Waters Corp (WAT) 2020 Q1 法說會逐字稿

Good morning. Welcome to the Waters Corporation First Quarter 2020 Financial Results Conference Call. (Operator Instructions) The conference call is being recorded. (Operator Instructions) 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 First Quarter Earnings Conference Call. Before we begin, I will cover the cautionary language.

During this -- 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 commentary on potential markets, business conditions the company expects for the second quarter and full year 2020. We caution you that all such statements are only our present expectations 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 the risk factors included in our annual report on Form 10-K for the fiscal year ended December 31, 2019, in Part 1 under the caption Risk Factors and the cautionary language included in this morning's press release, including with respect to risks related to the effects of the COVID-19 pandemic on our business. We further caution you that the company does not intend to update any of its predictions or projections, except during our regularly scheduled quarterly earnings release conference calls and webcasts or as otherwise required by law. The next earnings release call and webcast is currently planned for July 28, 2020.

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 release issued this morning and available on the company's website. In our discussions the -- of the results of operations, we may refer to non-GAAP 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 stated otherwise, references to quarterly results, increasing or decreasing, are in comparison to the first quarter of fiscal year 2019. In addition, unless stated 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 Chris O'Connell, Waters' President and Chief Executive Officer. 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.

I hope you and your loved ones are doing well at this challenging time and staying positive as we all strive to overcome the global COVID-19 public health and macroeconomic challenge. Like most of you, we are all working from home, so please bear with us if we encounter any unforeseen audio issues with today's call.

During today's call, I will provide an overview of our first quarter operating results as well as some broader commentary on the impact that COVID-19 is having on our markets and business. Sherry will then review our financial results in detail and discuss our financial actions as it relates to the balance sheet and cost structure. We will then open up the phone lines to take your questions.

As you well know, the COVID-19 global pandemic is a significant challenge for the world that is putting extraordinary pressure on the economy, our customers, employees and their families. I would like to personally extend my gratitude for the hard work and dedication that everyone has shown over the past few months. I'd especially like to thank all of our dedicated employees who have been working in our manufacturing facilities, laboratories and distribution centers, ensuring that we can supply our products and expertise to our customers. I also want to thank our talented field service engineers who have been on the front lines, installing and maintaining critical, analytical instruments and data systems to support the ongoing work of our customers. These efforts are incredible and truly inspire me. But they don't surprise me, as I've consistently seen our great people step up to deliver benefit to our customers under all conditions.

To briefly review our operating results for the first quarter, Q1 sales declined 8%, and adjusted earnings per share declined 28%. The biggest COVID-19 impact on our business in Q1 was China, which declined 45% in the quarter, impacting total company sales by approximately 8 percentage points in constant currency. As severe containment actions were implemented in China at the time of the spring festival, economic activity and demand significantly decelerated, and these conditions persisted through the quarter.

On a positive note, it was encouraging to see flat sales ex-China for the quarter, and 4% growth ex-China through week 12 of Q1 before broader containment actions went into place in the U.S., Europe and India. Rapidly changing market conditions in these geographies during the final week of the quarter included declining access to customer sites as well as the inability of some customers to place and receive instrument orders.

Through 4 weeks of Q2, we have seen signs of recovery in China and other parts of Asia and Europe. though we expect the conditions seen at the end of Q1 in the U.S., India and some parts of Europe will persist into Q2, making the second quarter likely more challenging than the first quarter.

As we operate in this fluid environment, we have 5 overriding priorities: #1, putting the health, safety and well-being of our employees and customers first; #2, ensuring business continuity; #3, maintaining financial strength, flexibility and liquidity; #4, actively planning for recovery, particularly in maximizing the benefit of our strong new product flow; and #5, contributing our expertise and capabilities in the global fight against COVID-19. Let me say a little bit more about each of these 5 priorities.

First, the health, safety and well-being of our employees and our customers is our clear top priority. At every stage of the pandemic, we have taken decisive and appropriate cautions, including a mandatory remote work policy for all employees, with the exception of manufacturing, distribution and certain laboratory environments as well as bans on nonessential travel and visitors into our facilities. Early on, we engaged a medical adviser to guide our policy deployment and we continue to take proactive measures to ensure the health of our global employee base and the safety of all customer interactions.

Our second priority is to ensure business continuity. The vast majority of the markets we serve, most notably the pharmaceutical, biomedical research, food and environmental and clinical markets have continued to operate at various levels, and we are working closely with these customers to ensure their seamless operation. Over the last several years, Waters has executed on a digital workplace strategy focused on providing modern connectivity and collaboration tools to our employees. Our strategic technology investments have enabled us to swiftly meet the remote working needs as the situation has escalated.

From a customer-facing standpoint, we are leveraging digital demand generation activities, including virtual demos across all regions, remote instrument installations, virtual sales seminars, online product training and a rapid acceleration in one-to-one communications over e-mails, phone and video conferencing. We also recently launched a new customer portal on waters.com, enabling a convenient and personalized online experience that's more mobile-friendly, augmenting the recent expansion of our digital commerce capabilities. We are continuing to invest to provide our customers a similar world-class experience through digital means as they receive in person, and we are seeing great customer engagement.

