Waters Corporation (WAT) Q2 2012 Earnings Report, Transcript and Summary

Good morning. Welcome to the Waters Corporation Second Quarter 2012 Financial Results Conference Call. [Operator Instructions] This conference is being recorded. [Operator Instructions]. I would like to introduce your host for today's call, Mr. Douglas Berthiaume, Chairman, President and Chief Executive Officer of Waters Corporation. Sir, you may begin.

Thank you. Well, good morning, and welcome to the Waters Corporation Second Quarter Financial Results Conference Call. With me on today's call is John Ornell, the Waters Chief Financial Officer; Art Caputo, the President of the Waters division; and Gene Cassis, Vice President of Investor Relations. As is our normal practice, I will start with an overview of the quarter's results, and John will follow with details of our financials and provide you with our outlook for the third quarter of 2012 and for the full year. But before we get going, I'd like John to 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 this time for Q3 and full year 2012. 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 10-K Annual Report for the fiscal year ended December 31, 2011, in part one under the caption Business Risks, 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 result except during our regularly scheduled quarterly earnings release conference calls and webcasts. The next earnings release call and webcast is currently planned for October 2012. During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is attached to our company's earnings release issued this morning. In our discussions of the results of operations, we may refer you to pro forma results, which is excluding impact of items such as those outlined in our schedule entitled Reconciliation of Net Income for Diluted Share, included in this morning's press release. Doug?

Thank you, John. Well, overall the second quarter's organic results were close to our original estimates, but they do suggest that we have a need for a moderately higher level of caution, as we look into the second half of 2012. The second quarter started up positively for us, as most orders that we had identified as delayed in the first quarter were booked in April and as business momentum initially improved in India with the issuance of new capital budgets. In May, we had a strong presence at ASMS, where our new products were well received and where we felt encouraged that demand for research-focused instrumentation might hold up better than expected, this despite heavily publicized concerns that academic and government budgets were under pressure. On the other hand, as the quarter unfolded, we began to see general economic conditions weaken in Europe and in some Asian countries. The value of the euro and the rupee fell from levels that we saw in April. And it seems as if the approval processes for instrument purchases in nearly all of our larger accounts were dragging on a little longer than anticipated. In general, a greater level of conservatism was marginally impacting demand across almost all of our end markets. Consequently, our orders and shipments in the second quarter came in a little lighter than we had hoped, and our current outlook for sales growth in the remainder of the year is accordingly tempered to account for market uncertainties. Fortunately, we ended the quarter with a conservative spending plan and throughout the quarter, tightly controlled our spending while maintaining disciplined pricing policies. Flexibility of our business model allowed us to deliver operating leverage despite a foreign exchange headwind and lower-than-anticipated shipment volume. All in, we managed to deliver adjusted 8% EPS growth on sales that grew organically at about 4.5% and at 1% after foreign currency translation. For the Waters division and geographically, Asian markets outside of China and Japan were weaker than we had expected, as industrial, chemical and applied market segments declined in the quarter. Shipments in India were slightly down year-over-year, as ordering delays seem to materialize with the weakening of the local currency. Our business in China held up well with sales up in the double-digit rate in the quarter and with all major customer segments delivering consistent growth. Developing markets in Eastern Europe, the Middle East and Latin America also were under pressure during the quarter and adversely impacted the division's overall sales growth. In these regions, nonlife science applications were most negatively affected. Our business in the U.S. held up well in the quarter, as strong pharmaceutical, governmental and academic sales offset weakening demand from chemical segment. Pharmaceutical instrument sales benefited from continued strong uptake of ACQUITY H-Class, while the nonprofit end market growth can be attributed to research mass spec shipments. Pharmaceutical segment sales in Western Europe were also fairly strong, although government and academic spending was under pressure. All in and despite all the negative news coming out of Europe, the outlook there may not be so grim for the second half of the year given Waters' exposure to the more stable pharmaceutical base. Waters division constant currency sales in Japan were about flat in the quarter, with strong pharmaceutical sales offset by weak chemical analysis results, a recurring theme as we look at our business geographically. Looking more closely at pharmaceutical sales, outside of India, most regions experienced robust growth in the quarter with sales in the U.S., Japan, Europe and China all contributing at levels above the company's overall growth rate. As we've seen in recent quarters, the lion's share of increased sales was from specialty, generic and CROs and not from our larger accounts. For our largest pharmaceutical customers, we did see sequential as well as year-over-year sales growth. However, just about all of this growth can be attributed to business that moved from the first into the second quarter's results. And speaking with these customers, we know that some planned spending has been pushed to the second half but also feel recent announcements concerning the relocation of major research facilities accompanied by continuing project streamlining programs may further hamper growth at certain large accounts. Combination of government and university shipments grew moderately for this division. The growth was geographically variable, with the U.S. and Asia posting double-digit increases, Japan flattish and most of the rest of the world, significant declines. As I had mentioned earlier, high-end mass spec sales significantly account for the positive results in the U.S., where both government and academic labs delivered strong performance. While we remain cautious on the sustainability of growth from nonprofit customers, we remain encouraged by researchers' responses to new instrument offerings that we introduced at ASMS. Looking outside our life science end markets and for the Waters division, I think it's interesting to note that following the deep recession we all experienced in late 2008 and through 2009, sales growth from our industrial, chemical and applied markets generally have been accretive to our quarterly and full year results. However, this trend changed in the second quarter of this year, and with the exception of our business in China, most regions saw declines. The applied markets, namely the combination of food and environmental customer sets, have always been somewhat lumpy and have enjoyed surges in growth when new regulations were passed or when an unfortunate contamination issue surfaced. We saw that during the baby formula issue in China a couple of years ago. In the second quarter, these applied markets were weaker, and at this point, we feel that it's a temporary pause in growth, as we continue to be very optimistic about both the market potential and in our competitive position in these areas. We are a little more concerned about the negative growth that the Waters division saw for industrial chemical customers, as we feel that this trend is indicative of lower spending in anticipation of deepening global economic instability and may continue to dilute Waters revenue growth until a clearer pathway toward a sustainable economic recovery becomes more apparent. The stronger second quarter performance that we saw for this segment from our TA Instruments group is somewhat encouraging. However, they, too, may experience more pressure during the second half of the year. Looking a little more closely at TA Instruments, the division continued to deliver superb results, delivering double-digit constant currency growth in the quarter. High temperature applications based on the division's more recent acquisitions contributed nicely in the quarter as did the division's biocalorimetry offerings. Geographically, TA saw a relatively balanced growth. Turning back to the Waters division and looking at product line trends. H-Class ACQUITY UPLC and Xevo tandem quadrupole based systems, especially our ultrasensitive Xevo TQ-S, continue to drive instrument systems growth. During the quarter, UPLC MS/MS system sales for food safety and environmental applications declined against top prior year comparisons. In addition, a combination of competitive pressure as well as the ASMS introduction of our new high-performance Xevo QTof G2-S, a system that will begin shipping in volume in the third quarter, resulted in the quarterly decline for high-end MS system sales. We are encouraged by the ASMS customer reception and subsequent positive responses to recent demonstrations of our newly introduced Xevo QTof G2-S and our UNIFI-based UPLC MS/MS solutions and feel that delivery of these new systems in the second half of this year will help accelerate our growth. In addition, our newly introduced and award winning UPC 2 System began shipping in the second quarter, and business momentum is building for this high performance and exclusively Waters instrument technology. Our recurring revenues, the combination of service and chromatography consumables, grew organically at a 5% rate in the quarter. A slight sequential decline in recurring revenue growth in the quarter can largely be attributed to slower chemistry sales in developing markets, a trend that we expect may correct in the second half of this year. Before turning you over to John, I want to view our first half's performance in a slightly broader context. Sequentially, we saw a rather typical increase in our second quarter sales volume. As in prior times of economic uncertainty, we benefited from the more consistent performance of our recurring revenue lines and from our ability to modulate our expenses in response to challenging end market conditions. Our current customer base is, by most measures, more diverse than it has ever been and provides us with a better buffer against select geographic, competitive or customer-specific challenges than we have historically enjoyed. Better than hedged [ph] , we remain very confident with our product portfolio and with our competitive position. In fact, we remain comfortable in our ability to weather a severe downturn and believe we are well positioned to benefit from any acceleration in customer demand. Going to show you that we'll be conservative as we manage expenses, but we also plan to continuously invest in product development and customer support programs to drive our technologically focused strategy. I think it's a strategy that differentiates Waters from other companies and one that has a demonstrated record of success. Now I'd like to turn you over to John with further details on our financials and our future outlook.

