool space flagged some incremental headwinds in that market yesterday with some government tender commentary there.

Can you just talk about a little bit more about the situation there and what you’re seeing in 4+7? And also just anything in terms of unusual activity from either a pricing perspective or potentially orders going to more local vendors there? Thanks..

Sure, Derik. Let me jump into that and start with the 4+7 as you began. As I mentioned in the prepared remarks, we did see really a loosening of some of the spending that had been so constricted in the first quarter, particularly in the month of March.

And as I mentioned, we saw some of the winners come forward with instrument purchasing from the first round. And just as a reminder, Phase 1 of the 4+7 involved a target of 31 drugs, 25 were actually completed through the tendering process. And now we do have some expectation as Phase 2 is upon us.

I think there is still some lack of clarity in the market as it relates to how it all plays out, but I would characterize the tone of our customers as being a little bit more balanced than we saw them in Q1.

Q1, the news was so new, the process was so new that it really had a freeze effect in the market and we did see some chilling of that freeze and some better underlying demand. As I mentioned many times, we see the overall objectives of the 4+7 program being positive for the consumer in China and ultimately for instrument purchases.

And so we’re just managing our way through it. As it relates to the rest of the market in China, we didn’t see any unusual activity to your question on pricing or any local bias. As you know, a lot of our business in China is in highly regulated categories and therefore there is less of a local competition dynamic than perhaps other companies.

But China obviously is a dynamic market right now. We’re just staying very, very focused on what we do well there which is to serve our customers and deliver technology to them.

And our overall expectations for China over the rest of the year are what I’d say cautious and balanced where we’re seeing some great strength in areas like large molecule, biomedical research, clinical diagnostics with ongoing questions on 4+7, so we’re in a little bit of a wait and see mode there.

Our exposure in government food labs has been under pressure while we also see some good development on the independent side. So, overall, kind of a balanced view but certainly not any expectations that China comes all the way back to historical levels. We see more of a continuation of the trends that we saw in Q2..

Thank you. Our next question comes from Tycho Peterson of JPMorgan. Your line is open..

Hi. Good morning. Chris, I’m wondering if you can talk on the pharma recovery. Last quarter, you talked about some delays on the budget release.

How much of this quarter was just catch up versus what could be a sustainable recovery from pharma?.

Sure. Thanks. Good morning, Tycho. Yes, we did see – we definitely saw better pharma tone really across the portfolio in Q2 and that had been a welcome sign after Q1. I don’t know that I would characterize it as a catch up from Q1 per se, but just an overall health and strength of the pharmaceutical market. As I mentioned, we grew in all key geographies.

We continue to see robust large molecule trends. And despite some of the hits on the small molecule side we’ve taken in recent years in India and China, we do believe in the ongoing health of that market driven by expanding patient access to therapies.

I guess one other comment there is in particular what we call our top pharma, which is our top 15 pharma accounts, we are very encouraged by them. They had a better quarter in Q2 than we’ve seen in a while.

And while we’re not assuming any unusual flush activities in the back half of the year, we expect what I’d characterize as normal second half improvement in a pattern that we’ve seen over the last several years.

So it was nice to have pharma overall for us at the historical growth rates in that 6% growth range and as long as that continues on that pattern, which we do expect, we gain confidence in our numbers in the back half of the year..

Okay. And then for the follow up, can you just address the guidance reduction? It sounds like pharma is stabilizing a bit. China is maybe going to be consistent with what you saw in 2Q.

So it is really just the industrial outlook that you’re factoring in the back half of the year for the guidance reduction?.

Yes, I’ll make a quick comment and let Sherry go a little deeper on the guide. Obviously, halfway through the year it’s just math on the first half.

And so you take the actual for the first half and then you take our outlook for the second half which we’ve tried to be clear we do expect to be better than the first half and have some of these market trends continue plus the incremental benefit of our new products.

And so what ends up in forming the overall range for the year is simply the first half actuals, because we came in a little bit in the lower end of our range in Q2 that had the effect of taking down the first half actual a little bit.

But looking at the second half, I think you’ve characterized it correctly which is we expect a solid and healthy pharma, solid and healthy U.S. environment that was a real nice part of the quarter with a balanced view in China and I’d say probably more caution on the European environment overall..

And just adding to that a little bit, when you think about the markets, Chris had talked about pharma, also probably a little bit cautious on the industrial given what we’ve seen so far in the year. When you look at our EPS guide range, we lowered it from the midpoint. There’s really two factors that drove that. One would be our FX guidance update.

