Waters Corp (WAT) 2011 Q2 法說會逐字稿

Good morning. Welcome to the Waters Corporation second-quarter 2011 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 objections, please 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. With me on today's call, as usual, is John Ornell, the Water's Chief Financial Officer. And as our normal practice, I'll start with an overview of the quarter's highlights, and then John will follow with details of our financial results and provide you with our outlook for the third quarter and for the full year. Before we get going, however, I'd like John to cover the usual 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 2011. 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, 2010, in part one under the caption Business Risk Factors.

We further caution you that the Company does not obligate or commit itself by providing this guidance to update predictions. We do not plan to update predictions regarding possible future income statement results, except during our regularly scheduled quarterly earnings release conference calls and webcasts. The next earnings release call and webcast is currently planned for October of 2011.

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 the Company's earnings release issued this morning. In our discussions of the results of operations, we may refer to pro forma results, which exclude the impact of items such as those outlined in our schedule entitled Reconciliation of Net Income Per Diluted Share, included in this morning's press release.

Thank you, John. Well, our sales in the quarter grew 14% and our adjusted earnings were up about 16%. This growth in revenue and earnings, although a little lighter than we had anticipated, was driven by an order volume that was higher than recorded sales. Highlights of the quarter include significant new product launches at the ASMS conference, strong recurring revenue growth, and continued double-digit Asian sales growth. The stronger orders that I referred to and the accompanying backlog build were significantly associated with bookings for newly introduced products with third-quarter shipping terms.

In the United States, sales to combined government and academic institutions were soft in the second quarter, and orders from pharmaceutical customers slowed as we approached the quarter's close. On the other hand, our chemical analysis business continued with good momentum. Globally, Waters Division sales to the pharmaceutical end market were in line with the division's overall growth rate, with particular strength observed in Western Europe, Latin America, and India. Applications within Pharma that are driving growth include regulated bioanalysis, biological pharmaceutical development, and QC testing. Here, I'm referring to protein and peptide-based therapeutics. ACQUITY H-Class uptake remains strong in QC applications.

Sales at our largest accounts grew sequentially from a strong first-quarter performance, and also in comparison to the prior year's quarterly results. Global government and university spending were soft for the Waters Division, and moderately impacted overall sales growth. The major exceptions to this trend were China and Latin America, where we saw double-digit sales increases. So, we are not overly optimistic about worldwide governmental support for research for the foreseeable future. We do feel that our innovative new systems, especially in high-end mass spectrometry, will allow us to compete favorably within this more challenging funding environment.

Sales to industrial chemical accounts varied somewhat by geography, with stronger growth in developing countries than what we saw in Western Europe and the US. Our TA Instruments division's strong performance corroborates continued underlying strength in industrial spending. If you look at TA, the division delivered yet another double-digit sales growth quarter. Sales growth for TA was geographically balanced and included revenues associated with shipment of the new [Discovery DSE] instrument. This new system is the launch of a new instrument platform configuration that will embody the majority of TA's future performance-leading thermal offerings.

Also interesting to note is that earlier this month, we closed a smaller-sized acquisition that secures technology which will allow TA to pursue higher temperature thermal analysis measurements, critical to the characterization of materials such as ceramics and metals. Sales for our applied markets, dominated by food and environmental applications, grew at a double-digit rate in the quarter.

In Japan, our businesses rebounded nicely, in light of the circumstances endured there during the first part of the year. The drivers of growth in Japan were a pickup in our service business and strong sales of LC/MS systems for chemical analysis applications. Constant currency sales growth in Europe for the Waters Division was consistent with the Company's overall performance, with stronger pharmaceutical results driving Western European growth and chemical analysis segments performing well in Eastern Europe. In the second half of 2011, we anticipate that pharmaceutical spending, primarily in larger Western European countries, and continued strength in Eastern Europe will continue to drive growth.

In light of all the concerns around macroeconomic issues in Europe, we are pleased that our business has maintained positive momentum and that we in fact built backlog associated with new product introductions that we plan to ship in the third quarter. In Asia, ex Japan, sales were in line with our expectations, with China continuing as the growth engine, with significant year-over-year acceleration in university spending and very robust chemical analysis growth. Our second half outlook for Asia, ex Japan, is for a continuation of the strong performance delivered year to date.

Now I'll discuss some product line dynamics that we saw in the quarter, and afterwards I will briefly review our ASMS new system launches. Our recurring revenues, the combination of service and chromatography consumables, posted strong results in the quarter, growing close to 10% in constant currencies. The growth in chromatography consumables was primarily driven by ACQUITY column sales in our more mature markets, and by overall strong column sales in developing markets -- most notably China, Eastern Europe, and Latin America. Similarly, our service business benefited from faster growth in the same developing markets.