Thank you, Doug, and good morning. Second quarter sales increased by 1%, and Non-GAAP earnings per diluted share were up 8% at $1.17 this quarter compared to earnings of $1.08 last year. On a GAAP basis, our earnings were $1.09 this quarter versus $1.07 last year, and a reconciliation of our GAAP to non-GAAP earnings is attached to our press release issued this morning. Reviewing Q2 sales results in comparison to Q2 last year. Before currency translation, sales were up about 4.5% from prior year's second quarter. Translation reduced sales by about 3%. Looking at our sales growth geographically and before foreign exchange effects, sales within the U.S. were up 7%. Europe sales were flat. Japan was down 1%, and sales in Asia outside of Japan were up 7%. On the product front and in constant currency within the Waters division, instrument system sales increased by 2%, and recurring revenues grew by 5% this quarter. Within our TA Instruments division, sales increased by 11% versus prior year. Now I would like to comment on our Q2 non-GAAP financial performance versus prior year. Gross margin performance came in as expected at 60.7%, comparable to Q2 last year. SG&A expenses were lower than anticipated this quarter and were down 3% overall. Operationally, we restrained spending in light of the more difficult economic conditions we saw earlier this year, and foreign currency translation reduced SG&A by 3% this quarter. For the second half of the year, we expect SG&A to be about flat with prior year. R&D expenses increased by 4% this quarter, as we continued to invest in product advancements to support future sales growth. Our effective operating income tax rate came in as anticipated at about 16%. Net interest expense was $5.8 million, and share count came in at 89.4 million shares, 3.9 million shares lower than Q2 last year as a result of our continued share repurchase programs. On the balance sheet, cash and short-term investments totaled $1,392,000,000, and debt totaled $1,101,000,000, bringing us to a net cash position of about $291 million. As for share repurchases, we bought 1,260,000 shares of our common stock for $103 million. This leaves $770 million remaining on current authorized share repurchase programs. We define free cash flow as cash from operations less capital expenditures plus any noncash tax benefit from stock-based compensation accounting and excluding unusual nonrecurring items. For Q2, free cash flow came in at $90 million after funding $18 million of CapEx. Excluded from this calculation is $30 million of capital spending related to the consolidation of our mass spectrometry facilities in the U.K. and $3 million of litigation payment. Accounts receivable day sales outstanding stood at 72 days this quarter, down 2 days from Q2 last year. And inventories increased by just $4 million this quarter. So overall, 2012 got off to a slow start in the first quarter and improved modestly in the second quarter, but business momentum remains below the level we had anticipated. As we now think about the remainder of 2012, we expect to see this somewhat more difficult economic environment continuing to affect our customers' willingness to deploy capital. We are therefore taking a more cautious view of the remainder of the year and now expect sales growth before foreign currency effects of 2% to 4% in the second half of 2012. Currency at today's levels would reduce sales by about 4% in Q3 and 3% in Q4, resulting in relatively flat sales in the second half of 2012. For full year 2012 then, sales growth before foreign currency translation would be between 2% and 3%. Negative foreign currency translation of about 3% is expected to push sales down to just under flat with 2011. Moving down the P&L. Gross margins are expected to be about flat with 2011 at about 60.5%. Operating expenses are expected to be about flat with 2011 as a result of tight operational controls on spending across the year and the beneficial effects of foreign currency translation. Net interest expense is expected to be approximately $23 million, and we expect our operating tax rate to be about 16%. Our fully diluted share count for 2012 is likely to be around 89 million shares outstanding. Rolling all of this together, we currently expect 2012 non-GAAP earnings per fully diluted share to be in the range of $4.90 to $5 per share. As we think about our expectations for the third quarter of 2012, we expect organic sales growth of about 2% to 4%. Currency translation at today's rates would reduce sales by about 4%, resulting in reported sales flat to down 2% in Q3. Our non-GAAP earnings per fully diluted share are expected to be in a range of $1.16 to $1.21 in the third quarter. Doug?

