Waters Corp (WAT) 2018 Q4 法說會逐字稿

Good morning. Welcome to the Waters Corporation Fourth Quarter 2018 Financial Results Conference Call. (Operator Instructions) This conference call is being recorded. If anyone has objections, please disconnect at this time.

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

Thank you, operator. Good morning, everyone, and welcome to the Waters Corporation fourth quarter earnings conference call.

Before we begin, I will cover the cautionary language. During the course of this conference call, we will make various forward-looking statements regarding future events or future financial performance of the company. In particular, we will provide guidance regarding possible future income statement results of the company for the first quarter and full year 2019. We caution you that all such statements are only predictions and that actual events or results may differ materially.

For a detailed discussion of some of the risks and contingencies that could cause our actual performance to differ significantly from our present expectations, see our annual report on Form 10-K for the fiscal year ended December 31, 2017, in Part 1 under the caption Risk Factors, and the cautionary language included in this morning's press release and 8-K.

We further caution you that the company does not obligate or commit itself by providing this guidance to update predictions. We do not plan to update predictions regarding possible future income statement results, except during our regularly scheduled quarterly earnings release conference calls and webcasts. The earnings -- the next earnings release call and webcast is currently planned for April 23, 2019.

During today's call, we will be referring to certain non-GAAP financial measures. Reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures are attached to our earnings press release issued this morning. In our discussions of the results of operations, we may refer to pro forma results, which exclude the impact of items such as those outlined in our schedule titled, Reconciliation of GAAP to Adjusted Non-GAAP Financials, included in this morning's press release.

Unless we say otherwise, references to quarterly results increases or decreases are in comparison to the fourth quarter of fiscal year 2017. In addition, unless we say otherwise, all year-over-year revenue growth rates, including revenue growth ranges given on today's call, are given on a comparable constant-currency basis.

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

Thanks, Bryan, and good morning, everyone. Thank you for joining us today. Along with Bryan Brokmeier, joining me on this morning's call is Sherry Buck, Waters' Chief Financial Officer.

During today's call, I will provide an overview of our fourth quarter and full year 2018 operating results as well as some broader commentary on our business. Sherry will then review our financial results in detail and provide commentary on our first quarter and full year 2019 financial outlook. We will then open up the line to take your questions.

Jumping right in, I'm pleased with our fourth quarter results, particularly given the dynamics of the business earlier in the year, as we delivered growth across all 3 of our broad market categories and demonstrated strength in key geographies and product lines.

Geographically, we saw continued strong performance in China in Q4 as well as strengthening in the United States, offsetting expected softness in Europe and India as we closed out the year. Q4 product sales included continued strength in demand for stand-alone liquid chromatography systems, our expected rebound in sales for thermal analysis systems after a temporary Q3 dip and increasingly positive signals in demand for our mass spec technologies.

Furthermore, steady reoccurring revenues contributed to our strong finish in 2018. Overall, our fourth quarter revenues grew 5%, and adjusted earnings per share grew 14% versus prior year Q4. On a full year 2018 basis, revenues grew 4% and earnings per share grew 11%.

Taking a closer look at the business, starting with a review of our market categories at the corporate level, sales to every major market category were up for the quarter and for the year. Fourth quarter sales to our broadly defined pharmaceutical category increased 7% year-over-year, driven by double-digit growth in China and the aforementioned pickup in the United States, partially offset by expected softness in both European and Indian pharma markets. Importantly, demand for our LC product line remains strong outside of market-related pockets of weakness in Europe and India.

For the full year 2018, overall sales to our pharmaceutical category grew 4%. In total, our 2018 results were characterized by strong performance with pharmaceutical customers, including steady growth in small molecule and robust growth in large molecule.

As noted before, our pharmaceutical category also includes sales to biomedical research customers, which were down for the year, partially offsetting strength noted above with our pharmaceutical customers. We feel very good about our pharma market position, including both small molecule applications as well as the ever-increasing application requirements of our large molecule customers. The investment environment in pharma remains robust, particularly as it relates to the increasing pace of innovation on new biologic drugs.

Fourth quarter sales to our worldwide industrial category, which includes material science, food and environmental markets, grew 2% year-over-year, led by strength in material science. Industrial growth for the full year was 1%.

Sales within our TA brand bounced back from Q3 as we expected, resulting in 7% TA growth for both the fourth quarter and the full year. Our strong TA performance gives us confidence in the positive outlook for our industrial category as volume in our thermal and rheology product lines has historically been our best proxy for industrial end-market demand.

Sales into our governmental and academic category increased by 3% in the fourth quarter with strong growth in Asia, partially offset by softer demand in Europe and the Americas. Weakness in biomedical research applications was more than offset by strength in pharmaceutical discovery. For the full year 2018, sales into our governmental and academic categories were up 7% over 2017.

Next up, we'll review our sales performance by geography at the corporate level. Asia, our largest region in terms of revenue, was up 9% in the fourth quarter on strong double-digit growth in China as well as great performances in Korea and Japan. Demand in China continues to be robust and in Q4, was led by strong growth in pharma. Our Indian business was about flat on a year-over-year basis in Q4, although for context, Q4 in 2017 was the largest quarter of sales in our history in India.

The pharma environment in India appears to be improving with customers operating at increasing instrument utilization, which bodes well for future instrument purchases. Additionally, we are seeing encouraging development of other Indian growth opportunities, particularly in food safety testing. For the full year, Asia grew 6%, again, highlighted by double-digit growth in China.

