Waters Corp (WAT) 2010 Q2 法說會逐字稿

Good morning and welcome to the Waters Corporation 2010 financial results conference call. All participants will be able to listen only until the question-and-answer session of the conference. This conference is being recorded. If anyone has any objection, you may disconnect at this time. 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. And 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, the Vice President of Investor Relations. As our normal practice, I am going to start with an overview of the quarters highlights. John will follow with details on our financial results and provide with our outlook for the third quarter and the full year. But before we get to that I would 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 future profit, future income statement results of the Company, this time for Q3 and full year 2010. We caution you that all such statements are only predictions and that actual events or result 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, 2009 in part one under the caption business risk factors. I 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 call and webcast. The next earnings release call and webcast is currently planned for October 2010.

During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measure to the most directly comparable GAAP measure is attached to the Company's earnings release issued this morning. In our discussions of the results of operations, we may refer to proforma results which exclude the impact of items such as those outlined in our schedule entitled reconciliation of net income per diluted share included in this morning's press release.

Thank you, John. Well from many perspectives, I think we're pleased with our second quarter performance. Sales of our newly introduced instrument systems and a broad based improvement in customer demand contributed to 9% currency neutral sales growth and close to 20% growth in earnings per share. At the same time, we are confident that our exciting new product launches which we showcased at June's ASMS conference and earlier this year will provide us with a powerful competitive edge in the second half of 2010 and further into 2011.

If you look at the quarter, sales growth to pharmaceutical and industrial chemical customers significantly improved in comparison to what we have been seeing in the last few quarters. As the pharmaceutical segment represents more than half of the Waters division sales and it was improvements in this customer set that contributed most meaningfully to the division's growth in the second quarter. Geographically, pharmaceutical growth was strongest in North America and Asia, with drug discovery in QC applications leading the way.

Sales for the quarter for most of our large cap drug accounts grew sequentially from the levels that we saw in the first quarter. However, in absolute terms, demand remains somewhat weak, as many of these customers continue to rationalize their operations. Fortunately, strong demand from generic, specialty BioPharmaceutical and CRO customers, much more than offset be slower sales at our largest drug firms and all-in, our pharmaceutical business segment enjoyed double digit top line growth in the quarter. Sales to industrial chemical accounts were also strong in the quarter, and our TA instruments division benefited from a significant and broad rebound in capital spending.

As you may recall, TA's largest customer segment is the industrial chemical market, manufacturers of fine chemicals and polymers used in applications ranging from consumer electronics to aerospace components to medical devices. And as you may remember, the severe economic conditions that we endured in late 2008 and through 2009 resulted in a pronounced decline in TA sales. Throughout this difficult period, TA continued to maintain its technological leadership, provided market leading customer support and successfully maintained system pricing.

This year, as we continue to emerge from a recession, we are seeing a very impressive rebound in demand for both instrumentation and services at our TA division. Within the Waters division, we are seeing a similar recovery in demand at fine chemical accounts, though this customer segment has a smaller percentage of the Waters division overall business. If you look at our nonprofit customers, the combined government and academic sales grew more modestly in the quarter, and were highlighted by robust shipment volumes of high-end Mass Spect systems to universities.

US stimulus related business was not a significant factor in the quarter and in almost all regions, sales to government customers softened as new measures seem the to be having somewhat of an impact. Looking at our overall sales geographically, Asia and North America saw impressive growth in the quarter. Within Asia, the recovery of business in India from last year's weak levels was a very significant growth driver, while our businesses in China and eastern Asia also continued to grow nicely. The outlook for businesses in Asia outside of Japan appears healthy as we move into the second half of this year.

In Japan, you will recall that we had a very successful first quarter sales result as government stimulus funds were spent ahead of the close of their fiscal year. We knew that last quarter sales were not indicative of long-term demand in Japan, and expected full year currency neutral revenue growth to be at the mid single digit level.

In the second quarter, we saw our modest decline in sales, in Japan, bringing the first half constant currency sales growth rate to a little less than 10%. Recently, much concern has been voiced about economic weakness in Europe. However, in the second quarter, our European currency neutral sales grew at about the same rate as the Company's overall rate. Within Europe, sales growth in eastern Europe was strong and for the region as a whole, mass spectrometry systems were robust. Moving forward, we share in what appears to be a prevailing concern that western Europe may again experience a period of soft demand.

However, we are not currently see this in our order trends and continue to believe that our overall European business will deliver at least moderate growth in the second half of 2010. Earlier today, I mentioned that our recent new product launches positively contributed to our results in the most recently completed quarter. And now I would like to review with you the instrument systems that I was referring to and provide you with some perspective on the potential impact of these products on our future performance.

