Waters Corp

NYSE:WAT

Earnings Call Transcript 2018-Q1

[Operator]

Good morning. Welcome to the Waters Corporation First Quarter 2018 Financial Results Conference Call. [Operator Instructions] 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.

[Bryan Brokmeier, Senior Director-Investor Relations]

Thank you, operator. Good morning, everyone, and welcome to the Waters Corporation First 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 of the company for the second quarter and full year 2018. 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, 2017, 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 July 24, 2018.

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 is attached to the company's 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 we say otherwise, references to quarterly results increasing or decreasing are in comparison to the first quarter of fiscal year 2017. In addition, unless we say 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 Waters' Chairman and Chief Executive Officer, Chris O'Connell. Chris?

[Chris O'Connell, Chief Executive Officer, President and Director]

Thanks, Bryan. Good morning, everyone, and 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 Q1 operating results as well as some broader commentary on our business. Sherry will then review our financial results in detail and provide an update on our Q2 and full year 2018 financial outlook. We will then open up the phone lines to take your questions.

Briefly reviewing our financial highlights for the first quarter revenues grew 2% and adjusted earnings per share grew 9%. We were disappointed with our first quarter revenue results which were weaker than we had expected due to two main factors, under performance within our mass spectrometry product line and a very soft market in India as we close the quarter. The weak performance of the mass spec product line was attributable to an unusually sluggish start in biomedical research, particularly high resolution mass spec in the OMEX area. Combined with temporary disruption from territory realignment within our U.S. mass spec sales team made as part of an ongoing growth initiative.

As a reminder our sales of high end mass spec products in the biomedical research market is a small part of our business and prone to variability quarter-to-quarter. Furthermore, the sales force realignment is now complete, new positions have been filled by high quality professionals and we have begun to establish a strong order pipeline giving us confidence in a mass spec reacceleration.

In India, our customers delayed purchases in Q1 as they focused on protecting their balance sheets and P&Ls in their final fiscal quarter of what turned out to be a difficult year for them, particularly caused by the GST implementation. As a reminder the vast majority of Indian multinationals complete their fiscal years in March. Based on order visibility and the overall positive tone of our Indian pharmaceutical customers, we anticipate that India will improve in the current quarter and normalize in the second half of 2018.

On the positive side, sales to our pharmaceutical customers outside of India saw continued strength. As did sales of our TA product line and China had a solid start. Furthermore, we ended the quarter with a strong pipeline and remain confident in our business outlook. I'll provide more color on that in a moment.

Looking briefly in the P&L, we were pleased with the solid earnings results despite the weaker than expected top line growth. While investing in growth through organic innovation we demonstrated disciplined operating expense control that drove margin expansion and enabled us to exceed our planned earnings per share.

Now 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 grew 3% in the quarter. Excluding India, sales to the pharmaceutical market were up 6% with double digit growth in China and mid-single-digit growth in the developed markets, indicating the continued health of our core business.

Sales to our worldwide industrial category, which includes the materials characterization, food, environmental and fine chemical markets, were down 3% in the quarter. The decline was most notable in mass spec sales to chemical food environmental customers due in part to territory realignments mentioned before. Sales growth within TA continued the strong momentum seen last year growing at 6% and giving us confidence in the positive outlook for our industrial category as volume in our thermal and reality product lines has been our best proxy for industrial end market demand. We continue to be excited about our product positions and pipeline, as well as the breadth of opportunity across materials characterization, food safety and environmental applications.

Looking at our governmental and academic category, we saw sales grew by 7% in Q1, with strong growth in China, driven by food research applications, partly offset by weakness from biomedical research customers in the developed markets.

Next I will review our sales performance by geography at the corporate level. Asia, our largest region in terms of revenue, was flat in the first quarter as weakness in India offset high-single-digit growth in China, despite a greater than 20% comp in the prior year’s quarter. China is off to a solid start this year and met our expectations during the quarter.

Turning to the Americas, overall sales grew 4% in the quarter. While sales within the U.S. grew 5%. Sales growth trends in the U.S. continue to improve with strength in TA Instruments, as well as solid growth in pharma, partially offset by weakness in biomedical research markets.

In Europe, sales were up 2% in the quarter. Industrial, as well as academic and government were a drag on the region while European pharmaceutical demand remained robust. We saw strength in large molecule applications where we are well positioned with our targeted LCMS and biopharmaceutical analytical solutions. We also saw a strong service revenue from our large and growing base of installed systems.

Finally, I’ll review product line dynamics within our waters and TA brands. Waters branded instrument sales were down 4% in the quarter, driven by the previously mentioned mass spec weakness. On the other hand, we were pleased with our sales of chromatography instruments. Within LC I would like to highlight two meaningful recent product launches that give us confidence in ongoing strength. Early in the quarter we introduced the ACQUITY Arc Bio System, a versatile LC system that is specifically geared to GLP/GMP laboratories for routine use with large molecule drugs. The ACQUITY Arc Bio allows customers to experience true plug-and-play HPLC and UHPLC bio separations and modernize existing legacy methods. Early response to the system has been very positive.

Additionally, earlier this month, Waters introduced ACQUITY UPLC PLUS series, a series of three new ACQUITY systems with unparalleled, flexibility, performance and ease of use ideal for complex sample characterization in research and development through roofing product release testing these systems offer a two-fold to four-fold improvement in carry over performance resulting in improved sensitivity and characterization of samples.

Waters branded recurring revenues, which reflect the combination of service and precision chemistries and represent approximately 50% of the business’ total sales grew 6% in the quarter. Recurring revenues were driven by global strengthen in our service sample prep and application kits and various other complete chemistry offerings.