Thank you, John. And operator, at this point, I think we can open it up for Q&A.

[Operator Instructions] Our first question comes from Daniel Brennan with Morgan Stanley.

As we think about your second half guidance, could you just maybe put a little more details around how you're thinking about growth from your different end markets and/or geographies given the lower top line? Just want to think about like where you see the biggest contraction versus what you were thinking before.

Sure, sure. I'll go through that. From a geographical perspective, Dan, we're thinking about that U.S. being kind of a mid-single-digit growth driver for the business as we move through the back half of the year. Europe and Japan are kind of flat, as we think about continued pressures in Europe remaining and no sign of anything getting much better there as we think about Q3 and Q4. Asia on the other hand, I'd say, we continue to look at the kind of high-single-digit type of an expectation for that part of the world and a little bit more conservative view of ROW of places like Latin America and other areas that had been growing closer to double digits, we're now thinking might be closer to mid-single digits. So all of that pulls the growth down to something that gets somewhere between 2% and 4%.

And when you think about after the first quarter guidance reduction given was timing related with pharma, and you guys thought you had caught, obviously, enough vote [ph] , lower numbers enough to reflect the issues that you had seen and built an even a cushion, now we're coming down again. What's your level of confidence -- just kind of how -- can you give us any more kind of feeling for the level of conservatism that you feel this new guidance incorporates?

Well, we try to put us and you kind of in the middle of a range of possible outcomes. I'd say, we've been challenged to achieve the middle of the range, even though we set out each quarter thinking that's where we are. This past quarter was very challenging, and as we look forward, even though our field continues to be optimistic, the data we're getting back at ground level concerning the field interactions with their customers suggest that they really have demands, I think, as that gets translated up the hierarchy though, clearly, management controls and our customer set in terms of available spending has tempered what we think is a reasonably robust level of demand at the ground level. So as we look out into second half and have taken our expectations down a notch, we don't think that the second half gets materially worse, but we don't see a lot of signs that there's a particular factor that's going to create an uptick. So we think we're a little bit on the conservative side as we look at the second half, but I'd freely admit that it's a challenging environment, and we're still keeping a very tight handle on the spending lever.

If I can just sneak one more in, just on the OpEx control, the SG&A flat in the second half of the year. What would -- what is that level of spending outlook necessitate? Is that within the normal course of business? Or is there a onetime kind of a headcount reductions that are occurring and how much more control do you have to bring that down further if things turn out to be weaker than expected?