That’s about half of the change, 1 point we’re seeing as FX, and then the volume changing kind of our midpoint growth volume for the full year..

Okay. Thank you..

Thanks, Tycho..

Thank you. Our next question comes from Ross Muken of Evercore. Your line is open..

Good morning, guys. So I appreciate some of the color on the cyclical end markets and some of the industrial noise. I guess as you’re thinking about second half, the CapEx line in general in terms of instruments has been sort of a source of weakness now for I don’t know, maybe 12, 18 months.

I think probably the weakest periods were instruments since maybe '08, '09. Obviously, you’ve got a lot of new products coming in that you can control.

But on the stuff you can’t, I guess how are you thinking about the degree of risk from just general macro slowdown, so PMIs continue to decelerate, some of the challenges in China, we know of Europe obviously the threat of hard Brexit there that’s tough to figure out but it seems like a risk? And then layering in what we know about 4+7, obviously we were there in China not long ago.

It seems certainly like there was going to be an expansion. And so, again, that’s something not in your control and may end up positive but still causes some lack of visibility.

So I guess how are you thinking about the cadence of the product rollouts, what you can control versus the risk of what you can’t control, because it seems like the key to getting Waters back to its more normalized growth rate is obviously going to be getting that CapEx line back to a more – the instrument line back to a more normal level.

Like, how do you put that whole pie together as you think about getting back to, I don’t know, 3%, 4%, 5% instrument growth by next year which you need to kind of get back to your long-term growth rates?.

Yes, thank you, Ross, and good morning. And that’s exactly the goal here is to get that instrument line moving and you correctly pointed out that there is a lot in the new cadence that we do control, and we’re really excited about that. Like I said on the prepared remarks, we’ve invested assertively.

We’ve really put our heads down to improve our overall product portfolio and we’re really I think going to be able to see the positive benefits of that and it’s certainly been something that’s energized our customers and our field organization as we look into the back half of the year. And so we definitely try to focus on what we can control there.

In terms of a lot of the macro pieces that you identified, we’ve tried to put together a guide that really bakes in a lot of that question, if you will, and there are different points that you mentioned.

The general industrial slowdown is certainly something that’s affected our business and that’s primarily a European question as our industrial business in the U.S. was actually quite positive in the quarter and has been positive. The European environment is really characterized by a lot of uncertainty particularly as you point out around Brexit.

There’s no question that the northern part of Europe has in particular been impacted by that. We’ve seen more pressure in the northern part of Europe than we have in the southern part of Europe, but obviously that’s going to work its way towards a resolution point one way or another here by the end of the year.

And of course, in China, it’s a variety of factors there and most prominent to us has been 4+7 in the food question. But like I mentioned earlier, I think there’s a little more moderation around 4+7 expectations as participants in the market come to grips with the new process but also see the growth that’s inherent in this marketplace.

We don’t know exactly what Phase 2 is going to look like there. We do understand that unlike Phase 1, there may be multiple winners per tender accepted which could moderate the dynamic overall. So some uncertainty but we believe all those factors are baked into our near-term guide here..

Chris, maybe on a strategic level, one of the things that sort of differentiated growth this quarter and last quarter or sometimes when the group is kind of exposure to bio production, you guys have some presence there but certainly not the same scale you do in small molecule.

I guess as you think about strategically how you’ve deployed your capital, with some of the bumps you’ve had, the stock has hung in there given all the buyback that’s happened.

I guess has there been any thought maybe to getting a little bit more aggressive on the sort of strategic tuck-in M&A side to maybe get the bias particularly on pharma where you’ve got some a dominant presence a little bit more skewed towards the biotech side versus maybe where you are today?.

Yes. I think that’s an important topic and as you know from our capital allocation priorities which we have really refined since U.S. tax reform which was a real game changer for us, we do have as our first priority for capital deployment growing the business and that’s why we’ve allocated more capital to internal R&D.

It’s why we’ve allocated more capital to CapEx. And we’ve over the past several years built a corporate development function within the company to be more active outside the company looking for opportunities to deploy capital to highly purposeful selective M&A.

And so we are definitely more active on that front, but with a high degree of both strategic and financial discipline. In the overall bio production world there’s obviously a lot of analytical technologies in that space where we’ve been forward leaning for some time.

We’ve had some market leading technology in areas like process analytical and other related areas in terms of more participation in some of those spaces. Some of that would be logical. We’re always going to stay within a framework of our specialty focus as a company, but we do see that to provide incremental growth opportunity.