Turning to our TA product line, sales increased 6% in the quarter. Instrument sales for TA increased 6% as well and service sales increased 5%. There was broad based sales growth across our key thermal, microcalorimeter and electroforce product lines. In particular, growth within our Discovery line of thermal analyzers has been very strong. Our new DMA 850, the newest product in the Discovery series is easier to use and raises the bar in performance, offering a 100-fold improvement in displacement resolution. Looking ahead we continue to see opportunities to capitalize on the market trend of rising innovation in highly engineered, high performance materials.

In summary, we delivered on the EPS line in Q1, but clearly had a weaker start to 2018, than we expected on the revenue line. We fully understand the factors that led to the Q1 shortfall in revenue versus our expectations, believe they were transients in nature and maintain a positive growth outlook for the remainder of the year. Our key growth drivers remain intact, including global pharma demand, China market strength and an overall robust business model that include consistent recurring revenues. We expect these factors to support solid growth in 2018.

As always we remain steadfast we focus on executing our five point value creation model. As we have previously communicated we aim to create shareholder value by first, holding a focused and highly differentiated leadership position in structurally attractive markets; second, executing a clear growth strategy, driven by organic innovation; three, seeking opportunity for continuous operational improvement; fourth being a disciplined capital allocator; and fifth, operating with a performance-oriented culture and management team.

I would like to make a few incremental comments related to capital allocation. We prioritize our capital allocation in three buckets, number one, invest in the business; number two, maintain our balance sheet, strength and flexibility; and number three, return capital to shareholders. Now with access to our global cash and substantially increased financial capacity following U.S. tax reform, we see opportunities in all three of these capital allocation buckets. In line with our first priority of investing in the business, we had another quarter of robust R&D investment. And we recently announced a $215 million capital investment to transform our strategically differentiated precision chemistry operation in Taunton, Massachusetts. This investment will create even more impactful precision chemistry center of excellence that will enable us to serve the strong growth in customer demand that we expect, enhance our chemistry innovation capability and support ongoing operational efficiency gains.

With respect to returning capital to shareholders, as communicated in our earnings press release today, our Board of Directors has authorized an additional $3 billion share repurchase program targeted to be completed over a three-year period. As previously noted, this is incremental to the remaining $526 million in our prior program authorization. As you are well aware we have a long-term, well-established, share repurchase program in place which has created significant value for our shareholders. We believe this new authorization underscores our commitment to returning capital to our shareholders in a disciplined fashion, while maintaining a strong balance sheet and financial flexibility. Sherry will provide further details relating to capital allocation in her comments.

And with that I'd like to pass the call over to Sherry Buck for a deeper review of our first quarter financials. Sherry?

[Sherry Buck]

Thank you, Chris. And good morning everyone. In the first quarter we recorded net sales at $531 million, an increase of approximately 2% before currency translation. Currency translation increased sales growth by approximately 5% resulting in 7% sales growth as reported. In the quarter sales into our pharmaceutical markets grew 3%, sales into our industrial markets declined 3% and sales to academic and governmental customers grew 7%. Looking at our product line growth our recurring revenue which represents the combination of precision chemistry products and service revenue grew 6% in the quarter and was partially offset by a 2% decline in instrument sales.

As we noted last quarter, recurring sales were impacted by one last calendar day in the quarter which resulted in a slight reduction in service revenue sales. Looking ahead there's 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 2018 compared to 2017. Breaking products sales down further, sales related to Waters branded products and services grew 1%, while sales of TA branded products grew 6%. Combined LC and LCMS instrument platform sales decreased by 4%. And TA’s instrumentation system sales grew 6%.

As Chris already shared we are encouraged by the strong start in TA instruments as we saw the benefits of new product introductions and positive industry dynamics. Our total recurring revenues associated with both waters and TA products grew by 6%. Looking at our growth rates in the first quarter geographically and before currency translation, sales in the Americas were up 4%, with sales in the U.S. up 5%. European sales were up 2% and sales in Asia were flat with sales in China up 7%.

Now I'd like to comment on a first quarter non-GAAP financial performance versus the prior year. Gross margin for the quarter was 58.3% versus 57.6% and the first quarter of 2017, in line with our expectations. Moving down the first quarter P&L, operating expenses were up approximately 1% on a constant currency basis. And foreign currency translation increased operating expense growth by approximately 7% on a reported basis. In the quarter our effective operating tax rate was 11%, up 180 basis points year-over-year, which was better than expected, due to the timing of discrete items in the quarter.

Net interest expense was $4.2 million, down $1.2 million from the prior year as a result of debt repayments in the quarter as part of our capital allocation framework. Our average share count came in at 79.7 million shares or approximately 1.1 million shares lower than in the first quarter of last year. This is a net effect of our ongoing share repurchase program.

Our non-GAAP earnings per diluted share for the first quarter were up to 9% to a $1.59 in comparison to earnings of a $1.46 last year. On a GAAP basis, our earnings were a $1.40 versus a $1.31 last year. A reconciliation at our GAAP to non-GAAP earnings is attached to the press release issued this morning.

Turning to free cash flow, capital allocation and our balance sheet, I'd like to summarize our Q1 results and activities. We define free cash flow as cash from operations, less capital expenditures and excluding special items. In the first quarter of 2018 free cash flow came in at $160 million after funding $16 million of capital expenditures. This represents a strong start to the year as we were able to convert $0.30 of free cash flow from each dollar of sales. Consistent with our capital allocation priorities, beginning with investing for growth, we announced a significant $215 million investment in our precision chemistry operation in Taunton. The cash outflows will be spread over the five-year project with approximately $30 million of capital expenditures expected in 2018.