Turning to the Americas. Overall, sales grew 6% in the quarter with sales within the U.S. growing 5%. Growth in the U.S. was broad-based across key end markets and product lines. We were particularly encouraged by the pickup in spending from large pharmaceutical customers in the United States, who had been more cautious in the first half of the year. For the full year, sales in the Americas were up 3% with the U.S. growing 2%.

In Europe, sales were down 1% in the quarter as pharmaceutical growth was not sufficient to offset weakness in both industrial and governmental and academic. Central and southern Europe were both strong, offset by northern and eastern Europe, largely due to macro factors including concerns related to Brexit and Turkey. Overall, Europe played out as we expected in Q4. For the full year, Europe grew 1%.

Finally, I will review product line dynamics within our Waters and TA brands. Waters-branded instrument sales were up 3% in the quarter and were flat for the full year with strength in liquid chromatography instruments. Our overall LC sales growth was largely driven by QA/QC demands in drug production with strong growth across most major geographies, further reinforcing the strength of our LC position in regulated markets.

Our mass spectrometry product line continued to show signs of improvement in the fourth quarter, including continued stabilization in our high-resolution mass spec portfolio. In particular, we were encouraged by the strong mass spec growth in our pharma business, which was mostly offset by weakness in biomedical research.

During the quarter, we also began shipping the recently launched RenataDX, our next-generation screening system for high-throughput general-use clinical diagnostics. This fully integrated benchtop system is an open platform with proven reliable and robust performance, and it builds upon Waters' 20 years of experience serving the needs of newborn screening and general clinical diagnostic laboratories. We are looking forward to further strengthening our mass spec product line in 2019 across multiple categories.

Waters-branded recurring revenues, which reflect the combination of service and precision chemistries, grew 6% in the quarter. Leading this performance were our chemistries, which grew 8% year-over-year, further emphasizing the recurring nature of our business model. This continued strength in our recurring revenues was driven by global strength in service plans, application kits, UPLC columns and bio separations columns. For the full year, our service and chemistry revenues both grew 6%, indicative of strong utilization rates for the installed base of Waters instruments.

Turning to our TA product lines. Sales increased 7% in both the fourth quarter and for the full year. Q4 instrument system sales for TA increased by 6%, and service grew 10%. For the full year, TA Instrument system sales grew 6%, and service grew 9%. There was broad-based sales growth across our key thermal analysis, rheology and ElectroForce product lines in the quarter and for the full year. We are paying close attention to the dynamic macro conditions affecting the industrial markets, but we continue to see strength in our TA business. Furthermore, we are still relatively early in the broader product cycle of our discovery line of thermal analyzers.

In summary, I'm pleased that Waters ended 2018 on a high note, with improving momentum in key market categories, products and geographies. I was particularly encouraged by strength in our pharmaceutical category, our liquid chromatography and TA product lines in China as well as strengthening performance in the United States. And looking at the P&L, we maintained strong operating discipline all year long, while investing heavily in R&D and exceeding our earnings expectations for both the quarter and the year.

Looking ahead to 2019, I'd like to start by reiterating that we remain steadfastly focused on executing on our 5-point value-creation model. As we regularly communicate, we aim to create shareholder value by: first, holding a focused and highly differentiated leadership position in structurally attractive markets; second, executing a clear growth strategy driven by organic innovation; third, seeking the opportunity for continuous operational improvement; fourth, being a disciplined capital allocator; and fifth, operating with a performance-oriented culture and management team.

We have now turned the page to 2019, and I'm truly looking forward to what lies ahead. While Sherry will provide further detail, our outlook for 2019 is based on 4 key factors: first, generally positive end-market dynamics; second, building on the momentum we have coming off a robust Q4; third, the benefits of a new product introduction cycle; and fourth, the continued implementation of our enhanced capital deployment plan, which starts with investing more assertively to grow the business and also includes working to optimize our balance sheet and return more capital to shareholders. In particular, I'm very excited about our innovation efforts. We continue to prioritize and invest in organic product development with full year 2018 R&D investments up 8%, growing consistently faster than sales.

While we continue to evaluate select external technologies to supplement our overall innovation formula, it is our internal product development efforts that have our organization so energized for 2019. We are looking to benefit from the increased pace of product launches we saw in 2018. But more significantly, we will be launching several major new systems in 2019 that form the foundation for an exciting new product cycle.

Our current innovation efforts are highlighted by yesterday's launch of the BioAccord LC-MS system. The pace of innovation in the biopharmaceutical industry is clearly accelerating, and with that, we are seeing increasing requirements by our customers and regulators in monitoring multiple critical quality attributes.

Waters designed the BioAccord System as a fit-for-purpose LC-MS solution for large molecule applications. For the first time in history, Waters is now delivering the benefit of rich, time-of-flight mass spectrometry data in routine workflows for improved productivity, more effective decision-making and enhanced regulatory compliance.

We have long invested in a robust channel serving this target market, and we have already received a significant amount of positive feedback from our customers through our early access program. Sales activities are now underway. We have already shipped revenue units, and we eagerly await further customer feedback and experience. We'll provide further detail on our BioAccord strategy at our upcoming Investor Day on February 28, 2019, in New York City.

With that, I'd like to pass the call over to Sherry Buck for a deeper review of our fourth quarter financials. Sherry?