If you look at the second quarter, SYNAPT Mass Spectrometry and ACQUITY H-Class systems were the star performers. With our SYNAPT G2 MS and SYNAPT G2 HDMS instruments we are continuing to strengthen our position in research grade Mass Spectrometry. Since we began shipments in late 2009, our SYNAPT user base has been rapidly expanding, more publications from leading researchers have described the instruments unique performance attributes for a variety of applications and we have continued to enhance the systems performance with more ionization options, new advanced promotography and application tailored software packages. At this year's ASMS conference in June, we introduced two new high performance systems, the Xevo G2 QTof and Xevo TQ-S.

These systems have been engineered to deliver industry-leading performance in compact and easy to use instrument configurations. The Xevo G2 QTof incorporates our new QuanTof time of flight technology an innovation that facilitates high sensitivity compound identification and quantification in a single experimental step. And applications from environmental, and food safety screening, the drug metabolite identification, the Xevo G2 can generate results in a single run that previously required running multiple experiments on a range of MS instruments.

I am pleased to tell you that we began shipping the new Xevo G2 QTof late in the second quarter and that we'll be ramping up production to address our order back log in the third quarter. The Xevo TQ-S is our new flagship research tandem or is commonly referred to triple quadra fold mass spectrometer. This new system target it is largest market opportunity in mass spectrometry based instrumentation and we are excited to have what we believe is the highest performance offering.

We feel that we have an opportunity to gain share in applications where high sensitivity that is the ability to see trace amounts of organic or bio molecules is of primary importance. Our ACQUITY UPLC position, a leading market position in chromatography for high performance MS applications gives us easy access to our targeted customer set and the ability to offer complete UPLC MS systems for those customers requiring a turn-key high performance solution. Order volume for the new Xevo TQ-S ramped nicely in the second quarter and we plan to begin customer shipments this quarter.

Earlier this year, I had the opportunity to speak to you about our ACQUITY strategy in new our ACQUITY H-Class UPLC system. As you may recall, the H-Class instrument offers capabilities that allow for running of Legacy HPLC methodologies while providing an easy upgrade path for UPLC performance. It is however, a true UPLC system with attributes that leverage the performance of our ACQUITY column chemistries. ACQUITY H-Class was developed based on feedback that we received from the largest ACQUITY users, primarily customer already deployed UPLC instruments throughout the development organization. They told us that they are now more confident of transferring UPLC technology throughout their quality control laboratories, or required instrument design features to facilitate that process.

These design features and additional performance enhancements were incorporated into our ACQUITY H-Class. While we introduced them and began shipments of the H-Class in the first quarter of 2010, in early feedback that we received from the market was very positive and that excitement level only grew throughout the second quarter. More important, in the second quarter its first full quarter in the market the H-Class has made significant inroads in opening the pharmaceutical QC market to UPLC technology and we are confident that this trend will continue in the second half of 2010 and beyond.

Orders are very encouraging dynamic. Not only are we pleased to see the rapid adoption of our new LC systems, we are also pleased to see signs that our new ACQUITY H-Class UPLC maybe a key factor in initiating a long waited new instrument for placement cycle in pharmaceutical QC. From my recent comments you can likely sense that I am very excited about the strength of our new product offering. However, our success is also dependent on funds being available globally to acquire a new goods and services and it is -- today's macroeconomic concerns that somewhat temper my near-term enthusiasm.

John will review with you our financial outlook for the remainder of this year, but before passing you on to him, I want to say that we feel that we are emerging from the first half of this year with strong business momentum and reasonable visibility for the third quarter. Capital budgets for some of our largest accounts are still being released and we enjoy order backlogs for our newly introduced products.

That said, we feel it is most prudent to be cautious in our full-year outlook and to adopt a reasonable but conservative spending budget for our business. Major product development projects will be fully funded and strategic initiatives such as our program to transfer instrument production to tax save and sites will proceed as planned. However we will continue to monitor customer demand and our internal spending in an effort to react appropriately to dynamic business conditions.

In the second quarter, our free cash generation exceeded $100 million, and for the half-year period, was more than $200 million. We feel that cash generation is an important internal and external measurement in evaluating the Company's performance and this year we believe we are well positioned to generate about $0.25 of free cash for each dollar of sales we make.