There's nothing extraordinary or restructuring in that, Dan. It's tight control on unnecessary travel. It's some natural in terms of commission and variable pay won't be as originally anticipated given the lower sales levels. It certainly -- headcount additions are unlikely in this environment. So all of the things that -- in every year, we keep a number of plans -- planned incremental spending in reserve until we see some of our planned growth come together, and as it hasn't, we're putting those increased plans in abeyance. So I'd say it's certainly an uptick in the level of control of spending and the deferral of things that aren't directly necessary to create sales, but it's not anything extraordinary in terms of restructuring. If we see a significant change in our expectations, we would, of course, look at what we needed to do to keep our P&L structure in balance.

Our next question comes from Ross Muken with ISI Group.

So look, I'm interested on sort of the pacing in quarter in terms of the demand flow-through. What we've seen in sort of our survey data and anecdotally heard, at least in the industrial exposed and applied exposed customer basis was the trend into June significantly sort of deteriorated and that sort of continued into July. And we've also seen that in sort of the macro PMI data. I guess, what's your assumption for sort of the trajectory? It seems like at least on the industrial side, you're looking for the deterioration to sort of moderate. I guess, is that being confirmed by sort of the order rates you're seeing or the anecdotal things you're hearing from customers? And then I want to turn to sort of the pharma side.

Yes, Ross, I would say we didn't really see quite that inflection point in the quarter. I'd say maybe some weakening as we went through, but the industrial segment of our business was...

Lackluster.

Yes, lackluster throughout. And I'd say in our outlook for the second half, we certainly don't anticipate it getting much better, but we don't see it dropping off a cliff. Now part of that specific to us, we're getting a very good reception to our UPC 2 System introduction, and that's having particularly raising eyebrows in certain industrial markets because of its applications there. So we might have a specific circumstance that helps us in those markets that haven't been there in the past. Was there a second question?

And turning maybe to the pharma aside. I mean, it seems like most of the growth is coming from sort of specialty, generics, CRO customers. Given sort of the weakness we've seen in emerging markets, I mean how -- versus sort of the last time we saw a deterioration in those markets, say, I guess that was probably '08, how would you expect just the pacing of moderation of growth there to occur or are you not assuming it will? And then on the in -- traditional pharma aside in terms of the larger folks, what do you think is sort of the crux of sort of the slowdown there? I mean I would have thought, given the commentary we've heard in the pharma so for this year, demand would be actually a bit better, and maybe that's encouraging, but I'm just trying to get a sense for kind of what you think the key driver there is on the large pharma side?

On the large pharma front, I think it's very lumpy and largely specific to individual accounts. We saw a pretty good results in large pharma in Europe and decent results in the United States. We saw growth in those large accounts, but it certainly wasn't anything that we'd call robust. The greater part of our growth story in the broad pharmaceutical market is in specialty pharma biotech, CROs and generics. But generics was certainly tempered by India, and India, there's no question that the weakness in the rupee is causing consternation amongst those account. I continue to believe that, that will get better. I don't think that there's a way for those businesses to delay spending forever, and we saw a little bit of a pickup. As we ended the second quarter there, we saw a particularly good pickup in underlying demand, but some of those accounts really faced issues in clearing letters of credit and getting their banks to release credit. So I think they're all working on that, and I anticipate that India is going to get better over the next 2 or 3 quarters. And that's basically hurt our growth rate in that area in the first half of this year. So our outlook just at big pharma stays pretty much in the route that it's in. We have some accounts spending robustly, but that's not true across the board. We think CRO spending is likely to pick up from somewhat restrained levels in the first half, and the net-net of that is maybe a little bit better in the future than we've seen in the immediate past.

One last quick one. John, anything in the forecast for sort of the fiscal cliff/sequester in terms of any assumption of different purchasing in the U.S.?

No. I'd say that this point in time at least, we're not getting feedback from our customers that would suggest that, that event is something that's going to strike us between now and the end of the year. And I suppose that could change, but certainly to date, we haven't been giving any indication that, that's going to be a meaningful event.

Our next question comes from Nandita Koshal with Barclays Capital.

Doug, I wanted to begin with a question around consumables and sort of attach rate on the H-Class installed base that you've built out on the QA/QC side. How does that look? And how much of a driver of growth has it been thus far? And what can we look for in the future?

The attach rate on the UPLC overall, Nandita, has been very good. The -- it is fair to say that with the H-Class, there's still a lot of applications being run there that are HPLC and not UPLC. That's one of the big attractions of H-Class. So the attach rate of UPLC columns on the H-Class isn't as high as it is on classical UPLC and things like the X-class -- excuse me, the I-Class. So overall, it is our fastest-growing consumables category. And I'd say we're seeing no real diminishment of the attach rates where we expect to. Over the longer haul, we're expecting H-Class to garner a greater share of UPLC consumables, and that's generally been happening since we've introduced the H-Class.

Okay. But fair to assume that customers now put off sort of the HPLC to UPLC switch for a longer period of time at least while the macro is weaker and the uncertainty persists?

I'd say it's a mixed bag. In certain cases, it's -- interestingly in generic cases, we're seeing customers go to UPLC performance quickly. In other cases, they just like the flexibility that the H-Class gives them in terms of converting methods or running both UPLC and HPLC columns. So maybe it's a little bit slower given economic conditions, but I don't think it really changes the overall model.