Thank you, Chris, and good morning, everyone.

In the fourth quarter, we recorded net sales of $715 million, an increase of approximately 5% in constant currency. Currency translation decreased sales growth by approximately 1%, resulting in 4% sales growth as reported. For the full year, sales grew by 4% before currency translation, which increased sales growth by 1%, resulting in 5% full year sales growth as reported.

In the quarter, sales into our pharmaceutical market category grew 7%, our industrial category grew 2%, and sales into our governmental and academic market category grew 3%. For the full year, the pharmaceutical market category grew 4%, our industrial market category grew 1%, and sales to governmental and academic customers were up 7%.

Looking at product line growth. Our recurring revenue, which represents the combination of precision chemistry products and service revenue, grew 6% in the quarter, while instrument sales grew 4%. For the full year, recurring revenue grew 6% while sales of our instrument product groups grew 1%.

As we noted last quarter, recurring sales were impacted by 1 additional calendar day in the quarter, which resulted in a slight increase in service revenue sales. Looking ahead, there is 1 less calendar day in the first quarter and 1 additional calendar day in the fourth quarter of 2019 compared to 2018.

Breaking Q4 product sales down further. Sales related to Waters-branded products and services grew 5%, while sales of TA-branded products grew 7%. Combined LC and LC-MS instrument platform sales were up 3%, and TA's instrumentation system sales were up 36%. Our total recurring revenues, which include both Waters and TA products, grew by 6%.

Looking at our growth rates in the fourth quarter geographically and on a constant-currency basis, sales in Asia were up 9%, led by 15% growth in China; sales in Americas were up 6%, with 5% growth in the U.S.; and European sales were down 1%.

Now I'd like to comment on our fourth quarter non-GAAP financial performance versus the prior year. Gross margin was 59.9% for the fourth quarter of 2018 compared to 60.6% in the fourth quarter of 2017. The lower gross margin relative to the prior year quarter was driven by quarter-specific mix of our business. For the full year, gross margin was in line with our expectations of 59% and was unchanged compared to the prior full year.

Moving down the fourth quarter P&L. Operating expenses increased by approximately 3% on a constant-currency basis, and foreign currency translation decreased operating expense growth by approximately 1% on a reported basis.

In the quarter, our effective operating tax rate was 12% versus 12.8% in the prior year quarter. The lower tax rate is a result of U.S. tax reform updates and a shift in the mix of profits in our tax jurisdictions.

Net interest expense was $1 million, down from $4 million in the prior year, benefiting from reduced debt levels. Our average share count came in at 75.3 million shares or approximately 4.1 million shares lower than in the fourth quarter of last year. This is a net effect of our ongoing share repurchase program.

Our non-GAAP earnings per diluted share for the fourth quarter were up 14% to $2.87 in comparison to earnings of $2.51 last year. On a GAAP basis, our earnings per share were $2.46 versus a loss of $4.44 last year. Our GAAP earnings in Q4 2017 included the impact of a tax expense charge of $550 million that we incurred as a result of U.S. tax reform.

For the full year, our non-GAAP earnings per fully diluted share were up 11% to $8.29 per share versus $7.49 last year. On a GAAP basis, full year earnings per share were $7.65 versus $0.25 in 2017. A reconciliation of our GAAP to non-GAAP earnings can be found in the press release that we issued this morning.

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

In the fourth quarter of 2018, free cash flow came in at $160 million after funding $32 million of capital expenditures. Excluded from free cash flow were $6 million related to the settlement of the U.S. pension plan and $5 million related to the investment in our Taunton precision chemistry operation. In the fourth quarter, this resulted in $0.22 of each dollar of sales converted into free cash flow and $0.25 for full year 2018.

Now I'd like to update you on our fourth quarter activities related to capital deployment, which, as we shared before, are prioritized into 3 buckets: first, invest in the business; second, maintain our balance sheet strength and flexibility; and third, return capital to shareholders.

In terms of investing in the business, during the fourth quarter, R&D grew 10% on a constant-currency basis in support of organic innovation. Also during the fourth quarter, we terminated our U.S. pension plan to derisk the balance sheet, resulting in a $46 million charge, of which $40 million was noncash.

In terms of returning capital to shareholders during the quarter, we repurchased 2.6 million shares of our common stock for $498 million. For the full year 2018, we repurchased 6.7 million shares for $1.3 billion. These capital allocation activities, along with our free cash flow, resulted in cash and short-term investments of $1.7 billion and debt of $1.1 billion on our balance sheet at the end of the quarter, resulting in a net cash position of approximately $600 million.

Looking ahead, we remain committed to deploying capital against these 3 priorities, starting with investing in the business through both organic and inorganic opportunities. Furthermore, in 2019, we plan to utilize our balance sheet in working towards a near-term capital structure of approximately 2.5x net debt-to-EBITDA ratio.

Towards that end, we currently plan to repurchase up to $750 million in shares in the first quarter and approximately $2.5 billion for the full year. These assumptions are reflected in our 2019 guidance. Over the course of the year, we will evaluate the pace and level of repurchases and provide quarterly updates on our plans.

In support of the share repurchase plans in 2019, and as noted in our press release this morning, the board has authorized the repurchase of up to $4 billion of share repurchases, targeted to be completed over a 2-year period. This authorization replaces our pre-existing programs.