We remain focused on a strong and flexible balance sheet as part of our capital allocation framework. As a result of U.S. tax reform we now have access to our cash outside of the U.S. which was $3.4 million at December 31, 2017. We've utilized a portion of that balance to pay down our bank revolver and a maturing note by $750 million which drove the reduction in our interest expense in Q1 versus the prior year.

In terms of returns to shareholders in the quarter, we repurchased 1.3 million shares of our common stock for $275 million. These capital allocation activities, along with our free cash flow resulted in cash and short term investment of $2.6 billion and debt of $1.3 billion on our balance sheet at the end of the quarter resulting in net and a net cash position of $1.3 billion. Accounts receivable days sales outstanding stood at 85 days this quarter which was comparable to the first quarter of last year. In the quarter inventories increased by $30 million in comparison to the prior quarter but just in line with typical seasonal patterns.

As we look forward to the balance of the year, I'd like to comment on our full year 2018 guidance. Our outlook assumes continued global growth and demand from a pharmaceutical end markets, year-over-year growth in our industrial markets and consistent growth in our recurring revenue. These dynamics, along with our first quarter performance support full year 2018 guidance for constant currency sales growth in the mid-single-digit range, which we define as 4% to 6% unchanged from our previous guidance. At current rates currency translation is assumed increase 2018 sales growth by approximately 2% to 3%. Gross margin guidance for the year is unchanged at 58.5% to 59%. Our plan for the full year is to continue managing operating expense growth at a rate that is below our sales growth rate.

Moving below the operating income line, net interest expense is expected to be approximately $15 million. This assumes that the debt repaid in the first quarter is not re-borrowed during the course of the year. Our full year tax rate guidance is unchanged and an effective tax rate of 13% to 15%.

Regarding capital allocation, we plan to allocate approximately $800 million to share repurchases during 2018 reflecting a significant increase in share repurchases versus the prior year of approximately 50% of adjusted free cash flow to greater than 100%. This will result in an average diluted share count of about 78.5 million shares outstanding, which is consistent with our January 2018 guidance. The additional $3 billion authorization and the remaining $526 million, which Chris discussed earlier is to be completed over a three-year period. Use of the additional $3 billion authorization is not contemplated in our full year EPS guidance.

Rolling all this together and on a non-GAAP full year 2018 earnings per fully diluted share projected in the range of $8.10 to $8.30, revised from a previous range of $8 to $8.25. At current rates the favorable foreign currency impact on full year earnings per share growth is expected to be approximately 1%.

Looking at the second quarter of 2018, we expect 4% to 6% sales growth. At today's rates currency translation is expected to increase second quarter sales growth by approximately 2% to 3%. Combining these top line factors with our moderate increase in expenses, we estimate second quarter earnings per fully diluted share in the range of a $1.85 to a $1.95 with an approximately 1% positive impact from foreign currency translation at current rate.

Now I'd like to turn the call back to Chris. Chris?

[Chris O'Connell, Chief Executive Officer, President and Director]

Great, thank you Sherry. As we move through 2018 we will continue to emphasize execution across our businesses. As I stated before, while we delivered on the earnings line, we did not meet our top line expectations in Q1. We understand the causes are addressing them now and our key business drivers provide us with confidence in our outlook for the remainder of the year and for the long-term.

With that we will now begin the question-and-answer session. As we are not able to always get everyone’s questions, please limit yourself to one question and one follow-up. If you have additional questions, please contact the Waters Investor Relations team after the call. Operator, can we have the first question.

[Operator]

Thank you. At this time we are ready to being the question-and-answer session. [Operator Instructions] One moment please for our first question. Our first question comes from Tycho Peterson with J.P. Morgan. Your line is open, you may ask your question.

[Tycho Peterson, J.P. Morgan]

Hey thanks. Chris, I wanted to start, as you might not be surprised with mass spec weakness. I assume will be people kind of honing on that. I guess can, you get us comfortable that this was really due the territory realignment and not a competitive issue or demand side issue? And maybe can you just talk to what drove the salesforce alignment in the first place?

[Chris O'Connell, Chief Executive Officer, President and Director]

Sure yes, I know. Tycho thanks for the question. As you know the mass spec business is traditionally lumpy for us and particularly in the first quarter of the year. So let's keep the context of the first quarter. And speaking directly to the territory realignment we have done a lot of interesting work on enhancing our growth strategies. And in the U.S. and in Western Europe as well we've made some very important changes that will help the business, we've added positions. And I honestly say that some of that process took a little longer through the quarter and impacted the quarter a little bit more than we expected. It's behind us now and we do expect improvement. We are not assuming an immediate bounce back, but we're certainly assuming an improvement.

As it relates to our position in mass spec, we feel really good about our product position in the core tandem quad area. As you know the Xevo TQ-XS is a relatively new product in the market that's making a lot of progress across different research applications including bio analysis. We've got strength with our TQ-S micro with a very accessible simple tandem quad and the TQD, we have strength of the single quad categories well with the QDa.

I think in the area of high resolution mass spec, we have a good solid platform, but we also have a lot of exciting new technology coming to that field. So we feel good about our pipeline, as well. And again I think we just saw in the quarter a little more accentuated lumpiness particularly in a couple of key end markets like biomedical research and we saw that primarily in the U.S. market. And that combined with some of the earlier disruption on territory realignment kind of compounded to create that difference.

So again we're looking at the rest of the year, we're looking at the core demand that we see really in all markets in a good product portfolio and are confident that we'll see recovery there.