From a supply chain standpoint, we have proactively and successfully secured access to raw materials for ongoing manufacturing needs, and we are working closely with our transportation providers to minimize any disruption to our distribution network. At this time, we do not anticipate any immediate supply or distribution concerns during the second quarter and are actively mitigating potential risks.

Our third priority is maintaining our financial strength, flexibility and liquidity under a range of business scenarios. We are seeking to balance prudent management of all areas of our spend, while continuing to invest in growth initiatives. We are taking a proactive approach to preserving balance sheet strength and liquidity as well as to appropriately rightsize our cost structure for the unpredictable months ahead. Specifically, we have paused our share repurchase program until we return to a more stable and predictable business environment. We are also taking actions in 2020 that will reduce our cost structure by about $100 million as well as actions that will result in about $45 million of cash flow improvement from CapEx and working capital management. Sherry will provide more details on these measures during her remarks.

Fourth, we are actively planning for a variety of recovery scenarios with particular emphasis on maximizing the impact of our exciting new product cycle, including products launched in the last year as well as new technology coming to the market this year. In the context of our cost measures, R&D investments continue to be a priority, especially those that will contribute to near-term growth. We remain sharply focused on our primary growth strategy of organic innovation. And as stated before, we have made durable improvements in R&D productivity, positioning us well to benefit as demand normalizes and for the long term.

Finally, while we're not assuming a material financial benefit, we have mobilized quickly to contribute our expertise and capabilities in the fight against COVID-19. We formed a COVID-19 innovation response team to bring Waters' industry-leading expertise to the forefront of the global scientific surge to quickly and effectively deliver diagnostics, therapies and vaccines. By extending our resources to scientists that are working on the challenging biology of the virus and pursuing a range of interventions, we know that we can help accelerate the push to defeat COVID-19.

A few examples include: First, Waters donated columns, service and instrumentation to hospital laboratories in Milan, Turin and Rome in Italy; and in Bordeaux, Lyon, Marseille and Paris in France. These donations are supporting drug monitoring and research for potential coronavirus therapies. Second, in the U.K. and Ireland, our team has been working overtime to quickly deliver specialized mass spectrometry instruments for researchers for measuring potential new COVID-19 drugs and experimental models of the SARS-CoV-2 infection. And finally, we are providing our unique glycan analysis capabilities to vaccine developers. The significance of glycosylation as an antigen is underscored by numerous recent publications on the structural biology of the SARS-CoV-22 spike protein. We are enabling high resolution, high sensitivity molecular glycan fingerprints in just minutes versus the days typically needed with traditional approaches.

Turning to guidance. As a result of the uncertainty surrounding the magnitude and duration of the COVID-19 pandemic and its impact on our customers, we are withdrawing our prior 2020 guidance which, as a reminder, explicitly did not include any impact from the COVID-19 pandemic. However, I will provide you with some color to help you better understand our current thinking.

We have built a range of scenarios by categorizing each geography into 1 of 3 phases of the COVID-19 pandemic: containment, recovery and return to growth. Importantly, we anticipate that the previously mentioned cost actions provide us with adequate flexibility, even in our most conservative scenarios. Looking at the various geographies, we believe that the U.S., India, Japan and parts of Europe are currently in the containment phase, and we expect these geographies to move into recovery in the second half of the year. We believe that China, many parts of Asia and some parts of Europe are currently in the recovery phase. And while there is a possibility for a second wave of the virus, we see them on an improving trajectory.

For geographies operating within the containment phase, we expect continuing limitations to customer sites. In these areas, pharma production and QA/QC activity remained stable, though we expect pauses in nonessential customer spending. At the same time, many resources in pharma R&D have shifted to COVID-19-related projects.

In terms of service, we are generating revenues through a mix of direct and remote access to their facilities, and we are seeing growth where customers have contracted service plans.

For geographies operating in the recovery phase, we are expecting a pickup in demand for recurring revenues and some stabilization in demand for instruments. That said, we anticipate that purchasing activity in governmental and academic markets may lag corporate customers.

When geographies enter the return to growth phase, we expect recurring revenue growth to normalize and for instruments to see growth, supported by the release of previously budgeted spending. As we look for signs of recovery and growth, we are closely monitoring service calls, quoting activity, recurring revenue trends and customer capital purchasing plans.

Market dynamics aside, we remain sharply focused on our primary growth strategy of organic innovation. Looking at the Waters product line, new products contributed positively to our performance in Q1, including the BioAccord, Cyclic IMS, SYNAPT XS and our 2 new tandem quads, furthering our confidence in a multiyear revenue ramp for these products. Our confidence in having the right technology at the right time has been bolstered by evolving customer needs. For example, we recently received multiple BioAccord orders from a major global pharma customer as this unique system and application set is truly fit-for-purpose for certain COVID-19 vaccine development and monitoring requirements.