So in closing, I will reiterate that I am pleased with our performance for the first half of 2010, we remain cautiously optimistic that we can continue to grow our top and bottom lines through the remainder of 2010 and into 2011 at rates more in line with our prerecessionary growth trend and we remain committed to a focused business strategy that has served us well for many years. So I would like to now turn it over to John for the financials.

Okay. Thank you, Doug and good morning. Second quarter sales increased by 8% and non-GAAP earnings per diluted share were up 19% at $0.93 this quarter compared to earnings of $0.78 last year. On a GAAP basis, our earnings were $0.90 this quarter compared to $0.72 last year and a reconciliation of our GAAP to non-GAAP earnings is included in our press release issued this morning.

Reviewing Q2 sales results compared to Q2 last year, sales were up 9% this quarter before currency translation. Currency translation reduced sales growth by 1% this quarter.

Looking at our sales growth geographically, and before foreign exchange effects, sales within the US were up 11%, Europe's sales were up 9%. Sales within Japan were down 3%, and sales in Asia outside of Japan were up 14%.

Turning to the product front, within the Waters division, instrument system sales increased by 8%, and recurring revenues grew by 7% this quarter, before foreign exchange effects. Within our TA instruments division, sales were strong and increased by 28% versus prior year as customers return to more traditional levels of purchasing activity.

Now I would like to comment on our Q2 non-GAAP reported financial performance versus prior year. Gross margin performance continued to be strong this quarter and came in about as expected at 60.3%, comparable to prior year and last quarter. SG&A expenses increased 2% this quarter, compared to prior year. Salaries increased modestly and marketing costs were up related to food safety programs but these increases were largely mitigated by lower currency translation costs, lower than anticipated incentive plan expenses from finalization of 2009 accrual balances and a continued restraint on adding additional head count at this time. For the remainder of the year, we expect SG&A to grow at a mid single digit rate.

R&D expenses increased by 6% this quarter from continued new product development programs, partially offset by favorable currency translation related to our mass spec operations in the UK. We expect R&D to grow at a similar rate during the second half of the year.

Our effective income tax rate came in a little better than projected at about 18%, a modest shift in estimate production levels in favor of our tax advantage geographies, reduced our anticipated full-year 2010 tax rate by about a half a point. This provided about $0.01 of benefit to our Q2 EPS.

On balance sheet, cash and short-term investments totaled $754 million and debt totaled $757 million bringing us to a net debt position of about $3 million. On the stock buy back front, we continued to purchase our shares in the open market and during the second quarter, we purchased 1.1 million shares of our common stock for $75 million.

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 remains strong. It came in at $102 million after funding $11 million of CapEx and adding back about $1 million of noncash tax benefits from stock based compensation. This strong start to the year allowed us to accelerate our buy back program and keeps us on a firm path toward $400 million of free cash flow this year. Comparable free cash flow in Q2 last year was $63 million which included funding $18 million for a new TA facility.

Accounts receivable days sales outstanding stood at 73 days this quarter, down one day versus Q2 last year. And inventories were up $13 million from year-end as is typical at this point in the year. Overall, our Q2 results were stronger than we had anticipated at the start of the quarter. Our new products have been well received and continue to gain traction and customer demand continues to recover from depressed levels we saw last year.

In April, we said we expected our currency neutral sales to grow between 5% to 7% for the full year of 2010. Through the first half, we grew 8%, slightly over our expectations primarily due to a strong rebound in our TA instruments business.

For the second half, we now project our sales growth to average about 7% with Q3 growing a little faster than this and Q4 a little slower, given differing bases of comparisons. Easier in Q3 and tougher in Q4. New product introductions of ASMS, a strong ramp of sales of our new H-Class product and a building backlog of orders, all together give us confidence that the organic growth of the business is on more stable footing as we enter the second half of the year.

On the other hand, general economic uncertainties remain and cause us to be a bit cautious as we consider growth expectations in the fourth quarter. For the full year then, we expect organic sales growth of between 7% and 8%. Currency translation at today's levels is expected to reduce sales growth by about 1%.

Moving down the P&L, gross margins continue to be favorably affected by product cost reductions, and by foreign currency translation in the second half, given the continuation of relative weakness of the British pound and strength of the Japanese Yen, additionally product mix is favorable to margins and our new products are performing well earlier in the production ramp up. Given these factors, we expect full-year gross margin to be up about 50 basis points versus 2009.

Operating expenses are expected to grow at a mid single digit rate, net interest expense is expected to be about $13.5 million and as I mentioned earlier, we expect our operating tax rate to be approximately 18%. Our fully diluted average outstanding share count for the full year of 2010 is currently estimated to be around 93.5 million shares. Rolling all of this together, we currently expect non-GAAP earnings per fully diluted share to be in the range of $3.92 to $4.02 per share.