Looking at our Waters Division instrument system sales, growth was comparable for LC and LC/MS instruments. On the chromatography front, UPLC systems grew at a double-digit rate, with H-Class now dominating ACQUITY sales. And our new ACQUITY I-Class will start shipping in the third quarter. LC/MS system growth was primarily driven by tandem quadrupole replacements in the quarter, with our high sensitivity Xevo TQ-S capturing more bioanalytical opportunities, and our workhorse TQD base systems more heavily devoted to food, environmental, and clinical new instrument sales.

SYNAPT MS demand slowed in the quarter, especially in comparison to strong academic shipments in the 2010 quarter and in anticipation of the new SYNAPT G2-S that we introduced at ASMS in early June. At ASMS, we showcased three significant new instrument system launches -- the aforementioned SYNAPT G2-S, in both MS and HDMS configurations; a system for regulated bioanalysis, incorporating a new ACQUITY I-Class front end; and a replacement for our successful TQD workhorse tandem quadrupole, that we have named the Xevo TQD. I encourage you all to go to our website for more detailed information about each of these new systems, and I'm pleased to tell you that we plan customer shipments for all of these systems in the third quarter.

A significant launch for us at ASMS was a new application-focused instrument system for regulated bioanalysis. Our regulated bioanalysis system integrates a new ACQUITY I-Class UPLC with our Xevo TQ-S mass spectrometer, all operating with a tailored version of our new unified operating system. The system is the result of an exhaustive effort to thoroughly understand the workflow of scientists working in drug development, and to layer onto this workflow the most advanced technologies to prepare samples, affect superior separation and detection, and to finally amass all of this critical information in a secure and easy-to-navigate information management system.

We believe that our new regulated bioanalysis system does this and more, by not only addressing the current needs of the market, but anticipating future requirements, especially in the areas of data integrity and advanced separations chemistries for biologically synthesized drugs. Combining these new systems with the business momentum that we are enjoying with our ACQUITY H-Class sales, I think Waters is in an advantageous position. However, that is not stopping us from pursuing an aggressive new product introduction plan that you will see us execute over the next several quarters.

We have a strong new product pipeline, and remain committed to maintaining our position as an industry leader. So, how are we to look at the remainder of 2011 and beyond? Well, I remain positive on our outlook for the second half of 2011. After a somewhat muted finish to the second quarter, especially in the US, and ahead of the July 4 holiday, the third quarter has started off well. And I'm encouraged by the customer reception to our newly introduced systems.

I also feel that the major business manifest of our new system launches will be most apparent as the year progresses, and should allow us to continue to show nice top-line growth, despite a more challenging base of comparison. In all, I feel that the full-year growth outlook that I shared with you in April remains intact, and that 2011 should prove to be another year of market-leading growth and profitability for Waters. So, at this time, I'd like to turn it over to John for a more detailed financial review.

Okay. Thank you, Doug. Good morning. Second-quarter sales increased by 14% and non-GAAP earnings per diluted share were up 16%, at $1.08 this quarter compared to $0.93 last year. On a GAAP basis, our earnings were $1.07 this quarter versus $0.90 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 in comparison to Q2 last year, sales were up 14%. This growth includes 6 points of growth from foreign currency translation.

Looking at our sales growth geographically and before foreign exchange effects, sales in the US were up 2%, Europe sales were up 6%, Japan was up 11%, and sales in Asia outside of Japan were up 14%. On the product front and in constant currency within the Waters Division, instrument system sales increased by 6%, and recurring revenues grew by 9% this quarter. Within our TA Instruments division, sales increased by 10% versus prior year. Now I would like to comment on our Q2 non-GAAP reported financial performance versus prior year. Gross margin performance came in at 60.7%, up 40 basis points from Q2 last year. This quarter we saw positive effects on margins from manufacturing cost reductions, volume leverage, and favorable currency comparisons.

SG&A expenses increased by 17% this quarter, with currency translation responsible for about 6.5 points of this increase. We had expected SG&A to grow more quickly earlier in the year, due to difficult comparisons; and this quarter's growth was additionally impacted by stronger foreign exchange effects than projected, and higher costs associated with new product launches. Looking forward, we expect SG&A to grow about -- with sales in the third quarter and slower than sales in the fourth quarter.

R&D expenses increased by 11% this quarter, with currency translation responsible for 3 points of this growth. Our full-year effective operating income tax rate came in a little better than expected, at 16.2%. On the balance sheet, cash and short-term investments totaled $1.1 billion and debt totaled $836 million, bringing us to a net cash position of about $285 million. As for share repurchases, we bought 845,000 shares of our common stock for $81 million. This leaves $403 million to go on the current authorized share repurchase program.