Turning to working capital. Accounts receivable days sales outstanding increased to 74 days this quarter, up from 71 days in the fourth quarter of last year. In the quarter, inventories increased by approximately $21 million in comparison to the prior year quarter, which is in line with historical trends.

As we look forward to the balance of the year, I'd like to comment on our full year 2019 guidance. Our outlook assumes generally positive end-market dynamics, continued growth in our recurring revenue and incremental contribution from new products. Geographically, we assume continued strength in China and improved conditions in India, U.S. and Europe. These dynamics support full year 2019 guidance for constant-currency sales growth of 4% to 6%. At current rates, currency translation is assumed to decrease 2019 sales growth by 1 to 2 percentage points.

Gross margin guidance for the year is expected to be consistent with our historical trends of approximately 59%. Our plan for the full year is to manage operating expense growth at a rate that is less than our sales growth.

Moving below the operating income line. Net interest expense is expected to be $30 million to $35 million, an increase compared to 2018 as a result of our plans to utilize our balance sheet over the course of the year, as noted in my earlier remarks. Our full year effective tax rate is estimated to be in the range of 14% to 15%. Our guidance regarding capital allocation assumes share repurchases during the year, which would result in an average diluted share count of 68.5 million to 69 million shares outstanding.

Rolling all this together on a non-GAAP basis, full year 2019 earnings per fully diluted share are expected to be in the range of $9.20 to $9.45, which assumes an approximate 1 percentage point negative impact from currency translation at current rates. Looking at the first quarter of 2019, we expect 4% to 6% constant currency sales growth. At today's rates, currency translation is expected to decrease first quarter sales growth by 2 to 3 percentage points.

Combining these top line factors with a moderate increase in expenses, we estimate first quarter non-GAAP earnings per diluted share in the range of $1.65 to $1.75, which assumes an approximate 3 percentage point negative impact from currency translation at current rates. Additionally, we expect an increase in our tax rate in Q1 of about 3% due to the timing of discrete items in the prior year quarter.

I would like to pass the call back to Chris to make a few summary comments. Chris?

Great. Thank you, Sherry. In summary, we were pleased to end 2018 on a high note with solid momentum in our key business drivers, and we are excited about the year ahead in 2019, highlighted by our new product cycle and enhanced capital deployment activities.

With that, we will now begin the question-and-answer session. (Operator Instructions) Operator?

Yes, the first question in the queue is from Stephen Beuchaw with Morgan Stanley.

I would love to just get a couple of detail on how you're pulling together the top line outlook for 2019. Maybe I'll ask a 2-parter, and then I'll get back in queue. I guess, maybe the most important one is, how are you thinking about hardware growth in the 2019 outlook, given the commentary on BioAccord now out in the market, and it sounds like you anticipate a cadence of further product launches throughout the year. So the balance between hardware and consumables or recurring revenue growth will be my first question. And then the second part of my very long-winded 2-parter is, can you just talk through expectations for some of the regions in 2019, particularly India and China? And then maybe any commentary on Europe given what we've seen in the quarter would be great. And I'll jump back in queue.

Great. Thanks, Steve. Appreciate the questions, and I will take a crack at some of these and have Sherry supplement in terms of how we're thinking about '19 overall. But really, starting at your first -- the first part of your question, Steve, the mix between recurring and hardware. It's a good reminder to all of us that we do have that steady, recurring revenue of chemistry and service. And even in the type of year we have behind us, those lines were really steady, both growing 6%. And so looking forward and not assuming everything goes perfectly right, we expect continued contribution of our recurring revenues as a nice foundation. With that being said, we are looking at the instrument business, if you will, and looking at a year that should firm up. We definitely showed some improvement as we got towards the end of the year really across the board in our instrument business, that's LC mass spec as well as TA Instruments. And of course, as noted in the commentary, we're very excited about new product launches. At this point, I'm not going to put a lot of specificity around what we expect relative to, say, the BioAccord launch, other than to say that that type of technology gives us greater confidence in our instrument outlook for the year and then, of course, as you allude to, will be supplemented by other instrument launches throughout the year. So with respect to the regions and starting with India. As noted in my comment, Q4 was interesting. It was slightly below prior year -- very slightly below prior year. But for context, the prior year was our #1 quarter ever in India. So this fourth quarter was actually our second-biggest quarter historically in India. So while the year-over-year growth wasn't there, certainly, the volume was good, and the overall picture just feels like it ought to return to growth this year. Now India has come back more slowly than we expected, so we'll probably ever be cautious until those numbers show up. But certainly, our recovery in India represents further confidence in our overall outlook for the year. China is, as I commented on and Sherry commented on, was strong all year long, particularly in pharma and government and academic. As I've commented on many times before, our Chinese business is a very broad-based business. We have more balance in our Chinese business than most other major geographic markets. And as typical, we'll enter the new year assuming relative stability in market conditions in China. There's certainly a lot of macro noise out there in China. But really, I don't have anything new to say or updates on, on any of the trade-type matters. We're really just focusing on what we can control. And at the same time, we don't always assume everything goes perfectly in China. We try to have a balanced outlook in the last several years that China has outperformed our balanced outlook, but we'll, again, moderate our assumptions going into the new year. And then you asked about Europe, a little more on Europe. Again, for context, while soft in aggregate over the course of the year, we have had several regions within Europe that have been strong, particularly Central Europe and Southern Europe. Our Northern Europe business, which is U.K., Ireland, Nordics, Benelux, et cetera, was -- we had a bit of a down year but just had a huge comp from a year before. And so we think the business is in good hands and is in good shape there, and we're expecting some modest improvement in Europe. We're certainly not expecting or modeling a large bounce back, but we're being cautious given the macro environment and some of the uncertainties, but do expect some basic improvement there. So as in most years, we will enter the year with a balanced outlook across all these markets, and we'll obviously update everything as we go along. I don't know, Sherry, if you have anything to add to that? Okay.