Okay, that's helpful. And I also wanted to ask about some of the service infrastructure that you'd put into place last year. Are those costs being fully absorbed today? Or can you look for some kind of margin sort of upside from that?

Yes. I'd say on the service front, we traditionally need to add service headcount at about the same rate as service sales grow. We went through a period certainly during the recession. We didn't do that. We caught up a little bit on that expense as of late, and I think right now, we're probably right in line with where we need to be. We have been adding a few heads in some of the developing parts of the world where we've needed to. But I would say, don't expect any meaningful change in gross margin on the service side. Because I'd say we're pretty well fully utilizing the headcount that's there and have very small plans for additions to keep up with the sales volume in emerging markets that will, net, keep that margin where it is.

And just real quick. Could you comment on pricing as well?

Our pricing, I'd say there's no news on the pricing front. In this climate, you might expect that pricing competition would heat up, you could say, maybe in a few situations. But we have always maintained our position as selling based on most everything else other than low price. So service and support and technological differentiation, we believe continue to be the drivers of our business. And as you can see from our margin performance, we're not wavering from that theory and see no signs that we're losing material amounts of business because of it.

Our next question comes from Dan Leonard with Leerink Swann.

I was hoping that you could give us some flavor of what the bookings and the book to bill look like as we exited the quarter.

The very little difference between order rates and sales rate, Dan. So I'd say it's no news there.

And also, could you give us a little more color on what's behind your expectation that India is going to get better over the next couple of quarters?

I think -- first of all, our forecast -- the numbers that John shared with you don't count on a tremendous uptick in that business. But on the ground level and really -- with orders in India, we typically wait to book the orders until those customers have cleared their letters of credit. That process -- that end process in typical years is not a big delay process from when the customers place their purchase order to when they clear their bank credit. That process has slowed significantly with the weakness of the rupee and a lot of these companies having to change their credit lines. So what we're looking at is a pretty big -- I don't want to call it backlog because those orders don't become into our backlog as until they clear credit. But a good sign that the underlying demand on the ground in India is much higher than our current run rate. Now they still have to ultimately get the money, but I -- traditionally, in periods of a weakening rupee, they have done that. I think there's a little additional flavor of government turbulence in India and change in leadership, so that might add a degree of uncertainty. But long term, those generic accounts have to build capacity to take on the generic marketplace. So -- and we have, by far, the leading share in our product lines in those accounts. So if that breaks through at all, we should see meaningful uptick in our expectations.

And then my final question is just housekeeping. John, when you mentioned the new guidance incorporates current exchange rates, does current mean end of the quarter or -- and so like $1.27 euro? Or does it mean today we're at $1.21 euro?

I actually use the $1.22, is what I used in the numbers.

[Operator Instructions] Our next question comes from Jon Groberg with Macquarie Capital.

I wonder, Doug, if you -- I was very interested in kind of what you talked about the quarter. You said April was good, orders came in. May was okay. And then you said kind of throughout June, you saw kind of the -- you saw the approval process for capital expenditures starting to become elongated. Can you maybe talk about, either geographically more where your -- where that comment was coming from or via end market? And in particular, I'm wondering -- I mean it sounds like you expected the U.S. to still remain fairly strong, kind of mid-single-digit growth here, but it's -- Danaher, on their call said -- in their kind of -- in their sort of life science markets in the U.S., they actually started to see weakness in some of the areas you were talking about. So just kind of wanted to get a little bit more detail there.

Well, I think that you may be -- what I said was that some of the orders that were delayed in the first quarter, we really saw them booked in the early part of April. So that did encourage us that some of those delays were behind us. Unfortunately, we saw a new delay kind of creep into the process, Jon, so that didn't signal a real uptick in run rate. I think this issue of when things occur in the quarter -- as you know, we always have a big bolus of orders that comes in late in the quarter. I think everybody in this industry still runs on that kind of model. Our experience in June was pretty good. Orders were -- saw [ph] the fields talking about run rates picking up. We see one area up, one area experiencing slowness. You're continuing to monitor that. So it's a bit of a struggle to, say, overall, anything changed in June. Some areas picked up in June, and some areas that were expecting orders to come in, didn't. So I'd say the life science business was actually reasonably good right through June. It was the industrial piece that probably -- we saw -- we certainly didn't see the run rate of business late in the quarter that we expected. It wasn't strong early, but it was probably weaker as we ended the quarter. So I mean that's part of the reality of saying, what's the next month, the next quarter, the next half year going to be like. And we roll in all of this. We listen to others in the industry, the competitors and what they're saying and roll in our specific factors. I think we've got some individual circumstances that give us some reason to be optimistic that the second half could be better than the first half. But overall, we think that the economic climate's going to be pretty much like it is now, I mean, maybe a little bit worse in some areas, but I think we have no reason to believe that it's falling off a cliff.