We define free cash flow as cash from operations less capital expenditures, plus any non-cash tax benefit from stock-based compensation accounting and excluding unusual non-recurring items. For Q2, free cash flow came in on target at $88 million, after funding $19 million of CapEx and adding back $9 million of non-cash tax benefits from stock-based compensation. Through the half, free cash flow is $199 million, versus $197 million last year. Accounts receivable days sales outstanding stood at 74 days this quarter, up one day from Q2 last year. Currency effects increased DSO 2 days this quarter versus prior year.

Inventories were up $18 million this quarter; currency translation accounts for about $3 million of this increase. We expect inventories to decline as we approach the end of the year, as product build associated with new products is relieved. Overall, our second quarter's performance was slightly less than we anticipated, on both the top line and bottom line, as we experienced a slowing of business in the US late in the quarter. Since then, demand in the US has rebounded, and we now believe that these events were largely temporary and related to ordering delays associated with new product introductions at ASMS and the Fourth of July holiday.

As we begin the third quarter with a larger-than-anticipated backlog providing additional confidence early in the quarter, the softness we saw in the government and academic markets, we believe, will be tempered by growing interest in our new mass spec products; and that even in a more difficult funding environment, we will see some improvement here in the second half versus our Q2 results. As we think about the remainder of 2011, we continue to see relative stability in our end markets, and continued momentum in the acceptance of our new products.

We continue to expect to see around a 10% growth in sales for the full year 2011 before currency translation; and at today's rates, currency is likely to add 3 points to reported sales growth. Moving down the P&L, gross margins for the full year are expected to be between 60.5% and 61%, as we continue to be favorably affected by product cost reductions and volume leverage offsetting margin pressure for new product introductions. Currency at today's levels looks to be slightly favorable to margins in the second half of the year.

Operating expenses are expected to grow about equal to sales in the third quarter, and at a slower rate than sales in the fourth quarter. Net interest expense is expected to be approximately $17 million, and we now expect an operating tax rate to be about 16%. Our fully diluted average outstanding share count is likely to decrease by 1.5 million shares in 2011. Rolling all of this together, we currently -- we continue to expect non-GAAP earnings per fully diluted share to be in the range of $4.80 to $4.90. For Q3, we expect organic sales growth of about 9%.

Currency translation at today's levels is expected to add about 4% to sales growth this quarter, bringing reported revenue growth to about 13%. Gross margins percentage is expected to be comparable to Q2, and operating expenses are expected to grow about equal to sales. And we plan to proceed on our share repurchase program under the authorized $500 million program. All of this is expected to result in third-quarter non-GAAP EPS of between $1.10 and $1.15 per fully diluted share. Doug?

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

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Dan Leonard, Leerink Swann.

Just one quick one and a follow-up. The delta versus expectations in the quarter -- I understand the weakness in US academia, but why would July 4 have played a particular surprising role versus expectations?

Yes. We saw in the US much less of a hockey stick in the last week of the quarter. The business was off by -- pretty significantly as we advanced in week 13, and we saw a lot of that business actually come back early in Q3. So, we were a little surprised to see the softening as that week went on. I think for a lot of people, maybe Wednesday the 30th was the end of their fiscal quarter, and we saw much less business than is normal in the closing of the week, on Thursday and Friday.

As we look at the first few weeks in the US in Q3, we saw a lot of that business come right through. So, a lot of the orders that we were chasing at the end of the second quarter have been booked and shipped, as we speak. So, it appears that the strength in the US is kind of back to what we would've expected early in the quarter, and it appears to us to be merely a delay, and not anything more than that at this stage.

But, Dan, just to be sure, that's kind of one factor. We were expecting to be able to close more business. ASMS was more significant on the high-end mass spec side. We think that kind of delayed some existing product orders. That also seems to be a hypothesis that's playing out in what we're seeing early on in the third quarter. So, yes, we did see that weakness.

We are doing our best to understand it. And of course, when you hear the sales management and the sales force say -- gee, I expected to get that order, I expected to be able to ship it, but it didn't -- well, the fact that it did come in the first week in July and then ship the first week in August -- excuse me -- no, first week in July. (Laughter) I'll get there. It adds credibility to that, that's all I think John is saying. Dan, are you still there? Operator?

One moment, please. Ross Muken, Deutsche Bank.

It seems like, to Dan's point, the bigger delta was on the Waters instrument line. If you had to sort of tease out kind of timing effect, based on new product launches, some of the weakness you saw specifically in the US, mass spec versus LC. I'm just trying to get a little more -- bit more color in terms of the components of how you would attribute the delta between whatever the internal forecast was and sort of what was reported on an instrument basis, since that's where it seems to be kind of the major focus point?

Hi Ross. I think that as we look at the areas where we saw the softness develop, I would say that as we look at the government and academic piece, that appears to be much more heavily weighted towards the timing of the new product launches. There's a fair amount of interest in that segment in the new (inaudible), G2-S. We believe that as that product begins to make its way to demo labs and ramps up production across the quarter, that we're likely to see some relief with shipments to that customer base.