And obviously a lot of specifics we can put around that until you see us more active..

Okay. Thanks, Chris..

Thanks..

Thank you. Our next question comes from Brandon Couillard of Jefferies. Your line is open, sir..

Thanks. Good morning. Chris, I want to come back to the China generics market in 2Q specifically.

Are you seeing sequential growth in that part of the business? Was it ahead of plan? And kind of what are you embedding for the second half outlook? And sort of do you feel like kind of the worst is behind you there at this point?.

Yes, I think I’d probably stop short of saying the worst is behind us. I think it’s just generally a cautious environment. But we definitely saw better dynamic in Q2 than Q1. And as I mentioned in the prepared remarks, we saw growth in both small and large molecule applications within China.

In the case of large mol, that’s been a consistent trend for some time reflecting the underlying innovation that’s going on in the biomolecule space. And in small molecule we’re weighted towards generics there and we did see some of our customers kind of perk up during the quarter.

And those that are feeling confident in these bidding processes are looking to spend their capital budgets over the course of the year. So, yes, we did see sequential improvement on the generics side. But until we gain more clarity on how everything plays out, we’re making sure we had relatively moderate type expectations..

Thanks.

I’d love to get your perspective on how you think the order book is kind of building for some of the newer products, like BioAccord, Cyclic and the new SYNAPT system, how the order funnels are building the areas of most interest and what you think the impact might be to instrument revenues from some of those new systems in the back half?.

Yes, we’re definitely focused a lot on that. And I’d also want to mention the two new tandem quad launches that we announced yesterday, which really delighted our field organization to improve our core kind of midrange tandem quad line with Xevo TQ-S cronos and the Xevo TQ-S micro refresh.

So when we look at that, we do have an expectation for improving mass spec performance in the back half of the year.

In terms of the order book activities, since ASMS we’ve been out with the high end, high resolution systems and as I mentioned we’ve received some orders already for both Cyclic as well as SYNAPT XS even though those are back half launches, if you will.

And BioAccord because it’s really a new to market technology targeting an emerging space, it’s more of a market development activity and we’ve been really focused on a tremendous amount of demonstration type activity working with customers to evolve their own – support their own budgetary processes to free up money within the year and to develop that overall lead opportunity and quoting pipeline.

And we monitor and manage those statistics rigorously and are pleased with that, and so we do expect to see a more visible impact on BioAccord in the back half of the year and really something that as I said in the prepared remarks is really a multiyear phenomenon.

So, again, I don’t want to put specific numbers on any one of those categories or the portfolio overall other than to say in our efforts to really get the instrument line moving, these product launches are critical and we’re excited about them..

Super. Thanks..

Thanks..

Thank you. Our next question comes from Doug Schenkel of Cowen. Your line is open..

All right. Good morning. Thank you for taking my questions. I want to start by talking about chemistry and then I want to come back and talk about the revised growth outlook for the year. So starting on chemistry, just to unpack results in the second quarter and the outlook from here, you’ve generated better than corporate average growth this quarter.

But the last couple of quarters have been a bit below historical trend. You’ve called out timing headwinds in the first quarter that were supposed to benefit Q2.

Did these tailwinds materialize in the quarter? And can you comment generally on recurring revenue growth? Is the slight deceleration in the first half just due to weaker installed base growth over the past few quarters? And if so, is the expectation that over time as instrument placements improve that chemistry and broader recurring will improve?.

Yes, thanks, Doug, and good morning. On the chemistry line and unpacking that a little bit, there was in our portfolio strength on the chemistry side in the biopharm area and pharmaceuticals evolved really at historic-type level with some softness on the industrial side given the overall end market dynamics there.

Chemistry sales in part move with installed base and in part move with overall volume of testing activity. And so the extent a segment like industrial is a little bit soft, you’re going to see some effect to that on chemistries.

And so really what I’d say is a little bit of a tale of two cities on positive chemistry results on the pharma side and slightly below normal on the industrial side.

In terms of the overall recurring revenues as well as service, we continue to sell a wide range of service programs into the market and to some degree it does reflect underlying instrument activity.

But sometimes we also see dynamics in certain product lines where there’s been slower instrument growth take on a little bit more of a service burden and so we get some benefit from that. So overall, we expect to see continued solid recurring revenue growth over the course of the rest of the year.

And certainly as instrument growth picks up with our new product cycle, we think there’s opportunity in both those lines..