In our TA Instruments product line, the first quarter featured 3 important new product launches: the Discovery X3 Differential Scanning Calorimeter, Discovery Hybrid Rheometers and the TAM IV Micro XL isothermal microcalorimeter. Each of these instruments builds greater productivity and efficiency to the development of next-generation, high-performance materials, and we believe will further enhance our innovation leadership in the thermal analysis market.

In summary, sales in our first quarter were impacted by the COVID-19 pandemic. Aside from China, our largest geographies were performing well until week 13 when many countries within them implemented containment measures, which impacted the close to Q1 and have created uncertainty in the near term. That said, the Waters business model has historically proven sustainable through challenging macroeconomic environments, driven by our global footprint, large installed base of instruments, strong recurring revenue mix and diverse largely regulated end markets. These factors have had a limiting impact on periods of negative revenue growth, and supported consistent free cash flow in most scenarios.

We are confident that our strong balance sheet, access to capital, focus on preserving flexibility and liquidity and our robust new product flow will translate into a sustained bounce back as market conditions allow.

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

Thank you, Chris, and good morning, everyone. In my comments today, I will review our first quarter results and provide more details on the actions we have implemented to mitigate the impacts from the COVID-19 pandemic.

In the first quarter, we recorded net sales of $465 million, which is down 8% against the prior year in constant currency. Currency translation decreased sales growth by approximately 2%, resulting in a 10% decline as reported. Excluding China, which was more significantly impacted by the COVID-19 pandemic in the quarter, constant currency sales were flat against the prior year. As a reminder, the previous guidance for Q1 and full year results excluded any impacts from the COVID-19 pandemic.

During the quarter, sales into our pharmaceutical markets were down 6%, our industrial category declined 7%, and sales into our academic and governmental category were down 22%.

Looking at product line growth, our recurring revenue, which represents the combination of service and precision chemistries, was flat in the quarter, while instrument sales declined 19%.

As we noted on our last earnings call, recurring revenues during the first quarter of 2020 were impacted by one less calendar day in the quarter, which resulted in a slight reduction in recurring revenues. Looking ahead, there is no year-over-year difference in the number of calendar days during the second or third quarters, but there are 2 additional calendar days in the fourth quarter of 2020 compared to 2019.

Chemistry revenues were down 1% in the quarter as weakness in academic and governmental offset pharma growth.

On the service side of our business, revenues were flat as mid-single-digit growth in service contract revenues were offset by a decline in on-demand service revenues and spare parts.

Breaking first quarter product sales down further, sales related to Waters-branded products and services declined 9%, while sales of TA-branded products and services declined 4%. Combined LC and LC-MS instrument platform sales declined by 21% and TA's instrument sales declined by 5%.

Looking at our growth rates in the first quarter geographically and on a constant currency basis, sales in Asia were down 19%, driven by a 45% decline in China. And sales in Americas were down 5% with a 4% decline in the U.S., while European sales grew 4%. Excluding China, Asia was up 2%.

Now I'd like to comment on our first quarter non-GAAP financial performance versus the prior year. Gross margin for the quarter was 54.7% compared to 57% in the first quarter of 2019. The lower gross margin relative to the prior year was primarily driven by foreign exchange rates and lower manufacturing fixed cost absorption.

Moving down the first quarter P&L. Operating expenses increased by approximately 3% on a constant currency basis, and foreign currency translation decreased operating expense growth by approximately 1.5% on a reported basis. In the quarter, our effective operating tax rate was 11.3% compared to 10.8% in the prior year as a result of discrete items in the prior year quarter. Net interest expense was $10 million, an increase of about $7 million, as anticipated. Our average share count came in at 62.6 million shares, a share count reduction of approximately 14% or about 10 million shares lower than in the first quarter of last year.

Our non-GAAP earnings per fully diluted share for the first quarter declined to $1.15 in comparison to $1.60 last year as a result of lower sales due to the COVID-19 pandemic. On a GAAP basis, our earnings per fully diluted share declined to $0.86 compared to $1.51 last year. A reconciliation of our GAAP to non-GAAP earnings is attached to the press release issued this morning.

Turning to free cash flow, capital deployment and our balance sheet, I'd like to summarize our first quarter results and activities. We define free cash flow as cash from operations, less capital expenditures and excluding special items. In the first quarter of 2020, free cash flow came in at $121 million after funding $31 million of capital expenditures. Excluded from free cash flow was $21 million related to the investment in our Taunton precision chemistry facility. In the first quarter, this resulted in $0.26 of each dollar of sales converted into free cash flow.

During the quarter, we also deployed $80 million of capital relating to the acquisition of Andrew Alliance. This investment broadens our technology portfolio to include advanced robotics and software that will positively impact our customers' workflows across pharmaceuticals, life sciences and material science markets.

In terms of returning capital to shareholders, we repurchased approximately 800,000 shares of our common stock for $187 million in the first quarter, consistent with our previously communicated buyback plans.

These capital allocation activities, along with our free cash flow, resulted in cash and short-term investments of $394 million and debt of $1.9 billion on our balance sheet at the end of the quarter. This resulted in a net debt position of $1.5 billion and a net debt-to-EBITDA ratio of about 1.9x at the end of first quarter.