There's some orders booked already for that instrument and a lot of interest. And there's no doubt that it had slowed the order ramp post-ASMS, as we began to promote that instrument. Now, we knew some of that was going to happen, and we did anticipate that a backlog build would develop from that; but the backlog build was much larger associated with that instrument than we had estimated.

On the LC side, I would say that there were just a significant number of Pharma accounts in the US that just tailed off business late in the quarter -- and that's the business that's already come in and shipped early in the third quarter. So, we've seen -- we saw a decline in our Pharma business in the US, from about 8% or thereabouts in the first quarter to about a 4% growth in the second quarter; and that seems to have turned right back around and come back to us early in Q3. So, that's a little bit more color on what we've seen in those couple of markets.

And maybe to dig in a bit more, obviously from a macro basis, there was kind of a deterioration in confidence during the time period. You highlighted where you started to see some weakness at the beginning part of July, end of June, just based on all that was going on in Europe and the US on the debt side. You know, if you start to think about the trends you've seen so far in 3Q, obviously, you said it's improved. How well do you think -- if you think about the typical pacing of a normal Q3, how well do you think that sort of characterizes the rest of the trend for the quarter, in the context that -- are the first few weeks of Q3 important? Are the last three weeks? I'm trying to get a sense for how Q3 differs versus other quarters, in terms of typical pacing; and how much confidence we should take in the early trend to read through to the whole quarter?

Well, I think your question is a good one, because three weeks do not a quarter make. We are encouraged, because it specifically points to the issues that we saw in the latter part of the second quarter in the US. And so, we're specifically seeing unusual early strength in that segment of our business coming as we speak. So, it's not like -- gee, a surge in Chinese orders is offsetting weakness in the US. It's -- it kind of adds a clear level of confidence, that what the field was telling us was happening in the latter part of the second quarter seems to be playing out, as they were confident that those orders were coming in. And coming in at a growth level that was over and above what you would expect out of a normal beginning to the quarter.

So, that is clearly encouraging to us. We are still -- we're not taking that current run rate of our business and straight-lining it for the quarter. Frankly, if we did, our growth rate would be much higher. But what it certainly does is give us a level of confidence that our outlook has a degree of credibility to us that's warranted, given the current start to the quarter.

Great. Thanks, Doug.

Doug Schenkel, Cowen.

You guys maintained full-year guidance. You talked about some of the Q2 business shifting into Q3. However, it looks like your expectations for the second half are actually more back-loaded than what the Street was expecting. Specifically, it looks like you guided Q3 maybe below where the Street was on an organic basis -- or certainly, it doesn't look like it was any better than where the Street was -- again, in spite of the fact that some of those Q2 sales seemed to move into Q3. Were we just too aggressive with our Q3 expectations, or is there some reason now that you're now thinking that sales are going to be more back-loaded than certainly what we were expecting previously?

Yes, hi, Doug. I would say that as we look at the ramp-up of the new products, we expect to begin to ship the new G2-S starting in early September. We'll be ramping that up across the third month of the quarter, and certainly ramping it through all of Q4 to meet the demand that we expect for that product. So, the fact that we're early on in preproduction, moving to production in these products gives us a level of confidence that a 9% growth in this quarter, certainly coming into the quarter with a meaningful backlog, makes sense to us.

But we think that, really, the real benefit of these new products is really going to be seen in the fourth quarter. So, there is a little bit of a shift, if you will, associated with these products into the fourth quarter. Additionally, we have a little bit better currency environment, so that plays a little bit of a factor in the fourth quarter, as well as the third quarter. And that -- it's currency that's kind of offsetting the delta in the second quarter, to keep that full-year guidance intact.

Okay. And one quick follow-up -- any chance you would provide a little bit more detail on how much higher book-to-bill was this quarter than the last few quarters, given that you did call that out as a sign that the business was the still strong and improving --?

One level of flavor is that our backlog build was significant in our terms, and it was substantially higher than it is traditionally in the second quarter.

Okay. Great, thanks -- oops, sorry.

Okay?

All right. Thanks for taking the questions, guys.

Jon Groberg, Macquarie.

Maybe just to follow up a little bit on the last one, Doug or John. Given the shortfall in the second quarter and outlook for the third quarter, why maintain guidance here? I guess that it looks pretty aggressive at this point. And just given the fact that you just witnessed in the second quarter, you don't always have the best visibility in terms of what's going to happen. Any thoughts as to maybe tempering guidance a little bit, and then seeing if things play out better than you expect?

Well, John, as you know, through many, many years of this, we try, through all of our inputs, to draw a pretty mid-line between a conservative outlook, a liberal outlook, and a mainline outlook of what we see. We certainly saw a slower close to the second quarter than we anticipated, and that would've tempered our outlook somewhat for the coming year. But when we roll up all the factors, we look at the new product launches, we look at the backlog position, we look at our current run rate of our business, we look at the field inputs, and we draw that middle line, we say -- we don't want to yo-yo people, we don't want to yo-yo our own organization into allowing spending to creep up a little bit, and then to haul it back.