Next question is from Tycho Peterson with JPMorgan.

Chris, I'd like to start with the pharma recovery. I'm just curious as to whether you think there was any kind of onetime dynamic here in terms of budget flush. I know you called out the lack of a budget flush earlier in the year. So how much of this was maybe transitory and a catch-up effect? And then, on BioAccord, I understand you don't want to kind of put numbers around it, but can you maybe just talk to the degree of pent-up demand you see into the launch? And do you think the adoption curve will be different than prior systems given that you're really kind of going after the QA/QC and process development market?

Sure. Great. So starting with pharma, Tycho, we'll just give a couple of comments there. So we grew 7% in the quarter, and that was clearly a strong quarter and better than we'd seen all year overall. And I would also note that pharma result was delivered even with India, obviously, being flattish. And as you know, India is a -- by and large a pharma market. I would say there was nothing unusual as it related to a flush at the end of the year. We certainly have seen the pattern in the U.S. over the last couple of years, where we have had a slower start to the year and a faster finish. That kind of manifested itself again. But I think we were encouraged. We were encouraged by the balance in pharma, as I mentioned for the year. In retrospect, we ended up solid in small mol and very strong in large mol for the year. And we're particularly encouraged in the quarter by high-res mass spec in pharma. So as I mentioned, the tone has been improving in mass spec, and the area we probably saw that most acutely was high-res mass spec in pharma. U.S. pharma was strong and even within Europe, pharma was better than the other market categories in Europe. It was still relatively modest, but it was positive. So I think heading into the year, again, taking a balanced view, there's a lot of dynamics affecting the pharmaceutical industry, but what's unmistakable to me is just the pace of innovation that's happening. And we talk a lot about that in large molecule, but there's also quite a bit going on in small molecule and a diversification and a globalization of the generics business. So where we typically see a lot of good generics business and revenue out of markets like India and China, we are seeing the United States contribute a lot of growth in generics as some of those companies look to increase their footprint in the United States. So maybe segueing from there to the BioAccord, and you used the term pent-up demand. It's interesting because I think there is a gap there, and just let me clarify. We do see the BioAccord ultimately finding its way into QA/QC, but we're really targeting method development and process development, so late-stage development where methods are being developed. As you know today, there are many, many different tests being run on biomolecules. I've seen data that as many as 30 or 50 different assays are being run on biomolecules, and that just simply, over time, is going to require more powerful tools. I actually just after -- actually, after your conference in San Francisco, I went out to the field and visited one of the major biotech companies and sat down with their development people. And we had a 1.5 hour discussion on the pressures on speed to market and cost and the frustrations they have moving faster on multi-attribute monitoring, because they just don't have the right tools. The tools today that are sold into there, including our own, are too manual, too slow. And the data systems are not fully ready to handle the regulatory requirements. And so this particular group as well as many of the folks that have seen the BioAccord are very excited and want to learn more. In fact, this group was actually going to come to the WCDP meeting in D.C. next week, where we're going to be showcasing the system, just to see it. But all the requirements that are unmet today around robustness, reproducibility, easy to operate, the performance informatics, that's a gap in the market. And we think we have the right product at the right time. So again, the way technology rolls out in this space is a matter of happening over the years, not months. And so while we do assume incremental revenue coming from the BioAccord this year, we'll not put too fine a point on that at the outset, and we'll update you more on that as we get to the year. And obviously, we're going to try to go a little deeper on this exact topic at our Investor Day coming up at the end of February.

Ross Muken with Evercore ISI.

I just want to get back to China pharma for a minute. So it sounds like the market was quite robust, but the government late in December made a number of changes around pricing. And they're sort of essentially encouraging a consolidation of the generic industry in China, and then seemingly also trying to promote the innovator side. And so help us understand how that dynamic and sort of mix shift has played out in your business. And if we think about where your revenue mix is today, at least in that generic and CRO market, versus what seems like will be a much bigger biotech market, just help us kind of understand how that plays out through the P&L.

Sure, yes. No, Ross, as you know, the Chinese market is one we watch very closely, and it's constantly changing in terms of policy and standards and so forth. And I can't speak specifically to the policy changes you're referring to. I'm generally familiar with some of those directions, and they're consistent where the Chinese government has been in the past. I mean, to the extent the government has an interest in consolidating the generics space, that's being done for the reasons of scale. The government is intent upon increasing patient access to basic medical therapies. And whatever tactic is needed to do that, if it's consolidation, if it's regionalization, it's all being driven at that aim, and that's all going to drive volume. And as you know, our small mol business is very much a volume-oriented type of business. And on the other end of the spectrum, the promotion of innovation, that's clearly happening. There's tremendous activity in China around the development of biosimilar companies and even novel drug innovators. And so I think in that way, China is sort of a microcosm, if you will, of what's going on in the world. There's business for us at both ends of -- the volume side of it on generics and also on the kind of testing-intensive side of the innovation. And just in terms of our business, in rough terms, and we'll update this further at the Investor Day, but in rough terms, 2/3 of our business is related to the small molecule world, that sort of generics volume business; and 1/3 relating to the biomolecule development with very, very little in QA/QC. But we see biomolecules going down that same path. Just like our small molecule business grew up around late-stage development, method development, process development and evolved into manufacturing quality control, we see large molecule going down the same path, which is why we're investing so much to make sure that we can serve the market to make that transition. And at this point, both ends of that formula are important to us.