[Tycho Peterson, J.P. Morgan]

Okay, and then for the follow-up industrial obviously TA did well. Industrial overall still got a bit here. Can you maybe just talk about where you're feeling better exiting the quarter and any commentary on how things have trended in April on the industrial side?

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes I mean industrial was a little slow off to start as you pointed out a small decline. Keep in mind we had a 9% comp in prior year industrial. I'd say interestingly in industrial one of the main culprits was China. Industrial was a little bit lumpy there we had a very strong quarter in China Pharma which is really our core. But as we looked at a couple of geographies in particular partially affected by some of that mass spec commentary, some of the miscellaneous areas were a little weak in industrial. But as you sort of point out TA Instruments it’s really our best proxy for the industrial market category and TA was rock solid across the board really every geography in a broad participation of product lines from thermal, to reality, to microcalorimeter and even electroforce. And really give us that confidence that the industrial end markets are promising for the year. That's certainly backed up by a lot of the macro economic data that we see. And so we have high expectations for our industrial category over the balance of the year.

[Tycho Peterson, J.P. Morgan]

Okay, thank you.

[Chris O'Connell, Chief Executive Officer, President and Director]

Thank you.

[Operator]

Thank you. Your next question comes from Dan Leonard with Deutsche Bank. Your line is open you may ask your question.

[Dan Leonard, Deutsche Bank]

Thank you. So first off given the Q2 guide, it looks like you're expecting about a 6% organic revenue growth rate in the back half of the year to hit the low end of the 40% range for the total year. So curious if you could elaborate on the visibility towards that, especially given that some of the back half comps are rather challenging in some of your markets?

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes maybe I'll make a quick comment Dan and then Sherry can certainly add to comment on guidance. But as traditionally we see early in the year we do plan for balance across our markets, our geographies and our product lines. At this point in the year we still see a decent balance between pharma and industrial and some of the research categories. Certainly from a geography standpoint we feel the U.S. is in better shape heading into the year than it was a year ago with continued positive outlook for big geographies like China and Europe. Obviously we've talked about India. I think the India – the last year in India is easier to see in retrospect especially the dynamic at the end of the March fiscal year. And so we're confident in the India situation recovering. So I think we're looking at pretty decent conditions from an assumption standpoint.

But as always I'll also comment that we don't assume that everything goes right in making our assumptions. We try to put a plan together that seeks to balance the changes and assumptions that inevitably occur over the course of the year. And so our models for the year do not indicate a best case scenario, it really is a balanced scenario like we always try to do coming into a year. Sherry, you want to add to that?

[Sherry Buck]

Yes so just building off of that our revenue guidance is the 46% and the FX is expected to be positive about 2% to 3%, might take an opportunity to talk about the EPS. We’ve raised it at the midpoint, the factors going into that were upbeat Q1, some improvement in FX and interest and remaining constant on our full year tax rate guidance. We had some favorability from discrete items in the quarter but expect that to normalize. So those are the factors that go into the EPS guidance.

[Dan Leonard, Deutsche Bank]

Yes I appreciate that. And then for my follow-up, I was hoping you could elaborate a bit more on India. How much of the year end dynamic here do you think was related to GST, versus maybe some price declines in the generics markets or any other factors that you could flag?

[Chris O'Connell, Chief Executive Officer, President and Director]

Sure happy to comment further on India. I would say that we didn't fully anticipate the kind of end of year buying behavior of these companies after the year they've been through. We did mention GST, we talked a lot about that last year. I think we really felt that the bulk of that hit in our third quarter last year which would have been India’s second quarter. And we did see some improvement in Q4. There were also other things going on in the Indian economy such as demonetization and other regulation changes. And really at the end of the year a lot of the multinational Indian customers which represent the vast majority of our customer base were cautious and they pushed business into the year we just started. They were cautious because they were protecting their balance sheets and P&Ls like you might expect.

I was actually in India about three or four weeks ago, personally. And what I can tell you from my visit is that the order pipeline was solid. We did have a little bit of a backlog build in India as a result of this dynamic which gives me some confidence. And I think the overall tone of the customers was positive. I spent a full day in Hyderabad visiting pharmaceutical customers of all types. I met with three CEOs of Indian pharmaceutical customers. And I can tell you that market continues to invest, that market continues to compete for the largest share of the worldwide generic drug market. And as you know India historically has not always been on a straight line and sometimes there were fits and starts. And I think that’s what we've seen with a little bigger accentuation given that the end of year dynamics.

So overall our outlook for India is positive. We're confident in our team. Like with the mass spec point earlier we're not actually assuming it all bounces back immediately. We expect improvement in the current quarter and then continuing improvement upon that. So I think we've taken a balanced outlook, but I think have a very good handle on the Indian dynamic, but it definitely was a pothole in the quarter.

[Dan Leonard, Deutsche Bank]

Appreciate all that color. Thanks Chris.

[Operator]

Thank you. Our next question comes from Ross Muken with Evercore ISI. Your line is open. You may ask your question.

[Ross Muken, Evercore ISI]

I just want to pulling in again just on Q2. So if we just do the walk from Q1 to Q2 obviously it seems like on the capital equipment side is still being priorities [ph] declining. Can you kind of confirm that because that’s the only way I could see you guys getting to sort of 2% to 3% growth? And then is there a way you can size kind of the level of disruption of the mass spec just because it feels like relevant to the size of that business overall and sort of first half growth we're going to see from this business which is kind of below, yes well below the mid singles we’re used to. It's got to be a pretty decent up the delta versus just India or some of the other parts that seem a bit maybe off from what was originally anticipated?

And because we imply again to Dan’s question the implied back half around has to that on the instrument side just given the comps. And so I'm just trying to figure out all of that math.