Okay. Just maybe a follow-up and are you -- internally, are you kind of elongating or changing your own approval process for capital expenditures? And then if I -- as a quick follow-up too on the industrial, what is it that's keeping -- typically, we thought TA would be much more kind of that exposed to the industrial, but you're still getting double-digit growth there. So maybe, why do you think you're seeing that in TA given the comment [indiscernible] ...

Yes. I'll let John talk a little bit about TA. But in terms of our own capital, yes, we are tighter on our capital release. Now one of our more significant capital programs is the site in Manchester for our mass spec operations, and that's kind of all systems go. But we are tighter. However, you know we're not a capital-expensive business, so -- But I think we share everybody else's -- when we tighten the belt, we don't just tighten the belt on expenses and go wild on the capital side because the depreciation and interest hit you later. I mean, we apply the same general constraints across the board and look much more hard on the immediate payback to those capital programs. And John, you want to talk about TA?

Yes. I would say as it relates to TA, TA Instruments, as you know, has a very competitive offering up and down its line right now. So I'd say, competitively, it's in a very good shape. We've said earlier that microcalorimetry had a good quarter, had the good half. The outlook there is very optimistic and continuing to be able to place those instruments into pharmaceutical settings. So the pharma piece of what they do is very strong at this point in time. And the new high-temp products that are just now being integrated into the line and passed out to the sales force is very encouraging. We think that the technologies that we have, they'll be able to compete with the market leader in that space, and we think that, that will continue to allow TA to drive growth at least mid-single digits as we think about the second half of the year in spite of perhaps a more difficult industrial chemical customer base.

Our next question comes from Amit Bhalla with Citigroup.

I want to just understand this outlook in the second half for Europe, Japan. I think, Doug or John, you said that Europe, Japan combined would be flat in the second half. But your Europe comps get a lot harder. Your Japanese comps get a lot easier on constant currency basis. So can you split those 2 country -- or those 2 geographies out and give us some more specifics on how you're viewing Europe and Japan for the second half guidance?

I would say that the run rate of what we're expecting is going to be about the same moving into Q3 and Q4. Japan has been a difficult environment for us for many years and for others. So we've never had much more than kind of a low-single-digit expectation for that part of the world anyway, so thinking about that being relatively flat is not really too far off from historical expectations. Europe, we saw a rather, I guess, traditional split of growth in Europe, kind of soft in the southern side where you would expect. Germany was okay. France was okay. U.K. was a little bit soft in Q2. We don't think that, that continues as soft as it was in the second half of year. Certainly, we don't have any expectations for Southern Europe to get better. But we have also had a somewhat softer Eastern Europe than we might have thought, and we think that there, it's possible that we'll see a little bit more growth in the second half than we did in the first. So I mean, maybe Europe ends up being, from base of comparison, a little different than what we saw in the second quarter, but I don't think it's dramatically different, and you end up splitting hairs at that level.

And then on pricing, Doug, you said there's a few situations where pricing is actually heating up. Can you elaborate on that? Are you talking about mass spec? What exactly do you mean by [indiscernible] pricing in India [ph] ?

No, you misunderstood me. I say every quarter you see some particular order where somebody's dramatically discounting and the field wants to it match it, something that -- I would say we're not seeing a materially different environment today than we've seen for the last 1.5 years. I mean, every quarter, some competitor decides that price competition is the way they're going to make their quarter, and we deal with that all the time, and we don't respond to it. So that's why our margins hold up, and I don't want anybody to come away with the fact that we're seeing a dramatically different climate. We're seeing the same amount that we always see.

Okay. So then specific to mass spec, can you just comment on the competitive environment there? And were you able to launch your new single quad and what kind of traction that got?

Sure, John.

Yes. The new single quad actually grew relatively nicely in the quarter on a pretty poor base of comparison. So I'd say we're optimistic that the single quadrupole space for us will look better than it has historically as we look at the back half of the year. That being said, I'd say we're probably comfortable with our tandem quadrupole position and continue to look at that as being a very competitive space but one where we have a competitive product and don't feel uncomfortable there looking into the second half. It's probably the high-end part of the market where we see the most competitive pressure, and there are good and valid options for customers on that front. And that is the market space for us that today is the most competitive.

And it's the place that a big piece of that market is into nonprofit government and academic labs. We're worried about that segment of the market more than others. We are beginning to ship our new high-end G2-S products, so we're hopeful that, that can stimulate things. But overall, we're not holding out for a return to aggressive growth rates in that segment of the MS market.

Our next question comes from Doug Schenkel with Cowen.

Who is that?

Doug Schenkel.

Let me -- can I just start with a housekeeping question. What was the M&A contribution for the quarter? And what's built into expectations for either the second half or the full year?

Yes, there was this -- a very small amount in TA. I think about 3% of their 11 were 0.3 bps in the total business was associated with the high-temp acquisition. And that's not likely to be dramatically different as we look at the second half.

Okay. And then actually maybe another housekeeping, QTof -- I apologize if I just missed this. But I know QTof was one of a few weak spots in Q1. Did that hold up any better in Q2?

It was still down in the quarter. It wasn't down as much as it was, I believe, in the first quarter if I recall the sales numbers correctly. But it was still detracted certainly from the growth, and I think it's the G2-S that we're holding out some hope for in being able to prop that up as we move forward.