So, we think we're -- we have a forecast for the rest of the year and guidance here that's at the same level of credibility that we would normally have. It doesn't make it a dead solid cinch, but neither does it make it an extraordinary amount of risk that goes into it. We think we're drawing that same middle line with an opportunity. You've seen us in previous quarters exceed our guidance. And somebody might have said -- well, you sandbagged it. Well, we don't think we sandbag. We think we kind of have the opportunity to exceed these numbers, and there's some risk, as we saw this last quarter, that we might underachieve them. But we haven't changed our practice, I guess that's my -- and yes, you could say, arbitrarily, take it down by some arbitrary number. But we don't -- that's not our policy and that's not our practice, so we haven't done it.

Okay, fair enough. If I could just follow-up then, you mentioned Pharma got weak, I think, in the US in the second quarter, but it seems -- that was one that seemed to rebound. Where do you currently sit in terms of your comfort level with replacement market brewing in the QA/QC market for Pharma, and kind of the timing of that?

Well, as John said, the specific area where we saw the most softness was in the US. And that's the specific area where we've seen the most rebound coming in our current results in the third quarter. So, I think that's an encouraging dynamic. We had a pretty good first quarter in the US. We anticipated that to continue. It was less robust than we thought.

And the H-Class actually did pretty well in the quarter -- in spite of the overall results, the original ACQUITY saw some meaningful softness and some shift to the I-Class. We did, obviously, see some reduction in the growth in both H-Class and Alliance, but those two have come right back around, as Doug said, as we enter the third quarter. The I-Class will begin shipping late August, and we expect to see growth in the research-grade side of the LC market, once we put that I-Class back into position in the second half of the quarter.

Okay, great. Thanks a million.

Peter Lawson, Mizuho Securities.

Doug, wonder if you could toss out the slowing growth you saw in Pharma, how -- whether it's large, small, generic, [CROs], and which businesses bounced back?

I'm sorry Peter, I missed half of that question. Can you repeat that?

It's just regarding the slowing growth in Pharma, and could you parse that out? I know you have large, small, generic CROs [passed] into the same group. Wonder if you could break that out.

Yes. I think we saw, particularly in the US, the slowing would be most dominated by the large accounts. So, that's where -- and that's typically where we have pretty good visibility. And that's also where we're seeing a number of those orders come in early in the third quarter. So, I would say it's mainly a large account dynamic. That doesn't necessarily mean ethical. We now have some very large bio and generic accounts. But I'd say the weakness that we saw was in the large accounts.

And then, the strength in the TA business, what's the outlook there? And is that predominantly driven by Asia?

You know, probably our highest growth was in the developing world, including Asia, Latin America, and Eastern Europe. But TA's remarkably consistent across geographies. And I would say it'll be interesting as the new DSC really gets rolling, and we've really just started rolling that out, you'd expect that to get the most play in your most sophisticated accounts. And that would have an impact in the US and in Western Europe. So, I'm optimistic that TA could even surprise us a little, although Terry Kelly would deny that to me. But I think they have a good roll-on.

Great. Thanks so much.

Amit Bhalla, Citi.

I wanted to know if you could just expand a little bit on the industrial end markets. You talked about some softness in US and Europe, so could you get into a little more detail there?

Yes, John. You want to start with that?

Sure. I would say the traditional chemical industry accounts were the area where we were the softest. So, the large producers that we all know had a somewhat softer quarter in Q2 versus prior year. Where we saw strength continued to be in the applied markets -- so food safety, the environmental beverage, we continued to see an uptake of our instrument systems there, our triple quadrupole placements were actually pretty good in those areas. So, that's somewhat a continuation of a trend that we saw coming into the quarter, and not really too much of a surprise. It's really the applied markets that have been driving growth, and that's continuing as we speak.

And how much of the food safety component is coming from new legislation versus just traditional growth in that market?

I don't think we're seeing a lot of dynamic from new legislation. But most of it's coming from applications and accounts that we've identified in our traditional lines. And the impact of that legislation is still yet to be seen.

Okay. And just quickly on the academic government side in the US, your outlook is for that to be just continued weakness, but you have new products coming in to help your business growth. But overall, outlook will be weak for the market. Is that fair?

Yes. I think we're expecting that the market dynamic is going to be flattish. We think that we have the opportunity to do better with the new product, because we saw weakness in kind of the cutting edge proteomics mix and life science research. Those applications tend to be higher on the priority list for spending, and we know we saw some delays as a result of the G2-S introduction that go into those applications. But we are still reluctant to bank too much on that whole market, because of the uncertainty of funding. So, that doesn't factor significantly into our expectations for growth for the second half.