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes Ross maybe I'll make a – try to make a general comment. Again we don't want to really break out everything in excruciating detail because very well that this business is hard to look at on a one quarter basis and I wouldn't want to over extrapolate one quarter. You really have to look at it over a rolling basis. But if you look at it the midst to our expectations and I won't perfectly quantify it, but I look at – what the way I look at it is we have a certain expectation for our business. And what I'm focused on is where the delta was relative to our expectations and that's why I highlighted mass spec in India.

About three quarters of the miss in our expectations related to the mass spec category just to give you a little bit a feel. And we think the reasons within that category are very explainable, very understandable, very addressable. As you know also that Q1 is our smallest quarter and tends to be more variable. On the mass spec side we have 80% of the year remaining. And we typically see investments particular in mass spec really balanced over the course of the year that's the dynamic we saw last year and what we're planning on for the rest of this year.

[Ross Muken, Evercore ISI]

And in terms of just the ordering dynamic over the balance of the quarter into Q2, can you give us a little bit of color there because again it just – I think I'm just getting a good sense as I’m not the only one a little bit confused on sort of the cadence. I mean how much conservatism is built into that sort of Q2 number because it doesn't feel like there's much implied that comes back versus the back half where you've certainly got more of a ramp. So – is it the order rate you're seeing that's not coming through yet and so you're being more conservative, or is it just given what happened in Q1 you’d prefer not to sort of set expectations for Q2 that are overly aggressive just given you still have some uncertainty on India and few of the other part?

[Chris O'Connell, Chief Executive Officer, President and Director]

I don't know there might be a little bit of – that interpretation might be a little bit conservative. And the way I'd say it is if we had a gap in Q1, we're expecting kind of an equal part recovery of that gap over the course of the year. We've not assumed to your point an immediate snap back, but we're also not pushing it all to the back half of the year either. We do expect improvement and to make up some of our gap from Q1 in Q2 and we expect kind of a relatively equal proportion of that make up over the course of the year. We – giving us confidence in making that statement include some of the things I've said around these specific issues that held us back in Q1, as well as a reasonable order pipeline heading into the quarter. We don't want to quantify our backlog per our usual practice, but we do a good about our order pipeline heading into the quarter.

[Ross Muken, Evercore ISI]

And just to be clear, just to triple check, the 2Q organic guide is 2% to 3%, correct, not 4% to 6%? Because I think what Sherry said that it was sort of not obvious to us, a number of us if that was reported organic.

[Sherry Buck]

Yes just to clarify that our guidance is 4% to 6% constant currency growth and we expect FX to have an impact of 2% to 3%.

[Ross Muken, Evercore ISI]

Okay, well that changes things. So that's a huge clarification. I'm glad I checked, then done the ramp in the back half makes more sense, because I think a number of us were assuming it was 4% to 6% reported and then less the FX, so that makes it a lot more helpful. Alright, thank you so much for that clarification.

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes and I hope and that makes the comments about how we expect to build over the year to be pretty steady how that will…

[Ross Muken, Evercore ISI]

Yes because you could see without that otherwise it looks like a hockey stick, right. Thank you.

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes it’s sort of a hockey stick.

[Ross Muken, Evercore ISI]

Thank you.

[Operator]

Thank you. Our next question comes from Amanda Murphy with William Blair. Your line is open, you may ask your question. Amanda your line is open go ahead with your question.

[Amanda Murphy, William Blair]

My apologies, can you hear me now? Sorry about that. I just had a quick question on the recurring side of the business. So obviously it's still a pretty good number with the 6%, I think, you said. And if you look historically that number has reached kind of high-single-digits at some point and obviously you’ve talked about demand between transitioning to UPLC and attach rates there. So just hoping to get some clarity around how you expect recurring sales fuel trend over time and is there anything specific in this quarter to keep in mind that's related to the 6% growth rate number?

[Chris O'Connell, Chief Executive Officer, President and Director]

No Amanda I think to be recurring revenues by a large met our expectations. Sherry did mention, there was one fewer selling day in the quarter which is a small matter but some service plans are booked by selling day, that you has a tiny effect. Really we feel very good about our service business in terms of the rising attach rates of service plan contracts continued contribution of our professional services line. And then from a consumable standpoint does to your point as we continue to see UPLC find its way into more and more applications. We do operate with higher margin chemistries and higher attach rates.

So we feel that that like we've seen in history that the recurring side of the business should grow at or slightly ahead of the rate of the corporate average.

[Amanda Murphy, William Blair]

Okay, and just one more on this sales force realignment I know you said about this earlier a bit but, I still need to get a little more clarity there in terms of kind of what drove that you talked about that is that sort of is that – are you kind of complete with that process and thinking about doing that in other areas of the business?

[Chris O'Connell, Chief Executive Officer, President and Director]

I don’t know that I have a lot more to add it's very much a routine process in building our sales force in terms of both expanding it as well as giving us more end customer specific capabilities. We were really excited about some of the evolutions we're making, most of that was in the U.S. and some in Western Europe in the quarter although as you know we continue to add significantly in Asia. But we ended up with more open territories over the course of the quarter than originally planned. And good news is that that hiring process has gone well. It affected us a little more than we thought, but just wanted to give you some flavor for that type of transition and its contribution to what we saw in the quarter. But we feel good about our team and we're excited about these evolutions which are very natural as a company scales and builds out the channel.

[Amanda Murphy, William Blair]

Got it. Thank you.

[Operator]

Thank you. Our next question comes from Puneet Souda with Leerink Partners. You may ask your question your line it's open.