For Q3, we expect our currency neutral sales to grow around 8%. At current exchange rates, currency translation should decrease sales growth by about 2% bringing reported sales growth to 6%. At this sales level, non-GAAP earnings per fully for the third quarter are expected to be between $0.93 and $0.97. Doug?

Thank you, John. And Operator, at this point, I think we can open it up for QandA.

(Operator Instructions) One moment for our first question.

Quintin Lai, Baird.

Your line is open.

Hi. Good morning, congratulations on a nice quarter.

Thank you.

Could you remind us again, in previous cycles when after a downturn and then pick up in the industrial, you had a really strong TA quarter, I mean, how long, how long does kind of a rebound like this usually occur, Doug?

Well, frankly, Quintin, we haven't seen anything that was quite as a sharp a drop off as we saw, late 2008 into 2009. So, I am not sure that what we have seen in the last 10 years is, is indicative of what we are likely to experience this time. We think that the second half is going to continue to be very robust in the TA business. And, probably has legs, just from that bounce-back, in 2011. there is no signs of, of this tailing off at this point.

The start to this quarter has been the continuing very robust at TA. And they're optimistic for the rest of this year. Realistically I think it peter's out as we get into the, further on in 2011. But, I see no sign that we are going in for another dip. So, I would say we look good into 2011.

I would say the Q3 comparison, Quintin, is pretty comparable to Q2 and then Q4 base is a bit stronger. So, I would say the, the Q2 results while we are not in our guidance suggesting that it continues at the high rate, the expectation would be for some type of double digit growth perhaps in the third quarter before it begins to mitigate as we exit the year.

Okay. Thank you. And then with respect to H-Class, have you seen an impact on your Alliance sales and the people that are taking it up, are they Waters legacy customers? Or are you seeing kind of market share wins to new customers?

I would say the H-Class hasn't had much impact on Alliance. What we have seen, if anything, an impact on higher end ACQUITY sales. So if you look at the mix, I would say some of those H-Class sales would have previously been ACQUITY sales, not so much Alliance. But our strongest Alliance customers today are still in India. And in those generic accounts. What is really encouraging about the H-Class is it is beginning to penetrate into classical QC applications. And that's -- that's works on several fronts, number one that is an area where we have seen large pharma drawn out, the replacement cycles, and number two, they tend to be the highest purchasers of, of columns, those applications are, are heavy column users. Now, the H -- the benefit of H-Class is they can use traditional columns but as they move to more high through-put applications and get truly into UPLC applications, they use more UPLC columns. So, I think that works in our favor, in a number of fronts. We think we are at the front end of that but the early signs are very encouraging.

Great. Thank you. I will jump back in the queue.

Next question.

Tycho Peterson, JPMorgan.

Tycho, your line is open.

Hi, good morning. Doug, in the earlier comments you talked about investing during the downturn in particular with regards to the TA business, can you talk about whether, the results you are seeing here are, are market growth or are you really starting to pull some share here and can you also comment on, competitive wins in mass spec overall and, are you starting to pull some share in that business as well?

I -- it is we need to be very careful about talking about share changes on the basis of one or two quarters, Tycho. So I firmly believe that our most recent mass spec offerings are at the top of the class, and our customers, tell us that they're very happy with the G2 kind of performance in our QTof grade instruments, and it is early on in the triple core business. But boy we see side by side evaluations of our new triple and, we haven't seen any side by sides where we have lost. So -- and that business is growing at very good solid double digit rates. And I -- nobody reports quite as much detail on that business we do, but we can't find too many competitors, reporting that kind of growth in their mass spec business, particularly the high end mass spec business. So, all those are good signs that probably in the short term, we're, we're leading the pack here, and if it continues over multiple quarters, it would be hard not to suppose that we are gaining share there.

Okay. And then in your comments you also talked about government sales softening and, I think you made the comment of starting measures having an impact and then later you talked about Europe holding up. Is it fair to assume that the government pressure was here in the US and can you elaborate on is that a lack of stimulus or are you seeing --

I apologize if that was the implications. I think that the government business softness we are seeing generally. If you look at our nonprofit business, it was the university market that was stronger, and government business, Japan in particular we saw very strong into their fiscal year growth in the first quarter and did not see a repeat of that in the first fiscal year of Japan. I think Japan was actually the most notable weakness in the government business, but we also see signs of it in Europe and in the US.