Okay, great. Thank you.

Tycho Peterson, JPMorgan.

Sorry to dial in on the Pharma dynamic again, but just to be clear, was the slowdown -- and obviously, things have picked up this quarter. But was the slowdown there a function of Pharma evaluating some of the new product cycles, or was there something more to it? And can you just talk, along those lines, about how you're thinking about I-Class going into Pharma discovery, when you launch it in the third quarter?

Yes. I wish I could be very definitive about it, Tycho. You know, we saw good performance there in the first quarter, and then it slowed a bit in the second quarter. H-Class continues to do well, although it grew at a slower rate than in the first quarter. We clearly saw, in some of the higher-end research applications, customers wanting to wait -- because the I-Class that we introduced clearly has kind of eye-popping performance. And so, in those front-end research applications, where performance kind of controls, I think we clearly saw a delay in ACQUITY orders because of the introduction of the I-Class, and we won't be shipping that until the third quarter.

So, that's something we can specifically point to. And other than that, traditionally, I'd say we see the big Pharma accounts delaying their capital spend at the front end of the year. And sometimes they delay it right up until the fourth quarter -- that doesn't mean they don't spend anything, but they hold back significant pieces of those capital budgets. We thought, with the first-quarter performance, that we saw a difference there; and yet, in the second quarter, we saw some reluctance to spend in those large accounts. Now, I'll tell you, we have looked exhaustively at competitive dynamics, and -- did an account -- did we lose share in specific accounts?

I can tell you unequivocally that we don't think that that dynamic is occurring. Clearly, we don't have 100% of the market; and clearly, we lose some bids and win others. But as a broad characterization, this was not a competitive dynamic that we saw in the second quarter. And again, we see some signs that it could well have been temporary. Now, whether that was because these accounts worried about macroeconomics or they worried about regulation, it's hard to tell. But we do see some signs that it's not continuing into the third quarter.

And how are you thinking about your own level of spending? I mean, you've always talked about -- that going to be somewhat dependent on top-line growth. And understanding you're not changing the guidance for the year, but are you holding back a little bit on spending in the near term, or how you think about --?

I think we're being careful. I think -- again, it's important to recognize that in 2010, we were pretty conservative with our spending plans through the first half of the year. And then, you can see that as our volume increased, we increased our SG&A spending as the year went along. So, we had tough compares in the first half of 2011, versus that tighter spending situation in the first half of 2010. As we go through this year, those comparisons clearly get easier.

But in the second quarter, we did spend more, given the robustness of that new product position, particularly on the G2-S and the new I-Class. So, we're not going to have to repeat that as we go through the year. I think the second quarter was a little bit of an anomaly, as you look at our SG&A spending. John, would you agree with that?

No, I would agree. And I would say, certainly, by the time you get to the fourth quarter, we're going to have a very favorable comparison and you're going to see the SG&A growth come down dramatically. In the third quarter, there is still a little bit of a difficult comparison, and SG&A is likely to be a little less than sales. In the second quarter, we had the ASMS rollout; we had a number of costs associated with that, including a large number of people that we sent to the show, given a large user meeting and the like that was there. So, there's no doubt that the spend will decline on those types of activities as we make our way through the back half of the year, and you'll see SG&A become more rational as we exit the year.

And then, geographically, looks like Europe was okay, up about 6%. We've seen some other data points in the space that suggest that Europe's gotten a little bit softer. Have you seen anything thus far in the third quarter that indicates a change in sentiment in Europe?

No. I'd say, particularly -- the area of Europe that I have been -- had a higher level of concern with is Western Europe, the traditional -- and historically, where I've been more worried is the large countries. But in general, particularly the UK has been very good. Germany's been good. France, maybe a little bit lighter. And in many of the areas we've seen macro government issues, we're not seeing the issues in our accounts. So, Western Europe has been remarkably resilient through this, and the Eastern areas have been very strong. So, we clearly continue to see some investment of those traditional Western European companies being put into the areas in Eastern Europe. But even despite that, we're seeing good performance in our traditional Western European geographies.

And then, one last quick one -- you guys had more of an emphasis, it seemed like, on software earlier this year at Pittcon. Are you seeing software as a vehicle to kind of drive instrument sales? And can you talk about UNIFI and how you are viewing the software [portfolio]?

Well, Tycho, to be fair, software has always been an important part of our systems approach. And I think, certainly in the sophisticated user community, going back to our Millenium -- going back even before Millennium, but Millennium and Empower have had overwhelming market shares in those applications. But of course, when mass spec became a more significant part of our product line and the various software products proliferated between HPLC and mass spec, that's when we saw the need to really manage this within one platform, and that was the birth of UNIFI.