[Puneet Souda, Leerink Partners]

Yes hi. Thanks Chris. I hate to bring this up on an mass spec again, but just trying to understand specifically is this associated with the Q tough [ph] and any sense of increasing competition from high resolution mass specs there? Or is this just broadly across the triples and the Q toughs [ph]? And do you – how do you think about the longer term position here for Waters as bio molecules will increasingly become a larger part of the mix here? And at least in the developmental phase of pharma you are going to require high res and OMEX focused to mass specs? Hoping to just understand the longer term picture and maybe in the near-term just dynamics on the Q tough [ph] and the triples. Thank you.

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes thanks Puneet. I appreciate the question. In the quarter I mentioned some of the higher resolution mass spec and clearly a little lumpier in that higher end category I did also mention our product position in tandem quads in the market now being very strong and our pipeline being very, very strong at the higher-end. I agree with you. I think the evolution of mass spec technology in the biomolecules, particularly in development and ultimately in the later-stage operational regulated workflows is a big trend.

I think we're investing towards that. We're very excited about the progress of our bio tough system in product development – in the later stages of product development. We also have a number of other very significant advances in the highest resolution mass spectrometry area that we don't want to talk too much about right now, but you know over the coming year we will.

And so we feel good about the future of this particular product line and the innovations that we're bringing forward, and expect that over the course of the year some of the things that held us back in Q1 to correct themselves.

[Puneet Souda, Leerink Partners]

Okay, thanks. And on India specifically. Just wanted to understand, in terms of the product mix itself, has that changed a bit? I know traditionally it was all largely alliance and lately has that product mix changed or is it evolving more towards the UPLCs? Thanks for taking my questions.

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes India is by and large an HPLC market but it's also a very strong informatics market as well. And really it's in that core pharma area that we saw the weakness in the quarter. We have a small bright spot in India in more of the government sectors or relates to mass spec for food applications, but that's a pretty small part of the business. So I think the Indian market is going to continue to be dominated by the pharma world particularly the generic pharma world. And beyond that probably the area that that we see the most potential in is the food testing area.

[Puneet Souda, Leerink Partners]

Okay, great thank you.

[Operator]

Thank you. Next question comes from Derik De Bruin with Bank of America Merrill Lynch. Your may ask your question, your line is open.

[Derik De Bruin, Bank of America Merrill Lynch]

Hi Puneet has actually asked part of my question. I was going to talk about the – on the LC side about the mix in India. But I'm just curious on the sort of the new acuity product launches that you just put out, I mean can you maybe just talk about where we are in the developed markets in terms of upgrade replacement cycles and just or like where the underlying demand is for new ACQUITYs. I mean you’ve come off a couple of very strong years of your developed pharma customers buying products. I'm just curious in terms of where you sort of see underlying demand for the new products?

[Chris O'Connell, Chief Executive Officer, President and Director]

Sure. So the two new products are the ACQUITY PLUS, which is an enhancement of the overall ACQUITY platform it’s outlined in then the ACUITY ARC bio, which is taking the arc platform, which as you know is a transitional technology between HPLC and UHPLC methods. And making it more directly compatible with bio molecules just like we have an UPLC already the ACQUITY bio now we have the ACQUITY ACR bio. Interesting enough the ACQUITY ACR historically has been a little more of an emerging markets product is strongest start off the launch was really in China. But as we see the trend of product development on a large molecule we see this ACQUITY ACR bio being much more broadly adopted product and we’re excited about that.

On the ACQUITY PLUS, I think, that just adds to the breadth and strength of the family and again the key driver for UPLC methods has been in some of the more – in really biotech end of the market and new drugs that are being developed. There we've talked about before there's really not an upgrade cycle as it relates to people migrating a particular molecule from HPLC to UPLC it's really when new molecules are being developed. And certainly as we look at some of the bigger opportunities in developing QA/QC in biotech, UPLC is really going to be the standard we believe and that's why we continue to invest in that platform.

[Derik De Bruin, Bank of America Merrill Lynch]

Just a quick follow-up financial question for Sherry. Sherry when you look at that tax rate I mean it's going to a lot of variability over the last couple years I know some of that is just because the tax law changes. Is that I mean should we just – given that you typically tend to come in the lower end of the ranges I mean should we just model 13% for the full year just as a way to look at it, or – I guess basically what drives at the tax rate up to the 15% range when you just sort of look at historically the company always seems to manage to squeeze out a couple of percent of lower taxes once you guide to?

[Sherry Buck]

Derik this is Sherry. So on our tax rate I'd say the impact of tax reform is really what is driving our full year guidance to the 13% to 15% versus last year. It's about 2% higher. I say there's still a lot of moving parts and really seeing all the regulations coming out supporting the U.S. tax reform Q1 I can say was one more favorable than what we were expecting because of some very discrete items. Our expectation is, is that will normalize throughout the remaining quarters. And so our full guidance still remains at 13% to 15%. And I wouldn't necessarily assume that it would be at the lower end.

[Derik De Bruin, Bank of America Merrill Lynch]

Thank you.

[Operator]

Thank you. Your next question comes from Doug Schenkel with Cowen. Your line is open. You may ask your question.

[Doug Schenkel, Cowen]

Good morning. You usually tell us to model to the midpoint of the guidance range. That said coming off a weaker than expected Q1 and recognizing that Q1 – I’m sorry Q2 guidance does not seem to embed much of a catch up. Is it fair to say you're more comfortable at the lower end of the 4% to 6% full year core revenue growth range, at least relative to where we were back in early January when you initially provided guidance?