Okay. Thank you for that, Chris. And on the growth outlook, just to go back to this at least one more time. It seems like the key driver to the full year of growth guidance reduction and I think your words were first half results coming up a little bit light and then a change in the industrial outlook.

If I’m doing the math right, it seems like it has to be largely the latter because mathematically if we adjust for how Q2 came together, it still seems like you’re essentially cutting the second half growth expectations by almost 100 basis points.

So with that in mind, I would have thought your expectations on industrial were already pretty muted at this point.

So could you first quantify exactly what the changes in industrial expectations, confirm that there isn’t another dynamic here because mathematically it suggest something else is possibly going on here? And I guess lastly, TA was flat year-over-year against a really tough comp overall in instruments.

I’m just wondering if you still expect TA to grow at least low single digits in the second half of the year or even coming off of a tough comp and a strong quarter, relatively speaking is this a bit optimistic given your comments on industrial in Europe? Thank you..

Thanks, Doug. I guess the way I would describe maybe the difference between what we expected and what we saw in Q2, which plays through to the rest of the year, certainly we were very pleased with the U.S., we’re very pleased with pharma, we were pleased to see China come back a bit.

Really Europe was probably the main swing factor there that probably put us in the lower part of the range versus the middle or upper part of the range and Europe, as I mentioned, is primarily an industrial headwind there because we did see better pharmaceutical performance in Europe in the quarter.

And so I think it’s fair to say that if there’s any kind of conservatism built into our overall second half outlook, it’s really around the challenging European environment, particularly in the industrial category.

That’s really where we saw the difference in terms of our own expectations in the quarter and obviously play that through for the rest of the year. But that being said, we’re really looking to pharma on the U.S. to lead the way and a more balanced outlook on China. To answer your TA question, you’re right.

TA kind of came back from negative to flat on tough comps and we do expect some modest continuing progress on the TA side and certainly something in the low-single digits for the second half is what we’re looking at. TA product line is great. The team is very focused doing a good job.

And yes, some of those markets are challenging but there’s also some bright spots within the TA portfolio. The U.S. was actually quite strong in TA. And decent in China, in Japan with pressure in Europe and some other parts of Asia.

And interestingly enough, we do sell some products in TA into the pharma sector, particularly in the microcalorimetry line for sort of biomolecule characterization and that pharma business for TA is doing really well. Anyway, maybe I’ll leave it at that..

Okay. Thank you..

Thanks..

Thank you. Our next question comes from Dan Brennan of UBS. Your line is open..

Great. Thanks for the questions. Chris, not to belabor, but I was hoping to go back to China one more time, if you don’t mind.

Could you just flush out and just remind us specifically how large is your China generics and China food business, specifically what did they grow in the quarter, if you could share that? And then, well, I can appreciate the visibility is limited given the government hasn’t really enacted the next step on the generics presumably.

You’re in a better position than we are to kind of assess kind of what’s a reasonable kind of rate of outlook for growth for your businesses and I think it’s important for us to get some sense on what the potential parameters around that business growing going forward as these programs rollout.

So if you can help us with that that would be terrific?.

Sure. Let me see if I can add some incremental thoughts there, Dan. Thank you. As it relates to kind of mix where you started on generics and food, just some broad parameters. Small mol versus last mol in China last year was in the sort of 80-20 range; 80 small, 20 large.

And if you look at our overall mix of generics, it’s higher in China than it is around the world. Globally, generics is maybe 30% of pharma and you can call it a little bit more than that in China, so China is more weighted there.

On the food side, food testing not including environment, it’s about 15% of our China business which again is a little bit over indexed compared to the overall global mix. And we still see in the backdrop of China a robust pharma environment. Clearly 4+7 was a shock to the system in the first quarter.

And like I mentioned earlier, we’ve gained some incremental insights just on what happened in that first wave around the 25 drugs that actually went through versus the 31 targeted with Phase 2 and coming probably in the fall timeframe, but maybe a different dynamic as the market broadens to multiple winners.

We also know that expectations on hospitals and other purchasers of these drugs is for a majority of the listed drugs to come from winning bidders, but not all of them. So there is some belief in the marketplace that there’s still room for a number of players.

And as this program expands over the next two to three years that there will be room to play for a variety of different types of companies, and because of that we did see some back-to-business attitude in the part of our customers.

Because there is some continued uncertainty there, we haven’t assumed a spring back to what I call a normal pharma purchasing environment this year, but hopefully we’ll gain continued visibility of that over the course of the year.