Turning to working capital. Accounts receivable days sales outstanding came in at 99 days this quarter, up compared to the first quarter of last year, and inventories increased by $11 million in comparison to the prior year quarter due to the slowing demand related to COVID-19.

Waters has a strong balance sheet, access to liquidity and a well-structured debt maturity profile. We have $1.2 billion of available liquidity at the end of first quarter, inclusive of our bank revolver and about $400 million in cash and short-term investments.

Given the uncertain global business environment related to the COVID-19 pandemic and the anticipated impact on our business, we've implemented a comprehensive program to reduce our cost base and have revised our capital deployment plans to better align our operations and investments with a near-term growth challenge. I'd like to walk you through these actions.

From a P&L perspective, we've taken actions to reduce our cost structure by approximately $100 million for the year. We've reduced the base salaries of our CEO, Executive Committee and Vice Presidents, as outlined in the press release issued this morning. We've implemented a combination of furlough, reduced work schedules and salary reductions across the organization for a 90-day period and reduced nonessential operating expenses, implemented a hiring freeze and adjusted certain benefit programs.

From a capital deployment perspective, we've revised our current year plans to better align operations and investments with the current operating environment. These actions will improve cash flow by about $45 million over the remainder of the year. We have delayed certain capital expenditures while continuing to maintain business plan objectives. We've revised production plans to better align with our updated demand forecast to reduce inventory and taken other actions to reduce working capital requirements.

In terms of returning capital to shareholders, while our future capital structure target of approximately 2.5x net debt-to-EBITDA remains unchanged, our immediate focus is on maintaining financial flexibility and preserving liquidity. As a result, we have temporarily paused share repurchases, and so we see a more stable and predictable business environment. Additionally, we have suspended our previous full year guidance that we shared in our Q4 earnings call to repurchase $800 million of shares during 2020.

We expect these actions will provide us with adequate flexibility under a variety of potential recovery scenarios. We are closely monitoring our business conditions, and we'll adjust these action plans as appropriate.

As Chris shared earlier, due to the fluid environment related to COVID-19, we will not be providing the usual financial guidance that we normally do. However, there are a few data points that might be helpful for full year modeling.

Current rates, currency translation is expected to decrease sales growth by about 1 percentage point and to negatively impact earnings per share by about 3 percentage points. Net interest expense is expected to be in the range of $40 million to $42 million, primarily due to lower interest rates.

Now I'd like to turn the call back to Chris for some summary comments. Chris?

Thank you, Sherry. As we move through 2020 and our management of the COVID-19 crisis, we are staying focused on our long-term innovation strategy and investments that support a sustained recovery as market conditions improve. We are confident in the durability of the opportunity in our end markets, our strong market position and our consistent strategy.

With that, we will now begin the question-and-answer session. (Operator Instructions) And if you have additional questions, please contact the Waters Investor Relations team after the call. Operator?

First question is Derik De Bruin, Bank of America.

So can you talk a little bit more about some of the recovery in your emerging markets? Just basically just questioning -- you mentioned you saw some pickup in China and some pickup in some of the European geographies. Can you talk a little bit more about that and specifically what you're seeing?

Sure. Yes. Thanks, Derik, and I hope you're well. We have established a really robust framework for how to think about recovery. And as you might imagine, it's not a one-size-fits-all approach. Every geography is really undergoing a different dynamic as it relates to 2 primary dimensions of recovery. One is the overall spread of the virus and what the local public health response is. And the other dimension being the knock-on effects of that approach to the local economic conditions.

And there's obviously a wide range of programs around the world. China, which went through this first, I would characterize as seeing a steady recovery that continues to gain traction at this point in time. About 90% of our customers in the pharmaceutical sector have restarted production. And there's been a very phased approach affecting both the customer operations as well as even our own offices and employees as they go serve.

There are some geographies that have bounced back more quickly. If you look at Korea, as an example, which actually is now our #5 country in the world. As you know, from the papers, they had a very assertive testing policy and program early in the process, and they're really back almost in the return-to-growth phase. The European countries I referred to, Europe is very much a mixed bag. Some countries, including the U.K. and countries in Southern Europe, like Spain, Italy, France are very much still in containment, while other countries in Central Europe and even Eastern Europe, Germany, Austria, Switzerland, Denmark, et cetera, are more in a recovery phase. Again, very, very local dynamics there.

It's also hard to categorize them in emerging and developed for the reason I just stated in Europe, but also another example of an emerging market that was actually doing very, very well in Q1 until the end of the quarter was India, where India, as you know, at that point in time, the last week of March, went into severe lockdown mode. They still are in that mode. And so while India had a very strong start to the year, they're very quiet now. And hopefully, those measures will be effective in hastening their recovery in the back half of the year.

So it's really quite different depending on where you are in the world and our model looks at a number of scenarios, a base case scenario, a conservative scenario and an optimistic scenario for each country around the world, depending on where they are in those recovery phases. And obviously, most of our focus is on the base case and the conservative case in terms of our modeling and cost actions, not spending too much time on the optimistic scenario. Otherwise -- though, in the case where opportunity materializes faster, we are prepared to take advantage of that. So it just requires a very agile management process, and we feel good about the way we're approaching it.