Okay. Then just lastly on the manufacturing over to Singapore, can you comment on where you are with H-Class and transitioning that over and then, I think you have also made the decision not to move ACQUITY production over there, ac ACQUITY over there. Can you talk about the kind of rationale behind that?

Yes, I would say at this point, Tycho, we are pretty much on track with the original plans at the start of the year and the H-Class product will make its way over there in the second half. In the interim we have moved various UPLC detectors that have begun to ramp up production volumes there and ultimately as we transition from our existing high end ACQUITY to its next generation it is likely that production in following years will make its way over to Singapore. So I would say, we are on track, we are feeling really good about the business as being generated out of that geography, and everything remains pretty positive as we look to the tail end of this year and 2011.

Okay. Thank you very much.

Next question.

Ross Muken, Deutsche Bank.

Ross, your line is open.

Thank you and congrats on a great quarter. Can we get a little more on sort of the Pharma commentary, as you thing about some of the non big Pharma accounts whether it is the CRO's, some of the specialty guys, the generic, can you kind of compare and contrast what you are seeing, in those various players and also, is it geography-based? The comments on India were pretty encouraging. And so I think maybe that has part of it to do with it and then I have sort of a follow-up.

Yes. I would say a couple of things that are relatively positive and a couple of thing that is still flash some warning signs. But the big drug accounts still, I think are struggling with their acquisitions and their restructuring. So, if you look at absolute comparisons of our largest pharmaceutical companies around the world, those results were negative quarter on quarter. That is compared to the 2009 quarter. What's interesting is that sequentially, they improved from the first quarter to the second quarter, we are seeing order rates improve. We are also seeing a great deal of interest and quote rate activity is pretty strong there. I think, holding my breath and crossing my fingers the sequentially we'll continue to see improvement in those accounts, hard to imagine that they could, they could get worse. And particularly in the bio applications of those accounts we are seeing a huge amount of interest from our most recent offerings with our bio ACQUITY and the results coming out of the new systems offerings. So that's all encouraging.

In terms of current business, generic accounts that being particularly true in India bouncing off core results last year, but generic accounts in Europe and in the United States are all very strong, and that's across the board, and that's where some of the, the interest that we are seeing in H-Class and QC applications is coming from. I think that's pretty broad based. And that's also true CRO activity, pretty broad based geographically, so that's I think the, the results of our good performance in Pharma. Again we -- across the board we had double digit growth in Pharma in the Waters division this quarter. So, we are pretty enthusiastic about that.

And can you talk about the type of purchasing patterns we are seeing for the H-Class, you talked about the potential to spur and more significant replacement cycle. Are we seeing, sort of broad adoption across the BioPharma base in terms of small and large type companies looking to add or replace the instrument and with the larger ones are we seeing, sort of several box orders, are we seeing large scale box orders or is it very sort of customer specific?

It really is customer specific. We have begun to see multiple unit orders, in Pharma accounts in QC, which -- but I caution it is the front end of that cycle. And, I need to see more evidence before I really take it to the bank. I would say it is an encouraging early sign. It is across the board. We are seeing that activity show itself in big Pharma, in specialty Pharma, and in bio tech. I would say the bio applications are probably the most near-term where the traditional small molecule Pharma is longer term. But of course all of these accounts are saying they're gearing up for the bio applications. So I think we are well positioned to take advantage of things there. And those are the most near-term areas where they have the most money to spend out there.

Great. Thanks, Doug.

Next question.

Amit Bhalla. Citigroup.

Amit, your line is open.

Hi. Good morning. I just wanted to continue to follow up on that H-Class QA/QC question. Is there any way to tease out the second quarter, what percentage of the H-Class is going to the QA/QC setting, 5%, 10%, any sort of you know numbers to put there? And can you also talk about the backlog? Did it actually grow quarter-over-quarter? Thanks.

Yes, our backlog did grow in quarter. So, that is certainly an encouraging sign. In terms of the H-Class in QC, I don't know whether we can actually give you a specific number there. Art, do you have anything qualitative to say about H-Class in the QC market?

Generally speaking, we don't go into that level of detail. But I suffice to say that the product was really targeted at the downstream development method development and quality control segment. So it is safe to say that easily, half our sales are going into those two areas in that product. It is also being well accepted and food testing, environmental testing. So it is broad based but the product was designed to be, whereas the original ACQUITY was leaning on the front end. For the bulk of the sales the H-Class was designed for the pre quality control development of methodologies and then carrying it down into the execution and being a system that can either conduct a legacy method to quality control or either go through the conversion of UPLC or be a system that down the road, if they ever decided they did want to improve the productivity their separations that UPLC do that within H-Class. So, in rough numbers, it is the bulk of the sales. It is -- it is, roughly half the line of that business that goes into those two segments.