So just turning back to some questions about -- I guess a question following up on some of the spending questions from earlier. Your management of SG&A in the quarter was really encouraging, but maybe at the same time, I guess, arguably surprising, given how positive you guys seemed to be over the first couple months of the quarter, and I think your annual compensation increase actually occurred in April as planned, so I guess what I'm curious about is when in the quarter exactly did you start to really pull back on spend. And I guess somewhat related to that, how low can constant currency revenue growth drop to for you guys where you can still get operating leverage? I think that number, at least recently, used to be around 5%. It sounds like it's a little bit lower than that now.

Yes. I'd say right out of the gate and certainly the start of the year, we had many of the incremental spend programs targeted to begin in the second quarter. And having had a relatively slow start to the year, shall we say, we pushed many of those programs out to the beginning of the third quarter. So right out of the gate, even though we might have been thinking that the quarter was going to materialize to be something a bit higher organically that it turns out to be, we did not do anything on the spend front to turn up the gas, if you will, at the start of the second quarter. All of the controls that were in place through the first quarter remained in the second quarter. So from that perspective, we really had kind of a head start, if you will, and have held back in many areas: travel, advertising, project expense. There was a number of different areas where we've been able to hold the line, and that's in spite of, as you point out, the fact that we went through a relatively normal merit process around the world. But that was up against the base of a merit program that was comparable. So the comparable number increased, too. So I would say, the holding of the line in SG&A going forward to organically be a very low-single-digit type of an increase that will be completely offset by FX and nets out to something that might be flattish to maybe down slightly is really just holding the line on the expenses that we currently are. I would say that there's not a lot of room to go much lower organically than where we are without having to take different measures. But this is certainly a couple of points organic growth less spend. What we would -- what we have historically said, it's kind of the floor from which you can get margin leverage. And actually at these levels, we're really just holding operating income about flat with prior year. We're not providing incremental leverage. A lot of the EPS growth that you're getting at a flat top line with currency is coming from the share repurchase program.

Okay. So the new 5% is something like 3% in terms of where you can get leverage at the operating line?

Yes, right. And that's how many years that can be sustained. I mean, we'd have to really look at that in a bit more detail. But certainly, this year is intact at that level.

Yes, over the short term, I think that's there.

[Operator Instructions] Our next question comes from Tycho Peterson with JPMorgan. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: A lot of mine have been answered, but maybe just to go back, Doug, to your comments on the competitive dynamics in mass spec, understanding that the market still remains challenging, do you see an opportunity here to pick up share given your current product lineup? And conversely, are you convinced that all the kind of delays you saw last quarter and I think you talked about a few this quarter, are actually delays versus swap-outs?

Well, I wouldn't argue long and hard that in the first 6 months, we haven't lost some high-end orders, Tycho. The SYNAPT G2-S is an important piece that's coming into the market, and we'll have to see how that responds. But this whole area, I think, is one of the most challenged for instrument manufacturers. These are high-end instruments. The academic and government market is a much bigger piece of this market than it is of the traditional chromatography market. And I think that's the market that's going to be most challenged. So it's a tough area for all of us. That doesn't mean there's no spending there, but it's not the area that I'd look for the most rigorous uptick in the second half. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: And how are you thinking about the clinical opportunity for mass spec? I mean, a handful of us were at ACC last week, and there seems to be a bit more emphasis from the tool providers you were earlier on and kind of moving mass spec into the clinical side of things. Can you just talk about the competitive dynamics there? And are there milestones we should be thinking about as you continue to kind of build out the clinical business over the next couple of years?

Well, I think we're very optimistic about the clinical business. It's still less than -- well, it's a single-digit piece of our overall business. It has major opportunities, but it's an area where the regulatory issues still kind of have to be worked out in many of these applications. There are some applications that are robust, tried and true. Drugs of abuse and pain testing and things like that are very active areas today. And I do think some of them have flipped over to mass spec technology almost exclusively. So that's good news. I think to the extent that a number of these customers are still being challenged on their own, that is the clinical testing markets, still a little bit cautious about looking for extraordinary growth there, but I think it's likely to be better than average as we go over the next 6 to 12 months.

Our next question comes from Jon Wood with Jefferies. Jon Davis Wood - Jefferies & Company, Inc., Research Division: Can you just -- in the context of the 2% Waters instrument systems growth, I'd love to hear if you roll up mass spec and you roll up LC, what did those 2 businesses do? And also what are you looking for, for the year for mass spec instruments and LC instruments?

Yes. 2 points, and I decide [ph] LC did better than mass spec. And certainly, as you look at tougher CapEx environments, mass spec comes under pressure a lot more quickly, as you know, than the LC side. So there was more stability as you'd expect in the LC instrument side, and there's more variability with the mass spec instrument. Jon Davis Wood - Jefferies & Company, Inc., Research Division: Okay. And then, John, can you update us on cash flow guidance and buyback guidance for the year, please?