Great. And just one follow-up, if I may. The -- can you talk a little bit about what you're seeing with your chemical and some of your industrial customers just as obviously, we're approaching recession, looks like we're going to be in a recession scenario. How are they thinking just sort of beyond the initial COVID impact? Are you seeing people pulling back heavily on their CapEx plans there?

Yes. Thanks, Derik. It’s a bit of a mixed bag on the industrial side. As you know, about half of our industrial business is food, environmental, and environmental piece of that's actually been reasonably robust through this, and about half is the material science, the chemical and polymer piece. Overall, the industrial category, for us, in the quarter, was down about the same as pharma. And the mix of that was China taking a bigger hit. U.S. down in that mid- single-digit range. Actually, Europe grew on the industrial side in the quarter. And so it is a little bit of a mixed bag.

We're seeing some industrial customers hold back. We don't really see many outright closures per se. And we have seen some investment on the polymer side. These markets were pretty soft last year, and we believe there's some pent-up demand and we're actually seeing, I would say, reasonable tone in the industrial end markets although as you know, those are -- those markets are a lot more instrument-oriented with less recurring revenue, particularly in the TA instrument side. So watching it carefully. But at this point, it's probably too hard to overly generalize. There's pockets of strength and weakness there.

Our next question is from Dan Arias, Stifel.

Chris, on the pharma side, can you just talk a little bit about how things look if you separate out the large molecule, which I think is about 30% or so of the mix from small molecule? And then what your expectations look like if you're just trying to assess the components of pharma demand this year by pipeline?

Sure. Yes. So pharma, thanks, Dan. I hope you're well. The -- on the pharma side of the business, which is a little more than half of our revenue, and as you correctly point out, it's about a 70-30 split, we were actually seeing really solid pharma business through the week 12. We were up in the mid-single digits on both the small mol and large mol a little bit better. So some decent start to the year before a lot of the containment activities, outside of China, that is. Those numbers are outside of China.

China, obviously, is a real outlier for the quarter. And so the way we're looking at that is the manufacturing QA/QC part of the business. We've seen continued operations. We've seen growth in QA/QC outside of China. We've seen fairly steady recurring revenues, although more growth where we have contracted service plans and where there's more full production. Some QA/QC has been on split shifts or rationalized capacity. We see that in the contract segment as well. But we're basically expecting to see reasonable -- reasonably stable conditions on the QA/QC side.

On the innovation side, much R&D does continue. Some of it has been diverted to COVID. As you know, there's more than 200 trials underway for COVID-19 therapies and up to 100 different vaccine programs out there right now, 6 of which are already in trials. So as I alluded to in my remarks, we've seen some nice response in that segment.

And obviously, China is a big part of the overall pharma picture, and that's -- that certainly colored our Q1 results. But we're -- we feel -- we're glad that we have such a nice concentration of pharma in our overall portfolio and expect that to be a reasonably stable market as we move through this and improve over the course of the year.

Okay. I appreciate that color. And then, Sherry, any help you can offer in terms of the extent to which the $100 million will flow through R&D versus SG&A?

And then on the $100 million, is there a back-half weighting that we should think about for the cost savings? Or are you looking to have the portion of the cost structure in the current quarter match what you're trying to do overall? How aggressive have you been in 2Q?

Yes. Great. Thanks. I'd be happy to answer that. So the cost actions we put in place, a lot of them related to employee-related actions through salaries, furloughs, work schedules, really trying to rightsize, particularly in the second quarter as we expect it to be more challenging slightly than Q1. And then other just nonessential costs that we can defer.

So the $100 million in cost actions, the base against that is really against our internal plan that we've been working on for the year of 2020. The savings would flow through -- about 3/4 of it would flow through operating expenses and about 1/4 of it would flow through the cost of goods sold. As far as the timing, we did see some benefit of it in Q1 and we see -- we plan to see about 1/3 of those cost actions flow through in Q2, kind of that 90-day period we talked about with some of the actions, and that would flow into a little bit of Q3, but then the remainder of it would be in the second half.

Next question is from Tycho Peterson, JPMorgan.

Chris, you haven't preannounced 6 of the last 7 misses, I think. But given the magnitude of the unique environment and the fact most of your peers did preannounce, I'm just curious why you didn't feel this was warranted to get out there ahead of the call.

And then secondly, as we think about China, I appreciate the color. Can you just talk a little bit more on pharma versus food in China and instruments and consumables, maybe a little bit more color on some of the end markets?

And then any color you can provide on April trends in the U.S. and Europe, relative to the last 2 weeks of March?

Yes. Yes, thanks, Tycho. As you know, it's been a very fluid environment here. And as we noted in our Q4 earnings call, we didn't include the -- any impact of COVID in our guidance. And as I mentioned before, other than China, which I think we all knew was in a challenging environment in Q1, we were actually operating within our plans really through almost until the end of the quarter. And so as we closed the books, we just felt it would be better to issue our results when we saw the biggest and fullest picture possible of both what happened in the quarter and our expectations going forward and try to incorporate all the different steps we're taking to navigate the environment. And so that's why we took the approach we took.