That gives you a sense, Amit.

Yes, thanks. Can I ask you one quick follow up on the gross margin? You are talk about 50% year-over-year, or 50 basis points year-over-year growth in the gross margin, can you just tease out the pieces for a second? There's FX pressure but there's mixed manufacturing lift so you can just tease out the three pieces that is are leading to the gross margin expansion for the year. Thank you.

I would say if you look at the gross margin performance, it was relatively strong in the first half of last year, the gross margin in the third quarter came down a bit. And we are suggesting that we are more likely to be somewhat consistent with gross margins as we move into the third quarter from the second this year as a result of product mix and also the currency environment remains very favorable for us. We have, a relatively strong Yen still as we speak. So our sales in that region are being translated favorably where there's no production in that part of the world. So there's no offset to the cost of sales line, and the British pound continues to be relatively weak. So our, our units coming out of, out of our Manchester operation in they're sold around the world are favorable. So, that environment continues as we look at the second half. So I would say that you are looking at, probably maybe two-thirds or so of the overall improvement is currency, and the remainder is associated with cost reductions and product mix and some of the newer products that are actually coming out pretty strong in margins. So that based on where we are today, that's how it looks.

Thanks a lot.

Sure.

Next question.

Marshall Urist, Morgan Stanley.

Marshall, your line is open.

Hi guys, thanks for taking the questions. So first one I know you had some comments about, about some sort of conservatism built into the back half outlook. So can you talk about where you feel like you're being conservative, where could the upside and I guess by the same token, where could the down side come from?

Well, conservative, I mean our second half organic growth rate is just a smidge slower than we're experiencing now. And, if we continue to see current run rates and things evolve on the new product front, it is not impossible that we can see better results. But tempering our expectations is, major questions about western Europe, particularly the government supported segment of the western Europe business.

Frankly, all in, Europe, you know has been pretty good but we have seen pockets of weakness in western Europe. And, that government supported piece is under a fair amount of strain. So, that tempers our expectations. We certainly saw a strong government spending in Japan in the first quarter, weaker in the second quarter. So that causes us some element of concern. We are backing that into our results. If things evolve a little bit better, then, then we could possibly do a little bit better.

We frankly have not seen a lot of results from stimulus spending in the United States, from government stimulus spending. That could be a little bit better, but frankly we are not banking too much of that in the second half either. That is, I would say where, where most of our conservative comes in. We might be a little conservative on how long we think the, the TA bounce and how high it can get. So that is another element that if we turned out a little bit better, we wouldn't be totally surprised. Those are the key elements of when I say we are a little bit cautious in the second half, those are areas that we think we have injected some degree of conservatism.

Okay. Perfect. Then just one other one for me. I was just curious on, on China, the kind of underlying, underlying dynamics there, are things still, strong sort of business as usual, no major changes, or are you seeing anything, any impact on the dynamics in that market?

I would say it remains strong. we have -- we have continued to have good, strong double digit growth in China, some indications that it could even be elements of strengthening. So I think China and Asia outside of Japan in general, still showing very good opportunities. And across technologies.

Okay. Great. Perfect. Thanks, guys.

You're welcome.

Next question.

Paul Knight, CLSA.

Paul, your line is open.

Good morning. Do you have any difficult comps still in the China market that are you are still going through like melamine?

No, no. I would say, you shouldn't expect us to say it is an this year, maybe next year but I think with China specifically that's true. Business in China although we have a obviously a better comp in Q3 versus Q4 but not relating to anything to do with China really specifically.

In Asia are your order patterns different than the rest of the world, in that are they large unit orders? Or is it the same world wide?

I would say typically it the same worldwide. In China some times we will get a concentrated order that's a little bit larger. And certainly, with some of the potential business that we are seeing in the second half, that could be true but typically it hasn't been the case. I would say in general, we are seeing the strength in high end mass spectrometry, our average order size is tended upwards but that's more of a product mix issue, Paul than it is a general, statement of how tenders are being done.

Sometimes in Ching you get a somewhat larger governmental order and that might get to different places but, that's a one off here or there, it is not the common way of doing business at least historically.

Are you seeing any impact from the Indian and Korean stimulus packages on research?

I would say we are seeing a little bit in Korea, probably. But our India business is traditionally highly focused on the generic drug business. So it is not a key ingredient of what we are seeing in India.