So I think our outlook in China of kind of that balanced and somewhat cautious view is appropriate and continuing to look at the type of trends that we saw in the second quarter..

Great. Thanks, Chris, for that. And then just back to the small mol with U.S. and Europe, so can you just give us some flavor specifically like how your businesses did for pharma in U.S.

and Europe? I think you might have said that already, but maybe just clarify that? And then secondly is whatever concerns that were there on the first quarter for this small mol-related spending slowdown, are those removed and it was just normal budget timing or are there any lingering issues to point to related to small molecule? Thank you..

Yes. Thanks, Dan. As I mentioned, we did see better tone in the market in small mol in Q2 than Q1. In Q1 we’ve seen this pattern in previous years which is kind of a wait and see caution kind of attitude in the earlier parts of the year, particularly among our larger customers.

But like I said, we saw our larger customers really come back and actually have about as good of a quarter as they’ve had in a while. In terms of the European and the U.S. kind of overall pharma growth in the quarter, it was in that solid mid-single digit range. And so we were encouraged by that.

And like I said earlier encouraged at our overall pharma business was operating in the quarter at historical kind of rolling trend rates. And so we think that stability is something we expect for the second half of the year..

Great. Thank you, Chris..

We have time for about one more question, operator..

And that question comes from Sung Ji Nam of BTIG. Your line is open..

Hi. Thanks for taking my questions. Just a couple of quick ones, one on China again. For the academic, government segment there, some of your peers are seeing some strong growth.

And so curious as to – I’m just trying to reconcile what maybe your product mix there? Is it largely food testing environmental versus biomedical research, if you could provide some color on that?.

Sure, no problem. Thanks, Sung Ji. In China, there’s a pretty wide range of activity in government and academic categories and so mix really matters there. When you look at our academic and government sector, we have a really strong concentration in the food safety testing which as we’ve commented for a few quarters now has been very, very soft.

We made up for that a little bit through the independent testing labs, but the government and academic part of that has been overall weak. And there is a lot of reorganization going on in the government right now that has worked its way through the national level and now working into the provisional and city level.

And so we are cautious about the overall government market and the academic market which is sometimes related to that. So, it can be pretty lumpy as well though. So I think we’re not drawing any real conclusions based on what we’ve seen this year so far, particularly with our mix and other parts of government and academic beside food.

But at this point it’s something that held us back in the quarter..

Great. And then just – it sounds like you’re seeing some decent momentum for the newly launched products this year.

Wondering if I might be able to extract some more color based on kind of the quoting activity, the early market development activities as well as customer feedback in terms of how the order growth is kind of trending? Is it pretty much in line with your expectations ahead of launch or I’m just trying to figure out – I don’t know if it’s too early to tell, but maybe is there some better than expected outlook for some of the newly launched products?.

It’s a good question. You never know the exact timing of how the order book builds per se, but all the leading indicators for that are something we’re putting quite a bit of effort into understanding in more detail.

We’ve build a sales operations function that is more closely linking the commercialization activities to all the different activities in the field and giving us the data points we need to gain comfort that we’re moving in the right direction.

But it starts all the way back with customer introduction with the demoing process for which we’re doing some new things this year, and then translating into an overall lead and opportunity which is a highly qualified lead book and then into quoting activity and all those trends seem to be moving in the right direction.

We’re thrilled that we have some orders already for the SYNAPT and the Cyclic systems, the BioAccord pipeline is strong and to throw on top of that yesterday we launched the new tandem quad which is exciting for our field organization.

Anyway I don’t want to put too much specificity on forecasting orders or sales other than to say the overall portfolio effect is something that we really believe is going to help us in the back half of the year. So it’s really an outcome of all the good work we’ve been doing in R&D.

So, anyway I know we’re out of time and sorry we couldn’t get to more questions, but really enjoyed the questions and look forward to further discussions with all of you.

In conclusion, we are focused on delivering a stronger second half of 2019 headlined by continued pharmaceutical strength, improving stability in key geographic markets and the increasing impact of our exciting new product cycle.

Furthermore, we remain confident in the long-term health of our end markets, our very strong competitive position within our priority categories, our focused growth strategies and our talented people around the world. So on behalf of our entire management team, I’d like to thank you for your continued support and interest in Waters.

We look forward to updating you on our progress during our Q3 2019 call, which we currently anticipate holding on October 29, 2019. Thanks and have a great day..

Thank you for your participation in today’s conference. You may now disconnect at this time. Have a wonderful day..