In terms of China and color on some of the different categories. Pharma, if you look at the overall China result of down 45%, pharma was in -- roughly in that range. Pharma is about half of our business there. The food business suffered primarily because a lot of the import-export restrictions that went into place, put a bit of a hold on laboratory-type activity and so food was down in similar ranges.

And academic and government, obviously, was the area of greatest weakness in China as a lot of universities were closed for the bulk of the quarter and the government was delaying tenders. And we do expect that government environment, where there is quite a bit of food business as well to continue to remain soft as the country looks at recovery. The recovery should be led by the -- more of the industrial corporate sector, particularly the pharmaceutical business.

In terms of the instruments and the recurring revenues, we saw an impact on both parts of that business. Certainly to the extent we were serving customers and operating facilities and had access, we were able to maintain some recurring revenues. Although, as you know, the contracted service plans are less of a mix in China than they are in other parts of the world. So we saw it also in the on-demand service and in the parts -- spare parts business. But China went through a pretty significant lockdown where a lot of activity went on hold. And that activity is coming back, as I mentioned, which is steadily being managed, very tops down, in that environment -- in that operating environment. And we expect to improve directionally in Q2 and recover more fully in the back half of the year.

And then on the $100 million in cost, obviously, a lot of that is focused on salaries and some of the hourly workforce. Can you just give us comfort that, that's not going to impact some of the gross initiatives -- growth initiatives, given that you've moved share loss in the past? How do we get comfortable that you're not cutting into potential growth opportunities going forward?

Yes. Yes, that was our guiding principle, of course. We wanted to match some of our spending needs. We made some calculations, as I alluded to, for -- in a conservative scenario, how do we maintain the financial flexibility that we've always enjoyed. And so we modeled some numbers for the year and said how do we pull that into a short concentrated period. And we looked at programs, both capital and projects that were going well, that we had an ability to still meet our objectives on and just take a temporary pause. And obviously, shared the burden of salary reductions or hours reductions across much of the workforce.

But our -- one of our guiding principles has been to sustain the momentum we have in new product commercialization. And in fact, we believe we found ways not just to sustain our near-term pipeline, but actually to enhance it for benefit -- to give us benefit in the second half of the year. And so we've taken a very, very thoughtful approach. We took time to do it the right way. And we've stayed very, very close to our entire employee base, and with tons of communication and context and feel good about the balance that we've struck there.

But our growth initiatives -- our primary growth initiatives are very much intact. And as I alluded to in the remarks, our product portfolio, particularly on the mass spec side, where we had acknowledged some share pressure in recent years is doing very well. It did very well in Q4. It led our performance through much of the first quarter until the containment measures hit in. And when we look at our pipeline strength in the future, we do see the benefit of our new products.

Our next question is from Doug Schenkel, Cowen & Company.

Glad to hear you're doing well. So you talked about holding back on working capital spend. I'm thinking that means building less inventory. If we were to move into recovering quickly than expected, which would obviously be great news for all of us, is there any concern that you wouldn't be optimally positioned to play offense?

And along those lines, is your working assumption that instrument revenue that you expected within the first half, but isn't coming in due to the pandemic, isn't necessarily going to come back in the second half as customers work through challenges and the hangover associated with what's going on right now?

Yes. Sure, Doug. Happy to. We think we have a lot of room on our inventory, and I'll let Sherry add to this, if she'd like. But the inventory management piece is certainly prioritizing, making sure we have plenty of capacity in some of the faster-moving technologies, ones where we have visibility to pipeline. So we match our inventory goals and inventory reduction goals as needed against dynamics in terms of where we expect our pipeline to be. So even with some of the smart working capital spend management, we think we'll be perfectly able to be responsive and to play offense, in fact, if conditions allow.

And that's why we've actually, as I alluded to before, assembled a -- an optimistic case scenario. So while we're focused more on our base case for planning and our conservative case for liquidity management and financial flexibility, we are -- we do have our eye on what that would look like and make sure that we wouldn't miss a beat should things improve a little bit faster.

Relative to your -- the second part of your question, Doug, where instruments got -- that we expected in the first quarter or even in the second quarter, given the near-term caution are less likely, we really believe in all of our pipeline analysis says that those are delays, not cancellations. We still think that when we look at our quoting activity and our sales pipeline and then our order book, while they do reflect that near-term caution, in general, I'd say, and particularly among our pharmaceutical customers, there's an optimism about the future and an intent to returning to investing for growth in the foreseeable future. Obviously, we'll update that as we move through the year. But we see more of a pause in that spending and don't have any real evidence of any cancellation-type activity in scale.