Next question is from Derik De Bruin with Bank of America Merrill Lynch.

Two questions. First one, just a little bit more commentary on your academic and government comment about Europe. And then also on that, just sort of what are your thinking plans in terms of preparing for Brexit, because you do have that big U.K. facility in Manchester? And then just any signs of any pull-forwards at the end of the year because of people worried about trade issues.

Sure. Again, thanks there, Derik, for the questions. And I may ask for a clarification on the pull-forward part of it. But let me jump into the academic and government. We did have a -- as you know, a really quite of a strong year, if you will, in academic and government at 7% growth, with a little less growth at the end of the year. And that was really a function of Europe, but we actually had growth in the U.S. and strong growth in China and Asia in academic and government in the quarter, which really reflected a pattern all year long with a little bit of softness in Europe. In Europe, it probably reflects more of that wait-and-see kind of tone in some of the markets related to some of the macro conditions. That's about as good of a thought I can have there. There is a bit of a mix in the academic and government sector between biomedical research, where it's been weaker, and pharma discovery, where it's been stronger. And again, for reference, keep in mind our academic and government is a significantly smaller part of our portfolio than everything else. And even within that, our academic and government business is about 2/3 or more academic and university and, therefore, the government piece is smaller. But we're watching that closely. And like I said earlier, it was nice in Europe even though it was a little bit of a soft year than we expected, that pharma was a -- could offset that sum a little bit as well. So from a Brexit standpoint, yes, we watch Brexit closely. I've been very tuned into this since the beginning. And as you point out, we have a large research facility in Wilmslow in the U.K. There's obviously, a range of possibilities as to what could happen with the Article 50 process. And while it seems that most -- more recent political events have made a hard Brexit probably less likely, because I think politicians on both sides are sort of in violent agreement, if you will, that a hard Brexit is the worst scenario. And whether it's a pause or whether it's a renegotiation or whether it's even a new referendum, there's a lot of other things that could happen. But even with that, we've decided that it's prudent to prepare a contingency plan for a short-term disruption in the case of a hard Brexit. And so we are well down the path on that contingency plan, and that plan is simply designed to maintain our servicing of customers. About 4% of our worldwide revenue is in the U.K. And obviously, you can imagine, there'd be some forward stocking just to prepare for any disruptions. And then furthermore, on the export side, making sure that we have plenty of inventory, finished goods inventory that comes from the U.K. -- outside the U.K. I will say that over time, we've evolved the majority of our mass spec production out of the U.K. into Ireland and other places. And so really, Wilmslow is primarily a research-and-development facility with some smaller-volume, high-res lines that we can certainly manage through in that type of a scenario. So while I think a hard Brexit, personally, is a very low probability, we're just trying to be prudent in preparing for that. But on the pull-forward question, and I'm happy to get a clarifying point from you on that. I don't really see evidence of that, particularly in Europe. So I think if we -- if there was more of a pull-forward dynamic, we probably would have seen stronger results in Europe. But I just -- I think that people are more in a wait-and-see mode, is how I'd characterize it.

Yes, I was just talking about the fact that some of the life sciences and industrial companies have talked about trying to -- some of their Chinese customers pulling forward just because they're worried about trade issues. I'm just wondering if you saw that run through.

Yes. China, I wasn't thinking about China when you asked the question, but that's perfectly fair. And again, don't have a lot of evidence of -- an unusual pull forward or a flush of any type there. The business, throughout the fourth quarter in China, reflected more typical Q4-type dynamics.

Next question is from Doug Schenkel with Cowen and Company.

I'll just get them both out there, and then get back into the queue. First on TA, would you quantify the impact of timing dynamics on Q4 core growth for TA? And what are you assuming for 2019 TA growth? Presumably, you're thinking above the corporate average again. And then my second topic is on mass spec. What was mass spec core growth in Q4? And are you assuming in guidance that growth improves to at least mid-single-digit levels in 2019 given new products and favorable comparisons?

Yes, thanks, Doug, I appreciate it. On TA, when you roll the whole year up, it was a really solid year, growing 7%. It was growth in 7% for the quarter. And as you recall, from Q3, we had a little bit of a dip down to the low single digits for TA sales growth in the quarter, although we felt strongly enough that, that was a temporary dip that was really based on a different mix of inventory at the end of the quarter, that we identified the fact that all underlying orders growth was consistent in Q3 as it was in the first half. And really, when you roll it together, I think that that's exactly what played out in terms of both order and sales growth for the year being really solid, right in the range that we reported. And in terms of 2019, we're making the same type of forecast of a risk-adjusted number. I don't want to give you a specific number and -- but I would say TA ought to perform at least at the company average. We're in a good product position there. The business continues to diversify. One experience I had also recently in being in the field, calling on customers, is the increase in tech companies, for example, buying our thermal analysis; rheology; and even as they work to develop better materials for various computer-type products, utilizing the Waters chemical analysis, particularly the gel permeation chromatography-type product line. So our materials franchise is broader than TA, and it does feel to me, over time, that, that industrial market is diversifying to include other sectors besides the traditional chemicals and polymers and inorganics side of the business. Related to mass spec, I don't really want to break out the details on the specific growth. But what I would say about mass specs is it was better in Q4 than it was in Q3, and Q3 was better than the first half. And furthermore, our orders performance in Q4 was better than our sales performance. And so I think we are heading into the year with -- on a little stronger footing, and we certainly expect our mass spec product line to contribute to growth in the year ahead, where it, in aggregate, didn't contribute all that much growth in 2018. So certainly very excited about the product cycle. BioAccord, as I mentioned before, we have a new super-high-resolution mass spec technology coming out during the year as well as some other things that I don't want to comment on yet. So anyway, thanks, Doug. Appreciate the questions.