I think it's been a long haul, it's been a massive project, and you're beginning to see us move into the market with the early iterations of it, particularly with our introduction of the Bio product earlier this year. But the real significant launches that come over the next year and a half, as UNIFI really kind of replaces our existing software platforms, we think that's going to be a major significant market-moving dynamic, but it's not going to come this year. And so, it's a very important strategic position for us. You may see the results kind of embodied within a system sale, as opposed to an individual software sale; but you're absolutely right that it's an important part of our R&D spending and it's an important strategic part of our future system sales.

Great. Thank you very much.

Quintin Lai with Robert W. Baird.

On the SG&A line -- so, you talked about the new product launches. You also talked about FX. Were there some FX volatility in the quarter that you didn't expect, that caused the number to be higher? And then, as you look out in the back half of the year, could you repeat again what you said in the prepared remarks about your FX expectations with respect to margins?

Yes. As it relates to the second quarter, we had a expectation that currency would lift expenses by 5%. And instead of that, the expenses were lifted about 6.5%, associated with currency. So, the -- versus original expectations, we had a somewhat start stronger euro then I had originally forecast, and that lifted the expenses in the European area, that lifted about 1.5% the overall translated costs versus the original plan. So, that was about a half of the overage in SG&A, that -- versus what I had expected. And then, secondly, we had about another 1.5% growth in SG&A organically, associated with the activities around the new products, that we felt was warranted given the impact that those products would have later in the year. (Multiple speakers)

And as it relates in the second half, our guidance on currency, we said the currency in the third quarter would be four points of [pleasure on the top line]. That will be modestly accretive to the gross margin performance. Gross margins, as a percent of sales, I think will be very comparable to what we saw in the second quarter. And in the fourth quarter, it looks like currency is going to be about 2% positive, based on where rates are today.

And then, as a follow-up, Doug, you -- appreciate the color on what you see in terms of the competitive environment and market share. What are you seeing in ASPs? Are your products, especially the new products, are the customers comfortable with that? Or are they expecting maybe more discounting, given their budgetary pressures?

Well, I think you can see from our margins that we're not seeing extraordinary discounting, Quintin. And I would say that we're not facing anything unusual. We still see that customer -- frankly, you can just look at the products, look at the G2-S, it is the high end of the mass spec product line, and it's premium priced, not discount priced. You always, in individual competitive situations, have customers who might be trying to get an extra point or two of discount. That's kind of noise level in our business.

I wouldn't say that there's any overall dynamic that suggest that prices are going downstream. I think they're holding, and the product mix may actually be suggesting it [leans more]. You know, the I-Class is a more premium-priced product than the ACQUITY that it will ultimately replace. The G2-S is a higher-end product. So -- and the DSC in TA's world has very good prices and very good margins. So, I just don't see any overall dynamic that would lead me in that direction.

Thanks for the color. Appreciate it.

Isaac Ro, Goldman Sachs.

Just wanted to ask -- first one, on Pharma spending, could you maybe speak to any customer concentration that might have impacted the late second-quarter dynamic that you mentioned? And then, could you also comment on any progress you had that was measurable regarding attach rates for a H-Class columns this quarter?

I'm sorry, Isaac -- the concentration question, could you repeat that?

Yes. Was there any handful of large Pharma customers that really drove the dynamic late in the quarter that you mentioned around the Fourth of July, or was it more broad-based among a range of large pharmas?

Yes, there were a couple absolutely notable ones that we're working, that we thought would close in the second quarter, that ultimately closed in the first two weeks of July. So, I'd say we can point to specific issues. But I'd say the overall dynamic of the large Pharma accounts being softer in the second quarter than the first quarter wasn't a one or a two. That was a broader dynamic. It's never 100%. I mean, we had some good performing accounts, but it was more broad-based than we expected, particularly coming out of the first quarter.

Got you. And then, a follow-up was on the attach rates for the H-Class columns. Any notable uptick in the attach rates? And then, another question on expenses.

I wouldn't say noticeable uptick. It still continues to be good.

Right. The chemistry growth was double-digit, actually, this quarter. And it was the ACQUITY columns that really drove that increase; attaching it specifically to H-Class versus traditional ACQUITY is hard. But certainly, the ACQUITY columns continued to be the driver of growth in the chemistry business and pushing it to double digits.

Got it. And then, just one last one from me, on expenses. Gross margins there looked a little bit better, and wondering how we should think about the impact of the continued volume ramp in H-Class for the back half of the year, and what that impact will be on gross margins. And then, along with that, I think you mentioned the SG&A run rate having had a bit of a blip in the second quarter, related to ASMS. Is that the right run rate to look at in the back half, exclusive of your revenue ramp?

Yes. I said -- as it relates to margins in the third quarter, I said that you'd see the gross margin percentage being comparable to what you saw in the second. Could the H-Class placements drive that a little bit higher? I mean, that's possible. But my model right now would suggest that you think about the third quarter having a gross margin percentage comparable to the second quarter. That will actually be a fairly good relative comparison to Q3 last year, where the margins were under 60%.