Okay. That's super helpful. And just a quick follow-up. Regarding recurring revenue, I mean, that was nearly flat in the quarter. I know there was some pressure in geographies beyond China late in the quarter. I'm just wondering, along those lines, if you'd be willing to quantify how recurring revenue trended real late in March globally and early April, and if there's any ability to use that as a launching pad as to how you're thinking about recurring revenue specifically in the second quarter, essentially, have things kind of at least leveled off at late-April levels?

Yes. So I'll just -- maybe a little bit of color on that. Thanks. Yes, the recurring revenues for the quarter were flattish, as you mentioned, and we're trending better than that toward -- to the end of the quarter. We normally do have purchasing activity at the end of the quarter on consumables, just as we do on instruments, not to the degree, but that definitely affected it. And it's a little bit of a mixed bag on recurring revenue from the standpoint of service.

There's 2 big pieces of the service there. There's contracted service plans where we're seeing consistent growth at normal historical levels. And then you have the on-demand service, which includes spare parts in a meaningful way, where as our service engineers can't access many customer sites, we obviously have weakness in those areas. And so in general, the early patterns in April reflected sort of where we were towards the end of the quarter, particularly in our largest geographies outside of China.

Whereas China, we're seeing clear evidence of our -- of increasing access of our service engineers into customer accounts over time here on an upward slope. We've seen continued containment measures in some of the other parts of the world. So I think that dynamic of a mix between contracted service plans, on-demand, chemistry heavily utilized in certain areas and held back in other areas will probably persist for a little while here into the quarter, and we'll certainly update you on that as we get more information next quarter.

Our next question is from Vijay Kumar, Evercore ISI.

Chris, maybe you could start off. I don't think I heard you guys mention the exit rate in ex-China. I know you mentioned fourth week of March was materially worse. So what's at the bottom have we seen the rest of the world regions stabilize at those levels or April trends are perhaps coming in better or worse? Any comments on the exit rate, I think, would be helpful.

Yes. Thanks, Vijay, for the question. Appreciate it. I don't think we want to overly -- get overly precise on early trends in April. As you know, our first month of our quarter is the lightest of the 3. In general terms, my comments earlier were that China and parts of Asia and even parts of Europe have seen an improving trend, whereas the U.S., other parts of Europe, India have seen the continuation of the type of containment measures.

So it's really all about -- it'll -- as we get in deeper into the second quarter, it will really be about the restrictions, the lifting of restrictions promulgated by both governments as well as corporate policy in terms of getting people back to work and scaling up production in facilities, and that's going to look different in pharma companies and contract companies and industrial companies. And so I don't want to put too much credence in early April results, other than we expect for the immediate near term, some continuation of what we saw towards the end of the quarter with some of the improvements noted.

That's helpful. And then maybe as a follow-up to that, when you look at end markets, we've heard perhaps some holding by consumers on pills, respiratory drugs in anti-infective drugs and maybe pill count is going up.

What is the implication of that on your -- I guess, when you look at small molecule consumable business, in academic and government, is that a trend we should extrapolate from China to other parts of the world? That's materially worse in pharma.

Yes. It's a really interesting question. I think it's probably a bit of a reach to try to draw too many conclusions between consumer behavior in the short term and something like consumable usage in our business. I'd look at it more as something that colors the overall pharmaceutical industry. As we look at big pharma right now, there's a lot going on. In most cases, the production continues. There's clearly more of a focus in the pharma companies on existing drugs versus new product launches, simply because their teams can't fully get out there and launch new products.

Obviously, there's a COVID-19 focus with new trials with research on immune modulation and biomarker analysis. But clearly, some of the stay-at-home-type orders have resulted in fewer doctor visits for normal routine-type health care and medical therapies, and to some degrees, that's coloring big pharmas' mindset as they navigate through this process.

So -- but to boil that all the way back to consumables, I'd say our consumables revenue, and to some extent as well, the instrument purchases are reflecting more of just the caution that most of our customers are taking, stepping through this. But I will say that every single one of our customers, we've stayed very active with, even if remote. We've had extremely positive interactions with them and had some real breakthroughs in terms of how to serve them effectively at a distance.

Our next question is from Dan Brennan, UBS.

Chris, I wanted to ask you. I know you pulled guidance for 2020, obviously, and you've given a bunch of color regarding trends between geographies and kind of customers. But I'm wondering, given you did discuss several scenarios that you're kind of mapping for different customers and geographies, is there a range?

Or is there any way to think about a broader range of outcomes in 2Q? Obviously, you're not going to give us a single data, a single number for guidance, but I'm wondering if there's any kind of broad range that you could kind of offer or speak to about how we should think about that.

I think we'd probably want to stay short of that, Dan, for now. I'd rather just provide qualitative description of how we're thinking about those ranges. Obviously, a base case-type of scenario where we have more of an expected progression of these countries through recovery -- sorry, containment recovery and return to growth, a conservative case scenario where if we see the persisting low levels of demand for instruments and high levels of containment and obviously, building our financial plans off of a conservative scenario and then in an optimistic case, to say, hey, what if it comes back faster and there's some pent-up demand that materializes sooner?

Those are just qualitatively how we're looking at it. I -- at this point, I think it's premature to spend too much time describing what those numbers look like, and we'll obviously try to do more of that as we move through the year.