On the cash flow side, with the new guidance that we've put out there, I'd say that we’re looking to approach maybe $475 million free cash flow for the full year before the Manchester facility. That will probably bring it down to closer to $450 million for the full year. And on the share repurchase side, we just did 103, we did about 60-something in the first quarter, so around 170-ish, I think, through the midyear. You're probably looking at that to grow to somewhere around 300, 325, anyway, as we make our -- $300 million to $325 million as we make our way through the second half of the year. And we'll see depending on share price, we may do a little more, a less but something in that range probably makes sense.

[Operator Instructions] Isaac Ro with Goldman Sachs.

Doug, if I can ask a question on China, just some of your peers have been talking about the release of government funds for the 5-year plan kind of picking up in the back half. The trajectory of that acceleration has been somewhat under debate, but generally, one that we're also looking for. So could you maybe comment on what your view is there in terms of visibility on government funds? And then secondarily, I thought you said that attach rates for UPLC are lower than HPLC. Can you confirm that's what you said because I actually thought you guys have been saying the reverse in previous quarters because...

Sorry, you said -- what do you think I said?

Attach rates for UPLC. I think in the past, you guys have said that the attach rates are higher because there's less competition. And I thought you said they were lower on the call earlier [indiscernible] ...

H Yes. What I was referring to is that the attach rates on H-Class are lower than the attach rates on classical UPLC because with H-Class, you're still seeing our customers run traditional HPLC methods as they -- a way to switch over to UPLC. So that's still a good source of UPLC columns. It's just not as high an attach rate as the I-Class or the traditional HPLC.

Okay. And then China? Yes.

Yes, China. We are more -- we more look at the individual input that we're getting from individual ministries and our people on the ground. As other people have been concerned about China, our organization has held pretty firm. One of the benefits we have in China is that our business is very diverse. I mean it's -- unlike some of the other areas that are heavily aimed at pharmaceutical and pharmaceutical-like applications, China is into food safety, food quality. It's a good mix between western companies who are in the China market as well as more traditional Chinese customers. The mix of all of that has held up well, and we're reasonably confident of it holding up in the second half. Frankly, we haven't factored in an uptick because of long-term planning on the part of the Chinese. We think it's kind of more run rate like that we're likely to see in the second half.

Next question comes from Sung Ji Nam with Cantor. Sung Ji Nam - Cantor Fitzgerald & Co., Research Division: Just have one quick question. Doug, you talked about applied markets being a little softer, and you kind of mentioned about the temporary pause. What gives you confidence that's more temporary and it's not maybe, perhaps, the market becoming more saturated?

Well, we see no sign of saturation in terms of the underlying dynamics, the request for demonstrations, the request for quotes on the part of these application. And we've seen these kinds of swings historically where you've got a big amount in the base, you've got a lump of business and then that lump tails off. But out of each cycle comes a higher level of spending. The regulations in these markets aren't getting easier. If anything, the opportunity for the regulations to get more stringent in the United States as we really await the implementations of the food safety regs in the United States, we think have the opportunity to add momentum in these markets. So we're not terribly concerned. The one exception to the non-pharmaceutical there is the industrial chemical market. It's more related to macroeconomic demand. A lot of it's derivative to the world auto industry as that places demands on polymers and chemicals. And we're cautious about the dynamics in that segment of the market.

Our next question comes from Derik De Bruin with Bank of America.

John, I just want to talk a little bit about FX and gross margins. I mean, in 2007 and '08, you had significantly big improvements in the gross margin. Some of that -- and certainly in 2009, that helped offset some of the weakness in the market. And I mean, I know you -- obviously, there's other things in terms of product mix, the manufacturing that kind of goes with this. But as we kind of look for 2013 and we think about where currency rates are right now, and how much can you kind of offset? And what could you predict would be the impact of FX that we're kind of looking through really. Would you still have the same type of ability to offset some of the headwinds?

Yes. I'd say, certainly, as we've looked at FX across this year, kind of including the second quarter where rates currently sit, I mean we didn't, in the second quarter, experience the full impact of the rates where they've landed at the end of the quarter. As you know, it's average of those rates across the quarter, but there was very little impact on gross margin percentages based on the fact that the relationship of the currencies versus the dollar kind of moved consistently. We have a -- we had a euro that for us, we can pretty much hedge the same way that organically, we see flow-through from our business. We see about the same flow-through on the euro impact, so it doesn't have a big gross margin impact. We didn't see a big change in the yen or the pound. Those are items that are, generally speaking, are strong. Yen is good for margins. A weak pound is good for margins. And we didn't see dramatic movements in those currencies, so we had some stability in the gross margin performance on the FX side. So I'd say the FX flow-through was pretty much what we expected, more of it because of the -- overall, there was a bigger impact. But given where rates are right now, I wouldn't have you believe that there's going to be a big gross margin percent impact like we had seen historically.

Okay. Well, thank you all for sticking with us. We ran a little bit later than we traditionally do, but hopefully, that got most of your questions answered, and as always, we'll be prepared to answer any follow-up questions that you have as the next few days unroll. So thanks a lot, and we'll hopefully be back with you next quarter. We can sign off now.

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