Great. Thank you.

And before we go to the next question, we ask you limit your turn to just one question.

Macquarie Capital.

Corey your line is open. Please state just one question. Thank you.

Good morning. This is Jon Groberg. So I guess the just with one clarification question, and then a question I will ask at the same time. But can you maybe you talked about having good synapse, a pretty good synapse backlog through I think the first half of this year, and then depending on what happened with government, but maybe that wasn't as clear, and from what I am hearing, you are saying government really, some of that money hasn't materialized. So can you talk about where you are about with synapse? And then that was just the clarification. Then also if you can talk about the free cash flow strength and given the balance sheet whether there's any design or appetite to be a little more aggressive on the buy back front? Thanks.

Sure. The second question first, Jon. Our cash flow is strong. I would say there's nothing unusual in that. It is not like we dramatically raised our payable balance or anything. We think it is sustainable and we continue to evaluate the aggressiveness of our buy backs. We continue the believe that our stock is a very good investment. So I think you could think of us continuing to be on the aggressive side of that equation rather than the less aggressive side. We will continue to lean in that direction.

In terms of our synapse business, and really talking about our high end mass spec business, we are very confident of our position. We had a great first half in that, and that's particularly so on the orders front but also true on the shipment. It is true that we built some backlog. What we are talking about in terms of concerns or potential issues in the second half is not related to high end MS. If anything I'd be surprised if we saw a material softening of high end mass spec in the second half.

But we are continuing to see the university piece which of course is an indirect level of government spending in most of our areas be very strong as they look to that high end mass spec product line. And we have a great list of opportunities coming out of second half. So that is a very encouraging piece of our business.

Great. Thanks a million.

Next question.

Jon Wood, Jefferies.

Jon Wood, your line is open. Please limit to one question. Thank you.

All right. Thanks a lot. John, can you just comment on the buy back plan in the context of the current M&A environment? I mean it slowed down a bit in the second quarter, but still heavily weighted obviously in first half. Are you seeing anything different on the M&A side or, any emergence of opportunities that might be responsible for tempering.

I guess I would say, that we are, we thought we would front-end load the program we have front-end loaded the program, and we were relatively agressive in the second quarter I would say at $75 million. We talked about the program at least early in the year being targeted at maybe $250 million for the full year so, we are well ahead of that cliff certainly as we make our way through the first half.

We principally spent what we have generated if you will on the program say for $25 million, so I would say it is the message there is that we are, bullish on being an agressive buyers of the stock. We have done that. There really isn't anything on the front burner right now from a M&A perspective. We continue to look at the small bolt-on acquisitions that you know were are typically trying to close but I would say that at least in the near term it doesn't appear to be one that would consume cash, so it's likely that we'll continue to get back in the market when the window opens and continue to buy our shares in the second half, it is not impossible but we will go well beyond the $250 limit to the extent we don't find something on the M&A front.

Okay. Great. And then can you just give us a sense of the contribution from the suite of new products in the second quarter whether qualitatively or quantitatively and then within that I know Doug mentioned strong double digits in high end mass spec, can you give us more quantitate around how the high end mass spec business did in the second quarter.

Well I think In terms of mass spec, the overall mass spec business was well into the double digits, and our high end mass spec was beyond that. It was the strongest performer across the line. So that's probably as much detail as I want to go into. It was a very strong quarter at high end mass spec. In terms of the new product contribution, in the mass spec area, most of those, most of that performance were products that were introduced prior to this year's ASMS. We didn't shift any of the products that were introduced at this year's ASMS, maybe a few, but nothing of any significance so that's an where we are being perhaps a little conservative as we look to the second half. And while the H-Class did very well as a percent of our LC business it is still rather modest since the trajectory is very good but it had -- that would have had less of an impact perhaps on LC and we'll have more as we make our way through the second half.

Yes, but still very -- I mean the uptick in the H-Class is, is very strong. That's all. I don't want to break out unit data but boy from a standing start in the first quarter to where we are now, it has been strong and our new product is in probably where -- ACQUITY was very strong five years ago when we introduced it but H-Class is very comparable.

All right. Great. Appreciate the color. So it is safe to say that in the first half of this year very limited contributions, in terms of incremental contribution from new products and that should definitely build into the second half?

Those words are yours, Jon. Yes, the -- particularly on the mass spec side, those new products should contribute in the second half.

Right.

Go ahead.

No, I was just going to say understood.

Okay. Good.

Thanks a lot.

Derek Brown, UBS.

Please limit to one question. Thank you.