[Chris O'Connell, Chief Executive Officer, President and Director]

No I don't think so. I think we've tried to provide a balanced outlook. And maybe it's oversimplifying but at the lower end of the range that would assume a slower recovery of some of the factors we've talked about and at the higher end of the range that would assume a higher and faster recovery. And both scenarios are possible. And that’s why we try to give a range that incorporates a reasonable probability of anything in the range which would kind of land us towards that midpoint.

[Doug Schenkel, Cowen]

Okay. North America was one of the geographic regions where you performed relatively well. That said it was against a pretty favorable comparison especially in the United States. With that in mind how much of Q1 performance in the region would you ascribe to improving demand and execution versus the favorable comp in a more normalized budget release this year relative to what you described in Q1 of 2017?

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes I would agree that the U.S. was better, but we're not fully satisfied with the U.S. And you know Canada was a little bit down which impacted North America but Canada tends to be quite lumpy given that it's driven more by tenders. I think the U.S. is still a work in process and some of the territory realignment I outlined earlier was a factor in the U.S. So I'm watching the U.S. very closely I have high hopes for the U.S. I think the U.S. is a solid market and certainly feels better as a market towards the end of last year and heading into this year than it did a year ago because I recall a year ago there were so many questions about tax reform and other government policy that it was a sluggish start to the year.

So we saw improvement in the U.S. over the course of the year, it's okay right now starting off in this year but I actually expect better from the U.S. as well.

[Doug Schenkel, Cowen]

Okay thank you.

[Operator]

Thank you. Your next question comes from Dan Arias with Citi Research. Your line is open, you may ask your question.

[Dan Arias, Citi Research]

Hey good morning. Thank you. Chris just given how tied they are to one another does the mass spec softness impact the healthy forecast for the year? And I guess have you seen any or do you expect any decoupling so to speak in terms of the percentage of water is healthy systems that go out the door with one of your mass spec devices on the back?

[Chris O'Connell, Chief Executive Officer, President and Director]

No I don't there's a direct tie, I think the mass spec factors that hit us in the quarter were somewhat isolated to some of the dynamics I described earlier. And then like I implied in the call if you look at the core LC instrumentation we did we did just fine we met our expectations and we feel good about our portfolio and the outlook for the year. So we like our strategic position in having a strong LC and mass spec combination. And we expect to leverage that advantage throughout the future in particular bringing more and more LC plus MS type workflows together. So I think I wouldn't read too much into the LC business on that score.

[Dan Arias, Citi Research]

Okay. And then maybe on the industrial side how would you sort of rank the application areas in terms of strength of demand right now for materials, food, environmental and chemicals? Are you able to sort of touch on what your expectations are on at least a relative basis there out of those buckets for the year?

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes I'd say in general the part of the materials our industrial franchise that we feel best about right now is really in the core TA thermal reality type business. And that had a good year last year, a good finish, a good start to this year. As we've talked about we feel good about the industrial end markets overall, we feel great about our product position in that category. And really besides that I'd say the food category is one that's garnered a lot of attention. I think there's a lot of interest in a broad range of players in food safety and food testing. In fact I was personally invited last week and participated in a IMF World Bank panel in Washington D.C. with a variety of health ministers talking about capacity building and investments in countries of all types, including lesser developed countries in food safety testing methods.

And our organization has done a great job over time really developing a presence of mind in that market in thought leadership. And so I think in the short and long term we expect that market to be a priority for us and for the world. Really if you look at all the categories you described, I think, outlook for us is more balanced and that's certainly what we're expecting out of those end markets and we'll continue to provide color as that develops.

[Dan Arias, Citi Research]

Okay, I appreciate it.

[Operator]

Thank you. Your next question comes from Jack Meehan with Barclays. You may ask your question. Your line is open.

[Jack Meehan, Barclays]

Thanks, good morning. So I just want to be clear, do you think there are any changes in the competitive environment in the quarter and some of the loft [ph] mass spec sales did those go to competitors or can you elaborate on just why you think they'll come back in over the next few quarters?

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes Jack I think I've covered the specific dynamics in terms of what we think happened in the quarter again a smaller lumpier quarter for us some things accentuated that. And no I don't think there was any change in competitive dynamic in the quarter. If you take a look back at last year, we had a really solid mass spec year in 2017, we grew in the upper single digits in mass spec for the year last year. And it's not like we come into Q1 and all of that changes. We like our competitive position in mass spec. There's some areas that we have a stronger position in the market and others where we have a strong product development pipeline.

So I think our view is that those factors that I described fully earlier explain the quarter. We're watching it closely, we’re intent upon demonstrating improvement and continue to give you color on it. But the overall competitive dynamic, I think, doesn't change in one quarter like that.

[Jack Meehan, Barclays]

Great, thank you Chris. And then the new share repurchase authorization, do you think the rate you're running in 2018 is going to be sustainable over the next few years? Can you just put in the context of the long-term guidance that you laid out at the previous Analyst Day?

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes, so I'll make a quick comment and have Sherry go further. We're really excited about this share repurchase authorization and obviously with all the newness of tax reform and the need to get an understanding as to how the flows worked we've been intently working on this over the quarter. And clearly we announced at the beginning of this year a bigger share repurchase program for the year. We're really sticking to that, we’re maintaining our guidance on our 2018 share repurchase program. But clearly we are looking to enhance that as we move from there and keep a strong range of cash return to shareholders in the coming years.

So in terms of in terms of guidance on our share repurchase program I would focus on what we said today, what we said at the outset of the year and then we'll continue to update that as we move through the year in terms of what 2019, 2020, 2021 will look like. But Sherry you want to say more?