And then, in the fourth quarter, the volume leverage typically pushes the gross margins even beyond the high end of the range that I supplied, the 61%, pushing the full-year, then, somewhere between 60.5% and 61%. So, I'd say the new products are likely to somewhat favorably affect margins, but that's kind of built in, to some extent, to the model that I'm describing to you. On SG&A, we're looking at still a little bit more of a difficult comparison in the third quarter, so I'm going to model SG&A growing about with sales there,

And that does include four points of currency translation. And then, by the fourth quarter, you're going to see the SG&A growth rate be maybe half the growth rate thereabouts of what you see on the sales line, as a result of a rather easy base of comparison, as we had a growth in the expenses in the fourth quarter and we had an overage in the fourth quarter's performance where there was a bit more variable compensation cost included in the fourth quarter that we've spread across the quarters this year.

Got it, got it. Okay, thanks very much.

(Operator Instructions) Tony Butler, Barclays Capital.

I just wanted to round out the comments on geography. Doug, could you just comment on India, and India alone? And then, the second question is -- and again, apologies for increasing questions on the pharmaceutical side end market. But could you focus some thoughts or some questions around just the generic manufacturers? What are you seeing there? Has that been a change, as well? And had that been part of the delay in Q2, or has that been a steady run rate? Thanks very much.

Sure, Tony. India continues to do well. It is true that India did a little slower growth in the quarter than they had in the last couple quarters. But I don't think it's anything extraordinary. They had always planned that this quarter -- it was up against a good comparison last year, and I don't think it's anything to particularly worry about. We are still anticipating good double-digit growth coming out of India in the second half. So, I think India continues to be a situation that is consistent with what we've seen for the past year or so.

Generics were, I'd say, consistent with the experience that we had across the Pharma. We had some very good performance, some not so good performance, and overall, we saw a slower growth rate in generics in the second quarter than we did in the first. Again, we don't think that's related to any consistent dynamic. We think that's the -- just almost serendipity. We don't hear a consistent story coming out of those. We fully expect that we're going to continue to see good growth coming out of generics as we go along. So --

It was a rather tough comp on the generics.

It was a tough comp in the second quarter of last year. And we see nothing out of those accounts, other than good long-term expectations of higher investments.

Thanks, Doug.

(inaudible), Gleacher.

So, you guys launched a lot of products in the last 12, 18 months. And could you maybe prioritize or rank for us the biggest growth drivers going forward from these product launches? And also, maybe talk about how much growth, going forward, is coming from market expansion versus product replacement cycles? Thanks.

Sure. I think in the very near past -- last year we launched the TQS tandem quadrupole that was specifically aimed at taking some share in the regulated bioanalysis marketplace. And this year, we combined that with the new I-Class for regulated bioanalysis systems. So, that I-Class was just launched at ASMS. We didn't see any result of that in our second-quarter results, but the TQS has had excellent response in the marketplace, has led to good strong double-digit [triple-quad] performance consistently since its introduction, and we anticipate that continuing to happen.

The new TQD that we launched at ASMS -- again, we'll start to see results from that in the second half of this year. We're doing well in the applied markets; that's principally where we'll focus the TQD -- the Xevo TQD, as we're terming it. And I think that will continue the momentum there. The second-half results will probably most be affected by the SYNAPT G2-S, where -- we launched that at ASMS, we're already seeing response in our order rates. We're expecting significant shipments of that in the end of the third quarter and into the fourth quarter,

So, I would say that on the high-end side, the I-Class introduction on the UPLC front, I think marks a further pushing of the envelope in the UPLC sphere. This, by far, will be the best-performing UPLC. We expect that it will dominate the front ends of mass spectrometers, and should take a good position in classic UPLC application in those high-end research applications. So, I guess that's the order that I'd suggest. Good [possibility] in regulated bioanalysis from the TQS and the I-Class. And we expect strong results from the SYNAPT G2-S.

Great, thank you.

I think, Operator, in the interest of time, we can probably take one more question.

Thank you. Paul Knight, CLSA.

Doug, did academic get better as the quarter concluded?

No. I'd say it was a pretty consistent -- I mean, we really saw that -- it became more reinforced, I'd say, as the quarter went along, but it wasn't --

And it was really, I'd say, post-ASMS that we really began to see more interest than we originally anticipated in some of the -- specifically, the G2-S. And the business there tailed off meaningfully after that and has created some order backlog since then, but it was really -- that one was more pronounced, associated with the new product offerings.

Okay. Thanks.

Okay. I think -- I appreciate everybody staying on, even a little past our normal stop time. And hopefully we covered all those questions. If you have any more, I'm sure Gene and John will be standing by to answer the more detailed financial questions. And we look forward to updating you next quarter. Thank you all for sticking with us.

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