Hi. Good morning. One question in five parts, no just kidding. So, when you look at your R&D SG&A spin you are still being conservative, as you look toward the outlook. I mean what type of cost do you need to add back into 2011 to start looking for? Are there things -- at what volumes do you think you need to -- to start adding people and infrastructure for next year. And also on SG&A R&D, the SG&A question, historically going between Q2 and Q3 you tend be a little bit lower in the Q3 number in SG&A, same trend this year?

Let me answer the second one first. Expect a mid single digit growth from a year-over-year perspective, Q3 to Q3 in SG&A. So, the that's down a little bit than it is, and they're relatively flat Q2 to Q3 but a mid single digit growth in SG&A year-over-year is what we are forecasting.

Okay.

As it relates to longer term, a need for investment in the like, we -- I believe currently, that to the extent that the business continues to pick up and to the extent that the economy continues to do better, that we will have the ability to kind of live within the organic top-line growth rate and being able to fund investments in SG&A and R&D that don't force those expenses to grow at the same rate as sales. Now, whether they can grow a point, two points less than sales or more is obviously dependent, but I don't foresee that we are going to be needing to grow SG&A -- faster than what we see in the pipeline. That does afford us to put some personnel in place, principally service-type people, that come into the cost of sales line, but other support people as well. We have been doing some of that, even, even as we have made our way through the first half of the year, principally international folks. so I would say we are not, in a dire need there, yes we will make investments in head count as the business grows and it should -- I am confident it will be contained within what you expect from us as being able to leverage our basic costs.

Great. Thanks.

Question.

Doug Schenkel, Cowen

Your line is open.

Hi. Good morning. A couple of questions, real quick ones. You guys talked about concerns about austerity measures, I think specifically in Europe, can you just size up how you are thinking about exposure as a percentage of sales to anything that would change in terms of European government spending specifically? And then my second question is, I believe you reduced the full year gross margin growth guidance by 25 basis points. If I am wrong forget the question. If I am right can you break out how much of this change is attributable to FX versus a couple of variables like production improvements, geographic mix or product mix? Thank you.

Within Europe the government piece of the business there is under 10%, probably closer to 6% to 7% perhaps. I don't have that right in front of me. It is under 10%. And to the extent it flows down a bit it is not, we're not saying it will go to 0 but it is likely to have an, impact it might be a few percent of growth opportunity. The other, and as it relates to the gross margin if you will year expectation. It is down 25 basis points all currency, just the slight movement that we have seen in currency from where we last gave guidance, the rest of the margin, expectations from an organic perspective are comparable to what we said in April.

Okay, John just to clarify and make sure people don't get confused, 7% of Europe, that's 7% of Europe not total sale, I mean that's clear. But I want to make sure everybody understands that I understand it correctly.

That's correct. Yes.

Okay. So much smaller percentage as a percentage of the total. All right. Thank you.

Yes.

Next question.

John Sullivan, Leerink.

John Sullivan, your line is open.

Hi guys, good morning. Can you just speak for a second as you talk about investing in your business on going basis, what kind of investment goes on in these emerging countries like China and India? How are you improving your capability and infrastructure in that part of the world? Thanks very much.

Yes, John, every -- every budget cycle you have competing plans, and we have at traditionally been investing in terms of head count. And with us, it is, in areas of growth, like India and China, it is sales and service, and application support people, and that continues to be where we put, our incremental head count in those higher growth areas in the business. It has been true for a number of years now, where we have kind of hold the line and the more industrial lower growth areas of our world and add head count in China and Latin America et cetera. It is no different than it will continue.

Thank you.

Next question.

Steve Willoughby, Cleveland Research.

Steve, your line is open.

Hi. Good morning. Just wondering if you can you talk a little bit about the consumable and service side of the business and the trends you are seeing there and if you are seeing any -- it sounds like you're seeing an uptick or starting to see an uptick in maybe some Pharma spending, what are you seeing on the activity side if you can give us some color?

Yes. The service, the con -- service and consumables case of our business grew nicely in the quarter particularly true in our traditional column business and particularly true with, with the, the UPLC column consumables, that are tend to be very closely tied to our instruments unlike the more open platforms of traditional HPLC. So we are seeing a return to very predictable growth in that high profit consumables piece of our business.

Okay. Thanks very much.

(Operator Instructions).

Operator, we can probably take one more question and then bring it to a close.

I am showing no other questions at this time.

Well, very good. Thank you all for being with us this morning and we look forward to talking to you next quarter. Thanks.

That will conclude our conference for today. All participants may disconnect at this time. Thank you.