But as I alluded to in my remarks, we've seen periods of macroeconomic pressure historically in different scenarios. And we have always benefited from the underlying strength and demand characteristics in the end markets that we choose to focus on. And so we're planning for a solid rebound when market conditions allow.

Okay. Great. And then maybe just on the industrial end market, you had a comment earlier that sounded fairly, I'm not saying constructive, but didn't sound like the expectation would be that things would worsen materially. I'm just wondering, could you break down a little bit within industrial, your exposure to chemical, given what's going on with oil prices and spreads?

And environmental, I believe you had a favorable comment about the trends in the quarter and obviously, broadly for thermal for TA. So maybe could you give us a little flavor for what's going on within industrial? And does the '08, '09 experience with how your broader industrial business performed, has that sort of predicated it at all? Or is the business mix just too different to use that to kind of help us think about the impact in 2020 and 2021?

Yes. Yes -- no, it's a really interesting thing to dig into. The industrial category is about 30% of total revenues, which is, in rough terms, half and half between food and environmental and material science. Material science tends to be the more cyclical piece. And the majority of that is chemicals and polymers.

We've seen -- I mean, the chemical side of the business is the smaller piece. Polymer is the bigger piece, especially advanced polymers. And we've seen sort of okay customer activity in that area. The chemical area is generally smaller and it's probably too hard at this point for us to draw a direct correlation between what's going on in some of the energy markets in that right now.

TA is the biggest piece of the materials, as you know, and is more affected than Waters generally with fewer recurring revenue sales. Capital equipment sales are 80% of that. And we've seen more cyclicality in that business, as you know, although we feel really well positioned in that area. I mentioned 3 new products that are exciting in TA. We have the strength in the Discovery line. We've got a gradually improving mix towards high-tech, high-performance materials, pharma and even consumer products. And so I think we're better positioned in the materials sector relative to where we have been historically and even some of our peer groups because of some of the investments we've made there. So we're watching it carefully, obviously expecting the pharma part of the business to lead the recovery as it happens. But feel very good about our overall materials -- material science, industrial portfolio.

Like I mentioned, the food could be pretty lumpy, especially with the big concentration in China. And on the materials side, we've seen actually some reasonable demand through cycles in recent years with a lot of what we're doing on applications, PPOFs and other type of applications that have been invested in by governments and municipalities.

We probably have time for one more question, please?

Brandon Couillard with Jefferies.

Just 2 questions, Chris. Could you touch on government, academic trends geographically? Was that end market fairly weak throughout the period? Did it see a more precipitous fall-off toward the end of the quarter?

And then could you just remind us, in terms of your service mix, the breakdown between contracted versus break fix and spare parts?

Yes. Thanks, Brandon. Appreciate the questions. And first of all, in academic and government, that was the weakest of the categories, as we mentioned. It was geographically the most weak in China, where we saw a bigger decline in the government and academic business, relative to even the overall business. And that was a function of the fact that most universities were closed in China for much of the first quarter and the majority of government tenders were delayed. So that was a pretty clear line.

And in China, historically, the academic and government business is a bigger mix of our overall business in part because of the government food labs, and that's nearly 1/4 of our business historically in China. So that had a big impact.

We actually saw some more -- actually better performance, kind of flattish to slightly up, in the U.S. in academic and government where we were doing pretty well. And that did have an impact at the end of the quarter, but that business was performing reasonably well, but have limitations to customer sites in the -- in probably the immediate future.

And then Europe was -- if you look at the overall European performance of up 4% for the quarter, that was led by strong pharma, modestly positive industrial and offset by negative on academic and government in Europe, which was a more cautious environment in that sector in the quarter.

Relative to the service, contracted plans generally run in the sort of 40 percent-ish plus range in the developed markets and less than that in emerging markets. So between 1/3 to 40% or so of our service businesses in the contracted service plans, with the remainder being on-demand, spare parts and lines of that nature. So, yes, we've continued in all of those categories, although we are seeing much better performance in the contract and service side, as I said.

So with that, we're at the top of the hour. Thank you, everybody, for your questions today and joining the call.

In conclusion, as we navigate the operating environment right now, we are executing to 5 overriding priorities, as I mentioned: #1, putting the health, safety and well-being of our employees and customers first; #2, ensuring business continuity; #3, maintaining financial strength, flexibility and liquidity; #4, actively planning for recovery, particularly in maximizing the benefit of our strong new product flow; and #5, contributing our expertise and capabilities in the global fight against COVID-19.

We're confident in the strength of our business, and we're taking a pragmatic approach to preserve our balance sheet strength and flexibility, including the most significant cost actions in the history of the company. Our goal is to position Waters to recover quickly and sustainably when market conditions allow.

So on behalf of our entire management team, I'd like to thank you for your continued support and interest in Waters. We look forward to updating you on our progress during our second quarter 2020 call, which we currently anticipate holding on July 28, 2020. Thanks, everybody, and have a great day.

And thank you. This does conclude today's conference call. You may disconnect your lines, and thank you for your participation.