Next question is from Sung Ji Nam with BTIG.

Chris, was wondering about you guys are posting 4% organic growth this year -- in 2018, and you're guiding to 4% to 6% outlook for 2019. I was curious as to kind of is it mostly attributable to the end-market general outlook that you guys have? Or is it more due to new product launches? I'm just curious as to kind of slight improvement potentially in the outlook for the year.

Yes. Thank you, Sung Ji. I think that's correct. I think we're -- to me, the end-market outlook is more of a baseline. And certainly, as we experienced this year, you always make assumptions, and those assumptions can change. And so we try to make sort of risk-based assumptions coming into the year and not assuming everything goes right. But for the most part, in general sense, we feel that the end markets are reasonably stable. And certainly, if there's some incremental growth this year, it is based on a better product position. We certainly don't have a crystal ball, if you will, that's any better than anybody else's as it relates to the macro conditions. But in terms of what we can control and what is different at Waters heading into this year is the product position in terms of the new launches, both in 2018 as well as the ones that I've alluded to and mentioned in '19. I guess, I'd -- furthermore, I'd say the other thing we've done alongside of the market prep -- on market preparation relative to these launches is we've really invested in our commercial operations. I'm very pleased with a number of things we're doing across the board in our commercial operations around the world in terms of we built a new sales operations function, we have a new sales enablement process. So that by the time technology hits the market, our teams are really ready to go. And furthermore, we've supplemented headcount in our field operation on both the sales and service side, as we've talked about in the past. And so it's really a total team effort and a 360-degree process of getting ready for this type of new launch cadence, and I think that's probably what's -- probably what would explain better growth in '18 versus -- or sorry '19 versus '18. And Sherry, go ahead.

Yes. Sung Ji, maybe just to put a little bit macro perspective around it. When you think about our business, our recurring revenues represent about 50%, and our recurring revenues grew this year 6%. So if you think about our guide range of the 4% to 6%, that gets you halfway there. And so -- then the other levers that Chris talked about then would be improvement in some of the geographies that we saw momentum towards the end of the year, and the continued solid market dynamics, and then the impact of new product introductions. That might give you some parameters to think about.

Next question is from Dan Leonard with Deutsche Bank.

Question for Sherry. Sherry, the -- on capital deployment, so 2.5x net debt-to-EBITDA, that's not a 2019 target, correct? That's a target over 2 years.

Dan, the way we've looked at our capital allocation, as you know, the U.S. tax reform is a real game-changer for us as we got access to our cash. And this year, we started ramping up our share repurchases, and we've talked about this year working towards the 2 point -- 2.5x net debt-to-EBITDA leverage ratio. Our guidance for the full year, we've assumed about $2.5 billion so that wouldn't get you to that kind of leverage at this guidance point. But what we're going to do is we're going to evaluate throughout the course of the year. There's lots of dynamics here. So we've given you guidance also for Q1, and as the year unfolds, as we look at our performance, what our investment needs are and opportunities are, macro factors, et cetera, we will kind of adjust it accordingly.

Okay. I just wanted to confirm. And then my follow-up question, can you help me think about the sources of operating leverage in 2019, a year where you're investing in sales and marketing ahead of some new product launches? You've been growing R&D at twice the rate of revenue, and gross margins tend to be kind of flat. Can you help me think about the drivers?

Yes, sure. So I'd probably characterize, first, just kind of overall operating margin leverage as we look at it. And I'd say, we really look at kind of the 2 big factors is our top line growth goals that we have, and then what are our needs to invest in the business to drive that top line growth. And then there's obviously other factors, such as whatever FX falls through throughout the course of the year and offsetting inflation, et cetera. And so as we set our plan for this year of 4% to 6% revenue guide and then our EPS growth, we look to be able to deliver modest operating margin improvement. If you look at our 2018 results, where we ended the year with about 4% constant-currency growth, we were still able to deliver about 50 basis points of operating income improvement. So those are kind of the factors that we look at, because as we learned from 2018, there's a lot of moving parts. So we really set out to, within our revenue guide, just to have some modest operating leverage as we look at the different levers we have to pull.

Brandon Couillard with Jefferies.

Just a quick one for Sherry. If you could tell us what you're penciling in for free cash flow for the year as well as CapEx? And if there's any added spillover from the Taunton expansion in the CapEx number for the year?