[Sherry Buck]

Sure, yes, so just that jumping into that, so for of the current year 2018 our plan is $800 million worth of share repurchases. With the new authorization, with what we have remaining from first quarter on that and the new one so a total of $3.5 billion to be spread over three years. So we feel really good about the sustainability over the next three years to be able to return, really greater than one hundred percent of our free cash flow to share repurchases. And that's up from 50% last year. So we have $800 million baked into our guidance. And we’ll evaluate opportunities as we go, but I think it's just reinforcing our sustained share buyback program over the next several years.

[Jack Meehan, Barclays]

Great. Thank you, Sherry.

[Operator]

Thank you. Next question comes from Jeremy Rosenberg with Morgan Stanley. Your line is open. You may ask your question.

[Steve Beuchaw, Morgan Stanley]

Hi this is Steve Beuchaw on for Jeremy Rosenberg. First I just want to unpack China a little bit. Chris you made a couple of really helpful comments about China. Number one, spiking out that the industrial piece of it was maybe a little slower. And two, spiking out that the pharma piece of China was really healthy. I wonder if we could just unpack that a little bit more. Have you seen any improvement in the China industrial trend? How do you expect that to play over the balance of the year? And on the pharma front when you say China was good I mean is China on the pharma side of it holding up one hundred percent, or is it may be moderated just a little?

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes I know I think Steve your read of it is very accurate, the themes are correct and I don't want to overly quantify it. But there's also a tale of the comparison as well China had a fantastic quarter a year ago and a very significant quarter in both pharma and industrial. So about half of the business in China is pharma and we were pleased with our China pharma growth on a very big comp. Industrial was off a little bit again due to some of the traditional lumpiness of those end markets, but again off a very, very large comp. The research sequitur was strong in China. As I mentioned particularly in the governmental food research areas. And I contrast that with the independent lab food testing which was more in the industrial category, but the research end of that was very strong and drove growth in China with a little easier of a comparison.

So overall we expected the type of performance that we saw in China. And all of our assumptions in terms of what we're expecting for the year in China are still out there for us and we're confident our team there.

[Steve Beuchaw, Morgan Stanley]

Okay, really helpful. I wonder though taking a step up toward 10,000 feet as we look at the model if it's possible that we're all just parsing this too finally. When I look at the variation over the trends in growth in the last few quarters, couple of quarters, what stands out of course is the variation on instrument growth. In the fourth quarter it was a good quarter on top of an extremely difficult comp and here we are with instruments weaker on a comp that’s a little bit more normal. Could the explanation for all this be something very, very simple? Did we just have budget flush in the fourth quarter and here in the first quarter there are some labs out there that are still hard at work, digesting all the stuff that they bought in the fourth quarter. Just that, thanks.

[Chris O'Connell, Chief Executive Officer, President and Director]

Yes I guess if I go back to your first point there Steve, I think, sometimes the temptation is to parse things pretty finally on a quarter-by-quarter basis. But what we've seen in this business is that trends look – are a little more so explainable if you will over kind of a rolling period. So again we look at the quarter and the dynamics and we think a lot of the things that happened in the quarter are very specific and explainable at least from our standpoint to some dynamics in a couple of key products segments and geographies. And then we take a look at that and step back and look at trends that to your point come from prior year and extend out into this year and try to make a forecast as best we can on some of the broader macro trends. But at the end of the day the worldwide pharma market looks solid, this sector continues to invest, and produce and grow.

The industrial market by many measurements including some of our internal ones appears to be stable and robust and we see a good balance as we go over the course of the year. I can’t explain questions of year end, or beginning of your budget flush and things like that, there are too many nuances in that equation and I wouldn't over interpret any of that. I would just take on its face some of the things that we've talked about in Q1. But also our read of the end markets will continue to lean into that. We’ll continue to try to better understand these trends, and explain them best we can and make sure we're focused on executing against a variety of different assumptions in our plan.

[Steve Beuchaw, Morgan Stanley]

Okay, thanks so much.

[Chris O'Connell, Chief Executive Officer, President and Director]

I think we have time for one more if that's possible.

[Operator]

Thank you. And our final question then comes from Patrick Donnelly with Goldman Sachs. Your line is open you may ask your question.

[Patrick Donnelly, Goldman Sachs]

Great, thanks. Chris maybe on the margin side if growth does remain a bit lower than anticipated where the real levers you could pull to drive expansion? And then does one quarter of low growth leads you to be more aggressive on the cost side or do you try to find balance of patients and then also still being nimble if things do slowdown for a bit here?

[Chris O'Connell, Chief Executive Officer, President and Director]

Well again to your point on the margins, despite the softness on the top line in Q1, which is our smallest quarter of the year, we were very pleased with our operating performance and we delivered some modest operating leverage, while actually growing our R&D expense faster than our top line. So we continue to invest for growth. And of course we're anticipating an improvement in the revenue line. But we feel we have sufficient operating control to feel good about protecting our earnings although for us growth is the key.

We’re investing for growth, we're expecting growth and we're expecting to work through some of the things that held us back in Q1. And deliver in that range of our guidance that we've given.

[Patrick Donnelly, Goldman Sachs]

Right, thanks.

[Chris O'Connell, Chief Executive Officer, President and Director]

Okay I think we're out of time here. So I do want to thank everybody for your great questions.

In conclusion, we remain focused on delivering our growth plans for 2018, headlined by strength in our core pharmaceutical market, continued growth in TA and broad based growth in China. We believe that market conditions in our strong competitive position support continuing success. 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 Q2 2018 call which we currently anticipate holding on July 24, 2018. Thank you very much and have a great day.

[Operator]

This does conclude today's conference. We thank you for your participation. At this time you may disconnect your lines.