Yes. So it's a great question. So we have a big investment that's a 5-year project with the Taunton chemistry operation. This year, we've probably spent about $11 million related to that from CapEx. But that's a 5-year program and would be $200 million over the 5-year period. Next year, we probably expect spending about $90 million on the Taunton facility. However, we are calling that out as an adjustment from our cash flow, so really looking at it as a major facility investment as we've done with some of our major facilities, for example, in Wilmslow and other areas. So if you kind of strip that out and really look at it, as we look at our cash flow, in general, we'd look to grow our cash flow in line with our top line. And our depreciation historically has run 2% to 2.5% of sales, and I'd say we'd expect that kind of operating CapEx probably towards the higher end of that in 2019.

Next question is from Steve Willoughby with Cleveland Research.

A couple of questions for you. First, I guess, just on SG&A, in the last few quarters, it's been running a little bit below, at least, our expectations. Just was wondering if you could comment there on what you're doing to hold in SG&A. And if that's sustainable going forward? And then, I guess, secondly for Sherry maybe, your guidance here for the first quarter at the midpoint looks like about 7% earnings growth compared to the full year of 12% to 13% earnings growth. Just given the somewhat easier comparison in the first quarter, just wondering how you're thinking about kind of the back half weighting, so to speak, for your overall EPS guidance.

Yes, maybe I'll take -- thanks, Steve. I'll take a quick one on SG&A, and Sherry can certainly add to that plus talk about the guide a little bit. If you look at the overall body of work in 2018, I think we managed the P&L very well to gain some modest operating leverage while investing heavily on R&D. And as we got into the fourth quarter, in part, given some variable expense dynamics as well as the investment premarket, if you will, ahead of the BioAccord launch, that ticked up a little bit. But we have a number of levers to pull relative to cost initiatives, and we're doing more than ever before in the company, now in our third year of kind of a new type of budgeting cycle, to really make sure we're pivoting resources and allocating resources to the things that give us the best chance for growth. And so I think we're comfortable that we'll continue to manage our P&L -- our SG&A well over any reasonable rolling period, like we saw in '18, get that balance right. So Sherry, I don't know if you want to say more about that plus the guide.

Yes. So I'll address your question on the guide for Q1. I'd say there's a couple of factors in Q1 that is impacting the overall EPS growth. A common I talked about is the tax rate. So just to put the tax rate in perspective, last year was our first year coming out of tax reform. We guided to a 13% to 15% tax rate. As you know, with our current results, we ended at the low end of that range with a variety of factors around evolving clarification on tax reform, some discrete items and kind of the mix of our business. So for full year next year, we're guiding to a full year tax rate in the range of 14% to 15%, just kind of narrowing that. But in the first quarter, kind of that range of the tax rate has a bigger effect in Q1, because last year, we had an exceptionally low tax rate. It was about 11%. So if you look at the flow of our EPS from Q1 and then look at that in contrast to the full year, the tax rate is definitely -- has a bigger impact in Q1. And then I'd say the second item in Q1 would be the impact of FX. It's about a 3% headwind in the first quarter. And kind of overall, you're seeing more impact in the first half on the FX than in the full year. So I'd say those would be the 2 big factors.

Dan Brennan with UBS.

So Chris, could you just give us color on specifically, what did China do actually in the quarter? I know -- I think you mentioned strong double digits. And how did this break out across your kind of customer groups? I think you said it was broadly healthy, but is there any more color there? And then finally, what's kind of baked in for China growth as we move into 2019?

Sure. Thank you, Dan. And we'll finish with the question on China there. So China, for the quarter, Dan, grew about 15%. So that was a really solid result on a similar result a year ago. So like we've commented on, China was pretty solid, very solid all year long. And that growth was really led by pharma, which was north of that growth rate; and also the academic and government sector within China, which certainly represents a number of things within the portfolio, material science, food testing and -- that happens in the academic and government labs. The industrial business was a little bit softer in China relative to the overall growth rate, but very much led by pharma and academic and government. In terms of the year ahead, I would just reemphasize kind of our typical approach here. And as I alluded to earlier, we -- our Chinese geography has outperformed in recent years, and we always enter the year with numbers that are a little more modest than we've ended up with. And obviously, it's a dynamic environment. Like I said earlier, we don't have any incremental new information on impact of trade or tariffs relative to what we've been seeing all along. So we follow the news as closely as we can but really try to stick to what we can control, and that's investing in our people, it's investing in our training, it's investing in our demo labs. And I think that market has shown an appetite for growth in innovation. In fact, one of the first units of BioAccord we shipped was actually over to China. And so that market is attuned to the technology that is coming out and is needed to progress all the innovation that's happening there. So we just try to follow the strong pace of innovation. And because there's a lot of innovation in China, we're continuing to invest in that market. So thanks for that question.

And let me all -- let me wrap up and -- in the interests of time and just say thank you for all your questions. I enjoyed engaging with all of you. In conclusion, all of us at Waters are focused on an exciting year of growth and innovation in 2019. As we discussed on the call, our top line expectations are grounded in what appear to be stable market conditions and are headlined by a compelling new product cycle that has resulted from our diligent investments in R&D. As always, we're also focused on continuing to deliver on reliable earnings performance based on our organic growth and supported by our enhanced capital deployment program.

So on behalf of the entire management team, I'd like to thank you for your continued support and interest in Waters. We look forward to seeing many of you at our Investor Day on February 28, and then to further update you on our progress during our first quarter conference call, which we currently anticipate holding on April 23, 2019.

Thank you very much, and have a great day.